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Executives

John Engel – Chairman, President and CEO

Ken Parks – VP, CFO

Dan Brailer – VP, IR and Corporate Affairs

Analysts

David Manthey – Robert W. Baird & Co.

Deane Dray – Citi Research

John Baliotti - Janney Montgomery Scott

Steven Fisher – UBS

Ajay Kejriwal – FBR Capital Markets

Anthony Kure - KeyBanc Capital Markets

Matt Duncan – Stephens Inc.

Adam Uhlman – Cleveland Research

Steve Tusa – JP Morgan

Josh Pokrzywinski – MKM Partners

Sam Darkatsh – Raymond James

WESCO International, Inc. (WCC) Q3 2012 Earnings Call October 18, 2012 11:00 AM ET

Operator

Good morning, and welcome to the WESCO Third Quarter 2012 Earnings Conference Call. (Operator instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator instructions) Please note that this event is being recorded.

I’d now like to turn the conference over to Dan Brailer. Mr. Brailer, please go ahead.

Dan Brailer

Thank you. Good morning, ladies and gentlemen. Thank you for joining us for WESCO International’s conference call to review our third quarter financial results. Participating in the earnings conference call this morning are the following officers: Mr. John Engel, Chairman, President and Chief Executive Officer; and Mr. Ken Parks, Vice President and Chief Financial Officer.

Means to access this conference call via webcast was disclosed in the press release and was posted on our corporate website. Replays of this conference call will be archived and available for seven days.

As you know, yesterday afternoon we announced the acquisition of EECOL Electric. An 8-K was filed with our press release and presentation and posted to our website. This announcement along with our third quarter earnings will be discussed in today’s call. Additionally, relating to this morning’s release of our third quarter earnings announcement, a supplemental financial presentation has been produced, which provides a summary of certain financial and end market information to be reviewed in today’s commentary by management. We have filed the supplemental presentation with the Securities and Exchange Commission and have posted it on our corporate website.

This conference call includes forward-looking statements, and therefore, actual results may differ materially from expectations. For additional information on WESCO International, please refer to the company’s SEC filings, including the risk factors described therein.

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

I would now like to turn the conference call over to John Engel.

John Engel

Thank you, Dan and good morning everyone. Our third quarter results reflect the continued effective execution of our One Wesco growth strategy. We delivered another strong quarter of earnings growth and cash generation against the backdrop of moderating demand levels in our end markets. Driven by both gross margin expansion and operating cost leverage, operating margins improved 40 basis points to 6.2%, the highest level since the economic downturn in 2008.

Free cash flow exceeded our net income in the quarter and is up over 300% September year-to-date versus prior year. Our investments continue to pay off and our lean operational excellence initiatives are producing the expected productivity gains. We have now posted eight consecutive quarters of double-digit EPS growth on a year-over-year basis.

In the third quarter, organic sales per work-day were up in all four of our end markets: industrial, construction, utility and CIG. But sales momentum slowed considerably. The declines in organic sales momentum were principally driven by data communications and government which were down approximately 6% and 10% respectively.

Organic sales per work-day varied across the quarter and were up 4% in July, 2% in August and 4% in September. Overall organic sales in the U.S. were roughly flat versus prior year while organic sales in Canada and the rest of the world were above 10%.

While incoming order rates are positive, our fourth quarter is off to a slow start with sales currently trending below our third quarter levels. In July, we completed the acquisitions of Trydor Industries and Conney Safety Products. These two acquisitions strengthened our product and service portfolio and support our One Wesco growth strategy of providing our customers with comprehensive supply chain solutions. The integration of these two acquisitions is on track. We have now completed seven acquisitions since mid-2010 with annual sales of approximately $580 million as of their respective closing dates.

Last night we announced that we signed an agreement for WESCO to acquire EECOL Electric for a purchase price of approximately C$1.14 billion. This is a significant event for both companies and we are very pleased to be making this announcement. It is a milestone transaction.

EECOL was founded in 1919, is one of Canada's premier full-line distributors of electrical equipment, products and services with approximately 57 branch locations in Canada and 20 locations in South America in the countries of Chile, Peru Argentina and Ecuador. EECOL has an effective warehouse-based business model focused on serving a broad set of over 20,000 customers in the commercial and residential construction, industrial, oil and gas, mining and utility industries.

EECOL’s annual sales are approximately $0.9 billion with low double digit EBITDA margins. The company has established a long and successful track record of delivering above market sales growth and profitability. We have a high regard for the EECOL sales culture, their team of more than 1400 associates and their outstanding customer service capabilities and supplier partnerships, all of which complement WESCO very well.

The addition of EECOL expands WESCO’s presence in Western Canada and enhances our ability to grow and capitalize on the ongoing investments we have made across the Canadian market. In addition, EECOL will broaden our international footprint and our One WESCO capabilities in South America. This transaction meets our key acquisition investment criteria and is expected to be accretive to earnings by approximately $1 per diluted share in the first full year of operation. The transaction is subject to certain closing conditions, including approval under Canadian Competition Act and is expected to close in the fourth quarter of 2012.

In summary, our investments are paying off. Effective execution of our growth strategy continues and we are pleased with our business results in the first three quarters of 2012. As we move through the fourth quarter, we’re operating with a much stronger and more diverse business - stronger and more diverse in terms of customers and end markets, products and suppliers and geographies. Our long-term outlook for a multi-year economic recovery remains unchanged. We expect the economy to continue to recover slowly over the next several years.

We are continuing to invest in our eight growth engines and our six operational excellence initiatives, and we remain focused on executing our One WESCO growth strategy while delivering strong results in this slower growth economic environment.

Now Ken Parks will provide the details on our third-quarter results and our updated outlook for the fourth quarter. In addition, Ken will address the EECOL financing and our post-closing estimated leverage and liquidity. Ken?

Ken Parks

Thanks John and good morning. I’m going to review the results in the context of the outlook that we provided in July during our second-quarter earnings call. At that time we expected third-quarter consolidated sales, including acquisitions price and foreign-exchange to grow between 9% and 11% year-over-year. Consolidated sales in the quarter actually increased 4.8% year-over-year and that included 4 percentage point contribution from acquisitions and estimated 0.6% negative foreign-exchange impact and a 1.6% negative impact from one less day in the quarter compared to last year's 3Q.

As John mentioned earlier, organic sales growth in the third quarter slowed from the first half. Adjusting for the impact of one less work-day, organic sales grew 3%, including a positive pricing impact of 0.5%. This was down from the 8% normalized organic growth we saw in the first half.

We reported at our August 7 investor day that organic sales per work-day were up approximately 4% in July and August organic sales per work-day growth slowed to approximately 2% and then in September came in at approximately 4%. September sales per work-day did reach a record high.

Backlog remains at a healthy level. While core backlog declined 3% from the end of the second quarter, it does remain up 2% versus year end 2011 with solid growth in Canada as well as our international business. Four companies accounted for our acquisition growth in the quarter. Brews Supply with annual sales of approximately $50 million was acquired in October 2011. RS Electronics with annual sales of approximately $60 million was acquired in January of 2012. And then in the third quarter we rolled in the acquisitions of Trydor with annual sales of approximately $35 million and Conney Safety Products with annual sales of approximately $85 million both of which closed in the month of July.

In July, we estimated that third-quarter gross margin would be at or above 20%. It actually came in at 20.5% or obviously a 50 basis point increase over the prior year. Approximately half of that expansion was driven by acquisitions while half came from improvements in the core. We continue to focus on our gross margin target of 22% and we feel good about the progress against that during the quarter.

SG&A for the quarter was $225.8 million, that’s 13.6% of sales and compares to $216.2 million or 13.7% of sales in the prior year quarter. Approximately $8.5 million of the year-over-year SG&A increase was a result of the four acquisitions noted earlier. Therefore core SG&A was essentially flat on organic sales growth of 3%.

Core employment levels did grow 1% year-over-year as we do continue to invest in our growth engines but remain unchanged from the end of the second quarter. Sequentially, SG&A declined $5.4 million, that’s 2.3% even after absorbing $4 million of incremental SG&A from the Trydor and Conney businesses. That SG&A reduction was the result of cost containment and productivity actions which were taken in the quarter in response to the slowing sales growth momentum that we saw.

In our July call, we estimated third-quarter operating margin would be at or above 6%. Operating profit for the third quarter was $103.1 million or 6.2% of sales, and that’s up 12% or 40 basis points over last year’s comparable quarter. Gross margin expansion was the primary driver of the increase.

At our investor day, we outlined our objective to expand operating margin by 40 to 60 basis points annually through the combination of both gross margin expansion, as well as operating cost leverage. We continue to progress toward that objective and we’re pleased to see the contribution from gross margin in the third quarter. Year-to-date operating margin has expanded 40 basis points over the prior year.

Operating profit pull through, measured as year-over-year incremental operating profit dollars divided by year-over-year incremental gross profit dollars, is a metric we use to drive operating margin expansion while continuing to invest in the business for growth. Over time our objective is to consistently generate an operating profit pull-through rate of approximately 50%. Our reported operating profit pull-through rate was 49% for the third quarter and is at 48% for the first nine months of the year.

On the core, operating profit pull-through rate for the third quarter was 72% and 55% for the first nine months of the year.

Interest expense in the third quarter was $12.7 million versus $15.1 million in the prior year, and in the prior year the interest expense number included a $1.8 million non-cash one-time costs related to the write-off of deferred financing fees which is a result of entering into a new revolving credit agreement.

While our weighted average borrowing rate at 4.4% is flat compared to last year, cash interest expense decreased slightly due to lower borrowing levels. The third-quarter effective income tax rate came in at 29.9% and is 29.7% on a year-to-date basis, that’s consistent with our expectations.

Net income for the third quarter increased 18% year-over-year to $63.4 million and resulted an EPS of $1.25. This compares favorably to net income of $53.9 million and EPS of $1.11 in the third quarter of 2011. Of note, net income has increased at least 15% year-over-year for the last eight consecutive quarters. For the first nine months of 2012, net income was $175.3 million. That’s up 24% over the comparable 2011 period of $141.4 million. EPS during the same timeframe was $3.43 or up 21% versus $2.84 in 2011.

Our trailing 12-month ROIC grew to 12.6%, that's growth of 70 basis points from the full year 2011 metric. We continue to progress toward our long-term 15% ROIC target that we communicated at the August investor day.

CapEx was $7.2 million in the third quarter and $19.5 million for the first nine months of the year. We continue to invest in our people, our technology as well as our facilities through both capital expenditures as well as operating expenses.

Now free cash flow for the third quarter was $67.2 million, that’s 106% of net income and compares to free cash flow of $41.2 million or 76% of net income in last year’s third quarter. For the first nine months of 2012, we generated free cash flow of $170.1 million or 97% of net income, well above our ongoing free cash flow to net income target of at least 80%.

WESCO has historically been a generator of strong free cash flow throughout the entire business cycle. As a first priority, we always redeploy cash through organic growth and acquisition initiatives to strengthen and profitably grow our business. Second, we work to maintain a financial leverage ratio between 2 and 3.5 As we exited the third quarter, our financial leverage ratio was 2.2 which was down from last year's ratio at the end of the third quarter of 2.7.

Liquidity defined as invested cash plus committed borrowing capacity was $489 million at the end of the third quarter. We expect to finance the EECOL acquisition on an all-debt basis with a new institutional term loan and through our current facilities by increasing the size of our existing revolvers. We estimate that upon closing the announced transaction, our leverage ratio will be less than four when we include EECOL’s trailing 12 months of EBITDA with liquidity of at least $300 million.

I’ll now take a look at the fourth quarter outlook. We continue to believe the pace of economic recovery will be slow and that we’re well-positioned to take share and outpace economic activity even in this slower growth macro environment. As previously indicated, we expect the EECOL transaction to be completed sometime during the fourth quarter and that would be subject to the regulatory approval process. Therefore our fourth quarter outlook does not include any results from EECOL.

We expect fourth quarter consolidated sales growth of approximately 2% to 4% above last year's fourth quarter and that would include acquisition-related growth of approximately 2% to 3%. Year-over-year organic sales growth is expected to be flat to up 1%.

Sequentially, organic sales are expected to be flat to down 2% from the third quarter. While different from the last two years, this is directionally consistent with the typical seasonal trend from 3Q to 4Q which we usually see when sales have historically declined 2% to 4% from the third quarter to the four. In the fourth quarter, we expect gross margin to be at or above 20.2%. That's consistent with our gross margin rate for the first nine months of the year and we expect operating margins to be at least 5.6%.

The fourth quarter effective tax rate is expected to be in the range of 30% to 32%. With this outlook we now expect sales growth of between 7% and 8% for the full year with 2 to 3 points coming from acquisitions and approximately 5% of organic growth. This is within our expected organic growth range of 5% to 8% but has moved to the low end as we see sales growth momentum slowing.

While we are not surprised by the moderating growth that we're seeing in the second half, it’s clearly more pronounced than was expected at the time of our investor day in early August when we provided our first look at 2013. As always, we will closely monitor business trends through the balance of 2012 in order to better refine our outlook for next year both at the top-line and on earnings.

In addition, a fourth quarter closing of the EECOL acquisition would have a significant impact on 2013. Consistent with our past practice, we will provide an updated outlook for 2013 during our fourth quarter earnings call in January.

Now with that, I’d like to open up the conference call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And the first question comes from David Manthey from RW Baird.

David Manthey – Robert W. Baird & Co.

Just first question, in terms of – as looking at the price you’re paying for EECOL and the accretion, are we looking at two different time periods there? Is the 10 times EBITDA trailing figure versus the dollar is obviously 2013, I assume that’s a synergized value and could you just talk about the synergies you are expecting both in terms of magnitude and what areas?

Ken Parks

Two, or the 10 times EBITDA is a trailing multiple to answer that question. What we’re looking at for synergies, as you know we have a pretty good tax structure in Canada. We believe that rolling this business as we model it in, into our Canadian structure does provide us with tax related synergies. And as far as the remainder of the synergies, it’s really rolling the business in as it is. It’s complementary to our existing footprint, and that's basically the makeup of the deal.

David Manthey – Robert W. Baird & Co.

And in terms of the rest of the business, just so we have an idea, is D&A roughly similar to WESCO core D&A? And then in terms of the borrowing rate you’re assuming for your accretion calculation, you touched on that, and then the tax rate that EECOL will be coming in at –

Ken Parks

Yeah, as far as the borrowing rate, as we talked about in the 8-K and in some of the other materials, we’ll be entering into a new term loan facility. We've obviously already had some preliminary discussion with our bankers about what that looks like and first of all, I can say based upon what’s going on in the market right now, we are seeing a lot of – we’re anticipating seeing a lot of interest in this new term loan. And the rates are running very comparable to what our existing variable rate portion of our debt portfolio looks like. So you can look at what the variable rate of our portfolio looks like and kind of estimate where you think the rates would be.

The part of your question about tax rates, we’ve not disclosed publicly what our existing effective tax rate is in Canada. But it is lower than our overall effective tax rate. And then on depreciation and amortization, we’d expect it to run at essentially the same kind of rates as we’ve seen for other transactions.

Operator

And the next question comes from Deane Dray from Citi Research.

Deane Dray – Citi Research

First question is, for the quarter any time I see WESCO coming in a little bit light on the topline but then a good progress on gross margins, good progress on op margin and pull-through, it’s usually mix is little bit better but also you’re passing on what could have been unprofitable business. So could you provide some color both on mix and maybe on what businesses, what types of business you might have passed on?

John Engel

Good morning, Deane. Yeah, thanks for that question. I would say that has been our historically characteristic of how we run the business. That hasn't changed. We still spend a lot of time and energy and focus our management attention around what – I’ll use the term both customer selection and project selection. And so that's not changed. We clearly saw a downshift though in terms of demand across our end markets in the third quarter. I think what was most notable to address your question, first on the cost structure side, we began really working hard on kind of tuning up and checking actions on the discretionary – several debt discretionary cost categories and I think that ended up bearing fruit in the quarter. And we did that as we started to see the slowing in the end market momentum as we went through kind of the second half of the quarter and moved through the balance of the quarter.

The gross margins we’re very pleased with, to be a 20.5% in a market that is downshifting, we’re particularly pleased with that. In the investor day this year we gave a little more insight in terms of the breadth of initiatives that we are working on and driving margins. And so we’re going to continue to plug away at that but I think we’re hopeful that this represents kind of a good data point and a good indication now that we’re beginning to make progress on kind of fundamental core billing and gross margin expansion.

Deane Dray – Citi Research

And is there anything on the mix that you’re going to call out?

John Engel

Not really. I mean if you look at from an end market perspective, it did contribute a bit but not helpful, actually created a little bit of a challenge because look at industrial being down in a very low single digits, construction CIG flat, this is on a non-work day adjusted basis, and utility at 4% to 5%, and the utility margins are little different profile as we've spoken over the years than fundamentally industrial and construction kind of falls in the middle. So I would say that mix wise if anything it didn’t have a major factor but may even present just a little bit of a challenge. And then we feel good -- given that challenge we feel good about the gross margin.

We feel particularly good though about the ability to deliver the operating profit pull-through. As Ken mentioned, on a reported basis it’s 50% but when you adjust for acquisitions, we were 70 plus percent. And we haven't been at that level for some time. So I think our cost actions are productivity initiatives and just that focus on being very diligent around cost controls is still a hallmark of how we try to operate.

Deane Dray – Citi Research

Great. Just the last one from me, on the acquisition, what can you comment on regarding EECOL’s best practices? The coming in with higher margins, comment on the growth, they’re obviously doing something well in terms of their approach to distribution, maybe the supplier relationships, the warehouse model. But what and how does WESCO expect to benefit from being able to take best practices from EECOL and then apply to the rest of the company?

John Engel

If you look at EECOL versus WESCO side by side and say, and first of all, let me say Deane, it’s a great question. There is a lot of similarities -- the similarities are in culture, the customer service orientation, the way that they partner with suppliers. So there is a lot of similarities. They're very growth oriented. I mean the company has been around almost a century, they’re private, and they have done exceptionally well in terms of outperforming the market. And so I think there is a lot of similarities. The one difference which we’re very excited about is fundamentally they are much more warehouse stock and inventory based. And so you know if you look at WESCO’s profile, we have a terrific stock and warehouse business but we also have a direct ship business and the ability to manage large complex projects. And our mix is different than more of the classic independent electrical distributors.

EECOL’s large in size and scale and that capability I think is terrific. We’ll get some good, best practices out of that. In addition, you’ve got to look at where they’re positioned geographically and they are predominantly positioned in the western half of Canada which has fundamentally very attractive end markets in terms of growth characteristics. This is something we spotlighted in particular at our investor day. You will recall, Deane, you were there in Toronto earlier this year and was Canadian oriented. And finally, I think the South American business were, remember then, significant upside for us. It’s not just in South America. The majority of that business is in Chile and Peru which are particularly attractive to us.

If you look at the growth characteristics versus market and the fundamental operating margin characteristics, not at an absolute level but just in general, the relatives, it performs very similar to our Western Canadian business does, and which is also strong and well run.

Operator

And the next question comes from John Baliotti with Janney Montgomery Scott.

John Baliotti - Janney Montgomery Scott

Ken, you guys did a very good job on the gross margin that came in above what we should have been expecting. And the SG&A looked like you guys did a nice job of absorbing that extra debt from Trydor and Conney. I am wondering that, it seems then you really haven’t been able to get or you haven’t benefitted yet from the accretion you’re expecting, so that still sounds like that’s what follows, is that fair?

Ken Parks

The accretion that we’re expecting from –

John Baliotti - Janney Montgomery Scott

The 10 to 15 -- $0.10 and $0.05 from those two deals.

Ken Parks

It’s effectively in there because if you think about the gross margin expansion, which is about half of that expansion comes from the acquisitions and in the quarter that was primarily Conney and Trydor. So we’ve started to see some of the accretion in the margin line.

John Engel

I mean if you look at the gross margin, if you were to decompose it, as Ken mentioned about half is from acquisitions, half is improvements in our core operations business, both billing and gross margins and again it’s all those initiatives that Steve Van Oss talked about at the investor day. The acquisition that contributed, John, is not just Trydor and Conney. And on a year-over-year basis, it’s Brews Supply which was done latter part of last year, RS Electronics done in January, Trydor Industries and Conney Safety Products done in July. So it's all four that contributed to the acquisition component of the gross margin expansion.

John Baliotti - Janney Montgomery Scott

But they all did contribute –

John Engel

And they all did contribute, including Trydor and Conney. I mean they were done early in the quarter. They did contribute.

John Baliotti - Janney Montgomery Scott

Right, right. I don’t think we should have expected them to be gained a full benefit of that because it was still so early since –

Ken Parks

That’s fair. Exactly. But they are beginning – the integrations that John pointed out are on track and they are beginning to contribute.

John Baliotti - Janney Montgomery Scott

Sure. I was thinking more of that fact that you haven't – despite the improvements in margins you still haven’t gotten the full benefit of those two yet.

Ken Parks

Correct.

John Baliotti - Janney Montgomery Scott

On EECOL, it’s interesting that given the margins and given the business, it seems like Western Canada for some companies could be harder just because of the way things are spread out there and I am wondering how can you – what benefit can you get from their business let’s say in the U.S., is enough opportunity to bring that down here in terms of some of their model as you were kind of talking about earlier?

John Engel

No, I would say that best practice sharing across both companies will start and it’s what we do with every acquisition. So we could see some potential best practice sharing in terms of how we run large branches with -- that have a large footprint with inventory management and there are some of our DC concept in the U.S. but that is - I would say that is the kind of tertiary. Primary and secondary opportunities are taking advantage of the fundamentally strong inherent growth characteristics of the Canadian market and its natural resource base both in the tar sands, oil sands region of which both EECOL and our western Canadian business are very well positioned geographically with capabilities of -- and in mining.

And so these long cycle industries in Canada we view very bullishly over the mid-to long term. When you look at the global macroeconomic environment, you look at it – and you take a long-term view of the globe, we think the Canadian economy and these various industries are very well-positioned over the mid to long term. Reason, we spiked out also our growth in Canada and rest of world, outside the U.S. with north of 10% in the quarter organically. So that’s without Trydor and Brews. And so we've got very good fundamental organic sales momentum in Canada and I think EECOL acquisition just positions us to continue to take advantage of that.

The final point I made which is inherent in your question is spread out, tough landscape to do business, you're right. Reality is EECOL has been around since 1919. WESCO Canada has been in operation since 1942. And you have two companies that together have been around the better part of a century, and I think history, reputation, location, experience, multiple cycles matters.

John Baliotti - Janney Montgomery Scott

Right, they actually make it a defensible market share.

Ken Parks

And we’re also excited not to forget about the South American piece of this that adds on to our footprint in South American. They bring almost $90 million of sales that we add to our existing footprint. And as we continue to expand in that area, that’s significant contributor as well.

John Baliotti - Janney Montgomery Scott

And could you just quickly comment on the return on invested capital, how does that complement the progress that you’ve been able to make so far with the base business?

Ken Parks

Well, we will clearly to take up -- it will not progress on the rate that we talked about in the investor day call. We set a target for 15%. We still have that target. We need to absorb this acquisition, and we will recalibrate the timeline for the 15% target if it does change. But the 15% target is not out of the reach of reality with this.

Operator

And the next question comes from Steven Fisher from UBS.

Steven Fisher – UBS

Just trying to reconcile a couple of things, you said that EECOL was more a stock business but it’s also based in Western Canada where I thought the growth is generally expected to come from a more project based opportunities that – so does that mean that they are going to serve those project from a stock type of structure? And then I guess the real question is, what has to happen in the underlying EECOL business to achieve that $1 share of accretion? Are you relying on some of these bigger projects too, to go forward on a particular schedule?

John Engel

Yeah when we say it’s a stock based business model, that’s the fulfillment method. Fulfillment method. And so –and you get a sense of what the product category mix is laid out on the deck that we issued along with the press release. So we didn’t talk about this as of yet but when you look at the mix, and this is our current estimate. We will ultimately do as we do with all acquisition do a detailed product code mapping after the closing. But with that said, you look at their mix and the general supply there and particularly lighting, you know very, very attractive in terms of that product category which lines up nicely with our growth engine.

So Steven, think of it as the fulfillment method to serve that region is more stock-based warehouse-based fulfilment. The reality is yes, capital investment – these large – the tar sands is the capital investment driven market. But whenever these capital investments are being made, a significant infrastructure that’s built up around that is not temporary. And so there's a tremendous amount of demand that flows subsequent from that. .

In terms of the final question, what has to happen in EECOL, Ken addressed this. When you look at the $1 of accretion, the synergies that we have captured in our operating model are related to tax and our tax position and tax structure in Canada. In terms of the base business, we have a very good view of Canada, from a WESCO perspective haven’t been there again since 1922, and we expect EECOL business to continue to run at their current trajectory. And that’s our view of what they will do and that’s what’s factored in the model and that’s our view of what our WESCO Canadian business will do. So it’s in a step we get in additional synergy that would be upside to the $1 if we get true operational synergies. But again we are not counting on that, though we haven’t baked that in those models.

Operator

And the next question comes from Ajay Kejriwal from FBR.

Ajay Kejriwal – FBR Capital Markets

Congratulations on the deal. And maybe a couple on EECOL, so Western Canada natural resource base, I imagine seeing a nice growth the last couple of years. So if you can maybe just share with us what the growth rate in that business the last couple years and then what are you kind of expecting? I know you said sustaining the growth rate but any thoughts beyond that? And on the synergies, that’s the upside, so you, I guess, are bringing – there are some common suppliers but you obviously have lot more suppliers. So is it possible to kind of leverage your supply base and use their customer relationships to drive the upside?

Ken Parks

As far as the growth rates, we don’t disclose the specific growth rates but as we talked about the growth rates in Canada have been higher than the overall average. So it’s been a solid growth rate business. The synergies clearly again come from the tax structure that we have in Canada and operational synergies would be on top of it.

John Engel

And as part of that Ajay, the operational synergies – again we don’t have factored in any supplier leverage or supply synergies. So to the extent that happens down the road, that would be upside. Again, I think the real opportunity is here is this terrifically well run business with an outstanding set of talent. I mean the people that we met at EECOL we’re thoroughly impressed with, and the culture that they have matches us very well in terms of discipline, the way it’s run, the customer service orientation, the ethics and integrity and the reputation is impeccable with customers, and the way they partner with suppliers, they operate similar to us. So we just think this is the terrific combination and what we’re essentially doing is acquiring this terrifically well run company that has excellent end market exposure. These are higher growth markets. We expect the growth will continue in terms of what we've seen in Canada.

The Canadian market is growing. The non-residential construction market in Canada is growing. Our construction piece of the Canadian market on the WESCO side grew double-digits in the third quarter organically and overall it grew double-digits. So I think we’re bullish on Canada and this is why earlier this year we went and had that investor day and really shine the spotlight on our business up there, the composition what our long-term view is. And in addition, what this acquisition does is bring us some terrific capability and position in South America which is very attractive to us. And the substance of that, the strength is really in the mining vertical which matches very well with WESCO’s long running capability goes way back in the Western Canadian space (ph).

Ajay Kejriwal – FBR Capital Markets

And so just directionally, is it fair to say that EECOL grew faster than your Canadian business the last couple years or –

John Engel

No.

Ken Parks

Very consistent.

John Engel

Very consistent with our Canadian business and our Canadian business, and we have shared this before has grown at a higher rate over the last three years in WESCO overall which is what -- we went through this in some detail at our investor day in Toronto earlier this year.

Ajay Kejriwal – FBR Capital Markets

Maybe one more on the fourth quarter, so as revenues kind of decelerate, how should we be thinking about the rebates?

Ken Parks

Well, keep in mind that we’re still growing year-over-year, right? So the rebates will continue to be -- we anticipate rebate volume to be essentially in line with what we had expected because as you know, there are triggers and thresholds as you reach certain volume.

John Engel

I’d say, as you will recall, we are always – we are looking at rebates on a full year basis and we do that as we go through every month closing in our hard close every quarter. And so we have a view of what the four full year is. What happens is when you get into the fourth quarter to the extent we over-perform or underperform our expectations, that is a factor, and it could be a measurable factor if we significantly outperform or significantly miss the topline. What’s a more significant factor is the mix because these programs vary by supplier and for a given supplier there may be certain product categories that has unique and special incentives on it, if that’s a particular product that’s important to us, as part of new product launch or whatever. And a lot of times these SVR, supplier volume rebate curves, are nonlinear. So you hit a certain point and you kind of get an increased rebate rate back to $1, and there’s all different structures that are in place.

So I think mix is the biggest determining factor. Last year you will recall it’s probably the nature of your question that we ended up outperforming our view of what our sales would be in Q4 and also the mix was favorable, which resulted in a significant benefit to supplier volume rebates in the quarter. So the volumes helped but also the mix was significant. So the mix is the factor.

Operator

And the next question comes from Anthony Kure with KeyBanc.

Anthony Kure - KeyBanc Capital Markets

Just talked a lot about the Canadian construction market obviously for good reason but just want to touch on the U.S. construction market here. Obviously incremental data – well first question is maybe if you could gauge for us how far would you guess below a normalized cycle do you think we still are not relative to prior peak but relative to what’s a normalized construction market in the U.S.? And then I guess with incremental data points coming out over the last several months to the positive, do you see any upside for expectations as we move into next year, has your opinion of the construction market domestically changed at all?

John Engel

I won’t give you a precise number. We are – I would say we are double-digits below where the normal recovery cycle could have and should have been but it’s not. First point. Second point is here is what is encouraging. I’ll give you a little color. One is the residential construction market is absolutely starting to recover. I think we have enough data points now that we see that recovery has started. Typically residential construction needs leads the non-residential construction recovery. This recovery cycle has been different in that it was industrial led but it is encouraging to see the non – the housing starts increased. And I think that’s a positive factor going forward for ultimately non-residential construction, which flows from that later in the cycle plus our utility business as that drives new meter starts.

In addition, I’d say that – and we are obviously on a daily basis deeply engaged with consulting engineers and design architects, and lot of the activities are continuing. There is a number of projects that are in final design phases that have not yet been approved. That’s kind a six to nine-month lag. So it’s a great question Tony. We had a view that not many others had a few years ago that non-resi recovery was a few years out of, and we were wrong. Everyone else thought it was a bit earlier, we were kind of an outlier, say it was going to take longer, we were wrong. It’s taking even longer than we thought. So – but I think it is still out there in front of us and again the housing and resi construction recovery is an encouraging leading indicator.

Anthony Kure - KeyBanc Capital Markets

And just a quick follow up more on the structure of WESCO now going forward with the EECOL in there. We’ve talked about in the past the achievement of the 6% EBIT margin being sort of a benchmark or watermark to that you’re progressing towards now, with this mix benefit so to speak coming in, does that bar get set higher or just the timeframe become a little bit more near term to, maybe progress past that 6% EBIT margin on an annualized basis?

John Engel

Well, a great question. First, we’re very pleased that we got north of 6% this quarter, it could be a 6.2% operating margins to get north of 6% with the challenging end market conditions and the topline we delivered, we’re very pleased with that. And I think obviously the acquisitions that we've done, this would -- obviously it’s not closed yet, we’ve got to get through that process. We do expect that to close in the fourth quarter but this would be our 8th acquisition since the middle of 2010, June of 2010 when we started playing offense again and we launched our new growth strategy, One WESCO growth strategy with all the growth engines, it’s the largest acquisition we’ve ever done in the company by a significant margin.

And as Ken reviewed at our investor day in August, the prior seven acquisitions all of them met our four key investment criteria, higher gross margin, higher op margins, that is part of our value creation strategy. It’s got two legs, fundamental priority one is organic growth above the market and to do that profitably and have a 50% pull-through of the operating target. And number two is to accretive acquisitions and operate within our leverage ratio bench and use the good cash flow characteristics to pay down the debt quickly, so we can reload to do more acquisitions. So we are working hard to close this acquisition and then we will be back as Ken said to say what the 2013 and beyond look but I think this puts us – you kind of get – we take another step up the ladder in terms of size, scale and fundamental profitability we’re very excited about that.

Operator

And the next question comes from Matt Duncan, Stephens Inc.

Matt Duncan – Stephens Inc.

Want to look at sort of organic growth trends for a minute, you said you were up I guess 4% July, 2% August, 4% September but the guide for the 4Q is kind of flat to up 1%. Should we extrapolate that to mean that’s sort of what you're seeing so far in October or is that you’re maybe forecasting further deceleration?

John Engel

In my opening comments and you may have missed that, Matt. So far in October we are growing versus prior year but it’s at lower rates than we delivered in the third quarter. It's early but that's where we are today.

Matt Duncan – Stephens Inc.

And that John, maybe as you look at the end market, can you talk a little bit about sort of what you think is causing the deceleration that you're seeing right now and should we expect to see pick back up in 2013?

John Engel

Yeah I think that’s the question that all of us are kind of wrestling with. We are hopeful that that it will pick up but the way we run this company is we’re saying look, the environment we’re seeing now, if that’s the environment that we’re going to continue to have to deal with in the next couple of quarters, we need to execute in the context of that market. So that’s how we operate, we’re very consistent with that.

I’ll just give you a few color points, maybe that helps. We are seeing some of our customers are reducing their inventory on the industrial side. We talked a little bit about some of the activity levels in construction. Utility, we think we had a really nice quarter. We will see where the other competitive data points come out relative to our growth. That was a really nice quarter we think given the backdrop. We’re still bullish on utility, the housing starts is good kind of leading indicator for future growth. But utility, they’re being very – have a kind of a tighter light script on spending as we’re going through – went through the third quarter, into the fourth. We did win another new major IOU alliance agreement in the third quarter. It’s integrated supply for both PowerGen and delivery, we are very excited about that and that will start to really kick in, in the fourth quarter. Those take four to six quarters to reach full implementation rate.

Datacom, very challenging, we didn’t have any questions on that yet, but we are absolutely seeing kind of weak – these weak construction markets and government activity levels and IT spending constraints impacting our communications business, it’s broad-based. And feedback from suppliers and other sources have confirmed that demand is much weaker than expected for communications in the third quarter. So clearly I think the markets have downshifted and it's relatively broad-based. Our focus is on our initiatives and how do we perform given this backdrop of still growing overall but a lower growth rate.

Matt Duncan – Stephens Inc.

And two quick questions on the EECOL deal, first of all, Ken, is there any help you can give us as you look at that $1 of EPS accretion, what annual level of amortization of intangibles are you accounting for in that accretion estimate?

Ken Parks

We are still working – I mean clearly that’s driven by all kinds of analysis around the valuation of the businesses and the components. It’s early for us to tell you that piece.

Matt Duncan – Stephens Inc.

And then looking at the post deal leverage, it looks like you’re going to be up sort of close to four times I think and I know the high end of the comfort zone for you guys is kind of 3.5. So does that suggest that maybe now you need to shut down the M&A in a very short run unless it’s a small bolt-on and sort of absorb some of the bigger deals that you have been doing and how quickly are you hoping to get leverage maybe back closer to the middle of your leverage target range?

Ken Parks

I think the important part of that answer is that you're right, we will be a bit – as I said a bit below 4 as we anticipate at closing. That will come down nicely over a few quarters and will be back within our range.

John Engel

And so we have shown that historically, look, this is the largest deal we've ever done, it’s very strategic and very compelling in terms of what it does for us. And it’s absolutely line up with our strategies, so we feel terrific about it.

In terms of your question on the pipeline and the process, M&S process, here is our view. We still have a very active pipeline. We’re going to keep managing the pipeline and running the evaluation process in parallel. Here is the reason why we're not going to shut it off and trying to restart it again. It’s part of our offensive growth strategy. EECOL has been on our list and in our pipeline for many, many years, and EECOL is another example of our ability to execute and capture acquisitions of private companies in a non-public market auction process. The only way you can do that consistently over time is to consistently work the pipeline. So we are going to continue to do that and it’s our plan and our intent and given how we’ve operated historically and the cash flow generation characteristics of this business and our operating margin expansion goals and targets that we’ve laid out, that we’re going to bring down that leverage ratio over next series of quarters. And we continue to work the M&A pipeline in parallel. We’re going to continue to keep that as one of the key legs of our value creation.

Operator

And the next question comes from Adam Uhlman from Cleveland Research.

Adam Uhlman – Cleveland Research

Can we dig into the SG&A expense for the quarter? John, you had mentioned there were some temporary actions taking, the demand slowed, I guess I am wondering how you are thinking about that going into the fourth quarter as those turn into permanent actions or maybe just little bit more color on why the cost came in below which you thought they would?

Ken Parks

Yeah, I wouldn’t really categorize them as temporary actions in the sense of what that indicates to me. What it is, is really we have a bucket of things that are really non-payroll related discretionary expenses and things that are much more variable that as we saw the volume growth start to slow early in the quarter, we started to control those things which allowed us to continue to not have to take kind of temporary actions that could turn into permanent. We were really managing the things that we could move right, the things that we didn't need to spend out of the variable cost buckets. So as you think about it for the fourth quarter, I think what I would tell you is that we will continue to manage those variable costs very tightly just like we have. And that's what I would think about as we move through the balance of the year.

Adam Uhlman – Cleveland Research

And then a couple of questions on EECOL, there has been a lot of talk about the mining and other exposures that has, wonder if you could just put the numbers around what the end market breakout looks like. We’ve got the product and the geographic in the slide deck. And then if you could also just talk to – or if there is any supplier agreements you need to sign off on before the deal closes, anything that’s hold it up?

Ken Parks

No, as far as the further breakdown, we’re going to clearly have to refine that as we continue to go through the process. We don’t -- after as we get to closer to closing.

Okay. So I think with that – I think let’s play and we still have a few in the queue. I know that with the acquisition combined with earnings is a lot of news. So let’s, Dan, if it’s okay, do you want to go another five minutes –

Dan Brailer

Let’s extend another five minutes.

Operator

And the next question comes from Steve Tusa from JP Morgan.

Steve Tusa – JP Morgan

Just on the industrial side, are you seeing – could you maybe just talk about the project spending on that front, maybe just a magnitude of what you’ve seen a lot of companies on the industrial side of the house talking about, pushing projects forward, have you seen any of that? What is the magnitude and then I guess have you at all changed your inventory buying patterns because of what you're seeing – what you talked about some inventory reductions to some of your customers?

John Engel

On the second question, though, I think as you can see, our inventories are at a very healthy level consistent with prior year. We have a very disciplined process, we made no change fundamentally to how we are managing inventory and working capital. And we are not seeing a wholesale shift of projects moving out to answer your question. The market is challenging, it’s been bumpy but I would -- absolutely not seeing this shift of things fundamentally moving out. We do though have good insight into again on the design architects as the consulting engineers where projects are in various stages and there are still projects, they are kind of not at the design – approval phase that are kind of locked in a little bit. But no, we are not seeing a wholesale shift, Steve .

Steve Tusa – JP Morgan

And one last question just on the deal, do we read into that at all about your kind of confidence in the macro? I mean clearly we are not really growing very much here, there is a lot of consternation out there. Does this mean that you think kind of recession is off the table and so you are willing to kind of make this big bet, how should we read that from a confidence perspective?

John Engel

I think you should look at this way. Look at the profile of the company that we’re looking to complete the acquisition of, the Canadian business in profile that they have and the South American business in profile that they have. So you look at those fundamental markets what the inherent market growth rates are, how EECOL positioned against the appropriate verticals in those two respective geographic markets and we've got good data around how we have been performing in Canada, right, which is performing at a higher rate. So it is a terrific transaction and deal, we hope to consummate it here in the fourth quarter, we worked on it for many, many years and I think it’s lined up – given our view right now very attractive organic market kind of growth characteristic in Canada and South America as we look out in the next year. So that’s our view of it.

Operator

And the next question comes from Josh Pokrzywinski from MKM Partners.

Josh Pokrzywinski – MKM Partners

Just a couple of questions, can you talk about maybe some of the product lines in the quarter, how whiting or medium voltage or some of the tech and telecom verticals did, just trying to get a sense of what was bad or what was worse?

John Engel

I will just spike out two. We had some lighting growth, so that was encouraging, up little bit, very low single digits versus prior year but sequentially moved up very nicely. And so we continue – even though the challenging construction markets aren't helping in terms of new builds with lighting, the retrofit renovation and upgrade markets we’re focused on in and solid state of lighting solutions including control, we have a terrific set of suppliers and we are working those aggressively. So we are encouraged with kind of the building momentum of lighting, it is one of our growth engines. That’s on the plus side.

On the minus side is with datacom as I mentioned and that datacom was down 6% in the quarter and relatively broad-based. And the rest kind of fell – they were the cute (ph) – I think one of the spike out lighting the sequential growth and kind of spiked out datacom in terms of the challenge and the decline, that’s kind of book ends of the business.

Josh Pokrzywinski – MKM Partners

So the rest of it, I guess, including automation would kind of be somewhere in the middle?

John Engel

Yes.

Josh Pokrzywinski – MKM Partners

Okay. That’s fair.

John Engel

Some may have been a little bit above but the other two, I want spike out for you.

Josh Pokrzywinski – MKM Partners

And then maybe I missed it earlier on the call, but can you help me with the walk in the SG&A from 3Q to 4Q, how much of that is the deal and then thinking about kind of ex-deal costs, what is expected for gross profit pull-through in fourth quarter?

Ken Parks

Well, as we said we haven’t included anything related to the acquisition of EECOL in our outlook. There will be some deal costs in the fourth quarter but we have a pipeline of activity that's been going on for a period of time and those costs will continue. So I would say they're not significantly different quarter to quarter. So I think the walk from 3Q to 4Q will be primarily driven by our continuing management of headcount likely at the levels that we’re at out right now, as well as managing the variable cost part of the equation as we see the volumes growth continue to moderate. There is really no significant one-time big items plus or minus in that walk.

Josh Pokrzywinski – MKM Partners

Just thinking about absolute revenue, it’s more or less flat 3Q to 4Q, it seems like you get a little bit of erosion on the OpEx line and I don’t get the sense that you guys are curtailing a lot of that – those cost controls in the third quarter?

Ken Parks

We’re going to be continuing to manage those costs through the fourth quarter.

Josh Pokrzywinski – MKM Partners

Right but then op margins are going down.

Ken Parks

Right and what we said is that we are expecting our gross margin part of the equation to be at about 20.2% in the fourth quarter and that's really what drives the op margin change.

Josh Pokrzywinski – MKM Partners

And then just body language from customers in terms of a pause in activity and maybe some uncertainty around the election fiscal cliff etc. versus really wanting to sit back and feeling like they are out of organic opportunities, are you getting feedback that this is a timing issue, and we want to keep some irons in the fire?

John Engel

I would tell you -- I wouldn't – I know there is a lot of talk about tying it to the election uncertainty. We’re still getting – our bidding activity levels are still very high even in the construction but particularly in industrial and with the utilities. And so I think there is still a lot of evaluation and they are looking at what they can be outsourcing, what they should be outsourcing. They still have these very high and they are higher than they’ve ever been expectations for process improvements and savings in the supply chain. So I think it is just a matter of – they are still evaluating, seeing what's available, how can they improve their operations fundamentally. But there has been a pause in terms of pulling the trigger and doing the spending. So hopefully that’s something that brings back here shortly.

Operator

And the last question comes from Sam Darkatsh from Raymond James.

Sam Darkatsh – Raymond James

I apologize if these questions have been asked as my line got dropped midway through the call. Talk about pricing expectations for Q4, I think four quarters in a row we have seen moderating trends. Are you seeing those moderating trends even perhaps decelerate further with the moderation in the end markets? And then lastly Ken, at what point do you begin to deleverage OpEx naturally over the next year or two with respect to growth rate, at what growth rate do you begin to deleverage OpEx?

John Engel

I will handle the first one. And good question because we have not had this one yet. And I know we didn’t address it in our first comments, Ken (indiscernible) on the beginning. As we sit here today and I say this is notable, there is a significant reduction in the number of planned supplier price increases that will be announced in the fourth quarter. So your question is spot on, we did see that, it’s declining as we kind of went through the third quarter in terms of number of price increases and also the level at which the price increases we’re trying to be pushed through by suppliers with us to customers on the input side of our equation. And we have seen it, again it’s just a significant reduction in those numbers as we sit here today for Q4. It’s notable.

So that’s our current view, it could change as we move into the first part of January, as we get into – past the election and we’re into the new year, I don’t know. But that’s what we see right now. One thing I will mention and we did outline in our press release and our supplemental deck up what our estimated pricing impact was, which was below 1%. We had it at 0.5%, I mean that’s something that’s very notable in Q3. One thing I will mention and we found this to be interesting is we got Conney acquisition, we didn’t get a question about that. But we’re very pleased with how that’s starting. We got some nice new wins since closing in July. One particular global accounts ask for a centralized web-based safety solution which Conney could deliver and we captured that. It’s not something we ever could have had before, or ever could have participated in before and also we had an integrated supply customer where we were able to deliver substantial cost savings by switching to one of Conney’s private label products. So we’re very encouraged of what we've seen out of gate with Conney. That’s the backdrop.

In terms of pricing, Conney’s pricing was roughly around 4% in the quarter and so actually probably little better than that. So I think we really feel good about that additional portfolio, we’re learning a kind of what that model can do and what the pricing power is. I thought It’d share that, we didn’t get a question about that because I know it’s probably EECOL acquisition, most of the question. The Conney has been part of us now just really for a few months and it’s off to a great start and we really like what we see. Ken, you want to handle the second part of that?

Ken Parks

Yeah, absolutely, so as far as deleveraging OpEx, you saw us deleverage a little bit this quarter with 3% organic growth. We've looked at 2013 and we gave you initial guidance that’s set 7% to 11% topline with 5% to 8% of organic. Really when we get to those mid-single-digit level organic growth numbers is when we start to see solid deleveraging of the OpEx line. So I think the point to answer question is as we see and start to define what the quarter calendarization looks in 2013 that's when we can tell you kind of as that starts to come back and we delever.

Sam Darkatsh – Raymond James

What did you have in Q4 for the assumption for pricing, John? I am sorry, I didn’t know if you answered that.

John Engel

We don't have that. We don’t do that prospectively as you know, Sam. All I want to share was it was approximately 0.5% in Q3 and that’s in our supplemental. And right now as we sit here looks like there is a reduction – significant reduction in number of announced supplier price increases planned for Q4, just – I am just speaking the kind of a general trend in the market which I think was your question.

Sam Darkatsh – Raymond James

Very helpful. Thank you both.

John Engel

Let me now start with some closing comments. Thank you very much for your time today and that we went a bit long and your continued support. As you can see, we are continuing to execute our One WESCO strategy of investing in our business and in our people to deliver above market organic growth plus accretive acquisitions. We strengthened our global enterprise since we started playing offense a few years ago and remain focused on producing strong shareholder returns. Thanks again and have a great day.

Operator

Thank you. Conference has now concluded. Thanks for attending today’s presentation. And now please disconnect your lines.

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