U.S. Markets closed

Edited Transcript of WCC earnings conference call or presentation 30-Jan-20 3:00pm GMT

Q4 2019 Wesco International Inc Earnings Call

PITTSBURGH Feb 5, 2020 (Thomson StreetEvents) -- Edited Transcript of Wesco International Inc earnings conference call or presentation Thursday, January 30, 2020 at 3:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* David S. Schulz

WESCO International, Inc. - Senior VP & CFO

* John J. Engel

WESCO International, Inc. - Chairman, President & CEO

* William Ruthrauff

WESCO International, Inc. - Director of IR & Corporate Communications

================================================================================

Conference Call Participants

================================================================================

* Cristian Jose Ramos

Wolfe Research, LLC - Research Analyst

* David John Manthey

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

* Deane Michael Dray

RBC Capital Markets, Research Division - MD of Multi-Industry & Electrical Equipment

* Mario J. Cortellacci

Jefferies LLC, Research Division - Equity Analyst

* Robert Douglas Barry

The Buckingham Research Group Incorporated - Research Analyst

* Robert Stephen Barger

KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst

* Samuel John Darkatsh

Raymond James & Associates, Inc., Research Division - Research Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Hello, and welcome to the WESCO Fourth Quarter and Full Year 2019 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I'd now like to turn the conference over to your host today, Will Ruthrauff. Please go ahead, sir.

--------------------------------------------------------------------------------

William Ruthrauff, WESCO International, Inc. - Director of IR & Corporate Communications [2]

--------------------------------------------------------------------------------

Thank you, Keith. Good morning, ladies and gentlemen. Thank you for joining us. Joining me on today's call are John Engel, Chairman, President and 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. Please see the webcast slides for additional risk factors and disclosures. 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. Replay of this conference call will be archived and available for the next 7 days.

With that, I'll turn the call over to John Engel.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, Will. Good morning, everyone, and thank you for joining us for today's call. I'll lead off with a few high-level remarks, and Dave will take you through our fourth quarter and full year results and provide an update to our 2020 outlook.

We announced the agreement to acquire Anixter International 2.5 weeks ago, and I'd like to provide you with a brief update on our recent activities. We remain very excited regarding the transformational combination of WESCO and Anixter, which will create a premier electrical and data communications distribution and supply chain services company. Our integration planning is well underway, and we are actively speaking with external partner candidates to provide integration advisory services and to help us achieve the sizable synergy opportunity that this combination presents. The required filings with the SEC as well as other regulatory approvals are in process. Anixter has not yet scheduled their shareholder vote to approve the agreement. However, we expect that we'll have them promptly once the required SEC filings are in place. And we remain on target to close this very exciting transaction in Q2 or Q3 of this year.

Now moving to our results on Page 4. We were pleased to finish the year on a strong note, with sales up 4.4% to $2.1 billion. For the second quarter in a row, sales grew in all end markets and geographies. These results were achieved in an economic environment that was more challenging than we expected across our end markets. Our continued trend of increasing organic growth in the U.S., coupled with double-digit growth in datacom, Utility and CIG end markets, is encouraging.

Gross margin declined in the quarter, driven partly by business mix as well as the time lag required to pass through the higher levels of supplier price increases that we experienced last year. Dave will take you through our margin drivers in more detail in a few moments.

We continue to focus on effectively managing our operating cost and delivered adjusted operating margin that was in line with our expectations. Free cash flow was also strong in the quarter, and our financial leverage ended the year at 2.8x net debt to EBITDA.

With that, I will now turn the call over to Dave to provide further details on our fourth quarter and full year results as well as our full year financial outlook for 2020. Dave?

--------------------------------------------------------------------------------

David S. Schulz, WESCO International, Inc. - Senior VP & CFO [4]

--------------------------------------------------------------------------------

Thank you, John, and good morning, everyone. I'll start with an overview beginning on Page 5. Reported sales in the quarter were up 4.4%, above our implied outlook for growth of approximately 3.5% that we provided in October. Recall that we issued a press release stating that quarter-to-date sales through December 23 were up approximately 5%. In the last week of December, we saw a step-down in daily sales. This result was driven by higher-than-normal slowdown in year-end activity due to midweek timing of the holidays and customer shutdowns, particularly in Canada.

For the quarter, U.S. sales were up 4%, with growth of 15% and 11% in our CIG and Utility end markets, respectively. Construction grew 2% in the U.S., and Industrial sales were down approximately 2%. Sales in Canada were up 2% with our Industrial and CIG end markets up 6% and 5%, respectively. Construction sales in Canada were flat with the prior year. Utility sales were down 7%, partly due to the contract nonrenewal mentioned in previous quarters that we lapped during the quarter and partly due to slow sales in the second half of December. International sales were up 13% on an organic basis driven by growth of more than 20% in both Construction and Industrial.

SG&A expenses were approximately 1% higher than the prior year after adjusting for costs associated with the Anixter acquisition. This increase was driven by the SLS acquisition. Excluding the SLS acquisition, SG&A expenses were down from the prior year due to a reduction in variable compensation expense, reflecting results below incentive targets for 2019.

Adjusted operating profit, excluding costs associated with the Anixter acquisition, was approximately $87 million in the quarter or 4.1% of sales, which was slightly below our implied outlook of approximately 4.2%.

The effective tax rate for the quarter was 22%, slightly higher than our expected rate of 21%. Our effective tax rate is typically impacted by the tax effect of intercompany financing, foreign tax rate differences, nondeductible expenses and state income taxes. The effective tax rate was above our outlook for the quarter, primarily due to the full application of the international provisions of U.S. tax reform.

Turning to Slide 6. Gross margin was 18.6% in the quarter, flat sequentially with the prior quarter and down 80 basis points versus the prior year. Relative to the prior year, gross margin this quarter was impacted by 2 primary factors: price/cost headwinds and business mix. On the right side of the slide, you see an overview of historical differences in gross margin by sales type.

Starting first with the end markets. Growth in the quarter was primarily driven by Utility and CIG markets, which are either below or in line with the company line average for WESCO. While our Industrial end market, which typically generates above the line average gross margin, experienced the lowest growth rate in the quarter. The influence of this disparity in the growth rates of these end markets contributed to a mixed drag to gross margin. The same was true on a geographic basis as sales in our higher gross margin Canadian business grew less than in the U.S. and our international markets. Lastly, the margin impact from the mix of direct ship, stock and special order sales was approximately neutral to gross margin.

Regarding supplier price increases, we are aggressively working to pass through increases to our customers. In 2019, the number of supplier price increases were moderately lower than 2018, but the percent increase amount was higher than those seen in 2018. Tariffs were cited as a significant driver for approximately half of all increases. The magnitude of supplier price increases slowed in the fourth quarter and averaged mid-single digits in the quarter but high single digits for the year. We made progress in passing through a greater proportion of increases to customers but continued to be impacted by the time lag of working the increases through the value chain that we have experienced in prior quarters. We expect to see the positive effects of our efforts in the coming quarters with January month-to-date billing margin up sequentially compared to Q4.

Moving to the diluted EPS walk on Page 7. We reported adjusted diluted earnings per share of $1.32, which was 5% above the prior year level. This reflected a combined $0.17 benefit from core operations and a lower share count, partly offset by negative $0.11 combined due to the unfavorable foreign exchange rates, a higher net tax rate and the impact of the SLS acquisition. We've also provided you the reconciliation of our organic and reported sales growth. Foreign exchange was a drag to reported sales but more than offset by the benefit of the SLS acquisition.

Turning to Slide 8. On a full year basis, adjusted diluted earnings per share was $5.20, a record result and up 8% from the prior year. This reflected a $0.12 increase from core operations and a $0.41 benefit from lower share count, partially offset by $0.04 combined due to foreign exchange tax rates -- excuse me, foreign exchange, tax as well as an $0.11 negative from SLS. This was obviously a disappointing result from the SLS acquisition that we made last March. The earnings loss was attributable to a significant revenue miss that was unexpected and inconsistent with the prior revenue levels of the business. We have initiated an aggressive business improvement plan and expect that SLS will be accretive to WESCO's earnings in 2020.

On the right side of the page, you will see that organic sales grew 2.6% in 2019, with 170 basis points attributable to growth in the U.S. and 60 basis points and 30 basis points attributable to growth in Canada and International, respectively. Also, 1 less workday in 2019 had a 40 basis point impact on reported sales.

Moving to our end market results, beginning on Page 9. Industrial sales were up approximately 1% overall, which represented our third consecutive quarter of organic growth, with Canada up 6% in local currency and the U.S. down 2%. Consolidated October and November sales were up 2% and 6%, respectively, from the prior year. However, December was down 4%, driven primarily by a high number of plant shutdowns, which impacted sales demand in the last part of the month.

Technology and petrochemical were the strongest performing verticals during the quarter, while OEM was down versus the prior year. For the full year, Industrial sales were up 2% with growth in every geography. Although they have moderated, macroeconomic indicators still support solid production levels and capacity utilization rates in the U.S. and Canada. RFP quotations and bidding levels are strong. During the quarter, we were awarded multiple contracts worth $18 million in aggregate from a petrochemical refiner to provide electrical equipment for a plant expansion in the U.S. Gulf Coast region.

Turning to Page 10. Sales in the Construction end market were up 1% in the quarter, reflecting sales that were up 2% in the U.S. and flat in Canada in local currency. Sales were down 1% sequentially from the third quarter, in line with typical seasonality. As we mentioned last quarter, we have seen some project delays with Industrial contractors due to skilled labor constraints and overall uncertainty related to the macroeconomic environment and international trade concerns. These challenges persisted in the quarter. However, project activity levels are still high. WESCO is known for supply chain management services we provide to drive value for our customers. We continue to help our customers navigate their challenges by reducing supply chain complexity and increasing construction job site productivity.

Backlog in constant currency was down versus prior year and sequentially, reflecting typical seasonality. We were pleased that margin in our backlog, although flat sequentially, was above prior year levels. As an example of our recent success, this quarter, we were awarded a multimillion-dollar contract to provide electrical switch gear, lighting and other materials for the expansion of a food distribution facility in Canada.

Moving to Page 11. Our Utility sales continued to be strong. Sales were up 10% in the quarter with the U.S. up 11% and Canada down 7%, partly related to the nonrenewal of a contract that we exited in late 2018. For the full year, sales were up 4%, representing our ninth consecutive year of organic growth despite a 26% decline in Canada due to the contract nonrenewal.

WESCO is continuing to benefit from secular trends in the utility sector, including grid hardening and reliability projects, construction market growth, higher industrial output and increased demand for renewable energy. In addition, we continue to expand our scope of services with investor-owned utility, public power and utility contractor customers. We expect to continue to grow in this market in 2020. Bidding activity levels remain high, and we continue to have a robust opportunity pipeline. This quarter, we expanded our scope of service with a public utility as we were awarded a multiyear contract to provide lighting products and material management with a value of $25 million.

Finally, turning to commercial, institutional and government, or CIG, on Page 12. Sales were up 11%, with the U.S. up 15% and Canada up 5% in local currency. Sequentially, sales were up 4%. Sales to datacom and security customers were up double digits. On a 2-year stack basis, CIG sales were up 23% in the quarter and 13% for the full year. This performance was again driven by our strong capabilities and value-added services for data center construction, LED lighting renovation and retrofit applications, fiber-to-the-x deployments, broadband build-outs in Canada and network and security solutions. As an example of the continued strength we are seeing in CIG, this quarter, we were awarded a multimillion-dollar contract to provide turnkey LED lighting retrofit materials and services to upgrade a convention center facility in the U.S.

Turning to Page 13. The company generated free cash flow of $94 million or 178% of net income in the quarter and $180 million or 81% of net income for the full year. We were disappointed to fall short of our free cash flow generation target of 90% of net income for the full year. The primary driver was an increase in inventory, including an inventory build to support the ramp-up of new utility alliance contracts as well as lower-than-expected sales in the back half of December. Due to the timing, we did not see the corresponding offset to accounts payable, resulting in procurement being a net cash draw in the quarter.

Debt leverage, net of cash, was approximately 2.8x trailing 12-month EBITDA, down from the prior quarter, driven primarily by an $89 million reduction in outstanding debt. Leverage is effectively at the midpoint of our target range of 2 to 3.5x trailing 12-month EBITDA. We maintained strong liquidity defined as available cash plus committed borrowing capacity of $823 million at the end of the quarter. Our weighted average borrowing rate was 4.3% for the quarter. Our fixed-rate debt is approximately 66% of total debt, consistent with historical averages.

Capital expenditures were $14 million in the quarter, reflecting investments to digitize our business, including information technology tools and digital applications. For the full year, capital expenditures were $44 million, approximately $8 million higher than the prior year. This increase is consistent with our expectation that moving forward, CapEx will represent a slightly higher proportion of operating cash flow than it has historically as we accelerate our investments in digital tools.

We did not make any share repurchases during the fourth quarter. Between signing and closing of the Anixter merger, our capital allocation priority will be to invest in organic growth opportunities and repay debt. With the increase in debt expected to fund the Anixter merger, we expect leverage of about 4.5x pro forma EBITDA at closing and expect to return to our targeted range of 2 to 3.5x EBITDA within 24 months of closing the Anixter transaction.

Turning to Slide 14. You will recall that last quarter, we provided our preliminary outlook for 2020 sales growth. And today, we are confirming that outlook is unchanged. Overall, we expect that the softer demand environment that we experienced in the second half of 2019 will continue this year. This softer demand environment, coupled with macroeconomic uncertainties, provide less certainty for our Industrial and Construction end markets, so we are maintaining our wider range for these end markets and expect them to be either up or down low single digits. We have more visibility pertaining to our Utility and CIG end markets and expect these markets to be up low single digits and flat to up single digits, respectively. Our outlook includes outperforming the end markets by 1% to 2% by leveraging our full range of WESCO services and solutions, investing in our people and digital capabilities and maintaining our cost and cash management discipline. As a result, we continue to expect sales growth in the range of flat to plus 4% for 2020.

Turning to our outlook for the full year. We expect this revenue growth to translate into operating margin of 4.1% to 4.4% and diluted earnings per share of $5.10 to $5.70, with an effective tax rate of approximately 22%. We continue to expect to generate free cash flow of at least 90% of net income. We expect an average share count of approximately 42 million shares for the year. This outlook does not include any impact from the Anixter acquisition. Additionally, the $100 million termination fee that we paid on behalf of Anixter and which was funded by a draw under our bank facilities will be treated as part of the purchase consideration and will, therefore, not have an impact on our income statement.

For the first quarter, we are expecting sales growth of 2% to 5%, with operating margins of 3.4% to 3.6%, approximately in line with prior year and typical seasonality.

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

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [2]

--------------------------------------------------------------------------------

First off, a lot of observers out there are thinking that there's an upward bias to Commercial, Industrial end markets as we look to the back half of this year. And I'm wondering, John, how are you thinking about the complexion of 2020? And what are some of the factors that inform you on that outlook?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Okay. It's a great question. Well, you saw what outlook we provided, and that outlook was provided at the last third quarter's earnings call, Dave. And then we've kept that outlook the same. If you look at the nature -- I'll first talk about some of the supporting factors and then give the outlook. And we're talking about kind of the nature and mix of our backlog and how that's performed throughout 2019, particularly in the second half, it's a really solid backlog, and we feel good about what's in the backlog, the mix of the backlog. And it's performing more consistent with normal seasonality. So -- and the margin rates in the backlog are up year-over-year. So that's a good, strong data point, I think, as we enter 2019.

By end market, and as Dave outlined, we've got kind of greater visibility, I think, into both Utility and CIG. Utility is supported by the pipeline of opportunities that we're working. What we did and what we expect a bit as we move through the first part of 2020, and we got really good momentum, and you can see how Utility performed in the fourth quarter. I think that's very supportive of that, and the backlog is very healthy.

In CIG, we've got really solid momentum in our datacom and security categories. And that was reestablished and built momentum throughout 2019. And that's against the end-market backdrop that isn't particularly robust for those applications overall but relatively stable and consistent with what we're seeing now. So I think that performance and outperformance we expect to continue.

When you move into Industrial and Construction, I think that's where there is more variability. I would say that the indications around Industrial, notwithstanding some of the overall weakness that we've seen in the end markets and is reflected by others in their initial reported results for the fourth quarter, notwithstanding that, I think given the macroeconomic conditions, our outlook for Industrial in 2020 is -- we should -- relatively stable to what we've been seeing with the potential to improve as we move through 2020. And I think that represents really an excellent opportunity as we move through the year. Business spending is a pause. It's a potential stabilizing factor and accelerating factor to demand as we move through 2020. And I think some of the trade uncertainties are getting resolved, and we'll see how the next chapter of that plays out. So that is looking like we're potentially facing an improving demand curve. I'm hopeful that that's the case. And that would obviously be very, very supportive of our accelerating sales growth in Industrial.

In Construction, there's a series of pluses and minuses. Overall, we expect construction to be relatively consistent end-market-wise in 2020 to 2019. I will say that we had really solid growth in the fourth quarter in Construction, which gives us some confidence as we move into 2020. The majority of our geographic regions in the U.S. grew into Construction or growing in the Construction end market in the fourth quarter. And what's also important to note, and this is not something we've talked about, I think, for several quarters, we -- a lot of times, we'll do the mix in Construction of Industrial-oriented contractors versus commercial contractors, and Industrial-oriented contractors has declined in Q1 and Q2 as part of Construction in the U.S. in 2019 but returned to growth in Q3 and Q4. And obviously, we had growth with commercial-oriented contractors in Q2, 3 and 4 of -- Q1, 2, 3 and 4 of 2019.

So -- and then when you move to Canada, we've seen real strength in DC in Construction, also in Québec. Atlantic and Ontario is solid. We have seen some weakness in the Prairies, and it's not unexpected. We're seeing that both on the WESCO side in pockets of the Prairies and on the EECOL side. And that's in our Q4 numbers. That's really, I think, what brought the Canadian number down a little bit. Overall, oil and gas sales were flat in the quarter, all in. But -- and we had growth -- international growth in the U.S. The Canadian oil and gas was down a bit in the quarter.

So Dave, that's kind of the composite. I wanted to kind of go through by end market. I know it's a long answer. But our daily activity levels, our backlog, and then I'll end on this note, the opportunity pipeline that we have that we measure is phase gated is very large. For Global Accounts, it's at the highest levels we've ever seen. And so that does give us some encouragement, I think, in terms of what the potential is, as confidence improves as we move through 2020, and confidence being customer confidence.

--------------------------------------------------------------------------------

Operator [4]

--------------------------------------------------------------------------------

And the next question comes from Deane Dray with RBC Capital Markets.

--------------------------------------------------------------------------------

Deane Michael Dray, RBC Capital Markets, Research Division - MD of Multi-Industry & Electrical Equipment [5]

--------------------------------------------------------------------------------

I think you've explained the mix issue this quarter. We get that. And maybe if you could provide some more color on price/cost. So when you referenced the time lag in putting through supplier price increases, overall, you like the conditions and rising prices. So -- and you should be prepared for that. So were these lags a system issue, a procedural issue, or was it customer resistance? Because that -- I saw that second bullet about the competitive environment. So maybe if you could just tie those together, price/cost, what the dynamics are there.

--------------------------------------------------------------------------------

John J. Engel, WESCO International, Inc. - Chairman, President & CEO [6]

--------------------------------------------------------------------------------

Yes. So I think there are 2 factors. I think the environment was challenging, and you saw that someone else reported this morning, a few other reports were prior to today, and you get a sense of what those other distributors are seeing in terms of customer pricing environment. So I think, overall, the environment was a bit challenging. That's on the customer pricing side that -- call that market, Deane.

On the supplier side, Dave outlined, that's why we want to specifically point that out with his prepared comments about the number and the magnitude of the price increases. In number, they're a little bit lower in '19 and '18, but the magnitude of the increases were substantially larger in '19 than '18. So that's on the other end of our value chain with suppliers. So that's the market, and that continued through Q4. It was a little different for WESCO, and we've talked about at length over the years is our mix. And so it takes us some time to work it through with our Global Account customers, our Integrated Supply customers and such. And that time lag we've seen time and time again. We're working through that. I think we've got good traction in terms of how we're pushing those through. The time lag now is we should start seeing the other side of that as we move through 2020. And we're encouraged with the start of January. January is not fully done yet. But month-to-date, we've seen a step-up in our daily transaction margins, billing margins, sequentially versus the fourth quarter, which is an encouraging data point.

--------------------------------------------------------------------------------

Deane Michael Dray, RBC Capital Markets, Research Division - MD of Multi-Industry & Electrical Equipment [7]

--------------------------------------------------------------------------------

Yes. I probably should have added that we have seen industrial distributors this quarter 1 reported today that had negative price for the first time in years. So yes, we understand this is the environment that you're in, and it's not a WESCO-specific pressure there. And then second question, could you give some color around the SLS issue? Was this execution and degree of confidence in addressing the problem this quarter?

--------------------------------------------------------------------------------

John J. Engel, WESCO International, Inc. - Chairman, President & CEO [8]

--------------------------------------------------------------------------------

Not execution. I would say the -- that there's an excellent and very strong pipeline of opportunities, and we actually cited -- we always try to cite wins by the market. Two of the wins that we cited this quarter were lighting LED retrofit, renovation update retrofit-related projects. Look, I think the real challenge was just some delay of the projects that they have been working in their pipeline opportunities as well as projects that were underway. So there's been a bit of a delay on some of those projects, which move things to the right.

And how would you read that or translate that? That translates into, for a retrofit renovation and upgrades, those types of projects, there is a -- you could -- there's a discretionary aspect to those in terms of when they get launched. So if there's some uncertainty around the environment by customers, they can kick the can out a quarter or 2. The economics and the ROI in terms of lower energy saving -- lower energy consumption, which translates to energy savings and sustainability benefits, those business cases are intact. And LED retrofit projects are providing very compelling business cases to do the retrofit, but the decision on making those can get kicked out a month, a quarter or 2, depending on what that particular customer's view of the market environment is and what their particular situation is on spending. So that's what happened, Deane. I still -- lighting is one of our big growth engines. We're still very bullish on our prospects in lighting, and we have an excellent set of end-user customer relationships. The opportunity pipeline is very large and robust, and we expect that to be a strong contributor as we move through 2020 and beyond for WESCO.

--------------------------------------------------------------------------------

Operator [9]

--------------------------------------------------------------------------------

The next question comes from Sam Darkatsh with Raymond James.

--------------------------------------------------------------------------------

Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [10]

--------------------------------------------------------------------------------

Two questions, if I could. First, Dave, last week, Standard & Poor's disclosed that it doesn't -- it's not going to be considering the 9.25 preferred as an equity instrument when determining their ratings, their debt ratings. How does this -- or does this affect your thoughts on the amount or the -- what constitutes the equity and/or debt issuance going forward? I think there's a fair amount of confusion or concern in terms of whether this actually means that there would be more of an equity dilution or an equity issuance because of it.

--------------------------------------------------------------------------------

David S. Schulz, WESCO International, Inc. - Senior VP & CFO [11]

--------------------------------------------------------------------------------

Yes, Sam. So that's obviously something that we're still working our way through. But as -- just to give you a little bit of the background on this, as we put together the offer consideration for the Anixter combination, we work with our advisers to structure the preferred to receive equity treatment. And that was based on the guidelines that are established by both agencies that we're using. You may have seen that Moody's has issued a note saying that they expect to assign full equity credit to the preferred. S&P placed our rating on watch negative. And in their preliminary note, they expressed the need for more information. So we're going to continue to work with S&P to provide them with the information that they need and hopefully reach a -- the conclusion that we were planning for when we put together the consideration mix with the preferred.

As we think about it, right now, there's still a lot of situations that we're working our way through as it relates to this. So as soon as we have more details on that, we expect to inform the market, particularly when it comes to the capital structure to complete the acquisition. And again, right now, there's just a lot of moving pieces on that, but we're expecting, from an accounting treatment perspective, the preferred has not changed. We intend to recognize the preferred as equity. We're waiting to see how the rating agencies will also view that going forward.

--------------------------------------------------------------------------------

Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [12]

--------------------------------------------------------------------------------

So to be clear, the 4.5x leverage that you expect considers the preferred as equity? That's the consideration?

--------------------------------------------------------------------------------

David S. Schulz, WESCO International, Inc. - Senior VP & CFO [13]

--------------------------------------------------------------------------------

That is correct.

--------------------------------------------------------------------------------

Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [14]

--------------------------------------------------------------------------------

Okay. And then the last question I have, there's a fair amount of question as to potential accretion from the deal, especially year 3. There's obviously a huge range out there that we've seen from both the sell side and buy side. And any thoughts or quantification or range that you might be able to provide at this point?

--------------------------------------------------------------------------------

David S. Schulz, WESCO International, Inc. - Senior VP & CFO [15]

--------------------------------------------------------------------------------

We expect to provide an estimate of the accretion during the first quarter. So right now, we are still working through several factors that will inform and influence that accretion calculation. Obviously, the timing of the close, the amount of cash that's generated by both companies between signing and close and how that will impact the capital structure. And obviously, we're still doing quite a bit of evaluation work as it relates to the intangibles on the purchase price. So there's a lot of variables that we're still working our way through, but we fully expect that during the first quarter, we will be informing the market of our estimate of accretion, at least for year 3.

--------------------------------------------------------------------------------

Operator [16]

--------------------------------------------------------------------------------

And the next question comes from Nigel Coe with Wolfe Research.

--------------------------------------------------------------------------------

Cristian Jose Ramos, Wolfe Research, LLC - Research Analyst [17]

--------------------------------------------------------------------------------

This is Cristian Ramos sitting in for Nigel. So I just wanted to touch back on Anixter. And we've been getting questions on whether or not the management team would consider issuing the equity a little sooner, just given the overhang that exists in the stock today. Any color or thoughts there?

--------------------------------------------------------------------------------

David S. Schulz, WESCO International, Inc. - Senior VP & CFO [18]

--------------------------------------------------------------------------------

Yes. Cristian, it's Dave Schulz. So again, we're still working our way through the capital structure decisions. I would tell you that we're clearly focused on ensuring that we get a Q2 or Q3 close of the deal. We're working through all the appropriate regulatory approvals that are required. We're working through the specifics on the capital structure. Again, I would tell you that it's not going to be influenced as much by our stock price as much as it's going to be influenced by the timing of those approvals and then when we can get out and begin raising the appropriate number of shares outstanding. So we're working on it.

--------------------------------------------------------------------------------

Cristian Jose Ramos, Wolfe Research, LLC - Research Analyst [19]

--------------------------------------------------------------------------------

Got it. That's actually very helpful. And then just if I could squeeze another one on price -- on gross margins, really. Could you guys parse out how much of the decline was driven by price/cost versus mix?

--------------------------------------------------------------------------------

David S. Schulz, WESCO International, Inc. - Senior VP & CFO [20]

--------------------------------------------------------------------------------

Yes, I would tell you that in previous quarters we said that it was approximately half and half: half mix, half price/cost. I would tell you that in this environment, in the fourth quarter, we saw a little bit more of an impact on price/cost. But again, our gross margins were sequentially flat with Q3. And again, we saw a little bit more of an impact from price/cost in Q4. As we think about our operating margins going forward, we fully expect, as is shown in our guidance, that we're going to see operating margin improvement in 2020. That includes improvement in our gross margins as well. So again, for the fourth quarter, a little bit more on the price/cost as an impact than we saw in Q3.

--------------------------------------------------------------------------------

Operator [21]

--------------------------------------------------------------------------------

And the next question comes from Hamzah Mazari with Jefferies.

--------------------------------------------------------------------------------

Mario J. Cortellacci, Jefferies LLC, Research Division - Equity Analyst [22]

--------------------------------------------------------------------------------

This is Mario Cortellacci filling in for Hamzah. So a kind of question on the deal. So I believe one of the reasons why you wanted to do a transformational deal is to get better supplier concessions. And I think the largest supplier for you and Anixter are different. So I was just curious to know, I guess, how hard or how tough those negotiations tend to be. And how long do you think it'll take before you get better rebates?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

So first, I think the construct of your question kind of centers around a point you're making on the rationale for the deal. That's not the rationale for the deal. So let me kind of take you back through that. I think it's incredibly important. I spoke at this at length at our Investor Day last year in June, so I encourage you to go back and go back through that. We spent -- we had a 4-plus-hour Investor Day. And we -- we're very clear about our views of the nature of the B2B distribution value chain, how that's evolving, the impact of digital, what's happening in terms of the customer end of our value chain, and those customers are looking at consolidating the supplier base, what's happening on the supplier end of our value chain where suppliers have been coming together, be it acquisitions and combinations over the last decade, and it was an imperative for distribution. It is still very highly fragmented, particularly in North America, both U.S. and Canada, to consolidate. And we consolidate at a faster rate.

And I foreshadowed that I expected that the bigs would come together, "the bigs." The bigger distributors in the core and the distribution portion of the value chain would come together. And I also said the imperative was that these will be -- give the opportunity for the bigs to have a transformational combination that does several things. You have greater scale with an enhanced footprint, geographic footprint, and a broader portfolio of supply chain services. That absolutely is the case with the WESCO-Anixter combination. And also, the combined platform would provide significant growth and cross-selling opportunities. That absolutely is the case for the WESCO-Anixter combination. And there'll be the opportunity to generate significant synergies in the first 3 years after combination. That absolutely is the case with the WESCO-Anixter combination.

And four, there's strong cash flows, both of these companies have been well-run distribution companies. The cash flows are very strong across all phases of the economic cycle. They're countercyclical when the economy slows down, and so their strong combined cash flows, the enhanced margins as a result of the combination and EPS accretion in the first full year of ownership is the compelling financial rationale.

Finally, most importantly, the combined business would be in a much better position to invest in digital capabilities and to take a leadership role in transforming their business in the context of a more digitized value chain in B2B distribution, like what exists in B2C, the value chains. And that evolution has occurred over the last few decades.

So very compelling set of rationale. I mean the short summary would be, in terms of growth, 1 plus 1 is going to be much greater than 2. Putting these 2 together in terms of cost, 1 plus 1 is less than 2. And then that increased margin allows us to deliver a significant portion to our investors in the form of accretion and also invest to a greater degree in the business to drive and lead the digital transformation. So that's the rationale of the deal.

--------------------------------------------------------------------------------

Mario J. Cortellacci, Jefferies LLC, Research Division - Equity Analyst [24]

--------------------------------------------------------------------------------

Great. Appreciate it. And then just one follow-up, and I'll turn it over. Just curious to know, I guess, how you're thinking about structuring your sales force or the combined sales force once the deal is closed.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

In terms of specific integration planning and those details, look, we're early in our integration planning, preparations and discussions. So look, we're very focused on getting through the activities between sign and close. And as we move forward in the process, we get the deal successfully closed, we'll have a dedicated integration team and be working aggressively to take the best of the best of both companies and drive what I said, the top line opportunities, the cost synergies. And through that process, we'll be very clear as we make decisions and integrate the 2 large leading distribution companies.

--------------------------------------------------------------------------------

Operator [26]

--------------------------------------------------------------------------------

And the next question comes from Steve Barger with KeyBanc Capital Markets.

--------------------------------------------------------------------------------

Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [27]

--------------------------------------------------------------------------------

Well, I appreciate all the end-market commentary you gave to start the call. I just want to make sure I understand the 1Q revenue guide. I believe you said you expect softer demand environment in the first part of the year, but the 1Q revenue guide of 2% to 5% is above the full year guidance of 0% to 4%. So can you just talk through the assumptions that went into that specifically?

--------------------------------------------------------------------------------

David S. Schulz, WESCO International, Inc. - Senior VP & CFO [28]

--------------------------------------------------------------------------------

Yes, certainly, Steve. It's Dave Schulz. So clearly, as we take a look at Q1 and knowing what we have in our backlog, what's expected to ship in Q1, clearly, we're comfortable with the range that we put out there. It also was demonstrated by our results in the month of January. So we talked about January month-to-date being up low single digits. We're right around the midpoint of the guide of 2% to 5% in the month of January to date. And so we feel good about the 2% to 5%. Remember that last year, Q1 was also probably our softest comp, and we have 1 extra day in the quarter this year versus last year.

--------------------------------------------------------------------------------

Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [29]

--------------------------------------------------------------------------------

Got it. And I understand, Dave, the comment on how the secondary won't be influenced by stock price but more the timing of approvals. But just as you've gotten more to the planning process, is there any updated thought on the size of the planned secondary? And just in general, do you think that's a 1Q or a 2Q event when you go to market?

--------------------------------------------------------------------------------

David S. Schulz, WESCO International, Inc. - Senior VP & CFO [30]

--------------------------------------------------------------------------------

Yes, Steve. We haven't been able to define that size more definitively, yes. We talked about it being greater than $400 million in equity or equity-content securities that we would issue. We're still working through the timing. Obviously, a lot of that will be dependent upon when we receive regulatory approval as we've got to file the registration statement with the SEC. We're working through all of that. So that will obviously influence the timing of when we're out there marketing the equity.

--------------------------------------------------------------------------------

Operator [31]

--------------------------------------------------------------------------------

And the next question comes from Robert Barry of Buckingham Research.

--------------------------------------------------------------------------------

Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [32]

--------------------------------------------------------------------------------

So I know you don't like to get into specifics in talking about guiding gross margin, but just given the pressure seems to be continuing and when you look at the expectations for growth by end market, it does suggest some continued mix pressure on gross margin this year. Just is it fair to assume, though, that in that 4.1% to 4.4% op margin outlook that you have contemplated I know there's some decent amount of gross margin pressure in there?

--------------------------------------------------------------------------------

David S. Schulz, WESCO International, Inc. - Senior VP & CFO [33]

--------------------------------------------------------------------------------

Hey, Rob, it's Dave Schulz. Yes, we have that included in how we think about 2020 and the progression of the gross margin in 2020. So very clearly, looking at the outlook for 2020 with a midpoint of 2% on sales, plus inflation on the SG&A, in order for us to get that margin improvement at the midpoint, we do have gross margin improvement. That's what we've been working on. We've talked about being able to recover that price/cost lag as we progress through 2020. So again, we do have the gross margin improvement built into our expectations for this year.

--------------------------------------------------------------------------------

Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [34]

--------------------------------------------------------------------------------

So I'm sorry, just to clarify, you think that the gross margin will be up in 2020 year-over-year?

--------------------------------------------------------------------------------

David S. Schulz, WESCO International, Inc. - Senior VP & CFO [35]

--------------------------------------------------------------------------------

That is correct.

--------------------------------------------------------------------------------

Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [36]

--------------------------------------------------------------------------------

Okay. Yes, I was actually suggesting the opposite. It just seems like given the comments about price/cost and given the outlook for growth is better in the lower gross margin end markets, that, in fact, the gross margin would be down. But it sounds like, I don't know, you have some confidence that there'll be some offsets there where pricing will improve.

--------------------------------------------------------------------------------

David S. Schulz, WESCO International, Inc. - Senior VP & CFO [37]

--------------------------------------------------------------------------------

We do. And very clearly, we've been seeing that lag, particularly the last 6 months, on getting price/cost. And we've been able to push through on a dollar-for-dollar basis, but we've seen the erosion of the gross margin rate, which is just the math. Our team is working very diligently to continue to pass through price increases from suppliers and restore the gross margin rate. And so that's something that we're focused on. We understand, and it is clear that based on the mix of our outlook with the end markets for 2020, we do have clearly some higher growth in like our Utility business as expected. That will create a slight impact on the mix line, but we are laser-focused on driving through price to our customers and again, ensuring that we get full value for the products and services that we can provide. So we do have that assumption built into our 2020 outlook.

--------------------------------------------------------------------------------

Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [38]

--------------------------------------------------------------------------------

Got it. Got it. And then, I guess, I just wanted to get a little more clarity on what was going on in CIG. I mean the growth rate really stepped up dramatically against actually what was also the toughest comp of the year. So any kind of big projects happening there or timing of anything or anything to say about just that significant step-up in growth?

--------------------------------------------------------------------------------

John J. Engel, WESCO International, Inc. - Chairman, President & CEO [39]

--------------------------------------------------------------------------------

Rob, I already alluded to that, I think. And Dave had it in his prepared commentary, and I hit it earlier with an answer to a question, datacom. Datacom and security, very strong growth, built momentum across 2019. We feel very good about the execution we're doing with that -- with those categories, with those customers.

--------------------------------------------------------------------------------

Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [40]

--------------------------------------------------------------------------------

Got it. Got it. Just lastly for me, a quick one on the deal. This may also be a question you don't -- can't answer at the moment yet. But any thoughts initially on what your amortization might look like? And if it's significant, might it be warrant considering going to a cash EPS number?

--------------------------------------------------------------------------------

David S. Schulz, WESCO International, Inc. - Senior VP & CFO [41]

--------------------------------------------------------------------------------

Yes, Rob. That's one of the things that we're still working our way through is the valuation of the purchase price allocation to the intangibles and what impact that would have on amortization. Clearly, this is work that we were only really able to start after we had signed the agreement, so we're still relatively early in this. That is something that, right now, we don't have an answer. And that's also one of the key reasons why we're just not at that stage where we're able to provide you with that full accretion estimate. Once we nail that down, along with the capital structure, we'll be able to provide you with more details.

--------------------------------------------------------------------------------

Operator [42]

--------------------------------------------------------------------------------

This concludes our question-and-answer session. I would like to turn the conference back over to John Engel for any closing remarks.

--------------------------------------------------------------------------------

John J. Engel, WESCO International, Inc. - Chairman, President & CEO [43]

--------------------------------------------------------------------------------

Yes. Thank you all for your time this morning. Brian and Will will be available to take your questions. And we look forward to seeing many of you at one of our investor marketing events that we will be participating in during the first quarter, including the Raymond James 2020 Institutional Investors Conference in early March. Have a great day.

--------------------------------------------------------------------------------

Operator [44]

--------------------------------------------------------------------------------

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