WESCO International, Inc. Q2 2008 Earnings Call Transcript

Jul.24.08 | About: WESCO International, (WCC)

WESCO International, Inc. (NYSE:WCC)

Q2 FY08 Earnings Call

July 24, 2008, 11:00 AM ET

Executives

Daniel A. Brailer - VP, Treasurer, Legal and IR

Roy W. Haley - Chairman and CEO

Stephen A. Van Oss - Sr. VP, Chief Financial and Administrative Officer

John J. Engel - Sr. VP and COO

Analysts

Deane Dray - Goldman Sachs Equity Research

Sam Darkatsh - Raymond James

Brent Rakers - Keegan

Matt Duncan - Stephens, Inc

Shannon O’Callaghan - Lehman Brothers

Dan Leben - Robert W. Baird & Company, Inc.

Steven Fisher - UBS Securities

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2008 WESCO International Earnings Conference Call. My name is Karisa [ph] and I will be your coordinator for today.

At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this call. [Operator Instructions]. I would now like to turn the presentation over to your host for today's call, Mr. Daniel Brailer, Vice President and Treasurer. Please proceed.

Daniel A. Brailer - Vice President, Treasurer, Legal and Investor Relations

Thank you. Good morning, ladies and gentlemen. Thank you for joining us for WESCO International's conference call to review the second quarter 2008 financial results. This morning participating in the earnings conference call are Mr. Roy Haley. WESCO's Chairman and Chief Executive officer; Mr. John Engel, Senior Vice President and Chief Operating Officer; and Mr. Steve Van Oss, WESCO’s Senior Vice President and Chief Financial and Administrative Officer.

Means to access this conference call via webcast was disclosed in the press release and was posted on our corporate website. Replay to this conference call will be archived and available for seven days. This conference call may include forward-looking statements and therefore actual results may differ materially from expectations. For additional information on WESCO International, please refer to the company's annual report on Form 10-K for the fiscal year ended December 31, 2007, including the risk factors described therein, as well as other reports filed with the SEC.

The following presentation may also include a discussion of certain non-GAAP financial measures. Information required by Regulation G with the respect to such non-GAAP financial measures can be obtained via WESCO's web site at www.wesco.com.

I would now like to turn the conference call over to Roy Haley.

Roy W. Haley - Chairman and Chief Executive Officer

Hello, everyone, and thank you for joining us. In a few minutes, Steve will provide a recap of performance for the quarter, and John will describe activity levels in our key customer segments. But, I'd like to open the meeting with a brief update on a couple of areas of company-wide emphasis and priority.

Last year during our second quarter earnings call, we announced a new initiative to combine a program of continuous sales force development with our ongoing commitment to productivity and performance enhancements driven by the application of lean methodologies.

I'm pleased to report that WESCO's personnel have made excellent progress on both of these initiatives. We've now surpassed 70% of our initial target of adding 200 net new customer facing sales personnel over an 18- to 24-month period, and programs that we launched to upgrade recruiting capabilities, maintain information on local market talent and deploy new training programs are rapidly gaining momentum.

I am confident that we'll reach our target of expanding the sales and service organization by almost 10%, but more importantly we are changing the dynamic of historically reacting to attrition and making selective additions to a well supported and long-term strategy of continuous recruitment in sales force development.

Elaine [ph] is an important and critical part of this process because new sales personnel are naturally going to be producing at a below average level during their first 6 to 18 months in a new position. Additionally, new infrastructures required to support training, recruiting and on boarding. We couldn't accomplish all of this while maintaining our little cost structure without achieving productivity gains across the entire organization.

As you’ve seen in our report, our SG&A expenses are well controlled despite a variety of cost pressures and our overall productivity parameter of sales and earnings per employee has again hit best ever performance levels. Now, you might ask, is all of this sustainable? Personally I believe that our performance gains in positive momentum are sustainable.

As other companies and industries, we too have taken some big hits with weakness in selected market segments, increasing product and commodity costs and escalating fuel and delivery costs. But because of our operating reach, our highly diversified and well-balanced customer base and operating discipline, we're able to absorb and adjust to market conditions.

Our business model is resilient and we’ve achieved a level of size and scope, profitability and cash flow to continue to invest in organizational capabilities, marketing and customer development programs and new talent.

As you can tell, we are committed to building a bigger and stronger organization. Even in weak economic conditions, we see expansion opportunities in markets and product categories where we may not have been as focused in the past and with existing customers looking for operational efficiencies, energy cost savings, and technology driven solutions. We are confident that the increased attention we're giving to our already very strong sales organization will pay dividends over time.

Well, with that opening, let me now turn it over to Steve and to John.

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

Thanks, Roy. Good morning, everyone. Before we get into a more detail look at results, I think it's appropriate to provide a few comments to put the quarter’s performance into context.

First, we produced our best-ever top line performance and our second best-ever earnings per share results. Cost controls were effective, as we've reduced our overall employment levels during the quarter while continuing to add to our sales force. Working capital performance improved sequentially. Although we experienced gross margin contraction due to mix and the time lag associated with pushing supplier price increases due to channel and like others, we are dealing with the rapid run-up and transportation costs. We are confident in our ability to regain and improve our gross margin performance.

Overall, our organization produced solid results for the quarter and is now better positioned for continued growth in both the near and longer term.

Looking back a little, we previously communicated that on the first of this year, we created a joint venture and sold a majority interest in our LADD operation to its primary supplier, Deutsch’s Industrial Products Division. Effective with this year's first quarter, we no longer report the LADD results in our financial statements as revenue, cost, operating profit, etc. Our 40% interest in the new joint venture is now reported on an equity basis as other income below the operating profit line.

The LADD operation is an excellent business and our partnership with Deutsch has further strengthened the operation. Financial results for the first six months are ahead of last year. And lastly, for comparison purposes in the second quarter of 2007, we've recorded a non-cash benefit of $4 million in SG&A expenses due to favorable foreign exchange gains associated with our Canadian operations, which we considered to be of a one time in nature. This compares to the second quarter of this year where we had a net benefit to SG&A expenses of approximately $1 million for items of a one-time nature.

On a consolidated basis, earnings per share for the second quarter of 2008 was $1.38 versus $1.22 last year, an improvement of $0.16 per share. Our share repurchase program was designed to capitalize on our earnings and strong free cash flow and deliver sustainable earnings accretion. The program is working.

Since 2007 when we announced the first of two $400 million share repurchase authorizations, we have repurchased 8.7 million shares or 17% of our outstanding shares for a total of $492 million. Despite incurring additional debt in interest expense associated with the share repurchases, the earnings per share impacted this program on the second quarter of 2008 results was favorable at $0.15.

And looking at the first quarter little more directly, as indicated, we posted company best ever quarter sales results. Adjusting for LADD, consolidated sales were up 6.3% over last year’s second quarter and organic sales were up approximately 5.7% in the face of tight end markets, primarily in our utility, manufacturing, housing and recreational vehicle end markets, which have been directly impacted by the continued residential construction slowdown.

Strong net income and improvements in working capital performance absorbed the cash requirements associated with a higher sales volume and resulted in free cash flow of $38 million. Free cash flow was utilized to repurchase over 900,000 shares of WESCO stock for approximately $36 million under our current authorization program.

Investments of approximately $157 million in share repurchases and $25 million on acquisitions have been made during the last 12 months. Return on invested capital, which we define as reported net operating profit after-tax in relation to our total unadjusted capital base, including the three acquisitions completed in the last half of the 2007, was 15%, and reflects continued growth in earnings and high asset efficiency.

Consolidated gross margins at 19.5% were down 80 basis points from last year and 70 basis points from this year's first quarter. LADD and mix accounted for approximately 50 of the 80 basis points decline from last quarter. Mix accounted for approximately 20 of the 70 basis points difference from the first quarter of this year.

SG&A expense as a percent of sales improved by 140 basis points sequentially and was up only slightly over the second quarter of 2007 even with the headcount growth associated with our sales force expansion. Cost associated with the sales force expansion was approximately $3 million in the quarter. We're continuing to invest in marketing programs and sales personnel, which we feel will provide superior growth as we move forward.

We will drive our cost containment programs utilizing LEAN and for the remainder of the year, we are targeting a net reduction of personnel from current levels while still maintaining a bias towards sales additions.

Our all-in borrowing costs are low at approximately 3.7% and along with good working capital performance have allowed the company to reduce interest expense by over $2 million sequentially and by over $4 million from last year's second quarter.

With liquidity at over $300 million and strong free cash flow projected, we continue to have ample capacity to fund organic growth, purchase additional stock, and make accretive acquisitions while maintaining targeted levels of leverage.

Let's now focus on the first quarter top line results. We said before consolidated sales were up 6.3% with sale from core operations up 5.7%, above our initial expectations for the quarter. Sales for workday increased sequentially throughout the quarter and we are at record levels in June.

Adjusting for price inflation and a positive impact of foreign exchange, we believe our real sales were up 2% to 2.5% for the quarter. We're seeing good momentum in our end markets that are not significantly impacted by residential construction. In our core sales, growth rate outside of these markets was almost 8% for the quarter reflecting the success of our ongoing sales and marketing initiatives.

Backlog, which consisted firm orders for future delivery, increased more than 15% over both last year's second quarter and year-end. The increase in backlog was well balanced over most end markets. This signals what we believe to be sustainable demand for our construction end markets to the next several quarters. Sales to customers in industrial and commercial construction end markets were up in the mid to high single-digit range. We continued to see the negative impact of residential construction market slowdown as sales in manufacturing, housing, and recreational vehicle markets were down low double-digits and sales to customers and utility end markets trended positively which showed only modest growth.

So far in July, our consolidated sales month-to-date are up mid single-digit. Actions to increase the capacity of our sales force have been effective as discussed by Roy and we’ve added approximately 145 sales or sales related support personnel since the third quarter of 2007 with over two-thirds of those positions being added this year. While this has added to our SG&A costs, we believe this course of action will allow us to outperform the market and to gain share in the upcoming quarters and years ahead.

At this time, John Engel, our Chief Operating Officer, will provide additional commentary on our end markets and initiatives that we are taking to strengthen our organic growth. John?

John J. Engel - Senior Vice President and Chief Operating Officer

Thanks, Steve, and good morning, everyone. Starting out with a summary of our performance for each of our major end markets, construction sales were up 7%, industrial sales were up 6%, and utility sales were up 1% versus the second quarter of last year. All three of these major end market segments also showed improved sales momentum versus the first quarter of 2008.

Our emphasis and focus in '08 remains on sales and marketing execution and in investing in our total capacity expansion, initiating the second half of '07 while keeping tight controls of our overall cost structure.

Now shifting to commentary on our major end markets. First starting with utility. Sales of the utility customers showed good improvement in the second quarter reversing the trend experienced in the previous four quarters. Overall, utility sales were up 1% versus last year and were up double digits sequentially, for investor on utility, public power and utility contracts or customers versus the second quarter of last year, sales to IOUs were up double digits offset by declines with public power customers.

Utility spending continues in spite of the residential construction downturn. The customers are shifted a higher percentage of our capital spend towards transmission related and alternative energy projects, which were primarily being served direct by manufacturers.

Customers are reporting that the surplus inventory that was build up in a supply chain in 2007 has in a large part being corrected. So we anticipate that end market levels in the second half of this year will be consistent with the first half. The market remains active with bid request and interest in our national account and integrated supply capabilities remaining time.

We are confident that our share in this market is steady and we remain well positioned to capitalize on the forecasted future increases in spending on maintenance expansion and automation of the nation’s electric power grid infrastructure.

Now shifting to construction. We saw positive momentum in the quarter with sales to constructions customers up 7% versus last year and up double digits sequentially across since the first quarter. Construction sales results were well balanced with all geographic regions posting positive sales growth versus last year and last quarter.

Backlog strengthened in the quarter and ended up 16% versus year-end and 4% versus the end of the first quarter. Despite forecast of the decline in construction starts this year, non-residential construction continues to present project opportunities across the major market segments that WESCO serves.

Tight lending conditions, high commercial office vacancy rates, rising commodity prices, and contraction in the residential construction market are continuing to raise concerns across commercial segment. Infrastructure-related construction segments, which are longer cycles such as power, energy, communications, and medical are expected to show continued demand in 2008.

As evidenced in our results, we are continuing to gain traction with national and regional contractors, including engineering procurement construction companies or EPCs by applying our national accounts model to service their project management and supply chain needs across their many locations.

And finally, we're continuing our capacity expansion program to add sales personnel and increased our sales coverage in attractive growth verticals and geographies while executing senior management sales engagement program to drive additional penetration at new and existing customers.

We also saw growth in the second quarter in data communications sales. They grew low single-digits, driven by strong sales to government, education, and data center customers, partially offset by softness and low voltage audiovisual products. Our sales and marketing initiatives remain focused on the combining CSC's expertise and network infrastructure, data communication, audiovisual, and Internet technology-based physical security product with WESCO’s electrical and power capabilities, geographic footprint, and national account positions to provide solutions for both construction and industrial customers.

We are making good progress and are encouraged by second quarter wins in multiple industries, including energy producers, food processing, financial services, and others. Our outlook is for increasing demand... is for increasing demand for bandwidth in commercial, government, and residential fiber-to-the-premise applications as customers migrate to higher capacity network architectures such as 10-gigabit Ethernet and invest in data centers and improve the security of their facilities and IT networks.

Now moving to industrial. Sales to national accounts and integrated supply customers also showed good strength in the quarter and were up 13% and 7%, respectively. Despite the recent performance in the ISM index and the GDP rate, feedback from our customers in the industrial MRO market is generally positive, consistent with our high levels of capacity utilization and industrial production.

Bid activity levels remains high, and the national account opportunity pipeline remains at an all-time record level. Our national accounts business model continues to demonstrate its effectiveness with two major customer renewals in the quarter and two new Fortune 500 customer wins in the quarter.

We're continuing to place the priority on providing value-added services to our customers and selling the complete WESCO portfolio of products to serve their needs in electrical and non-electrical MRO, capital projects, and OEM materials and value-added services.

In summary, we consider most of our end markets to be in recently good shape except for utility and manufactured structures, which continued to be impacted by the lower residential construction activity.

We're encouraged by improved sales momentum in the first half of 2008. As we enter the second half of the year, we're continuing to make the necessary adjustments, including more aggressive sales execution, margin improvement, and cost management actions and are confident in our ability to execute in a tougher economic environment.

Now back to Steve.

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

Thanks, John. Couple of quick comments on commodity pricing and then we'll look at the third quarter. Our best estimate of the top-line impact of overall price inflations for the quarter is in the range of 2.5% to 3%. Commodity prices are relatively stable during the last two quarters of 2007, but ramped up in the first half of this year prompting an acceleration of price increases from our suppliers. Copper prices averaged $3.22 a pound last year and have averaged around $3.67 a pound for the first half of 2008.

While the commodity spot market has been quite volatile, the street price of copper based products did not fluctuate as rapidly as this spot market. Steel prices most have risen this year. Sales of copper and steel-based products are up sequentially and on a quarter-over-quarter basis. While we continue our practice of aggressively marking up our inventory at current market levels and push supplier increases through the channel, we are unable to realize meaningful inventory profits during the quarter. Margins for these product sets are up slightly over the first quarter of this year and basically flat to last year's second quarter.

With the remainder of the year, typically our seasonality such as the first quarter has the least sales, the second and third quarters are similar and the strongest, and the fourth quarter is down sequentially from the third quarter, but higher than the first quarter.

Economic data pertinent to our end markets continues to be mixed. The current weakness in the credit market and softness in residential construction markets have the potential to weaken future end market activity levels.

At this time, the consensus view is overall market activity levels will be somewhat slower for the remainder of the year. We are confident that our sales and marketing initiatives and our strong market position will enable our company to perform better in the second half of 2008 than in the first half of the year.

For the third quarter, we expect to see sales growth rates quarter-over-quarter in a range of 4% to 5% after adjusting for the LADD joint venture accounting. LADD sales were approximately $25 million in the third quarter of 2007. Gross margin percentage should show a slight improvement sequentially, but we will be facing challenges with additional anticipated supplier price increases and higher delivery cost. SG&A as a percent of sales and joint venture income should be similar to what we saw in the second quarter of 2008.

Operating margins are expected to improve sequentially and anticipated to be in the range of 6.3% to 6.6%. Our tax planning initiatives have been very effective. At the present time, we anticipate that 2008 full-year tax rate will be around 32%. Working capital productivity should be maintained and free cash flow over the next several quarters will be directed at debt reduction and WESCO share repurchases. Based on share repurchases to-date, share count for third quarter 2008 is anticipated to be approximately 44 million shares.

In summary, we had a strong quarter and are encouraged by our progress on sales initiatives and are working hard on the margin front. We are looking forward to setting record-breaking performance and best ever earnings per share for the year. Our view for the remainder of 2008 calls for more aggressive action on the sales front, and will require us to continue capitalize on sales opportunities to meet our growth objectives. We are confident in our ability to execute in a tougher environment and expect to grow our core business in a low-to-mid single digit range for the year even given a more difficult environment in 2007.

Karisa, could you please open the call for the question-and-answer session?

Question and Answer

Operator

[Operator Instructions]. Your first question comes from the line of Deane Dray from Goldman Sachs. Please proceed.

Deane Dray - Goldman Sachs Equity Research

Thank you. Good morning, everyone. Steve, could we just follow-up with your comments, the clarification on organic revenue growth? In your remarks, you said 5.7%, and is there any foreign exchange in there, so I’m going to ask the question, whether you include Mexico or not? So, it's a first question.

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

Foreign exchange results are in at approximately a point, it's primarily coming out of Canada. But that would be... Mexico would be included in our core as well.

Deane Dray - Goldman Sachs Equity Research

Okay. So you would take so from a comparable to other measures of organic revenue, it's 4.7, if we exclude FX and acquisitions, etcetera?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

Correct.

Deane Dray - Goldman Sachs Equity Research

Okay, good. And then beyond that you also said... and I missed the clarification but it’s a 2% to 2.5% of real core growth and I wasn't quite sure what you were... what that pertain to?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

Obvious, it’s the way I’d look at it, 5.7% reported on our core business, comparable business taken out of roughly a point for foreign exchange and take out roughly 2.5% or so. From what we considered to be the price inflation impact on it we get that type of a number forward.

Deane Dray - Goldman Sachs Equity Research

So, that's a volume reference.

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

That would be more of a volume reference.

Deane Dray - Goldman Sachs Equity Research

Perfect, okay. I got that. All right. And then second question is how putting contracts the decline in gross margin because this is banned one of the positive points in the overall view on WESCO for the past several quarters, is that you have not chased low margin business? And that was the anything north of 20%, that was one of the, the positives that you could draw? From now, as you did below that you did mention that mix had some a negative impact, but just address specifically about mix, how much of that you expect to reverse over the next couple of quarters and did you chase low-margin business during the course of the quarter?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

The first comment, there is several items in there, Deane, the LADD joint venture is not in the 2008 numbers, we believe that number, that’s about 30 basis points of the change, mix was about 20 basis points. And we wouldn't characterize the remainder of the decline is chasing low margin business. This would be more of character, I’m not sure, John can weigh in as well. The amount and the magnitude of supplier price increases there have been driven by the recent run-up in commodity prices and it’s more of a lead-lag impact on that. We except to regain portion of that going into the third and fourth quarter and that will be somewhat dependent as I mentioned earlier on the velocity of supplier price increases that we anticipate to see over the next six months.

John J. Engel - Senior Vice President and Chief Operating Officer

Yeah, Deane, this is John. Let me make few additional comments. Yeah, we are experienced really an unprecedented number of supplier price increases. It's been a challenging but we’ve faced this in the past. So, we are seeing a large number, and we're seeing larger magnitude as well. I think as we talked about in the past, the portion of our business is competitively bid in construction customers and contractors and utility and industrial OEM, and we're executing a price increase strategy on commodities which we you walked you through in the past, as well as working hard to push through price increases to our customers, including national accounts, and national account customers, there is typically a lag factor, and it takes some time to manage through.

We're also working the transportation cost side of the equation. We’ve rationalized a number of our service providers and are working on customer freight charging and fuel surcharge strategies on customer delivery that are uniquely, we're looking at future business models and the programs. I would tell you that the margin disciplines, the pricing disciplines, and the mindset and culture is as strong as ever. Our entire field sales and national account organization is focused on this as a top priority, and we have been hit on the input side, and we're aggressively working with customers to push it through on the output side, and we've shown the ability to manage us effectively over the years. Steve gave us a date point on July sales to date versus June up mid-single digits. Our July margins versus June, half way through the month are up slightly sequentially. And they are flat to up in all shipment categories. So, I am not declaring success at this point, I think it's a challenging environment, but we do have the disciplines, we did not chase low-margin business.

Deane Dray - Goldman Sachs Equity Research

Okay. Just to make sure we're clear is that last quarter in terms of guidance on gross margin expectations that you would be flat sequentially and that did include from what I understood the LADD JV impacts. So I am not sure how you can say that that turned around against when it was already in your guidance.

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

Yes. I've two comments on that. One, there was a mix change a little bit further than what was anticipated as we saw some very good results of our initiatives of driving the project business. And secondly, the impact on the transportation costs and on the price increases frankly came in of higher than what we anticipated.

So I'd really feel that this is a more of a timing issue at this point in time than a systematic change, backup of what John said, we have a laser focus on this area and we're not chasing lower margin business. But we also had a third comment of kind of where we go forward on this from a mix perspective and our industrial businesses remained strong, but we're seeing even further successes in the project business.

And on balance, we'd expect to see that mix continue forward. So a low bit more negative mix on the gross margin, but it also helps us and yourselves also seen and agreed that we have good cost controls and that helps in that environment as well, even with the addition of the sales force which added about $3 million of cost for the quarter. We were able to maintain very good cost control and so on. I feel real good about the business overall.

Deane Dray - Goldman Sachs Equity Research

And just to clarify when you talk about unprecedented supplier price increases we agree, we see it. Is that entering to the equation for potential inventory gains or is that strictly a copper price into a quarter?

John J. Engel - Senior Vice President and Chief Operating Officer

As the inventory gains are related to the copper, which physically mark ourselves, and there is a broad based of supplier price increases or something we need to manage through all our day-to-day business as we are driving and bidding with customers.

Deane Dray - Goldman Sachs Equity Research

Great. And then just last question, leverage as you accept second quarter, last quarter you were 2.9 times, your range is 2 to 3.5. Where do you stand today?

John J. Engel - Senior Vice President and Chief Operating Officer

3

Deane Dray - Goldman Sachs Equity Research

So, if that’s still within that band of comfort range. So you have got flexibility, buybacks and acquisitions?

John J. Engel - Senior Vice President and Chief Operating Officer

Yes, lots of flex. Our liquidity improved, five or six quarter high. Leverage we maintained it right, we’re right in control, we got a lot of flexibility or everything is in good shape there.

Deane Dray - Goldman Sachs Equity Research

Thank you.

Operator

Your next question comes from the line of Sam Darkatsh from Raymond James. Please proceed.

Sam Darkatsh - Raymond James

Good morning, John, and how are you?

John J. Engel - Senior Vice President and Chief Operating Officer

Good morning, Sam.

Sam Darkatsh - Raymond James

Not to continue to hop on whether you're chasing low margin business or not, did you see that promotional environment in the industry ramp up or get, to remain pretty acute? I mean, is the part of the problem also or is it just a timing issue as you’re just struggling to get the prices through to customers as quickly as you're seeing it.

John J. Engel - Senior Vice President and Chief Operating Officer

It's the timing issue. I didn't see anything extraordinary in terms of promotional activity in the marketplace.

Sam Darkatsh - Raymond James

Okay. Second question, you noted encouragingly that that things tended to progress better as the quarter progressed. Is that on a volume basis or is that on an overall sales basis, John, because again, there was the… your volume was about half of what the overall sales growth was?

John J. Engel - Senior Vice President and Chief Operating Officer

Yes, I would say, my comment was we were encouraged by the growth for each of our major end market/customer savings versus Q2 last year and then sequentially in Q2 in total versus Q1, we saw a very nice growth across all three major segments, Sam, construction, industrial, and utility. If you were to look at sales per workday basis, we also saw that ramped through the quarter but that is typical, but it would be nice to see that trend continue this year as it had in prior years.

Sam Darkatsh - Raymond James

On a year-on-year basis, I am trying to get the seasonality out of it, also on a year-on-year basis, the volume growth was stable to accelerating as the quarter progressed. Is that how I should look at it?

John J. Engel - Senior Vice President and Chief Operating Officer

Yes, if you look at it and go back and you back out price from previous quarters and everything, I would say we’re probably [inaudible] another additional point on what we consider to be real volume growth. I’ll reiterated what we said in the past, this is a bit of an art versus something specific we don't make a manufacturer, we can say out of 100 washing machines this quarter and 98 last year, so part was volume and part was price. We have… we sell a million SKUs a year, so we look at pricing that these across our major product categories and with discussion with suppliers. We do it consistently as we look at it. It may not be precisely accurate, but it’s consistent, and I would, our impression is that we're getting real volume growth better than we did last year.

Sam Darkatsh - Raymond James

And you mentioned that mix was, I think, Steve, you said with a 20 basis point degradation to the gross margins, which I guess signals that your MRO, you’re out of stock is not growing as fast as the project business. Are you seeing any signs of encouragements there or a little bit of pick-up there or is it still real sluggish as customers are trying to trim back on discretionary spending?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

I don't think it's sluggish to say there, I mean, it's certainly we believe we are taking share. It's really a rate of growth this year. We still haven’t good growth rates in the industrial market, and it looked pretty good.

Sam Darkatsh - Raymond James

Okay. Thank you.

Operator

Your next question comes from the line of Brent Rakers from Keegan. Please proceed.

Brent Rakers - Keegan

Good morning. Just a follow-up, just even more on these gross margin questions, in your guidance you don't seem as convinced as you do with your rhetoric in terms of this only being a timing issue, how should we be more convinced in terms of the third quarter bouncing back up towards say a 20% number?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

Our… the challenge really is that we're continuing, I don't call it tsunami but continuing way for growth increases coming through there. And we're working important equation hard, and I think that we're confident. I know we're confident and we’ll get through that. But, I don't know that we’re necessarily bounce up above-mentioned 20% number in a quarter.

Brent Rakers - Keegan

Let me, Steve, let me take it from a different way then, in terms of your guidance for the third quarter, you referred to continued constant price increases that are being put through. Does your revenue guidance reflect all these new price increases and is that guidance consistent with your gross margin number that seems to be guiding a little bit more cautiously?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

Yes, the bulk of those… the gross margin guidance is one on timing, we're making if you take like financial account type of customers, there are commodities we can get those to pretty rapidly. They have monthly openers on others, you might have to wait a bit longer period of time, but we are making good progress in that regard. So the second quarter sales came in a bit higher than we anticipated. And we are calling for similar growth rates in the third quarter on a quarter-over-quarter. So I think it's baked into that already.

Brent Rakers – Keegan

And what is your--?

John J. Engel - Senior Vice President and Chief Operating Officer

Brent, this is John, I had one point that, and again it’s still early in the quarter. But if you look at July as Steve mentioned and as I mentioned versus June on a sequential basis, it's tracking. I mean mid single-digit sales growth and margins slightly up sequentially. So it's consistent with the commentary on Q3 versus Q2 sequentially.

Brent Rakers - Keegan

And then again giving this constant push-up in price inflation, do you have a kind of guidance number as to what you think the contribution from price would be in Q3 or Q4?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

No, I don't have that right now.

Brent Rakers - Keegan

Presume the way those are, Steve, higher than the levels in Q2 correct?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

It’s hard to tell you, it really depends on you tell me what copper and steel are going to do for those with a couple of bigger components. We had a pretty significant ramp-up in steel that's need to stabilized and copper has actually pulled back a little bit from the time.

John J. Engel - Chief Operating Officer

And also what your suppliers decide to do. In some cases, they give you… give some warning and other cases they try to push things too faster as they are facing the same issue on their input side of the equation in terms of rising transportation cost, fuel cost, and commodity pricing.

Brent Rakers - Keegan

And then just final question from me. When we look at other industrial distributors reporting, we have not seen a material pressure on the gross margin line in this quarter. Any maybe... can you maybe explain what the difference might be between a WESCO and some of these other industrial distributors?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

My comment, I'm sure, John, as you as well is if you look at it from a customer/ buyer’s standpoint, we tend to have larger customer, deeper relationship in areas where that are a bit more competitive... competitively bid. And when you have that situation you have the distributor channel perhaps having different cost basis or when they bought material that was raising the prices. Other people may not have the find the target, so.

John J. Engel - Senior Vice President and Chief Operating Officer

And that would be coupled with again our... which is a great strength that over the long term, our national account customer base or integrated supply customer base. So in a nature of those relationships are such that, you got to manage the price increases through and nothing is automatic. And so, it requires muscle and work and we have shown ability to do that again, but that translates into effectively a lag factor.

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

One last comment, Brent, is that industry structure plays into this a bit as well and in the electrical industry, the predominant pattern for our competition whether it would be regional firms or local firms is pricing after the fact meaning that the prices in the marketplace get adjusted after supplier price increases. Some of the distributors you may be looking at our in effect pricing with catalogue pricing established in effect in advance, and while we would perhaps like to be in that particular situation that's not the competitive environment that we operate in or the way customers have been trained for 50 years. So it's again not trying to make any excuses, just that we are operating in a competitive environment we have to adapt to that environment as well.

Brent Rakers - Keegan

That’s great. Thanks a lot

Operator

Your next question comes from the line of Matt Duncan. Please proceed

Matt Duncan - Stephens, Inc

Good morning guys

Roy W. Haley - Chairman and Chief Executive Officer

Good morning

Matt Duncan - Stephens, Inc

First question I have got is that if we look at the SG&A cost reductions that you guys have put in place here, what type of... what type of cost you're cutting out as you're growing your sales force, what are some of the areas that you're trimming in?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

Primarily it is with the in the branch operations as far as administrative clerical and warehouse operations and then at the headquarters level and administrative, we're able to continue to grow and keep a tight lid on headcount.

Matt Duncan - Stephens, Inc

Okay, so that would be the areas that you would look to continue to pull cost out going forward as well?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

We're doing that. This isn't just cutting costs out and sacrificing in quality and service. So, our LEAN initiatives continue to be very effective and making us more productivity, eliminating waste out of the channel, and it gives us a pretty clear view on productivity improvements.

Matt Duncan - Stephens, Inc

I’ll look at your construction business, and you got a big increase in backlog, sales are up nicely sequentially. That kind of goes against what other people are saying, it is happening in non-residential construction. Maybe can you address why you think it is, your guys are still successful of getting growth there? And whereas you look out at the market, what do you see from construction kind of for the balance of '08 as we get into '09?

John J. Engel - Senior Vice President and Chief Operating Officer

Yes. Well, this is John. Let me try to address that. What we're seeing and we're encouraged by what we're seeing and really our execution, commercial construction activity from our perspective is being led by healthcare, higher education, data centers, industrial projects, and are associating the oil and gas production and refining and alternative power. Throughout the second quarter we were awarded numerous projects that will shift throughout 2008 and conclude in 2009 and beyond.

Most notably, we had wins that included power generation plant upgrades, a large office building in New York, an air port upgrade in California, a new hospital in Pennsylvania and a government facility expansion in Virginia. So what we are really seeing is and what we are encouraged by is the positive results that we're getting from our increased focus on EPC, the national contractors, the application of our national account model.

We are beginning to see the productivity of our sales force addition. We have been focusing on a number of these vertical growth markets for some time and it’s translating into two things really, backlog growth that we saw in a sequentially in the quarter which were encouraged by, and nice sales growth that we saw sequentially in the quarter. And again, it's not just one segment, as I mentioned before, the sales growth geographically, all the regions we have across the U.S. growth.

Matt Duncan - Stephens, Inc

John, if I am hearing you correctly, it sounds like a lot of the types of projects you are winning right now are sort of infrastructure stuff, healthcare, government, power, oil and gas, the kind of areas of market that I guess are a little bit safer right now. So is your focus more on that stuff and kind of away from commercial, office building and that kind of thing right now. We are kind of where are you focusing your sales energy in the construction business?

John J. Engel - Senior Vice President and Chief Operating Officer

I would say, I would say that's traditionally been a great strength of WESCO at a bias and that is a focus. We think we have a terrific value proposition there. We also, we pick up nice commercial projects and have that capability. In addition what I didn't mention, Matt, which I should is, we have got an aggressive set of green and sustainability initiatives. We have got the industry's first green catalogues that's been published, and we're taking that green value proposition to our customer base both in construction and industrial, and that's translating into some nice growth as well.

So we're seeing an increase in lighting retrofit and energy conservation retrofits, a whole series of products that will help really serve that green and sustainability set of needs we see our customers having today and honestly, we look at that is really a very strong growth trend that will only accelerate through the next decade.

Matt Duncan - Stephens, Inc

Great, okay. And Steve just a couple of quick numbers questions and I will get back in queue here. What was the revenue contribution from the three acquisitions you've made since the second quarter of last year and this quarter?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

Pretty nominal, if you look, it was like a half of a point. There were three relatively small but very nice acquisitions that the largest of which manufactured housing, we've essentially got that fully stimulated and integrated into our core business. And we've some visibility on that from an acquisition standpoint. So for the most part, consolidated sales and core sales are converging to be the same number. So this is not a significant number.

Matt Duncan - Stephens, Inc

Okay. And I guess just looking at those, J-Mark would probably be down revenue wise since you buy given their markets. Would that be a safe assumption?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

I would say the end markets are definitely down. We've had some tremendous success within acquisition in integrating their business into the big position that we had in those markets from a WESCO standpoint.

Matt Duncan - Stephens, Inc

Okay. And then last two things. First, can you address how rising fuel cost impacted the margins and then the last thing, what you are seeing out there in the acquisition landscape right now? Thanks, guys.

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

The fuel costs were certainly sensitive and we’ve got a number of initiatives to neutralize that. It did not have a material impact on the margins. The bulk of our fuel costs are on the delivery side and that hits up in SG&A, and we were able to observe and manage that in another areas to keep SG&A under control. So the bulk of fuel while there is some on gross margin, the bulk of ours hits in the SG&A.

And as far as the acquisition front, still we're always active in the pipeline, we don't have anything significant in the new term, but continued to see attractive alternatives out there.... opportunities out there, and we've got the balance sheet to be able to take advantage of that when it's appropriate?

Matt Duncan - Stephens, Inc

Okay. Thanks for answering my questions.

Operator

Your next question comes from the line of Shannon O’Callaghan from Lehman Brothers. Please proceed.

Shannon O’Callaghan - Lehman Brothers

Good morning.

Roy W. Haley - Chairman and Chief Executive Officer

Good morning.

Shannon O’Callaghan - Lehman Brothers

You know on SG&A a little more, I mean you mentioned some of the areas you would go after. Can you just size for us a little bit how much opportunity there is here, is an offset to some of the gross margin pressure? And can this... in the phase of the sales force expansion, I mean, can this actually continue to go down as a percentage of sales? Is 13 kind of for that or can you give us a feel?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

Okay. In a reverse order, the 13 range we would consider to be a long term for but certainly in the new term, it's one that we'll continue to, I think protect around that level, and we continue to add the sales force, but as we mentioned in the second quarter, our net headcount was down slightly. So we're trying to trying to apace, we go there, we believe in that investment, it's showing some dividends now. We pay much bigger dividends kind of the year out and don't intend to slow down on that.

Our basic SG&A structure is one such that roughly two-thirds of our cost relates to payroll and payroll-related costs. So it is a people issue and with the natural inertia of inflation that's out there on the base, we have to continue our productivity just kind to maintain parity there. So, I wouldn't expect to see big changes from an absolute dollar standpoint. The rate gets impacted by the top line.

John J. Engel - Senior Vice President and Chief Operating Officer

And that's where our kind of our LEAN programs, which are in full strength and we’re aggressively driving, give us that operating costs leverage as we grow the top line and we get the productivity of that base. That equations work well for... very well for us over the years and an equation we still have in place. That's why we have all this emphasis and focus on kind of the sales force expansion and sales force productivity and effectiveness issues

Shannon O’Callaghan - Lehman Brothers

Okay, great. And then just on the markets, I guess on utilities, specifically, a nice improvement there from what had been some tough decline. What gives you confidence that this isn’t a blip and that the second half can kind of track along like we’ve seen in 2Q?

John J. Engel - Senior Vice President and Chief Operating Officer

Yes, let me talk about that. Given a little more color on utility, we're encouraged by the results in the second quarter. It represents a different set of results versus the last four quarters. And we got... we experienced double-digit sequential sales growth for all three major customer segments, investor and utility, public power and utility contractors.

So, in the second quarter versus the first and versus the second quarter of last year, our IRU customers were up double-digits, public power was still down and utility contractors were just down slightly. So, overall, I think just from a momentum perspective, when you look at it, our value proposition, our national account/integrated supply model is playing extraordinarily well with investor-owned utilities.

We're now starting to see some interest with large public power utility customers as well. It's a small industry and so, many of our customers are aware of what we've been doing with Duke and implementing that integrated supply model, which is on track, and so that's boding well for us. We're also encouraged by the utility contractor side, the sequential improvement in the second quarter over the first.

So, the commentary is really around much more solid quarter in the second quarter, and as we move into the second half of this year, we see that… kind of Q3 tracking like Q2. Absent or adjusted for anything we see in terms of major hurricane activities.

Shannon O’Callaghan - Lehman Brothers

Great.

John J. Engel - Senior Vice President and Chief Operating Officer

Another item on the utility industry would be the power generation, plant construction of a lot of activity on this front. And you see it in a couple of different areas, whether that has to do with new plants for expansion or with environmental controls that are being applied to existing plants or in effect being used as a way to reduce the environmental issues around carbon and other byproducts.

So that's going to continue to be a very big development over time, most of that kind of activity, we actually end up working through contractors as opposed to utilities. It is the utility industry, but the engineering and construction firms, the big firms along with others that they might subcontract to end up being our particular customers in those situations. We're well positioned with these firms. These are long projects but they are also very big and so that's another positive factor that is on the horizon for us.

Shannon O’Callaghan - Lehman Brothers

Okay, Thanks a lot.

Operator

Your next question comes from the line of Dan Leben from Robert W. Baird. Please proceed.

Dan Leben - Robert W. Baird & Company, Inc.

Thanks. Good morning, guys.

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

Good morning

Dan Leben - Robert W. Baird & Company, Inc.

Just, can we take a little bit deeper dive on the non-residential construction portion of the business, could you try to help us break it down, I understand the mix in terms of how big you are in the kind of different sub areas, so kind of the commercial side office and retail, schools, government, energy all of these areas, you have talked about, etcetera?

John J. Engel - Senior Vice President and Chief Operating Officer

Yes, Dan, this is John. We really do not have a good way to roll that up and we don't, virtually, it's impossible to do, when you think about our business and the way we go to market and the types of customers we sell to, there are EPCs, there are national contractors, regional contractors, it could be direct with end users. When you look at all the various channels, it's just... we don't have a good way to really to segment that and break it out except to say to highlight some of our key wins and we know what kind of key wins we have and what types of projects they are.

So the other factor is that the contractors that are our customers who work on a range of projects typically, now there are some that are highly focused to a particular market segment, but most of them have a… part of a generalist approach to their work and help bid on a variety of projects in the commercial space, it could be casinos, but they could just as easily do an airport.

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

One strategy that we discussed in prior quarters was taking a national accounts model approach to large national contractors. I mentioned a few quarters ago that we secured national agreements with three large national contractors. Those three were up double digits in the quarter, but when you look at those three for example, as Roy mentioned, they serve really... if you look at all the non-residential commercial constructions sector, they serve segments, they serve them all, and they even serve high-end residential and multi-family dwelling. So it is extraordinarily difficult to really get a precise number of a segment-by-segment or sub-segment by sub-segment, let me say.

Dan Leben - Robert W. Baird & Company, Inc.

Okay. Great. And then two quick questions for, Steve. First, did you talk about the contribution to sales growth from the new sales people you have hired?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

Not directly. We tried to look at that inside each one of the branches and it's a tough number to get at for some or same reasons that John was talking about, but we are confident that they will be as productive in time but there are certainly not at the same productivity level.

John J. Engel - Senior Vice President and Chief Operating Officer

And just to give a little more color and insight into that, this is part of an entire, let's say, an aggressive sales management process. So when we put a new sales resource into a location, we have to stand in the phone book and say, okay, good, you have this geographic territory, go find your customers. I mean we are leaders in that location, put together a business plan we approve it. They look at the accounts that have their balance and they rebalance the account. So there is some, which basically freeze up captive accounts on the current sales force that's in that particular branch. So it is very difficult to get a rolled up aggregate number, but that that a process and approach is critical. It's managing territories in each of our given locations.

Roy W. Haley - Chairman and Chief Executive Officer

Respecting your time, commitments, we'll take one more question and then wrap up, if that's okay.

Operator

Your last will come from the line Steve Fisher from UBS. Please proceed.

Steven Fisher - UBS Securities

Good morning. Was there any kind of turning point in the quarter that you started to see those supplier price increases ramp up, to take the margins below guidance or was it kind of a more steady as the quarter went along?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

It really started hitting more in the latter part of May, it was more towards the end of quarter. And that speaks, we believe that some of the fleet lag issue that we have.

Steven Fisher - UBS Securities

Okay. And then just confirming, the 2% to 2.5% volume growth, that was better than you were expecting for the quarter?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

Somewhat yes.

Steven Fisher - UBS Securities

And where... what was it that the utility... improving the utility market or was it the strength in construction and industrial or was it just sort of all of those types?

Stephen A. Van Oss - Senior Vice President, Chief Financial and Administrative Officer

I would tell you that on a positive note, it was a more broad based for us in both end markets and in geography.

John J. Engel - Senior Vice President and Chief Operating Officer

As a macro level, I'd say industrial is tracking where we thought, very strong and we feel good about the track where we go. Construction, we saw some improvement. With the backlog and the sales and the balances of the sales growth and the utility, we saw the improvement. So I'd say, it is a kind of a little bit kind of construction plus utility.

Steven Fisher - UBS Securities

Okay. Great, thanks a lot.

Roy W. Haley - Chairman and Chief Executive Officer

Okay. Let me just wrap up. We had a number of questions about margin and margin improvement. This is something we pay a lot of attention to at a lot of different levels. We have the information systems capabilities to zero in on where issues may be, we know how to drill down to specific products and specific customers, but at the end of the day, these are negotiations that we have to have and frankly no one, no customer welcomes a price increase.

And to one of the questions, I think Steve had is how did these develop and when did they develop, this is a little bit of the problem. They are a continuous factor and if you go to see a customer every two days and every two days you are announcing or bringing another price increase before long, they don't welcome you or agree to see you any longer.

So these are tough issues for us to push through these kinds of issues because they are not simply priced at a time of delivery for a good bit of our business, including business that's in our backlog that will perhaps has been negotiated three months ago or even five months ago. These are somewhat fixed.

Now generally when do that we've got protection from suppliers, but in the current environment with the dramatic increases, particularly with steel, suppliers are changing the rules of the game. We are attempting to forestall that so that we are not put in a position where we have got quotes outstanding and agreements from suppliers on those, and yet there is a inconsistent follow-through, I will call it.

So we have got a lot of work that we're doing with our own customers and with suppliers. We know how to go about this. We know where we have to put our energy, but we have got a lot of, if you will, hand-to-hand combat type negotiations to get these things through on a timely basis.

We will be working on this diligently over the remainder of the year, I am sure, maybe even in the next year. It's a focal point something we think about and look at and work on every single day. Let me close by simply saying that we appreciate your continuing interest in WESCO, and we look forward to seeing you in your travels or ours. Have a good day.

Operator

Thank you, for your participation in today's conference. This concludes your presentation. You may now disconnect. Good day.

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