WESCO International, Inc. (NYSE:WCC) Q3 2023 Earnings Call Transcript
WESCO International, Inc. (NYSE:WCC) Q3 2023 Earnings Call Transcript November 2, 2023
WESCO International, Inc. beats earnings expectations. Reported EPS is $4.49, expectations were $3.85.
Operator: Hello, and welcome to WESCO's Third Quarter Earnings Call. I would like to remind you that all lines are in listen-only mode throughout the presentation. [Operator Instructions] Please note that this event is being recorded. I will now hand the call over to Scott Gaffner, Senior Vice President, Investor Relations, to begin.
Scott Gaffner: Thank you, and good morning. Before we start, I want to remind you that certain statements made on this call contain forward-looking information. Forward-looking statements are not guarantees of performance, and by their nature, is subject to inherent uncertainties. Actual results may differ materially. Please see our webcast slides as well as the company's SEC filings for additional risk factors and disclosures. Any forward-looking information relayed on this call speaks only as of this date, and the company undertakes no obligation to update the information to reflect the changed circumstances. Additionally, today, we will use certain non-GAAP financial measures. Required information about these non-GAAP measures is available on our webcast slides and in our press release, both of which are posted on our website at wesco.com.
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On the call this morning, we have John Engel, WESCO's Chairman, President and Chief Executive Officer; and Dave Schulz, Executive Vice President and Chief Financial Officer. Now I'll turn the call over to John.
John Engel: Thank you, Scott. Good morning, everyone, and thank you for joining us today for our call on the third quarter earnings release. As you've seen from our earnings press release and webcast materials, we delivered a strong set of operating results in the third quarter. Highlights for the quarter included great cash generation, stable gross margins, SG&A cost actions now taking effect. They're the actions we took over the last two quarters. Sequential EBITDA growth and sequential EBITDA margin expansion, better inventory management, strong cross-sell execution and continued market share gains. The power of our portfolio and industry-leading value proposition is clear, and we're in a great position to create value across all phases of the economic cycle.
That is without regard to the exact economic environment that will prevail over the near term. So starting with cash. We generated very strong free cash flow of $357 million or more than 140% of adjusted net income, and this highlights the strength of our B2B distribution business model. Over the past two years, global supply chain constraints due to the pandemic required us to invest in our inventories to service our customers. With supply chain healing, we are focused on reducing our inventory and returning to our historical levels of strong and consistent free cash flow generation. We saw this in the third quarter in fact, and deployed capital in a balanced manner to reduce our debt and returned cash to shareholders through a share buyback.
Importantly, our financial leverage now stands at 2.7 times, below the midpoint of our target range and is at the lowest level since the Anixter acquisition in June 2020. We expect our strong free cash flow generation to continue, and we expect to use that cash to invest in above-market growth, continue to pay down our debt and increase the return of capital to shareholders. Now turning to our third quarter financial results. Overall results were in line with our expectations with improved performance in our EES business, and that was coupled with continued share capture and higher operating margins in both our CSS and UBS businesses. The multispeed economy has increased the importance of our array of internal initiatives and our continued operational excellence as we drive outperformance versus our end markets.
We again exceeded our expectations for cross-sell, I'm happy to say, and are raising our sales synergy target from $2 billion to $2.2 billion. Our long-term secular growth drivers remain intact, and our portfolio mix shift in the higher-growth end markets has driven and is expected to continue to drive more consistent financial performance. We remain focused on what we can control as we continue to invest in our digital transformation plan and deliver game-changing digital capabilities that will benefit our customers and supplier partners. We've revised our full year outlook to reflect a moderating economic environment and are confident in delivering record sales, record adjusted EBITDA and record free cash flow in 2023. Finally, as we look to 2024 and beyond, we remain confident in and committed to delivering the financial value creation objectives presented at our Investor Day last year.
And as you know, these include our long-term margin expansion, profit growth and cash generation targets. So now let's move to Page 4. The strength of our business model and the success of our integration efforts since closing the Anixter acquisition in mid-2020 have established a track record of success and exceptional results for our company. Over the past three years, we have outperformed the market and delivered impressive sales growth and margin expansion, and we did this all while rapidly deleveraging our balance sheet. With a three year integration program coming to a close at the end of this year, we are exceptionally well positioned to capture the benefits of the enduring secular growth trends as well as the anticipated increased infrastructure investments in North America.
And we will do this by using our global scale, industry-leading positions and now expanded portfolio of product, services and solutions. So with that, I will now turn the call over to Dave.
David Schulz: Thanks, John, and good morning, everyone. I'll start on Slide 5 with a summary of our third quarter results. As John mentioned, the company delivered record third quarter sales, up 4% on a reported basis. Year-over-year increases in our CSS and UBS businesses were partially offset by a decline in sales in certain EES segments. On an organic basis, which includes the adjustment for one less workday in the quarter, sales were up 3% over the prior year, driven mostly by a low single-digit contribution from price, as volume was approximately flat. The flat volumes in the quarter represent a modest year-over-year decline in market volume that was fully offset by the combination of share gain in our cross-sell program.
During the quarter, we experienced some negative impacts from the normalization of supplier lead times, which led to customer destocking in certain parts of our business. Project backlog continues to be at a historically high level, supporting our outlook for the rest of the year and into 2024, but is normalizing. In total, backlog was down 6% year-over-year and down approximately 7% sequentially from the end of June. We expect our backlog will continue to moderate as supply chain lead times have improved for most product categories. Gross margin of 21.6% was flat sequentially with the second quarter and flat year-to-date with the comparable period in 2022. Gross margin in the quarter was down compared with the prior year due primarily to lower supplier volume rebates as a percentage of sales as well as mix.
We continue to prioritize profitable top line growth and as an industry leader, we intend to protect the progress we've made on gross margin with continued execution of our enterprise-wide margin improvement program. Adjusted EBITDA was down slightly versus the prior year as the benefit of higher gross profit was offset by increased compensation and volume-related costs and higher costs associated with our digital and IT transformation. Adjusted SG&A was 13.7% of sales, flat with the prior year and down 40 basis points sequentially, driven by the cost reduction initiatives executed in the second and third quarters. As we mentioned last quarter, we took steps in June to address higher costs, and we took additional cost reduction actions in Q3.
Collectively, these actions are expected to reduce costs by approximately $45 million on an annualized basis. Adjusted diluted EPS for the quarter was $4.49, flat with the prior year as the increases from Rahi, a lower effective tax rate and lower share count were offset by foreign exchange rates and higher interest expense. As we start the fourth quarter, end market demand trends have moderated versus our prior expectations. We experienced a step-down in demand in October, with preliminary reported sales per workday down 2%. CSS was up low single digits including the benefit from Rahi. EES was down low-single digits with growth in industrial offset by declines in construction and OEM. UBS was also down low-single digits as we continue to see broadband down double digits, offsetting modest growth in utility and integrated supply.
Notably, book-to-bill remains above 1.0 for all three of our business units. Turning to Page 6, this slide bridges the year-over-year changes in sales and adjusted EBITDA. As I mentioned a moment ago, organic sales increased 3% versus the prior year, including an approximate 3% benefit from price while volumes were roughly flat. Market volumes declined and were offset by share gains. As expected, the contribution from price moderated again in the quarter relative to 2022 as there have been fewer supplier price increases and the magnitude of these increases has been smaller. You can also see the drivers of the decline in Q3 adjusted EBITDA. Of note, adjusted EBITDA margins in the quarter improved by 40 basis points sequentially, driven by our cost reduction actions.
Turning to Slide 7, organic sales in our EES business were flat year-over-year. On a like-for-like basis, sales were up 2% over the prior year, adjusting for the impact of intersegment transfers at the beginning of 2023. Construction sales were flat with large project growth, offset by continued declines in wire and cable. Industrial sales were strong, up high-single digits over the prior year, driven by strength in automation. OEM was down high-single digits in the quarter. Backlog was down 5% sequentially and up 3% from the prior year, driven by strong bookings for large projects as we are now beginning to win large projects associated with the unprecedented levels of infrastructure investments in North America. In the third quarter, adjusted EBITDA was down approximately 15% from the prior year.
Adjusted EBITDA margin was 8.7%, 140 basis points lower year-over-year. The reduced profitability in EES was driven by lower supplier volume rebates, business mix and higher SG&A as a percentage of sales. EES margins improved slightly compared to the second quarter, and we expect sequential improvement in the fourth quarter, driven by the benefit of the SG&A reduction actions previously taken. On this slide, we've also highlighted that we were awarded a five year $250 million contract to provide electrical and electronic products to support MRO and capital project activity of a major metal producer in the United States. This is an indication of the larger project activity in the electrical industry. Turning to Slide 8, third quarter sales in our CSS business were a record, and up 11% versus the prior year on a reported basis, and up 4% organically.
We saw solid growth in network infrastructure with reported sales up low double digits, driven by data center and cloud applications. These gains were partially offset by destocking at service providers, along with overall softness in the structured cabling business, while security sales were up low single digits and professional audiovisual installations were up double digits, driven by strong international sales. As we noted earlier in the year, backlog continues to moderate to normal levels in CSS as supplier lead times have returned to pre-pandemic levels. Backlog was down 19% year-on-year and down 10% sequentially. Profitability was also strong with record adjusted EBITDA margin of 9.9%, 10 basis points higher than the prior year, driven by operating leverage, integration cost synergies and the continued successful execution of our margin improvement initiatives.
In the quarter, the combined WESCO and Anixter data center and power portfolio enabled WESCO to win a three year $135 million contract to supply data center infrastructure, wire and cable, power and switchgear products to support the construction of a hyperscale data center in Latin America. Global hyperscale demand remains strong, and we are exceptionally well positioned to capture the secular growth. Turning to Slide 9, third quarter sales in UBS were up 6% versus the prior year on an organic basis. Sales in our utility business were up high single digits as electrification, green energy and grid modernization investments continued. Integrated supply was up low double digits versus the prior year. Broadband sales were down double digits as certain customers continue to work through inventory and delayed purchases as projects are pushed out.
We now expect broadband sales to remain pressured until the second half of 2024 as customers in the supply chain continue to work through inventory destocking, along with the expected timing of government stimulus funding in 2024. Backlog continues to normalize and was down 7% from the prior year and down approximately 8% on a sequential basis but remains at historically high levels. Profitability was exceptionally strong as Q3 adjusted EBITDA was an all-time record of $196 million and EBITDA margin was 11.7% of sales, driven by operating leverage on higher sales, margin improvement initiatives and integration synergies. In the quarter, we were awarded a 5-year $100 million contract to supply high-voltage equipment to support the construction of utility-scale renewable energy projects, again a testament to our industry-leading value proposition.
Now moving to Page 10, the size of the cross-sell opportunity continues to exceed our expectations. This quarter, we recognized more than $270 million of cross-sell revenue, bringing the cumulative total to more than $2 billion since the beginning of the program 3 years ago. Our pipeline of sales opportunities remains healthy. We are continuing to capitalize on the complementary portfolio of products and services as well as the minimal overlap between legacy WESCO and legacy Anixter customers. As we look at the last 3 months of the program in 2023, we are increasing our expected cumulative total to $2.2 billion, reflecting the strength of our value proposition and cross-sell execution against the backdrop of accelerating secular trends. Turning to Slide 11, we realized cumulative run rate cost synergies of $188 million in 2021 and $270 million through 2022.
We remain on track to meet or exceed our expected target of $315 million of cumulative cost synergies by the end of 2023. Our focus through the balance of the year is on our supply chain network optimization and field operations to drive the remaining cost synergies. Turning to Page 12, recall that after a cash draw in the first quarter, we were approximately neutral to the first half of the year. In the third quarter, we generated free cash flow of $357 million or more than 140% of adjusted net income, highlighting the strength of our B2B distribution model. Working capital management, specifically lower accounts receivable and inventory, contributed to the strong cash generation in the quarter. Over the past two years, global supply chain constraints due to the pandemic required us to invest in inventory to service our customers.
With supply chains healing, we are focused on reducing our inventory and returning to our historical levels of strong and consistent free cash flow generation. We saw this in the third quarter and used our available cash in a balanced manner to reduce our debt and return cash to shareholders through a share buyback. Moving to Slide 13, reducing our leverage has been a top priority since we announced the acquisition of Anixter, and we are pleased that leverage is now at its lowest level since closing the transaction in June of 2020. Notable this quarter was that our strong cash flow enabled us to reduce net debt by approximately $250 million, which was the primary driver of the lower leverage. Leverage is now approximately 2.7x trailing 12-month adjusted EBITDA, a reduction of 3 turns since June of 2020.
We are now below the midpoint of our targeted range of 2 to 3.5x trailing 12-month EBITDA, and delivering on this commitment enables us to pursue additional capital allocation options to increase shareholder returns. During the third quarter, we purchased $50 million of our shares. Based on our outlook for continued cash flow generation through the balance of the year, we expect to fund additional share repurchases and pay down debt in the fourth quarter. Now moving to Page 14, this slide shows the uniquely strong position of our company to drive growth and profitability in the years ahead. The end-to-end solutions that we provide to our global customers are directly aligned with the 6 secular growth trends shown on the left side of this page.
Our participation in these trends, coupled with increasing public sector investments in infrastructure, broadband and partnerships with the private sector, position WESCO exceptionally well. As we outlined at our Investor Day last year, over the long term, we expect to grow 2% to 4% above the market due to the combined benefit of secular growth trends and increasing share. Moving to Page 15. We are updating our 2023 outlook today based on year-to-date results and current market conditions. For the year, we expect organic sales to be up approximately 4%, at the low end of our previous range of 4% to 6%. The change in our outlook reflects moderating market conditions, including a slow start to the quarter in the month of October. We now expect volumes to be down slightly year-over-year as gains in CSS and UBS are offset by a decline in EES, with price driving total market growth of approximately 3% to 4%.
Our share gains and cross-sell initiatives remain a powerful driver of our performance and are expected to provide another 1 to 2 points of organic growth. After factoring in the additional revenue from Rahi, the impact of 1 less workday in 2023 and the impact of foreign exchange rate differences, we estimate our reported sales growth for fiscal year 2023 will be approximately 5%. For our strategic business units, we now expect EES reported sales to be down low single digits year-over-year versus our prior expectation for growth to be flat. As we noted earlier, we have experienced headwinds in EES due to customer destocking along with overall weakness in commercial construction and certain end markets in our OEM business. Our outlook for CSS remains unchanged from our prior outlook, with the top line expected to be up mid-teens.
And lastly, for UBS, we now expect reported sales to be up high single digits year-over-year versus our prior expectation of high single to low double-digit growth. The lower expectation is driven by an extended period of inventory destocking within our broadband business, along with deferred purchasing at some of our utility customers who are balancing near-term customer affordability and cash generation with long-term service reliability. For the fourth quarter, we expect UBS revenue to be relatively flat due to a difficult comparison year-over-year, continued softness in our broadband business and moderation in utility growth rates. We expect lower project activity, limited storm recovery in the current year and customers adjusting order patterns to align with reduced lead times.
This aligns with a more normal seasonal pattern for our UBS business. For adjusted EBITDA margin, our outlook is for a range of 7.8% to 8.0%, unchanged from our prior outlook and still representing approximately $1.8 billion of EBITDA. We expect stable gross margin in the fourth quarter as we overcome notable year-over-year headwinds related to supplier volume rebates. Based on current assumptions, supplier volume rebates for the full year are expected to be a headwind of approximately 20 basis points. We are increasing our outlook for adjusted earnings per share to $15.60 to $16.10, driven by a lower full year effective tax rate and lower share count. We continue to expect free cash flow between $500 million and $700 million. This outlook still reflects record sales, record adjusted EBITDA and record cash flow.
In the appendix of this presentation, we have shown our revised underlying assumptions for certain items on the income statement. We increased the low end of our expectation for interest expense for the year from a range of $370 million to $390 million to a range of $380 million to $390 million, primarily driven by higher variable rates and the timing of debt paydown in 2023. Additionally, we now expect other expense to be approximately $20 million for the full year versus $20 million to $30 million previously. Regarding the quarterly cadence, we expect Q4 top line results to be down low single digits sequentially. This is in line with typical seasonality and note that there is 1 less workday compared to Q3. Before opening the call for questions, let me provide a brief summary of what we covered this morning.
Free cash flow was particularly strong in the quarter as we delivered approximately $360 million of free cash flow, bringing our year-to-date total to $384 million. Overall, sales and earnings in the third quarter were in line with our expectations, with internal initiatives and operational excellence driving outperformance versus a multispeed economy. We delivered record third quarter sales in both CSS and UBS, which offset the impact of supply chain destocking and select market weakness within EES. Profitability improved sequentially in the quarter, with adjusted EBITDA of $15 million and adjusted EBITDA margin increasing 40 basis points. We reduced our leverage this quarter to the lowest level since acquiring Anixter in 2020, and we are now below the midpoint of our target range.
We expect to generate significant cash flow in the fourth quarter, enabling continued investment in our strategic objectives and increasing shareholder returns. With that, we'll open the call to your questions.
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