Good morning. My name is Adam, and I will be your conference operator today. At this time I'd like to welcome everyone to the Anixter International Second Quarter 2019 Earnings Call. All lines have been place on mute to prevent any background noise. [Operator Instructions] Kevin Burns, SVP, Investor Relations and Treasurer, you may begin your conference.

Thank you, Adam and welcome to Anixter's Second Quarter 2019 Earnings Call. With me to review our financial results are Bill Galvin, President and CEO; and Ted Dosch, Executive Vice President and CFO. Following our prepared remarks, we will take your questions. Today's presentation includes both GAAP and non-GAAP financial information, which are reconciled in our earnings release and accompanying the slide presentation which are available on our website at www.anixter.com. During our comments today we will be referencing these slides. We believe the non-GAAP measures we disclose provide the best representation of our ongoing operational performance. Before we begin with our prepared remarks I want to remind everyone that we will be making forward-looking statements about future results, which are subject to a number of factors that could cause Anixter's actual results to differ materially from what is indicated here. We do not undertake to update these statements and refer you to our SEC filings for more information. With that, I will turn the call over to Bill.

Good morning and thank you for joining our second quarter 2019 earnings call. This morning I will begin with an overview of our second quarter financial performance, including sales and gross margin trends. I will then turn the call to Ted to review our financial performance in more detail and provide additional thoughts on our outlook for 2019. As we have stated, our long-term strategy is to deliver above-market sales growth in the markets we serve while expanding our gross and operating margins to continue sustainable earnings growth. We have been achieving this by bringing our comprehensive solution capability to all our customers and providing a best-in-class customer experience enabled by our investment in digital innovation and business transformation. As you saw from this morning's release, sales in the quarter increased 5.8% to $2.3 billion, which is the highest quarterly sales in our history. Our strong sales performance was driven by record sales in all segments. Organic sales, which are adjusted for acquisitions, copper and foreign exchange, increased by 6%. This is the fifth consecutive quarter with organic sales at or above 5%. This organic growth was above our outlook range of 3% to 5% driven by our NSS segment, with strong growth in global accounts and security, and utility customers in our UPS segment. In addition to strong sales growth, we delivered year-over-year improvement in gross margin for the third consecutive quarter driven by actions we have implemented across the business. This reflected excellent execution by the team and is evidence of the value we continue to provide to our customers. The organic sales growth in Q2 of 6% was lower than the 8% we delivered in Q1, but as we said on our last call, our second quarter was more difficult comp. The two year cumulative growth for…

Thanks Bill, and good morning everyone. Bill covered our strong sales and gross margin performance, so I will begin with a look at operating expense. Looking at Slide 8, second quarter operating expense of $344 million compares to the prior year operating expense of $348 million. Excluding the non-GAAP operating expense items detailed on Page 11 of our release, adjusted operating expense increased 4% or $12 million to $335 million. As a percentage of sales current quarter adjusted operating expense improved 30 basis points to 14.8%. The primary drivers of the increase in adjusted operating expense were $5 million related to the acquired companies, $5 million related to our digital innovation and business transformation initiative as well as volume related costs associated with our 6% sales growth. However, we were able to offset these increases with sales and back office productivity gains and the benefits from warehouse consolidations and automation to decrease adjusted operating expenses as a percentage of sales by 30 basis points. Sequentially adjusted operating expenses were flat and decreased as a percentage of sales from 15.9% to 14.8% as we leveraged our expense base to support the 7.3% sequential growth in sales. Adjusted EBITDA increased by $22 million to $129 million due to strong volume and margin improvement in the segments along with strong expense discipline. Adjusted EBITDA margin of 5.7% increased 70 basis points from 5% in the prior year. Adjusted EBITDA leverage for the quarter was 3.4 times due to the factors mentioned above. We do not think these high levels of operating leverage are sustainable and we will be making additional investments in head counts along with further investments in our digital innovation initiative in the back half of this year to support the expected continued strength in the business. Details of operating income…

Thank you. [Operator Instructions] And our first question does come from David Manthey of Baird. Please go ahead.

Thank you. Good morning guys. So first off, last quarter, emerging markets in NSS you said, might not be sustainable all year at these high growth rates but should remain positive and you said it was based on new and existing customers as well as ongoing and project work. You obviously had another very strong quarter there. As the comps get tougher in the back half, do you assume some kind of deceleration there? I'm just checking again to see if there's any kind of project work or something that you might think would peel off in the back half.

Yes, Dave, I think we'd say that the business will remain strong, but against the comps you'll see a kind of decelerating growth. But we still expect it to be relatively good, and it's on the backs, again, of the supply chain and services business that we've been driving as well as global account activity, which remains strong, and the pipeline still looks good for us.

Yes. And I think the other thing to add to that, Dave, is a large portion of this year-over-year growth is due to what you've heard us refer to over the last couple of years as complex programs as opposed to just projects. And these programs are typically multiyear contractual agreements. So the comps will get more difficult in the back half, as Bill talked about, but we don't see any significant drop in that revenue due to timing of projects.

Okay. That's good to hear. And second, on operating expenses. Ted, you mentioned additional investment in head count and digital in the second half would drive that number up, the SG&A number, by maybe $5 million to $10 million. But if I look at flat SG&A percentage of sales for the full year, that would imply maybe another $10 million in the fourth quarter. Is that how to think about it, we should see an additional ramp in the third and in the fourth quarters?

Yes. I – at this point in time, I'm not sure we have that much of an increase in Q4. But the numbers that we talked about there for Q3, keep in mind, that's not just the investment in our innovation and business transformation, but it's also to support the significant organic growth that we had. And Bill can elaborate on that in just a second. But as you might imagine, with these levels of growth that we've seen in the top line, we've really stretched the organization to support that type of top level performance.

Yes. And to add to that, as we mentioned, and Ted said it too, we can't expect to continue to get that kind of leverage of 3x on the business. So we are investing in sales and capability resources for customer acquisition and revenue. So we expect that to be feathered in throughout the rest of the year.

That’s great, guys. Thank you.

Thank you.

And your next question comes from Michael McGinn of Wells Fargo. Please go ahead.

Good morning, gentlemen. I just wanted to follow up on the security growth to-date. Based upon what we're seeing in the market, our checks that's above the market growth, you mentioned share gains. Can you just comment where you guys are winning? And is Inner Range playing a large part in that?

Yes, Michael, it's a good question. Yes, we think we are achieving above-market growth and we think it has to do – kind of a combination of things. Lots around the strategy of how we're going after the market and where we've made investment, I think the global accounts business and global support with customers on solutions around the world is also a big driver of that. So I feel like it's strategy-driven. I think the Inner Range as well as the distribution businesses we acquired in Australia had been helpful. But even without that, our organic growth was 9% in security, and again, I believe that's taking share on what you're seeing in the market.

Okay. And it's nice to see the NSS margin target came up. The commentary around EES, it sounded a little softer from a macro perspective, but the segment margin target remained the same. Can you give us a little color there? I mean, is there – how confident are you that the second half expectations – do you have enough built-up already in the backlog or visibility to meet those targets?

Yes. So first, on the revenue side for EES, as we said, the headwind there has been on the OEM segment, which we think and everyone points to macroeconomic issues in the manufacturing sector, especially in semi and auto. But we've seen good strength in industrial and in the commercial construction business. So we don't see any reason that's going to change right now. So we're doing a lot of things to continue to expand the OEM business into other sectors. So for us, the margin piece of that is related to mix and it is something that we watch closely as different parts of that business accelerate, decelerate. So we're confident in what we put out there, but it certainly is not the layout, if you will.

Yes. And I would just add back to, Mike, to your specific question about margin for EES. We did have a strong operating margin for EES in the quarter despite the much lower growth rate than we saw in NSS. That will be heavily influenced in the back half of the year with mix of the business, as Bill just said, between OEM, which, as we've always said, is a higher margin than the C&I portion of the business. But we do think that the target we had for full year is still achievable, even with a somewhat lower top line growth rate. On the NSS side, we're seeing a result of the strong – leveraging the strong top line growth. And again, part of what makes us feel really good about that operating margin improvement is we're achieving that despite the fact that the security side of the business is growing at an even faster rate than the infrastructure and the rest of the business. And again, as we've talked, security has a lower margin profile than the infrastructure side. So we felt it was appropriate to take that NSS outlook for operating margin up based on the continued strength we're seeing through the first half.

Michael, one more comment on that too, and I think we've said it in prior calls. The OEM business for EES doesn't run at a higher margin. So the performance on the margin is actually very good, and it's attributed to a lot of the effort we put in on sales tactics and sales strategies to improve margin across the rest of the business.

Got it. Understood. And if I could just sneak one more in. This is a little bit of a different question. One of your larger suppliers was recently asked the impact from Huawei. And I believe they're both – Huawei is both a customer and a supplier for them. If the wireless spend 5G initiative becomes more of a nationalistic kind of – take some more nationalistic kind of tone to it, is that a mix-up or market share play for you guys? How do you feel this is progressing in terms of the overall macro standpoint?

Yes. No, I'll even broaden that beyond Huawei. It goes to the conversation on security and security products coming out of China that have the same challenge from a nationalistic point of view, Michael. So it absolutely has an opportunity to bring advantage for us in the business as we work on the supply chain. I would tell you that a lot of the business, especially in the 5G piece for us, is broad-based and service-oriented, right. So in some cases, we're supplying the electronics. In some cases, we're not. But we're providing complex services to support the project rollout. So all in all, as long as the investment continues, we see an opportunity to take advantage of that market.

You bet. And is there an update on timing for when you expect that market to reach critical mass? Or do we get past these – everyone's trying to figure out the spectrum. When do you see things really taking off from here?

Well, I think you're seeing some companies just in this past earnings seasons come out and say they're starting to see strong benefit from 5G investments. So I expect we're going to continue to see that accelerate over the next several years. But as you know, Michael, that's very complex investment strategies and very large capital investments. So to me, it's never as fast as you want it, but I do think we'll start to see acceleration from this point on and reaching probably peak in the next two to three years.

All right. Thank you very much. I’ll pass it along.

Yes.

Your next question comes from Shawn Harrison of Longbow Research. Please go ahead.

Good morning, everybody and I congrats on the strong results.

Thank you, Shawn.

Thanks Shawn.

If I remember correctly, this time last year was when you started to see the larger projects within NSS really begin to accelerate, and so you're beginning to anniversary that. I was hoping, could you maybe talk about kind of the large project backlog within NSS and whether there's any puts and takes in the back half of the year and just how things look like they could shake out?

Yes, Shawn, good point. We actually said in the fourth quarter of 2017 that we were going to start to see acceleration in Q1. If you remember, we were a quarter off on that. It was building at that point, and we started to see the results then in Q2, and that continued to accelerate through that. And I would tell you that, on a general basis across the entire NSS business, that is still the case. So we think and continue to see bookings and backlogs strengthen and believe that, that will at least continue for the next several quarters.

Yes. And just to reiterate one thing, Shawn. I think I said it earlier, but to Bill's point, we really saw that growth rate begin to take off in Q2 of last year. In NSS in particular, which has half of our overall business then significantly influences the total company growth rate. So as we sit here looking at our first half performance and see a 10.1% kind of two year cumulative growth rate, we feel very good that even though we use words like decelerating growth rates in the back half, it's still going to be about at the midpoint of the ranges we've given, 10.5%, two year cumulative growth rates year-over-year in second half. And a part of that which I think makes that even, I guess, better for the long-term is that a significant part of that growth is really coming from our complex programs, which don't subset like a project that could be a few quarters or even a year. So the fact that the growth rate is driven more by programs than projects bodes well for the continuation of that revenue.

And the base grows, right. So the fixed base grows, so all the other growth on project activity is on top of that.

That's helpful. As a follow up, just the C&I growth you saw this quarter, if I listen to Fastenal or Grainger, MSC or whomever, they're citing slowing industrial growth in the business. And so I know you're seeing that in the OEM business, but the commentary also seemed a bit weaker on just a broader commercial and industrial. And so do you think you're taking share in that market? And if so, kind of what factors are driving the share?

Yes. I think in fairness, what we're – for instance, in the U.S., we said 4% growth on that business, and that's with OEM in it. I think in that quarter, we took growth. I think if you look at it over a long period of time, it's probably even with the market. But it is project-based, Shawn, so we'll see some puts and takes in each quarter. I think we're going to hold our own, and as that market performs, we'll perform with that. I do think we continue to focus also on efficiencies, though, and investment into the areas of the market we feel like we can get growth. So I'm happy with the performance in a difficult market, but there's other things we can do.

And then just lastly, from a high level, has there been any discussion with the Board in terms of a share buyback program being put in place? I mean great results today. The stock is up a little bit but not significantly over the past 12 months. Earnings are going up, and the valuation is going down. So it's probably a frustration internally, but any thought of a buyback?

Yes, Shawn. Here's how we think about it, and it's not significantly different – or I should say it is not different than how we really framed it for the last several years. As we think about our capital allocation strategy, what is always first and foremost as a priority is to fund the organic growth. And with growth rates like we’ve seen here, 8% in Q1, 6% in Q2 and even though it's projected to be a little lower than that for the back half of the year are still significantly higher than, say, in the previous two, three years. So our number one capital allocation priority funding is organic growth, which largely for us means working capital. And we're sitting here today with working capital that's more than $100 million higher than last year at this time, I think about $120 million, which is what really drove the cash usage of over $60 million this year compared to generating over $60 million in the first half of last year. So that is, has and always will be the number one priority. Secondly, we've said funding inorganic growth. And like we said recently, we're not anticipating and don't see that being that next big transformational acquisition but more the bolt-in or – bolt-on or tuck-in like we did last year. And so we still feel we have the capacity to do that as we move forward. So some return of value to shareholders in some form or another is still on that list of the top four priorities from a capital allocation standpoint. But I think we need to be prudent while we're sitting here with our leverage ratio that the EBITDA still – while it's now within the range, it is still at the high end of that 2.5x to 3x range that we've discussed.

Okay.

And your next question comes from Brian Bernard of Morningstar. Please go ahead.

Hey, good morning, guys and a nice quarter.

Thanks Brian.

Yes, I just had one question for you, and you've kind of touched on it here. But obviously, we've seen some other distributors that are – said they're going to tighten their spending due to softening demand. Now you guys are obviously enjoying strong growth, and you talked about adding heads to support that growth, your innovation, transformational investments, et cetera. But I'm just curious, if the environment were to change, how nimble do you think you can be in terms of adjusting the cost structure if need be?

Yes, Brian, I think we've demonstrated in our past the ability to move pretty quickly on a significant change in demand in the market, and I feel like we have – even more so are able to do that today. Because of the strong growth, we still think there are segments in the market that we have an opportunity to invest and grow. We think doing activities to pivot from what we would consider slower growth or markets where we feel like the return is not where we want it to be in the company profile, we feel like we've done a lot of that. Now we need to really make a little bit of investment into growth. And we've been investing in the innovation of digital systems and capabilities for our customers, which is also a part of that. And by the way, as you know, that expands productivity and allows us to continue to grow the business off the same base. So I think we can move pretty quick. And if anything changes, we'll be able to do that.

Okay, thank you.

And your next question comes from Michael McGinn of Wells Fargo. Please go ahead.

Thanks for the follow up. If I can just go back to the spending initiative again and the operating expenses, you guys are expecting a ramp year. Can you kind of frame for us what is growth and what is maybe duplicate cost that you're expecting to roll out – roll off after your first ERP rollout, which I believe is scheduled first half of 2020? Is there any framework around that?

Yes. So Michael, I suggest you think about it this way. And so remember, in the third quarter, we won't have the year-over-year increase in OpEx due to the acquisition, and that, for the last, say, four quarters, has been the single biggest driver of dollar increased spend year-over-year. We only had about $5 million of increased spend in Q2 of this year in our innovation and business transformation. And on our fourth quarter call and in our first quarter call, we framed that more as something in the range of $7 million to $8 million a quarter. So again, this is a big project, and that spend can be a little lumpy from quarter to quarter. We still expect to get to that same kind of full year number but a little more in the back half than in the first half, just the way the project work had come together. So as we go forward from here, we now expect the investment in innovation and business transformation to be the single largest driver of the growth, followed by the spend to support the volume growth, which sequentially, most of that spend is in there other than what we talked about now having to do with some investment in head. So if you think about the variable cost to support that volume growth of warehousing and freight, et cetera, that's already in our Q2 run rate. But spending – investing in some head count and so forth, that will be incremental going forward. Thinking of 2020, though, again, we are implementing this new system as a pilot in a relatively small part of our business to mitigate or minimize risk associated with our moving to the cloud and some significant business process change. So we will drive savings in that part of the business, most likely not starting to the back half of 2020. But keep in mind, that's only in a relatively small part of the business for next year.

And long term, we said $40 million to $60 million of cost savings as of the late – when we fully ramp that up throughout the couple of years after 2020.

Okay. And then lastly, there's been some big announcements in terms of wind investment here in the Northeast Corridor. I was wondering how you guys are positioned from a T&D spend standpoint. Short-term, long-term, anything you can give there?

Yes. Renewables, both wind and solar, are a strong, say, customer vertical of ours within our EES business. So we have participated in a significant portion of those projects historically. I can’t speak specifically to projects you might think of in the northeast right now, but we do continue to have a strong position in that area.

Great, thanks.

And we do have a follow-up from Shawn Harrison of Longbow Research. Please go ahead.

Hi, again. Just a theoretical question, not looking you to guide 2020. But if you were in a low single-digit growth environment in 2020, considering the investments that need to be made for kind of the digital, the new ERP system, the ongoing transformations, would you still, in a low single-digit organic environment, be able to deliver 1.5x EBITDA leverage? Or is there an incremental cost step-up next year that we need to consider?

Yes, Shawn, that's a great question. So let me try to frame it for you this way. As we said, here in Q2, we had exceptionally strong leverage with this kind of volume growth combined with gross margin improvement and OpEx leverage that we delivered a 3x-plus leverage, higher than we've ever done before as a company. But as you think about different ranges of growth, if we were operating or delivering, say, low single-digit top line growth, I would expect us to be able to have operating margin leverage in the 1.25 to 1.5 range. If we're, say, mid single-digits, I'd expect us to be able to – on an ongoing basis, to be more about 1.5. And if that top line growth is high single-digits, then I would expect that operating margin leverage to be more in the 1.5 to 2 range. So I think our business model is such that we can do that. And also, back to our investment in innovation and business transformation, I would not expect to see any significant year-over-year growth in that spend next year. We will still have that project spend continuing through next year. But unlike this year, when it's a significant increase in spend versus 2018, it should not be any significant increase between 2019 and 2020.

So I'd also add that we continue to focus on operational efficiencies that will help us continue to drive that leverage. So we're not done. There's still many things we're working on to drive efficiencies in the operation and facilities and many other costs that we think we have opportunities to improve on.

That’s great, guys. Very helpful.

Thanks Shawn.

And we have no further questions at this time, so I will turn the call back over to the presenters.

Thank you. That concludes today's call. If you have any additional questions, please don't hesitate to reach out to Kevin. As always, thank you for listening to today's call.

And this does conclude today's conference call. You may now disconnect.