Anixter International Inc. Q1 2009 Earnings Call Transcript

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 |  About: Anixter International Inc. (AXE)
by: SA Transcripts

Anixter International Inc. (NYSE:AXE)

Q1 2009 Earnings Call

April 28, 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

David Manthey – Robert W. Baird & Co.

Matthew McCall – BB&T Capital Markets

Jeff Beach – Stifel Nicolaus

Ted Wheeler – Buckingham Research

[Kevin Sarcini – Legend]

Michael Terwilliger – Bank of America

Nat Kellogg – Next Generation Equity Research

Operator

Welcome to the Anixter first quarter earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Chris Kettman for opening comments and remarks.

Chris Kettman

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'll open the lines for Q&A session.

Before we begin, I would like to remind everyone that statements 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 could cause the companies 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 companies SEC filings for more information.

At this point, I will turn the call over to Dennis.

Dennis Latham

I'd first like to comment briefly on the first quarter business environment before discussing the quarterly results. During the first few days of the quarter, the overall business climate reflected the same levels of extreme customer demand softness we saw in the latter weeks of 2008. However, as we move further into the period the business did rebound, although not to the same levels that we saw in the early weeks of the fourth quarter, and then stabilize throughout the last ten weeks of the quarter.

As expected, year-on-year sales comparisons for the first quarter of 2009 were negatively affected by the strengthening of the U.S. dollar that occurred early in the fourth quarter of 2008 and the substantial decline in spot market copper prices that occurred during the fourth quarter of 2008.

While these negatives were partially offset by sales from businesses acquired in the second half of last year, collectively these three factors combined to account on a net basis for approximately half of the 14% year-on-year decline in reported sales. Also, as expected we generated good cash flow in the first quarter and anticipate that this will be sustained as we continue to adjust our inventory levels to correspond to the current demand environment.

Next, I'd like to move to a more detailed discussion of the first quarter results beginning with sales. For the quarter, we reported a year-on-year decrease in sales of 14%. After adjusting for $99.9 million of negative foreign exchange effects, an estimated $37.7 million of negative copper price effects and eliminating the sales associated with acquisitions we had an organic sales decline of approximately 7%.

It's important to note that, while the current recession according to official government measures started in the fourth quarter of 2007, this is the first quarter in this recession cycle in which we have reported a companywide organic decline in sales. In addition to the end markets where we saw organic sales declines in late 2008, this quarter's organic sales decline reflects for the first time in this recession cycle negative organic sales comparisons in our North American Electrical Wire & Cable end market.

In addition while we are still reported positive organic growth rates in our North American OEM supply and emerging market businesses, those growth rates were lower than in recent periods. Looking at first quarter sales trends within each of our end markets we see the following. On a worldwide basis Enterprise Cabling and Securities Solution sales, exclusive of foreign exchange effects, declined organically by 4% as compared to the first quarter of last year.

Within this end market, our securities sales continue to be a bright spot as we saw sales and security products, exclusive of foreign exchange effects, increase by 11% compared to the first quarter of 2008. Geographically, our Enterprise Cabling and Securities Solutions sales were down 5% organically in both North America and Europe as compared to the year ago quarter reflecting the trend of the past few quarters of less project activity in this market environment.

The emerging markets our Enterprise Cabling and Security Solutions sales increased organically by 1%. This emerging market growth rate was substantially lower than we have seen in recent quarters and was due, as had been expected, to lower project volumes in Asia Pacific where we actually reported a year-on-year organic decline in sales of approximately 12%. Offsetting the softness in Asia Pacific was organic growth of approximately 7% in Latin America where market conditions on a comparative basis to the rest of the world have remained relatively stronger.

Worldwide Electrical Wire & Cable sales, exclusive of foreign currency and estimated copper price affects and the elimination of sales from companies acquired in late 2008, reported an organic decline of 9% in the quarter. The organic sales decline of 10% in North America, which is the first reported decline in this end market during this recession period, reflects declines in both project and day-to-day volumes within this market.

In Europe, we experienced an organic sales decline of 5% compared to the year ago quarter as we saw a weakness throughout this business in the U.K., Continental Europe, and the Mid East. Our worldwide OEM supply business continues to be negatively affected by customers operating at reduced production levels. For the quarter, after elimination of foreign exchange affects and sales from businesses acquired in the second half of 2008, we reported an organic sales decline of 13% as compared to the first quarter of 2008.

Similar to what we saw in the fourth quarter of last year, our North American OEM supply sales grew year-on-year despite production cutbacks at many customers. The 12% organic growth in North American OEM supply sales reflect sales to new customers added in the second half of 2008 and continued solid demand from aerospace and defense customers. In Europe, we had an organic sales decline of 32% on significantly reduced production rates throughout our customer base with the recession affects particularly noticeable in the Italian and U.K. markets.

As we look forward to the next couple of quarters we expect reported sales to remain under pressure from the year-on-year comparisons of a stronger U.S. dollar and lower spot market copper prices. Assuming the dollar continues to trade at approximately the same level as it has for the past few months, we would expect the next couple of quarters to see the same comparative sales impact from foreign exchange rates as we saw in the first quarter.

The anticipated impact from copper over the next couple of quarters is a little harder to estimate. We do know the first quarter sales did not reflect a full quarter affect of the lower copper prices that would have been implied by the fourth quarter drop in spot market prices as the industry continued to work through older higher cost inventory and complete deliveries on orders that were booked prior to the late 2008 drop in spot market prices.

At the same time, we have seen a significant rebound in spot market copper prices over the past few weeks and it remains to be seen if prices will remain in the range of $2 per pound or will move back closer to those late fourth quarter levels.

Acquisitions will continue to add $45 to $50 million to reported sales in the second quarter, but after that the positive effects from acquisitions will begin to decline as we reach the anniversary dates of the various acquisitions completed during the third and fourth quarters of last year. Setting aside the effects of foreign exchange rates copper prices and acquisitions, the organic demand environment remains uncertain for the next few quarters.

While there are some economics statistics that suggest the economy may be beginning to find a bottom, including some areas of our business that showed periodic strength through the quarter, there is not yet pervasive evidence that we have found the bottom to this current cycle. Bob will discuss current trends in more detail in a few minutes.

Turning next to gross margins, in the first quarter we reported gross margins of 23.1% as compared to 23.7% in the year ago quarter. This decline is almost entirely to mix as we saw our highest gross margin business, OEM Supply, report organic sales declines of 13% as compared to the companywide organic sales decline of 7%.

At the same time, our second highest gross margin business, Electrical Wire & Cable, reported worldwide organic sales declines of 9%. Gross margins were not affected in any material manner by product pricing, as product pricing overall has remained fairly stable despite the soft macroeconomic environment. The effects of lower copper prices did, however, reduce gross profit dollars by $8.6 million as compared to the year ago quarter.

Looking for a moment at operating expenses, we saw a 4% year-on-year decrease in expenses from $247 million in the year ago quarter to $236.4 million in the most recent quarter. Reported operating expenses benefited from the stronger U.S. dollar, which had the effect of reducing reported expenses by $19.9 million.

However, reported operating expenses were $13.6 million higher than the first quarter of 2008 due to the addition of operating expenses of business acquired in the second half of last year. After eliminating the effects of foreign exchange rates and acquisitions, operating expenses decreased by approximately 2% year-on-year.

Just as important as the year-over-year decline in expenses is the consecutive quarter expense trend. After adjusting fourth quarter operating expenses for unusual items identified in our fourth quarter earnings release, including the expenses associated with the 53rd fiscal week, on a consecutive quarter bases our operating expenses declined by nearly 5%.

Included in the fourth quarter of 2008 unusual items was a restructuring charge of $8.1 million, which is expected to yield annualized savings of approximately $14.7 million. Only a portion of this savings was realized in the first quarter pending the actual departure of the affected employees. At the same time, we have continued to trim staff and expenses in response to the changing business conditions.

Operating expense control remains a high priority and as the year progresses, we will continue to evaluate activity levels and productivity to ensure our expense structure is sized to meet the near-term realities of the economy, while at the same time balancing the short-term objective with longer term strategies and programs.

So, to summarize from an operating income perspective, the effects of all the items we have just discussed caused operating profits to fall from $101.5 million in the year ago quarter to $56.9 million in the most recent quarter. Looking at this $44.6 million decline in operating profits, foreign exchange effects account for $3.4 million of the decline and lower copper prices account for $8.2 million of the decline, and acquisitions reduced the year-on-year operating profit by $500,000 due to loses in those businesses.

The remaining $32.5 million decline in operating profits reflect the combined effects of the 7% organic decline in sales, the 60 basis point decline in gross margins caused by unfavorable sales mix, which was then partially offset by the 2% organic decrease in operating expense. As a result, operating margins fell to 4.5% in the first quarter as compared to 6.9% in the first quarter of the prior year.

As we move further down the income statement, interest expense, as adjusted to reflect the new accounting treatment for convertible bonds required by FASB staff position 14-1, was constant with the first quarter of the prior year at $14.5 million, as interest cost associated with higher borrowings was offset by lower average borrowing cost.

The increase in borrowings during the past 12 months resulted from $180.6 million used for acquisitions and $62.9 million spent on share repurchases in the second quarter of last year, less the cash generated from operations. Importantly, however, compared to the end of the fourth quarter, borrowings decreased by $45.8 million and invested cash balances increased by $39 million.

In the current quarter, our average cost of borrowings was 5% as compared to 5.7% in the year ago quarter. At the end of the first quarter, approximately 87% 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 form a net expense of $300,000 in the year ago quarter to income of $600,000 in the most recent quarter. In the most recent quarter, income of $3.4 million related to the expiration of liabilities associated with a prior asset sale were partially offset by loses of $500,000 on the cash surrender value of company in life insurance policies due to poor financial market performance in the quarter and foreign exchange loses of $1.9 million.

The first quarter tax provision reflects an effective tax rate of 40.3% as compared to an effective rate of 35.7% in the year ago quarter. The prior year first quarter effective rate included a benefit of $1.6 million related to foreign tax benefits associated with the recognition of net operating loss carry forwards, without which the effective rate last year would have been 37.5%.

The increase in the effective tax rate reflects significant changes in country level profitability and the effects of tax rate differences by country. Due to the uncertain market conditions, it is likely that the mix of earnings by country will remain volatile and precise predictability of the tax rate within a range between the high 30% and low 40% range is difficult.

Net income for the quarter was $25.7 million compared to $55.8 million reported in the year ago period, which included the previously mentioned tax benefit of $1.6 million. On a diluted bases, earnings per share were $0.72 in the most recent quarter as compared to $1.40 in the year ago quarter inclusive of the $0.04 per share associated with the previously mentioned tax benefit. The current quarters fully diluted net income per share benefited from an approximately 10% 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 first quarter, we generated $88 million in cash from operations as compared to $55.4 million generated from operations in the year ago quarter. This increase in cash flow reflects $48.6 million of working capital reductions in the quarter associated with the organic decline in sales and lower copper prices. We anticipate continued strong cash flow in coming quarters as we continue to adjust the inventory levels commensurate with current sales activity.

This expectation of continued strong cash flow, combined with approximately $299 million in available committed unused lines of credit and $44 million of invested cash balances, will give us the liquidity we need to support the business through 2009 and beyond.

This liquidity position gives us ample flexibility to deal with the potential [hoodie] event on our 3.25% convertible bonds in July of 2009, any potential questions concerning renewability of our accounts receivable securitization facility in September of 2009, and the possibility of increased working capital needs late in 2009 associated with some projections of economic recovery commencing late in the year.

To the extent that one or more of these continuances do not occur, then excess liquidity will be used to reduce financial leverage for the near-term. We regard our strong financial position and ample liquidity as important differentiators from many companies in today's market as they provide us with the financial flexibility to adjust quickly to new market realities including allowing us to capitalize quickly on the eventual market rebound when it occurs. Over the near-term we expect this financial position to improve even more based on expectation of continued strong cash flow in this environment.

At this point, let me turn the call over to Bob to discuss strategic initiatives, current business trends and near-term outlook.

Robert J. Eck

The first quarter presented several challenges for us arising out of the recessionary macroeconomic environment. The impact of slowing sales, copper deflation and the stronger dollar affected both sales and earnings. At the same time, the benefit of expense control actions initiated in the fourth quarter, along with very focused working capital management, enabled us to exit the quarter with strong cash flow generation.

These effects will continue to be realized in the second quarter as additional expense reductions steps; particularly in Europe, will begin to impact our business. The Enterprise Cabling and Security solutions business experienced patterns in the first quarter that were similar to the later part of the fourth quarter of 2008.

The daily sales rate, excluding the holiday weeks, has been roughly flat from November through the end of the first quarter and, as Dennis noted, down from the first quarter last year. The result is not surprising, given that companies tend to quickly tighten discretionary IT spending in difficult economic periods leading to reduced project activity.

The market environment during the quarter was similar in North America and EMEA. Importantly, market pricing for data cabling has not degraded at this point in the recession, as it did in the last recession. We believe this is the result of consolidation across the manufacturing base. While there has been some softening in the security market, we have continued to see growth in security in both North America and EMEA, although at somewhat reduced levels from what we saw last year.

Growth in North America was 5% over prior year, and EMEA grew 30% adjusted for currency. Additionally, interest in our ready branded supply chain services continue to enable us to provide greater value to our customers by reducing their total cost in working capital. This has allowed us to maintain a good position in a weak project environment. Finally, our new business development initiative continues to add new customers and sales in our enterprise business.

The emerging market has experienced mixed results, with continued weakness in Asia, but modest organic growth in Latin America. The Asia business has seen volume pressure from reduced IT spending by multinational companies.

Latin America, however, has continued to grow in both project opportunities, as well as day-to-day sales. In addition, our security sales experienced double-digit organic growth in both Asia and Latin America. We are taking steps this year in Asia to broaden our market presence to serve the larger domestic enterprise market.

In summary, the enterprise business around the world continues to be challenged by limited project environment, in which IT spending has been reduced. However, by leveraging our ready services, we believe we are maintaining, to modestly increasing, our share in a difficult project environment. Our security initiative continues to grow, due to the combination of the migration to IP surveillance, the desire to provide more secure public and private places, and the fragmented nature of the market

During 2009, we are continuing our global technology seminars, focused this year on Integrated Physical Security and Data Center Optimization. These seminars include Anixter technology leaders, as well as recognized industry experts, providing customers with insight on the changing technical alternatives, as well as considerations regarding sustainability and green data centers.

By continuing to focus on helping customers evaluate security and data infrastructure solutions, we will be well positioned as the economy and IT spending recover. The Wire & Cable end market was affected in the first quarter by the combination of lower copper prices and significant softening in demand for specialty wire for OEM customers.

These factors lead to the decline in sales over the prior year that Dennis has previously mentioned. Sequentially, from the fourth quarter, excluding the impact of copper and currency, sales in North America experienced an organic decline of 11%, while sales in EMEA grew by 7%.

North America experienced a greater sales decline because the OEM customer segment is a greater part of the revenue mix, as well as the fact that in EMEA we have a continuing opportunity to take share, due to our smaller market position. We continue to add active project pipelines and quoting activity for our industrial segment reflecting the ongoing activity in the oil and gas industry, power generation, and alternative energy.

We are benefiting in the project business from our ability to leverage our global organization to work with customers to support design teams in one country, and project management teams in another country who are engaged in the same project. In addition, our ability to offer ready services enables customers to more efficiently manage materials in these complex projects and meet their committed project timelines. This ability also positions us to assist customers with the ongoing MRO needs after the project is completed.

We are continuing to invest in our industrial automation initiative. We continue to see growth in sales of industrial automation products, in spite of the challenging economic environment. Automation is undergoing a transition, much like the security business, from Legacy field bus architecture to industrial Ethernet.

Our unique position as an organization that has experience in both IT and industrial infrastructure enables us to help customers select the right products to begin migrating to the latest technology. We are in the process of updating our infrastructure lab to include demonstration of automation technology, alongside our data and security technology evaluation tools.

The Wire & Cable team did a great job through the quarter working to reduce higher cost copper inventory and take inventory levels down overall to reflect the recessionary level of activity. The result is that we have inventory substantially in line with current demand in North America. In EMEA, progress was made reducing inventory with further opportunities for reduction in the coming quarter.

We are carefully balancing the need to manage working capital with the desire to have inventory available to meet customer's needs. Critically, given copper costs, we have managed to sell through substantially higher cost inventory without impairing our gross margin percentage. We will, however, reduce gross margin dollars going forward due to the deflationary copper's having on certain cable products.

Shifting now to the OEM supply business, we experienced very challenging conditions in the first quarter, which were a continuation of trends seen in the fourth quarter. On a positive note, in North America we achieved growth in the industrial and aerospace and defense markets. This resulted from having won several major new contracts in 2008 that were implemented in the later part of the year, and therefore, provided lift to sales in the first quarter.

At the same time, production rates at large customers in both North America and Europe continue to decline. While we have also added new parts to existing contracts, the effect of the production cuts offset this positive development. We gained additional customers and revenue from the acquisitions completed last year, which will add scale and leverage as the economy recovers.

In light of the declining revenue in the end market, we have been engaged in an ongoing right sizing of this business. Various steps were taken in the fourth quarter that were implemented at the beginning then and it helped reduce costs in the first quarter. Additional steps have been taken in North America and Europe. The cost-saving steps in Europe are beginning to have a positive effect, due to the lag in implementing such actions there. There will be incremental cost reductions realized in the second quarter.

We are also in the process of reducing inventory, to reflect the lower production levels we are seeing. Due to factors related to lead times and customer forecasting, it will take longer for us to realize inventory reduction in this segment than in our other businesses. However, improvements should begin to be seen in the second quarter.

We are beginning to see signs of stress in our competitor community in the OEM supply market, due to revenue and capital constraints. We are now engaging in new customer opportunities to possibly displace competing suppliers that are struggling to deliver expected levels of service. Our ability to pursue these opportunities is substantially due to the fact that while we are focused on managing our operating expense, we are also focused on managing for the longer term.

This means we have to keep people onboard who can be deployed into implementing new programs, even when it appears that the market is very soft. In doing this, we can advantage of opportunities that this environment may present. As we have continually said, we strive to maintain a flexible operating model that enables us to flux our cost in response to changes in volume in our business.

We have implemented significant expense controls, including consolidating facilities, reducing overtime and temporary labor, reducing headcount, and restricting travel. We have reacted quickly to reduce working capital in line with business activity. At the same time, we cannot create lasting value unless we continue to invest in the initiatives that will build our business geographically, and across product and end markets to maintain our franchise as we go forward. While it is critical to manage profitably through the recession, it is also critical to be positioned strongly when the economy recovers.

Today, we have limited visibility as to how this year will unfold. While sales volume stabilized through the quarter, recessionary pressure could mute the normal seasonal improvement in Q2. However, the breadth of end markets and geographies we serve, along with our attention to expenses and working capital, will enable us to weather the recession and take advantage of the recovery.

We will now open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question from David Manthey - Robert W. Baird.

David Manthey – Robert W. Baird & Co.

Bob, when you talk about activity levels stabilizing, just clarification, are you talking about dollar levels or sort of average daily sales type numbers as opposed to year-to-year change?

Robert J. Eck

Yes, it is dollar sales levels and booking levels that we see.

David Manthey – Robert W. Baird & Co.

Okay. And, second, when you talk about low single-digit or mid single-digit quarter-to-quarter revenue increases, typically, this may be an obviously question. But, there you're talking about organic revenue trends, not including copper currency acquisitions, right?

Dennis J. Letham

That's correct, Dave.

David Manthey – Robert W. Baird & Co.

And then the last question. Could you tell us approximately, if you have an idea, what percentage of your business today you think is project related? I am sure that numbers come down here recently. And finally, could you talk about any trends you're seeing in data center or the Mac business year-to-date?

Dennis J. Letham

I guess the first part of that answer would be that the project business has declined. We've in the past used sort of an 80/20 rough approximation of day-to-day project versus day-to-day. The project activity is declining. We're probably seeing something more on the order of, instead of a 20% project volume something more in the order of a 10% to 15% project volume currently, potentially down a little bit lower than that.

I think the important thing, as we look at it is that the project boards that our sales pipelines show are full of activity around data centers. But the reality is that a lot of those projects are probably not funded today and so that's creating the downward pressure on project activity. So there's a lot of activity in the pipeline but there's not as much activity being funded. And that takes us down to the low end of that range, to a project volume that's 10% or potentially less than 10% of the number.

Operator

Your next question comes from Matt McCall - BB&T Capital Markets.

Matthew McCall – BB&T Capital Markets

So on the inventory, I think a couple different comments there talk about a focus on bringing inventory down. I heard commentary that the Electrical Wire & Cable business was in line in North America. OEM, you're trying to work down. Did I miss the enterprise commentary? What's the expectation for your inventory over there maybe broken down geographically?

Robert J. Eck

Fair question, Matt, I did not specifically address that. In North America, the enterprise inventory is very much in line with demand. It's come down, it's were we would like it to be at the present. Europe is a little bit higher and working it's way down. One of the challenges in Europe is that you have a more difficult footprint to serve and you have to keep inventory closer to customers due to transportation, networks, etc.

So, we never quite get the same leverage out of inventory in Europe that we do in other parts of the world. But the enterprise inventory is substantially in line in North America, it's in line in the emerging markets as well, and we're working it down in Europe.

Matthew McCall – BB&T Capital Markets

And the next question was about Europe. It sounds like some of the cost reduction efforts are definitely focused on that market and, Dennis, you talked about the incremental, I think this is more on a broader or on a companywide scale, the incremental SG&A decline. I guess two parts to the question. What's the expectation going forward for the profitability of Europe based on your outlook? And then as we look at SG&A overall, if your going to see even more muted sales sequential pickup, how do you look at SG&A dollars relative to the expected top line?

Dennis J. Letham

Well, I think on actions that have been taken to date to the first part of your question, the things that we talked about in fourth quarter were largely European focused because that's were we saw most of the fourth quarter decline. We did not get the full benefit of those actions in Q1 because to the extent that we were terminating people, there's a process and timeline for doing that in most countries in Europe that meant we probably at best got half of the benefit of the people cost reductions in Q1.

So, that's yet to be fully realized and should be fully realized as we go into Q2. At the same time, we have continued to, I guess I'd use the term, sort of surgically remove costs in people throughout the business as we've seen demand patterns change. And that's something that literally is happening kind of month by month and will continue to happen month by month. And I would suggest that we should see, if volume were flat Q1 to Q2, and I am not saying will be, but if it were then we'd expect to see sequential reductions in operating expense for Q1 to Q2 from the actions that have been taken.

During the first quarter and annualizing or getting a full impact of the fourth quarter items, obviously, to the extent of volume increase there will be variable costs associated with that volume increase that will offset some of that decline as we move through the year.

Robert J. Eck

If I can piggyback a little bit on what Dennis just said. One of the things that I think is important is perspective in this is that don't look for us to have big announcements on restructuring charges. We did have an announcement in the fourth quarter but, as part of our philosophy of operating the business, we are trying to be very attentive to operating expense, as well as working capital on an on going basis.

As Dennis said, we're looking monthly at trends in the business and need to take expense actions and that is going to continue and it'll continue until we see the market turn. But, as I also said, we won't cut so deeply that we can't react when we see opportunities to react to. But we will ongoingly be looking at operating expenses in the business.

Dennis J. Letham

And I think it's also fair to say that to the extent that's there are still some slices of business that are showing growth, such as the 11% growth in security sales, the 12% growth in OEM supply in North America. We'll continue to make sure we are putting the right resources into place to continue to support that type of growth. So, it's not cut, cut, cut across the board. It will be selective to the market conditions in the varied markets.

Matthew McCall – BB&T Capital Markets

You broke down the project exposure. If you look at the day-to-day or the MRO type business and maybe qualitatively if you could talk about the book-to-bill trends there, what you're seeing, maybe in electrical and on the enterprise side and if it's given you any incremental comfort on what you're expecting for next quarter.

Robert J. Eck

I guess the important understanding behind that would be that our backlog tends to be typically around a month sales or less than a month sales in Wire & Cable and Enterprise. So, with numbers like that we don't see sort of a leading indicator of what the trends are. So, I guess I'd say we have about a month ahead look and a month ahead look looks like we're pretty flat.

Operator

Your next question comes from Jeff Beach - Stifel Nicolaus.

Jeff Beach – Stifel Nicolaus

I follow the company sequentially rather than year-over-year. So, in looking at the first quarter you had lower volume and some drag from copper and that seems to explain, by my estimate, about a third of the decline sequentially in earnings. You had mentioned mix being hurt. Can you expand on that? And then along with it, even with mix, was there some issue here with your pricing in the market kind of going down faster leading your inventory costs of the products your selling, and give us a little bit more color on this margin erosion that has occurred?

Dennis J. Letham

Well, I think if you looked at fourth quarter gross margins, if you are going to look at this thing sequentially, I'll just go to the back there and pull the number there for a second. I think it was, one second, Jeff, sorry, 23, low 23 somewhere. Don't have the number right in front of me will get it here in a second, but sequentially margins haven't changed that much.

But our fourth quarter margin issue was the adjustments made in the fourth quarter for vendor rebates that we had been accruing during the year, volume incentives that, because of the tail-off in volume at year end, that resulted in a negative adjustment that reflected back on the whole of the year. Without that in there margins would have been higher than that in Q4, and if we look then from Q4 to Q1, really the issue that's hurting us is the next issue with the 33% or 32% drop on an organic basis of OEM supply sales out of Europe.

That is our highest gross margin business, more in the kind of 27% range. At the same time, we talked about 9% organic declines in the Electrical Wire & Cable business. There we're probably averaging a good solid point above our corporate wide gross margins. So, it's the greater decline in the higher gross margin businesses that cause the mix to soften.

The volume incentive issue is not an issue in the first quarter and is reflective of what we expect to earn for the year and doesn't have the same impact it did in Q4. Does that answer your question?

Jeff Beach – Stifel Nicolaus

I'm getting away I think from the gross margin and just looking at the operating profits if you were adjusting for that item would have been about $95 million or maybe more in the fourth quarter versus reported here $57 million.

By my estimates here, if I look at contribution margins or if you look at that I'm seeing about 1/3 of the decline coming from volume, and you're saying mixed also contributed to the decline in the operating margin. And I'm trying to figure out is there other, are you seeing pricing erosion relative to the carrying costs of your inventories.

Dennis J. Letham

No, in that I think we were clear on it as we said earlier in our comments, pricing during the quarter was stable. Pricing was not a factor other than the impact of copper, which as we've outlined here, was about $38 million of revenue and eight point some million dollars less of GP. But other than that there was no pricing issue in the quarter.

Operator

Your next question comes from Ted Wheeler – Buckingham Research.

Ted Wheeler – Buckingham Research

If you took today's daily sales rate, which I guess you said has been pretty static since November and just assuming it continued, what would be balancing your need to be flexible and be able to service growth? What would be your optimal decline in OpEx? What would be the goal of OpEx decline to be equivalent and consistent with the daily sales that we see now?

Robert J. Eck

Ted, I don't have a precise number for you on that. I think as we tried to describe there's a lot of puts and takes in getting to the OpEx number. There's some things we can scale to volume pretty quickly. There's some things that take longer to scale to volume whether that's a geographic issue or, I guess, primarily geographic. The other key thing is that we do want to ourselves positioned for growth.

I don't think any of us, well, I will certainly will say I don't know whether we're at the bottom or whether we're potentially exposed to a further decline, but I do want to have us positioned such that we can take advantage of the upturn when it comes. And I think that's a critical part of profile.

We've always been both short and long-term focused in our business and that affects our ability to say come to a number where we would I think squeeze OpEx to the point where we could maximize short-term profit at the current volume level.

Dennis J. Letham

Yes, I think the other thing that's hurt a little bit in the quarter and maybe this circles back a little bit to Jeff's question too, is if you look at the acquisitions we've done in the past year, much like one of the opportunities we have in the marketplace is to capitalize on smaller competitors who when volume goes down a little bit they suffer a lot of operational de-leveraging.

To date the businesses we acquired second half of last year, the honest answer is they are not integrated into Anixter. They are still a collection of smaller standalone businesses, so to the extent that they've had less volume in them than was expected. As you heard in my earlier comment, there was $45 million of sales of which we lost about $500,000 at the operating profit line.

So until we get those things integrated, we have kind of the same de-leveraging on the acquisitions that we see competitively and that we're trying to take advantage of in the marketplace. So I mean things like that come into play as part of this at the moment too. And that will take some time to get some of those expenses out of those acquired businesses and get them consolidated.

Ted Wheeler – Buckingham Research

I guess if I thought about this a little bit looking at it another way, the daily sales rate is pretty similar to what you saw in the fourth quarter when you embarked on some restructuring actions. And I think you said maybe your realization of the savings is maybe half or maybe not even half. So if I were to just go to a 4% decline in OpEx would I be consistent with what you thought you were trying to do in December or November when you implemented the restructuring, is that close?

Dennis J. Letham

Well, from fourth quarter to first quarter OpEx is down almost 5%. If we take out those unusual adjustments from the fourth quarter and the 53rd week of expenses, so we are down on a consecutive basis 4% to 5%. And as I said a little bit earlier, if we assume volume is flat, which we're not saying it is, but if volume were flat we would expect sequentially from Q1 to Q2 that OpEx would be down a little bit more from the actions that we're continuing to take.

But, of course, if we get some seasonal pickup in business here and we see some increase in volume Q1 to Q2, there will be variable costs associated with that.

Ted Wheeler – Buckingham Research

I was just trying to posit that we keep the daily rate where we are, and then in addition to the incremental actions that you've taken, I think you said that the fourth quarter actions had not yet fully been realized and that perhaps even half or so is yet to be realized.

Dennis J. Letham

Yes, let's look at that though. I mean we talked about roughly $14 to $15 million of annualized savings there so we're dealing with something less than $4 million a quarter. If we got half of it in Q1 we get the full amount in Q2, we're talking $2 million more of incremental expense reduction. It's not close to $250 million or $230 some million of quarterly operating expense, it's a percentage point.

Ted Wheeler – Buckingham Research

And I guess just one last one, you talked about sounds like cash operating flow will be even better than the very nice number you put up for the March quarter. I know you'd probably prefer and I'd prefer that's not the case.

Dennis J. Letham

Right, but I do think at least for the next quarter we still have inventory to get off the balance sheet so the cash flow from the income statement will be supplemented by further working capital reductions coming primarily from inventory. Hopefully, we get to a seasonal pattern as the year unfolds that actually has us putting a little bit of working capital in and support of that. But at least for the near-term we would expect to continue to have very strong cash flow here in Q2.

Ted Wheeler – Buckingham Research

And then possibly pretty flattish for the second half if you get a little pickup?

Dennis J. Letham

Yes, depends on how much the pickup is.

Operator

Your next question comes from [Kevin Sarcini – Legend].

[Kevin Sarcini – Legend]

I'm sorry to do this but can we go back to the project business and if you could break it out by enterprise and the wire and cable that would be helpful? I think last quarter you talked about 10% project business in the enterprise and 20% I believe in wire and cable. Have those changed much?

Robert J. Eck

Yes, they have not changed much. Potentially enterprise has dipped a little bit. Wire and cable has probably softened a touch, but the wire and cable business project activity is I think we've kind of been saying all along has held up better in the industrial segment and that's really being driven by continued spending on development of oilfields, refining capacity, power generation, alternative energy projects.

A lot of those projects have very long lead times in terms of engineering, project planning and implementation, so that activity for us has not seen the same kind of quick reaction that the IT spending tends to see. So I think those kind of ratios hold up reasonably well.

[Kevin Sarcini – Legend]

Now is there a point where those projects electrical wire and cable kind of start falling off and you see a big dip?

Robert J. Eck

Currently, our project activity and quoting activity indicates that the rates we're kind of running at should probably hold up. There is definitely the potential as you look forward that some of the projects that are being engineered today may not get funded. I'd be speculating if I told you I knew what was going on with that specifically.

[Kevin Sarcini – Legend]

And is the 90% plus I guess maintenance adds and however you define it, now do you get the sense that companies are putting off spending or is it business as usual and just the economic activity, employee adds and so forth just is not really growing that much?

Robert J. Eck

The Mac work ebbs and flows with the economy, but it doesn't have the same kind of sudden, sharp reactions that the project activity have because it is small dollars and it is stuff that's in a sense almost noise within a large enterprise. So, if you think of a large company looking at a data center build versus sort of ongoing Mac spending, the Mac spending ends up kind of chunking along.

There may be some impact with headcount within a company, but sometimes that headcount activity actually spurs some Mac work because companies consolidate space, and when they do that, they reconfigure space and so that will trigger some Mac spending. I think the big effect really is the issue that IT project spending that's hardware related that drives structure, cabling business tends to very obviously slows down in difficult times.

[Kevin Sarcini – Legend]

On the copper front, copper pricing, you talked about 275 to 300 potential kind of compression I guess is the way and you saw 38-1/4. Do you still expect that 275 to 300 is your timing more frontloaded and kind of a softening in the back, or how do you feel that will flow through.

Dennis J. Letham

As we've said in the comments, copper's probably the hardest thing to predict at the moment because the price has been bouncing around so much. It was clear in the first quarter we didn't have as much impact as you might have thought, in combination of, I think, people still working through higher cost inventory, and I say that on an industry-wide basis from manufacturers through the distribution channel that muted some of the spot market changes in price.

I think, also, there's the issue of working on orders that were placed before the prices dropped that are still being delivered at higher price points. Then kind of the wild card in there is really what's happened with the spot price. I mean, we dipped well below $1.50 at the end of the year, we've been back up in the $2 range here more recently.

Where that settles and the impact that that volatility has on the product pricing is a bit of a wild card in there. I think it's fair to say with only $38 million impact in the first quarter, that any ranges of numbers that were kicked around pre-2009 would appear, probably, to be a little high based on the fact we've got a quarter behind us with less than a quarter of those annualized estimates.

[Kevin Sarcini – Legend]

Along that line, are manufacturers being pretty rational, you think?

Robert J. Eck

Yes, I think the manufacturing community has been very rational. I think, as Dennis said, there was a lot of high cost copper in the whole supply chain, from manufacturers finished goods inventory to work in process to inventory in the distribution channel. That, I think, helped manage pricing as we went through the first quarter. What we're seeing on the products that tend to be priced more off price lists is fairly stable pricing patterns currently.

I think the thing that's important to have perspective on is that the cabling products we sell, whether it's in a data environment or in the electrical and electronic wire and cable environment, demand for those products is really not all that price elastic. These items are 5% to 10% of the cost of whatever project they're going into and so the demand is really independent. The demand for the project activity is going to be independent of the price of the cabling products.

[Kevin Sarcini – Legend]

Just thinking about gross margins, historically, you've kind of been at 24% plus or minus basis points and mix has changed a little bit, but even before Electrical Wire & Cable and OEM supply were this big a piece of your business you were doing about that level. Is there is something that we should think about why it could or could not get back to the normal 24% plus or minus basis points going forward after all this noise kind of gets behind us.

Dennis J. Letham

I think, as you work through the recession period here, last year each quarter we had some event that seemed like it caused us to be off of the 24% mark. Here we've got a bit of a mix issue that hopefully will rebound as the economy starts to rebound. I think nearer term you think about margins being closer to 23% than 24%, but then as we come out of the recession and we start to kind of rebalance the mix and we get some recovery in those markets that have been hit a little bit harder, we should see it move back towards the 24% type number.

Operator

You next question comes from Michael Terwilliger – Bank of America.

Michael Terwilliger – Bank of America

Apologies if I missed this, but have you guys talked at all about bad debt expense or any other write-offs you had for customer weakness? I believe you had something in the fourth quarter of some note, wondering if you have any update on that.

Dennis J. Letham

There really is no update on it. The two events that occurred in the fourth quarter, which was that integrator NetVersant and Nortel which combined for about a $24 million loss, were particular in the fourth quarter. In the first quarter, there was nothing unusual and bad debt expense was very much in line with historical levels, except in that fourth quarter event.

Michael Terwilliger – Bank of America

So your expectation is that you don't anticipate any further write-downs or any other concerns regarding that?

Dennis J. Letham

Well, I'd say in this environment you can't say that there won't be customer bankruptcies. I think the thing that works in our favor is the fact that we have a very diversified customer base. While there's one customer upwards of 3%, you very quickly are under 1% of sales and just the diversity in the customer base mitigates against having big problems with any regularity.

Michael Terwilliger – Bank of America

Just some quick clean-up questions, depreciation and amortization for the period in CapEx, what were those numbers?

Dennis J. Letham

CapEx was about, $66.5 million on CapEx, I think, and on the depreciation you've got about $5.7 million, amortization you've got $3 million, and then you have accretion on debt that's non-cash of $4.9 million, and stock-based compensation that's non-cash of another $3.5 million.

Michael Terwilliger – Bank of America

So if I were to be coming up, based upon those numbers, EBITDA based upon that would be in the context of around $70-ish million. Does that seem consistent with where you're at?

Dennis J. Letham

Fifty-six million plus and 16, yes, that's in the ballpark.

Michael Terwilliger – Bank of America

Yes, I mean, just coming up real quick it looks like, yes, just a little bit north of 70, does that sound…?

Dennis J. Letham

Yes, that's in the ballpark, right.

Operator

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

Nat Kellogg – Next Generation Equity Research

Just on sort of talking about working capital over the next couple of quarters, it looks like the receivables balance and DSO were pretty low. Would you guys expect that to pickup going forward or do you actually think you can continue to get some other receivables as well?

Robert J. Eck

I think the receivables, our DSO has been fairly static. I think the DSO, we don't expect it to deteriorate and I would also say we don't expect it to improve, so I would think the DSO will stay at about the level it's at and receivables ought to track about with sales on a little bit of a lag.

Dennis J. Letham

Just one thing that does help us there a little bit year-on-year on those comparison is, as you know, with that 53rd week in last year, it means we've gone from quarters that end on like the 27th or 28th of the month to quarters that end now on the 2nd or 3rd of the following month after quarter end. So to the extent that you have a portion of your customer base that always sends in remittances at the calendar end of the month that works some to our favor this year versus where it would have left us last year.

Nat Kellogg – Next Generation Equity Research

Then on the gross margins as far as sort of the vendor rebates due to volume discounts and stuff, I would assume that given what happened sort of from September to today, that those volume numbers are lower and there's a greater chance that you might actually hit those volume levels this year, or is it because business is down so much that it's still not likely to happen.

Dennis J. Letham

The programs aren't static, there's new programs each year with each of the manufacturers that offer those things that are reflective of the macro environment that the industry's operating in that year. So basically what's coming through earnings in the first quarter is reflective of the programs that are in place for this year and the activity levels that we expect against those programs. So, you can't really compare one year to the next because the programs are not necessarily the same programs from year-to-year.

Nat Kellogg – Next Generation Equity Research

And then it looks like, I realize there was a gain to sort of offset some of the currency losses due to translation, but looks like that is obviously a lot more under control than it was in Q3 and Q4 last year, and just sort of curious if you guys feel like some of the programs you put in place and the hedging stuff that you guys did at the end of last year are following through as you expect and will we continue to see a favorable trend along those lines or if there is more work to do?

Dennis J. Letham

We're continuing to work on it. I think we're pleased with the progress we've made month-by-month and I would say that, unless we have something really wild happen on relative exchange rates, we would expect to see that number continue to come down on foreign exchange as we go forward at this point. We got a bit of a wake-up call with all that volatility in Q4 and I think the processes have been and are being adjusted accordingly and we expect that to be history here.

Robert J. Eck

I think Dennis hit on a good point talking about volatility. While we've made significant changes and we think we are much better positioned to cope with foreign exchange swings, if there was the type of volatility we saw in October and November, we might see some issues again. But we think they'll be dampened by the procedures that we put in place.

Nat Kellogg – Next Generation Equity Research

Lastly, Dennis, can you give me the number for the interest expense related to the change in the new accounting standards, where you have that $300 million note now as to how…?

Dennis J. Letham

So, the interest expense we reported for the period was $14.5 million in both years. Without that change in accounting, last year's interest expense would have been $11.5 million and this year's would have been $11.1 million.

Nat Kellogg – Next Generation Equity Research

So, there's about a $3 million delta there?

Dennis J. Letham

Right.

Operator

And it appears there are no further questions at this time. Mr. Eck, I'd like to turn the conference back over to you for any additional or closing remarks.

Robert J. Eck

Thanks, everyone, for joining us on the call today. The first quarter reflected the difficult global economic environment and the steps we have taken to keep our company healthy in this challenging time. We continue to believe that our unique model of providing consultative technical support and supply chain management services in all of our end markets across the world puts us in a good position to provide value to our customers and suppliers. That proposition, along with the attention to expenses, will enable us to profitably manage through this tough time. Thanks.

Operator

That does conclude today's presentation. Thank you for your participation.

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