Anixter International Inc. Q4 2008 Earnings Call Transcript

Feb. 3.09 | About: Anixter International (AXE)

Anixter International Inc. (NYSE:AXE)

Q4 2008 Earnings Call

February 3, 2009 10:30 am ET

Executives

Chris Kettman – Investor Relations

Dennis J. Letham – Chief Financial Officer, Executive Vice President, Finance

Robert J. Eck – President, Chief Executive Officer

Analysts

Celeste Santangelo – Bank of America-Merrill Lynch

Kyle O'Meara – Robert W. Baird & Company

Jeff Beach – Stifel, Nicolaus & Company

Ted Wheeler – Buckingham Research

Nat Kellogg – Next Generation Equity Research

Matthew McCall – BB&T Capital Markets

Operator

Good day and welcome to the Anixter fourth quarter earnings conference call. (Operator Instructions). At this time I would like to turn the conference to Mr. Chris Kettman for opening comments and remarks. Please go ahead, sir.

Chris Kettman

Thank you. Good morning everyone and thank you for joining us to discuss Anixter's fourth quarter and full year 2008 results. By now everyone should have received a copy of the press release which was sent out earlier this morning. If anyone still needs a copy you can either go to Anixter's website or call Chris Kettman at 312-553-6716 and I can resend the information.

On the line today from Anixter's management team are Bob Eck, President and CEO and Dennis Letham, Chief Financial Officer. After management completes their opening remarks we will open the lines for a Q&A session. Before we begin I want to remind everyone that statements made on this conference call including words such as believe, expect, intend, anticipate, contemplate, estimate, plan, should, may or similar expressions are forward-looking statements.

They are subject to a number of factors that cause the actual results to differ materially from what is indicated here. These factors include general economic conditions, technology changes, changes in supply or customer relationship, risks associated with the integration of recently acquired companies, commodity price fluctuations, exchange rate fluctuations and new or changed competitors. Please see the company's SEC filings for more information.

At this point I'll turn the call over to Dennis.

Dennis J. Letham

Thank you, Chris. Good morning everyone and thank you for joining us. Well, as we all know the fourth quarter of 2008 had an abundance of macroeconomic and credit market headlines, as well as extreme volatility in the equity, bond, foreign exchange and commodity markets. These headlines and the volatility associated with the headlines each had some implications for the company and the results we reported today.

While our performance reflected the challenges of operating in this environment there were a number of very positive developments in the quarter which reflect the benefits of the diversity of the end markets served by the company.

These positive highlights include strong year-on-year sales growth in our emerging markets, North American OEM supply and European wire and cable businesses, double digit growth in our security sales as we continue to achieve good success with this important growth initiative.

Stable sales trends in our North American OEM supply business, generally stable product pricing trends, good cash generation relative to the organic sales trends, and the year ended with a strong balance sheet and good liquidity position.

Let's start the discussion by talking about sales in the quarter where we had a reported year-on-year decrease of roughly 2%. Importantly, despite all of the negative macroeconomic factors in the quarter, after adjusting for negative foreign exchange effects and eliminating the effects of acquisitions, we still had positive sales growth of approximately 1%.

While this continues the trend of decelerating growth rates experienced in the past few quarters, we view the fact that we remain positive in this turbulent quarter as very positive and indicative of the benefits of the diversity of markets we serve and the importance of our growth initiatives. There are four factors regarding sales that deserve further comment. In order of importance those four factors are the effects of foreign exchange rates, business conditions, acquisitions and copper prices.

The rapid strengthening of the U.S. dollar in the fourth quarter versus virtually all the major currencies in which we conduct business, meant that sales for the quarter translated to about $97.5 million less than would have been reported at the year ago exchange rates. The velocity at which the dollar strengthened also meant that when comparing the fourth quarter sales to the immediately preceding quarter, foreign exchange rates reduced reported sequential quarterly sales by approximately $88.1 million.

Lastly, although it's impossible to measure the rapid changes in exchange rates also likely cost the company some actual sales opportunities as we found it hard to quote or honor open sales quotation due to significant daily changes in exchange rates.

As we looked at 2009 and assuming exchange rates hold at approximately at current levels, we anticipate that exchange rate comparisons will create negative year on year sales comparisons through the first three quarters of the year with the comparisons being most difficult in the third quarter of 2009 when the dollar was at a low point relative to other major currencies in the recent rate cycle.

With respect to business conditions the quarter began on a reasonably solid note with October sales, adjusted for exchange rate differences, actually showing improvement when compared to both August and September. However, as we moved through the month of November especially from the Thanksgiving holiday period through year end, we saw noticeable weakening in sales in some of our key end markets.

Most notably we saw an increased number of our OEM customers scaling back production and extending holiday vacation shut down periods. While this pattern was broadly pervasive throughout our entire supply business it was most pronounced in Europe and in the U.K. in particular. In the U.S. we were able to overcome this trend with continued strong growth with our aerospace and defense customers and through the continued addition of new customers.

The net result despite the difficult market conditions was that our North American OEM supply business grew in the fourth quarter by 20% on an organic basis, excluding acquisitions and foreign exchange, versus the year ago quarter.

As we look forward to our OEM supply business in 2009, it's clear some of our customers will continue to run at reduced production rates, and there could also be further production cutbacks. In addition it is likely that strong growth rates we have seen from our aerospace and defense customers in the past few years will begin to moderate as those OEMs face softening order books. On the other hand we continue to ramp up volumes on recent new customer contracts and we have a healthy level of new contract quotation activity which should help to minimize sales declines in this end market during these difficult economic times.

Turning to the enterprise cabling and security markets we saw further declines in project volumes as well as declines in daily move, adds and change orders as customers seemingly worked to conserve capital and cash on all fronts. This slowdown was most notable in Europe where we saw an 8% drop in organic sales in this end market, and in North America where we experienced a 4% organic decline.

On the positive side, despite the importance of the multi-national customer project volume to our sales efforts in this end market, within the emerging market geographies we still posted 21% organic growth in the quarter. In addition, within the enterprise cabling and security market our initiative to grow our presence in the security market continued to meet with success. Here we saw sales grow on a global basis by 11% excluding the effects of foreign exchange.

While security growth rate is lower than we have experienced over much of the past few years, it is indicative of how continued focused efforts in this area can help to offset some of the overall macroeconomic environment. We anticipate being able to continue to grow our presence in this market in the coming quarters due to the underlying drivers in this market.

Lastly, despite the economic climate we were able to post year-on-year organic sales growth in our wire and cable business in both North America and Europe. In Europe our efforts to expand the geographic presence of this business beyond its largely U.K. base, continue to be successful as our non-U.K. sales grew by 47% exclusive of foreign exchange effects.

While our order book in the wire and cable market remains healthy, there is a longer term question regarding future project levels assuming continued tight credit markets. At this time however it is difficult to quantify what those impacts might be as the year progresses.

Overall acquisitions added $49.2 million to sales in the fourth quarter. At this time, using current foreign exchange rates, we anticipate that in 2009 the acquisition completed in 2008 will add approximately $147 million to sales prior to their first year anniversaries in the July to October 2009 timeframe.

The last point with respect to sales relates to copper prices. During the fourth quarter spot market copper prices fell dramatically from an average of 345 per pound in the third quarter to an average of $1.76 in the fourth quarter. This rapid drop in copper prices however, had only a limited effect on product prices during the fourth quarter. It is our view that the supply chain entered this correction period with fairly normal levels of what became high cost inventory during the quarter as flat market prices fell.

As a result product prices did not move in line with the spot price of copper as everyone attempted to realize the carrying value of their beginning of the quarter on-hand inventory. It is anticipated that the spot market copper prices remain at the current level of approximately $1.50 per pound. Then we will begin to see some deflationary pressure on sales as we move through 2009. This pressure will likely begin in the first quarter as the industry works off their higher cost inventory and replaces it with lower cost product that will set new product pricing points going forward.

There’s no precise way to forecast the impact of this commodity price deflation in 2009. But we do know that when spot market copper prices move from $1.68 per pound in 2005 to $3.12 in 2006. It had the effect of adding over $190 million to our revenue base in 2006. At this time our electrical wire and cable business is larger than it was in 2006 and we’re looking at copper moving from an average of $3.13 a pound in 2008 to a current level of near $1.50.

Turning now to gross margins, the fourth quarter had three items to highlight; supplier volume incentives, an inventory mark-down adjustment, and sales mix. As has been the case for the past couple of quarters, the lower sales growth rates have resulted in lower supplier volume incentives. This was particularly true in the fourth quarter when the latent year drops in enterprise sales resulted in a negative reassessment of the amounts earned for the full year. This was in contrast to the year ago fourth quarter when the final calculations for the incentives earned for the full year of 2007 resulted in a positive adjustment.

During the quarter we recorded a $2 million inventory mark-down adjustment with respect to certain wire and cable product lines where the depth of our current inventory position likely exceeds market inventory levels to a degree that it is probable that by the time we sell through our current inventory of those products, we will not be able to realize a profit on all of the current inventory.

Lastly the drop in OEM supply sales in Europe, which is one of our highest gross margin businesses, had the effect of lowering OEM supply sales as a percent of our total sales mix, therefore reducing gross margin rates.

Looking for a moment at operating expenses, we had 15% year-on-year increase in expenses. Contributing to this increase were the bad debt expenses on the NetVersant and Nortel bankruptcies and severance and lease write down costs that in the aggregate, along with the bankruptcies, totaled $32.2 million.

In addition, acquisitions completed in the past year added $13.4 million to our expense structure. And lastly the extra fiscal week in 2008 also added approximately $6.5 million to our operating expenses as compared to the year ago period.

Lastly, operating expenses did benefit from the foreign exchange impact of a stronger dollar, which lowered reported expenses by $20.8 million. Excluding the effects of all of these items our run rate expenses increased by approximately 2% versus the fourth quarter of the prior year. As we head into 2009 we believe we have made appropriate adjustments to right size our expense structure based on the changes in individual and market sales activity during the fourth quarter.

Operating expense control remains a priority and as the year unfolds we will continue to evaluate sales activity levels and productivity to ensure our expense structure is sized to meet near term realities while at the same time balancing the short term with a goal of supporting longer term strategies and programs.

Before leaving the subject of expense control, we want to comment on controls for customer credit and collection. The current economic and credit market conditions have been unprecedented. Historically our credit practices have proven to be rigorous and up to the task of balancing risk and growth of the business. In addition our practices with respect to providing for possible collection problems have proven to be conservative over the years.

Each of the two major bankruptcies in the fourth quarter had their own unique facts and circumstances surrounding our exposure and the events leading to the respective bankruptcy. We have reassessed and in some cases modified some of our credit and collection practices to cope with these extraordinary times. We believe our practices are appropriate for our business model, customer base and currently challenging environment.

So, to summarize from an operating income perspective, the effects of all of the items we have discussed meant that operating profit fell from $114.4 million in the year ago period to $50.7 million in the most recent quarter. At the same time operating margins fell from 7.7% in last year’s fourth quarter to 3.5% in the most recent quarter.

If we exclude those items identified in the earnings release as the fourth quarter 2008 unusual items, specifically the NetVersant and Nortel bad debt losses, the inventory mark-down adjustment and the severance and lease write-down cost, all of which total $34.2 million, then operating profits would have been $84.9 million and operating margins would have been 5.8% in the fourth quarter.

As we move further down the income statement, interest expense in the fourth quarter increased year-on-year by about $1.7 million or approximately 14%. About 40% of this increase in interest expense is due to the added week in fiscal 2008, while the remainder reflects an increase in borrowings of $196.3 million.

The increase in borrowings during the past 12 months resulted from $180 million associated with acquisitions, $104.6 million spent on share repurchases less the cash generated from operations. In the current quarter our average cost of borrowings was 4% as compared to 4.3% in the year ago quarter. At the end of the fourth quarter approximately 69% of our outstanding debt had fixed interest rates, either by the terms of the debt or through hedging contracts.

The other income and expense line changed dramatically from income of $300,000 in the year ago quarter to an expense of $16.7 million in the most recent quarter. The difference in other income and expense between years largely reflects foreign exchange losses and reductions in cash surrender value of company-owned life insurance policies.

As stated earlier, in the fourth quarter of 2008 we saw both a sharp change in relationship between the U.S. dollar and all the major currencies in which we conduct our business, and for a several week period, extreme volatility in daily exchange rates. Historically with the exception of occasional emerging market currency devaluation and issues surrounding ineffective hedging markets in certain emerging market countries, our hedging programs have effectively protected us from significant income statement impacts from exchange rate changes.

The extreme volatility we saw in the fourth quarter, however, meant that our historical hedging program which relies on collecting data from 30 some countries concerning thousands of transactions per day, was not fast enough in an environment where rates sometimes change by percentage points each day, which was a relatively unprecedented environment.

While we responded quickly to revise our hedging programs and processes, the systems and process changes took several weeks to implement, with the resulting impact of significant losses for the whole of the quarter. We believe the changes that have been implemented to date, along with those which will be implemented in the first quarter, will better position the company to deal with extremely volatile environments such as those experienced in the fourth quarter.

The other component of other income and expense to produce significant losses in the quarter was a 14% decrease in the cash surrender value inherent in a series of company-owned life insurance policies associated with the company-sponsored deferred compensation programs. The combined effect of both equity and fixed income losses associated with very poor financial market performance in the fourth quarter resulted in the cash surrender value losses for the quarter of $4.8 million.

The fourth quarter tax provision reflects an effective tax rate of 54.3%. The exceptionally high rate reflects an adjustment to the full year effective tax rate of 38.5% including $1.6 million of tax benefits recorded in the first quarter from an estimated effective tax rate of 37.4% recorded through the first three fiscal quarters of the year. This adjustment to the full year rate, when applied to the comparatively low level of pre-tax earnings in the fourth quarter, resulted in this very high rate.

The current quarter's tax rate compares to an effective tax rate of 31.6% in the year ago quarter, which included a benefit of $9.7 million related to foreign tax benefits and the finalization of certain tax audits. Without those benefits, the prior year effective tax rate would have been 41%. The full year effective tax rate for 2008 of 39% compares to the 2007 full year effective rate of 39.1%, both exclusive of previously described foreign tax and audit settlement benefits.

Net income for the quarter was $9.4 million or 87% lower than the $70.5 million reported in the year ago period. Excluding the fourth quarter 2008 unusual items totaling $33.2 million after tax from the 2008 reported results, and excluding the tax benefits of $9.7 million from the prior year reported results, then net income in this year’s fourth quarter would have been $42.6 million as compared to $60.8 million in the year ago quarter.

On a diluted basis, earnings per share were $0.26 in the most recent quarter as compared to a $1.69 in the year ago quarter, excluding the fourth quarter 2008 unusual items totaling $0.91 per diluted share from the 2008 reported results and excluding the tax benefits of $0.23 per diluted share from the prior year reported results, then, diluted earnings per share in this year’s fourth quarter would have been $1.17 as compared to $1.46 per diluted share in the year ago quarter.

The current quarter’s fully diluted earnings per share benefited from approximately a 13% drop in the fully diluted share count primarily as a result of share repurchases and lower dilution associated with convertible bonds.

Looking at cash flow in the fourth quarter, we generated $34.4 million in cash from operations as compared to $92.9 million generated from operations in the year ago quarter. The reduced cash flow from operations is due almost entirely to the lower level of net income in the quarter. To save time, it’s important to note that the cash generated from working capital reductions was just $11 million despite what appeared to be significant reductions in working capital on the balance sheet as compared to a September end 2008 balance sheet. In fact, most of the reductions in working capital noted in comparing the fourth quarter and third quarter balance sheets were exchange rate driven.

The comparatively low actual reductions in working capital were consistent with the fact that sales between the third and fourth quarters of 2008, after adjusting for exchange rate differences in acquisitions completed in the third and fourth quarter, showed a decrease of less than 3%.

As we look forward to 2009, with an expectation of a softer global economy and slower growth, we anticipate strong positive cash flows as incremental working capital requirements will remain low and the cash generated from earnings will not be affected by the fourth quarter 2008 unusual items. We believe this anticipated cash flow, together with the fact that at year end we had approximately $248 million in available committed unused credit lines, should give us the liquidity we need to support the business through 2009 and beyond. For the near term, we will use the added liquidity in the company to reduce the amount of leverage in the capital structure.

The last point I want to make, before turning the call over to Bob, is with respect to expected impact in 2009 of new accounting rules related to the accounting for convertible debt securities. As a result of these new rules, we anticipate that 2009 earnings will be approximately $0.23 per diluted share less than they would have been under the previous rules.

As a result of the adoption of these new rules, we will also be restating prior year earnings per share with an anticipated reduction of $0.20 and $0.19 for 2008 and 2007, respectively, from the numbers previously reported and discussed in this call.

Bob, let me turn it over to you.

Robert J. Eck

Thanks, Dennis. Thanks everyone for joining us today. As Dennis has just reviewed, we had a challenging fourth quarter. While the business news was dominated by negative results on the economy, we were able to achieve slight organic growth. We worked through the quarter to add new customers and continued to invest in our key strategic initiatives. By leveraging our global presence, and focusing on delivering services that helped customers manage their supply change more effectively, we were able to grow in some geographies and end markets. The market share gains that we achieved in those areas helped to offset weakness that we experienced in other areas of the business.

Shifting focus now to the operations, our enterprise cabling and security solutions business experienced the continuation of the trends we discussed in the last call. IT spending, particularly related to large projects, was constrained through the year and decelerated somewhat during the quarter as customers tightened up on discretionary spending. Offsetting the decline was continued good performance in security sales and sales to new customers. Adjusted for currency, sales in North America were down 4% in Q-4 and, basically flat for the year.

In EMEA, the same reduction in project spending led to a decline in both the quarter and full year sales. However, in EMEA, we experienced very good growth in security sales. The emerging markets saw growth in Latin America and Asia Pacific, both in the quarter and for the full year. Solid growth in Latin America occurred across virtually all countries, excluding Venezuela. The market in Venezuela was negatively impacted by changes in importation regulations implemented during the year. The broader Latin America market continues to experience stronger spending than we are seeing elsewhere.

In Asia Pacific, growth was modest due to spending constraints by multi-national companies. This, however, was offset by growth in security. As is clear from the comments so far, the physical security negative continues to provide very good growth and buffers some of the decline in IT spending that has impacted our enterprise business.

The business drivers of both the shift to digital technology as well as the desire to provide more secure public and private places continue to present opportunities for this initiative. While the growth rates slowed in the fourth quarter, we saw year-on-year organic growth in North America of 19%, 35% in EMEA and 51% in the emerging markets. As this market is highly fragmented, we anticipate continued good growth in 2009 that may be dampened somewhat by economic constraints.

Across the enterprise business, we continue to add supply chain services to a greater portion of our sales. These services, branded as ready services, simplify the deployment of materials to the jobsite, reducing costs, shrinkage, waste, and help our customers meet delivery time requirements. Certain services can also enhance customer’s application for leadership in energy and environmental design certification. As the recession drives continued cost focus, we believe these services delivered globally will help our customers complete projects more economically.

Turning now to the wire and cable business, we experienced modest growth in North America in the fourth quarter in spite of the poor economic conditions. The growth was driven by project activity in oil, petrol-chemical and gas production and processing, as well as power generation, mining and alternative energy.

Our initiative to develop a global customer focus has helped us significantly increase sales to engineering, procurement and construction companies in the past year. These companies manage most of the large resource and industrial projects often completing design and engineering work in one city or country and, then, delivering the project in another.

The EPC customers gain value from our unique ability to provide local support in both places, as well as utilizing ready services to reduce their supply chain costs and risk. The expansion of the wire and cable business has continued to bring positive growth. While the U.K. business slowed in the fourth quarter, the continued growth in Continental Europe and the Middle East delivered very solid growth in the quarter and full year.

As just mentioned, the ability to leverage our global presence to support multi-national customers has proved very valuable in this business. In addition, once we have established a local customer relationship during the project implementation, we are then very well positioned to provide ongoing MRO material needs for that customer.

In addition, our market penetration in Continental Europe and the Middle East is still very low in spite of our recent growth. As a result, we continue to build many new customer relationships in these markets where our business model is unique. As a specialty wire and cable distributor, we focus solely on helping customers understand the best product for their application and then delivering the product to the customer in the most cost effective way. Due to the size of the market, we believe we can continue to grow in Continental Europe and the Middle East with only modest impact from the recessionary environment.

Moving to our industrial automation initiative, we continue to make progress developing this program. The interest from the user community for support in managing the migration from fieldbus communication technology to industrial Ethernet continues to grow. Our knowledge of the products and applications in both the legacy systems, as well as IP-based systems, positions us well to help customers understand the infrastructure needed to successfully work through that migration. We will continue to invest in developing this program in 2009.

The last subject to address for the wire and cable business is the impact of the sharp reduction in the price of copper during the quarter. As Dennis has already noted, the decline in the price of copper did not have a meaningful effect on sales during the fourth quarter. As we said during the last call, a portion of sales are based on previously agreed pricing that is not affected by the spot price of copper. In addition, some specific products are less sensitive to changes in copper price.

The result of these factors, combined with the inventory in the supply chain, worked to limit the effect on sales in the quarter. In addition, during the quarter we worked hard to reduce our inventory of products more sensitive to copper cost by limiting replenishment. As a result, we will replenish our inventory with lower cost product and will be better prepared to maintain margin as the reduced price of copper works its way into the supply chain. We do expect the lower price of copper to affect sales and margin dollars, and consequently, to have some impact on operating margin as the year unfolds.

The OEM supply business had a mixed quarter. In North America we benefited from continued very strong performance in the aerospace segment, additional revenue from QSN acquired in the third quarter, and new sales from contracts won earlier in the year. This was offset by reduced production volumes that many customers, including early holiday shutdowns in December.

Particularly gratifying through the course of the year was the growth and sales to several existing customers whose overall production rates declined. This was the result of adding new parts to existing service programs. We continue to focus on opportunities to help customers improve their cost and efficiency by providing more products through the existing supply chain service that we provide to them.

The European OEM supply business was negatively impacted by reduced production rates, as well as extended holiday shutdowns across the U.K. and Italy. While we were able to add new products to several programs, the effect was minimal.

In the fourth quarter we did benefit from added sales from Camille Gergen and Sofrasar, and we are currently working to expand our relationship with their new customers to build business with them in other countries in which we operate.

Lastly, as operations begin to ramp up and our new OEM supply operation in Suzhou, we are beginning to see an increase in sales to our global customers' manufacturing facilities in China. We have also begun to realize modest cost reductions in cost of goods for material sourced in China. Both of these trends will contribute modestly in the coming year.

As we've said in previous calls this year, we have a flexible operating model and have been very focused on managing volume-related expenses this year. The expense controls we have described included reduced incentive compensation, reduced overtime in our warehouse operations, reduction of temporary employees in the warehouse, full time staff reductions and finally consolidation of underutilized facilities.

During the quarter, we moved even more aggressively, which led to the restructuring charge Dennis outlined. We believe that we have properly adjusted our expense base as we go forward, and we'll realize approximately [$15] million in savings in 2009. It is our intention now, as always, to manage effectively in the short term without forfeiting longer term opportunities.

In closing, we continue to face a recessionary economy in the U.S. and Europe. This will challenge our ability to grow as customers delay discretionary IT spending and reduce manufacturing production rates. In addition, we expect to see unit price deflation in the wire and cable business, but in an environment in which customers continue to have very healthy project backlogs.

These challenges will be offset by the full year benefit of the acquisitions completed in the second half of 2008, the continued strength of our security initiative, and full year sales contribution from several new contracts awarded in 2008 to our OEM supply team. We will look to expand our efforts in all the businesses, the vertical and geographic markets where we see opportunities to take additional market share.

Finally, the breadth of the geographies and markets served, coupled with the cost control steps we have already taken, will help us manage through this challenging time.

We will now open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll take our first question from Celeste Santangelo – Bank of America-Merrill Lynch.

Celeste Santangelo – Bank of America-Merrill Lynch

Thanks, good morning. Question on the outlook, when you talk about over the next few quarters seeing limited sales growth, if any, how should we look at that? Is that for Q4 levels or a run rate exiting the quarter? And if so, could you just talk about maybe the linearity between October, November and December?

Robert J. Eck

Well, Celeste, I'll start, and Dennis will jump in.

What we're really intending to say there is looking at late in 2008, meaning kind of November and December run rates, which were down from October, as Dennis mentioned, we think as we look into 2009 our visibility is probably as imperfect as anyone else's. But we think that those kind of trends, if they stay consistent, will lead to a fairly challenged opportunity for growth in the coming year.

In terms of linearity I'm not exactly sure what you're looking for. But that's roughly our feel. And I don't know that I can highlight it in any more detail than what we said in the release.

Celeste Santangelo – Bank of America-Merrill Lynch

And then, regarding cash flow, I've seen some drags at the end of Q4. Can you talk about maybe a little more detail around what you expect in Q1? And then, regarding funding the convert that's putable in July? And then, maybe for the full year, how you look at it either by dollar amount, or even just directionally, the cash flow from operations in excess of '08 levels? If you could just provide a little more detail around that?

Dennis J. Letham

Of course cash flow is about what's happening sequentially, not year-on-year in the business. If we look at what happened from Q3 to Q4, we had less than a 3% reduction in sales and most of that came in, I'll say in the last six weeks of the year. As a result of that, you kind of get real-time impact of receivables coming through. But certainly the inventory corrections would lag because of how late sales drop off came.

So there's probably a little bit of mismatch in the cash flow number for the quarter versus the volume numbers. As we look forward to the first quarter we would expect those inventory corrections to fall into place and we pick up some additional cash flow from inventory, in addition to kind of the remaining real-time impact on receivables.

Importantly, of course, as we go into 2009 you don't have the unusual items that impacted net income in the fourth quarter repeating themselves again in 2009. So you – from a cash flow from P&L standpoint you benefit from that perspective.

When we put that together – and again, we're talking about sales expectations coming off late in the quarter-type numbers that would imply, certainly, a year-on-year decrease in sales that would mean less working capital, again, plus cash flow from the P&L that should give us for the full year pretty strong cash flow numbers.

We do have this potential put event in the middle of the year surrounding the 3.25% zero coupon bonds we have outstanding. That would be a $171 million cash obligation if we're required to fund the put at that time. We certainly believe that the combination of the cash we expect to generate from the business this year, combined with availability in our bank lines, which I want to be clear, those lines are available to be used to fund the put if needed.

It would still leave us in a position where we would expect to end the year with higher cash balances than what we have at the end of 2008, even if we fund the put.

Celeste Santangelo – Bank of America-Merrill Lynch

And then, just a last question on the enterprise business, you talked about weakening in the day-to-day business, can you talk about how that progressed in Q4? Did you just see it at the end of the quarter? And to any extend that you could talk about what you're seeing now in Q1 on that business? And then if you could just split out security, how much of your enterprise business has that grown to as a percentage of sales?

Robert J. Eck

Well, Celeste, the day-to-day sales decline really showed up late in the quarter. I think Dennis talked about the October numbers organically, and I think it's an important point is that we actually had a solid October, and then a pretty rapid decline as we got into November and December. And that's really when we saw the slowdown in the day-to-day moves, adds and change spending.

I don't think January right now gives us a good indication of what's coming in the year because we came off of a very slow holiday week. The back-to-work recovery in the first week of January was just about non-existent. So what we're seeing is a pick-up as the month progressed in day-to-day sales, or daily sales rates including the day-to-day kind of sales. But I think it's much too early to make a projection from that on how the quarter or the year is going to unfold in that segment.

For security specifically across the company I think we indicated that we were seeing 20%-ish growth and it was growing to be about a $640 million-ish piece of the business and that's really how it's played out for us, actually very much in line with our expectation for the year.

Operator

(Operator instructions) Your next question comes from David Manthey – Robert W. Baird & Co

Kyle O'Meara – Robert W. Baird & Company

This is Kyle O'Meara on for Dave. Took out some headcount in the fourth quarter, if things stay at the current level do you have any plans to further reduce expense? Are there other levers that you can pull as we move through 2009?

Robert J. Eck

If sales stay at the current levels we're probably sized correctly. If we saw a decline we can certainly take additional steps. So I think the steps that we really took the charge for, some of which by the way will actually happen in the first quarter, although we made decisions to take these reductions in the U.K. particularly there's been a negotiation process that goes on that causes a little bit of a delay in when the delay actually occur in staff.

But all the reductions will be in place in the first quarter. And as I say I think we're about where we need to be unless we see deterioration in the business and if we see deterioration in the business then we'll take additional steps.

Dennis J. Letham

That's one of the challenges with the expense structure at the moment is the fact that we do have parts of the business with solid volumes and parts of the business that are growing. So this isn't an environment where you can take what I would call across-the-board expense reduction actions.

You have to be careful and what we've done to date is basically more like surgically deal with operating expense around those parts of the business that have been most soft and will continue to evaluate that as we see conditions play out month-to-month.

Robert J. Eck

I think a kind of important piece of color with that is if you looked at our OEM supply business you have some customers whose production rates declined. In the meantime we had to add people to staff new forward-stocking locations to support new contracts that were signed kind of in the summer and even into the fourth quarter period to begin to ramp up those programs.

So there are puts and takes but in the aggregate I guess I'd leave you with this. We have a very detailed view of what's happening in each one of the end markets and each one of the geographies. And we will add people where we think it's appropriate to add people and facilities and we'll reduce where we think it's necessary to reduce.

Kyle O'Meara – Robert W. Baird & Company

And just to help me understand, copper, I understand as we cycle to the lower price inventory over 2009 it's going to be a revenue headwind. But where we sit today we don't expect any more inventory write-downs. Is that correct? Is that kind of all in there what you guys expect for the year?

Dennis J. Letham

Actually we believe that in aggregate our inventory is appropriately valued to reflect market conditions, market pricing, that sort of thing with the exception of we did have a couple of product lines in particular where we had, what we believed, too much inventory in those product lines. And we think it's likely we will incur some losses before we can sell off all f that inventory that we're currently holding on those product lines.

So in general we think we're in very good shape. I think the fact that we're looking here a something well under 1% of the value of the [inaudible] that's required, well under 1% of the wire cable inventory which is where the copper sensitivity is at, so that the controls around purchasing and managing pricing and that sort of thing are working pretty effectively. We just have a couple of particular products we've got to deal with.

Operator

(Operator instructions) Your next question comes from Jeff Beach – Stifel, Nicolaus & Company.

Jeff Beach – Stifel, Nicolaus & Company

When I model here the fourth quarter and complete with all of the adjustments that you walked through, including foreign currency, everything, volume doesn't explain the decline, totally the decline in the fourth quarter results.

And the only thing that I can spot here that you mentioned is the volume incentive at the end of the year that maybe reversed. I didn't know how that worked. I wonder if you could quantify that and then sales mix may have some effect but I wondered if you could just walk through a couple of factors outside of volume that may have pushed this quarter's results down in addition to the volume?

Dennis J. Letham

I think, Jeff, the biggest thing is the volume incentive kind of final calculations for the year. If you looked a year ago our gross margin we reported was about 24.2%. This year I think we're around 23.1% on the GP rate.

A year ago as we got to the fourth quarter and did our final assessment where we stood on those incentive programs we ended up with a positive adjustment that helped to push the GP rate up in the fourth quarter. This year when we got to the end of the year given the tail-off in volumes particularly in the enterprise business late in the year, we ended up with less earned for those programs than we had anticipated we were going to earn.

And basically if you think about it, it's kind of like a effective tax rate adjustment when it comes late in the year you've got to true-up the amount earned for the whole year. So that is without a doubt the single biggest factor on the change in rates year-on-year.

In addition the fact that the OEM supply business in Europe was down 16% organically year-on-year that's one of our higher gross margin businesses and from a mix standpoint that definitely had an impact on gross margins.

So I think the gross margin story there is pretty much summarized in those two items. The other thing I'd say is on the expense side. You can take out the unusual items that we have in there. One thing we shouldn't forget about or lose sight of is we did end up with a 53rd week of expenses in the year with the fiscal calendar. And quite frankly when you look at the sales volumes in the fourth quarter it's pretty hard to figure out where you got much incremental sales activity out of it.

Robert J. Eck

I think you've got to look at that 53rd week being the week between Christmas and New Year's in a very difficult economic environment where across the OEM supply business virtually every customer's plant was shut down. And from a construction standpoint again given the economic environment virtually nothing happened.

So if we would have said, "Gee we might get three or four days of sales out of that week," we probably got two days worth of sales and then took a week of expense.

Jeff Beach – Stifel, Nicolaus & Company

Just as a follow-up I was impressed with the broad strength in emerging markets and I know that you are hedging a little bit on uncertain trends, but can you talk a little bit about as you've gone through December and through what you've seen in January, what you're seeing Latin America as well as Asia Pacific? Do you think you're aiming at a growth in those emerging markets in 2009 or is that really too hard to tell?

Robert J. Eck

Well I guess I'll start and Dennis again can jump in. January is a particularly difficult month to look at in Asia Pacific because we had the Chinese New Year which takes actually a pretty significant shutdown out of the month. So you had really kind of the combined effect of coming back from the Western calendar New Year plus Chinese New Year. So whatever's going on in Asia Pacific in January is to me not indicative of what we expect to see in the year.

Latin America I think will continue to be strong. I think there's different dynamics. I think we've been very successful as an organization taking market share really across Mexico and South America and the Caribbean base. So in a nutshell I would say our view is that we'll see growth in the emerging markets in the coming year but I wouldn't put a stake in the ground about what that growth would be.

Dennis J. Letham

I think one of the interesting things is that unlike North America and Europe where we saw a definite tail-off in the business in late November and December our growth rates year-on-year in the emerging markets held up pretty well and consistently across all three months of the quarter.

So, I think it's still a big question about what happens later in the year with multi-national customers on project activity in emerging markets but for the moment the trend did not have the same sort of drop off late in the year that we saw elsewhere.

Robert J. Eck

Yes. The other attribute I think in Latin America is a little more mature for us than Asia proper and as a result we have a lot more of a localized business. In other words we go with lots of integrators and end customers that aren’t specifically tied to Western multi-national business so we – I mentioned Asia saw some impact from slowdown spending with Western multi-nationals. We really haven’t seen a similar effect in Latin America.

Operator

Your next question comes from Ted Wheeler – Buckingham Research.

Ted Wheeler – Buckingham Research

Hi good morning all. A couple of questions on the project related business within the enterprise space I wonder if you could indicate the mix of that business for the year and maybe the mix as you exited the year.

Robert J. Eck

You mean percent of total sales mix versus day-to-day? You know I think we entered the year with a project mix that was at the lower end of sort of that 15 to 20% range we’ve talked about. As we got into the fourth quarter I'd say the range would have been even less probably more in the 10 to 15% range.

Ted Wheeler – Buckingham Research

And based on your view of proposals and activity levels would it be prudent to think that that will continue to be a declining mix?

Robert J. Eck

I don’t know if it will decline or whether it’s going to stabilize. It gets into this whole question of visibility into the coming year. The pipelines for the sales organization actually have lots of projects identified. If you think about it a customer does a lot of planning work on the front end before they fund a project. There’s design work that gets done, there’s technical specifications around products that get done. So where we see actually pretty active pipelines the question is will those questions get funded?

And I guess my guess is as good as anyone's. I think we’re going to see some challenge around discretionary IT projects in the year end. So I wouldn’t expect to see a pick up at least early in the year at least from the kind of project rate we saw in the November December period. Whether it will decline further honestly, I don’t have a good feel at the moment.

Ted Wheeler – Buckingham Research

I guess the other question you talked about your OpEx expenses being pretty well in sync with current activity levels. Just I wonder if you could elaborate since there was such a big movement in activity from October through the end of year. Are you talking about the average activity levels for the quarter or the exit rate of activity in terms of operating expenses being appropriate?

Robert J. Eck

Ted, really we’re talking about the exit rate.

Ted Wheeler – Buckingham Research

And then I guess kind of just to try to help modeling and I know you know you gave us a lot of good input on the puts and takes and what is sort of out there. Just normally, if we’re ever going to see a normal year, what would be the sequential revenue pattern versus a fourth quarter as you go though the next four quarters? You talked – we talked a little middle year about how that builds up, but I wonder if you could just remind me what a normal year would like relative to fourth quarter.

Dennis J. Letham

Yes. I think that you look at longer terms durable patterns relative to Q4 is usually pretty flat because you tend to have on the project or capital stuff a little bit of a slower start on those early in the year so there’s not much growth.

When you get from Q1 to Q2 historically you'd see something kind of low to mid single digit consecutive quarter growth. Again same sort of thing Q2 to Q3 and then typically the fourth quarter is going to drop off by a couple of percentage points because of the holiday impact.

Robert J. Eck

One of the things that you have to model a little bit differently, Ted, in the sort of current look of the company versus the past is when you get into Q3 in the OEM supply business, in the prior configuration of the company without as much OEM supply revenue where it was wire and cable and enterprise, you had project activity it was continuing to build.

In OEM supply you have manufacturers in Q3 who typically maintenance shuts down and vacation shut downs around kind of July and August. So that takes the in the OEM supply business the sequential growth from Q2 to Q3 barring other economic factors which you would expect it to actually soften a little bit.

Ted Wheeler – Buckingham Research

And then in this year you’ve identified some particular – certainly copper prices are going to be an impact and you know I guess the later cycle mining and energy related issues within electrical industrial wire you would expect some I guess slowing there too, would that not be prudent?

Robert J. Eck

Well I think it depends on where specifically the spending is happening and what’s driving it. What we see is power generation projects in the utilities are continuing. Pollution control projects are continuing because most of those have to do with regulatory compliance kind of issues. Alternative energy projects seem to be continuing at the moment. In the oil, petrochemical kind of part of the business I think we’ll kind of hold our judgment for now. We know that the EPC companies the [Floraspectals], [SNC Lavaland], those type of organizations have very healthy backlogs.

The question is which project will actually go and what will get deferred. If you look at some of the earnings release announcements that came out of the major oil companies, kind of a mixed bag from small declines in capital spending to holding capital spending even year-over-year in ’09 versus ’08 to in fact in at least one case a growth in capital spending.

So to me there is so much mush in all of that that you say well we think there is opportunity in that business and again we think some of it's market share-related for us particularly in the Middle East and Continental Europe.

Ted Wheeler – Buckingham Research

Thank you. I guess just one last, I should probably be able to figure this out, but the math of the accounting change impact of – is $0.23 going forward and it was a little less going backward. Does that – I guess what is that? Why would be the change there?

Dennis J. Letham

Basically you end up with kind of the equivalent of accreted interest. So as the debt balance gets bigger the interest rate applied to that growing debt balance puts more interest expense through the P&L.

Ted Wheeler – Buckingham Research

So this will show up in actual share equivalents?

Dennis J. Letham

This will show up in increased interest expense because you basically take the security, you split it between kind of a debt component and a option value around the convert. The debt component then is valued in a way that would reflect market rates of interest for straight debt. It's recorded on a present value basis and then you accrete the present value over the life of the thing.

So you would end up with from a balance sheet standpoint reduction in debt and shareholder equity actually increases because the option value goes into shareholder equity. From a P&L standpoint you end up with increase interest expense going through the P&L.

Ted Wheeler – Buckingham Research

Is that zero of potential put instrument? If I recall that’s convertible, isn’t it?

Dennis J. Letham

That is convertible.

Ted Wheeler – Buckingham Research

So does the $0.23 include your expectations that those might be put or not?

Dennis J. Letham

The 20/33 because we’re already past the date which it could have been put has no ongoing impact in there. It's basically, I mean there’s kind of goofy rules around what time period you do these things over, but that one basically has no future impact on it. It will have some impact on historical restatement. The numbers that we’re looking at on the impact for ’09 and forward is all related to the $300 million it’s in the 1% convertible due in 2013.

Operator

Your next question comes from Nat Kellogg – Next Generation Equity Research.

Nat Kellogg – Next Generation Equity Research

Thanks for taking my question just a couple of things. Guys, if you could maybe just help us a little bit on gross margins for ’09 and I guess the question is around when you’re talking about these vendor rebates and if you go forward to 2009.

I mean because it’s a tough economic environment can we just assume there’s no way that you’re ever going to make these or do they sort of reset the bar every year where it’s an easier bar to hurdle this year than maybe it would have been last year?

Robert J. Eck

Nat, the answer is that we negotiate the rebate agreements ever year, so it resets sort of where the bar starts from, but as with any negotiation there is pushing and pulling on both sides. You know it’s going to depend very much on how the revenue actually unfolds during the year.

So to the extent we're curious about whether the market, the economy broadly is stabilizing or going to dip further, that's really what will tell you, ultimately, what's going to happen with the rebates.

Dennis J. Letham

Now, you would think of these much like a bonus plan that's got objectives in it, too. This isn't just about pure volume. These are customized by vendor. They can include initiatives around driving certain particular product sets or stuff like that that can give you an answer that may not be 100% consistent with the overall volume in that market. So, they're very customized by supplier.

Nat Kellogg – Next Generation Equity Research

But, obviously, you do have some ability to reset the bar a little bit, so that it's not like you need to go back to the previous peak where things are terrific to get some of these rebates.

Robert J. Eck

Correct. We don't have to go back to sort of 2007 high watermark revenue run rates to get into earning money on rebates.

Nat Kellogg – Next Generation Equity Research

And then what was depreciation amortization for the quarter?

Dennis J. Letham

For the quarter depreciation was $6.3 million. Amortization of intangibles was $3.1 million.

Nat Kellogg – Next Generation Equity Research

And just I guess, last question on the share count here. I guess this will sort of be fluctuating between this sort of 36 and 39 depending upon where the stock price is. Is this – does the new accounting have an effect on the shares outstanding or is it just the flow through of the interest expense on the income statement.

Dennis J. Letham

It's the interest expense. It does not affect the share account calculation. One thing to keep in mind, of course, is that the calculation for the quarter is based on average price per quarter.

Nat Kellogg – Next Generation Equity Research

Right.

Dennis J. Letham

If you looked at the trend of where the share price was, we obviously in the latter months of the quarter were a lot lower than the earlier weeks in the quarter, okay. So, there is still some dilution in the quarter coming from the 20/33 convert that depending on where the stock is price at may, if it hangs around current levels, would actually be less in Q1 than it was in Q4. But we obviously won't know that number until we get the average price for the quarter.

Nat Kellogg – Next Generation Equity Research

Okay. And, then, obviously if that note ends up getting – the note ends up getting put back to you guys this summer that would also have the effect of taking out some shares down the line.

Dennis J. Letham

Yes, that would go away.

Operator

Gentlemen, we do have a few more questions. Would you like to continue?

Dennis J. Letham

Yes, go ahead.

Operator

We have the next question from Matthew McCall – BB&T Capital Markets.

Matthew McCall – BB&T Capital Markets

So Bob, back to one of the earlier questions, I think your comment was regarding your outlook. I think you said it would be fairly challenged. You see a fair challenge opportunity for growth in '09. I just wanted to make sure I understood what you're saying. Are you talking about from a Q4 run rate, from the run rate exiting the year, or are you talking about the full year, '08, growth on the full year of '08. I just want to make sure I understand what you were saying there.

Robert J. Eck

What we're saying is that we think that we'll be challenged to get growth over the Q4 kind of run rate, late quarter kind of run rate, because the economic uncertainty.

Matthew McCall – BB&T Capital Markets

And then, Dennis, on the other the other income align, the detail there, could you tell us, and sorry if I missed this, the breakdown of the cash surrender value versus the impact from hedging on that number, and how we should look at it, going forward, if we just assume a flat market? How do we look at that number as we move into '09?

Dennis J. Letham

The cash surrender value number is $4.8 million and the FX number was $12 million.

Matthew McCall – BB&T Capital Markets

And so it sounded like you had made some adjustments to your hedging strategies, and that $12 million should be, I mean how should we look at that going forward?

Dennis J. Letham

I think the $12 million will be a manageable number. There's always going to be some residual amount of foreign exchange gain or loss. So, I think that in an environment where the dollar is weakening it probably has a residual gain. If you're in an environment where the dollar is strengthening, it's a residual expense.

Robert J. Eck

I think the important thing is that we can implement a number of changes to process and IT systems, have more that are being implemented in the first quarter that should dampen some of that effect, that the issue wasn't so much that the dollar strengthened. It's that the dollar strengthened very dramatically in a very short period of time. And then there was intra-month volatility as well and managing both of those were really what caused the challenge for us.

Matthew McCall – BB&T Capital Markets

And then I guess on the $4.8 million of the cash surrender value, remind me of the company-owned life insurance? How should we look at that debt versus equity just using a proxy?

Dennis J. Letham

Well, there's about $28 million of cash surrender value there, I forget the breakdown in terms of how much it is. I think it's about 60% of that would be in fixed income securities; 40% would be in equity index funds.

Matthew McCall – BB&T Capital Markets

Okay. And then the final question, a lot of talk about the impact of how they shut down, for a lot of your customers. Any idea of what the impact was in total on the top line, and then obviously on the operating income line as well?

Robert J. Eck

No.

Operator

Your next question comes from Ted Wheeler – Buckingham Research.

Ted Wheeler – Buckingham Research

You talked about this year being an investment year for the Factory Automation Initiative.

Robert J. Eck

Yes.

Ted Wheeler – Buckingham Research

I'm just wondering what kind of revenues you might expect to see, or maybe a run rate as you exit the year, or any color you might want to share on the revenue side of that?

Robert J. Eck

Well, maybe what I'll share first is, when we talk about investing what we're really talking about. In that initiative we've made some modest investments in our lab here in our headquarters so that we can demonstrate this whole technology migration, from fieldbus to industrial Ethernet. And that's very small capital dollars.

The other investments are really in specialty headcounts. The people who've come out of the automation industry have a lot of knowledge. We train them on our product set, train them on industrial Ethernet and, then they augment the existing sales force. So when we talk about investments, it's not eight-figure or seven-figure kind of numbers. They're fairly modest numbers.

But it does help us get on the front-end with customers of this technology shift and the problem with the numbers right now is that when we did see growth in our automation products in the year. We saw actually reasonably good growth. The numbers are pretty small at the current time and I would expect that there will be some volatility, quarter-to-quarter, in those numbers.

So much like when we initiated our security program about six years ago, we probably won't talk much about sales numbers until we get some stability behind that, in more predictable run rates.

Dennis J. Letham

At this time since we're starting to recycle back through people on questions, why don't we make some concluding remarks and if people have follow-on questions, you can contact us individually.

Robert J. Eck

Great, thanks. So everybody, thanks for joining us on the call today. While our results did not meet our goals for the year we generated modest sales growth and operating earnings in a very challenging environment. The fourth quarter saw several one-time events that impacted otherwise reasonable core operating results.

We believe that we continue to have good opportunities in front of us in 2009, a business model of providing technical knowledge of products and applications coupled with supply chain services across multiple product segments and end markets around the world, positions us uniquely as a distributor. While the outlook is currently uncertain, we will continue to invest in initiatives that build our business for the long term, while managing our operating model to keep our business financially healthy in the short term. Thank you.

Operator

Once again, that does conclude today's conference. Thank you for joining us, and have a wonderful day.

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