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WESCO INTERNATIONAL INC Filed on Aug 9 2002
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in
conjunction with the information in the unaudited condensed consolidated
financial statements and notes thereto included herein and WESCO International
Inc.'s Financial Statements and Management's Discussion and Analysis of
Financial Condition and Results of Operations included in its 2001 Annual Report
on Form 10-K.
GENERAL
WESCO is a full-line distributor of electrical supplies and equipment and is a
provider of integrated supply procurement services. WESCO currently operates
over 350 branch locations and five distribution centers in the United States,
Canada, Mexico, Puerto Rico, Guam, the United Kingdom, Nigeria, Singapore and
Venezuela. WESCO serves over 100,000 customers worldwide, offering over
1,000,000 products from over 24,000 suppliers. WESCO's diverse customer base
includes a wide variety of industrial companies; contractors for industrial,
commercial and residential projects; utility companies, and commercial,
institutional and governmental customers. Approximately 89.5% of WESCO's net
sales are generated from operations in the U.S., 8.5% from Canada and the
remainder from other countries.
RECENT DEVELOPMENTS
Recent developments affecting the results of operations and financial position
of WESCO include the following:
In March 2002, WESCO Distribution, Inc. entered into a $290 million revolving credit agreement that is collateralized by substantially all inventory owned by WESCO and also by the accounts receivable of WESCO Distribution Canada, Inc. Availability under the agreement, which matures in 2007, is limited to the amount of eligible inventory and Canadian receivables applied against certain advance rates. Proceeds from this agreement were used to retire WESCO Distribution, Inc.'s existing revolving credit facility. Interest on this new facility is at LIBOR plus a margin that will range between 2.0% to 2.75% depending upon the amount of excess availability under the facility. As long as the average daily excess availability for both the preceding and projected succeeding 90 day period is greater than $50 million, WESCO would be permitted to make acquisitions and repurchase outstanding public stock and bonds.
The above permitted transactions would also be allowed if such excess availability is between $25 million and $50 million and WESCO's fixed charge coverage ratio, as defined by the agreement, is at least 1.25 to 1.0 after taking into consideration the permitted transaction. Additionally, if WESCO's excess availability under the agreement is less than $50 million, WESCO must maintain a fixed charge coverage ratio of 1.1 to 1.0.
At June 30, 2002, amounts available under the agreement were approximately $66.6 million and WESCO was in compliance with all covenants of the new facility.
RESULTS OF OPERATIONS
Second Quarter of 2002 versus Second Quarter of 2001
The following table sets forth the percentage relationship to net sales of certain items in WESCO's condensed consolidated statements of operations for the periods presented:
THREE MONTHS ENDED
JUNE 30
2002 2001
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Net sales 100.0% 100.0%
Gross profit 17.6 17.5
Selling, general and administrative expenses 14.6 13.7
Depreciation and amortization 0.5 0.8
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Income from operations 2.5 3.0
Interest expense 1.3 1.2
Other expense 0.2 0.5
----------------------
Income before income taxes 1.0 1.3
Provision for income taxes 0.3 0.5
----------------------
Net income 0.7% 0.8%
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Net Sales. Net sales in the second quarter of 2002 decreased $95.7 million, or 10.1%, to $848.4 million compared with $944.1 million in the prior-year quarter, primarily due to sales decline in the Company's core business. Core business sales decreased 9.9% from the prior year quarter. The continued weakness in the North American economy has affected the markets where WESCO participates.
Gross Profit. Gross profit for the second quarter of 2002 decreased $15.3 million to $149.5 million from $164.8 million in the second quarter of 2001. The decrease in gross profit compared to prior year is primarily attributable to the decrease in sales versus prior year. Gross profit margin as a percentage of sales was 17.6 % for the quarter ended June 30, 2002 and 17.5% for the quarter ended June 30, 2001. Billing margins increased by approximately 50 basis points over the second quarter of 2001 and were partially offset by lower levels of supplier rebates and cash discounts that resulted from lower purchasing activity and working capital improvements.
Selling, General and Administrative Expenses. Selling, general and administrative ("SG&A") expenses decreased $5.8 million, or 4.5%, to $123.4 million. SG&A expenses associated with WESCO's core business decreased 4.9%. The decrease was principally due to compensation and benefit program expense reductions. As a percent of sales, SG&A expenses increased to 14.6% compared with 13.7% in the prior year quarter reflecting lower sales volume in the current period.
Depreciation and Amortization. Depreciation and amortization decreased $3.2 million to $4.4 million reflecting the discontinuation of goodwill amortization based on WESCO's adoption of SFAS No. 142. Depreciation and amortization expense in 2001 included $3.0 million for amortization of goodwill.
Income From Operations. Income from operations decreased $6.4 million or 22.8% from the prior year quarter due to the previously mentioned lower sales volume.
Interest and Other Expense. Interest expense totaled $11.1 million for the second quarter of 2002, an increase of $0.2 million over the same period in 2001. Other expense totaled $1.7 million and $4.6 million in the second quarter of 2002 and 2001, respectively, reflecting costs associated with the accounts receivable securitization. The decrease was due to reduced fees and a lower level of securitized accounts receivable.
Income Taxes. Income tax expense totaled $3.2 million in the second quarter of 2002 and the effective tax rate was 36.7%. In the second quarter of 2001, income tax expense totaled $5.0 million and the effective tax rate was 39.8%. State tax reduction initiatives, the impact of SFAS No. 142 and establishment of a foreign finance company caused the reduction in the effective tax rate.
Net Income. Net income and diluted earnings per share totaled $5.6 million and $0.12, respectively, for the second quarter of 2002, compared with net income of $7.5 million, or $0.16 per diluted share, for the second quarter of 2001.
Six Months Ended June 30, 2002 versus Six Months Ended June 30, 2001
The following table sets forth the percentage relationship to net sales of certain items in WESCO's condensed consolidated statements of operations for the periods presented:
SIX MONTHS ENDED
JUNE 30
2002 2001
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Net sales 100.0% 100.0%
Gross profit 17.8 17.7
Selling, general and administrative expenses 14.8 14.2
Depreciation and amortization 0.6 0.8
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Income from operations 2.4 2.7
Interest expense 1.3 1.2
Other expense 0.2 0.5
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Income before income taxes 0.9 1.0
Provision for income taxes 0.3 0.4
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Extraordinary item, net of tax benefits 0.0 --
-----------------------
Net income 0.6% 0.6%
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Net Sales. Net sales for the first six months of 2002 decreased $214.8 million, or 11.5%, to $1,657.4 million compared with $1,872.2 million in the prior year period, primarily due to a sales decline in the Company's core business of 11.8%. The continued weakness in the North American economy has affected the markets where WESCO participates.
Gross Profit. Gross profit for the first six months of 2002 decreased $36.9 million or 11.1% to $295.1 million from $332.0 million in 2001. The decrease was primarily due to the aforementioned sales deterioration in the Company's core business. Gross profit margin percentage was 17.8% and 17.7% for the current and prior year period, respectively. Billing margins for the first six months of 2002 are 30 basis points over 2001 and are partially offset by lower levels of supplier rebates and cash discounts that resulted from lower purchasing activity and working capital improvements.
Selling, General and Administrative Expenses. SG&A expenses decreased $20.5 million, or 7.7%, to $245.5 million. SG&A expenses associated with WESCO's core business decreased 8.7%. The decrease was principally due to compensation and benefit program expense reductions in the period to period comparisons. Permanent employee headcount has been reduced approximately 11% since March of 2001. As a percentage of net sales, SG&A expenses increased to 14.8% compared with 14.2% in the prior year period reflecting a lower relative sales level.
Depreciation and Amortization. Depreciation and amortization decreased $5.4 million to $9.6 million reflecting the discontinuation of goodwill amortization based on WESCO's adoption of SFAS No. 142. Depreciation and amortization expense in 2001 included $5.8 million for amortization of goodwill. Capitalized software amortization increased $0.9 million and depreciation expense decreased $0.5 million compared to 2001.
Interest and Other Expense. Interest expense totaled $22.1 million for the first six months of 2002, an increase of $0.2 million from the same period in 2001. Other expense totaled $3.1 million and $10.7 million for the first six months of 2002 and 2001, respectively, reflecting costs associated with the accounts receivable securitization. The $7.6 million decrease was principally due to reduced fees and a lower level of securitized accounts receivable.
Income Taxes. Income tax expense totaled $4.8 million and $7.3 million in the first six months of 2002 and 2001, respectively. The effective tax rates for 2002 and 2001 were 32.0% and 40.0%, respectively. The 2002 effective tax rate differs from the 2001 effective rate because of a decrease in the rate applied to deferred tax items. WESCO believes this revised estimate reflects the cumulative impact of a change in the expected tax rate that will be applicable when these items reverse. The change in estimate was primarily due to state tax reduction initiatives. In addition, the impact of SFAS No. 142 and establishment of a foreign finance company contributed to the reduction in the effective tax rate.
Income Before Extraordinary Item. For the first six months of 2002, income before extraordinary item totaled $10.1 million or $0.22 per diluted share, compared with $11.0 million, or $0.23 per diluted share in 2001. The decrease in earnings is the result of lower gross profit, offset by lower SG&A, Depreciation and amortization and Other expenses in the current year.
Net Income. Net income and diluted earnings per share totaled $9.4 million and $0.20, respectively, for the first six months of 2002, compared with $11.0 million, or $0.23 per diluted share, for the first six months of 2001. Net income includes a $0.7 million extraordinary item net of tax, related to a charge incurred when WESCO replaced its revolving credit agreement.
LIQUIDITY AND CAPITAL RESOURCES
Total assets were $1.1 billion and $1.2 billion at June 30, 2002 and December
31, 2001, respectively. In addition, stockholders' equity was $157.1 million at
June 30, 2002 compared to $144.7 million at December 31, 2001. Debt was $490.7
million at June 30, 2002 as compared to $452.0 million at December 31, 2001, an
increase of $38.7 million.
An analysis of cash flows for the first six months of 2002 and 2001 follows:
Operating Activities. Cash used by operating activities totaled $68.6 million in the first six months of 2002, compared to cash provided of $92.2 million in the prior year. In connection with WESCO's asset securitization program, cash used by operations in 2002 includes $55 million used by our accounts receivable securitization program. Excluding this transaction, cash used by operating activities was $13.6 million in 2002 compared to cash
provided of $92.2 million in 2001. On this basis, the $105.8 million decrease in operating cash flow was primarily due to an increase in cash utilized to reduce accounts payable offset somewhat by reductions in accounts receivable and inventory.
Investing Activities. Net cash used in investing activities was $13.4 million in the first six months of 2002, compared to $59.5 million in 2001. Cash used for investing activities was higher in 2001 due to $52.1 million in cash paid for acquisitions. WESCO's capital expenditures for the six months of 2002 were for computer equipment and software and branch and distribution center facility improvements.
Financing Activities. Cash provided by financing activities totaled $31.4 million for the first six months of 2002 reflecting net borrowings of $33.9 million. In the first six months of 2001, cash used for financing activities totaled $48.9 million primarily reflecting increased repayments of long-term debt.
In March 2002, WESCO Distribution, Inc. entered into a $290 million revolving credit agreement that is collateralized by substantially all inventory owned by WESCO and also by the accounts receivable of WESCO Distribution Canada, Inc. At June 30, 2002, amounts available under the agreement were approximately $66.6 million, and WESCO was in compliance with all covenants of the new facility.
WESCO's liquidity needs arise from seasonal working capital requirements, capital expenditures, acquisitions and debt service obligations. In addition, certain of our acquisition agreements contain earn-out provisions based principally on future earnings targets. The most significant of which relates to the acquisition of Bruckner Supply Company, which provides for an earn-out potential of $80 million during any one of the next three years if certain earnings targets are achieved. WESCO paid $10 million pursuant to this agreement in April 2002 related to 2000 performance. The maximum amount payable in any single year under this agreement is $30 million. Certain other acquisitions also contain contingent consideration provisions, only one of which could require a significant payment. Management estimates this payment could range from $0 to $20 million and would be made in 2009. To meet its funding requirements, WESCO uses a mix of internally generated cash flow, its revolving credit facility, its Receivables Facility and equity transactions.
At June 30, 2002 WESCO's securitized accounts receivable balance totaled $275.0 million.
As of July 31, 2002, WESCO has purchased $32.8 million of common stock pursuant to the WESCO International share repurchase program, since its inception. WESCO did not repurchase any shares under this program during the six months ended June 30, 2002.
Management believes that cash generated from operations, together with amounts available under the credit agreement and the receivables facility, will be sufficient to meet WESCO's working capital, capital expenditures and other cash requirements for the foreseeable future. There can be no assurance, however, that this will be the case. Financing of acquisitions can be funded under the existing credit agreement and may, depending on the number and size of acquisitions, require the issuance of additional debt and equity securities.
As discussed above, WESCO refinanced its revolving credit facility in March 2002. The new facility matures in 2007. As a result of this refinancing and increased borrowings since December 31, 2001, WESCO is no longer obligated to repay $68.4 million in 2004. WESCO is contractually obligated to repay the revolving credit facility balance in 2007 and at June 30, 2002 the revolving credit facility balance was $107.5 million.
Other than the revolving credit facility refinancing, there have been no material changes in WESCO's contractual cash obligations and other commercial commitments during the quarter ended June 30, 2002 that would require an update to the disclosure provided in WESCO's Form 10-K for the year ended December 31, 2001.
INFLATION
The rate of inflation, as measured by changes in the consumer price index, did
not have a material effect on the sales or operating results of the Company
during the periods presented. However, inflation in the future could affect the
Company's operating costs. Price changes from suppliers have historically been
consistent with inflation and have not had a material impact on the Company's
results of operations.
SEASONALITY
WESCO's operating results are affected by certain seasonal factors. Sales are
typically at their lowest during the first quarter due to a reduced level of
activity during the early part of the year due to the cold and unpredictable
weather. Sales increase during the warmer months beginning in March and
continuing through November due to favorable conditions for construction and the
tendency of companies to schedule maintenance and capital improvement spending
during the middle and latter part of the year. Sales drop again slightly in
December as the weather cools and also as a result of reduced level of activity
during the holiday season. As a result, WESCO reports sales and earnings in the
first and fourth quarters that are generally lower than that of the remaining
quarters.
RECENT ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2002, WESCO adopted SFAS No. 141, "Business
Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets." Under SFAS No. 141, all business combinations are accounted for
under the purchase method. Under SFAS No. 142, goodwill is no longer amortized,
but will be reduced if it is found to be impaired. Goodwill is tested for
impairment annually or more frequently when events or circumstances occur
indicating that goodwill might be impaired. During the six months ended June 30,
2002, WESCO completed the transitional impairment review required by SFAS No.
142. Each of WESCO's reporting units was tested for impairment by comparing the
implied fair value of each reporting unit with its carrying value using
discounted cash flow analyses. Considerable management judgment is necessary to
estimate discounted future cash flows. Assumptions used for these estimated cash
flows were based on a combination of historical results and current internal
forecasts. No impairment losses were identified as a result of this review.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment of Long-Lived Assets." This statement addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of and supersedes SFAS No. 121. This statement retains the fundamental provisions of SFAS No. 121 for recognition and measurement of the impairment of long-lived assets to be held and used and measurement of long-lived assets to be disposed of by sale, whether previously held and used or newly acquired. This statement was adopted by WESCO as of January 1, 2002. The adoption of this statement did not have a material impact on the results of operations or financial position of WESCO.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 prescribes amendments to existing pronouncements on accounting for early retirements of debt and modifications of capital leases to operating leases. The provisions of this statement are effective for financial statements issued on or after May 15, 2002. The Company does not believe that the adoption of this statement will have a material impact on its financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity," under which a liability for an exit cost was recognized at the date of an entity's commitment to an exit plan. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized at fair value when the liability is incurred. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not believe that the adoption of this statement will have a material impact on its financial statements.
FORWARD-LOOKING STATEMENTS
From time to time in this report and in other written reports and oral
statements, references are made to expectations regarding the future performance
of WESCO. When used in this context, the words "anticipates,"
"plans," "believes," "estimates,"
"intends," "expects," "projects" and similar
expressions are intended to identify forward-looking statements, although not
all forward-looking statements contain such words. Such statements including,
but not limited to, WESCO's statements regarding its business strategy, growth
strategy, productivity and profitability enhancement, new product and service
introductions and liquidity and capital resources are based on management's
beliefs, as well as on assumptions made by, and information currently available
to, management, and involve various risks and uncertainties, certain of which
are beyond WESCO's control. WESCO's actual results could differ materially from
those expressed in any forward-looking statement made by or on behalf of WESCO.
In light of these risks and uncertainties there can be no assurance that the
forward-looking information will in fact prove to be accurate. Factors that
might cause actual results to differ from such forward-looking statements
include, but are not limited to, an increase in competition, the amount of
outstanding indebtedness, the availability of appropriate acquisition
opportunities, availability of key products, functionality of information
systems, international operating environments
and other risks that are described in WESCO's Annual Report on Form 10-K for the year ended December 31, 2001 which are incorporated by reference herein. WESCO has undertaken no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.