Yahoo Finance WESCO International, Inc. (NYSE:WCC) Q1 2024 Earnings Call Transcript
WESCO International, Inc. (NYSE:WCC) Q1 2024 Earnings Call Transcript May 2, 2024
WESCO International, Inc. misses on earnings expectations. Reported EPS is $ EPS, expectations were $2.43. 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 2024 First Quarter 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’d now hand the call over to Scott Gaffner, SVP, Investor Relations, to begin.
Scott Gaffner: Thank you and good morning to everyone joining us today. 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 and the company’s SEC filings for additional risk factors and disclosures. Any forward-looking information 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 on 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 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 our call today. Our first quarter sales met our expectations and our overall performance compared against a very strong first quarter a year ago. It was in line with our typical seasonal pattern and our full year outlook. Quoting bid activity levels and backlog all remain healthy and support our view for sequential growth as the year progresses. Our free cash flow generation is something we're acutely focused on was a record $731 million in the first quarter. We utilized a portion of this free cash flow to repurchase $50 million worth of common stock in the first quarter, and we've reduced our net debt, bringing our financial leverage down by two-tenth of a churn.
Our financial leverage now stands at 2.6 times EBITDA, and that's getting very close to our recently reduced target range of 1.5 times to 2.5 times. More importantly, and I want to highlight this, we generated more than $1.4 billion in free cash flow over the trailing 12-month period. Historically, WESCO has demonstrated the ability to consistently generate free cash flow of 100% of net income over time. With double-digit growth and significant supply chain disruption in 2021 and 2022 coming out of the COVID pandemic, we invested in net working capital, resulting in cash flow conversion that was well-below our historical average. Our trailing 12-month cash generation results smooth out the inter-quarter effects that we experienced last year as supply chains normalize.
I want to highlight that all three components of working capital, that is accounts receivable, inventory and accounts payable contributed to this record $1.4 billion of free cash flow generation over the last four quarters, clearly highlighting the power of distribution business model. In addition, during the first quarter, we announced the divestiture of our integrated supply business, which closed on April 1st. We expect to use all of the after-tax proceeds of approximately $300 million repurchased common stock starting in the second quarter. As Dave will discuss in more detail later in the call, we are reaffirming our previous full year outlook for organic sales growth, adjusted EBITDA margin and adjusted earnings per share. We completed $20 million of annualized structural cost reductions late in the first quarter, and I think as you all know, this is in addition to the $45 million of cost reduction actions we took in 2023.
Our outlook for the year has been updated to reflect the divestiture of our Integrated Supply business on April 1st and our expectation to fully deploy these proceeds to share repurchases. Given the record free cash flow generation in the first quarter, we are also increasing our full year free cash flow outlook to $800 million to $1 billion or more than 100% of adjusted net income at the midpoint, which provides increased optionality for share repurchases, debt reduction and/or M&A in the second half. Finally, we expect to be within our target leverage range as the recently reduced target leverage range, that is, of 1.5 to 2.5 times by year-end. We are laser focused on continual improvement and making the internal investments to improve our performance and our capabilities.
The long-term secular growth trends remain intact, and there are opportunities that will sustain WESCO's long-term growth and allow us to increase our share because of our unique global capabilities, our broad portfolio and our scale. I'll now hand it over to Dave to take you through our first quarter results in more detail as well as our outlook for the rest of the year. Dave?
Dave Schulz: Thank you, John. Good morning, everyone. Turning to page 4 of our deck, organic sales were down approximately 3% versus the prior year, reflecting about a 1% benefit from price, offset by lower volumes. Differences in foreign exchange rates were minor in the quarter as shown by the other category on the sales walk. The volume decline was attributable to a very challenging comparison, sales up 12% in the prior year period and continued choppiness in certain end markets. On the lower half of the page, you can see the adjusted EBITDA impacts of lower sales, gross margin headwinds and higher SG&A in the first quarter. Gross margin was down about 60 basis points with approximately half of the decline and the impact of lower billing margin due to mix.
We continue to see a higher proportion of direct ship sales, which has a lower gross margin than stock sales. Direct ship sales, however, have a much higher return on net assets as we recognize the sale and profit with the product never hitting our inventory. The rest of the decline in gross margin was attributable to billing to gross margin adjustments, including a higher inventory adjustment versus the prior year. The year-over-year increase in SG&A was primarily due to higher salaries and higher costs to operate our facilities. These increases were partially offset by the cost reduction actions taken last year. In total, adjusted SG&A represented 15.1% of sales, up 60 basis points from the prior year, with about 0.5 basis point increase driven by the impact of lower sales.
Turning to page 5. On a sequential basis, sales were also in line with expectations and were down 4% organically, primarily due to lower volumes. Differences in foreign exchange rates and the benefit of one extra work day contributed about 1.5 points to sales growth. Adjusted EBITDA was lower than the prior quarter, primarily due to lower sales. Billing margin was up sequentially, and gross margin was down 10 basis points due to billing to gross margin adjustments. Adjusted SG&A was up sequentially about 1%, reflecting the restoration of incentive compensation back to target. Turning to page 6. This slide shows how WESCO has outperformed both our supplier partners and our distributor peers. We believe this is a clear evidence of our share gains over the past few years.
The chart on the left compares WESCO's 10-year organic growth to the average organic growth of our 10 largest publicly traded supplier partners weighted to the proportion of our purchases that they represent. You can see that WESCO has outperformed the supplier average since the middle of 2021. The chart on the right compares WESCO's year-over-year organic growth to the electrical and data communications distributors in the Baird distribution survey, which is published quarterly. WESCO has outperformed its distribution peer in 9 of the 13 periods presented. We think these two data sets clearly demonstrate that our growth has exceeded our peers, indicating our market outperformance over the last three years. Turning to slide 7. First quarter organic sales in our EES business were down approximately 2% on both an organic and reported basis.
Construction sales were flat, reflecting large project shipments and strength in Canada, offset by continued weakness in solar due to a challenging comparable in the prior year. Industrial sales continued to be strong and were up low single digits over the prior year, driven by automation and a continued resurgence in oil and gas. OEM sales were down high single digits. Backlog was approximately flat on a sequential basis and down about 5% from the prior year, reflecting the continued reduction of supplier lead times. EES backlog remains at a historically high level. Adjusted margin was down from the prior year with EBITDA margin down 70 basis points. The decrease in EBITDA margin reflects gross margin headwinds primarily from lower supplier volume rebates.
SG&A was down slightly versus the prior year from the benefit of cost actions taken in 2023. Importantly, adjusted EBITDA margin was flat on a sequential basis. Turning to slide 8. First quarter sales in our CSS business were down approximately 4% from the prior year on both an organic and reported basis. Enterprise network infrastructure, which comprises structured cabling, along with sales to Internet service providers was down low single digits in the quarter. Sales to service providers in support of 5G, fiber and satellite connectivity projects were down double digits in the quarter. This was partially offset by growth in structured cabling sales versus the prior year. Security sales were down high single digits. Recall that prior year quarter was up low teens.
Q1 sales were negatively impacted by lower spending with small and midsized contractors. The security market has contracted over the past few quarters, but we expect it will grow in the second half of this year with strong secular growth in the out years. Data center sales were again primarily driven by growth with hyperscale customers and were up low single digits in the quarter. The growth opportunity of this business is exceptionally strong, given the step change in data center capacity needs, driven by artificial intelligence. As we discussed last quarter, CSS backlog is back to normal levels and was down 20% versus the prior year and up 9% sequentially. Adjusted EBITDA margin for CSS was down 140 basis points. The primary driver of the decrease was gross margin, including the impact of an inventory adjustment.
While SG&A was relatively flat with the prior year, the decline in sales also unfavorably impacted adjusted EBITDA margin. Turning to slide 9. UBS sales were down 5% in the quarter on an organic and reported basis. Sales in utility were down low single digits versus growth of more than 20% in the prior year. We continue to benefit from the secular trends of electrification, green energy, and grid modernization. We saw a decline versus the prior year in our stock and flow sales with customers more tightly managing inventory. Although we divested the Integrated Supply business on April 1st, sales from the business are included in our first quarter results and were up low single digits versus the prior year, consistent with the strength we experienced with other industrial customers within our portfolio.
Broadband sales were down over 20%, which reflected continued demand weakness as customers continue to work through inventory and delayed purchases until government funding is released. Backlog was down 7% from the prior year and down 1% on a sequential basis. Backlog remains near historically high levels. Adjusted EBITDA was down approximately 60 basis points versus the prior year, driven by lower supplier volume rebates, a mix impact and slightly higher SG&A as a percentage of sales. Turning to page 10. On this slide, we have highlighted a recent win by each of our business units that, in aggregate, represent more than $200 million of future project sales. These wins are consistent with the trend of our bidding and winning increasingly large complex projects.
Also worth noting are the end markets that these projects serve, a project that is expected to be the world's first zero-carbons emission ethylene cracker, enterprise data center project, and a large renewable energy project. Turning to page 11. Historically strong free cash flow has been a hallmark of WESCO and our distribution model. We are pleased to see a return to strong free cash flow as most global supply chains have reached equilibrium over the past few quarters. Free cash flow in the quarter was $731 million, driven by working capital, which improved on a days basis, both sequentially and versus the prior year. On a trailing 12-month basis, which this chart bridges to adjusted net income, free cash flow was more than $1.4 billion with cash generation improvements in all three components of working capital.
Note that free cash flow in the first quarter partially benefited from a temporary increase in accounts payable. We migrated a portion of our business to a new accounts payable system that resulted in delays in processing payments. This temporary benefit should reverse in the second quarter. Additionally, we did not take early pay discounts at our historical rate, which also resulted in a higher accounts payable balance. Note that in the second, third, and fourth quarters of last year, receivables and inventory were a combined source of approximately $340 million, partially offset by payables, which was a use of $233 million. It is important -- it is because of this significant increase to quarter-to-quarter variability that we believe free cash flow is best considered on a trailing 12-month basis.
We were pleased to see a return to cash flow generation beginning in the back half of 2023. With the significant sales growth we delivered in 2021 and 2022, we invested heavily in net working capital, and we're well-below our normal free cash flow conversion expectation. With this first quarter result, we are increasing the midpoint of our free cash flow outlook for 2024 from $700 million to $900 million, which is more than 100% of our implied outlook for adjusted net income at the midpoint, to a range of $800 million to $1 billion. Moving to Slide 12. On this slide, we have outlined our return of capital to shareholders over the past 3 years, along with our capital allocation priorities for 2024. You can see that we intend to fully utilize the net proceeds of the Integrated Supply divestiture for share repurchases in the second quarter.
In addition, the significant increase in our 2024 free cash flow outlook to $900 million at the midpoint provides optionality for us to opportunistically repurchase additional share, further reduce debt and/or pursue M&A in the second half of the year. Recall that we provided a long-term outlook for operating cash flow generation of $3.5 billion to $4.5 billion at our Investor Day in 2022. We remain on track to achieve this target and expect to return about 40% of our operating cash flow to shareholders through dividends, including our common dividend, which we increased 10% in 2024 and executing our $1 billion share repurchase authorization. The upside cash generation also allows us to continue to invest for organic growth and operational efficiency by our digital transformation.
Now moving to Page 13 for the key sales drivers of our strategic business units. We first provided this outlook by SBU last quarter with our initial 2024 outlook. Excluding the impact of the WIS divestiture, our outlook for sales at the SBU level is unchanged from our prior view. Within EES, we faced headwinds in both construction and OEM in 2023 that more than offset significant growth in Industrial. In 2024, we expect EES reported sales growth to be flat to up low single digits as construction end markets remain pressured despite an increase in large project activity. The Industrial business 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 last year and 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 in the nonresidential construction market, including renovations. Enterprise network infrastructure is the largest business for CSS and makes up approximately 40% of segment revenues. For CSS in 2024, we again expect 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 continue.
That said, we expect volume growth driving CSS sales up low to mid-single digits. Lastly, looking at UBS. In 2023, we generated double-digit growth in utility. This was partially offset by an approximately 20% decline in broadband due to customer destocking and delays of purchases until government dollars are released. In 2024, we expect growth in utility but at a more moderate pace as we lap strong comparisons, significant 2023 price increases and as utility customers more tightly manage inventory. 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 growth for UBS in 2024 with sales up mid-single digits. Please note these growth rates exclude the integrated supply business that we divested last month.
Moving to slide 14 for our 2024 outlook. We are reaffirming our outlook for organic sales growth, adjusted EBITDA margin, and adjusted EPS. The divestiture of our Integrated Supply business will represent a 3% headwind to sales, which reduces our reported sales outlook to a range of down 2% to up 1% or approximately $21.9 billion to $22.6 billion. At the midpoint of the range, prices are expected to contribute about one point to the top line with volumes relatively flat. From a quarterly sales perspective, we expect to see normal sequential patterns as we move throughout 2024. At the midpoint of our revenue outlook, reported sales would be roughly flat, including the Q2 through Q4 divestiture impact of approximately $700 million. On adjusted EBITDA margin, while we do not provide an outlook for gross margin, we expect to see improvement in 2024.
The integrated supply divestiture will be accretive to gross margin. Our billing margin was stable in 2023 and up slightly sequentially in the first quarter. We expect improved mix and flat supplier volume rebates as a percentage of sales along with the benefit 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 a return to target payouts for incentive compensation. Combined, these items represent an approximately $100 million cost headwind in 2024 and are expected to be only partially offset by the cost actions we took in 2023 and $20 million of annualized cost actions we took at the end of the first quarter. From a P&L perspective, we continue to expect adjusted EBITDA margin to be in the range of 7.5% to 7.9% or approximately $1.7 billion of EBITDA at the midpoint.
The revision to adjusted EBITDA at the midpoint reflects the impact of the integrated supply divestiture of approximately $45 million relative to our initial outlook. You can see that we are maintaining our outlook range for adjusted EPS of $13.75 to $15.75. The dilutive impact of the integrated supply divestiture will be partially offset by the $300 million of share repurchases we expect to initiate during the second quarter. As I discussed a moment ago, we are increasing our outlook for free cash flow from a range of $600 million to $800 million to a range of $800 million to $1 billion. This free cash flow outlook represents the highest free cash flow in our history and more than 100% of adjusted net income. We have assumed in our free cash flow outlook that net working capital days improve, including a 3-day improvement to inventory days outstanding.
Before turning to Slide 15, I want to draw your attention to some updates we have made to our underlying assumptions for 2024. We have increased our outlook for other expense to the upper end of our range or approximately $25 million based on first quarter results. This expense is a combination of our pension costs and the impact of changes in foreign exchange rates on the balance sheet. On shares, we reduced our expected average share count to 50.5 million shares based on the buyback activity of $50 million completed in the first quarter and our expectation to buy back $300 million of shares in the second quarter. And lastly, while we continue to expect an effective tax rate of approximately 27% for the remaining 3 quarters, the lower rate in Q1 reduces our outlook for the full year to approximately 26%.
Turning to Page 15. This slide shows the 2023 year-over-year monthly sales growth comparisons with monthly growth rate for the first quarter and our expectations for the second quarter. Like the rest of 2024, we expect to see normal seasonality in the second quarter, including a sequential increase in sales. On a year-over-year basis, we expect organic sales to be flat to up low single digits and down low single digits on a reported basis. We expect our gross margin rate to improve sequentially, primarily reflecting the benefit from the Integrated Supply divestiture, and for SG&A to increase sequentially due to the annual merit increase. Preliminary April sales per work day were down 2%, in line with typical sequential patterns. Now moving to Page 16.
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 partnership 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. Turning to Page 17. We've covered a lot of material this morning so let me briefly recap the key points before we open the call to your questions.
Sales in the first quarter were in line with typical seasonality and our full year outlook. Backlog remains at very high levels in each of our business units. Free cash flow was more than $700 million in the quarter and more than $1.4 billion over the past 12 months, including an accounts payable balance that will normalize going forward. We utilized our cash flow to opportunistically repurchase $50 million of shares in the first quarter. We are reaffirming our 2024 outlook for organic growth, adjusted EBITDA margin, and adjusted EPS and increasing the midpoint of our free cash flow outlook by $200 million. We intend to use the proceeds from the Integrated Supply divestiture to repurchase $300 million of our shares in addition to the $50 million bought back in the first quarter.
With the remaining free cash flow generated this year, we will balance additional share repurchases with reducing leverage while continuing to pursue accretive M&A. With that, operator, we can now open the call to your questions.
See also
15 Biggest Aircraft Carriers in the World and
Top 20 States Where the US Military Spends the Most Money.
To continue reading the Q&A session, please click here.
