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Executives

Chris Kettman - IR

Dennis Letham - SVP of Finance and CFO

Bob Eck - CEO

Analysts

Celeste Santangelo - Merrill Lynch

David Manthey - Robert W. Baird

Edward Wheeler - Buckingham Research

Jeff Beach - Stifel Nicolaus

Nat Kellogg - Next Generation

Anixter International Inc. (AXE) Q2 2008 Earnings Call July 22, 2008 10:30 AM ET

Operator

Good day everyone and welcome to our Anixter second quarter Earnings Call. Today’s call is being recorded at this time for opening remarks and introductions I would like to turn the call over to Mr. Chris Kettman please go ahead sir.

Chris Kettman

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

On the line with us today from Anixter’s management team are Bob Eck, President and CEO; and Dennis Letham, Senior Vice President of Finance and CFO. After management completes their opening remarks, we will open the line for a Q&A session.

Before we begin, I want to remind everyone that statements on this 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 company’s actual results to differ materially from what is indicated here. These factors include general economic conditions, technology changes, changes in supply or a customer relationship, risks associated with the integration of recently-acquired companies, commodity price fluctuations, exchange rate fluctuations and new or changed competitors. Please see the company’s SEC filings for more information.

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

Dennis Letham

Thank you, Chris. Good morning, everyone, and thank you for joining us. We’re pleased to report second quarter results that exceeded the expectations we laid out for the investment community following the end of the first quarter, particularly relating to company sales growth.

As noted in our first quarter conference call on April 22, we anticipated seeing normal seasonal consecutive quarter sales growth patterns from the first to second quarter of mid to high single digit percentage growth. Even better, our sales grew 10% from the first to second quarter of this year, topping our own internal expectations.

We also noted at that time that our year-on-year sales growth presented us with a difficult comparison, as we saw the first to second quarter of 2007 grow 14%, which was well above the historical trend line. With reported second quarter year-on-year sales growth of 7%, we are pleased to have exceeded our expectation.

Lastly, during our first quarter earnings call, we expressed that operating margins in the second quarter would begin to trend back toward the full year 2007 average of 7.5%. Thanks to better than expected sales growth, operating margins, excluding the charge associated with retirement of the company’s former CEO that was announced on May 19, increased from 6.9% in the first quarter to 7.8% in the recently completed quarter. As a result, our operating margins for the first half of 2008 were 7.4%.

With that overview, let’s now turn to the actual financial results for the second quarter, which included sales of $1.62 billion, which were up 7% from the $1.51 billion reported in the year ago quarter. Operating income of $121.8 million, inclusive of the $4.2 million of expense associated with retirement of our former CEO, increased 5% from $116.1 million in last year's second quarter.

Excluding the retirement related costs, operating profits were $126 million or an increase of 8% versus the year ago quarter. Operating margins were 7.5% during the quarter, compared to 7.7% last year. As mentioned as previously, excluding the CEO retirement related costs, operating margins were 7.8% in the second quarter. Net income in the quarter increased 4%, 66.9 million from $64.6 million in the prior year quarter. Excluding the retirement related costs, we saw an 8% increase in net income. And lastly, diluted earnings per share increased 12% to $1.71 as compared to $1.53 in the year ago quarter. Again, excluding the retirement-related costs, diluted earnings per share rose 16% versus last year’s second quarter.

Now, let’s take a few minutes to look at the major components of our second quarter financial results. The 7% sales growth achieved in the second quarter includes $4.2 million from acquisitions completed over the past year. At the same time favorable foreign exchange rates positively impacted sales by adding $43.1 million in the period compared to the prior year. After adjusting for the acquisitions and exchange rate differences, we generated 4% organic sales growth as compared to the year ago second quarter.

Spot market copper prices averaged $3.80 a pound in the current quarter as compared to $3.46 per pound in the year ago quarter. This increase, when combined with intra-quarter volatility of spot market copper prices, did not have a meaningful effect on sales between years. Digging a little deeper into the second quarter sales growth, it’s important to note that we again achieved solid results by productively executing company initiatives, including our continued success in building our presence in the security market and the geographic expansion of our electrical wire and cable business in Europe.

In the security market, we saw year-on-year sales increase in the second quarter by 22% to $167.3 million.

In Europe, we saw electrical wire and cable sales increase by 12% to $68.5 million, but electrical wire and cable sales outside of the U.K. market, where the bulk of our business has historically been centered, we saw sales grow by over 48%. Bob will discuss the initiatives in these areas in greater detail in a few minutes.

Our total North American sales of $1.11 billion increased by just 4% versus the year ago quarter. The low North American growth rate reflects the very difficult comparison to the second quarter of 2007, when we not only had 16% year-on-year growth, but also 16% consecutive quarter growth from the first to second quarter of 2007. As you will recall in the 2007 second quarter earnings conference call, we commented on the unusual strength in the quarter, particularly for large projects in both enterprise cabling and the electrical wire and cable end markets that fueled the unusually high growth in that quarter.

Now for a breakdown by end market in North America. Enterprise cabling and security solution sales in North America were $592 million, translating to just a 2% year-on-year sales gain. Within this end market, we saw approximately 16% growth in security market related sales and solid day to day business, but a decline in larger projects as compared to the very strong market conditions in the second quarter of 2007.

Favorable foreign exchange rates on Canadian sales accounted for $5.4 million of the sales growth versus the second quarter of last year.

North American electrical wire and cable sales were $395.6 million or an increase of 8% year-on-year. This sales growth was achieved despite a difficult comparison to very strong sales in this end market in the year ago quarter as project activity, particularly in the energy and natural resources vertical end markets, remained strong. Favorable foreign exchange rates on Canadian sales accounted for $10.2 million of the year-on-year sales growth.

Our sales growth in the North American OEM supply market were $125.7 million, or approximately 5% higher than the year ago quarter. Sales growth associated with aerospace and defense customers was again especially strong on solid fundamentals in that vertical market, helping to offset continuing weakness with certain customers in the industrial portion of this market who experienced production slowdowns that negatively impacted our year-on-year sales.

Second quarter European sales of $366 million reflected 12% increase as compared to the year ago quarter. Acquisitions added $4.2 million to sales and exchange rate differences added $21.2 million as compared to the year ago quarter. Excluding acquisitions and foreign exchange effects, year-on-year sales in Europe grew organically by 4%. OEM supply and market sales were up by 16% to $172.4 million.

A positive sign as we continue to expand existing customer relationships as well as add new customers. Electrical wire and cable sales of $68.5 million increased by 12%, driven by growth associated with our key initiative to expand our presence in this market beyond its historical base in the U.K., which more than offset some of the slower project volume in the U.K. market during quarter. Enterprise cabling and security solutions sales were up 7% to $125.1 million with sales growth continuing to be affected by less than favorable comparison to extremely strong market conditions that existed from mid-2006 to mid-2007 in this European end market.

In the emerging market of Latin America and Asia Pacific, sales of $140.5 million reflected 23% increase year-on-year with foreign exchange accounting for $5.8 million of the total sales increase. Excluding the impact of foreign exchange, emerging market sales were up 18%. Sales growth in both Latin America and Asia Pacific were up by roughly the same amount as the emerging market groups in total. Within these markets, we continue to experience overall economic growth in most countries, which combined with increased market penetration and expanding product lines is driving very good year-on-year growth.

Turning to gross margins, we reported second quarter gross margins of 23.8% versus 24% in the year ago quarter. During the recent quarter, we continued to experience some price pressure from rising steel prices in our OEM supply business and the effects of lower supplier volume incentives that resulted from lower year-on-year sales growth rates, particularly in the enterprise cabling market.

Moving down the income statement, operating expenses in the second quarter were up approximately 6% year-on-year. The second quarter operating expenses included $4.2 million of non-cash costs associated with the retirement of the company’s former CEO, and an incremental $1.1 million related to acquisitions made in the past year. The weaker U.S. dollar also caused reported expenses to increase by approximately $7.3 million as compared to the year ago quarter. Excluding operating expenses related to the previously noted CEO retirement, acquired business, and the effects of foreign exchange rates, second quarter operating expenses increased less than 2% versus the year ago period, or well below the increase in sales.

Core operating expenses remained very tightly controlled relative to sales growth. So we can continue to invest in our initiatives to grow our security business; expand the geographic presence of the electrical wire and cable business in Continental Europe and the Middle East; develop a presence in the factory automation market; and continue to expand our emerging market business.

So to summarize from an operating income perspective, the effects of 7% sales growth and good expense control were partially offset by slightly lower gross margins, resulting in a 5% increase in operating income versus the year ago quarter. Excluding the one-time expenses associated with the retirement of the CEO, operating income rose by 8%.

For the recently completed quarter, operating margins increased to 7.8%, excluding the previously discussed expenses associated with the retirement of the company’s CEO. This compares favorably to the 7.7% we reported in the year ago quarter. The current quarter operating margins also compare favorably with the record operating margin average of 7.5% that the company reported over the past 18 months.

As we move further down the income statement, interest expense in the second quarter was basically flat despite the fact that company has spent $183.7 million on share repurchases over the past year, some of which was financed through borrowings. In the current quarter, our cost of borrowings was 4% as compared to 4.2% in the year ago quarter. At the end of the second quarter, approximately 75% of our outstanding debt had fixed interest rates, either by terms of the debt or through hedging contracts.

Other income expense shifted significantly from income of $2.4 million in the year ago quarter to an expense of $3.6 million in the most recent quarter. The difference in other income and expense between years largely reflects gains in the cash surrender value of company owned life insurance policies in the year ago period versus $600,000 loss in the current quarter along with foreign exchange losses of $2.4 million in the current quarter versus gains of $1.7 million in the year ago quarter.

The second quarter tax provision reflects an effective rate of 37.5% versus 39.8% in the year ago quarter. The prior year period effective tax rate reflected certain tax audit settlements. Without the effect of those settlements, the year ago rate would have been 38.5%. The year-on-year change in the core effective tax rate reflects changes in the country level mix of pre-tax earnings.

Net income was $66.9 million for the quarter or 4% higher than the $64.6 million reported in the year ago period. If the cost associated with the CEO retirement was excluded from the current quarter results, we would have reported net income of $69.5 million in the 2008 second quarter for an increase of 8% in net income.

On a diluted basis, earnings per share was $1.71 in the most recent quarter as compared to $1.53 in the year ago quarter. Again, setting aside the retirement related expense for the company’s CEO of $0.07 per share in the second quarter of 2008, diluted earnings per share in the second quarter rose 16% versus the year ago period. The current quarter’s fully diluted earnings per share benefited from an approximately 7% drop in the fully diluted share count, primarily as a result of share repurchases over the past year, including 1 million shares repurchased during the second quarter of 2008 at an average price of $62.84 per share.

Our continued commitment to our buyback program reflects our strong confidence in both the company’s near and long-term prospects and our belief that Anixter shares represent a compelling value at current prices.

In the second quarter, we generated $43.5 million in cash from operations as compared to $30.5 million used for operations in the year ago second quarter. This brings year-to-date cash flow generated from operations to $98.9 million versus $35.3 million generated in the first six months of the prior year.

Our debt-to-total capital ratio at the end of the second quarter was 49.0% as compared to 49.4% at the end of 2007. As a result of our strong earnings results and improving capital structure efficiency, we achieved a slight decrease in this ratio despite the outlay of $104.6 million to repurchase a total of 1,750,000 shares in the first six months of this year.

The repurchase of 4.8% of our outstanding shares since the first of the year reflects our confidence in both the near and long-term outlook for our business. As of June 27, 2008, we had approximately $240 million in available, committed, unused credit lines to support organic growth or acquisitions should appropriate opportunities arise in the near term. In addition to our available credit lines, we would expect that at current growth rates we will continue to generate positive cash flow from operations in succeeding quarters.

At this point, let me turn the call over to Bob Eck for further comments on recent business trends, strategic initiatives and the business outlook. As I am sure all of you know by now, Bob Eck moved into the Chief Executive Officer role at the end of the second quarter, following the retirement of Bob Grubbs, who had completed 30 years of service at Anixter including 14 years as CEO of Anixter International and its principal operating subsidiary, Anixter, Inc. Bob?

Bob Eck

Thanks, Dennis. Thanks everyone for joining us today. We’re very pleased with the results Dennis has just described for the second quarter in what continues to be an uncertain economic environment. Beginning with the enterprise cabling and security solutions business, we continue to work through the difficult comparison to large project volume last year in the U.S. and Europe.

As Dennis noted, we experienced slow growth in the North American enterprise business, but the performance reflects successfully replacing during the first half of this year over $30 million of specific customer project (inaudible) from the first half of 2007 in enterprise cable. That project and new customer growth coupled with the continued healthy growth in security sales reflects the progress we are making expanding our product offering and adding new customers.

In the European enterprise business, we are again working through replacing some large project volume from last year. The bulk of that volume occurred in late 2006 through the first half of 2007 and was largely concentrated in the United Kingdom. So as we go forward, some of that difficult comparison will be behind us. More importantly, however, the security initiative in EMEA continues to gain traction and we have seen positive sales growth on the continent, particularly in France and the Nordic countries.

The emerging market growth was strong in the quarter as Dennis mentioned. This is a combination of solid, local and day-to-day business coupled with a pickup in project spending by U.S.-based multinationals. We also see very strong growth in security sales in the emerging markets.

The trends that have been driving our enterprise business, data centers, demand for greater bandwidth and the correspondingly higher performing cable systems that support greater bandwidth and the migration toward IP security all continue in place.

Focusing on two key initiatives, first, our supply chain service offerings continue to expand across all geographies as the cost, working capital and LEED certification benefits of our services resonate well with our customers. Using our services enables customers to deploy infrastructure at the lowest total cost, saving time, scrap and inventory costs. In addition, assisting customers in obtaining LEED certification helps those organizations meet their environmental goals.

Secondly, worldwide security sales continue to grow in the 20 to 25% annual range that we are targeting with higher growth in Europe and the emerging markets. As we have said before, our ability to help integrators and end-users understand how to take advantage of new IP technology and security applications and implement a high-performing infrastructure to support those applications, positions us well to growth in this evolving market.

Moving to the wire and cable business, we are very pleased with the growth Dennis mentioned given the large project volumes in North America and the United Kingdom in the prior year. The strength in the project business in mining, OPG and power generation, both traditional and alternative energy, continued through the second quarter. EPC companies continue to have strong project backlogs which indicate resource and energy related project activity should continue to be healthy as we go forward. We see ongoing benefits and leveraging both our global footprint and supply chain service capabilities for our customers.

Our cable management services enable our customers to efficiently manage large projects in many parts of the world. Finally, our goal of expanding the products set in the wire and cable business continue to move ahead with growth in sales of accessories like cable trade logs and ties.

In the last call, we described a one-time gross margin challenge in our Canadian wire and cable business. As we said then, we viewed the situation as being a temporary competitive pressure in the market for a specific industrial cable that arose due to excess building wire capacity being shipped to industrial cable. In the second quarter, that situation did correct itself as we anticipated and gross margins returned to our expected levels in Canada.

Addressing the geographic expansion in the Industrial wire and cable business, we continued to build on investments we have already put in place. Sales in the second quarter in continental Europe and Middle East grew 48% over the same period last year. This continued strong growth demonstrates both the market opportunity and our solid execution pursuing that opportunity. As we’ve noted in the past, we have relatively small market share in EMEA outside the U.K., and so we think we can continue to grow without disrupting pricing in the market.

In the emerging markets, we continue to make progress building the wire and cable business, adding new customers across Asia and Latin America, including both industrial and OEM applications. We will continue to focus attention on geographic expansion of our industrial wire and cable business, as we believe our mix of product and application knowledge combined with supply chain services presents a unique value offering in those markets where we have had limited activity in the past.

The industrial automation initiative continues to make progress in the wire and cable business. As we’ve noted previously, the communication technology for automation systems is beginning to shift from fieldbus communication to industrial Ethernet and IP. As this occurs, control systems integrators are interested in learning how to help their customers migrate to IP. Our knowledge of Ethernet and the infrastructure that supports industrial networks positions us well to assist in this process.

It is a key point that we can assist in the migration from older technology to IP, as often manufacturers convert sections of plants or work cells during maintenance turnarounds, but not necessarily the entire plant. Helping them understand how to integrate new industrial Ethernet systems with an existing fieldbus network is a critical technical problem that we can help solve.

Turning now to the OEM supply business, we continue to feel some margin pressure from steel price increases. While we have succeeded in negotiating price increases with our customers, which will begin to impact margins in the third quarter, those increases tend to lag the continued run-up in steel prices. Consequently, we are negotiating additional increases in steel escalator decrease provisions with our customers. We hope to catch-up with steel increases over the second half of this year.

As Dennis noted earlier, we did experience 5% growth in the North American OEM supply business with strong growth in the aerospace sector, offsetting some weakness with customers in the consumer discretionary and drivetrain markets. At the same time, we experienced very strong growth in Europe, from new customers as well as adding new products with existing customers.

Most importantly, in the second quarter, we were awarded five significant new contracts in the U.S. and Europe that began implementation during the second quarter, and will begin contributing meaningfully to sales as these new direct line feed programs are implemented during the remainder of this year and increasing through 2009. We are very pleased with the confidence these customers have in us and are now doing business in multiple countries with several of these new customers.

We have believed all along that we can build a unique global partner for multi-national customers, and we are beginning to see that strategy drive benefits for our customers and ourselves. Finally, on the last call, we spoke about the new sourcing, quality control and service center that we are opening near Suzhou, China.

We are progressing rapidly in site selection and recruiting. We will move people from our European fastener business to China late in the third quarter to lead this effort, and will be operational before the end of this year. As the Chinese manufacturing market matures, we believe the related cost pressures will increase the need for the cost and working capital benefits of our supply chain and quality services, opening more opportunities to us in that market.

In closing, while there are continuing concerns about weakness in the economy, we are seeing good growth across our businesses and around the world. We have continued to invest in the initiatives that will carry us forward in the coming years, while appropriately managing operating expenses enabling us to continue to gain operating leverage in the business. The drive toward globalization, new technologies and relentless management of supply chain costs are all trends that we believe we are well-positioned to participate in with our customers. We expect that the third quarter will again show sequential growth over the second quarter, as well as over prior year.

At this point, we will open the call to questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). And we’ll take our first question from Celeste Santangelo with Merrill Lynch.

Celeste Santangelo - Merrill Lynch

Good morning.

Bob Eck

Good morning Celeste.

Celeste Santangelo - Merrill Lynch

Good morning. Could you breakdown the components of your North American enterprise business and talk about the trends there? So I think you said that the day-to-day business was solid in the quarter? Could you talk maybe about the larger projects? What you are seeing, office construction versus data centers and what you expect in Q3?

Bob Eck

Well, Celeste, I think it’s challenging for us, as we’ve said in the past, to split out specific details on office construction versus data centers, and another point that we’ve, I think, frequently made is that one of the benefits in the enterprise business really is real estate churn versus just new construction. So it would be difficult in any kind of accurate way for us to split out data centers versus real estate churn versus new construction. I think the point is that we saw some challenges in project spending due to specific customer spending last year that we’ve said had to do with unique investments those customers were making.

As we then look forward this year, we’ve really worked on replacing a bunch of business that we knew wouldn’t repeat. I think I highlighted that we replaced about $30 million in that business in the first half. So we are seeing project business across multiple vertical markets. We’re also seeing strong day-to-day business, good sales to contractors as well, which to us is really a lot of day-to-day flow that indicates there’s good mid-market activity. And as we’ve always said, there’s a lot of move, add, and change activity that goes on in the enterprise market that doesn’t really necessarily constitute a large project, but drives a lot of spending.

Celeste Santangelo - Merrill Lynch

Okay. And then, looking at the supplier volume growth incentives, could you talk about whether that was, you feel that was transitory or is that permanent? And then, what does that mean for gross margins going forward?

Bob Eck

I think there’s an element of that that’s probably going to continue to play out over the balance of the year. As I commented in my remark a couple minutes ago, this was largely in the enterprise cabling market. And as you could tell from the fact that enterprise cabling in North America was only up 2% overall year-on-year in the quarter and embedded in there was 16% growth in security, there is an issue with some of the key data cable suppliers’ year-on-year volumes and where we sit relative to any volume growth incentive programs. And I would expect that the levels at which we’re recognizing those right now would probably continue for the balance of the year.

Celeste Santangelo - Merrill Lynch

Great. Thank you.

Operator

Our next question comes from David Manthey with Robert W. Baird.

David Manthey - Robert W. Baird

Hi, guys. Good morning.

Bob Eck

Good morning, David.

Dennis Letham

Good morning, David.

David Manthey - Robert W. Baird

I’m wondering if you could talk about with the OEM price increases, could you single out what the gross profit impact was in terms of basis points in the current quarter? And Bob, I think you said you hope to recapture that by the end of the second half. But just so we know what the swing factor is?

Dennis Letham

Well, on the OEM supply business, we’re probably running a good quarter of a point below gross margin expectations that would be steel price related. And the problem right now is chasing a moving target. We were pretty clear, I think, in the first quarter call that we thought we were taking appropriate actions to pass through those increases based on what had happened in the first quarter. Unfortunately in the second quarter, if anything, that the trend accelerated a little bit more which gives us a bigger gap to chase over the balance of the year. But I think Bob was clear in his comments, we’re taking action on that and would expect to close that gap during the second half of 2008.

Bob Eck

Yeah. I think, David, the challenge is that if steel prices continue to run up at a rapid pace, we’ll chase it for a while because you go through a cycle of negotiating an increase with a customer. And as you have a start date for that increase to take effect, if prices from suppliers continue to run up, you’re kind of chasing, as Dennis said, a moving target. We feel pretty good that we’re making progress on it. But it will be somewhat subject to how steel prices continue to move as we go through the rest of the year.

David Manthey - Robert W. Baird

Okay. And if you said it’s a 0.25% just in the industrial wire and cable business, I guess overall it’s a pretty small number?

Dennis Letham

Well, we’re talking about the industrial fast -- total OEM supply business is about 20% of our volume. About a quarter of that comes from aerospace, which isn’t impacted quite the same way. Different metals mix in that product set. So we’re dealing with about, call it, 15% of our company-wide volume where this is an issue.

David Manthey - Robert W. Baird

Okay. Right. OEM supply. Okay. Did you see any pricing on the enterprise cabling side this quarter?

Bob Eck

There’s been some pricing that’s come through. The major manufacturers have indicated price increases. Those typically take about three or four months to work their way into the market. So we’ve seen some price increase activity, but not a huge upside benefit. I guess the important thing is that in our business mix we have a lot of contracted customers where we have contracted pricing that is agreed between us, the end customer; the manufacturer is typically involved in that. And so, those prices tend to not be affected by the type of increases that were announced by some of the players back in April, and I believe there were some more announced in June.

David Manthey - Robert W. Baird

And when you look at the second half, what are your expectations in terms of increasing growth rate because of those price increases?

Bob Eck

I wouldn’t expect that the price increases will have a significant impact on the growth rate.

David Manthey - Robert W. Baird

Okay. And then, finally, in terms of product additions, could you talk about the number of SKUs this year versus the year ago period in terms of the number of SKUs you’ve added?

Dennis Letham

I don’t have that data point, Dave, in front of me.

Bob Eck

One way, David, to think of this as well is that some of the products we’ve had as part numbers, and we’re selling more of them. So we launch an initiative in security and we add, I’ll make it up, a couple of thousand new part numbers in security. But as we continue to penetrate, we add those products then across more of the business. The same thing is happening with the wire and cable additions. It’s not so much lots and lots of new SKUs as more sales of SKUs that we may have had in the business, but not sold in any meaningful level.

Dennis Letham

It does get -- the SKU comp gets a little bit distorted by the OEM supply business where there’s a lot of very unique SKUs. If you just picked up today’s earnings announcement and you compared it to last year’s earnings announcement, at the very end there’s a little section called About Anixter that just gives about four or five key data points. I think a year ago, we were talking about over 350,000 SKUs. And today, in the release we’re saying nearly 400,000 SKUs, but I would caution that a lot of that is due to a lot of very unique parts in the OEM supply business.

David Manthey - Robert W. Baird

Understood. All right. Thanks, guys.

Operator

Our next question comes from Edward Wheeler with Buckingham Research.

Edward Wheeler - Buckingham Research

Hi, good morning.

Dennis Letham

Morning, Ed.

Edward Wheeler - Buckingham Research

Very nice quarter. You talked a lot about -- and certainly optimistically about some of the growth initiatives and some of the actions you’re taking to broaden the sales growth, and then we have the 2% organic operating expense increase. I guess I -- just feels like that’s unsustainable. Could you add a little color as to just kind of where that OpEx growth ought to be given what you’re trying to do?

Bob Eck

Well, one of the things -- the OpEx growth, if you do nothing, if you kind of hold the structure steady, probably has inherent in it somewhere between 3.5, 4.5% inflation year-on-year. One of the things that’s working positively to bring down that actual comparison at the moment is any of our variable compensation, bonuses, incentives, and that sort of thing, which are tied to planned expectations with plans having been built in the latter months of 2007.

To the extent that we are short of planned expectations on the year, we have less variable compensation expense, which is offsetting some of the inflation that’s inherent in the structure as it is today. I think it’s also clear that in kind of the core parts of the business, we’re being very careful about productivity issues. If we get an opening, we’re making sure we only fill it if the productivity stats dictate that we need to fill it, which then gives us the flexibility to invest in people in resources around the initiatives that are important to growth.

Edward Wheeler - Buckingham Research

And that was my -- one of my other questions is quote activity, I guess it’s holding kind of steady the way it’s been for a while?

Dennis Letham

What type of activity, Ted?

Edward Wheeler - Buckingham Research

Quote activity.

Dennis Letham

Quote?

Bob Eck

Yes, quote activity what we see in our project boards are holding reasonably steady. We’ve got a lot of strength in wire and cable particularly with the EPC companies with energy-related projects with resources and we’re seeing good quote activity continued steady quote activity in the enterprise business. We’re not seeing big downward trends anyplace. So we’re pretty comfortable with the backlog of project work at this point.

Dennis Letham

And to repeat a point Bob made earlier, we’ve seen good quote activity in the OEM supply business and some good realization with some significant new contract activity over the last several months.

Edward Wheeler - Buckingham Research

I guess you answered the question. The other question I had and that was I think CommScope specifically talked about some pricing toward the end of the first quarter or early in the second quarter and I think you maybe suggested that takes several months to impact and your overall thought is that we really won’t see much of that in the results.

Bob Eck

Yes, that’s right.

Edward Wheeler - Buckingham Research

Thanks. Great quarter.

Dennis Letham

Thank you.

Bob Eck

Thanks, Ted.

Operator

Our next question comes from Jeff Beach with Stifel Nicolaus.

Jeff Beach - Stifel Nicolaus

Yes, good morning, and congratulations on another great quarter.

Dennis Letham

Thank you.

Bob Eck

Thanks, Jeff.

Jeff Beach - Stifel Nicolaus

I’ve got a couple of questions. First, you’re showing very good growth in Europe. Can you describe the growth from the economy in Europe versus Anixter’s strong performance? Are you seeing slowing end markets there? It didn’t sound like it from the commentary, but I was just curious if you could comment about the direction of the economy in Europe versus your high growth, to start with.

Dennis Letham

Yeah. It really crosses three business units and a lot of variables. If you looked at the OEM supply business first, what we’ve seen, and this has been typical of what we’ve seen in our OEM supply business around the world, there’s individual customers who may have slowing activity. And we’ve seen some of that in the European business. On the other hand, we have other customers who either because they are taking share in the market or are in a more rapidly growing market tend to pick up.

So I think if you looked at OEM supply, the U.K. market is beginning to slow a touch because there tends to be some talk about some macroeconomic factors there, but it’s being offset by growth with other customers and other geographies. In wire and cable, I think it’s important to look at, again, the expansion in continental Europe and the Middle East, which has just gone very well, and it’s an effort that we’ve put time into over the past couple of years, we’ve put people in place, and we’ve put managers in place, built the right supply relationships and customer relationships.

And so after a couple of years of really investing in the front end of that, this year we’ve seen good growth, and it’s not being impacted so much by the economy because, as we’ve said, we’re a fairly small market share player in the EMEA wire and cable business, again outside U.K. And so, we have the opportunity to grow faster than the market and really not disrupt the market because we are a pretty small player there today.

Dennis Letham

On that point, Bob, it’s important like in the second quarter, we did see some softness in the U.K. market year-on-year on electrical wire and cable that our growth initiatives overall helped us overcome in electrical wire and cable in Europe.

Bob Eck

Absolutely. And again, we saw growth in the enterprise business, which came both from the security investment as well, again, as investment in continental Europe where we’ve struggled in the past, and we’ve seen good pickup there which is offsetting slowness in the U.K. We’re just trying to recover from big project spend last year.

Dennis Letham

I think in general if you look at Europe, we would probably mirror what you read in the press in that the U.K. has been softer for us this year than it was a year ago. But the continent has held together pretty well, which when combined with our specific growth initiatives, has left us with decent growth coming out of Europe.

Bob Eck

Yeah, and I think important to remember, when we talk about continental Europe, we roll into that number our Middle East business as well.

Dennis Letham

Right.

Jeff Beach - Stifel Nicolaus

All right. Thanks. That was a good answer. Second, security growing 16% in North America this quarter, were you up specifically in security against good project sales as well in the second quarter of last year? Are we seeing because of the size of security a more of a mid-teens growth rate ahead? Can you help us there?

Bob Eck

We were up against strong project business in the second quarter last year. We had a couple of significant very large volume projects. So we were really quite pleased with 16% growth for the quarter given the volume that we had last year. I think going forward; we’re targeting a growth rate in the 20 to 25% annual compound growth rate in security for the next couple of years as we see it. That’ll come from around the world in different buckets, but the expectation out of North America should be strong growth approaching that companywide average.

Jeff Beach - Stifel Nicolaus

All right. Thanks. Last question is on visibility looking ahead. I’d like you to describe how see the markets out -- how long out ahead here, do you have, what you would call reasonable visibility? And even if it’s a guess, do you think we’ll see reasonably good growth across your markets in North America and Europe through the end of the year?

Dennis Letham

Jeff, I think we’ve touched on this point in calls from time to time over the years. Basically, we don’t have a lot of hard visibility backlog here at any point in time is typically in the range of about a month. We have pipelines on project type activity, pipeline tools that give us project activity outlook that extend beyond that. But projects are 15, 20% or so of our enterprise and electrical wire and cable business. The real issue here is as you get your bulk of your business day to day, short order, so there’s not a lot of long-term visibility, and nothing really has changed in that regard from how we would have answered the question one year or five years ago really in that respect, I think.

Bob Eck

Yeah. And I think if you looked at the OEM supply business, we also have project boards there. The question of what that leads us to conclude is that all of those are opportunities we’ll compete with somebody else on. We’ll win some, we’ll lose and it’s hard to take those and say that gives us a specific outlook on the business.

Dennis Letham

I think an important point on outlook for volume though in terms of growth rates is if you look at where we ended up in the second quarter of this year with sales of 1000, 000, 616, we only need 2 or 3% growth from Q2 to Q3 to push kind of the raw year-on-year growth number up around 8%, which gets us back closer to our target at 8 to 12% growth rate. And we know that comparisons start to get a little easier in the second half of this year versus last year. So, I think our ability to generate decent year-on-year growth is pretty good.

Jeff Beach - Stifel Nicolaus

Okay. Maybe this will help me a little bit, in the discussions you have right now with some of your largest cyclical companies in -- let’s say in your industrial markets, are they still indicating a reasonably good level of activity and optimism looking out past next month, four to six weeks?

Bob Eck

Yeah. I think that’s a very customer specific question. Some customers are challenged right now, like I mentioned in the consumer discretionary space, some of those customers are challenged right now and are looking at tighter production runs and tighter spending. Other customers are doing really quite well.

I think there are specific customers in retail that are spending a lot of money, there are specific customers in energy that are spending a lot of money, there are customers in alternative energy that are spending money. So it’s hard to draw one broad answer. Again, we operate in so many geographies and across so many customer verticals that where one type of customer or segment is soft, other segments are strong.

Jeff Beach - Stifel Nicolaus

All right. Thanks a lot.

Operator

And our next question comes from Nat Kellogg with Next Generation.

Nat Kellogg - Next Generation

Hi, guys, great quarter. Just a couple of sort of housekeeping things. Did you guys give a D&A expense for the quarter?

Dennis Letham

Hold on for one second, I’ll get that for you. Six million for the quarter, that brings the year-to-date number to 12.3 million, that’s for depreciation. Amortization of intangibles 2.1 in the quarter brings the full year number to 4.2 million.

Nat Kellogg - Next Generation

Okay. That’s great. And then, if I looked at operating margins in Europe looked pretty good. I mean there’s nice expansion, both sequentially and year-over-year. And I’m just wondering was there anything specific there that helped to drive that? And do you know, how sustainable do you guys think that is?

Bob Eck

Yeah. It was really volume driven. We talked about 16% growth in the OEM supply business in Europe. We talked about 48% growth outside the U.K. in the wire and cable business. We had growth in the enterprise business as well. So we’re getting leverage on volume, which is one of the stories we’ve talked about, that as we grow, particularly in continental Europe, leverage the existing expense base that’s already in place to, in effect, manage the back office, accounting and tax and operations. As we get enough volume, we leverage that and we begin to open up the margins a bit.

Dennis Letham

I would say on the point of sustainability on Europe, one thing to keep in mind is Europe is probably during the course of the year our most cyclical business in that when we get to the third quarter, we get these extended vacation periods, which impacts sales volume, which is going to give you a little bit of de-leveraging. Also when you look at Europe, today we’re getting about 40% of our total sales volume out of the OEM supply business.

That customer base in OEM supply tends to be the type of customers that have one and two-week factory shutdowns, either around vacations or model year changes in Q3, and then will again have one to two-week factory shutdowns around the Christmas/New Year’s holiday period. So that European business tends to have or should typically have its strongest performance in the first two quarters of the year and a little soft in the second two quarters of the year.

Nat Kellogg - Next Generation

Okay. Whereas the U.S. business, we should probably see a little bit of cyclical...

Bob Eck

Yeah. U.S. business doesn’t have quite -- it’s got less OEM supply in the total mix, and we don’t have that same level of vacation impact in Q3 that we typically see out of Europe.

Nat Kellogg - Next Generation

Okay. All right. That’s helpful. And then just on the buyback, I mean, obviously you guys said the cap is a little bit sort of closer to the higher end, I think you talked about 40 to 50%, and it’s sort of closer to 50% now, but obviously you guys are generating good cash flow. I mean, are our acquisitions looking more or less appealing these days? I mean, obviously your stock continues to be pretty cheap, despite a little bit nice performance today. I’m just wondering if you could talk a little bit about sort of how you see that capital allocation going forward?

Bob Eck

I think on the acquisition question, we’ve talked in the past about the markets being a little tight, not seeing a lot of opportunities. We’re seeing a couple more opportunities open up now. So I think we’ve said we’re interested in acquisitions that fit well with our initiatives, our expansion initiatives. So we’ll continue looking at those. If the right opportunities come along, we’ll try to take advantage of them. Other than that, I think, given the amount of cash we’re generating at the growth rates we’re at, we’re very comfortable with the debt-to-capital structure we’re sitting with today.

Dennis Letham

Yeah. And if you’ve noticed over the last few quarters, I mean basically almost -- very closely we’ve been matching the cash flow from operations each quarter with the amount of buybacks and keeping that debt-to-total cap number hanging right in the 49 to 50% range. So...

Nat Kellogg - Next Generation

Okay. That’s helpful. And then, just last if you could, and this is my last question, but if you guys could just give a little more color on sort of the factory automation initiatives. I’m just sort of curious about if are there any particular industries or verticals where you think that they’re sort of ripe for the picking, and where geographically if there is just more focus on the U.S. or Europe, but just a little more color there would be great.

Bob Eck

Yeah. In terms of industry, honestly we aren’t being terribly industry-specific at the moment. It’s a new initiative for us, and we think actually the right way to attack initiative is first to build relationships and create both supply chain and technical value for the control system integrators. And the control system integrators work across many vertical end markets. So it would be wrong to target a specific vertical end market and say we think its right for the picking. We think the integrators are ripe to be helped and are really responding very well to our message.

The U.S. versus Europe question is, has less to do with the markets and state-of-technology evolution and it has to do with how we’re trying to launch the initiative. Both are good market opportunities. It’s easier for us to launch an initiative in the U.S., put resources in place. And frankly, make mistakes along the way. It’s our expectation whenever we launch a new initiative that we’ll have fits and starts.

And if we can have those fits and starts in a big market that doesn’t have some of the cost pressure that the European market has, it gives us a way really to build the initiative, make our mistakes, correct mistakes, retool and then quickly roll that initiative into the rest of the world. It’s our expectation we’ll carry the factory automation initiative into Europe later this year or early next year. And actually, we’re looking at it in Brazil as well.

Nat Kellogg - Next Generation

Okay. Great. That’s very helpful. Congratulations on a great quarter, guys. And that’s all I got. Thanks for taking my questions.

Dennis Letham

Thanks.

Bob Eck

Thanks.

Operator

(Operator Instructions) and we’ll take our next question from Edward Wheeler with Buckingham Research.

Edward Wheeler - Buckingham Research

Yeah. Thanks for taking another call. I had one quick question. And that was, in the last downturn in the early 2001 timeframe, you were pretty quick at responding to demand and pulling down expenses. And I guess you have a playbook of things you are prepared to do. Just where do you sit if the world gets a little uglier? I mean are you seeing any indications that you need to implement some of those decisions that you did prior? Or kind of -- do you have any color on that? I guess...

Dennis Letham

I think the thing I would distinguish between the earlier time period and now is we in the 2001 timeframe came into that period with heavy exposure in the telecom market and with alternate carriers. And when we saw that market collapse, there was a clearly identifiable set of costs around that people, facilities and that sort of thing that we took very quick action on. I don’t see us having any particular end market or vertical market exposure today that would suggest that we would be taking similar-type action.

But I think if you look at second quarter and what we talked about before on expenses, pretty much mirrors the game plan for the moment unless there’s a dramatic change in the economy. And that is, carefully manage head count particularly around turnover, only replace open spots when productivity statistics for a given location or a subset of the business suggests that you need the head count, carefully manage all of your variable costs and continuing to invest in the initiatives that you believe and are confident you can success with regardless of what’s happening in the economy in general. And I think that would be the playbook for the short term.

Edward Wheeler - Buckingham Research

Great. Thank you.

Operator

(Operator Instructions) And it appears there are no further questions at this time. I would like to turn the conference back over to our speakers for any additional or closing remarks.

Bob Eck

Thanks again, everyone for joining us on the call today. We continue to see solid growth in the industrial wire and cable, OEM supply and security markets, our existing customers project pipelines coupled with our ability to add new customers gives us confidence as we look forward to the remainder of the year. As we look forward for the enterprise business, it is interesting to note that IBM recently released a survey indicating that 40% of IT executives at financial services firms expect increase spending this year and next, in spite of the credit crisis and losses many firms have recorded.

This is similar to data from IDC indicating that U.S. IT spending will grow through the year. These surveys coupled with our project boards leads us to expect sequential growth in through Q3 and over prior year in the enterprise business. Our ability to invest in growth initiatives while managing run rate expenses positions us well to continue to achieve good operating leverage, while building our organization to support our customer and partner suppliers, supply chain and global expansion needs. Thanks.

Operator

And that concludes today’s teleconference thank you for your participation, you may now disconnect.

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Source: Anixter International Inc. Q2 2008 Earnings Call Transcript
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