Lisa M. Gregory - Anixter International, Inc. William A. Galvin - Anixter International, Inc. Theodore A. Dosch - Anixter International, Inc..

Shawn M. Harrison - Longbow Research LLC David J. Manthey - Robert W. Baird & Co., Inc..

Good morning. My name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to the Anixter Second Quarter 2018 Results Conference Call. Thank you. Lisa Gregory, Vice President of Investor Relations, you may begin your conference.

Great. Thank you, Chris. Good morning, and welcome to Anixter's second quarter 2018 earnings conference call. With me here today to discuss our financial results are Bill Galvin, President and Chief Executive Officer; and Ted Dosch, Executive Vice President and CFO. Following their prepared remarks, we will open the line to take your questions.

Before we begin, I want to remind everyone that we will be making forward-looking statements in today's presentation, which are subject to a number of factors that could cause actual results to differ materially from what is indicated here. We do not undertake to update these statements and refer you to our SEC filings for more information.

Today's presentation includes both GAAP and non-GAAP financial results, the reconciliation of which is detailed in our earnings release and in the accompanying slide presentation that is posted on our Investor Relations website. Now, I will turn the call over to Bill..

Our customer access strategy, our commitment to technology and innovation, our focus on improving the profitability of the business and capital allocation philosophy.

First, the customer access model reflects our commitment to providing our customers with the capability to access all our solutions and the expertise required to support these solutions through their current selling organizations. This results in a simpler and more efficient buying experience.

As technology blurs the lines between solutions and we continue our journey to a more connected world, we provide a broad capability to support customers' needs. This customer access model keeps the engagement with Anixter simple by providing access to expertise needed to understand how all these solutions work together.

Customers are able to connect with Anixter any way they choose, through electronic commerce, in a branch location or from an inside sales rep or face-to-face with a specialist that can advise on unique and specific needs across our global footprint. Second, we have always been and will continue to be committed to technology and innovation.

Highly technical applications and complex deployments create ideal opportunities for Anixter.

We will continue to provide and expand a broad service capability for our customers, ranging from simple project services to complex global project services and complex program solutions, which provide our customers with a significant financial and risk mitigation strategy on a global basis. Third, profitability.

We are focused on delivering strong financial results. We have strategies in place to accelerate our sales growth, increase gross margin and improve our expense structure, striving to deliver strong EBITDA growth, resulting in consistent long-term performance. Finally, capital allocation.

A hallmark of our model is the significant cash flow we generate and the disciplined approach to capital allocation.

We remain committed to our stated policy of first investing in initiatives and strategies to drive organic growth, followed by investing in acquisitions we believe will provide a strategic benefit and meet our financial criteria and, finally, returning value to shareholders.

As we return to our strategic balance sheet and credit goals, we are focused on delivering continuing value to our shareholders. With that, let me turn the call over to Ted for a more detailed analysis of our results and actions on the cost side of the business..

Thanks, Bill, and good morning, everyone. Before I move into the details, I want to remind you that today's earnings release includes non-GAAP measures which are reconciled to GAAP measures in the financial tables that accompany our release.

We believe the non-GAAP measures we disclosed provide the best representation of our ongoing operational performance, and I will begin with a summary of these expense items.

Current quarter results included operating expense of $24.2 million pre-tax and $17.1 million after-tax, primarily comprised of $9.7 million of amortization of intangible assets and $9.2 million of restructuring charge, which I will discuss shortly.

Prior-year results included operating expense of $9 million pre-tax and $6.1 million after-tax of amortization of intangible assets. Excluding the impacts of the above items, second quarter 2018 adjusted earnings per diluted share increased 12.5% to $1.43 (sic) [$1.53].

All of my comments this morning including year-over-year and sequential comparisons are based on continuing operations only and on an adjusted earnings basis. Bill covered the sales and gross margins. I'll move directly to our expense trends. Operating expense of $347.8 million compares to prior-year operating expense of $313.1 million.

Excluding the non-GAAP operating expense items I outlined earlier, adjusted operating expense of $323.6 million compares to $304.1 million, an increase of 6.4%.

The increase was driven by inflationary pressures including freight expense and employee benefits, which was primarily higher medical expense, along with increased investment in our technology platform.

Similar to the first quarter, freight expenses specifically had an unfavorable impact approximately 20 basis points on operating expense as a percent of sales. Current quarter adjusted operating expense was 15.1% of sales, which compares to 15.2%.

We have initiatives in place to combat higher freight expense as well as more efforts to make our overall expense structure more competitive. We are currently projecting the operating expense in the third quarter to approximate the same percent of sales as Q2 with the investments in technology continuing at the same rate as the previous quarter.

Following the integration of the Tri-Ed and Power Solutions acquisitions for the past several years, we are rationalizing certain facilities and back-office functions as we make progress towards optimizing our distribution network and improving our overall cost structure.

These actions have resulted in a $9.2 million pre-tax restructuring charge in the current quarter. The majority of the restructuring relates to three areas; facility consolidation, systems integration and back-office processes which will impact approximately 3% of our global workforce.

The result will be a simpler and more efficient organization with a more competitive cost structure. We estimate these actions will result in savings of approximately $2 million in the second half of 2018 and $10 million in run rate savings, once fully realized by the end of 2019.

As Bill discussed, adjusted EBITDA of $107.8 million compares to $103.1 million, resulting in an adjusted EBITDA margin of 5% compared to 5.1% last year. Similar to the first quarter, we were impacted by a combination of pricing pressures on our top line and inflationary pressures on our operating expense.

Let me now review adjusted EBITDA trends by segment. Beginning with NSS, as shown on slide 12 of the presentation, adjusted EBITDA of $76.1 million compares to $69.8 million, an increase of 8.8%. The corresponding adjusted EBITDA margin of 6.9% compares to 6.8%.

The 10-basis-point increase was primarily driven by operating expense leverage and resulted in an adjusted EBITDA leverage of 1.4 times.

On a sequential basis, we had a strong 30% increase in adjusted EBITDA, resulting in a 100-basis-point improvement in adjusted EBITDA margin, driven by a recovery in volume combined with operating expense discipline. EES adjusted EBITDA increased 23.4% to $40.4 million, resulting in a 90-basis-point improvement in adjusted EBITDA margin of 6.7%.

The increase was driven by gross margin improvement, strong operating expense leverage associated with the volume increase and the benefit of higher copper prices, all resulting in strong adjusted EBITDA leverage of 3 times. On a sequential basis, EES adjusted EBITDA margin increased 60 basis points, driven by operating expense discipline.

Finally, UPS adjusted EBITDA of $23.1 million compares to $25.9 million. The corresponding adjusted EBITDA margin of 5.3% compares to 6.3% in the prior-year quarter. The lower EBITDA margin was due to inflationary impacts on operating expense as well as product costs.

Going forward, we expect these issues to diminish as we make progress with passing these costs through to customers. On a sequential basis, UPS adjusted EBITDA margin increased 10 basis points.

Moving, now, to the income statement, interest expense of $19 million compares to $17.9 million with the increase due to the impact of the acquisitions, partially offset by the repayment of the Canadian term loan in full in the fourth quarter of 2017. We expect interest expense of approximately $19 million per quarter for the remainder of the year.

Foreign Exchange and other expense of $3.3 million compares to $900,000. The increase in expense was caused by the unfavorable impact of changes in foreign exchange rates, primarily driven by Canada, Argentina and euro-denominated countries. Turning to taxes, our second quarter 2018 U.S. GAAP effective tax rate of 29% compares to 37.2%.

And on an adjusted basis, our second quarter ETR of 29.1% compares to 36.6%. The year-to-date GAAP ETR is 29.4%, which includes a $1.2 million net tax benefit primarily related to the reversal of valuation allowances. Excluding the net tax benefit, the projected full year ETR is 30.7%, which compares to the 2017 full year ETR of 54.1%.

The projected full year non-GAAP ETR of 28.8% for 2018 compares to 37.8% for 2017. The favorable rate changes are due primarily to the impact of the Tax Cuts and Jobs Act of 2017. Our diluted share count is 34.1 million shares, which should remain relatively flat over the balance of the year.

Turning to slide 15, our working capital ratio of 17.8%, which excludes the current portion of long-term debt, compares to 18.5% in the prior-year quarter, reflecting ongoing focus of working capital efficiency. We continue to drive improvements in our working capital processes to enable an even more efficient use of our balance sheet.

Year-to-date, we've generated $69 million in cash from operations. In the prior-year period, we generated $137 million. The change was primarily due to an increase in our working capital to support growth in the business. We continue to expect to generate cash flow from operations of $180 million to $200 million for the full year 2018.

Finally, in addition to investing $149.9 million in the acquisitions, we invested $24.5 million in capital expenditures in the first half of 2018 compared to $20.8 million in the first half of 2017.

We now expect to invest $50 million to $60 million in CapEx in 2018, with the year-over-year increase primarily due to increased investment in systems and technology. Turning to slide 16, our second quarter 2018 debt-to-capital ratio of 47% compares to 46.1% at year-end 2017 and remains within our target range 45% to 50%.

Our debt-to-adjusted EBITDA ratio of 3.3 times compares to 3.1 times at year-end 2017, slightly above our 3.0 times target. Both of these metrics reflect the impact of the Q2 acquisitions.

Our weighted average cost of borrowed capital of 5.1% is flat compared to the prior-year quarter, and our liquidity position remained strong with total available liquidity under revolving lines of credits and security counts receivable and inventory facilities of $631 million at the end of the quarter. Turning to our outlook for sales growth.

As Bill indicated, we've increased our outlook range for full year organic growth to the 3.5% to 5% range, which is a 150-basis-point increase from the low end of the range.

Based on current trends in the business through the first three weeks of July, we are estimating third quarter 2018 organic growth to be in the 4% to 5% range with growth expected in all segments.

To help with your modeling, I will provide our estimates for the impact of the acquisitions, copper and currency on third quarter and full year 2018 sales as detailed on slide 19 of today's presentation.

Based on our current projections, we expect sales from the acquired businesses of $25 million to $30 million in the third quarter and $60 million to $70 million for the full year.

Based on recent copper prices, we estimate an unfavorable sales impact of $5 million to $10 million in the third quarter and a favorable $5 million to $10 million sales impact for the full year. As a reminder, the average copper price is $2.58 per pound in the second quarter of 2017 and $2.80 for the full year of 2017.

With the current price of approximately $2.80 a pound, we project the full year average price to be approximately $2.90. Based on the current value of the U.S. dollar against other currencies, we estimate a third quarter headwind of $15 million to $20 million. We had a favorable impact in the first half of the year.

But at current rates, we expect a flat to somewhat negative impact in the second half of the year, resulting in a full year benefit of only $5 million to $10 million. Finally, because it is of interest to all of us, let me comment briefly on the issue of tariffs, which is still a developing issue as evidenced by the news just in the last 24 hours.

To date, tariffs have had little impact. Most likely though, the impact of tariffs will be reflected in the supplier price increases beginning in Q3 which we will pass through to our customers. We are continuing to monitor the issues and take actions to ensure that we're able to mitigate any unfavorable impact on our business.

Looking at the quarter overall. We were pleased to deliver strong sales growth while stabilizing gross margin on a sequential basis. With actions underway to improve our gross margin, we're optimistic that our margin trend will improve as we move through the second half and into 2019.

Regarding our operating expense, we faced similar challenges at the first quarter from higher freight expense. Additionally, we incurred higher operating expense related to ongoing technology investment and expect to continue to invest in our systems and supply chain capabilities going forward to support growth and innovation in the business.

Our strategy is to focus on delivering our growth goals while improving profitability which will enable us to deliver on the significant operating cash flow potential of our business. With that, we'll now open the call for questions..

Your first question comes from Shawn Harrison of Longbow Research. Your line is open..

My first question. I really just want to – Ted, if possible, thinking about the OpEx dollars, looking at the third quarter, maybe you could break out how much of the inflation you're going to see if maybe $20 million year-over-year is freight versus medical versus M&A versus the technology investments you're making..

Yes.

Let me just – using Q2 as an example and break it out into three buckets for you and they're each about 1/3, 1/3 and 1/3 with the freight expenses being about 1/3 of that increase, volume-related variable expenses being about 1/3 of that increase and the other 1/3 is primarily from these additional technology investments and the higher medical benefits.

I would expect probably similar kind of comparison in Q3..

And with the acquisition, is the OpEx profile similar to Anixter in terms of just the percentage of sales?.

It's slightly higher. But considering the size of the business, that won't skew the overall percentage..

Okay. And then, I know the conversation for the past couple of quarters has been on pipeline conversion into backlog into actual billings. Obviously, you're seeing some acceleration of that with the improved guidance.

But maybe you could just speak to how that conversion – is it going to – do you see it even improving further here in the back half of the year from pipeline to actual backlog?.

Yeah, Shawn. It's Bill. I would say that the rate of conversion is similar, but the trend continues to improve. So, as we're tracking backlog and pipeline, our outlook then says we expect that to continue. So, as the time progresses, we're converging that into revenue, and I expect that same rate of conversion to continue..

Okay. Thank you..

Your next question comes from David Manthey of Baird. Your line is open..

Hi. Good morning, all. First off, Bill, when you look through your priorities, I think number three was profitability and you said your goal was to accelerate sales and increase gross margin, leading to strong EBITDA.

Could you give us some more detail on how you plan to accelerate sales and improve gross margin?.

Yes. Sure, David. I think it's a long conversation, right? There's many aspects to that, but I also mentioned in the first one this customer access model. So, one way is to take all the available solutions that we have and bring that to every customer.

So, establishing an efficient sales model that we can bring security solutions into utilities and wireless technology into the electrical – different markets, that to me is a big opportunity for us. And the more efficient we get at that, the more we'll be able to exceed what I would consider as normal market growth. So, that's one thing.

There are other areas, like I mentioned, on the acquisition. Just that the new software that we have, now, access to, software and solutions in access control and intrusion, gives us the opportunity then to take and expand that into other markets, as well as things like utilities.

So, we have a very strong utility business now with the acquisitions in North America. The opportunity to leverage our global footprint to bring this same kind of value propositions to customers around the world gives us a unique opportunity.

Then, you take those sales opportunities for growth to exceed what the market grows, and then, we're considering – we're continuing to look at operational efficiencies that drive us better growth with better return on that growth.

So, we have focuses up and down all of that expense control, revenue growth, margin improvement, and the end result, of course, is driving much more – better improvement over EBITDA on a consistent basis..

Okay. Thanks for that. It sounds like cross-selling is a major focus for you.

But in addition, as you look down the segments and the sub segments of the company, are there any areas, specifically, of the business that are big enough and growthy enough in and of themselves to move the needle overall for the company? I mean, you mentioned normal market growth.

And I'm just wondering if, as you look at the segments of the business, are there any of the major categories that you're more excited about in terms of your ability to outgrow the market?.

Yeah. Again, the fact that we have this global footprint and taking things like the OEM business – and we mentioned it's been strong performance in OEM and it's really a service-based solution, right? So, leveraging our current footprint to invest and grow in that gives us a unique opportunity. So, I'm really excited about that.

I'm excited about our ability to leverage all the new solution sets we've picked up on the HD Supply acquisition in commercial construction to leverage that into not just commercial construction opportunities, but industrial opportunities.

And then, the ongoing expansion of our wireless business and AV business, which I've mentioned a few times, David, is a great opportunity. It's such a fragmented market. The opportunity to consolidate that and support customers in this changing technology – and I keep going back to how technology is blurring the lines.

You can't just run a business anymore and say it's all electrical. Electrical is being controlled by communication devices, and we have to remain nimble and run an organization that we can leverage all of those solutions into the types of customers we're calling on.

So, we call on such a broad market of vertical – different vertical companies and installers who (36:04) support those that bringing all of that to this new world of emerging technology gives us unique opportunity. So, I'm kind of excited about that. And then, of course, I know you've been talking to folks and hearing 5G.

Things like that and IoT will continue to drive investment..

one is expanded product sets with existing customers; two is taking on and winning contracts with new customers; and, third, penetrating into product categories that had traditionally been manufacturer direct.

The combination of those three, we believe, will continue to allow us to grow this business at a rate greater than market growth for the segment..

Okay. Thank you.

And if I could, just one more in here, Bill, are there any changes to your incentive program relative to Bob's targets as CEO that were outlined in the proxy?.

It's probably early to tell at this point, David. I think there are some focuses – you're talking about the executive comp or you're talking about field compensation strategies? Just want to make sure I understand the question..

What you specifically are compensated on?.

No, there's no relative difference to what Bob had..

(37:39) the metrics being used as well as the targets that are set for, certainly, the balance of this year is the same as what was approved by the board back at the beginning of the year for each of the named executive officers..

Got it. Thank you..

Your next question comes from Ted Wheeler of Wheeler Capital (38:03). Your line is open..

Can you hear me all right?.

Yes, yes. Good morning, Ted (38:11)..

Okay. Good. As you intensify this and analyze the cross-selling opportunities, I wonder how you see the competitive landscape. In other words, are there people kind of executing this concept today? Are you bumping up against new competitors? Just wonder if you could give some color on what you see there..

If you look at the individual opportunity, Ted (38:37), you'd say, yeah, we're coming up against new competitors as we expand kind of our reach across all these solutions. The reality is we're not coming up against to a lot of competitors that expand all of it.

So, the leverage you have is – if we're talking to a customer who dealt with five different solution for buyers for all of these technologies, they're now able to deal with one. So, to me, I see this breadth and depth and global presence as a leverage that will be hard to replicate by competitors.

Because of the technical knowledge that's required for this, it's – again, this distribution market is so fragmented and the technology is so fragmented. That opportunity to provide customers with such a breadth and depth of technical knowledge and innovation and supply chain and all of that becomes hard to replicate globally..

Thank you..

You're welcome..

There are no further questions at this time. I will now return the call to our presenters..

Great. Thank you. That concludes today's call. If you have any additional questions, please do not hesitate to reach out to Ted or Lisa. As always, thank you for listening to today's call..

This concludes today's conference call. You may now disconnect..