WESCO International, Inc. (WCC) Earnings Call Transcript & Summary

Good morning. I'm Sam Darkatsh. On behalf of Raymond James, I'd like to welcome you to the WESCO International presentation for this morning. WESCO is the largest North American distributor of electrical and electronic solutions, communications and security solutions and utility and broadband solutions. End-market verticals include commercial and industrial businesses, contractors, government agencies, institutions, telecommunications providers and utilities. With us today from WESCO is John Engel, Chairman, President and CEO; as well as Dave Schulz, Executive Vice President and Chief Financial Officer. I think the format this morning, John, about 15 minutes or so of prepared remarks, which should give us a little bit of time for Q&A from the audience. And so with that, John, welcome.

Great to be here, Sam. Thank you. It's always a terrific conference, and it's good to be out together with all of you face-to-face again. It's been an interesting couple of years. And look, it's my pleasure to be here with you today and share the story of the new WESCO with you. And some of you know WESCO well, but we're a brand-new company as a result of joining with another leading Fortune 500 company in June of 2020, and I'll talk about that. We're an $18 billion global B2B distributor and supply chain solutions company. Our purpose is to build, connect, power and protect the world. We have 18,000 associates around the world that really live that mission every day. We have over 100,000 customers we serve, and we're based in over 50 countries around the world. Through our differentiated and leading value proposition for both customers and suppliers, we're very much positioning WESCO to be the best tech-enabled supply chain solution provider in the world for our value chain. So we combined 2 leading Fortune 500 companies of equal size when we acquired Anixter in June of 2020. We struck that deal in early 2020, January, it's when Anixter's Board agreed to that deal. That was prepandemic, and we closed that deal in less than 6 months in June of 2020. And we did that under the cloud of the pandemic. We're only 18-plus months into this integration and digital transformation. I can tell you we're making terrific progress creating value for all our shareholders. From the time of the merger close in June of 2020 through the end of last year, we've delivered a total stockholder return of 250%. So off to a very good start. As we continue our strong execution of this integration plan, as I said, we're 18-plus months into it, it's a 3-year integration program. And we're also in the midst of a digital transformation that will extend beyond that another couple of years. As we continue to execute and with the increasing contribution of strong secular growth trends that we're exceptionally well positioned to take advantage of, I can tell you, we've only just begun on the value creation. So 2021 was an absolutely exceptional year. We achieved new company records for sales, backlog and overall profitability. And the way we like to think about it is we're measuring ourselves against 2019 prepandemic pro forma, which we've published. So many companies had different results in 2020. There's a lot of noise. And '21 versus '20 consequently has a lot of noise. So we focus on how did we do in 2021 versus 2019 in pro forma levels, the 2 companies as if they were combined. Our sales grew 6% at the end of '21, full year versus '19. Our EBITDA grew 30%, and our operating margins expanded 120 basis points. So again, very strong results, and we also accelerated our deleveraging. I'll talk more about that. And again it's against the headwinds of the pandemic and a series of challenges we all know about, global supply chain and high inflation. We've had outstanding execution of the integration plan and delivery of the synergies. This lays out our cost synergies. We published our cost-synergy commitment/target prior to the merger close, and we've raised it 3 times since we've closed the merger. The original target was $200 million of cost synergies across the 3-year period. We raised it to $250 million, then to $300 million. And last year, with the very strong results in 2021, we raised it again at the end of the last year to $315 million. So that's our commitment to deliver a cumulative $315 million of cost synergies by the end of next year. Also, sales synergies, we've made outstanding progress on our cross-selling plan. This is a major commitment and priority as part of our integration. And this typically proved to be the most elusive synergy whenever you put 2 companies together, particularly of equal size. Our pipeline of opportunities continues to grow. I can tell you here we've also raised our target. The target we published prior to merger close was 1% of combined sales. Pro forma sales were $16 billion. So that would have been $160 million of sales. We've raised this target twice since the merger closed in June of 2020. First, raising it to $500 million and now $600 million. And so that's almost a 4x factor versus the original target. And this is the cumulative sales synergies that we'll deliver through cross-selling by the end of next year. And you can see captured on the top right-hand side of this page, we've already delivered $365 million of the $600 million through the end of last year. So I'll tell you, I think that our sales synergies are proving to be the most outstanding and strongest value-creation lever of putting these 2 strong companies together. Let's talk about leverage. We had to obviously lever up to make this deal happen. We originally were going to use equity when we announced this in January of 2020. Once the pandemic hit, the stock market took a big hit. Our stock disproportionately we thought took a hit. We were at the $60 range when we announced this deal. Our stock dropped into the low teens -- teens. We did not waiver. We pivoted. We said we're not going to use equity. It's too precious to do the deal. So we pivoted to all debt, which means we levered up even more. I told you we closed in June of 2020. And when we closed, our total debt-to-EBITDA leverage ratio was 5.7x. As a well-run B2B distributor, we do -- we generate very strong free cash flow across all phases of the economic cycle. And our track record includes rapidly delevering post acquisition. I'll tell you, WESCO has done over 50 acquisitions since we spun out of Westinghouse via management-backed leverage buyout in 1994. So we're a veteran in terms of dealing with this, and we know how our cash flow models work. And I can tell you, I'm very pleased that we beat our deleveraging commitment. We had committed to get to -- back to our target leverage range of 2 to 3.5x after 3 years post close, which would be the middle of 2023. As of the end of last year, we're at 3.9x, under 4. So we've taken out 1.5 -- 1.8 turns of leverage in 18 months. So very strong execution. I'll tell you that, that did not surprise us. I know it surprised many others. Those that understand distribution even then, I think we accelerated at a faster rate than they would have anticipated. Let's talk a bit about digital. One of the reasons we put these companies together was we announced in our 2019 Investor Day that clearly scale matters in distribution. But digital was starting to impact the B2B value chain. It's pretty incredible what digital has done to the B2C retail distribution value chain over the last 2 decades. And I made the argument that industries, like companies and products, go through the proverbial S curve, and we're at the beginning part of the S curve of digital impacting B2B. That's the first point. The second point was suppliers were combining at a much more rapid rate than distributors, and were still fragmented in our part of the value chain. So it was imperative that the bigs started to come together. And that was, again, in the middle of 2019 when we had our Investor Day. And again, here we are a few years later, we made Anixter happen. So clearly, we're leading the consolidation of our portion of the value chain. But one of the strategic reasons we did this was, by putting 2 large bigs together, so to speak, we were confident we'd deliver a lot of incremental value with the synergies, but we also could use that to help fund increased investment in the company in terms of digital transformation, and that's what we've been doing. We're digitally transforming our business to propel our growth for the next decade and beyond. And the way we think about our digital transformation is really unlocking the power of our big data. It's going to enable new ways of working, new business models. We want to put WESCO at the center of the global supply chain tech ecosystem. Next to our people and our talent, our big data is the greatest asset that we have. It's incredibly powerful. And we're in the early innings of our digital transformation in unlocking the power of our big data. And I can tell you, the opportunities are going to be very significant. We'll be sharing our progress with you along the way. We're clearly seeing, as I mentioned, the outsized benefits of our cross-selling program and our new service capabilities and expanded portfolio on our results. What's also very exciting is the attractive secular growth trends that are in play over the next decade and beyond. And we're much better positioned as a result of putting these companies together to take advantage of those. They're going to amplify our growth opportunity. We've essentially mix shifted our company up into a higher growth trajectory. And these are 6 that we've been talking about we've been bringing to life over the last few quarters with some examples in our earnings calls. This page then takes those secular growth trends and brings it down into our 3 businesses and lists the specific opportunities that we have as a result of our 3 business -- global business units and our combined portfolio. And the bottom line is, you can see that all 3 of our businesses have outstanding growth opportunities in front of them for the next decade and beyond. This is our 2022 outlook. We presented this during our earnings call 3 weeks ago. It's summarized on this page. I can tell you that we expect to outperform the markets again this year, expand margins and deliver double-digit EPS growth. We carried very strong positive momentum into 2022, and the year is off to an excellent start. So in summary, we're really in the very early stages of unlocking the power and performance of the new WESCO. I can tell you, these are exciting times for our company. I said we're midway through the integration period, and we're in the early days of our digital transformation. The future has never been brighter, and we're very excited of what the future portends for us. So with that, thanks again, Sam. I'm going to open it up for Q&A.

I'm going to kind of cut right to the chase here, I suppose. I mean your stock right now is trading basically at a comfortable double-digit free cash flow yield, which is basically the market saying that you're never really going to grow free cash flow in perpetuity, which based on your end markets is silly. So I'm trying to think of what the other side of the case might be in terms of what the market might be missing. And so one thing might be, okay, is there going to be a deviation from the deleveraging plan? There has been some M&A of late in the space, albeit at really attractive prices. Are you yet at the level where you would be contemplating medium- to large-scale M&A? And if it does happen, would it be coming at a price that would be accretive to where WESCO trades right now in the public markets?

We're -- first, I want to be clear, we're very focused on getting our leverage back within our target range. It's 2 to 3.5x. That's the band we like to operate in. It gives us tremendous flexibility to run our business. And in doing that, we're paying down debt. We're obviously driving EBITDA growth. It's getting -- we're driving the deleverage, and we're investing in our business as I outlined. So that's clearly priority 1. And we're well on track, as I said, versus an accelerated timeline against that. As we get back into that range, it gives us a lot of increased optionality, as we've had over the years. We have been classically an acquiring company. The markets we're in are fragmented. I do believe opportunity is directly proportional to the fragmentation of the industry and the value chain you're in. And scale absolutely is a defining factor. Market leadership and scale are drivers to fundamental margin growth and expansion in distribution. We've shown ourselves, Sam, to be a very strong, disciplined and experienced acquirer. We've never paid outlandish multiples. We never paid above [ 10.Xx ]. Many of the deals we've done have been -- had a 6x, 7x kind of multiple factor. And then with post synergies, obviously, it's a much lower multiple. So I think we're very experienced at this. We're disciplined. I will tell you that M&A will be -- continue to be a key value creation lever for us as long as we're operating in a very fragmented value chain. Now we -- it's our intent to organically grow well above market. So anything that we do with M&A would be accretive on top of that. And I can tell you that the accretion is very, very critical to us in terms of inherent margin expansion if we do future deals. We won't necessarily be looking for -- I think we now have built a company, it's a new company and a platform that has inherent synergy leverage built into it that can be applied to future acquisitions.

And Dave, perhaps another concern might be debt leverage. You're under 4x now, but it's still, at least for some folks, optically elevated. You don't have any debt coming due, I think, until, what, the sizable debt coming due until mid-'25. I think you got, what, $1.5 billion note at 7 1/8% that matures then. You also have, what, $500 million, $600 million or so of callable preferreds at over 10% that's coming due about the same time. Talk about what options are available to you, whether you would need to refinance those, whether you would see yourself not only growing EBITDA but cash flow in order to pay those off. Just trying to get a sense of perhaps alleviating concerns that the balance sheet might need to be addressed.

Yes. Thanks very much for that question. And again, we've always opportunistically looked at our capital structure, how we can continue to drive what is the right optionality for us going forward. We do have the 2025 notes. There is a meaningful stepdown in the call premium. We disclosed what that premium is -- is going to drop down from about 103.6 to 101.5 on June 15. So we're taking a look at what possibilities that enables us to pursue. Again, no decision, of course, at this time, given the volatility that we're all experiencing in the markets at this point. We also do have a preferred stock that is out there. that pays 10 5/8%. That is a preferred perpetual that the first call date on that is 5 years post timing of the deal, so June of 2025. So it is our intent to continue to pursue options to reduce that perpetual preferred. Again, we're going to have to take a look at what market opportunities are available at that time and, again, continue to optimize our capital structure.

Secure -- talk about securitization ...

Yes, we did, and it was on the slide there. You may have seen that we did recently increase our liquidity through upsizing some of our current facilities and extending the maturities on those. So we just increased our liquidity by another $0.25 billion. Again, given the size of our company, we felt that, that was prudent and, again, it provides us with more optionality going forward.

For working capital needs? For -- what would the need for the additional liquidity be?

Yes, primarily working capital. And as you saw in our results for 2021, we invested in working capital as our sales continued to grow. We provided an outlook for 2022, where we expect our sales to again grow 5% to 8% on a reported basis. So again, it does provide us with optionality going forward. Or in the near term, we've been investing in net working capital.

When you acquired Anixter, you mentioned that there might need to be a wide-scale ERP rollout. I think both companies were operating under legacy somewhat antiquated systems. Where are you right now in the decision-making process in terms of what that might look like both with respect to structure and timing?

So I'll tell you what we're not doing, we're not doing a monolithic enterprise-wide ERP transition for the combined company. That is not happening. We have taken a best-of-breed approach. We've not talked much about this yet, but I'll give you a framework. We've taken a best-of-breed approach and looking at -- there is a new digital architecture we've laid out for the combined company. The centerpiece of it is taking all our requisite big data that was Anixter's and WESCO's legacy big data and putting it -- hydrating it into one world-class single data lake that we will then become the basis upon which a series of best-in-breed systems access and operationalize that data. So that's about as far as what we've gone externally at this point in terms of what we've shared. So some of those subsystems are already well underway. So we've gone Oracle for Financials. We've gone Oracle for Human Capital Management. We are now in the early days of rolling out a new WMS, TMS package; WMS being a warehouse management system. TMS being transportation management system; which is a world-class solution. And so think of these subsystems as those pieces knitted together within a very innovative architecture and middle layer approach, all playing against one world-class data lake with all our requisite big data in it. So that's about all that we've said externally to date. I don't necessarily want to -- most of our competitors are private companies, and I don't want to foreshadow our secret sauce on what we believe is our secret sauce that we're leveraging going forward. With that said, we do plan on giving you some more details when we have our Investor Day we're planning one for the second half of this year.

I'll just provide, back when we announced the merger in January of 2020, we outlined some of the capital expenditures that would be required to integrate primarily on the systems front that John just mentioned. And we had outlined that we would be spending in the neighborhood of $120 million per year for the first 3 years. That's in comparison to a $90 million pro forma run rate prior to the acquisition. So again, we are stepping up the investment, our capital expenditure budget primarily goes towards digital and IT systems, along with we're an asset-light company. So it goes along with what's required to operate our facilities around the world. So it's not a meaningful step-up in the historical run rate from a capital expenditure perspective pro forma. But again, we are focused primarily on our digital and IT systems. The other thing I'll provide is it's not all going to show up on the CapEx line. We walked through investors, how that's going to flow during our fourth quarter earnings call. We are migrating more from on-prem to cloud, so it doesn't show up as a hard asset on the balance sheet, it shows up as a subscription base. So you'll see that flowing through still in our free cash flow calculation, but not on the CapEx line, more on the operating cash flows.

[ Price/cost ] was a positive for you last year. I think that favorably surprised a lot of folks that have remembered how challenging it has been to get [ price/cost ] in the industry. Talk about the sustainability of [ price/cost ] as you see it, John?

Yes. Great question, Sam. And this is a question we get a lot. We're talking right before this. I think we're -- I'll start at the macro level. I think we're seeing the inherent benefits of a leadership position plus scale, plus the broader expanded complementary portfolio of products and services. You put those 3 things together, and we're in a completely different position in terms of the ability to serve customers. And in the supply chain, we're much more important to our supplier partners. First point. Second point is very interesting because both WESCO and Anixter had a disproportional share of their customer base being end-user customers versus contractors or system integrators. And so that is playing out very well for us as we bring complete solutions to them. Final point I'll make is Anixter had started an enterprise-wide gross margin expansion program 9 to 10 quarters before we came together as one company. You can take a look, they're a publicly traded company, look at the margin expansion, they got 10 quarters in a row, leading up through mid-2020. So it's 2018, 2019 and the first half of 2020, those 10 quarters. Keep in mind what the backdrop was. And many of the other publicly traded distributors were having gross margins go the other way, double-digit or triple-digit basis point declines. WESCO got a little bit of gross margin in that period. So when we put the 2 companies together, this was an important priority for the integration and one of the top priorities, getting fundamental gross margin expansion. We took that Anixter program. They wanted to make some changes and improve it. We looked at what WESCO would be doing, and we put the best of the best program together and launched that enterprise-wide. It did not get launched until January of 2020 -- so 2021, sorry. The second half of 2020, we were figuring out how to put the 2 programs together and go enterprise-wide. And I could not be more pleased with our gross margin expansion results when you take a look at what we've done all 6 quarters since we've been together. And on a legacy basis, both Anixter and WESCO, as if they were separate companies, have still expanded the gross margin, both and collectively; obviously, you've seen our reported results. So I can tell you, Sam, that, that has tremendous legs left to it. Because if you look at Anixter, you take these last 6 quarters plus the prior 10, that's 16 quarters in a row. 16 in a row they have a gross margin expansion. And so I think we've got a lot of legs left as a result of what we're driving enterprise-wide. I commented on digital. We're in the very early days of starting to apply digital to our big data to further accelerate our gross margin expansion. We got the initial makings of a dynamic pricing model, leveraging our big data. We have the initial makings of a smart search, digital product we're using inside our 4 walls to help our front-end sales desk get the best product for that customer solution. So unlocking the power of our big data with digital will be a further accelerant on top of this core gross margin program. We've gotten a lot of questions on what the secret sauce is. It's enterprise-wide. It's nonnegotiable. You got to do it. And we did adjust the compensation. So I will tell you that was a key enabler. Anixter had put a very innovative sales force compensation program in place wrapping around that for truly accretive margins, and it create -- it really drove the right behavior and we adopted, and that's what we've driven enterprise-wide. So I mean it's terrific. Look, we're focused on, make no mistake, about that operating margin expansion significant, and we see it as the recipe being a 1-2 punch, inherent gross margin, fundamental gross margin expansion and operating cost leverage, but the power of gross margin expansion is huge.

Any questions from the room here? Sure.

I mean have you guys give any guidance as to [ what the guidance of ] looks like [indiscernible] pro forma [indiscernible]?

We -- the question on pro forma leverage, we've given any guidance. We have -- if you look at our guide, we said free cash flow will be 100% of net income this year. We're currently at a 3.9x total debt to EBITDA exiting last year. And we said we'll be back within our target range in the second half, but we've not given an end-of-year number. Obviously, we've taken 1.8 turns out in 18 months, so we're moving at a nice clip.

Yes. Follow-up question. With supply chain tightness, [indiscernible] more of capital than [indiscernible] working capital?

With supply chain tightness, if we had to consciously commit more working capital, the short answer is we made that strategic decision. So the answer is yes. We added over $500 million to our inventory investment in calendar year '21. That's starting with a little over a $2 billion inventory base. This was not by accident. It was by design. So we grew our inventories at a much higher rate than our sales growth rate, by design. I can tell you, and it's working, that we see ourselves as the lighthouse in the storm or the oasis in the desert. It's amazing the nonlinear effects you have when you double the company. We took 2 leading Fortune 500 companies in their own right, doubled up overnight. And now with these global supply chain challenges, we're even more important to our supplier partners. We have new customers coming to us because we are leveraging the benefits of this combination and this scale, coupled with consciously increasing our inventories to maintain -- our laser focus is on our fill rates and our availability and supporting the record backlog we built, so I'll comment on that. In my tenure with the company, I joined in 2004, we have never grown our backlog sequentially every month in a year, ever, for almost 20 years. We grew our backlog sequentially every month of last year. Each of our 3 businesses has grown their backlog at least 65%. As a total company, we're up 88%. We're different than a manufacturing company. What's in our backlog is a real hard customer order with delivery requirements, and it's defined. And so part of that backlog -- part of that inventory build was to support the assembly of system solutions. And I can tell you, we're getting -- I'll be careful with how I say it, but let's say we're strongly partnering with our supplier partners to make sure we get our -- get the appropriate share what's coming off their manufacturing line in this globally supply chain-challenged world. So I think we're -- this has been a major enabler of our outperforming in the market in terms of sales growth in '21. And structurally, we're very well set up for 2022.

And with that, we're out of time. We will have to continue this in the breakout session. John, Dave, thank you very much.