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Anixter International (NYSE:AXE)
Q3 2019 Earnings Call
Oct 30, 2019, 10:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Anixter International Inc. third-quarter 2019 earnings conference call. [Operator instructions] I would now like to hand the conference over to your speaker today, Kevin Burns, senior VP of investor relations and treasurer.

Thank you, please go ahead.

Kevin Burns -- Vice President of Investor Relations

Thank you, Lisa, and welcome to Anixter's third-quarter 2019 earnings call. With me to review our financial results and comment on the acquisition news 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 slide presentation, which are available on our website at anixter.com.

During our comments today, we will be referencing these slides. We believe the non-GAAP measures we disclosed 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.

Bill Galvin -- President and Chief Executive Officer

Thank you, Kevin. Good morning, everyone, and thank you for joining our third-quarter 2019 earning call. Before we discuss third quarter results, I wanted to discuss the press release that we issued this morning announcing that we have entered into a definitive agreement to be acquired by Clayton, Dubilier & Rice for $81 per share in cash. The transactions that we announced today represents a total enterprise value of approximately $3.8 billion, including net debt.

The $81 per share is a 13% premium over yesterday's closed price and a 27% premium over the 90-day volume weighted share price. As we stated in the release, we believe this transaction is in the best interest of Anixter and our stockholders. After careful and thorough analysis together with our independent advisors, our board of directors unanimously approved the transaction with Clayton, Dubilier & Rice. CD&R has a strong reputation and track record of success, working with distributors, like Anixter, to prosper and grow.

In addition, our two organizations have very similar cultures and values. Plus, with their deep distribution expertise, we believe they can be an excellent partner. Under the agreement, Anixter may solicit superior proposals for the third parties for a period of 40-calendar days continuing through December 9, 2019. In accordance with the agreement, Anixter's board of directors with the assistance of its advisors intend to solicit superior proposals during this period.

We will be filing, in due course, a proxy statement regarding the transaction, and we recommend you review the statement once it is available. I will now discuss third quarter financial performance, including sales and gross margin trends, and then I will turn the call over to Ted to review our financial performance in more detail and provide additional thoughts on our outlook for the rest of 2019. As we have previously stated, our long-term strategy is to deliver above-market sales growth in markets we serve while expanding our gross profit 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, enabling our investment in digital innovation and business transformation.

As you saw from this morning's release, sales in the quarter increased 2% to $2.2 billion, with growth in all segments with the exception of EES. Organic sales, which are adjusted for copper and foreign exchange, increased 2.6%. This organic growth was within our outlook range of 2.5% to 4.5%, driven by solid growth in both NSS and UPS segments, which offset a decline in our EES segment. In addition to solid sales growth, we delivered meaningful year-over-year improvement in gross margin for the fourth consecutive quarter driven by actions we have implemented across the business.

This reflects ongoing excelling execution by the team and is evidence of the value we continue to provide to our customers. The organic sales growth in Q3 of just under 3% was lower than the growth we delivered in Q1 and Q2. But as we said on our last call, our third quarter was a more difficult comp. The two-year cumulative growth for Q3 of 10% compares to a two-year cumulative growth of 11% for Q2 and 10% for the first half of the year.

Overall, third quarter of 2019 GAAP earnings per diluted share of $1.73 and adjusted earnings per diluted share increased 19% from prior year to $1.92. Let me now turn to gross margin on Slide 7 of our presentation. As we discussed on the last two calls, the long-term strategy that we've implemented across the business continue to show good results. Third quarter profit improved 5% to $446 million, resulting in a gross margin of 20.1%, an increase of 60 basis points year over year and 30 basis points up on a year-to-date basis.

This increase for the quarter is above our outlook range of 20 to 40 basis points for the full year and at the high-end of the range on a year-to-date basis. We believe gross margin expansion continues to represent a significant opportunity. Let me now review our sales by segment beginning with network and security solutions on Page 11 of the slide deck. NSS, third-quarter sales of $1.2 billion increased 4% on an organic basis.

As we have seen for the last several quarters, growth was broad-based, including in our key strategic sales initiatives. These areas include global accounts, complex integrated supply chain programs and our security and professional audio/video business. We had strong growth in global technology and financial services companies and with service providers in emerging markets. This is the sixth consecutive quarter of organic growth for NSS.

By region, NSS North America increased 4% on an organic basis, driven by growth in the security business, global accounts and professional A/V initiatives. In EMEA, NSS sales were flat on an organic basis, driven by a solid growth in security, but partially offset by softness in network infrastructure. The flat organic sales were an improvement over the decline that we saw in Q2 this year. Emerging markets sales increased 9% on an organic basis with strong growth in CALA.

The growth in CALA was broad-based with strength in the all major countries, continued strength with existing and new service providers and global accounts in the region. Turning to the security side of NSS business. Sales of $522 million or approximately 45% of segment sales increased 8%, driven primarily by global integrators. Backlog was up over prior levels – prior-year levels, the declines that -- but declined slightly from Q2 levels due to strong Q3 billings and normal seasonal trends.

Moving to electrical and electronic solutions on Slide 13. Quarterly sales of $580 million decreased 2% on an organic basis. Looking at EES by region, North American sales decreased 2% on an organic basis, reflecting softness in both North America and commercial and industrial and OEM businesses. Our industrial proxy business with EPC customers continues to be strong, but we saw our fall off in our day-to-day industrial and commercial construction sales.

As we mentioned in Q2, the ongoing OEM softness was consistent with the decline in global manufacturing activity that we continue to see around the world, especially in semiconductor and automotive industries. However, we are beginning to see improving trends in -- in the OEM business, and backlog has moved into growth territory. In EMEA, EES sales were flat and on an organic basis. The flat organic sales in both C&I and OEM were an improvement over the declines that we saw from Q1 and Q2 this year.

In emerging markets, EES sales decreased 4% on an organic basis. This decrease was all in the CALA business where we experienced slowness in project activity and continued to exit unprofitable pieces of the business to improve long-term profitability. APAC performed well with improving trends in our Middle East business. Backlog was down year over year on a year-over-year basis, as well as on a sequential basis.

However, we are starting to see improvement in booking levels in the OEM business. Finally, our utility power solutions segment achieved record third quarter sales of $463 million, resulting in 4% growth on an organic basis, shown on Slide 15. This represents the 11th consecutive quarter of growth in this segment. Growth decelerated sequentially but was against a more challenging Q3 comp from a year ago.

The two-year cumulative growth of 13% in Q3 compares to 11% in Q2. Growth was broad-based with solid sales in both IOU and public power and across U.S. and Canada. The IOU business achieved strong growth with existing customers while public power continued to build its base and had strong project activity.

The fundamentals of this business continue to look positive in both the U.S. and Canada. However, as we look into remainder of 2019, we expect to see some deceleration in the year-over-year growth rates as we have projects and contracts that have ended and will wind down in the fourth quarter and large wins that will begin to implement in the end of the quarter and ramp into 2020. Therefore, the timing will be a short-term challenge, but the long-term outlook for this business is positive.

To summarize, our third-quarter sales performance reflected good execution by the team, while the market experienced some softness in the global economy. We achieved organic growth in NSS and UPS segments and in all geographies. Our market data indices -- indicates that we maintained or gained market share in all our major businesses. As we look forward to the fourth quarter of 2019, the demand factor continues to be generally positive in all our businesses, but backlog is down slightly from last year.

We continue to see weakness in the OEM business in North America and EMEA, which is tied to industrial manufacturing activity. But as I mentioned earlier, the booking trend is positive and the results will continue to improve as we focus on vertical mix in that business. While we are concerned about some of the broader and political and macroeconomic uncertainty, including ongoing trade tensions, we remain cautiously optimistic that overall positive trends will continue for the fourth quarter. Based on our 5% reported and a 5.4% organic sales growth rates through nine months, the generally solid trends we are experiencing and the success of our focused initiatives, tampered by ongoing uncertainties in the external environment, we are narrowing the range of our outlook for the full-year 2019 sales growth to be between 4% and 5% from the previous 4% to 6%.

After adjusting for copper and foreign exchange, our organic sales growth range is 4.5% to 5.5%, which is updated from the previous outlook of 4.5% to 6.5%. With that, let me turn the call over to Ted for a more detailed analysis for our results and our outlook for the fourth quarter 2019. Ted?

Ted Dosch -- Executive Vice President and Chief Financial Officer

Thank you, Bill, and good morning, everyone. Bill covered our strong sales and gross margin performance. So I will begin with operating expense. Looking at Slide 8.

Third-quarter operating expense of $345 million compares to prior-year operating expense of $335 million. Excluding the non-GAAP operating expense items detailed on Page 11 of our release, adjusted operating expense increased 4% or $12 million to $336 million. As a percentage of sales, current-quarter adjusted operating expense increased 20 basis points to 15.1%. The primary drivers of the increase in adjusted operating expense were $6 million related to our digital innovation and business transformation initiative, as well as volume-related costs associated with our sales growth.

Sequentially, adjusted operating expenses was flat, an increase as a percentage of sales from 14.8% to 15.1%. Adjusted EBITDA increased by $14 million to $126 million due to strong volume and margin improvement in the segments along with strong expense discipline. Adjusted EBITDA margin of 5.6% increased 50 basis points from 5.1% in the prior year. Adjusted EBITDA leverage for the quarter was 6.5 times due to the factors mentioned above.

Details of operating income and adjusted EBITDA by segment can be found on Slide 12, 14, and 16. Moving down to the income statement. Interest expense of $18 million decreased compared to prior year. And other net expense of $1 million, compared to $2 million in the prior-year quarter.

Turning to taxes. Our third-quarter 2019 U.S. GAAP effective tax rate or ETR of 27.8% compares to 30.6% to third quarter of 2018, and our adjusted ETR of 27.6% compares to 30.6%. The lower ETR is due to country mix of earnings, which reflects our continued movement to a U.S.-center led model, where we drive strategy to achieve global network synergies, which are even more attractive due to the recent U.S.

tax reform. Our year-to-date GAAP ETR is 27.7% and adjusted ETR is 27.4%. We expect the ful-year rates to be consistent with this. Moving down to EPS.

Our adjusted diluted earnings per share of $1.92 increase by 19% or $0.31 from the year-ago quarter. As we discussed, we experienced both copper and currency headwinds in the quarter. The $12 million impact on sales translates into a $0.02 unfavorable impact on diluted EPS. Our diluted share count is 34.3 million shares.

Looking ahead, we expect our full-year share counts to be flat. Turning to Slide 17. Our working capital ratio of 16.9% compares to 18.3% in the prior-year quarter. This 140-basis-point decrease was driven by strong working capital performance through the quarter, partially due to the favorable quarter-end calendar.

We would expect full-year working capital as a percentage of sales to be plus or minus 18%, consistent with our long-term goals. We generated $206 million in cash flow from operations year to date, which compares to $103 million generated in the comparable period in 2018. The year-over-year difference was primarily due to improved earnings and the strong working capital management. Finally, we invested $14 million in capital expenditures in Q3, which brings our year-to-date total to $28 million, compared to $32 million in 2018.

This lower year-to-date expenditures compared to last year is mostly due to the timing of major project spend. We still expect full-year 2019 capex of $45 million to $50 million. Turning to Slide 18. Our debt-to-adjusted EBITDA ratio of 2.4 times compares to three times at year-end 2018, and it's just below our target range of 2.5 times to three times.

Our weighted average cost of borrowed capital was 5.4% in both the current and prior-year quarters, and our liquidity position remains strong with total available liquidity under revolving lines of credit and secured accounts receivables and inventory facilities of over $750 million at the end of the quarter. Turning to our outlook for sales growth. As Bill said, our outlook range for full year 2019 shows growth of 4% to 5%, which translates into organic growth of 4.5% to 5.5%. Based on trends in the business through the month of September and supported by generally favorable but decelerating economic indicators, we are estimating fourth-quarter 2019 sales growth to be 2% to 4% and organic growth to be in the 2.5% to 4.5% range.

Please note that Q4 include 66 billing days due to an extra week in our fiscal calendar. However, with the holidays, the extra week is projected to deliver significantly less revenue with a normal fleet of shipments. We are confident that was the momentum we have seen in gross margin for the last three quarters will continue, and we expect gross margin to improve for the fourth quarter by 20 to 40 basis points over 2018 and 30 to 40 basis points from full-year 2018 results. Turning to operating expenses.

For the full year, we expect adjusted operating expense as a percentage of sales to be flat compared to prior year. We have implemented tight cost controls to help offset the increased operating expenses for digital innovation and business transformation programs. Looking at the fourth quarter, we expect our adjusted operating expense dollars to increase by $10 million to $15 million over Q3 due to the inclusion of an extra week of expenses in our fiscal calendar. With our gross margin actions and expense control efforts, we expect 10 to 30 basis points of adjusted EBITDA margin improvement this year, with further increases next year and beyond toward our long-term goal of 6%.

To further help with your modeling, we have provided our estimates for the impacts of currency, copper, and acquisition on the fourth quarter and full-year 2019 sales, on Slide 19 of today's presentation. And we have included estimates for operating expenses, interest expense, other net expense and ETR for Q4 on Slide 21. Looking ahead, we expect to generate $100 million to $125 million of free cash flow for the full year of 2019. We expect to generate cash flow from operations of $150 million to $175 million for the full year of 2019 and to invest $45 million to $50 million in capital expenditures in 2019.

Based on the current value of the U.S. dollar against other currencies, we estimate a sales headwind of $10 million to $15 million for the fourth quarter and a headwind of $70 million to $75 million for the full year. Based on recent copper prices of approximately $2.55 a pound, we estimate unfavorable sales impact of $2 million to $4 million in the fourth quarter and $15 million to $20 million for the full year. As a reminder, average copper price was $2.75 in the fourth quarter of 2018 and $2.93 for the full year 2018.

Finally, there will be no incremental sales impact from the acquired businesses in Q4 as those businesses were acquired in Q2 of 2018. The sales impact for the full year is $48 million, reflecting the incremental five months of ownership in 2019. Let me conclude my comments by reiterating that we were very pleased to deliver solid sales growth in the third quarter. We believe our differentiators of global reach, technical expertise, and supply chain excellence provide a competitive advantage and position us for strong growth into the future.

We delivered on our additional priorities of improving gross margin and increased earnings in the third quarter. We're pleased that we are continuing to see the benefits of the actions that we have implemented. We are continuing to progress with our digital innovation and business transmission initiative, which will deliver state-of-the-art customer-facing technologies and best-in-class enterprise efficiencies. We expect our investment and innovation to deliver significant long-term benefits with the goals of improving profitability, increasing cash flow from operations and creating value for all our stakeholders.

With that, we will now open the call for questions.

Questions & Answers:


Operator

Thank you. [Operator instructions] And our first question comes from the line of Shawn Harrison from Longbow Research.

Gausia Chowdhury -- Longbow Research -- Analyst

Hi, good morning. This is Gausia Chowdhury on for Shawn. Congrats on the results. I wanted to ask about the markets.

Have any of the market changed as the quarter progressed? Meaning, have any other components in the guidance change for the year. Since it looks like the high end of the organic was taken down a bit. Could you talk about that a little?

Bill Galvin -- President and Chief Executive Officer

Yeah. I think you can -- as we said in the comments, the OEM business and the deceleration that I think the general market has seen provide a probably more headwind than we expected this year, especially as you can see in the automotive and in the semiconductor sectors of that. We have been, as I mentioned, reconfiguring kind of our position in the OEM business and have a line closer to areas where we believe there is good growth and you're starting to see that trend turn. But I would point to that and mostly as something to think about.

Gausia Chowdhury -- Longbow Research -- Analyst

OK. Great. And then with gross margin, is there any more color that you can provide on the -- within a certain business segment?

Bill Galvin -- President and Chief Executive Officer

Yeah. No, actually it's very broad-based across all segments. And as we had said in comments, it is really an enterprise plan that we've worked with all of the leaders around the company and focusing on values and several -- many different types of areas where we felt like we could improve our margins. So overall, it is really an enterprisewide results.

And I'm very happy with how the team is executed on this and more importantly, how we focused on value and that -- the results are really shown there.

Ted Dosch -- Executive Vice President and Chief Financial Officer

Yeah. And if I just add to that. As you know, we don't specifically disclose the gross margin by segment. But to reaffirm Bill's point, all three of the segments are showing gross margin improvement on a year-to-date basis as a result of our increased focus and discipline around delivering value to our customers and getting paid for it.

Gausia Chowdhury -- Longbow Research -- Analyst

OK. Great. And last for me, why is this the time to go private? Do you believe that the market was undervaluing you? Or was there a concern with the ERP change and maybe wanting to do it more out of the public eye? Or are there any other factors?

Bill Galvin -- President and Chief Executive Officer

Yeah. Good question. We weren't looking to go private. We were running the company as a public company and we're prepared to do that.

We've been very public about what our strategy is long-term. And we were approached by a company that we felt was a serious -- seriously interested in our company, and, of course, it's our responsibility -- our fiduciary responsibility to consider serious companies. And that is how we started in this venture.

Gausia Chowdhury -- Longbow Research -- Analyst

Thank you so much.

Operator

[Operator instructions] I will now turn the call back to the presenters for closing remarks.

Bill Galvin -- President and Chief Executive Officer

OK. Thank you. That concludes the call for today. If you have additional questions, please don't hesitate to reach out to Kevin.

As always, thank you for listening to today's call.

Operator

[Operator signoff]

Duration: 26 minutes

Call participants:

Kevin Burns -- Vice President of Investor Relations

Bill Galvin -- President and Chief Executive Officer

Ted Dosch -- Executive Vice President and Chief Financial Officer

Gausia Chowdhury -- Longbow Research -- Analyst

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