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Edited Transcript of WCC earnings conference call or presentation 2-May-19 2:00pm GMT

Q1 2019 Wesco International Inc Earnings Call

PITTSBURGH May 6, 2019 (Thomson StreetEvents) -- Edited Transcript of Wesco International Inc earnings conference call or presentation Thursday, May 2, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* 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

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Conference Call Participants

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* Bhupender Singh Bohra

Wolfe Research, LLC - Research Analyst

* 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

* Deane Michael Dray

RBC Capital Markets, LLC, Research Division - Analyst

* Patrick Michael Baumann

JP Morgan Chase & Co, Research Division - Analyst

* Robert Douglas Barry

The Buckingham Research Group Incorporated - Research Analyst

* Ryan Thomas Mills

KeyBanc Capital Markets Inc., Research Division - Associate

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Presentation

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Operator [1]

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Good day, and welcome to the WESCO First Quarter 2019 Earnings Conference Call and Webcast. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Will Ruthrauff, Director of Investor Relations. Please go ahead.

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

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Thank you, Arianna. Good morning, ladies and gentlemen. Thank you for joining us for WESCO International's conference call to review our first quarter 2019 financial results. 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. 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 were 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.

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

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

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Thank you, Will. Good morning, everyone, and thank you for joining us for today's earnings call. I'll lead off with a few high-level remarks and then Dave will take you through our first quarter results and 2019 outlook. I'll then conclude with some comments about what we'll cover at our upcoming Investor Day before we open the call for questions.

We started off 2019 with sales and operating margin within our outlook range for the first quarter. Our sales growth rebounded nicely and margin continued in April after a slow start in January and February. Importantly, gross margin expanded both sequentially and year-over-year in the first quarter and reached its highest level since early 2017, demonstrating the positive impact of our margin improvement initiatives and the effectiveness of passing through price increases from our supplier partners.

Backlog increased sequentially and margin in our backlog also increased both sequentially and compared to prior year, providing a positive set up for the balance of 2019. After completing the SLS acquisition in the first quarter and accelerating our share buyback program last year, our financial leverage ratio is stable and well within our control band. Finally, as you saw in our release earlier today, we have a constructive outlook for our end markets this year and we are maintaining our full year 2019 outlook for sales, operating margin, EPS and free cash flow.

With that, I will now turn the call over to Dave to provide further details on our first quarter results as well as our second quarter financial outlook. Dave?

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

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Thank you, John, and good morning, everyone. I'll start with an overview beginning on Page 4. Reported sales in the quarter were down 2%, which was at the lower end of our outlook range of down 2% to up 2%. On an organic basis, sales were up 1% with 3% growth in Canada, flat sales in the U.S. and 8% growth in our international markets. Pricing provided a favorable impact of approximately 2%.

During the quarter, we experienced a significant number of branch closures and shipment delays due to winter weather events that impacted our customers' operations. This is primarily reflected in weaker-than-expected sales results in January and February, offset by stronger sales in March. Recall that 2018, our organic sales growth in the first quarter was 9%, 14% and 11% for January, February and March, respectively.

Billing margins improved in all end markets and geographies on a year-over-year and sequential basis in the first quarter, reflecting the positive impact of our margin improvement initiatives.

Gross margin was 19.5% in the quarter, up approximately 40 basis points over the prior year and up 10 basis points sequentially. Notably, this is the third quarter in a row of improvements in our gross margins. Gross margins this quarter were impacted negatively by business mix, although there was a slight benefit to gross margins from the SLS acquisition that closed on March 5. Neither of these impacts were material to the quarter's results.

The prior volume rebates as a percentage of revenue were consistent with rates in the prior year. SG&A expenses were approximately 2% higher than the prior year or 15.1% of sales, primarily reflecting the impact of the SLS acquisition. Excluding the SLS acquisition, SG&A was up approximately 1% primarily due to annual increases in payroll-related costs, partially offset by continued effective operating expense management and controls. Operating profit in the first quarter was $70.7 million or 3.6% of sales within our outlook range for the quarter. The effective tax rate for the quarter was 21.7%, slightly lower than our expected rate of 23%, but higher than the prior year rate of 19.6%.

Moving to the diluted EPS walk on Page 5. We reported diluted earnings per share of $0.93, flat with the prior year. This reflected a slight decrease from operations and a higher effective tax rate, positively offset by lower share count. The higher effective tax rate was primarily attributable to the full application of the international provisions of U.S. tax reform. The lower share count reflects approximately 2 million fewer shares due to share repurchase activity. The SLS acquisition was neutral to both operating profit and EPS in the quarter.

Moving to our end-market results, beginning on Page 6. Industrial sales were flat versus the prior year and down 2% sequentially. Compared to the prior year, sales were flat in both the U.S. and Canada in local currency. On a 2-year stack basis, sales were up 10%, marking the fifth consecutive quarter of double-digit sales growth. Overall, momentum with industrial customers remains positive. Several of our global account industry verticals grew over the prior year, including petrochemical, metals and mining and food processing, offset by declines with a number of OEM customers. We continue to expect growth in industrial end market in 2019. The macroeconomic indicators remain in expansion territory, supported by strong production levels and capacity utilization in the U.S. and Canada. Additionally, we see opportunities as customers spend capital to drive productivity. The opportunity pipeline activity remains strong with our Global Accounts and Integrated Supply customers and bidding activity levels increased in the first quarter.

During the quarter, we renewed a contract with a U.S.-based metals and mining company to support capital projects and provide electrical and MRO materials for 5 years with estimated total revenues exceeding $250 million. This represents 15% growth per year on average versus our current run rate with this customer.

Turning to Page 7. Sales in the construction end market were up 2% in the quarter, reflecting sales that were down 1% in the U.S. and up 8% in Canada in local currency. Sales were down 8% sequentially from the fourth quarter, approximately in line with typical seasonality. On a 2-year stack basis, construction sales were up 12%, reflecting incremental growth this year on top of more than 9% growth experienced in the prior year.

Business momentum improved in March with contractors in both the U.S. and Canada after a slow start in January and February. We expect moderate growth in the uptrend in the nonresidential construction market to continue in 2019. Construction customers remain challenged by a tight skilled labor market in the presence of both inflationary and tariff-related price pressures, which have increased costs for certain projects. Our WESCO project management and construction services solutions target these customer challenges by reducing supply chain complexity and in increasing construction job site productivity.

Backlog in current constant currency was down 2% versus the prior year and up 5% sequentially, reflecting normal seasonality. March backlog was the second highest ever and billing margins in our backlog are higher on both the sequential and year-over-year basis. As an example of our continued success, this quarter, we were awarded a multimillion dollar contract to provide electrical gear and equipment for a hospital upgrade project in Western Canada.

Moving to Page 8. Our utility sales were flat year-over-year with U.S. sales up 3% and Canadian sales down 38% in local currency. The decrease in Canadian utility sales primarily reflects the nonrenewal of a contract that was at an unacceptable margin that we discussed last quarter. Negative comparisons in our Canadian utility sales are expected to occur through the third quarter of this year. We continue to expand our scope of services with investor-owned utility, public power and utility contractor customers. WESCO is benefiting from secular trends in the utility sector, including construction market growth, increased industrial output, grid hardening and reliability projects and higher demand for renewable energy.

After 7 years of growth in utility, we expect 2019 to be another strong year. Bidding activity levels are high, backlog has grown and we have a robust opportunity pipeline. This quarter, we were awarded a 5-year contract with estimated total revenues of more than $350 million for a new investor-owned utility customer to provide electrical generation, transmission and distribution materials, lighting and MRO supplies, including tools and safety products. We expect to commence operations with this customer in the third quarter.

Finally, turning to commercial, institutional and government, or CIG, on Page 9. Sales increased 2% with the U.S. down 5% driven by declines with several end-user technology customers, but more than offset by Canada, which was up 22% in local currency. On a 2-year stack basis, CIG sales were up 11% in the quarter, marking the fourth consecutive quarter, in which sales increased by double digits on a 2-year basis. This performance was driven by our strong capabilities and value-added services in LED lighting renovation and retrofit applications as well as fiber-to-the-x deployments, broadband build-outs and network and security solutions. As an example of the continued strength we are seeing in CIG, this quarter, we were awarded a multimillion contract to provide lighting materials for an energy savings upgrade at a federal government facility.

Turning to Page 10. Free cash flow was $18 million or 43% of net income. Net working capital was a use of cash in the quarter, primarily due to an increase in accounts receivable related to the sales increase we experienced late in the quarter. Additionally, we made certain investments in inventory to support our Utility alliance customers. We remain on track to generate free cash flow of 90% of net income for the full year.

Debt leverage ratio was again 3.0x trailing 12 months EBITDA, well within our target leverage range after completing the acquisition of SLS in the first quarter. Leverage net of cash was 2.8x EBITDA.

As a result of adopting the new lease accounting standard at the beginning of the quarter, our balance sheet at the end of the period includes operating lease assets and liabilities of approximately $235 million. The adoption of the lease accounting standard did not have a material impact on the income statement or the statement of cash flows. We maintained strong liquidity, defined as available cash plus committed borrowing capacity of $781 million at the end of the quarter. Our weighted average borrowing rate was 4.6% for the quarter, consistent with historical averages. We repaid the remaining $25 million of debt under our term loan facility this quarter and at 68%, believe our percentage of fixed rate debt is appropriately balanced between fixed and variable rate instruments. Capital expenditures were $11 million in the quarter, reflecting investments in information technology tools, digital applications and facilities.

During the quarter, we purchased the assets of SLS for approximately $28 million and we settled the $100 million accelerated share repurchase transaction entered into last November. We received a total of nearly 2 million shares from this transaction, including approximately 0.4 million shares received in the first quarter.

Consistent with previous statements, we expect to complete additional share repurchase transactions worth at least $75 million prior to June 30 of this year. With the expected repurchase in the second quarter, we will have completed $200 million of the $400 million share buyback authorization that expires at the end of 2020.

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 consistent. 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 and 3.5x EBITDA. Third, we returned cash to shareholders through share repurchase under our 3-year $400 million share buyback authorization.

Now let's turn to our outlook for the second quarter and full year on Slide 11. For the second quarter, we are projecting sales growth to be in the range of 3% to 6% and operating margin to be 4.5% to 4.8%. At the midpoint, this operating margin is 35 basis points higher than the prior year. However, you may recall that the prior year operating margin was negatively impacted by a bad debt charge of $2.5 million for a specific Canadian customer, which reduced operating margin by approximately 15 basis points.

We are expecting an effective tax rate of 23% in the second quarter, consistent with the balance of the year. For the full year, our outlook is unchanged from the estimates we provided in January. We expect sales growth of 3% to 6%, operating margin of 4.3% to 4.7%, an effective tax rate of 22% to 24%, diluted EPS of $5.10 to $5.70 and free cash flow of approximately 90% of net income. This outlook now incorporates the SLS acquisition, which was not included previously. We expect SLS to add less than a point of sales growth in 2019. Compared with the prior outlook, the benefit of SLS is expected to be offset by additional foreign currency headwinds. We are holding the operating margin and EPS outlook range as SLS is expected to be neutral to profit in 2019, as we previously stated when we announced the acquisition.

With that, let me turn the call back over to John for some additional remarks before we open the line for questions.

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

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Thank you, Dave. I wanted to briefly preview some of the initiatives that we're looking forward to discuss with you at our upcoming 2019 Investor Day in June. As we look to the future, changes are accelerating in our business and up and down the overall B2B value chain. We will share with you our strategic initiatives to meet current and future needs of our customers, take share in the market and drive value creation for our shareholders. These initiatives include advanced digital capabilities, digitizing our business models and processes, while expanding our B2B e-commerce solutions for our customers. That's the first initiative we will outline for you.

Secondly, commercial excellence. That's leveraging our Big Data to improve execution in all phases of the customer experience. Third, operational excellence initiatives. They're all focused on optimizing our operations and overall supply chain through our distribution center network and branch structure, enhanced pricing capabilities and supplier management efforts. Finally and fourth, organization talent and culture. I've always said we're a people business, that's the foundation of our company. We'll be building on our lean continuous improvement culture and investing in our employees and in communities through increased training and development, sustainability endeavors and social initiatives.

With that, I'd like to open up the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Dray Deane with RBC Capital Markets.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [2]

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I know you don't like to blame external forces like the weather, but it did impact a number of distributors and other industrials this quarter. So maybe if we can start with sizing the impact, you could see it in January and February organic. Looks like some was recouped in March, but how much do you think was recouped in March? And what was the net effect for the quarter, please?

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

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Yes. I mean, Deane, we always -- we don't like to talk about that. You know that. That's not -- historically, we don't like to point the weather for any impact, unless there's a hurricane or something that results in a net positive sales. That's an episodic event. With that said, it was a challenging winter and there were some weather impacts driven by the severe weather winter and the polar vortex. In the first quarter, it affected a number of our U.S. branch operations and customer operations for that matter as well as Canada. And my time at WESCO, I'd be hard-pressed to remember when we've had actually some winter effects in Canada. And I think if you look at the profile of our sales, January, February and March, it clearly impacted late January, end of February. We saw a nice pickup in March, and that's extended into April. So I don't want to size that per se, but we saw the recovery in March. I saw your pre-notes. I'll answer that question to give a little better color. When you look at March sales, every end market and every geography grew and nothing was close to 0. So all kind of mid -- mid-single-digit range. So a really nice balanced growth profile in March, Deane. And we think we recovered some of the weather impact in Q1, but not all of it. So I think the balance of that will be in Q2. Because the impact on our operation, just given the mix of our business, our business model, by and large that demand, it's not perishable. It just kind of moves to the right a bit, right? Mainly project activity and stuff that we had in backlog we couldn't ship because branches were closed. As they get back running, that gets shipped with a delay. Does that help?

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [4]

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Yes, that helps exactly. So I appreciate that color. And just in terms of your verticals, can you expand more on what's going on in the construction markets that you touch, down U.S. by 1%. Could you calibrate us on bid activity, project size and maybe some color within the verticals in construction?

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

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Yes. I would say, overall and at the aggregate level, I think we had a solid quarter in construction. But to your point, if you kind of double-click underneath that, we had really solid growth. I'd even call strong growth in Canada at an 8% organic. We think that's obviously well in advance of the market. International grew -- it's much smaller portion, but that grew double digits in construction in the quarter. So the challenge was the U.S. and it was down 1% organically, roughly flattish. I think we had -- clearly had some of that weather impact, which was more notable in the U.S. When you look at across the various end-market verticals and even the geographic regions, over half of our regions in the U.S. grew in construction in the quarter. So -- but where we did have the impact, it kind of does sync up with kind of the slower start in January and February. I would say we're -- I'm still very optimistic and confident of how construction should unfold for the year. Our framework for low to mid-single-digit growth for the year is still intact. You see that we reaffirmed our guide for the full year, maintained it with SLS being added, as Dave mentioned, offset by increased FX headwinds when we gave the guide. And you look at our outline guidance, top line guidance for Q2, as we move in the construction season, it represents a nice performance versus what will be a very challenging comparable, right, in Q2 last year. So when you look on a 2-year stack basis, this outlook for Q2 represents accelerating momentum clearly in Q2 versus 1. Finally, I'd say backlog is strong. It's up 5% sequentially and the quality of the backlog is excellent, particularly as reflected in billing margins. So I think, we're well positioned as we start to move through the construction season, Deane.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [6]

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And just one last one for me, if I could. Just with regard to the weather issue. Some industrials have talked about the impact of a bigger pull-in out of first quarter into the fourth quarter. Might that have been at play at all in your weaker January or February? Or was that a nonissue for you guys?

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

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For us, nonissue. We really didn't see that. And if we had seen some -- any of that, we would have gave that color when we did the Q4 earnings release. That was -- nothing notable for us.

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Operator [8]

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Your next question is from David Manthey with Baird.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [9]

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So just quick question on the SLS acquisition. Based on the abbreviated cash flow statement, should we assume the purchase price was $28 million?

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David S. Schulz, WESCO International, Inc. - Senior VP & CFO [10]

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That's correct, Dave. So we had outlined that we paid approximately $28 million for SLS. That closed on March 5.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [11]

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Yes. Okay. And then in your filings, you typically say that quarters 2, 3 and 4 are generally 6% to 8% higher than the first quarter. Just so I'm modeling correctly, is that daily sales or is that just overall revenues?

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David S. Schulz, WESCO International, Inc. - Senior VP & CFO [12]

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Dave, we provided that as -- to provide our investors with a view of our seasonality. And we also highlight that, that varies considerably from business cycle to business cycle. That's on a reported sales basis as it's in our 10-K on a GAAP basis. One of the things that I'd highlight is I'm sure that you guys have done the math and you're seeing that we do have a substantial step-up in the balance of the year to hit the midpoint of our guidance for 2019. But if you take a look at some of the history on that, the -- in 2016, that first quarter to balance of the year was a 4% growth. In '17, it was 11%. So we've had quite a variability over the last several years on that seasonality.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [13]

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Yes. Okay. That's helpful. And then finally, on the days -- selling days per quarter, most of the other companies that we cover are saying that they lost a day in the first quarter, but they're picking up a selling day in the third quarter. But you're showing, what, 63 days in the third quarter of '19. Is there -- just as a rule of thumb, is there a methodology you use in terms of the selling days that would lead to that conclusion? I'm just trying to square that.

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David S. Schulz, WESCO International, Inc. - Senior VP & CFO [14]

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We always look at our selling days as the consistent workdays. It's the same methodology we use. And again, we use the calendar quarters. And we're just subtracting out the -- essentially the federal holidays. And again, on a lot of the holidays that some companies maybe reporting as not a workday, we're still open for business. So we have provided you with those numbers on a consistent methodology from year-to-year.

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John J. Engel, WESCO International, Inc. - Chairman, President & CEO [15]

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So we saw -- the 1 workday delta in Q1, we also had that in our first quarter results, Dave, to your point.

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Operator [16]

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The next question is from Nigel Coe with Wolfe Research.

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Bhupender Singh Bohra, Wolfe Research, LLC - Research Analyst [17]

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This is Bhupender here for Nigel. Okay. So I just wanted to get a sense of the -- I know this quarter was like a less day than actually the rest of the year in terms of 90 days quarter. Was there any impact from the movement of Easter holiday like from the first quarter to second quarter compared to last year?

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

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It's Dave Schulz. We didn't really see an impact from the movement of Easter. Easter was April 1 in 2018. We essentially are open in most of our locations on Good Friday and on Easter Monday. So we didn't really see an impact from the Easter holiday and how it was positioned in 2018 versus 2019.

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Bhupender Singh Bohra, Wolfe Research, LLC - Research Analyst [19]

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Okay. Got it. And just was looking at your balance sheet, actually, the inventory pickup in 1Q versus fourth quarter, you did actually talk about you didn't see any kind of pull-through demand or pull-through into the fourth quarter. So can you just explain why the inventory buildup actually in the first quarter?

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

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Sure. Clearly, as we expect sales to accelerate in the balance of the year, we begun planning the inventory specifically for some contracts that we were awarded. And so we are planning to ensure that we are having that inventory on hand to maintain our customer service metrics, and so we begun building that inventory in the first quarter. We typically see that throughout our history. We're generally a combination of the contracts that we have signed, plus the seasonality of the construction cycle. Generally, leased and inventory build up in the first quarter.

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Bhupender Singh Bohra, Wolfe Research, LLC - Research Analyst [21]

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Okay. Got it. And lastly, just wanted to focus on one of the comments you made last quarter about -- within your construction Canada business. I think, we talked about some market share gains over there. And I see, like, plus 8 number here in the quarter. Can you just expand on that, how that's coming along? Did we see any progress on that?

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John J. Engel, WESCO International, Inc. - Chairman, President & CEO [22]

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Yes. Very -- thanks for that question. Yes. Very pleased with the performance in our Canadian business. Geographically, most of the regions grew. We think we're taking share. We've a very strong backlog. We had a very strong backlog entering the year and the backlog remained strong as we kind of move through the first quarter as we're positioned to entering construction season here in Q2 and Q3. So we've got numerous growth drivers underneath that, too. It's commercial, it's institutional, some broadband growth and expansion. So really pleased overall with our Canadian results. And again, it's broad-based.

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Operator [23]

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The next question is from Christopher Glynn with Oppenheimer.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [24]

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Curious about the utility contractor you announced here. It sounds like a pretty unique win in terms of scale, particularly sizing it in a 5-year time frame. So curious from your perspective, does that -- starting at the run rates pretty quickly? And do you see comparable other opportunities out there? Or is this singular as it appears?

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

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Yes. You heard the commentary when Dave took you through to the end markets, and I want to amplify that a bit. I expect 2019 to be a very strong year on top -- on the heels of the last 7 years through 2018, where we dramatically expanded the -- our Utility business. We have a leading -- industry-leading value proposition. We've been taking share consistently. I think it's pretty clear what -- we've talked about what the issue was in Canada, and our margin discipline remains intact. When you look at the U.S. business grew 3% for Utility in the quarter. But I'll remind you last quarter, we mentioned we had 3 major renewals worth triple-digit millions a year and 2 new wins in the fourth quarter. And then to your point, this new win is also very sizable. And it really -- the way we're able to get that win and I won't talk about -- obviously, it's business that we are capturing that others have had, right? So the ability to get that win is really the result of our whole value proposition and what we're doing with large IOU and public power customers across the U.S. and Canada. So I'm bullish on Utility, our team, the value prop. And I think despite what -- on the optics of it, it looks like a slow start, particularly because of the Canada decline. And we got another couple of quarters of that until we comp that for Canada. But all in, I think it's going to be a very strong year for Utility, Chris.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [26]

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Okay. And then I had a question on the SG&A kind of expected run rates for the year relative to the first quarter level, 297?

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David S. Schulz, WESCO International, Inc. - Senior VP & CFO [27]

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Chris, you should expect to see an increase in the SG&A dollars as we go through the balance of the year, primarily because of the acquisition of SLS. We will also have our typical second quarter increase due to merit. So again, with people costs being a primary driver of our operating cost, we do have merit increases that are impacted for Q2 and beyond. And so those are the 2 factors that will increase the run rate versus what you've seen in Q1. But again, that's all incorporated in how we position the outlook for operating margin for the year.

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Operator [28]

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(Operator Instructions) The next question is from Robert Barry with Buckingham.

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Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [29]

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So you mentioned that April was up low single, not sure if that's 1, 2 or 3. But just curious the thought setting the 2Q range at 3 to 6 with April at or below the low end of that range.

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

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Sure. So, Robert, it's Dave Schulz. So again, if you take a look at our growth rates from the prior year, you begin to see the growth rates in 2018 decelerate in the base period. And so again, on a -- if you take a look at 2018, April is our toughest comp in the second quarter of 2018. And so again, we've taken that into account, along with, obviously, the feedback we've gotten from customers, some of the new contract wins that we've gotten and that's what's informed our guidance for the 3% to 6%.

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Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [31]

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Got it. Got it. And nice start here on gross margin. Just curious your thoughts, maybe not at this level year-over-year, but whether you think that can continue to kind of track up year-over-year as we continue here throughout '19.

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David S. Schulz, WESCO International, Inc. - Senior VP & CFO [32]

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We've seen continued progression on our gross margins. We highlighted that in our prepared remarks. And obviously, as you take a look back to where we were at the beginning of 2018, we're very pleased with the progress we have made with our gross margin initiatives. We continue to focus on our gross margin initiatives and we do expect to get incremental value from them. Again, we don't provide the specific outlook on gross margins, but again, the expectations for continued effort to drive margin and the margin expansion are incorporated in our operating margin guide for 2019.

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Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [33]

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Got it. Got it. Just lastly for me, I think the pull-through in 2Q is guided below 50%. I think you might have had some kind of merit timing there. But if you could just remind us what's driving that. And do you still expect it to be 50% or better in the back half?

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David S. Schulz, WESCO International, Inc. - Senior VP & CFO [34]

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Sure. Let me just address. Because we had the SLS acquisition, that's going to put pressure on our ability to generate the full 50% pull-through for the full year. When we take a look at our core business, excluding SLS, we still expect to hit approximately 50% on the pull-through. But again, SLS is going to have a substantial gross margin rate relative to the balance of the business, but as we've mentioned, it's basically neutral on operating profit. So that's going to put a drag on our pull-through numbers on a reported basis.

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John J. Engel, WESCO International, Inc. - Chairman, President & CEO [35]

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But that's always true when we do an acquisition because it will be in our current year reported results and not in prior year periods until we lap that after 4 quarters. And as we've done over the years, we've closed acquisitions, we'll report that with and without the acquisition, to be clear. But it's kind of simple math. When you're adding in that business and you don't have it in prior year, it does just put a drag on the reported pull-through at a consolidated level. We're still focused on ensuring that the core business separate from the acquisition, right, we're driving the strong pull-through, Robert.

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Operator [36]

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The next question is from Steve Barger with KeyBanc Capital Markets.

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Ryan Thomas Mills, KeyBanc Capital Markets Inc., Research Division - Associate [37]

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This is Ryan Mills on for Steve. Yes. So it's been a focus showcasing the value proposition that WESCO provides through all its services and there is no doubt that the value is there. And it sounds like you're going to talk about some next level offerings at your Investor Day. But I'm curious, is there a strategic plan in place or an update on how WESCO plans to get better compensated for the level of service that you provide?

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John J. Engel, WESCO International, Inc. - Chairman, President & CEO [38]

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Yes. Stay tuned. So I think, the reason I wanted to put kind of -- start the preview of what we're going to be talking about at Investor Day is you'll see an expansion of our broad array of supply chain solutions. We think services is a differentiator, and we'll also spotlight some recent success stories, where we think we're getting much better traction with that. Those offerings in our portfolio of solutions and we're getting better paid for them in a more attractive way as well as some additional new initiatives as I've kind of highlighted. So stay tuned. We look forward to that discussion with all of you. Hopefully, you can attend and it will be a great event.

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Ryan Thomas Mills, KeyBanc Capital Markets Inc., Research Division - Associate [39]

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Sounds good. And then can you maybe talk about the difference in growth rates from your results and your closest public peer who reported organic sales at 8% and then 8% in their Utility segment compared to your results?

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

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Yes. Normally don't comment about competitors. But since you have a focus question, I'll address that. When you look at their business, it's really 3 components. They've got kind of a communications and security datacom-driven business. They've got a core wire and cable business and they got a Utility business. I think we've already explained Utility on what the unique -- what our unique comparable is as we walked away from a competitor. So that gives you -- that will give you a good sense on Utility. And when you look at our communications and security category, so I'm glad you raised this question. Our communications and security category, which is one of our 6 major product and services categories, that was up high single-digits growth in Q1 versus prior year, and all our geographic regions grew, U.S., Canada and international. When we profile our results, we typically talk about them by geography and by end market; and we provide a pie chart on the product categories over time, which we'll keep updated on a rolling quarterly basis. Really nice performance. I'm very pleased with the performance in communications and security all in at high single-digit growth, as I said, organically in Q1. So I think, all in, we feel good about kind of the side-by-side comparisons. The wire and cable business is a much smaller percentage of our portfolio than that competitor has and that's their core. And they had relatively solid results in that. So very understandable and that's the composition.

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Ryan Thomas Mills, KeyBanc Capital Markets Inc., Research Division - Associate [41]

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Okay. And then, John, you've been optimistic on the LED opportunity for quite some time. You completed the SLS acquisition in March. So my question is, what's your growth expectation this year for that business as well as WESCO's legacy lighting business?

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

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Yes. So again, still very optimistic and bullish on the opportunity in lighting. We'll talk more about this at Investor Day, too, because I think that where we sit in the value chain and with our turnkey all-in solutions for retrofit renovation and upgrade, we're more than just a new construction-driven lighting business, as I've talked about over the last couple of years. When we bought Aelux/Lumigent, that's performing exceptionally well; and the SLS acquisition, which we think we got at an attractive price. And by the way, that's off to -- they're off to a terrific start. That management team, I think, is excited about the prospects of really executing with the additional capabilities that we bring to the table because, again, this is a priority category and growth opportunity for us. And all the management team is intact and we're -- the execution/integration is well underway. We're very pleased. So -- and the fact that we went out and acquired, that should also speak to what we think the opportunity is. And as I mentioned last quarter before we closed it, that -- it really is a talent acquisition play. We picked up some terrific talent in terms of lighting, domain expertise, application expertise that's going to serve us exceptionally well.

In our core legacy lighting business, we still have a legacy lamp business, believe it or not. So we're not 100% LED. And that business has got attractive margins, but it's declining at double-digit rates, roughly 15-plus percent declines every quarter. We'll ride that as long as we can. And obviously, we try to -- as that business moves forward, we try to convert that to LED. But we'll ride that. That's kind of the end of the S curve for those product categories. Our LED mix is growing at a much faster rate. And so in our overall lighting category, we still get those legacy sales, but it's the LED portion of the business that's growing at a much more attractive rate. And then again, it's not just new construction, it's retrofit renovation and upgrades. And we'll talk more about this at Investor Day, too, I think, and bring that to life a bit. We've used numbers on the order of $300 billion plus kind of addressable market install base out there, that's not -- that's addressable with vis-à-vis LED turnkey solutions. So an outstanding market opportunity that dwarfs the annual construction market opportunity for lighting.

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Ryan Thomas Mills, KeyBanc Capital Markets Inc., Research Division - Associate [43]

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Okay. And then if I could squeeze out one more in just because I didn't see it in the press release or hear it in your prepared remarks. You had about 1 month of SLS in your first quarter results, so is there any impact to the gross margin or EBIT margin from that business?

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David S. Schulz, WESCO International, Inc. - Senior VP & CFO [44]

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Yes. Steve (sic) [Ryan], so we provided you with the details on sales. So small benefit on the sales line. From an overall perspective, it was neutral. And so we do expect for the full year, SLS will be neutral to operating profit. And again, we mentioned in our previous call, that what is attractive about the SLS business is the services business. It does have a higher gross margin rate relative to the balance of our business. In Q1 specifically, there was a slight benefit, but we also saw an offset from the mix of our businesses on a core basis, which basically offset each other.

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Operator [45]

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Your next question is from Patrick Baumann with JPMorgan.

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Patrick Michael Baumann, JP Morgan Chase & Co, Research Division - Analyst [46]

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Maybe one quick one to start. In the first quarter on the gross margin front, was there anything unusual impacting the results there, maybe just a little bit better than we thought?

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David S. Schulz, WESCO International, Inc. - Senior VP & CFO [47]

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Patrick, there was nothing unusual in the first quarter for the gross margin. Again, I think that this is our continued progress against pushing through the supplier price increases and the organic margin initiatives that we've been implementing.

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Patrick Michael Baumann, JP Morgan Chase & Co, Research Division - Analyst [48]

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Understood. And then another quick one, just the -- did you guys give this earlier, I jumped on a little bit late, the -- what's the profile of that SLS business from like a gross margin and an operating margin perspective? I think, you said it's kind of rich gross margin, I heard you say that.

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David S. Schulz, WESCO International, Inc. - Senior VP & CFO [49]

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That's correct. We've not provided any specifics, but we have mentioned that it does have a higher gross margin rate than the balance of the WESCO business. But again, it's a services business, so it also has a much higher SG&A percentage of sales. That's why it's profit neutral for us in the first year of ownership. Again, this is a carve out from a corporate parent, and so we do anticipate not only having a significant amount of effort, but also cost to integrate the SLS business into WESCO.

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Patrick Michael Baumann, JP Morgan Chase & Co, Research Division - Analyst [50]

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Got it. I'm just asking because the step-up -- I guess, you're going to see increased SG&A from that business in the second quarter. And if I kind of run the math, it seems like gross margins are going to be down a little bit from the first quarter, just backing into it. And I think that's normal seasonally, but I just wanted to kind of run that by you, the sequential progression.

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David S. Schulz, WESCO International, Inc. - Senior VP & CFO [51]

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We do see normal seasonality on our SG&A. So usually because of merit increases that take effect in the second quarter, we do see increases in SG&A. Again -- but as a percentage of sales, we're expecting our SG&A percentage of sales to come down in the balance of the year, primarily as we get leverage and we continue to focus on cost management within our operating overhead groups.

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Patrick Michael Baumann, JP Morgan Chase & Co, Research Division - Analyst [52]

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Got it. And then one other one or maybe a couple if we have time. Can you provide any color on what you're seeing in your -- in the Englewood DESCO business with respect to industrial automation and from core machine tools, just how did it grow in the first quarter? And what are you hearing from your OEM customers for the balance of the year? We've seen some others reporting software like auto-related results. Just curious what you're seeing from Englewood DESCO.

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John J. Engel, WESCO International, Inc. - Chairman, President & CEO [53]

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Yes. So when we talked about our industrial end-markets results and some declines with select number of OEM customers, that also -- it was across the U.S. primarily in different locations, depending on where those customers were, and that would include our industrial automation offerings. It had some -- with certain customers, had some challenging declines with sales. In terms of the business, the value proposition, it's a very important part of the portfolio and does represent a terrific -- higher gross margin, higher operating margin business with a terrific array of end-user customers as well as system integrators. So it's -- and it's a business, I think, when we look out in the future, despite any, I'll call it, near-term choppy headwinds, the growth potential is significant over the mid- to long term driven by IoT -- the expanding -- what will be the expanding IoT applications across the entire industrial setting. So it's a critical part of our portfolio and increasingly a critical part of our portfolio coupled with our data communications business. You think about those 2 in conjunction as well as with electrical, industrial automation control the electrical plus the datacom and security -- IP security, you wrap all those together and we've got the makings of a really terrific solution for an increasing array of IoT applications.

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Patrick Michael Baumann, JP Morgan Chase & Co, Research Division - Analyst [54]

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Yes. Makes a ton of sense. And you mentioned choppy, I mean, is that -- what's your visibility on the rest for the year there? I guess, it was down in the quarter. Do you expect it to kind of improve for the year or is it going to be a tough year for that business?

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John J. Engel, WESCO International, Inc. - Chairman, President & CEO [55]

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Yes. No. Our outlook -- I mean, some of that choppiness is customer operations as well as our branches, where they are physically located. Again, I hate to go back to weather, but you look at where we are positioned, we definitely had some impacts with the polar vortex in the upper Midwest, Midwest portions of the U.S. and so did customer operations. So we've -- you look at what our guide is for Q2, you look at what our guide is for the full year. And specifically for industrial, we're still expecting low- to mid-single-digit growth full year basis for industrial, and I think it's going to be a solid year for industrial when we're all said and done for 2019.

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Patrick Michael Baumann, JP Morgan Chase & Co, Research Division - Analyst [56]

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Okay. Makes sense. And then lastly, if I have time for one more. Just from an oil and gas perspective, any color on what you're seeing in those markets in the U.S. market specifically, upstream versus downstream, those dynamics, curious...

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

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Yes. We got -- we had some growth in oil and gas in the quarter, both U.S. and Canada, low single-digit growth, upper low single-digit to mid-single-digit growth. So it's in a bit of a lower growth rate than what we saw throughout 2018. Oil and gas now is about 7% of WESCO sales and the peak of oil and gas for WESCO. Back in 2014, I'll take you all the way back to 2014, it was 10% of our sales. So even after -- last 2 years were strong double-digit growth in oil and gas after being down double digits in 2015 and 2016. 2017, 2018 up double digits. Q1 starts kind of low to mid-single-digit growth both U.S. and Canada. With respect to upstream versus downstream, there's still a lot of cost pressure in upstream. And I think our outlook is that's kind of more flattish. We have specific opportunities that are customer specific and driven, but I'm giving you more of a kind of a market view of that. For downstream, the trend clearly is up in petrochem and particularly LNG, and the outlook -- my outlook is very positive. And I think LNG, in particular, represents a really nice growth opportunity in the U.S. and especially in Canada.

So with that, I think we've cleared our queue of questions. So I'm going to bring this to a wrap. Thank you for your time this morning. Brian Begg and Will are available to take your questions. And we look forward to seeing many of you in one of our investor marketing events. There are a number of those in the coming weeks. And obviously, we have our Investor Day on June 13 in New York and hope you'll be able to join us. So thank you for your time again and your interest in WESCO. Have a great day.

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Operator [58]

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Ladies and gentlemen, the conference is now concluded. Thank you for attending today's presentation. You may now disconnect.