Q2 2019 Earnings Call
At this time I'd like to welcome everyone to the Anixter International second quarter 2019 earnings call.
All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question and answer session. If you would like to ask a question during that time simply press Star then the number one on your telephone keypad and if you do want to withdraw your question just press the pound key.
Thank you.
Hi, Kevin Burns SVP of Investor Relations and Treasurer, you May begin your conference.
Thank you Adam and welcome to Anixter second quarter 2019 earnings call with me to review our financial results are Bill Galvin, President and CEO and Ted notion 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 Dot com.
During our comments today, we will be referencing the slides we believe the non-GAAP measures. We disclose provides 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 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 strategies to deliver above market sales growth in the markets, we serve while expanding our gross and operating margins to continued sustainable earnings growth.
We have been achieving this by bringing our comprehensive solution capability for 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 youth 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 continued 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 Q2 of 10.9% compares to a two year cumulative growth of 9.3% for Q1.
Overall second quarter 2019, GAAP earnings per diluted share was $1.86 and adjusted earnings per diluted share increased 34% from prior year to $2.05.
Now, let me turn to gross margin on slide seven of our presentation.
As we discussed on the last two calls we have implemented long term strategies across the business to more fully recover inflationary price pressures of the last 18 months.
Second quarter gross profit improved 7% to 450 million, resulting in gross margin of 19.9% an increase of 30 basis points year over year.
This increase the midpoint of our outlook of 20 to 40 basis points for full year.
We believe gross margin expansion continues to represent a significant opportunity.
Let me now review our sales results by segment, beginning with network and security solutions on page 11 of the slide deck.
Record NSS quarterly sales of $1.2 billion increased 8% on an organic basis growth was broad based included including in our strategic sales initiatives. These areas include global accounts complex integrated supply programs and our security wireless and professional audio video business.
We had strong growth with global technology companies and with service providers and global accounts in emerging markets. This is the fifth consecutive quarter of organic sales growth for NSS.
By region NSS, North America sales increased 6% on an organic basis, driven by growth in both security and network infrastructure as well as strength in our wireless and professional Avi initiatives in EMEA NSS sales decreased 12.5% on an organic basis due to macro economic issues, including uncertainty around Brexit.
In addition, Q2 was a very difficult comp for our EMEA business as 2018 results grew 17% organically due to strong global account project activity.
The Q2, two year cumulative growth for NSS EMEA is 4%, we do however, see improving pipeline in project trends for the second half of the year, especially in the UK and middle East.
Emerging market sales increased 34% on an organic basis with strong growth in both cala and APAC.
The growth in Canada was broad based with strength in all major countries and continued strength of the existing new service providers in global accounts in the region.
Turning to the security side of the business sales of $525 million or approximately 44% for the segment.
Increased 14% driven by strong organic growth of 9% and the acquisitions completed in Q2 of 2018.
Booking activity and backlog continues to build especially with our global customers and continued strong project activity.
Moving to electric and electronic solutions on slide 13 record quarterly sales of $607 million increased 2% on an organic basis. This is the seventh consecutive quarter of organic growth for EPS.
Looking at EPS by region, North American sales increased 4% on organic basis as growth in North American commercial and industrial business was offset by declines in the OEM business. The OEM softness was consistent with the decline in global manufacturing activity that we're seeing around the world and as seen decelerating PMI durable good orders and other key macro indicators, especially in semiconductor and automotive industries.
In EMEA sales declined 6% and inorganic basis, we saw declines in both Cnine and OEM businesses in Europe , and the Middle East.
In emerging markets as sales decreased 4% on an organic basis with declines in both calendar impact.
Backlog declines from Q1 levels.
As this is is the business that is facing the deceleration of global industrial manufacturing activity affecting our OEM businesses and in macroeconomic activity in Europe .
While the Es business is down from Q1, it is still roughly flat with Q2 2018.
Finally, our utility power solutions segment achieved quarterly sales of 456 million, resulting in 5% growth on an organic basis shown on slide 15.
This represents the 10th consecutive quarter of growth for this segment.
Growth decelerated sequentially, but was against a more challenging Q2 comp from a year ago.
The two year cumulative growth of 11% in Q2 compares to 12% in Q1.
Growth was broad based with strong sales results in both IMU and public power and across the Us and Canada.
The value 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 continues to look solid in both the us and Canada and that backlog was largely flat in Q2. However, as we look at the remainder of 2019, we expect to see some deceleration in the year over year growth rates as Q3, and Q4 represent challenging comparables from 2018 with growth rates of eight and 13% respectively.
To summarize our strong second quarter sales performance reflected good execution by the team and benefited from a relatively stable economic backdrop.
We achieved organic growth in all segments in all geographies with the exception of EMEA.
Our market data indicates that we maintained or gained share in all major businesses.
As we look to Q3 and the rest of 2019 the demand backdrop continues to be generally positive in all our businesses and backlog is up mid single digits over last year. We do however continue to see weakness in the OEM business, which is tied to the industrial manufacturing activity and in our eastern European business.
This is some concern as key indicators had decelerated in recent months and we see signs of slowing manufacturing activity for industrial capital goods.
In addition, while backlog showed strong growth in Q2 in our NSS segment, we saw flat backlog trends in EPS and EPS for the quarter.
While we are concerned about some of the broader political and macroeconomic uncertainty, including ongoing trade tensions between us in China, we remain cautiously optimistic optimistic that our overall positive trends will continue for 2019.
We do not see any meaningful risk to our business from additional tariffs that may be levied on Chinese imports only a small portion of the products. We purchased our directly imported from China less than 1% for us the bigger impact has come from our suppliers, who import from China, and then pass those costs along to us as price increases.
However, we have been mostly successful in passing the tire related price increases along to our customers and we expect to continue to be able to do this if additional tariffs are put in place.
Based on our strong first half of the year. The generally solid trends, we are experiencing and the success in our focus sales initiatives tempered by ongoing uncertainties in the external environment, we are increasing the lower end of our range for outlook.
2019 of sales growth of 3.5% to 4% and reaffirming the upper end of the range at 6% after adjusting for copper and foreign exchange, our organic sales growth range is 4.5% to 6.5%.
With that let me turn the call off to Ted for a more detailed analysis of our results and our outlook for the third quarter 2019.
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 eight second quarter operating expense of $344 million compares to 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 headcount 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 and adjusted EBITDA by segment can be found on slides 12, 14 and 16 in our presentation.
Moving down the income statement interest expense of $19 million was flat with the prior year and other net expense of $750000 compared to $3 million in the prior year quarter.
Turning to taxes, our second quarter, 2019, us GAAP effective tax rate or EMR of 25.8% compares to 29% in the second quarter of 2018.
And our adjusted EBITDAR of 25.7% compares to 29.1%.
The lower EMR is due to country mix of earnings which reflects our continued movement to a US center led model, where we drive strategies to achieve global network synergies, which are even more attractive due to the recent use tax reform.
Our year to date GAAP EPS was 27.6%.
And adjusted EBITDAR is 27.3%.
We expect the full year rate to be consistent with this.
Moving down to EPS, our adjusted diluted earnings per share of $2.05 increased by 34% or 52 cents per share from the year ago quarter.
As we discussed we experienced both copper and currency headwinds in the quarter.
The 27 million dollar impact on sales translates into an eight cents unfavorable impact on diluted EPS.
The lower tax rate in the quarter contributed any of 11 cents per share benefit.
Six cents related to Q2, and five cents associated with the Q1 catch up.
Excluding the impact of the lower tax rate, our reported 34% increase in adjusted EPS would have been 27%.
Our diluted share count of 34.2 million shares looking ahead, we would expect our share count to be relatively flat for the remainder of 2019.
Turning to slide 17, our working capital ratio of 19.2% compares to 18.7% in the prior year quarter.
This 50 basis point increase was driven by working capital investment to support the growth in complex programs and projects in the business.
We would expect for the full year working capital as a percentage of sales to be plus or minus 18% consistent with our long term goals.
We used $63 million in cash flow from operations year to date, which compares to $69 million generated in the comparable period in 2018.
The year over year difference was primarily due to a larger use of working capital to support the business.
Finally, we invested $8 million in capital expenditures in Q2, which brings our year to date totaled $14 million compared to $25 million in 2018.
The 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 $55 million to $60 million.
Turning to slide 18, our debt to adjusted EBITDA ratio of 2.9 times compares to three times at year end 2018 and is at the high end of our target range of 2.5 to three times in the year.
Our weighted average cost of borrowed capital of 5.3% compares to 5.1% in the prior year quarter.
And our liquidity position remains strong with total available liquidity under revolving lines of credit and secured accounts receivable and inventory facilities of $547 million at the end of the quarter.
Turning to our outlook for sales growth as Bill said, our outlook range for full year 2019 is growth of 4% to 6%.
Which translates into organic growth of 4.5% to 6.5% and reflects a 50 basis point increase in the low end of our range compared to our previous outlook.
Based on trends in the business through the month of July and supported by generally favorable but decelerating economic indicators. We are estimating third quarter 2019 sales growth to be 2% to 4%.
And organic growth to be in the 2.5% to 4.5% range.
This outlook is for lower growth than we delivered in Q1 and Q2.
But has a more difficult prior year comp.
The two year cumulative growth outlook for the second half of the year is 10.5%.
Compared to 10.1% in the first half of the year.
We are confident that the positive momentum we have seen in gross margin for the last three quarters will continue and we expect gross margin to improve for the third quarter and the full year by 20 to 40 basis points from 2018 results.
Turning to operating expense for the full year, we expect adjusted operating expense as a percentage of sales to increase slightly we have implemented tight cost controls to help offset the increased operating expenses for our digital innovation and business transformation programs.
Looking at the third quarter, we expect our adjusted operating expense dollars to increased by $5 million to $10 million over Q2.
Due to expected sales and operations headcount additions to support growth in the business and increased investments in our digital innovation initiative.
As we have previously commented the investments and our innovation and business transformation can vary from quarter to quarter and were expecting more spend in Q3 than we saw in Q2.
With our gross margin actions and expense control efforts, we expect 10 to 30 basis points of adjusted EBITDA improvement this year.
With further increases next year and beyond turns are towards our long term goal of 6%.
To further help with your modeling we have provided our estimates for the impact of currency copper and acquisition on third 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 EMR for Q3 on slide 21.
Looking ahead, we expect to generate $95 million to $115 million of free cash flow for full year 2019, consistent with the outlook, we provided last quarter.
We expect to generate cash flow from operations of $150 million to $175 million for the full year 2019.
And to invest $55 million to $60 million in capital expenditures in 2019.
Based on the current value of the US dollar against other currencies, we estimate a sales headwind of $5 million to $10 million for the third quarter.
And a headwind of $50 million to $55 million for the full year.
Based on recent copper prices of approximately $2.70 per pound.
We estimate unfavorable sales impact of $3 million to $5 million in the third quarter and $15 million to $20 million for the full year.
As a reminder, average copper price was $2.73 in the third quarter of 2018 and $2.93 for the full year of 2018.
Finally, there will be no incremental sales impact from the acquired businesses in Q3 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 strong sales growth in the second 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 second quarter.
We are pleased that we are continuing to see the benefits of the actions we have implemented.
We are continuing to progress with our digital innovation and business transformation initiative, which will deliver state of the art customer facing technologies and best in class enterprise deficiencies.
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 of our stakeholders.
With that we will now open the call for questions.
Thank you at this time I would like to remind everybody. If you do want to ask a question just press Star then the number one.
Correct.
And our first question does come from David Manthey of Baird.
Please go ahead.
Thank you good morning, guys.
For the.
So first off last quarter.
Emerging markets in NSS, you said.
You 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 the supply chain and services business that we're been driving as well as global account activity, which has remained strong in 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 referred to over the last couple of years as complex programs as opposed to just projects and these programs are typically multi year contractual agreements. So.
The comps will get more difficult back half as as bill talked about but we don't see any significant drop in in that revenue due to timing of projects.
Okay Thats good to hear and second on operating expenses, Ted you mentioned.
Additional investment in headcount and digital in the second half would drive that number up the SGN a number by maybe five to 10.
A million dollars, but if I look at flat SGN 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, Hi, I at this point in time Im 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 for the investment in our innovation of 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 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 top level performance and to add to that sequence as we've mentioned Ted said it too is that we can't expect to continue to get that kind of leverage of three X on the business. So.
We are investing in sales and 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 Mcfadden 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 thats.
Above the market growth you mentioned share gains can you just comment where you guys are winning.
And his entire range playing a large part in that.
Yes, Michael that's a 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 were going after the market aware, 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 I feel like its strategy driven I think the interchange as well as the distribution businesses. We acquired in Australia have been helpful, but even without that our organic growth was 9% and security and.
Again, I believe that taking share what you're seeing in the market.
Congrats.
And it's nice to see the NSS margin.
Target came up the commentary around yes, it sounded a little softer from a macro perspective, but the segment margin target remain the same.
Oh.
Can you give us a little color there what I mean is there how confident are you that the second half expectations.
Yes, you do you have enough built up already in the backlog lower visibility to meet those targets.
Yes. So so first on the revenue side for E Commerce as we said the headwind there has been on the OEM segment, which we think and everyone points through 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 thats going to change right now.
So we're doing a lot of things to continue to expand the OEM business in 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 lay up if you will.
Yes, and I would just add to it back to Mike to your specific.
Question about margin for EPS, we did have a strong operating margin for EPS.
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 said between OEM, which we as we've always said as a higher margin than the.
Hi portion of the business, but we do think that that.
The target we had for full year is still achievable, even with a somewhat lower topline growth rate on the NSS side, we're seeing of.
As a result of 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 as a lower margin profile than the infrastructure side. So.
We we felt it was appropriate to take that NSS outlook for operating margin up based on the continued strength we're screening through the first half.
Michael one more comment on that Susan. The then I think we've said in prior calls the OEM business for EPS does run at a higher margin. So the performance on the margin is actually very good and is 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.
There's a little bit of a different question one of your larger suppliers, who was recently asked the impact from Wawa way.
And I believe they are both.
You always have both a customer and a supplier for them.
If the wireless spend the Fiveg initiative becomes more of a nationalistic.
Kind of take some more national is the kind of tone to it is that.
Mix up or market share play for you guys. How do you feel this is progressing in terms of the overall.
Macro standpoint.
Yes, I'll, even broaden that beyond while way it goes to the conversation in 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 in especially in the Fiveg 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 Rollouts. So all in all as long as the investment continues we see an opportunity to take advantage of that market.
And is there.
An update on timing for when you.
Expect that market to reach critical mass or we get past. These everyone's trying to figure out the spectrum went when do you. When do you see things really really taking off from here I think you've seen some companies just in this past earnings seasons come out and say they are starting to see strong benefit from fiveg. The investments. So I as 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 investment 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 along.
Yes.
Your next question comes from Shawn Harrison of Longbow Research. Please go ahead.
Good morning, everybody and congrats on the strong results.
Thank you St John .
This 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 are beginning to anniversary that I was hoping you could 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, John Good point, we actually said in in the fourth quarter of 17 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 than in Q2.
And Thats 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 we think and continued to see bookings and backlogs strengthen and believe that that will at least continue for the next several quarters.
Yes.
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 asset in NSS in particular, which as half of our overall business than significantly influences. The total company growth rate. So as we sit here looking at the our first half performance and see a 10.1%.
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 part of that which I think makes that.
Even I guess better for the for the long term is that a significant part of that growth is really coming from.
Our our complex programs.
Which don't Sunset 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 that revenue and the base grows right given the fixed base grows through all the other growth and project activities on top of that.
That's helpful. As a follow up just the CNS growth you saw this quarter, if I, if I listen to fastenal or granger efficacy or whomever they are citing slowing industrial growth in the business and so I know you are seeing that in the OEM business, but the commentary also seemed a bit weaker on just their 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 this year.
Yes, I think in fairness.
What we're seeing now for instance in the US, we said, 4% growth and and 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 base, Sean 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 will perform with that I do think.
We continued to focus also on efficiencies, though and investment into the areas of the market. We feel like we can get growth. So.
Im happy with the performance in a difficult market, but but theres other things we can do.
And then just lastly from a high level is has there been any discussion with the board in terms of a share buyback program being put in place I mean.
Great results, the stack is up a little bit but.
Not significantly over the past 12 months earnings are going up and the valuations going down so.
Probably a frustration internally, but any thought of a buyback.
Yes, Sean.
Here's how we think about it and it's not significantly different or I should say it it is not different than how weve really framed it for the last several years as we think about our capital allocation strategy, what has always first and foremost.
As the 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 a little bit that is 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 this 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 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 are not anticipating and don't see that being that next big transformational acquisition, but more the bold 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.
Forward.
So.
Some return of value to shareholders in some form or another is still on that list.
Of the top four priority from a capital allocation standpoint, but I think we need to be prudent why we're sitting here with.
Our leverage ratio debt to EBITDA off still.
While it's now within the range is still at the high end of that 2.5.
The three times range that that we've discussed.
Okay.
And your next question comes from Brian Bernard of Morningstar. Please go ahead.
Hey, good morning, guys and nice quarter.
Hey.
Just one question for you any kind of touched on here, but obviously, we've seen some other distributors and our you know said, they're going to tighten their spending due to softening demand you guys. Obviously enjoying strong growth and you talked about adding heads to support that growth your innovation transformation 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 we're 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've been doing activities to pivot from what we would consider slower growth or.
Market, where we feel like the returns not where we wanted to be in a 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 in that 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 then 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 again kind of Wells Fargo.
Please go ahead.
Thanks for the follow up.
If I can just go back to the.
Spending initiative again and.
Operating expenses you guys are expecting a ramp here can you kind of frame for us what.
Is growth and what is maybe duplicate costs that you're expecting to roll out roll off after your first ERP rollout, which I believe is scheduled first half 2020.
Is there any frame framework around that.
Yes so.
Mike I'd suggest to think about it this way.
And so remember in third quarter, we won't have 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 increase spend year over year.
We only had.
About $5 million of increased spending in Q2 of this year and our innovation of business transformation and.
On our fourth quarter call and in our first quarter call, we framed to that more as something in the range of $7 million to $8 million a quarter. So again. This is a big project in 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 than in the first half Jeff the way the project.
The project work has come together.
So as we go forward from here.
We now expect the Innovent the investment in innovation business transformation to be the single largest driver of the growth.
Followed by.
The spend to support the volume growth, which.
Sequentially.
Yes, most of that spend is in there other than what we talked about now having to do some investment in head. So if you think about the.
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 plenty plenty, 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 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 it relates to the process when we fully ramp that up throughout the couple of years after 2020.
Okay.
And then.
Lastly, there has been some big.
Renewed.
Announcements in terms of wind investment here in the northeast quarter. I was wondering how you guys are positioned from a t. NDC spend standpoint short term long term anything you can give there.
Yes.
Renewables.
Both wind and solar.
Our strong.
Say customer vertical of ours within our ETF business.
So we have participated in a significant portion of those projects historically I can't speak specifically to project 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.
Theoretical question not looking you to guide 2020, but if you're 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 transformation.
Would you still in a low single digit organic environment be able to deliver one and a half times EBITDA leverage or is there an incremental cost step up next year that we need to consider.
Yes, Sean 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 we delivered.
Three plus times leverage higher than weve ever done before as a as a company.
But as you think about different ranges of growth. If we were operating are delivering say low single digit topline growth I would expect us to be able to have operating margin leverage in the 1.25 to 1.5 range. If were 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 topline growth is high single digits. Then I would expect that operating margin leverage to be more than 1.5 to two range. So I think our business model with 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 would also add that we continue to focus on operational efficiencies that will help us continue to drive that leverage. So we're not done. This so many things we're working on to.
To drive.
Efficiencies in the operation in facilities and many other costs that we think we have if we have opportunities to improve.
That's great guys very helpful.
Thanks.
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.