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Edited Transcript of WCC earnings conference call or presentation 27-Apr-17 3:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Wesco International Inc Earnings Call

PITTSBURGH May 1, 2017 (Thomson StreetEvents) -- Edited Transcript of Wesco International Inc earnings conference call or presentation Thursday, April 27, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David S. Schulz

WESCO International, Inc. - CFO and SVP

* John J. Engel

WESCO International, Inc. - Chairman, CEO and President

* Mary Ann Bell

WESCO International, Inc. - VP of IR

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Conference Call Participants

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* Andrew Edward Buscaglia

Crédit Suisse AG, Research Division - Senior Analyst

* Andrew Krill

RBC Capital Markets, LLC, Research Division - Associate

* Charles Matthew Duncan

Stephens Inc., Research Division - MD

* Christopher Belfiore

UBS Investment Bank, Research Division - Equity Research Associate Analyst of Industrials

* Christopher D. Glynn

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* David John Manthey

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Hamzah Mazari

Macquarie Research - Senior Analyst

* Jiayan Zhou

Morgan Stanley, Research Division - Research Analyst

* Ryan James Merkel

William Blair & Company L.L.C., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the WESCO First Quarter 2017 Earnings Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Mary Ann Bell, Vice President of Investor Relations. Please go ahead, ma'am.

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Mary Ann Bell, WESCO International, Inc. - VP of IR [2]

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Thank you, Denise, and good morning, ladies and gentlemen. Thank you for joining us for WESCO International's conference call to review our first quarter financial results. Joining me on today's call are John Engel, Chairman, President, CEO; and Dave Schulz, Senior Vice President and Chief Financial Officer.

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 includes a discussion of certain non-GAAP financial measures. Information required by Regulation G of the Exchange Act with respect to such non-GAAP financial measures can be obtained via WESCO's website at wesco.com.

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 the next 7 days.

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

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [3]

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Thank you, Mary Ann. Good morning, everyone, and thank you for joining us today. Our first quarter results were in line with our expectations and the outlook we provided in January. We have improving momentum in our business, driven by a return to sales growth in industrial and in Canada, along with solid backlog growth to start the year.

April sales are down low single digits versus prior year, driven by the timing of the Easter holiday with a few days left in the month. On an organic basis and adjusted for Easter, April month-to-date sales are flat versus prior year. Operating margin was also in line with our expectations and free cash flow generation remained strong, enabling us to further reduce our debt and our financial leverage ratio in the quarter.

Now let's turn our end markets, starting on Page 4. We're encouraged with our return to growth in Industrial after experiencing 8 consecutive quarters of sales decline. Also of note, organic sales were up 2% versus the fourth quarter, reflecting our second consecutive quarter of sequential improvement. Our positive momentum in Industrial was driven by 3% sales growth in the U.S. versus prior year and sequential sales growth with our oil and gas, metals and mining and OEM customers.

Our Global Accounts and Integrated Supply opportunity pipeline is also very healthy, and I'm happy to report that our bidding activity levels have also increased to record levels, successive record levels in March and April, providing a positive set up for 2017.

While our Industrial customers remained focused on tightly managing their cost until demand picks up, they are cautiously optimistic about their future growth prospects and increased capital investment plans. With our extensive portfolio of supply chain solutions, we are focused on helping our Industrial customers reduce their cost, operate more efficiently and better plan and manage their projects.

Now turning to Page 5. As expected, construction sales declined in the first quarter, driven by the U.S. which was down 6%, but was partially offset by Canada which grew 3% in local currency. Overall construction sales were in line with normal seasonality on a sequential basis. In the U.S., sales growth of commercial contractors again partially offset weakness with industrial-oriented contractors, whose customers have been deferring capital investments in response to lackluster demand and ample capacity. Overall backlog grew sequentially and year-over-year, marking the first quarter of year-over-year backlog growth since the first half of 2014. Our outlook for nonresidential construction sales remains modestly positive for 2017 with support of forward-looking indicators and an overall market that is still below its prior peak.

During the quarter, we're pleased that we were awarded business by a Canadian oil company to supply electrical materials for their expansion of multiple facilities located across the oil sands. This is a testament to our deep experience in project management, cost control and risk mitigation, which helps our customers complete their project on time and under budget.

Now moving to Page 6. We posted a strong start to the year in Utility. As previously reported late last year, we walked away from an opportunity to renew a contract with a large Utility customer in the United States which was at unacceptable margin last levels. Excluding this customer, overall Utility sales grew 6% versus prior year, with the U.S. up 10%. And secondly, Canada was up -- or U.S. up 5%. And secondly, Canada was up 10% in local currency. A really strong start.

Through 2016, WESCO has achieved 5 years of sales growth from scope expansion and value creation with Utility customers including integrated supply solutions. This quarter, we were awarded a multiyear contract to provide power delivery materials and project management services for a series of transmission and distribution infrastructure upgrade projects at a current investor-owned utility customer.

The utility industry is ongoing continued consolidation, demand for renewal energy is growing and customers are seeking operational and supply chain savings. With our capital projects and supply chain solutions, WESCO is well positioned to benefit from these trends and remain valued long-term partners to our customers.

Finally, turning to CIG on Page 7. Sales declined in the U.S. but were up double digits in Canada. Growth in broadband communications, security and government did not fully offset lower datacom sales, which were primarily the result of large customer project timing versus prior year. We continue to expect low to mid-single-digit growth in this end market this year, driven by growth with government customers and in fiber to the x or fiber to the x deployments, data centers, cloud technology projects and cyber and physical security for critical infrastructure protection.

With that, I would now like to turn the call over to Dave Schulz. He will provide further details on our first quarter as well as an outlook for the second quarter. Dave?

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David S. Schulz, WESCO International, Inc. - CFO and SVP [4]

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Thank you, John, and good morning, everyone. Moving to Page 8. Our first quarter outlook was for sales to be flat to down 3%. Actual reported sales were flat with an organic sales decline of 1.7%, largely offset by favorable impacts from the AED acquisition and foreign exchange. Pricing had minimal impact on revenue in the quarter.

Our backlog increased 11% from Q4 to Q1, better than typical seasonality, and was up 1% versus last year on a constant currency basis. Gross margin was 19.7% in the quarter, down 30 basis points versus the prior year and up 30 basis points sequentially. The change versus prior year is primarily the result of lower billing margin in the quarter.

As John discussed on the last earnings call, the number of price increases from our suppliers is typically much higher in the first quarter as many of them set their pricing strategies for the year. With the first quarter having the seasonally lowest level of capital projects activity, customers competitively bid more of their work. We've also seen construction contractors being especially price-competitive in an effort to get projects started earlier in the year. We expect this pricing pressure to lessen as we move through the year, driven by overall inflation and an increase in customer activity levels.

SG&A expenses for the first quarter were $267 million, including the AED acquisition, which added approximately $4 million of incremental SG&A. Excluding the acquisition, core SG&A decreased by $6 million compared to last year. This reflects the savings from more than 500 fewer positions versus this time last year, part of our 2-year cost reduction program from 2015 through 2016 that eliminated a total of nearly 1,000 positions and consolidated or exited 40 branches. We also benefited from more favorable foreign exchange in the quarter.

Operating margin was 3.8%, within our outlook range of 3.8% to 4.1% and down 10 basis points from last year. This reflects 30 basis points of lower gross margin, partially offset by lower SG&A.

The effective tax rate was 25% in the quarter, down nearly 700 basis points from the prior year and below our outlook of approximately 30%. Versus prior year, the settlement of an outstanding tax matter in the first quarter of 2016 increased last year's effective rate by 340 basis points.

In addition, this year's effective rate was decreased by 310 basis points in the quarter as a result of applying the new accounting standard addressing stock-based awards. The effective tax rate was lower than expected as a result of applying the new accounting standards update which was not contemplated in our outlook, as the timing and magnitude of the tax impact on stock-based awards is difficult to determine. Additionally, the tax rate was lower due to the favorable mix of income before tax by country, reflecting relatively stronger performance in Canada.

Moving to the diluted EPS walk on Page 9. We reported net income of $0.76 per diluted share. Versus prior year, core operations unfavorably impacted EPS by $0.10, largely the result of lower gross margins. SG&A savings from headcount and branch reductions as well as favorable foreign exchange were partially offset by increased insurance and health care cost and the impact of a customer bankruptcy. Tax expense was favorable by a total of $0.07, including $0.03 from applying the new accounting standard on equity awards. A higher fully diluted share count decreased EPS by $0.04.

Moving to Page 10. First quarter free cash flow was $43 million or 114% of net income. The strong cash flow performance enabled us to pay down $46 million of debt during the quarter, further reducing our debt leverage ratio to 3.4x trailing 12 months EBITDA. Leverage net of cash was 3.2x EBITDA. Liquidity, defined as available cash plus committed borrowing capacity, was $727 million at the end of the quarter. Interest expense in the first quarter was $17 million and our weighted average borrowing rate for the quarter was 4.1%, consistent with historical averages. We believe our debt is appropriately balanced between fixed and variable-rate instruments.

Capital expenditures were $5 million in the first quarter. We continue to invest in our people, technology and facilities through both capital expenditures and operating expenses. WESCO has a history of generating strong free cash flow throughout the entire business cycle and we expect this to continue.

Our capital allocation priorities remain the same. The first priority is to invest cash in organic growth initiatives and accretive acquisitions to strengthen and profitably grow our business. Second, we target a financial leverage ratio of between 2.0x to 3.5x EBITDA. Third, we return cash to shareholders through share repurchase and currently have $150 million remaining in our existing share buyback authorization to do so.

Now let's turn to our outlook for the second quarter and full year 2017 on Slide 11. For the full year, we reaffirm the expectations that we first provided in our 2017 outlook call on December 13. We expect sales to be flat to up 4% and operating margin in the range of 4.4% to 4.6%. We anticipate delivering EPS in the range of $3.60 to $4 on an effective tax rate of approximately 30% and 49 million shares outstanding. Note that we will have 1 fewer workday in 2017 which occurs in Q3. We also expect free cash flow of at least 90% of net income.

For the second quarter, we expect sales to be down 2% to up 1% and operating margin of 4.2% to 4.6%. This reflects our expectation of improvement in our end markets as we move through 2017 and continued execution of our sales growth, margin and cost initiatives. We expect this quarter's effective tax rate to be approximately 29%.

With that, we'll open the call to your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have a question from Matt Duncan from Stephens.

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Charles Matthew Duncan, Stephens Inc., Research Division - MD [2]

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So John, first just on the sales trend, trying to make sure we understand the drop back down a little bit here in April. Is it simply the shift in Easter timing and selling days and really is comparable to March when you back those out? Is what it sounds like you're saying there, correct?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [3]

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Yes. Actually, when you, if you were to adjust March for the year-over-year Easter timing and then you were to adjust April for the year-over-year Easter timing and FX is moved from a tailwind to a headwind; it was a tailwind in Q1, it's a headwind in Q2, April's stronger than March.

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Charles Matthew Duncan, Stephens Inc., Research Division - MD [4]

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Okay. That's helpful. I think there might be a little confusion...

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [5]

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And I think that's a very important point. I think we're clearly seeing the momentum back there improve as we step through each of the months in 2017. So February was better than January, March was better than April -- or March was better than February and April is better than March.

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Charles Matthew Duncan, Stephens Inc., Research Division - MD [6]

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Okay. And then second question I've got, John, on the construction business. The backlog jump you've seen since year end, I think, is pretty notable. Can you talked about what end markets are driving that? And when do you think that starts to translate into revenue growth for that piece of your business?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [7]

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Yes. Good question. The -- first, I don't think we had this in the script, so I do want to get it out there so it's in the transcript because I know we'll get this question later. Oil and gas performance all in for WESCO was still down in the quarter. We were down 9%. Now that's much better than we were in 2016. We ended up being down 24% all in last year and then close to 30% in 2015. So oil and gas has not fully recovered. However, we've got some sequential step up in oil and gas. And I would say that's much more MRO-driven than it is capital projects. I would say all in, the capital projects still represent a significant opportunity in upside, Matt, as we look to move through the year. I'm very encouraged by our backlog growth. You're right. Sequentially, it's a nice step up. It always steps up, but this is bigger than normal. I think the important point is we've just come out of a couple-year period where we've not had any backlog growth. And so to have our first quarter of backlog growth since the first half of 2014, I think second quarter of that year specifically, is notable. We're seeing very good bed -- bid activity levels. We've got some recent wins in health care, lighting, datacom, product security, education, infrastructure. As you like -- as you kind of look across both the U.S. and Canadian landscape, we're beginning to see a better balance in terms of activity levels. We're particularly pleased with the improvement in Canada on a return to growth this year. So that's a little context setting to hit you. The direct response to your question is, do we think we're setting up for a nice entry into the construction season? And that will determine how the year ends up closing out, clearly. So as we move through the second quarter into the third, I think we're well positioned with the backlog growth and improving momentum vector of the business. And we are hearing from contractors that they're expecting a stronger second half versus the first. Does that help?

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Charles Matthew Duncan, Stephens Inc., Research Division - MD [8]

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Yes, it does. And just one more real quick one, if I can, just on the margins in that business. You said something about more competitive pricing in the contractor business. Should we be worried about what that means for margins going forward? Or is that not a...

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [9]

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No. I think what this is, this is a classic case of -- and I've been very clear what -- this is the environment we've been in for some time now. It's been a lackluster recovery. It still is a demand-constrained value chain. On the supply side of our value chain, inflation wants to start to tick up. Supplier -- we're working with suppliers. We're aligned with our supplier partners, we'd like to manage price increases through. But quite frankly, until customers see their demand pick up in a meaningful way -- and I think we're at the front end of that. But with that said, till we see a pickup in a meaningful way, they're continuing to keep the tight screws on cost reductions on their buy side equations for all types of purchases. And CapEx is under great scrutiny still. So even though they have improved plans to spend more this year, right, it hasn't been released yet. So that -- I think we got get the classic case of inflation starting to pick up, demand hasn't -- isn't pulling through the value chain yet, and there will be the lag effect, right? That lag effect of the ability to push price increases through. So that's our view currently when you look at kind of the nature of how pricing was. Pricing was flat in the quarter, as Dave mentioned. And you look at our margins at the end of the day, it's a little -- it's the same pricing pressure we've had and a little bit of mix-driven. Nothing that overly concerns us.

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Operator [10]

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Our next question is from Andrew Buscaglia from Crédit Suisse.

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Andrew Edward Buscaglia, Crédit Suisse AG, Research Division - Senior Analyst [11]

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Can you touch on -- could you just touch on your -- so Industrial and Canada were the kind of the 2 segments you really needed to see to get the good things working here. What is the typical lag -- I mean, I know you weren't expecting much in Q1, but what's a typical lag of when those markets start to work and when you really see it start to flow through the margin?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [12]

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Yes, I think that, again, we're encouraged with the pickup with Industrial, of our biggest end market, and with Canada. And for Canada, what we're most encouraged about is, again, oil and gas is not growing again yet, and we're still seeing a pick up in some of the MRO, but not the capital projects yet. So I think that represents a nice potential as we move to the second half of the year going into next year. Mining is picking up a bit, as we said sequentially. So is OEM. OEM is a good indicator for us, too, like portions of MRO. But OEM in particular is a very good indicator for us in terms of what's happening with our Industrial customers. The fact that, that was up nice sequentially is a good bellwether that Industrial is clearly picking up. A number of our supplier reporters, a number of our customers have reported results already. I think you're generally seeing for those publicly traded companies kind of a pickup in the industrial results. And I think this was our view, that this has the potential to occur, and we built it into our outlook and our plans for this year. It's begun. I would tell you, Andrew, that the year had started as we expected. Canada may be a little bit stronger than we thought, but we clearly expect that Industrial will pick up. And I would say the latest macro view coming out of Canada is that the -- is that it's going to be a better year. Economic growth should tick up. We're, again, particularly pleased with our results given the fact that oil and gas is not coming back yet in a meaningful way, I said, i.e. with the CapEx. And I think there is a view that Canada's 2 oil-producing provinces, Alberta and Saskatchewan, could return to positive overall economic growth this year, which would be a nice -- real nice positive for us because of our strength in the Western provinces. The rest of Canada is similar to what we talked about the last couple of quarters. You look at the Canadian dollar, you get to the Central. And then even in BC, they're still growing. We got a good position. So I think it's a setup for entering the middle of the year and particularly the back half. When we put the year together, the outlook in December, and our view remains unchanged, we had expected a much stronger second half than first. And it's playing out that way thus far. That's our -- It matches our current view.

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Andrew Edward Buscaglia, Crédit Suisse AG, Research Division - Senior Analyst [13]

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Okay. And then could you just touch on construction? Because that ticked down. And I was confused in the commentary when we talk about the industrial market within construction, contractors serving that market kind of adding to that weakness. What's your commentary there, and why that's pulled back?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [14]

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It hasn't pulled back in terms of momentum vector. On a sequential basis, it's in line with normal seasonality in terms of going Q4 to Q1. So that's the most relevant kind of metric I can give you or data point relative to momentum. And I told you, backlog had real nice growth off of year-end. And it's the first quarter of backlog growth, and that really is construction and construction projects, since the second quarter 2014. So I'd tell you that I don't -- construction wasn't consistent with our expectations in the quarter.

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Operator [15]

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Our next question is from Deane Dray from RBC.

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Andrew Krill, RBC Capital Markets, LLC, Research Division - Associate [16]

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This is Andrew Krill on for Deane. I was wondering if you can give a little color on the gross margin -- a little more color on the gross margin declines in the quarter, the cadence of how you guys expect this to improve as the year progresses. And I guess, just if there's any interpretation of -- if there may be an interpretation of chasing lower-margin business.

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [17]

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Yes. Maybe I'll start by saying we haven't changed how we're running the company. We're not chasing lower-margin business. I think we've been through the cycle, both ends of the cycle, through the cycle, many times. And I think we're seeing that classic challenge at the front end as inflation starts to pick up and customer demand doesn't fully support it yet. There's clearly a lag effect with distribution. So let me start out there and then hand it to Dave to expound further.

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David S. Schulz, WESCO International, Inc. - CFO and SVP [18]

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Sure. So Andrew, a couple of things to explain our margins for Q1. As you're aware, we do have significant margin differences in the type of shipments that we have. So our direct ship actually was a margin drag for the quarter relative to prior year. And as you're also aware, we had a better mix on Industrial and on Canada, which was a benefit to our gross margins. As we mentioned in the prepared remarks that we did have some drag on the building margins. And again, we believe that, that is a combination of the competitive nature of the construction market. And also, as we anticipate going forward, as that activity increases, we believe that we will have less of an impact due to that billing margin drag.

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Andrew Krill, RBC Capital Markets, LLC, Research Division - Associate [19]

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Got it. And then just as a quick follow-up. Is there any pricing change assumed in the 2017 guidance? I think before, you guys have said kind of flattish.

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [20]

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No, we -- I mean, don't -- as you know, we don't forecast or provide guidance relative to pricing. And so with that said, as Dave mentioned, pricing was flat in the quarter. It hasn't turned positive for us yet. So to the extent -- what I just described, Andrew, right? Demand starts to pick up, it starts to pull through the value chain. We're able to work with our supplier partners and get meaningful price increases pushed through and they stick and that lag starts to catch up, so to speak. Then we get back into more of the way the cycle works and we get some positive price contribution as the economy grows. And that's been our view of what -- how the year would play out, right? That we would move into that phase at some point. It was not our view that, that would occur in Q1. And I think on one hand, the pricing wasn't a negative, wasn't a positive. It was flat, consistent with expectations.

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Operator [21]

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Next question is from Nigel Coe from Morgan Stanley.

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Jiayan Zhou, Morgan Stanley, Research Division - Research Analyst [22]

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This is Jiayan filling in for Nigel. We just want to dig a little bit more into the pricing dynamic. Just to clarify, I think you guys talk about kind of a flattish pricing last quarter, and then we're seeing a little bit of pricing pressure in the construction market. So would you describe that as a step down versus last quarter? Or it was just no signs of improvement in this market yet?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [23]

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No step down. Margins are down a little bit year-over-year, but they're up sequentially. So no sequential degradation in the pricing environment. The answer is no.

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Jiayan Zhou, Morgan Stanley, Research Division - Research Analyst [24]

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Okay. That's clear. And in terms of price raws, so we're seeing some inflation in commodity prices. How do you expect the price raws to trend throughout the year? Do you expect that to become a headwind to margin over time?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [25]

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No, no, no. I just described the whole -- the way value chain works. And so again, as -- when inflation occurs, once it's supported by the appropriate demand through the value chain, we're able to work our pricing increases through. In addition, we're always working in conjunction with our supplier partners and our value proposition to sell value. But -- so no, that -- you should not view that as a headwind. That becomes a potential benefit and tailwind with the assumption that economic output does improve, i.e., customer demand improves, customer sales rates pick up, their utilization in their factories pick up and it kind of pulls through the whole value chain. So not a headwind, not expected headwind and expected benefit as we move through the year and get through the cycle.

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Jiayan Zhou, Morgan Stanley, Research Division - Research Analyst [26]

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Got it. Got it. That's very clear. A quick follow-up, if I may, just in terms of kind of the expected pricing improvement. What kind of visibility do you have? Do you see that in your backlog already and that gives you the confidence that pricing will improve through the year?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [27]

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Again, we don't forecast price, so I'm not going to give you any outlook with respect to price. Our visibility, typically in our earnings calls, and then Mary Ann and Dave follow up accordingly and we have these discussions. We give some insight into what we're seeing in terms of planned supplier price increases. And for the second quarter, supplier price increases are fewer in number than Q1, which is more typical. And the range is still in the kind of 1% to 5% range with selected categories a bit above that. So when you look at the range of price increases that suppliers would like to work with distribution to push through channel, the range of price increases and the average are consistent with the first quarter. And in terms of number, typical with kind of normal seasonality. The margin rate of our backlog, we do look at that, I think that it was also part of your question, and those are holding up just fine.

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Operator [28]

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Next question is from Christopher Glynn from Oppenheimer.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [29]

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So the Industrial guidance initially was down low single to up low single. You started out in the positive side of the ledger and very crisp, clear description of momentum building. So just wondering if you could put that in perspective, looks...

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [30]

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Yes. Very, very good question, Chris. We -- after the first quarter, we've not gone in and revised the page on kind of, let's call it, the composition of our outlook for the full year. And we're not adjusting our outlook. We feel good about the outlook that we put into place when we entered the year in December. So it's clear you understand what we're doing there. With that said, I do think that we did expect Industrial to return to growth. And as a company, as a total enterprise, our top priority was to return to growth in 2017. So I'll remind all of you about that. That is our top priority. It's clear to everyone inside WESCO, that's what we're driving for. For that to really happen, we need our biggest end market to return to growth. And so it's really good to see Industrial do that in the first quarter. We did expect it would return to growth this year, right? Even though we gave that outlook, there was some uncertainty about the timing of capital projects, oil and gas, where it would fall and such, Chris. And that was our -- take you back to the December time frame when we laid out that framework. With that said, I think the momentum vector was positive as we finished the fourth quarter, it's continued every month so far in the first quarter and so far in April, as I've outlined. So Industrial -- the Industrial improvement is better than we had laid out in our outlook guidance. And we had discussions back then. Some of you said, "Look, maybe you're a bit too pessimistic on Industrial." And some thought we were kind of right down the middle. Some thought we -- maybe, we were even incrementally optimistic. But so far, I think that's been a pleasant surprise, and so is Canada returning to growth. So it's a really nice start to the year with 2 very large parts of the business.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [31]

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Okay. And it occurs to me that maybe there's a little bit of offset in the construction side. I think number of peers in electrical components, at least lighting, have talked about just elasticity of short cycle, smaller projects seems to be a bit of a headwind near term.

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [32]

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Yes, I think maybe you could say construction for us, sequentially Q1 to Q4, is consistent with more normal seasonality. So what's the read of that? It's not getting worse, but it hasn't really started to pick up yet. So to the extent that someone says, "Oh, okay. Maybe WESCO is going to have an improvement in construction in a meaningful way versus normal seasonality in Q1," it didn't happen. With that said, our leading indicator is backlog. And the sequential backlog step up was very high at double digits. And then year-over-year, we got our first quarter of backlog growth. So that is our leading indicator. Bid and activity levels are high, and we're beginning to see, we foreshadowed that in Q3 but more so in Q4 last year, some of the larger project, the FIDs are -- decisions are being made, and those projects are beginning to progress. Now they're longer-cycle. They're not going to -- they don't really turn into meaningful sales in the first half of 2017, those decisions that were made last year. So anyway, I think that -- I think we've got -- with that said, the nonresi market still, there's some areas where there's -- it's still challenged. There's other areas where -- and we talked about this in the last couple of quarters, quite frankly, where the constraint is labor. I.e. for contractors, it's electricians. And those -- so there's some local markets that are somewhat labor-constrained. So it's -- there's a lot of variation and a lot of verticals in the construction market. All in, I would tell you our read is consistent with normal seasonality, it's good to see the backlog growth, it's a nice setup for the construction season, and the construction season will determine how this year turns out.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [33]

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Last one, just a little bookkeeping. The full year tax rate implies 32% or so in the back half, which seems a little out of bounds to the high side. If you could help bring firm that up.

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [34]

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Yes. Dave?

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David S. Schulz, WESCO International, Inc. - CFO and SVP [35]

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Sure. So as you're aware, we are heavily leveraged towards a U.S. recovery. And as we take a look at the mix of our earnings before tax between the Canadian business and the U.S. business, our international operations, that's what's driving our effective rate tax stat for the year. It's that mix of income before tax by market.

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Operator [36]

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And our next question is from David Manthey from Baird.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [37]

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So just first off, Dave, did you say that when you originally gave your guidance, the ASU 2016-9 was not contemplated at all? Or that the impact this quarter was greater than you thought?

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David S. Schulz, WESCO International, Inc. - CFO and SVP [38]

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So Dave, we did not include the adoption of the accounting standards in our original guide for the effective tax rate. It's extremely difficult for us to quantify what that impact would be.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [39]

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Okay. And then second for John. You discussed the positive momentum vector here overall, but I'm wondering if you look at it by segment and you think about the Industrial segment. It looks like things are improving and the market is improving a bit out there, but -- and you have an easy comp here in the first quarter and your comparisons continue to get more difficult as we move through the year, but you're telling us you still expect acceleration in Industrial specifically. Am my reading that right?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [40]

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Yes, so we -- that's what we've seen through the first quarter, and it's continued in April, Dave. And my view -- my current view is that I don't expect it to inflect the other way. I don't see any indications of that. And as you know, we've got -- even with our Industrial customers, in that segment let's say, it could be it's MRO, it's OEM, but it's also capital projects. And we're not seeing the benefit from any of the plans from certain customers to increase capital spending. There's a lag effect there versus, let's say, OEM and MRO. So yes, that is my view. I do think that we're at the front end of Industrial improving. All our own data points, discussions with customers, would suggest that. I think though -- there is also still -- and so customer sentiment has improved as we moved through the first part of 2017. With that said, I do think there is still expectations on behalf of our customers, as we have the same expectations, that there will be positive benefits due to regulatory reform, tax reform and some increased infrastructure spend. And so that requires decisions and actions to be taken there which haven't really been taken yet. So I think that's -- but I think our customers believe that, we believe that, and that's the underpinnings of the view.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [41]

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Got it. Okay. And then just finally on construction. You specifically say in the slide that you expect it to gradually accelerate through the year. And you cited backlog and some of the inquiries from customers and so forth. Just so we can size the backlog, how big is backlog for you relative to one quarter's sales in the construction segment, for example?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [42]

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I don't know and I'll take that under advisement with Mary Ann. I'm not sure we've ever sized it, Mary Ann.

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Mary Ann Bell, WESCO International, Inc. - VP of IR [43]

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No, we haven't.

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [44]

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And we'll go back and look, Dave. If we ever have, be can more clear about that going forward. I will tell you I use it -- and I've said this over the years. I use it as an indicator. Not as a directional indicator as opposed to a, now let us try to forecast by individual project and how that project plays out.

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Operator [45]

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Our next question is from Ryan Merkel from William Blair.

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Ryan James Merkel, William Blair & Company L.L.C., Research Division - Research Analyst [46]

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So first, John, could you just talk about lighting trends in the first quarter? And what was the growth rate there?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [47]

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Yes, so our overall lightning was flattish. And let me decompose that for you. LED, we had very nice growth and our mix is consistent with our supplier partners. And I think as you know, Ryan, we have relationships with the world's top lighting manufacturers. We have a terrific array of supplier relationships. What makes us a little different than some other distributors is the legacy lamp business that we have. And so when you think about our global account customers, and this had been -- it had been -- obviously, they're a source of WESCO's strength, period. But we -- for those customers that have facilities and we've got a global accounts agreement, we've been supporting their lighting. We had a replacement lamp business. And it's been a strong driver of our lighting category for as long I've been with the company. It obviously started way before I was with the company. This goes way back into the Westinghouse roots. That legacy lamp business is declining at a double-digit rate. Not ours, but our market. There's good market data on that, so you can look at the big 3. And there's good market data on that. So that's the headwind we're facing. The LED uptake is growing very nicely. So with all that said, am I disappointed with flattish lighting sales? I would have liked to have some kind of nominal growth in the quarter. It is still one of our -- my personal and the organization's top growth engines, I feel very good about our capabilities end to end, and we've done acquisitions even in the recent years to bolster those in the form of Aelux and Lumigent. And so it is -- it remains one of our top growth engines. We'll be talking about it on Investor Day. I'm still very bullish over the mid- to long term. And the reason is fundamentally, and I'm taking a long -- little bit longer with this answer because I think it's really important. Lighting historically, when you look over the last couple of decades, was construction market-driven, i.e. new construction driven. The biggest market that exists is the install base. And because now you've had a shift to solid-state lighting, essentially analog to digital, right? Going to semiconductor-based. It's a semiconductor capital economics curve. They're now at the foundation of lighting solutions, and that price -- performance is improving, price and cost is coming down, and that's opening up better ROI on upgrading and retrofitting and renovating the install base. And any place where you are right now, look out the window and you look at all the structures that exist, what percentage is LED? It's a very small percent. That's the opportunity. So we're still very bullish mid to long term.

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Ryan James Merkel, William Blair & Company L.L.C., Research Division - Research Analyst [48]

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Okay. That's helpful. And then secondly, price transparency has become an issue for one of the biggest MRO distributors, and I'm sure you've seen this. So I just wonder if -- is this an issue that's relevant for you? Or does your service model sort of protect you?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [49]

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Yes. Excellent question. First of all, we focus on 3 demand streams of our customers. Capital project, that's our deepest roots. And we have deep, deep domain knowledge around all -- everything electrical, OEM and MRO. We -- when you look at the structure of our back end of our operations, we have very few branches with counter business and we've never been geared for that, for that walk-up contractor who didn't know what they needed till that morning when they got to job site, said, "Here's what I need to complete my day." That's not how we've been built, that's not the customers we serve. We're great with multilocation customers in Industrial and Utility, governmental agencies, institutions, commercial. And then we're terrific with all range of projects. The more complex and challenging the project, the better we are. And we have a terrific service value proposition. So that's our deep roots in capability. If you were to transact with us over the -- over our website, you're not going to find that we do a lot of business with that -- with "a walk-up customer" who's just shopping on our website. Our e-commerce business is wrapped around customized, let's call it, applications for specific multilocation customers where we create punch-out catalogs unique to their operations. And that's tailored customer-by-customer. And so that's our deep roots. I'm taking a little bit longer with this because I think it's very important. And so we don't have -- we've never been a catalog model, a retail catalog model list minus discount pricing on the web. And so I think that is the very nature of our value proposition, our business models and the fact that an awful lot of what we do is application-specific, RFP-, RFQ-driven. It's technical sales. We're focused on the customer application with service that extends after the product is delivered as part of a contract. The fact that that's the nature of our business creates a -- it's different than a catalog-based model, where you -- where all pricing is transparent on the web. And so it creates a stickier business relationship. So thank you for that question. And this is a topic that we'll develop even more fully at the Investor Day.

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Operator [50]

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Our next question is Hamzah Mazari from Macquarie.

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Hamzah Mazari, Macquarie Research - Senior Analyst [51]

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Just the first question is around your M&A pipeline and what you're seeing there. It seems like you were pretty active in the deal market even with leverage sort of slightly higher than this in late 2015. And you haven't done a deal in over a year. Maybe just frame for us, is that conservatism around the balance sheet relative to history? Or is the pipeline just not as robust?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [52]

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Thanks, that's an excellent question, I appreciate it. So no. Look, we have a -- I would say our pipeline is as robust as ever. The 2 comments I would make is the last deal we did with AED, and that's was in March of 2016. So we just lapped the 1-year anniversary. This is one of the key value creation levers for the company. It has been, it still is and will continue to be in the future. And the reality is we don't always control the timing. At times, we end up doing 2 or 3 deals, boom, boom, boom in a quarter, and then there could be several quarters that go by where we don't have a deal that's done. So -- and the reason we don't control the timing is, when you look at it, the overwhelming majority of the companies we buy are private companies. And so if they're choosing to put their company into play, we always get a look. And we want to have last look and we'd like to have the only look. And if we've been working the deal, sometimes, we've been able to pull that off. Sometimes, we inspire them to put it in play. But it requires them to make a decision around governance and transition. And we view ourselves as a very high-valued acquirer. That's our reputation, so we always get a look at all transactions. With that said, we're also disciplined with what the business case needs to deliver for us to pull the trigger on the deal. So the bottom line on this is, as robust as ever a pipeline, this is not us changing our priorities or operating posture, it's just the nature of what deals we were -- we wanted to go after and that we did close versus -- it's just timing, really, quite frankly.

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Hamzah Mazari, Macquarie Research - Senior Analyst [53]

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Got it. Understood. And then just a follow-up question and I'll turn it over. Not too long ago, you had organized your businesses which were not branch-based into national platforms with specific customer segments and product categories. As you look out, is there any more restructuring you need to do, either around the branch network, the DC footprint or maybe the mix of transactions? Maybe more direct ship versus stock orders, special orders? Just looking out, is that mostly behind you? Or is the portfolio -- as the portfolio evolves, your go-to-market may evolve, too?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [54]

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That is an outstanding question. Thank you for that. I will answer it this way. In Canada, I would say that we are -- the heavy lifting has been done. We have a 4-distribution center model on the WESCO side of the business across Canada that I think is effectively well positioned to provide optimized hub-and-spoke support for customers in those geographic regions. And on the EECOL side, they have a similar model with, let's call it, a 6-region structure. There's a greater number of branches, more local branches, more local inventory, too, in the Western provinces. I think the work that's left to be done in Canada is just how do we continue to leverage that terrific combination of EECOL and WESCO. We got a #1 market position. And I think we're seeing the benefits with the results we're driving with customers in what's still an economy that's recovering. In the U.S., we have made substantial progress. With that said, we still got a lot to go. I would say we're not in the early innings, but we're far -- we're not in the late innings. But we're still in the first half of this -- of the game, let's say on terms of -- in terms of optimizing the back end. So if you look, Hamzah, at the last, I'd say 5 to 6 years, the new branches that we've opened are larger in format. We've done a number of consolidations of branch locations. I think there's the opportunity to continue to refine and optimize the back end, focused on customer service metrics and satisfaction metrics. So we don't talk a lot about that externally, but we've got an aggressive agenda on that. And I would still -- I would stay we still got a couple of years in the making on that left.

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Operator [55]

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Our next question is from Chris Belfiore from UBS.

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Christopher Belfiore, UBS Investment Bank, Research Division - Equity Research Associate Analyst of Industrials [56]

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Actually, I just wanted to kind of go back a little bit to the kind of Industrial stuff, but it sounds like you -- on the capital projects side, it's kind of as you had expected to start the year, but it was more like MRO kind of stuff that you guys thought had come back. And then with regard to that, in terms of the Industrial side being the stronger gross margin business, do the expectations for the year kind of -- is that kind of how the expectations for the year expected kind of play out with -- in terms of just capital projects kind of still being pushed out, with customers not being -- still being cautious, and it's more MRO?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [57]

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Yes. So let me be clear on Industrial. I think Industrial, the way I would say it is -- and this is what we've always seen in the past, is how the cycle works. You see, you should actually see kind of OEM leading. And that's where we saw it first. It started to pick up in the fourth quarter, and we spiked that out in our fourth quarter earnings call, that we saw OEMs starting to pick up, pick up sequentially. That's continued through the first quarter and through April, and we're very pleased with that. This is what I was alluding to in my answer to Dave Manthey earlier. And then MRO then started to follow and we haven't really seen the CapEx yet. So I think that represents, again, the real opportunity. And then that would speak to truly a full-blown kind of industrial recovery, right, when our Industrial customers are confident enough to begin to start spending more capital again, upgrading and expanding their businesses. So I would say Industrial played out a little bit faster than we thought in the first quarter. As we move through the year, I think the whole pricing and margin dynamic is as we've really are outlined in this call. And as Industrial accelerates and Canada has returned to growth now, we should have positive mix contributions as we're able to because, again, as the economy picks up, we're able to work pricing through the value chain. So that's our view.

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Christopher Belfiore, UBS Investment Bank, Research Division - Equity Research Associate Analyst of Industrials [58]

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Right. And I guess, just to that point, I mean, can you -- can the margin pick up if this year has no CapEx improvement? Can it just be OEM- and MRO-related kind of margin improvement?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [59]

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Yes. I mean, we're constantly working on optimizing and improving pricing and sourcing and working that spread. And so my commentary and Dave's are around kind of the where we are in the cycle and how we fit in the value chain. And so I think, again, I'm encouraged because we're seeing a faster pick up than we thought. It did return Industrial to growth without the CapEx. So when the CapEx kicks in, we can really -- we really see tremendous results. And I would take you back to coming off the trough of the great recession and take a look at what our Industrial growth was coming out of '09 and the '10, '11 and such. And that was kind of all 3 components driving Industrial growth. It was OEM, it was MRO and it was capital projects. And we had very strong organic growth in Industrial. And for the corporation, excellent pull through. So that's what we -- when all 3 components kick in, we're very well positioned for our operating model to work.

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Operator [60]

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And our next question is from Robert Barry from SIG.

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Unidentified Analyst, [61]

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This is [Ashish] on for Rob. Yes. So the question I have is, is the impact from exiting the lower-margin Utility business disproportionately weighed to 1Q or first half?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [62]

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No. When you looked at -- it was a very large customer. We sized it in our outlook call in December. And it was roughly, for all intents and purposes, equally balanced across the whole year. We had the contract -- we had customer for the entire year. And there was very little sales in this quarter. Essentially, the transition has occurred.

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Mary Ann Bell, WESCO International, Inc. - VP of IR [63]

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(inaudible)

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Unidentified Analyst, [64]

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Okay, sure. Another one which is, can you discuss the price/cost dynamic in different verticals? In other words, is it more or less challenging to get price in one vertical versus another?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [65]

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No. I mean, I guess, I don't want to parse that to that fine a degree. I think again, I would point you to that, in general, it's a bit of demand-constrained environment, that global macroeconomic forces are creating a set of conditions that's increasing inflation on certain commodity types. We are working with the supplier price -- supplier partners who try to push those through in general. But because it's still demand-constrained and -- the only thing I will say is this, customers have -- some customers have decapacitized in the last several years. So as they start to re-ramp their operations, they start pulling on the supply chain harder. They don't have the buffer stock they used to have, that will be a nice positive for growth. The distributors, by and large, there hasn't been a lot of capacity rationalization in our part of the value chain, so it's still competitive. And that's why it requires this demand-constrained environment to improve to create the conditions to kind of move price through. I would say it's overall. I did also mention, and Dave alluded to it, the contractors right now are being a bit aggressive with their pricing with their customers to try to stoke some of the demand on the projects side of the business. This is not unlike what we've seen previously in this phase of the cycle. So it's nothing new. But again, I think everyone's looking for, desiring and want to help -- wanting to help create a step up in the demand environment.

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Unidentified Analyst, [66]

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Okay, sir. And just a quick follow-up on that one, I'm sorry if I missed this. What was the price -- contribution of price in the quarter?

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [67]

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Flat.

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Operator [68]

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And ladies and gentlemen, this will conclude today's question-and-answer session. I would like to turn the conference back over to John Engel for any closing remarks.

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John J. Engel, WESCO International, Inc. - Chairman, CEO and President [69]

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Thank you for your time this morning and your continued support. We hope to see many of you at our Investor Day on June 7 in New York. In the meantime, Mary Ann and Dave are around today to take any further questions. Have a great day.

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Operator [70]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.