WESCO International (WCC) announced fourth-quarter earnings that exceeded the Zacks consensus estimate by a penny.
Revenue
Revenue for the period was $1.13 billion, down 1.7% sequentially and 20.8% year over year. This was better than the 4-6% decline forecasted by management, as the company saw improvements in some markets. Higher commodity prices helped on the pricing front, resulting in better product margins. The average revenue per employee was $743 million, up 3.1% sequentially and down 6.5% year over year.
End-Market Update
Industrial markets strengthened in the last quarter, with sales to industrial customers increasing 7%. However, seasonality and recessionary pressures combined to pull down sales to construction and utility customers by 5% and 13%, respectively.
The sequential improvement in the industrial business is attributable to gradual recovery across multiple industrial sectors. The company witnessed a 10% renewal rate on its national account program (now referred to as global account program) and signed up seven new customers. Strength is expected to continue into the next quarter.
Construction, including commercial, industrial and government, continues to see broad-based weakness across all geographies. However, sales to the government sector improved 20%, the positive result of focused management actions. Government stimulus funded projects are expected to take off this year, with the company booking around $40 million in orders for qualified projects in 2009.
Utilities spending remains restricted to maintenance activity, as industrial power consumption dropped to its eight-year low and domestic consumption also plummeted. Demand is currently focused on transmission-related and alternative energy projects, for which products are usually procured directly from the supplier. Although the company does have an alliance partner program in place, it has lost a couple of key customers to competition.
Margins
The gross margin was 18.6%, flat sequentially and down 33 bps year over year. The decline was on account of inventory-related charges, as well as lower supplier rebate rates. However, the company saw no negative mix impact, which remained consistent with the fourth quarter of 2008.
Operating expenses of $168.3 million were flat sequentially, but down 16.4% year over year. There have been double-digit declines in operating expense dollars in each of the last four quarters. This was the result of cost reduction programs initiated by management, which resulted in the elimination of 1200 positions. However, the operating margin of 3.8% was a decline of 25 bps sequentially and 110 bps from the Dec quarter of 2008, as the recession has resulted in significantly lower volumes.
Net Income
The company reported net income of $21.8 million, or 1.9% net margin, compared to $27.7 million, or 2.4%, in the previous quarter and $41.9 million, or 2.9%, in the year-ago quarter. The lower income in the last quarter was the result of a full-quarter impact of newly issued debentures.
There were no special items in the last quarter. Therefore, the GAAP EPS was same as the pro forma EPS at $0.51, down from $0.79 in the Sep 2009 quarter and $0.84 in the Dec quarter of 2008.
Balance Sheet
Inventories were up 2.4%, with inventory turns down from 7.6X to 7.3X. The inventory increase was in anticipation of stronger industrial product sales in the current quarter. DSOs declined slightly from 52 to 51. The cash balance at the end of the quarter was $112.3 million. The company generated $0.8 million in cash from operations and spent $2.5 million on capex, resulting in negative free cash flow for the quarter. The net debt position at quarter-end was $485.6 million, down $104.1 million during the quarter. Short term debt increased from $3.9 million to $94 million, as the company reclassified its 2025 debentures as short term since these are expected to be put to the company in the fourth quarter of 2010.
Guidance
Management expects revenue in the first quarter of 2010 to decline 1-3%, better than the normal seasonal decline of 2-5%.
Operating expenses are expected to be up $5-9 million, resulting in an operating margin of 3.4%. The current year is not expected to be a strong one for the company. Management stated that although it expects to see gradual recovery in the industrial, international and government markets, these improvements will be offset by further contraction in non-residential construction and utility markets. The net impact is expected to be a 3-5% contraction in the total served market. However, management expects recent growth initiatives to at least partially offset these negatives. It currently expects modest improvement in gross margins and some increase in operating expenses. Interest expense is expected to be flat to slightly up, the tax rate to be 28-30% and capex to be approximately $20 million.
Estimate Revisions
The Zacks Consensus estimate for the upcoming quarter is $0.45 and we see no estimate revisions over the last three months. However, the Zacks Consensus estimate for 2010 has been lowered by $0.05 since WESCO reported results.
The company has reported both positive and negative surprises over the past four quarters and it is difficult to establish a trend. However, the current estimate of $0.45 still appears to be too optimistic, so there is downside potential of approximately 2.22%.
Given these factors, we do not anticipate much movement in the share price in the near term and reiterate our long term Neutral recommendation on the shares.
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