Anixter International's CEO Discusses Q3 2011 Results - Earnings Call Transcript

Oct.25.11 | About: Anixter International (AXE)

Anixter International (NYSE:AXE)

Q3 2011 Earnings Call

October 25, 2011 10:30 am ET

Executives

Chris Kettmann - Senior Vice President

Theodore A. Dosch - Chief Financial Officer and Executive Vice President of Finance

Robert J. Eck - Chief Executive Officer, President, Director, Chief Executive Officer of Anixter Inc. and President of Anixter Inc

Analysts

Hamzah Mazari - Crédit Suisse AG, Research Division

Edward W. Wheeler - Buckingham Research Group, Inc.

Anthony C. Kure - KeyBanc Capital Markets Inc., Research Division

Ryan Merkel - William Blair & Company L.L.C., Research Division

Matthew S. McCall - BB&T Capital Markets, Research Division

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

Shawn M. Harrison - Longbow Research LLC

Brent D. Rakers - Morgan Keegan & Company, Inc., Research Division

Jeffrey L. Beach - Stifel, Nicolaus & Co., Inc., Research Division

Operator

Good day, and welcome to Anixter International Third Quarter 2011 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Chris Kettmann. Please go ahead.

Chris Kettmann

Thank you. Good morning, and thank you, all, for joining us today to discuss Anixter's third quarter 2011 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 go to Anixter's website or call Chris Kettmann 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 Ted Dosch, Executive Vice President, Finance. After management completes their opening remarks, we'll open up the line for a Q&A session.

Before we begin, I want to remind everyone that statements in this conference call, including words such as believe, expect, intend, anticipate, contemplate, estimate, plan, project, should, may, will or similar expressions, are forward looking statements. They are subject to a number of factors that could cause the company's actual results to differ materially from what is indicated here. These factors include general economic conditions, including the severity of current economic and financial market conditions; the level of customer demand, particularly for capital projects in the markets we serve; changes in supplier sales strategies or financial viability; political, economic or current currency customer viability; risks associated with accounts receivable; the impact of regulation and regulatory, investigative and legal proceedings and legal compliance risks; potential impairment of goodwill; and risks associated with the integration of acquired companies. These uncertainties may cause our actual results to be materially different than those expressed in any forward looking statements. We do not undertake to update any forward looking statements. Please see the company's SEC filings for more information.

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

Theodore A. Dosch

Thank you, Chris. Good morning, and thank you, everyone, for joining us. Before we discuss the current period operating results in detail, I think it would be beneficial to remind everyone of both the rationale and the impact of our recent divestiture of the Aerospace Hardware division.

As you are aware, on August 16, we announced that we have reached a definitive agreement to sell this business, and the transaction was closed on August 26. The final sales price of $155 million resulted in net proceeds of $137.6 million after adjusting for amounts placed in escrow, working capital adjustments and legal and advisory fees.

Although our historical performance in Aerospace Hardware had been strong, customer and supplier consolidation had resulted in a business model distinctly different than our preferred model. Despite the fact that this business delivered operating margins well in excess of our corporate average, the high level of working capital that it required resulted in a return on capital that was lower than our desirable levels. The conclusion of our detailed analysis was that selling this business and redeploying the proceeds in our core business was our best long term option.

For the 8 months of this year that we owned the Aerospace Hardware business revenue was $123.2 million with an EBITDA of $17 million, of which $29.1 million of revenue and $4.9 million of EBITDA was realized in the third quarter. The results for the Aerospace business, including the loss on the sale, are included in discontinued operations for this quarter, with all prior periods adjusted to exclude Aerospace from continuing operations. For your reference, our third quarter 10 Q will include more detail regarding both P&L and balance sheet restatements. Also, this morning, we posted the revised historical performance by quarter on the Investors page of our website to assist you in adjusting your models.

Moving on, let's now talk about our third quarter results from continuing operations. We are very pleased to report another strong performance, which resulted in a 100 basis point improvement in the year on year operating margin, as well as a sequential 40 basis point improvement. In addition, we delivered our sixth consecutive quarter of double digit leverage, with a 12% incremental operating margin on increased sales. The third quarter of 2011 also marks our highest quarterly revenue in our history.

Now let's begin with a more detailed discussion of our third quarter sales results. In the third quarter, we reported a 20% increase in year on year sales. After adjusting for $30.7 million of sales from the acquisition of Clark Security Products in the fourth quarter of 2010, an estimated $33 million of favorable effective copper prices and $35 million of favorable foreign exchange effects, organic sales still grew by 13% over the prior year period.

All 3 of our end markets as well as each of our 3 geographic segments delivered strong year-on-year growth during the quarter. Similar to Q2, the 3% sequential quarter increase in reported sales more closely approximates longer term historical seasonality trends. All geographic segments reported sequential growth from the second quarter of 2011. We believe our positive sales results, which are well in excess of broader GDP growth rates, reflect the combined impact of moderately improving macroeconomic factors and the success of our global strategic growth initiatives, which Bob will discuss in more detail later on in the call.

Looking at third quarter sales trends within each of our end markets, we experienced the following: On a worldwide basis, Enterprise Cabling and Security Solutions sales increased organically by 9% compared to the third quarter of last year, exclusive of foreign currency effects in the Clark Security acquisition. Continuing the very strong trends of recent quarters, total Security sales grew 34% compared to the third quarter of 2010 and 18% on an organic basis. Geographically, our Enterprise Cabling and Security Solutions sales reflected organic sales growth of 10% in North America, 9% in the emerging markets and 2% in Europe compared to the year ago quarter. On a sequential basis from the second to the third quarter of 2011, Enterprise Cabling and Security sales increased by 5% organically. With the continued strong organic growth in Security sales, plus our strategic addition of Clark, sales from Security products now account for 24% of our worldwide Enterprise Cabling and Security end market.

Worldwide Electrical Wire & Cable sales, exclusive of foreign currency and estimated copper price effects, experienced a year on year organic sales improvement of 14% globally, with North America showing an increase of 13% and Europe increasing by 9%. In addition, sales were up 76% in the much smaller, but strategically important emerging markets. We will continue to invest in emerging markets where our Project business remains strong, while the day to day business continues to grow as well. On a sequential basis from the second to the third quarter of 2011, worldwide Electrical Wire & Cable sales increased by 4% organically.

Continuing to show strength, worldwide OEM Supply sales reflected a 22% organic sales growth compared to the year ago quarter. This end market is the only end market of our 3 that has delivered double digit year on year growth each of the last 6 quarters, averaging 24% organic growth during that time. North America experienced an organic sales increase of 18% year on year, while Europe was up 23% and emerging markets were up 48%. Our global OEM Supply business has benefited not only from the higher production levels of our OEM customers in almost every customer vertical, but we have also grown market share by adding new customers and new part sets to existing customers. Sequentially, worldwide OEM Supply sales were down 1% organically in the third quarter due to seasonally normal holiday shutdowns in Europe. Despite the macroeconomic softness, we believe this end market is benefiting from slowly improving demand for capital industrial goods and durable consumer goods.

I would also like to point out that despite the very challenging material cost headwinds in our European Fastener business, we have delivered and even exceeded our expected improvement in the overall profitability of our European business. Whereas we are happy with the improvement in this year, we are certainly not yet satisfied and continue to focus on the additional earnings improvement necessary to return this region to an acceptable level of performance. Bob will discuss current business trends and the implications for the future in greater detail in a few minutes.

Turning next to gross margin. We reported third quarter gross margin of 22.5%, which was down 50 basis points year on year and 40 basis points sequentially. As we have discussed for past year, gross margin continues to be negatively impacted by cost pressures in our European OEM Supply business due to significant unilateral cost increases from European based fastener manufacturers.

Once again this quarter, we made progress recovering this cost increase through price increases to our customers. However, we have not fully recovered to the level of our second quarter 2010 gross margin in this end market. In addition, the lower gross margin is a function of less favorable product and project mix as we have sold a higher percentage of lower gross margin products that are accompanied by lower operating expense, resulting in higher operating margin business, albeit at a lower gross margin.

Looking next at operating expenses, we reported a year on year increase of approximately 2% from $238.3 million in the year ago quarter to $243.3 million in the current quarter, excluding the impact of expenses associated with Clark Security and currency. This 2% increase compares very favorably with the 13% year on year increase in organic sales, which also excludes the acquisition, foreign exchange and copper pricing impact.

Operating expenses declined sequentially by approximately 2% excluding the foreign exchange impact in the current quarter. During the quarter, the company finalized the settlement of several customer bankruptcies and disputes which resulted in lower than normal operating expenses for the third quarter.

To summarize, operating income was $101.7 million in the third quarter, representing a very strong 43% improvement from the $70.8 million reported in the prior year quarter. The 6.3% operating margin in the current quarter is a 100 basis point improvement over the 5.3% margin in the year ago quarter. Lower gross margin, which was primarily due to the previously mentioned less favorable product and project mix, was more than offset by our lower operating expenses. We also continued to improve our competitive cost position in the quarter which can be further leveraged as we take advantage of the continued macroeconomic recovery.

As we move further down the income statement, interest expense of $12.5 million was identical to the year ago quarter. The lower average cost of debt offset the impact of higher debt levels. The 4.9% average cost of debt in the third quarter of 2011 compares favorably with the 6.1% in the year ago quarter. At the end of the current quarter, approximately 65% of our outstanding debt had fixed interest rates either by the terms of the debt or through hedging contracts.

During the third quarter, the remaining 3¼% 0 coupon convertible notes were converted, which resulted in a reduction of $11.6 million of accreted value for these notes. There was no P&L impact of this conversion, which contrasts with the pretax loss of $2.7 million in the year ago quarter. The effective tax rate for the third quarter was 26.1% versus 43% in the year ago quarter. The lower rate in the current quarter was primarily a result of recording a net tax benefit of $8.8 million or $0.25 per diluted share, primarily driven by improved profitability in certain foreign entities and other factors resulting in the reversal of deferred income tax valuation allowances. The 43% rate in the year ago quarter was primarily driven by a less favorable global dispersion of taxable earnings. Excluding this onetime tax benefit, the current quarter effective tax rate would have been 36.6%, bringing the projected full year rate to 37.2%. As is always the case, global dispersion of income can cause changes in this rate in either direction.

For the third quarter, the company reported net income from continuing operations of $61.6 million or $1.78 per diluted share compared to $32.6 million or $0.92 per diluted share reported in the year ago period. This 89% improvement in net income would have been 54% or $1.53 per diluted share in the current period and $0.97 in the prior year's quarter, excluding the impact of the net tax benefit in the current period and the loss of an early retirement of debt in the prior year's quarter.

The loss on the sale of the Aerospace Hardware business, partially offset by positive earnings in the current period, resulted in a loss from discontinued operations of $18.1 million or $0.52 per diluted share. Excluding this impact, we reported net income of $43.5 million or $1.26 per diluted share.

Moving on to cash flow. We generated $18.7 million of cash from operations during the quarter despite the increased working capital requirements associated with the 20% increase in sales. Capital expenditures were $5.3 million in the third quarter, identical to the year ago quarter. We anticipate positive cash flow generation for the balance of the year, but at a rate lower than last year as we continue to support the working capital requirements associated with further increases in sales. We ended the third quarter with a debt to capital ratio of 45.7%, down slightly from 46.9% at year end 2010. This leverage ratio is comfortably within our targeted range of 45% to 50% debt to capital.

At the end of the third quarter, we had $328.2 million in available, committed, unused credit line, and $245 million of outstanding borrowings under our $275 million accounts receivable facility. We completed both of our previously announced share repurchase plans totaling 2 million shares during the quarter, which resulted in a partial quarter benefit of a lower share count amounting to $0.04 per diluted share. Beginning in the fourth quarter, we will realize the full benefit of having repurchased 6% of our outstanding shares. Combined with share repurchases in late 2009 and early 2010, we have repurchased a cumulative 11% of our outstanding stock in about a 2 year period of time.

Despite a very challenging and uncertain macroeconomic environment, our continued strong operational performance puts us in an excellent position to support our growing business while giving us the flexibility to consider strategic acquisitions while returning capital to shareholders. Our current leverage on the balance sheet and other favorable financial characteristics provide Anixter with the flexibility to quickly adjust to new market realities, fund investments in crucial long term growth initiatives and allow us to efficiently capitalize on future opportunities.

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

Robert J. Eck

Thanks, Ted. Thanks, everyone, for joining us today. The third quarter again delivered the strong sales growth we have been seeing throughout this year. In spite of concerns of decelerating economic activity in the U.S. and Europe, our team continues to deliver positive sales growth and earnings leverage. Sales strength was seen across most end markets, reflecting a mix of our initiatives, reasonable economic activity and share gains.

We experienced continued strong growth across all reporting segments. While sales growth was more varied across the end markets in EMEA, we are pleased to continue to deliver improved operating profit in that reporting segment, consistent with our plan for the year. Our company wide operating margin expansion continued again in the third quarter, reflecting both the improved sales volume and effective expense management as we continue to take advantage of our global supply chain platform to deliver strong operating leverage.

We are pleased with our performance for the quarter, and we will continue to drive initiatives targeted at increasing sales growth and managing efficient use of working capital. We were also pleased to have completed the sale of our Aerospace Hardware group, which I will comment on later. Finally, during the quarter, we returned $108 million to shareholders through the buyback of 2 million shares.

Enterprise Cabling and Security Solutions end market experienced accelerating growth in North America, continued high organic growth in the emerging markets and slower growth in EMEA. Third quarter growth is particularly positive in light of the healthy growth we experienced in the same period last year. As we anticipated on the last quarter's call, we did see a pickup in project activity in North America, consistent with what our pipeline had indicated.

Project activity has continued to be strong in the emerging markets due to local market activity, as well as U.S. based multinational companies investing more heavily in IT infrastructure in emerging markets. Security growth continued to accelerate across all geographies, reflecting both continued investment in security and the shift to sophisticated Internet protocol based systems. Security growth this year, excluding the acquisition of Clark Security Products, increased 18% year to date, with the emerging markets exceeding 28%.

Moving now to the Electrical and Electronic Wire & Cable end market. The third quarter experienced strong organic growth in North America and EMEA and very significant acceleration in the emerging markets, leading to market share gains in all of those geographies. We continue to experience solid project activity in the power generation, industrial, oil and gas and mining sectors. OEM demand for specialty wire has slowed in vertical markets related to semiconductors, but otherwise remains positive.

Continued global growth trends in industrial production, mining, oil and gas development and energy generation should continue to drive sales growth in our Wire & Cable market through the last quarter of this year. We are seeing continued strong quoting activity and increased opportunity to leverage our global platform in this end market. The investments we have been making to organically expand our Wire & Cable business in the emerging markets has begun to show significant improvement, including large new project awards in Latin America and Australia.

Turning to the OEM Supply end market. The most significant news is the sale of our Aerospace Hardware unit during the quarter. Although triggering an accounting loss due to the allocation of goodwill within our North American segment, the sale generated a strongly positive economic return to the company. The strategic drivers for exiting the business include consolidation among our supplies, distribution competitors and customers. Further, in the more consolidated environment, customers have been aggressively pushing for unlimited liability for any product defects and any related or consequential damages. This exposure to our company is very significant, and given the return on capital profile of the business, quite unacceptable. In addition, by exiting this business, we will be able to reallocate capital to our higher return businesses.

In the industrial OEM Supply vertical, we are continuing to experience strong sales growth compared to the already strong sales growth in Q3 of 2010. The recovery in manufacturing continues to lift production rates at our customers, translating into stronger sales. Our sales initiatives continue to drive new business wins for both part packages at existing customers, as well as new customer wins. Our ability to operate as a single global partner continues to resonate with multinational manufacturers.

Gross margin initiatives in EMEA continue to lag behind the ongoing price increases from our supply base. In North America, however, we are beginning to see recovering gross profit margins due to our price increases keeping pace with the inbound cost increases. We will continue to work on price increase and material sourcing initiatives in Europe to recover gross margin back to prior levels. While we work through margin challenges, we have also continued to develop a strong pipeline of opportunities in the Americas, Europe and the rest of the world.

We are pursuing multiple initiatives in all end markets and geographic segments to drive growth, including product and technology initiatives, new customer development, cross selling and promoting the efficiency benefits for our customers to be realized through our supply chain management services. We are continuing our investment plan in the emerging markets to expand our presence across the regions and our end markets. In addition, we continue to focus on geographic expansion both within our existing country presence, as well as evaluating the opportunity to enter additional countries.

As part of our continued geographic growth, we recently announced the formation of a joint venture to enter Saudi Arabia focusing on both our Enterprise Cabling and Security Solutions and Electrical and Electronic Wire & Cable end markets. We have been selling into the Saudi Arabian market through our regional hub in Dubai. We believe that the local presence and the leverage of the joint venture relationship will enable us to more fully participate in significant investments in oil and gas and infrastructure under way there.

Additionally, we have initiated a new investment program to improve and expand our e business platform to be more flexible and responsive to customer needs. While we continue to make organic investments in our business, we're also continually evaluating acquisition candidates that will enhance our position across our end markets and geographic regions. As the only distributor in the end markets in which we participate delivering a value added technical support and supply chain service model in over 50 countries around the world, we continue to find success with our customers by providing global reach with a local touch and selling across our end market specialties.

As we look forward to the balance of this year, we believe we will continue to generate 2011 sales growth solidly in excess of GDP growth rates through market share gains and our growth initiatives. We anticipate the normal seasonal impact in the fourth quarter of fewer selling days due to the holidays and the related plant shutdowns by our OEM customers. There continues to be some uncertainty in the macroeconomic environment due to the European government debt concerns and the effect on the U.S. budget deficit resolution which could impact growth. However, we will continue to invest in growth initiatives that can lead to better operational leverage of our extensive global service platform.

Operating cash flow, coupled with our available borrowing capacity, provides us with ample liquidity to pursue acquisitions or capital structure actions that can enhance shareholder returns in the coming year. This liquidity enables us to look past the short term when assessing strategies and investment opportunities.

We will now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Hamzah Mazari from Crédit Suisse.

Hamzah Mazari - Crédit Suisse AG, Research Division

The first question is just on the European OEM business or actually, just more broadly, could you remind us what your end market exposure is now in OEM Supply after getting rid of the Aero business? And then in the European business, specifically, could you talk about what your customers are saying and how much visibility you have there given what's going on with the macro, and anything you're doing on the profitability side to bring up margins?

Robert J. Eck

Okay. I'll let Ted address the revenue mix change with OEM Supply with the sale of Aero in terms of our total mix, but on your couple of questions, I think one was visibility to the future in Europe and what our customers are seeing, and the other question was profitability. Let me address profitability first, and address it in a sense of, as I commented, North America, we are already recovering gross margin. We're lagging in Europe. And there's a couple of differences that I think are important to continue to focus on. We've talked about them, but let me just highlight that in the U.S., first, there's more competition, which enables us to basically push back on some of the increases. We've also seen more customer acceptance of the price increases we're passing on to customers. Because there's no anti dumping in the U.S., we've also been able to source more material in the U.S. from China, which has been able to blunt some of the price increases. And finally, as you may recall, in the U.S., we do have a small amount of manufacturing capacity in the Chicago area, and we've pushed more volume into our own manufacturing plant which has also helped support the margins in the U.S. So in Europe, you still have this anti dumping provision, which is making it more difficult to resource material outside of Europe. Therefore, the European suppliers are actually continuing to push price increases into the market. To me, it's a very short term strategy by the suppliers because the anti dumping penalties expire, I believe, in 2013, and they'll be in a position where people will rapidly move away from them. So that's a challenge for them. We've also experienced much more pressure from the customers on accepting the price increases. So as I say, we continue to work on price increases with customers, continue to press on resourcing where we can. It's just taking longer in Europe. We've seen positive direction in some of the countries and programs, but not enough to affect the total gross margin yet. Let me shift then to visibility in Europe from our OEM Supply customers. I guess, first, we're continuing to see production rates increase at a number of those customers. Some of it is very customer specific, some of it is new vehicle introduction specific. As you know, we have very little exposure to the big autos. We have exposure to luxury autos in that market, and we've seen positive trends there. We're not hearing any customers talk about reducing production schedules, plant shutdowns, so right now we're still feeling positive about Europe as we look into the coming year.

Theodore A. Dosch

And just to add a little bit more color to that, Hamzah, with the sale of the Aerospace business across the rest of our industrial OEM Supply business, heavy truck would be our largest customer vertical we have exposure to. We have a very strong business both here in North America, as well as Europe there, including engines in support of that business. But we've also, over the last few years, much further diversified that business with significant growth, with agriculture equipment, construction equipment, medical equipment, and even other areas of consumer durables like lawn and garden and appliances and so forth.

Hamzah Mazari - Crédit Suisse AG, Research Division

Got you. That's helpful. I appreciate that. And then just a second question on you guys had pretty good operating leverage. Your incrementals came in above our expectation. How should one think about those going forward? Are they going to moderate going forward? Is that a fair assumption?

Theodore A. Dosch

Yes, I think as we talked on our last call, and I think would be true for the upcoming quarter or two, I would expect to see that incremental operating profit leverage to moderate more into the high single digits. We did benefit, as I said in my comments, this quarter with some recoveries on some customer bankruptcies and disputes that helped lower that operating expense in the quarter. But I think if we see top line revenue growth in that organic revenue growth, high single digits, we ought to be able to also deliver very high single digit type of incremental operating profit leverage.

Robert J. Eck

Hamzah, if I can add one more point on that. One of the things that Ted commented on was some decrease in gross margin while operating margin improved partly due to mix and partly due to project activity. And one of the things that happens in a couple of our businesses is when the project activity accelerates, we do more direct ship business than we typically do. And the direct ship business has very little operating expense attached to it and also typically then has very little working capital attached to it. So while it's lower gross margin, it's very profitable at the operating line and return on capital. So it's business we certainly are happy to take and enjoy participating in.

Hamzah Mazari - Crédit Suisse AG, Research Division

Okay. That's great. And just last question, if I may. On copper pricing, could you just touch on your sensitivity there, and what to expect there?

Theodore A. Dosch

Yes, as we've continued to say, as our business diversifies further, for example, with the OEM Supply business growing at the pace that it is, Security products growing at the pace they are, other categories that have little to no exposure to copper, we would estimate that there's only about 10% of our global revenue that has a direct exposure to the more short term swings in copper price. And again, that's the larger cabling within our Electrical and Electronic Wire & Cable business. So about 10% would be a good estimate.

Operator

We'll go next to Ryan Merkel of William Blair.

Ryan Merkel - William Blair & Company L.L.C., Research Division

So my first question is on the outlook. You're expecting sales growth unleveraged through the end of the year. What are you seeing in your business that makes you comfortable with this outlook?

Robert J. Eck

Well, basically, we've got very strong project pipeline. So like a lot of other distributors you to talk to, we maintain pipelines in our sales organization, and we have good visibility into projects that are coming. We see strong project activity continuing in Wire & Cable, continuing in the Enterprise Cabling business as well. And as we said at the end of the second quarter, that was leading us to expect the acceleration we saw in the third quarter in the Enterprise business. We're seeing good project pipeline, so that's why we're confident in the fourth quarter. And we're seeing some interesting opportunities, new business opportunities maturing in our OEM Supply business as well. So I think a lot of positive signals. And in addition, I think it's important to note that we aren't hearing from OEM customers about plans for extensive shutdowns over the holiday season, which suggests that their end demand continues strong. And I think if you look at companies that have also released earnings recently, like Cummins, like Caterpillar, you're seeing pretty strong growth in those type of organizations. So you put that all together, it gives us good confidence that we'll have a positive fourth quarter, but we do expect the seasonality sequentially from Q3 to Q4 because of the holiday activity.

Ryan Merkel - William Blair & Company L.L.C., Research Division

Great. And then secondly, in North America, can you just comment on Canada? What's the sales growth look like there, and what's been driving that growth?

Robert J. Eck

Well, we don't typically call out Canada as a geography. In terms of just color, there's a lot of resource development going out there. We have a strong position in the oil and gas business, the mining business up there, as well as power generation. We also have a strong position in telecom and data. And so right now we're enjoying I think reasonable growth in Canada, and we don't see that ebbing at the present.

Operator

We'll go next to Jeff Beach from Stifel, Nicolaus.

Jeffrey L. Beach - Stifel, Nicolaus & Co., Inc., Research Division

Would you because you continue to get this great growth in Security, would you kind of go through your entire Security, I guess, operations in terms of how much of your sales are projects or versus day to day? I think a few years ago, at least a couple of years ago, you're not really integrating and selling, I think, package systems of a bunch of different vendors, but maybe you are. And then give some color on the different geographic markets so we can understand this strong growth that continues.

Robert J. Eck

So, Jeff, I think, first, we sell solutions. We're not an integrator in the sense of doing installations, but we do design and sell solutions that include multiple products. So for us, one of the leverages on Security has always been the ability to drag through, with a Security sale, structured cabling products for in a legacy analog application, sort of traditional low voltage instrumentation type cable. And that has always been an appeal to us. So it is clearly our goal to sell through cabling, enclosures, power supplies, camera housings, et cetera, along with things like camera and also sell storage. When you add in the Clark acquisition, with Clark, we've got locking hardware, as well as IP access control. And the IP access control solution, again, is power supplies, request for exit devices, magnetic locks, along with the cabling infrastructure that goes with it. So we have day to day sales into locksmiths and security dealers and security integrators for onesie twosie kind of items that sort of normally what you'd expect out of distribution, but we also sell large complex projects. We've done we've worked with integrators doing complete supply chain solutions on metropolitan surveillance and school systems, so video surveillance systems, literally all around the world, from China to Brazil to Argentina to the United Kingdom, across the U.S., Sweden, the Middle East, Canada. And those systems include typically cameras, wireless access control devices, power cabling, power supplies, specialty enclosures. And those are typically all kitted together in one of our warehouses and delivered just in time. So there is a meaningful project element, as well as a day to day element, and pulling the whole solution together is really core to what we do in the market. And I think the other core thing we've talked about a lot is, not only are public companies, as well as governmental entities investing more in security, the whole migration towards IP creates uncertainty, as well as lots of new applications you can drive with these systems, and we've been on the front of that because of our knowledge of IP that comes from our enterprise cabling background. In terms of geographies, we're experiencing strong growth, as I called out, across the world. Emerging markets more rapid than North America and EMEA, although double digit kind of growth in North America and EMEA as well. And I think we're taking market share, but we're also participating in a video surveillance market, particularly in IP, that's growing at a reasonably good rate.

Jeffrey L. Beach - Stifel, Nicolaus & Co., Inc., Research Division

All right. And just one other simple question. How many selling days are there in the fourth quarter?

Theodore A. Dosch

61.

Operator

We'll go next to Shawn Harrison with Longbow Research.

Shawn M. Harrison - Longbow Research LLC

I wanted to just, I guess, delve in a little bit more on the day to day activity, Bob, particularly in the Enterprise business and maybe touching on industrial Wire & Cable too. I know you're talking about good project activity, but is the day to day weakening? Are you getting any, I guess, disconcerning trends from customers as we would move into the fourth quarter, into 2012, given that typically Anixter lags the macro maybe by one or typically 2 quarters, excuse me?

Robert J. Eck

Yes, I don't see think we're seeing any slowdown in day to day activity. Now day to day activity holds up better in a recessionary environment than the project activity. It decreases a bit, but it tends to hold up better because it's maintenance activity and moves as it changes that we've talked about in the past. It's not an area where we would expect to see the first signs of slowdown, but we aren't seeing any slowdown in day to day activity.

Shawn M. Harrison - Longbow Research LLC

I guess within Enterprise, the project activity, do you is this just through the fourth calendar quarter? Or Is this into early 2012? Is it more domestic? Is it more international?

Robert J. Eck

Domestic and international, and we have strong pipelines in the fourth quarter and we see good project activity continuing into the visibility that we have into early 2012, but I want to caution that visibility the further out we get, the more uncertain that visibility gets for us, like for any other company.

Shawn M. Harrison - Longbow Research LLC

Okay. And then just on the I guess, the slight benefit witnessed in operating expenses for the September quarter. How much was that, so we can just make sure our models are set property for the fourth quarter?

Theodore A. Dosch

The onetime benefit was probably a little less than $3 million.

Operator

We'll go next to David Manthey of Robert W. Baird.

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

First of all, as you're talking about the project business, Bob, I assume it's still in the midpoint of that 10% to 20% range that you've talked about recently. But also, could you talk about the makeup of that business today in terms of where you're seeing relative strength versus other industries, things like data centers and process industries, utility. What areas are you seeing the most strength in today?

Robert J. Eck

Well, I think we're still somewhere in that midpoint to the higher end of that 10% to 20% range. I would say we're more in the maturing phase of the recovery, just in the sense that we're getting closer to that 20% end of that kind of day to day versus project split. And we're seeing a lot of activity continuing in data centers. We're seeing strong activity in the emerging markets, as well as in North America. Europe's our business in Europe has been a little slower, as you can see from the numbers that we attached on the back of the earnings release. But we're seeing activity across geographies there, particularly accelerating activity in the Middle East, so I think it's fairly broad based. I don't think there's any one industry that we see slowing down. When you turn to Wire & Cable, oil and gas and mining continue to be strong, power generation continues to be strong. Those are good markets for us. And again, as I mentioned in my comments, we're picking up projects in the emerging markets that we're winning because we're able to touch the customer locally, as well as typically touch engineering organizations that are based in Europe or in the U.S. or Canada.

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then as you're looking at trends outside of North America and Europe, your Electrical and Electronic Wire & Cable efforts seems like that's paying off with good growth, but I was interested also to see the OEM business showing strong growth there as well. Maybe you could talk about some of the wins you've had in OEM in particular. Again, knowing that in Electrical and Electronic Wire & Cable you've had the initiative in place there, OEM seems a little unusual. So I'm interested in hearing what you have there.

Robert J. Eck

Yes, we probably haven't called that out as much. We've talked a bit about opening our sourcing center in Suzhou, China, and a warehouse there to serve some local customers. So we really have activity going on in 2 places. China and Mexico today are the primary places outside of North America and Europe where we have activity with OEM Supply. And typically, what we're doing is following a multinational customer. So it's not the case that we're picking up lots of local customers. We've picked up some in the appliance business in Mexico. But we're picking up business with U.S. or European multinational companies that have operations in those geographies. And what we're simply doing is leveraging our existing global infrastructure, our ability to manage importation, having a logistics presence on the ground in the country and extending that to the OEM Supply business. So it's again, we talk about leveraging the global footprint or the global supply chain infrastructure, and that's really what we're doing in the OEM business.

Operator

We'll go next to Matt McCall of BB&T Capital Markets.

Matthew S. McCall - BB&T Capital Markets, Research Division

One clarification. So I think there was a previous question, how many selling days in Q4. What does that compare to in Q3? If you gave it, I missed it. You gave 61 at Q4?

Theodore A. Dosch

Yes, it would be 63 in Q3. And let me just clarify my 61. We actually estimate the impact to be 4 nonshipping days because of days like the Friday after Thanksgiving, where we actually have warehouses opening but it's a very light day, Christmas Eve, where we actually do have our warehouses open but it's a very light day. New Year's Eve, et cetera. So it works out to on average about 4 down days out of the 65 in the quarter, so that would be 2 more than Q3.

Matthew S. McCall - BB&T Capital Markets, Research Division

Got it. Perfect. Okay. And, Bob, you talked about one of the answers to the previous questions, that I think the first sign of slowdown would not be day to day, it'd be project. One thing that jumped out, you mentioned semiconductors was one end market that was slower than others. Taking those 2 comments together, what would be the thing that you're watching for to be a sign of a slowdown? Is that semiconductor softness similar to what you've seen in the past? Just trying to get an idea of what you guys are watching to make sure we're not see something on the horizon.

Robert J. Eck

Okay. So I think the semiconductor thing is unique to that market. We have some OEM Wire & Cable customers who make instrumentation or manufacturing equipment that goes into semiconductor plants, and that's slowing. Having said that, the things that and by the way, that is not a big part of our big OEM Wire & Cable business, so it's not something that we're concerned about, but we pay attention to all the vertical markets to check were trends are changing. Basically what we look for is changes in production schedules from our OEM customers, as well as we track our pipeline activity and then what customers are saying to us about funding behind that pipeline activity or budgets behind that pipeline activity. So particularly with all the stuff going on in the media, you would be concerned about where things are heading. So we probably have more attention in our monthly business reviews on what our people are hearing on the ground, so to speak, from customers. And we're just not hearing that there's concern about project funding at the moment.

Matthew S. McCall - BB&T Capital Markets, Research Division

And would that apply to both the industrial side of your business, but also kind of that more commercial side of data? You mentioned data centers specifically, but that corporate CapEx that's tied to enterprise spending, is that the case for both of those end markets?

Robert J. Eck

Yes.

Operator

We'll go next to Ed Wheeler of Buckingham Research.

Edward W. Wheeler - Buckingham Research Group, Inc.

A couple questions. On the project activity, both in Wire and Enterprise, how would you compare it in terms of the bidding pipeline today versus maybe 6 months ago? Has there been any I know it's been strong for a while. I guess the question is: Is it kind of in a delta way any change, or is it kind of the similar strength that you saw a while ago?

Robert J. Eck

I would say it's similar. We aren't seeing a decline. I know that's what everyone's concerned about. We aren't seeing a decline in that activity.

Edward W. Wheeler - Buckingham Research Group, Inc.

And I think you mentioned, or maybe I interpreted it, OEM opportunities, it sounds like there's a bidding pipeline there for like new in either new supplies within existing customers or new customers? Is that pipeline comparable to where it's been? Or has there been any change in that pipeline?

Robert J. Eck

I guess I'd say it's probably comparable. We've seen some interesting new opportunities. We're typically cautious about talking a lot about the OEM Supply pipeline because it can take a long time to mature. They're typically large programs. There's an incumbent that's being displaced, or you're displacing some internal supply chain/purchasing/management organization. So those things take a while to mature. So we're seeing interesting activity, particularly in global customers. And I would say not much different than what we've seen since we began recovery.

Edward W. Wheeler - Buckingham Research Group, Inc.

Okay. And on the operating expense management, I know in times of when things are quite weak you don't like to cut it too much, but what is your flexibility to change your operating expense growth? You're growing 13% now. I mean, if it went to 3% growth, would you make any adjustment to operating expense? I wonder if you could just give us some color on that.

Robert J. Eck

Let me take a shot at it, and I'm sure Ted can fill in with some color as well. Here's an important statistic, I think, as you think about this. Our peak headcount in 2008, before we started restructuring actions in the fourth quarter, was about 8,800 employees. Our current headcount is under 8,300, and we're running at a quarterly sales rate comparable to or in excess, in fact, of the rate we were at in 2008, which was our prior peak as a company for sales. So I think what that shows you is we've been driving a lot of productivity gains across our organization. That means that if sales begin to decline, we have less room to immediately reduce headcount, but the fact is, if sales decline significantly, we have some flexibility. I think we can be with our current structure, we can be profitable, in fact comfortably profitable, at lower rates of growth than we are at today.

Theodore A. Dosch

Yes, I would just add to that comment of Bob's that, as I think all of you remember, over 50% of our operating expense is people related. So there is the more variable component of that certainly that we have in the warehouses, which is more directly related to the volume, where pick, packing and shipping and sending out the door. We have been, I think, very judicious in managing our cost structure in this recovery. And so I think what Bob is just reflecting on is a function of not just appropriately reducing costs in the recession, but I think just as importantly, managing those costs very well in recovery so as not to add unnecessarily to that cost base. So relative to where we were prerecession, no, we don't have as much cost to take out in if there were to be a significant decline in revenue, what we still can flex downward depending on the amount of change in volume.

Edward W. Wheeler - Buckingham Research Group, Inc.

And just one last question. Another company that is involved a little bit in the data center market talked about perhaps some slowing and maybe significant slowing in the very, very large data center activity, more of just delaying commitments rather than canceling, but just that there is some change in that niche of the data center market. Are you seeing anything comparable to that?

Robert J. Eck

Ted, I think we talked about it was either on the last call or the one before, in fact it may have been the call before, that one trend we were seeing in data centers this year was a trend towards not committing to the entire buildout upfront, but kind of building out the white space and then building cells within the data center. And where in the past we would see a pretty strong commitment to build out a lot of the infrastructure in the data center, today, we're seeing the buildout cell, and that as demand for storage or applications or whatever requires it, then they'll build out another cell. So we have noted that trend, that the data center builds themselves are smarter than they were prerecession. But by the way, what that means is they're like the gift that keeps on giving because people aren't using less bits and there's not less bytes of information being stored. In fact, if anything, we see acceleration, particularly with video applications. And so that means those other cells will get built out, it just kind of spreads the spend, I think.

Edward W. Wheeler - Buckingham Research Group, Inc.

I guess last one while I'm on here. Anything new on the factory automation initiative? I know it started up with the recession and got side tracked a bit. Is that still something you guys are working on?

Robert J. Eck

We are, in fact. We made some changes in our organization. We think we were progressing slower than we would have liked to, in spite of the recession. We made some changes in our organization around that. We've also invested in some more specialists on the street, so to speak, in U.S. and Canada. And now, honestly, we feel like that is beginning to accelerate. We're getting some awareness in the market. We actually have some a large global supplier in that market space has asked us to become a distributor for them. So we're getting some recognition. So it's not where I'd like it to be. I would say no one is happy with the progress we've made, but progress is beginning to accelerate. So I'm feeling better about that.

Edward W. Wheeler - Buckingham Research Group, Inc.

And lastly, on operating expenses, it's hard to with some of the puts and takes in the quarter, to interpret it. The other expense that I see looked quite a bit higher than normal. Is there anything unusual there? Or is that just part of the nonrecurring issues in the quarter?

Theodore A. Dosch

Below the operating line?

Edward W. Wheeler - Buckingham Research Group, Inc.

Yes, below the line. I'm sorry. Yes, other expenses below the line, correct.

Theodore A. Dosch

Yes, our 2 big drivers there, one was FX losses. With the significant volatility, literally on a day to day or week to week basis in some countries like Brazil, we did experience higher than recent quarter higher FX losses than in recent quarters there. We also got hit by a valuation on the cash surrender value of company owned life insurance. But both of those were significantly large items in the current quarter.

Robert J. Eck

And I think, Ted, we've talked about some this volatility in FX in the past. And one of the issues we have are there are markets where there are not sort of affecting effective hedging vehicles. We don't speculate on currency, first of all, which I think is important to say. We take forward contracts on transactions when we're in markets that where forward contracts are purchasable. We do have markets like Brazil where there is no efficient way to hedge, so we build a synthetic hedge sorry, I can't speak a synthetic hedge gets basically fixed at a point in time and stays fixed for about a month, and if there's volatility within the month, you can have losses. So it's an imperfect hedge, it's a very expensive hedge, and we tend to tweak up and down how much hedging we try to manage through that tool.

Edward W. Wheeler - Buckingham Research Group, Inc.

I mean to sort of model going forward, would we think that this is a number that's unusually high and we kind of go back to, give or take, $1 million or something like that?

Theodore A. Dosch

Yeah, I think that's a good assumption, but again, crystal ball a little bit as far as what's happening, in countries like Brazil where you see some pretty significant swings of late.

Operator

We'll go next to Anthony Kure of KeyBanc.

Anthony C. Kure - KeyBanc Capital Markets Inc., Research Division

Couple of questions on emerging markets. Can you just remind us when the real material investments in headcount for growth here started? Just given how fast you've grown this year, year to date, with pretty impressive growth statistics, I mean, is this sort of the for the foreseeable future, are we looking at this secularly higher growth rate out of emerging markets now that these investments are sort of taking hold?

Robert J. Eck

Tony, I think the main investment you're talking about is probably Wire & Cable investment in the emerging markets, and that was in 2009. We're about 2 years in, in Kalla [ph]. We just started the investment process in Asia Pacific, I'll say roughly 4 to 6 months ago. And basically, what happens, we started the investment in 2009, we saw very little growth for the first 12 months or so, and then we saw a modest acceleration and then more rapid acceleration now. And I think it's simply the nature of getting a sales force in place, getting in front of customers, getting in front of suppliers, building credibility in the market, leveraging some of our global relationships, and then building a pipeline, closing and delivering so that we can actually record revenue. So that actually has developed about the way we would have hoped, and the Wire & Cable investment started in Kalla [ph] about 2 years ago.

Anthony C. Kure - KeyBanc Capital Markets Inc., Research Division

Okay. Great. And then as far as the impact of the selling days and your expectations for the December quarter here, I think, Ted, you mentioned it's about 4 effective days. So I guess by my math that's about I don't know 6% or so sequential headwind. Are you expecting to sort of be in line with that sequential headwind from selling days? Or is there something that would cause you to decline more than that or actually decline less than that?

Theodore A. Dosch

No, just to be clear, I think it's only about a 3% to 4% sequential headwind because, again, we had 2 holidays in Q3. Think of it as an incremental 2 days impact.

Anthony C. Kure - KeyBanc Capital Markets Inc., Research Division

Okay. So is that the sort of expectation on the top line then, is how you expect the quarter to play out?

Theodore A. Dosch

Yes, and again, as we have for the last couple of quarters, return to what we would consider a more normal longer term seasonality, I think a 3% to 4% decline in that Q3 to Q4 would be normal.

Operator

And we'll take our last question from Brent Rakers of Morgan Keegan.

Brent D. Rakers - Morgan Keegan & Company, Inc., Research Division

Just to follow on with a selling day question. Ted, do you have the year ago selling days? Was it the same as Q4 '11?

Theodore A. Dosch

Yes.

Brent D. Rakers - Morgan Keegan & Company, Inc., Research Division

Great. And then I don't believe you talked a little bit about Wire & Cable pricing potentially as it relates to copper, but maybe if you could talk about pricing trends in Enterprise, as well maybe on a little Electrical Wire & Cable, what you think the outlook will be there?

Robert J. Eck

Pricing has been solid in the Enterprise business across the cabling products, but again the cabling products are I don't want to make up the number, they're not a they're less than 50% of the volume in the Enterprise Cabling business, in fact, quite a bit less than 50% of the volume. So there have been some pricing uplifts there. They've been modest. In the Electrical Wire & Cable market, there's, as Ted said, a small portion, it ends up being about 1/3 of the products are copper sensitive, and those will be driven by where copper goes. And the other products are basically holding up, I guess I'd say, currently. Again modest price increases through the year. We don't see any pressure for price decreases.

Brent D. Rakers - Morgan Keegan & Company, Inc., Research Division

Bob, in the Wire & Cable related to the copper sensitive products, typically, is there a time lag? Or how would you define the time lag versus the spot market there?

Robert J. Eck

Yes, there is a time lag, and there's not a direct relationship because there are a number of moving parts. You have to remember, we aren't selling copper at spot, we're selling cable. And so there's dynamics about the individual project or sales opportunity, there's compounds, jacketing compounds, there's manufacturing costs. So there's not as direct a correlation between spot copper and Wire & Cable pricing as people would like to infer. It may be directionally an indicator for that 10% of revenue, but it's pretty hard to make a direct correlation between where spot copper moves. I think particularly, I believe it was last year in the fourth quarter there was a big decline in the spot price of copper that did not affect our selling prices because of what was in the supply chain. So you have to also, as you think about swings up or down, recognize that there's cable and distribution inventory, there's finished cable and manufacture inventory, and there's raw copper and manufacture inventory that all flows basically is going to want to flow through the supply chain at the level it's at. So if copper drops, that doesn't filter immediately into this. If spot copper drops, it doesn't filter immediately into the market. If spot copper jumps up, that doesn't immediately filter into the market because people have inventory at a lower price point. And while you'd like to take advantage of that, in the current demand environment, you typically don't take advantage of that.

Brent D. Rakers - Morgan Keegan & Company, Inc., Research Division

And then last question, and I guess it's maybe a 2 part one. First, trying to do you have any means of quantifying the kind of the gross margin OpEx mix shift related to the products? Maybe how many bps gross margin may have been negatively impacted by this maybe the direct to consumer sales I'm sorry, direct from supplier sales?

Theodore A. Dosch

No, Brent. We don't have a good number on that. I think it would be fair to say, just from a rough estimate, that we're probably talking somewhere in the range of maybe 10 to 20 basis points. But that's not a very precise measure. As Bob mentioned, like with the project mix, we know we can quantify the amount of sales that we do, for example, on a direct ship basis, but we can't capture all of our operating expense on a project level basis.

Brent D. Rakers - Morgan Keegan & Company, Inc., Research Division

And then just the last kind of related question, in talking about this, the high single, mid single digit incremental margin target, I was maybe hoping you could frame at least the operating cost portion of that in terms of what aspects of variable expenses are in that, and maybe how large a portion investment spending is? Because I guess I come out with typically pretty higher incremental margins than the guidance typically is.

Theodore A. Dosch

Well, I think, the variable portion is most directly related to, obviously, warehouse costs, outbound freight, those types of direct costs, and obviously sales person commissions, et cetera. So if we're delivering to the bottom line operating margin that is 1.5x or more of our reported consolidated operating margin, then obviously we're getting extremely good fixed cost leverage off of that incremental sale. But we still are incurring somewhere in the neighborhood of probably 4 plus percent of variable purely variable costs for each sale.

Brent D. Rakers - Morgan Keegan & Company, Inc., Research Division

Any comments at all I know you don't typically talk specifically about investment spending, but obviously you have a large number of initiatives around the world. Any thoughts on maybe quantifying what that headwind might be?

Theodore A. Dosch

Probably not at this time. Initially, as we think about some of the incremental headcount that Bob referred to, that will be very small, less than 10 basis points, kind of get lost in the rounding. We are as he also commented, we'll be increasing spending levels for some other strategic initiatives like our e business initiative, and that will ramp up more into next year as we get a more firm project plan but won't have any measurable impact here in Q4.

Operator

At this time, there are no other questions. I'll turn the call back over to management for any additional or closing comments.

Robert J. Eck

Thanks, everyone, for joining us today. We believe that in spite of recent uncertainty, the global economy is undergoing a modest recovery, and diversification of our global reach, our strategic initiatives and value added business model position us well to support our customers in the months and years ahead. Thank you.

Operator

This does conclude today's conference. We thank you for your participation.

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