WESCO International, Inc. (NYSE:WCC) Q4 2023 Earnings Call Transcript
WESCO International, Inc. (NYSE:WCC) Q4 2023 Earnings Call Transcript February 13, 2024
WESCO International, Inc. misses on earnings expectations. Reported EPS is $2.65 EPS, expectations were $3.81. WESCO International, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Hello and welcome to WESCO's Fourth Quarter and Full Year 2023 Earnings Call. I would like to remind you that all lines are in listen-only mode throughout the presentation. [Operator Instructions] Please note this event is being recorded. I would now like to hand the call over to Scott Gaffner, SVP, Investor Relations, to begin. Please go ahead.
Scott Gaffner: Thank you, and good morning, everyone. Before we get started, 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, are subject to inherent uncertainties. Actual results may differ materially. Please see our webcast slides as the company's SEC filings for additional risk factors and disclosures. Any forward-looking information related 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 you can find on our website at wesco.com.
On the call this morning, we have John Engel, WESCO's Chairman, President and CEO; and Dave Schulz, Executive Vice President and CFO. Now I'll turn the call over to John.
John Engel: Thank you, Scott. Good morning, everyone, and thank you for joining the call today. You saw from our earnings release earlier today, we had a very disappointing fourth quarter to close out 2023, which results well below our expectations. These results, they're unacceptable. They're unacceptable to me and they're unacceptable to the entire WESCO management team. We understand the issues that drove our fourth quarter results, and we're already taking actions to address them. Dave will take you through this in detail shortly. But first, I'll summarize the three key issues we had in the fourth quarter. First, reported sales declined 2% versus our expectation for flat to slightly positive sales. This was due to a market downshift and reduced purchases with some customers.
Second, we experienced higher SG&A expenses. This was due to higher-than-anticipated benefits and health care costs, along with higher cost to operate our facilities and IT-related expenses. And finally, our free cash flow generation was below our expectations. This was due to a lower accounts payable balance related to the timing of purchases. On a full year basis last year, certain sectors, including utility, data centers, industrial security and network infrastructure continued to grow, somewhat consistent with our expectations, while others underperformed, including broadband and specific OEM and construction-related sectors. As a leading global provider of business supply chain solutions, the WESCO team effectively navigated through this mixed economic environment last year.
And this was all done while managing changing customer buying patterns as supply chains yield. I'm pleased that our team delivered 5% revenue growth in 2023 following two years of double-digit increases given these market challenges. We finished the year with our backlog near a historical high level and stable versus the end of September. Our free cash flow generation was higher in the second half and we returned 1/3 of our full year free cash flow to common shareholders through dividends and share repurchases. So as we move into 2024, and we take a look forward, the long-term secular growth trends that we have consistently described will continue to provide us with the opportunity to outperform the market and our competition. While our view of the general economic conditions in 2024 as favorable, I'm mindful of the uncertain backdrop that the election cycle, easing inflation, geopolitical upheaval and short-term borrowing rates may have on demand.
Regardless of these near-term impacts, as a market leader, we expect to benefit from our global capabilities, our leading scale and our expanded portfolio of product services and solutions. Our investment and commitment in our digital transformation are expected to magnify those benefits as we roll out that program over the next 36 months. The substantial cash flow that WESCO generates has supported that investment over the last two years while allowing us to return capital to our shareholders. I am confident that WESCO will outperform our markets again this year, and we are positioned to deliver profitable sales growth and continue toward our long-term EBITDA margin expansion goal. Finally, I want to take a moment to provide you with two important updates.
First, I'm very pleased to announce that we are narrowing and lowering our target leverage range for the first time since the company went public 25 years ago. You'll recall that we have historically had a target leverage range of 2.0 to 3.5 times net debt to EBITDA. Based on our size and scale and upsized cash generation, we believe it is the appropriate time to update this important target. Moving forward, our target leverage range is 1.5 to 2.5 times net debt to EBITDA and this represents a reduction of 0.75 of a turn at the midpoint compared with our prior range. Second, we are increasing our cash -- return of cash to shareholders in 2024. Our Board of Directors intends to increase WESCO's dividend by 10% beginning in the first quarter of this year.
We are also continuing our share repurchase program, and we expect our share repurchases this year to outpace last year. Now turning to page four. I want to take a brief word and a brief minute to summarize the successful completion of our three-year integration of Anixter. The acquisition of Anixter literally transformed WESCO. This acquisition not only established WESCO as the clear leader in several of our business segments, but it also mix-shifted our business to higher growth and higher-margin end markets, reducing our cyclicality and increasing our resilience across all phases of the economic cycle. If we look at our performance metrics since the acquisition, they underscore the extraordinary performance and commitment of the entire WESCO team.
We exceeded all our initial operational synergy targets set at the time of the Anixter acquisition. Sales increased 30% and adjusted EBITDA increased 89% versus the 2019 performance of the stand-alone companies. And EBITDA margin expanded 240 basis points. We did all this while rapidly delevering our balance sheet by three turns, 1 year ahead of schedule. Most importantly, since closing the Anixter merger in June 2020 through the end of 2023, total shareholder return was 353% compared to 62% for the S&P 500. As we sit here today, WESCO is much more than a traditional distributor. We're a critical partner to both our suppliers and our global set of customers. The combination of WESCO and Anixter has created a new paradigm. The digital transformation that we committed to at the time of the acquisition is designed to take that new paradigm and create the WESCO of tomorrow.
That further empowers us to capitalize on our long-term secular trends from which we are uniquely positioned to benefit compared to our competitors. I'll now hand it over to Dave to take you through our fourth quarter and full year 2023 results as well as our outlook for 2024. Dave?
David Schulz: Thank you, John. Good morning, everyone, and I appreciate you're joining the call today. As John mentioned, we had a disappointing quarter with sales, margin and cash flow below our expectations. On slide five, you see a summary of our fourth quarter results. Reported sales were down 2% year-over-year. Like the third quarter, growth in utility, industrial, data centers and enterprise network infrastructure was more than offset by declines in broadband, security, OEM and construction. We experienced customer destocking in our shorter-cycle businesses in the second and third quarters. In the fourth quarter, we saw a step-down in demand versus our expectations, particularly in December. On an organic basis, sales were down approximately 3%, as a two-point positive contribution from price was offset by a 5% decline in volume.
While our stock and flow sales were down in the fourth quarter, we continue to see strong project demand with direct shipment sales up versus the prior year. Project backlog continues to be at historically high levels, supporting our outlook for growth in 2024. In total, backlog was down 10% year-over-year and down approximately 1% sequentially from the end of September. We expect backlog to continue to moderate in 2024 as lead times have improved for most product categories. Gross margin was 21.4%, down 20 basis points sequentially. Relative to the prior year quarter, the 50 basis point decline in gross margin was driven by the anticipated reduction in supplier volume rebates as well as the impact of business mix. We continue to prioritize profitable top line growth and as an industry leader and tend to protect the progress we've made on gross margin with our enterprise-wide margin improvement program.
Adjusted EBITDA was down 15% year-over-year, primarily reflecting the impact of lower sales and gross margin as well as higher SG&A expenses, which I'll discuss on the next slide. Adjusted diluted earnings per share for the quarter was $2.65, $1.48 lower than the prior year, primarily due to lower sales and margins. The impact of higher interest expense and a higher effective tax rate were a combined headwind of approximately $0.40 in the quarter. As part of our commitment to return more capital to shareholders, we repurchased $25 million of common stock in November. As we start 2024, preliminary sales per work day in January were down approximately 5% from the prior year, with CSS down low single-digits and EES and UBS down mid-single digits.
This decline reflects the continued weakness in broadband, construction and OEM that we saw in the fourth quarter and a slow start in utility against a strong base period comparison. Of note, January backlog ticked up slightly compared to December. Turning to slide six. On this page, we want to provide you some additional insight to the sales miss in the quarter. As you can see, the exceptionally strong growth that we experienced in 2022 continued into 2023, but slowed materially in the second quarter as pricing benefits and volume growth moderated. In the second and third quarters, volume was relatively flat with price contributing about three points to the top line. As we moved into the fourth quarter and as we mentioned on the earnings call in early November, we expected to see an acceleration of sales from October to November and again into December, primarily driven by the shipment of projects from the backlog.
Instead, we experienced a further slowdown in our stock and flow sales, along with some project delays, primarily within our CSS business. We were expecting organic sales to remain flat and instead, they were down approximately 3%. Turning to page seven. As I mentioned a moment ago, organic sales were down approximately 3% versus the prior year, reflecting a 2% benefit from price offset by lower volumes. Market volumes declined and were only partially offset by share gains as cross-sell was a positive versus the prior year. On the right side of the page, you can see the adjusted EBITDA impacts of lower sales, gross margin headwinds and higher SG&A in the fourth quarter. The year-over-year increase in SG&A was primarily due to higher salaries and benefits, higher costs to operate our facilities and higher costs related to our digital transformation.
These increases were partially offset by the cost reduction actions taken in June. In total, adjusted SG&A represented 14.6% of sales, up 60 basis points from the prior year and I'll provide you more details on SG&A later in the call. Now moving to slide eight to review our full year results. Sales in 2023 were up 5% over the prior year, representing a full year record. Organic sales were up 3%, largely due to the benefits of carryover pricing. We are disappointed by the weaker-than-expected results in the fourth quarter. It's important to note that the growth we delivered in 2023 is a direct reflection of the power of our significantly diversified end market exposure from the Anixter acquisition. We delivered record sales in CSS from strong data center demand and share gains in security.
Sales in UBS, also a record, were driven by strong growth in utility and integrated supply partially offset by weaker broadband demand throughout the year. EES organic sales were up 1% on a like-for-like basis as strong growth in industrial was offset by weakness in OEM and construction. Adjusted EBITDA was relatively flat with 2022. Gross margin was down 20 basis points due to the impact of lower supplier volume rebates as a percentage of sales as anticipated. EBITDA margin further contracted due to higher SG&A, and we did not get the operating leverage we expected as sales moderated. Consistent with our commitment to return a greater proportion of capital to WESCO shareholders, we returned more than $150 million to common shareholders between share repurchases and dividends.
Turning to page nine. On this slide, you can see the relatively balanced contribution to our sales growth in 2023 from the market, including price, the benefit of share gains in our cross-sell program as the acquisition of Rahi -- as well as the acquisition of Rahi in late 2022. Each of these growth drivers contributed 1.5% to 2% of growth for the full year, a portion of which was offset by having one fewer workday and a net foreign currency headwind. On the right side of this page, you can see the relatively flat year-over-year EBITDA as the benefit of the 5% sales growth was offset by higher SG&A. Moving to slide 10. We have shown the quarterly cadence of SG&A by quarter. You can see that the step-up in second quarter SG&A was mostly driven by our annual merit increase.
In 2023, the merit increase was up mid-single digits versus a normal year in the low single digits. However, at the same time, we reduced our top line forecast for the full year and took $25 million of annualized cost actions in June and then an additional $20 million of actions in the third quarter. These structural cost reductions, along with lower discretionary spending were the primary drivers of the sequential decrease of $32 million in the third quarter. In the fourth quarter, adjusted SG&A increased $23 million sequentially. Approximately one-third of this increase was due to higher-than-anticipated benefits in health care costs and the balance was due to higher cost to operate our facilities and IT-related expenses. Given the downshift in fourth quarter sales and the slow start to 2024, we are taking actions to address these higher costs.
Turning to slide 11. Fourth quarter organic sales in our EES business were down approximately 4% year-over-year and down 2% on a like-for-like basis. Construction was down high single digits, reflecting continued weakness in wire and cable as well as weaker solar demand against a strong base period comparison. Industrial sales continued to be strong and were up mid-single digits over the prior year driven by automation and the oil and gas sectors. OEM sales were down mid-single digits. Backlog was down 2% sequentially and down 5% from the prior year, reflecting the continued reduction of supplier lead times. EES backlog remains at a historically high level as a percentage of sales. Adjusted EBITDA was down from the prior year with adjusted EBITDA margin down 120 basis points, which reflects gross margin headwinds from lower supplier volume rebates and higher operating expenses.
For the full year, organic sales were down 1%, but up 1% on a like-for-like basis. Similar to the fourth quarter, which reflects weakness in construction OEM, partially offset by continued strength in industrial, which was up mid-single digits in 2023. Turning to slide 12. Fourth quarter sales in our CSS business were up 2% on a reported basis and down 1% organically versus the prior year. Certain large projects with technology companies shifted out of the fourth quarter into 2024. Additionally, we experienced a slowdown in stock and flow sales to contractors. Enterprise network infrastructure, which comprises structural cabling, along with sales to Internet service providers, was up low single digits in the quarter as wireless growth was offset by declines with Canadian Internet service providers.
Security sales were down low single digits versus 2022, which was up more than 20% as small and midsized contractors were negatively impacted by lower construction spending. We saw the overall security market contract over the past couple of quarters, but believe we are well positioned and gaining share. Data center sales were up low double digits, driven by strength with hyperscale customers. CSS backlog has returned to normal levels due to significant reductions in supplier lead times and increased product availability. Backlog at the end of December was down 26% from the prior year and down 6% sequentially from the September level. For the full year, CSS sales were a record, up 12% on a reported basis and up 5% organically. We experienced solid growth in data center, including the benefit of the Rahi acquisition and share gains in security.
Enterprise network infrastructure was also up versus the prior year, driven by strength in wireless applications. Profitability was also strong with record adjusted EBITDA and record adjusted EBITDA margin of 9.6%, up 20 basis points, driven by cost controls and operating leverage on higher sales. Turning to slide 13. UBS sales were down 2% in the quarter. Sales in utility were up low single digits versus a strong 20% plus comparison in the prior year. We continue to benefit from the secular trends of electrification, green energy and grid modernization in our project business. As expected, we did see a slowdown in our stock and flow sales with customers more tightly managing inventory. Integrated supply was up mid-single digits versus the prior year, consistent with the strength we experienced with other industrial customers within our portfolio.
Broadband sales were down over 30%, which represented an unexpected incremental step-down in demand as customers continue to work through inventory and pause purchases until government funding is released. Backlog was down 5% from the prior year and up 4% on a sequential basis. Backlog remains at a historically high level as a percentage of sales. Adjusted EBITDA was down approximately 100 basis points versus the prior year, driven by lower supplier volume rebates, a mix impact and higher SG&A as a percentage of sales. For the full year, sales were a record and up 8% organically, reflecting double-digit growth in utility, cross-sell revenue and scope expansion, including with our integrated supply customers, partially offset by weakness in broadband.
UBS posted record adjusted EBITDA and record adjusted EBITDA margin despite the significant sales decline in broadband. Turning to page 14. Free cash flow generation in 2023 totaled $444 million, which was below the $500 million to $700 million range that we provided in November. Relative to the assumptions in our outlook, the primary drivers were lower net income due to the decline in fourth quarter sales and a lower payables balance. On the payables front, we quickly aligned our purchases of inventory to the lower sales environment, which drove our payables balance down versus the third quarter. Purchases were stable in the second and third quarter. As stock and flow sales were below our expectations in the fourth quarter, purchases were lower, resulting in a lower payables balance.
The decrease in accounts payable in the fourth quarter represented a use of cash of $233 million and the use of $320 million for the full year. Days payable decreased by approximately one day compared to the end of 2022. Moving to slide 15. As John mentioned at the top of the call, we are revising our target leverage range to 1.5 to 2.5 times net debt to EBITDA. This is an important milestone for the company as we have operated with the same 2 to 3.5 turns of leverage since our IPO in 1999. We will work to reduce leverage to our new range over time. Additionally, we will maintain the flexibility to go above the target range to fund acquisitions similar to what we did with EECOL in 2012 and Anixter in 2020. Our strong free cash flow generation allows us to quickly move back within the target range.
We remain focused on a balanced capital allocation strategy, and plan to opportunistically utilize our cash for debt reduction and share repurchases going forward. We will also return capital to shareholders via the dividend initiated during 2023. As John mentioned, we intend to raise the common stock dividend in the first quarter of 2024. On share repurchases, we will continue to be opportunistic based on market conditions. We are committed to executing against our $1 billion share repurchase authorization. However, we will continue to be balanced between share buybacks and debt reduction, considering the significant rise in interest rates over the past year. Now moving to page 16 for the key sales drivers of our strategic business units. We provided the details on the quarterly calls and want to summarize how we performed during the full year 2023, along with our expectations for 2024.
I'll start with EES as this is our largest segment. As you can see, we faced headwinds in both construction and OEM in 2023, that more than offset significant growth in industrial. As we move into 2024, we expect EES reported sales growth to be flat to up low single digits as construction end markets remain pressured in total despite an increase in large project activity. Industrial is expected to again benefit from continued growth from customers in many of the end market verticals we support. OEM is expected to be roughly flat. Looking at our CSS segment. We generated strong double-digit growth in WESCO data center solutions in 2023, along with significant share gains in security that allowed us to outgrow the market. However, enterprise network infrastructure, which is focused on service providers and data communication applications, including structured cabling products, experienced softness due to the slowing of 5G build-outs and construction-specific markets.
Enterprise network infrastructure is the largest business for CSS and makes up approximately 40% of segment revenue. In 2024, we again expect strong double-digit growth in data center and share gains in security but some of the weakness that we saw in enterprise network infrastructure is expected to remain. That said, we expect a strong volume growth year for CSS with sales up low to mid-single digits. Lastly, looking at UBS, we generated double-digit growth in utility and mid-single-digit growth in integrated supply during 2023. This growth was partially offset by an approximately 20% decline in broadband due to customer destocking and delays of purchases until government dollars are spent. We expect growth in utility and integrated supply in 2024, but at a more moderate pace as we lap strong comparisons, significant 2023 price increases and as utility customers more tightly manage inventory and projects.
In addition, based on customer and supplier input, we don't expect to see a recovery in broadband until late 2024 before turning to growth in 2025. Despite these factors, we expect strong volume growth for UBS in 2024 with sales up mid-single digits. Moving to slide 17. I'll summarize our outlook for 2024. Based on our view of growth rates for each of the businesses, we expect total revenue to be up 1% to 4% with organic sales flat to up 3%. At the midpoint of the range, price is expected to contribute about 1% to the top line with volumes relatively flat. From a quarterly perspective, we expect to see normal sequential patterns as we move throughout 2024. However, given the tough comparison in the first quarter, normal sequential trends would translate to a low to mid-single-digit decline in revenue year-over-year with growth rates improving in subsequent quarters.
At the midpoint of our revenue outlook, sales would be up 2.5% including approximately one point of carryover pricing from 2023. On adjusted EBITDA margin, while we do not provide an outlook for gross margin, we expect to see improvement in 2024. Our transactional margins were stable in 2023. We expect improved mix and flat supplier volume rebates as a percentage of sales, along with the benefits of our margin improvement program to drive higher results in 2024. On SG&A, there are headwinds related to our annual merit increase, along with the return to target payouts for incentive compensation. These items combined represent an approximately $100 million cost headwind in 2024 and are expected only -- to be only partially offset by the cost actions we took in the second and third quarters of 2023.
We plan to take additional actions to protect our margins and we'll be more specific regarding the cost actions when we report first quarter earnings. Bringing this all together from a P&L perspective, we expect adjusted EBITDA margin to be in a range of 7.5% to 7.9% with approximately $1.75 billion of EBITDA at the midpoint. Based on our range of sales growth and margin improvement combined with the underlying assumptions that you can find on the slide, we expect adjusted earnings per share of $13.75 to $15.75 and free cash flow of between $600 million and $800 million. This free cash flow outlook of $700 million at the midpoint would represent the highest free cash flow in our history. As I discussed a moment ago, we are focused on reducing our working capital days and expect to see an improvement in 2024.
Now moving to page 18. Despite the multi-speed economy in 2023 and 2024, our long-term secular trends are intact. 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 customer base are directly aligned with the six 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. Our long-term financial framework is for WESCO to grow 2% to 4% above the market due to the combined benefit of secular growth trends and increasing share. With that, operator, we can now open the call for questions.
Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Deane Dray with RBC Capital Markets. Please go ahead.
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