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Tech Data Corporation (NASDAQ:TECD)

Q3 2013 Earnings Call

November 20, 2012 9:00 am ET

Executives

Robert Dutkowsky – Chief Executive Officer

Jeffrey Howells – Executive Vice President, Chief Financial Officer

Arleen Quinones – Director, Investor Relations

Analysts

Matthew Sheerin – Stifel Nicolaus

Jim Suva – Citi

Brian Alexander – Raymond James

Rich Kugele – Needham & Co.

Ananda Baruah – Brean Murray

Osten Bernardez – Cross Research

Lou Miscioscia – CLSA

Craig Hettenbach – Goldman Sachs

Operator

Good morning. Welcome to Tech Data Corporation’s Fiscal Year 2013 Third Quarter Earnings conference call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question and answer session. To ask a question, please press star, one. Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

Now I will turn the meeting over to Arleen Quinones, Director of Investor Relations. Ma’am, you may begin.

Arleen Quinones

Thank you, Latanya. Good morning and welcome to Tech Data’s Third Quarter 2013 Earnings conference call. I am joined this morning by Bob Dutkowsky, Chief Executive Officer; Jeff Howells, Executive Vice President and Chief Financial Officer; Nestor Cano, President – Europe, and Murray Wright, President – The Americas.

Before we begin, I would like to remind all listeners that today’s earnings press release and certain matters discussed in today’s call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on the company’s current expectations and are subject to risks and uncertainties. These risks and uncertainties include but are not limited to those factors identified in the release and in our filings with the Securities and Exchange Commission. Please be advised that the statements made during today’s call should be considered to represent the expectations of management as of the date of this call. The company undertakes no duty to update any forward-looking statements to actual results or changes in expectations. In addition, this call is the property of Tech Data and may not be recorded or rebroadcast without specific written permission from the company.

I will now turn the call over to Tech Data’s Chief Executive Officer, Bob Dutkowsky.

Robert Dutkowsky

Thank you, Arleen. Good morning everyone and thank you for joining us today. As we entered our third quarter, we continued to face global macroeconomic headwinds and weak IT spending trends, as well as challenges in our U.S. operations following the implementation of certain SAP modules in Q2. Our third quarter results, which came in below plan in prior year, reflected the ongoing impact of these collective challenges.

Our worldwide results matched the solid performance by our European team in a difficult environment. With sales growth in euros of 8%, excluding the change for warranty service and fulfillment contracts, Tech Data Europe clearly outperformed the market, turning in the region’s highest third quarter sales in euros in its history. The majority of our nine trade regions reported year-over-year sales growth in local currencies with strong double-digit growth in the U.K. and in France.

Despite gross margin pressures due to product mix, a highly competitive pricing environment and aggressive vendor goals, our European operations also delivered the region’s highest third quarter operating income in euros in its history with every trade region contributing to a profitable quarter. This performance is attributable in large part to the region’s product diversification efforts and the team’s strong execution. Our European mobility division, Tech Data Mobile, was the quarter’s standout business, delivering strong double-digit year-over-year sales growth and operating income above plan and prior year.

Our Americas region was also challenged by competitive pricing, a changing product mix, and aggressive vendor goals as well as weak market conditions that worsened throughout the quarter. The region’s performance was further impacted by the effects of our implementation in the second quarter of the final core SAP modules in the United States. These factors collectively resulted in sales and earnings that fell short of plan in prior year.

As we indicated last quarter, our SAP system in the U.S. works; however, our overall execution is still not at the level it needs to be. Varied skill levels and lack of system proficiency impacted our productivity and ultimately led us to miss out on opportunities to sell more during the quarter. While the majority of our customers felt little to no impact by the system changes, some experienced a drop in service levels, prompting them to move pieces of their business. As a result, we lost market share in the U.S. in Q3.

We also continued to experience margin management challenges stemming from the use of new processes, tools and reporting. Our management of the front end for determining the price at which we sell products has not been as smooth a transition as we anticipated and, we believe, may have unintentionally contributed to more aggressive pricing in the market. Our intent is always to remain competitive but not lead with price; therefore, we are actively working to ensure that our pricing is in line with the market and that we are leading with our value proposition of service, product availability, credit, technical support, and flawless execution and logistics.

It’s important to note that logistics execution is not an issue for us; in fact, since completing the implementation of SAP warehouse management throughout the U.S. logistics centers four years ago, our logistics capabilities and productivity have continued to improve, even during the last two quarters. Rest assured that throughout our U.S. operations, there are tremendous amounts of energy and effort around regaining the confidence of our customers and vendors, and we are making good progress in winning back business from both. Each day, our U.S. team continues to sharpen its use and understanding of the system while making enhancements to ensure a return to previous levels of consistency and profitability. Importantly, as demonstrated by the recent performance of our European region which runs the very same SAP system, we are confident that the long-term benefits of the system far outweigh these short-term bumps in the road.

In other highlights, in September we announced an agreement to acquire the shares of several distribution companies belonging to Specialist Distribution Group, a leading distributor of enterprise and broad line IT products in the U.K., France and the Netherlands. The acquisition of SDG is particularly exciting because it accelerates our enterprise business, Azlan, in key European markets, provides us with increased scale, enabling us to efficiently leverage our infrastructure and reinforce our position as Europe’s leading distributor of value-add and broad line IT products. On November 1, we completed the acquisition and we welcome the SDG employees to the Tech Data team.

In September, we also completed the purchase of our joint venture partner’s 50% interest in our European mobility joint venture, now branded TD Mobile. Going forward, Tech Data shareholders will benefit from owning 100% of this fast-growing and highly profitable specialty division. Both of these transactions support our diversification strategy while demonstrating our commitment to and competence in the European IT and mobility distribution markets.

Also in September, we enhanced our capital structure through the issuance of a five-year, $350 million bond with a 3.75% coupon. This was the first public straight debt offering of Tech Data’s history, the proceeds of which were used to fund the acquisition of SDG. So as you can see, Q3 was a very busy quarter for Tech Data.

Jeff will now cover the financials, and then I’ll provide a few closing comments before we open the call up to your questions. Jeff?

Jeffrey Howells

Thank you, Bob. Many of my comments will reference supplemental schedules which are available on our website at www.techdata.com/investors.

Beginning with Slide 1 and Slide A1, net sales for the third quarter ended October 31, 2012 were $6.04 billion, a decrease of 8% from $6.59 billion in the prior year third quarter. The weakening of certain foreign currencies against the U.S. dollar negatively impacted the year-over-year net sales comparison by approximately 5 percentage points. In the first quarter of fiscal 2013, we prospectively revised our presentation of sales of vendor warranty services and certain fulfillment contracts such as they are now reflected on an agency basis as net fees as opposed to net sales and cost of products sold. These items would have contributed approximately $215 million of net sales in the third quarter which negatively impacted the year-over-year net sales comparison by approximately 3 percentage points. This change had no impact on gross profit dollars, operating income dollars, net income dollars, or earnings per share for any period, but positively impacted the gross margin and operating margins in the third quarter of fiscal 2013 by approximately 17 and 4 basis points respectively.

Also included in the prior year net sales is approximately $52 million related to the in-country operations of Brazil and Colombia, which the company exited at the end of fiscal 2012. Excluding the impact of these factors, net sales increased approximately 1%. This supplemental information is fully summarized on Slide A1.

Third quarter net sales in the Americas were $2.37 billion or 39% of worldwide net sales, a decrease of 15% from the prior year third quarter. The change in the presentation of vendor warranty services and fulfillment contracts reduced the Americas third quarter fiscal 2013 net sales by approximately $101 million. Included in the Americas prior year net sales is approximately $52 million related to in-country operations of Brazil and Colombia, which we exited at the end of fiscal 2012. Excluding the impact of these factors as well as the translation effect of certain foreign currencies, the Americas net sales decreased by approximately 10%. This decrease was attributable to general market conditions and the loss of market share in the U.S. following the implementation of certain SAP modules in the second quarter.

Net sales in Europe totaled $3.67 billion or 61% of worldwide net sales, a decrease of 4% from the prior year third quarter sales in U.S. dollars and a 5% increase on a euro basis. The change of presentation of vendor warranty services and certain fulfillment contracts reduced Europe’s third quarter fiscal 2013 net sales by approximately $113 million or €88 million. Excluding the impact of this change, net sales decreased by approximately 1% in U.S. dollars and increased 8% on a euro basis.

Slide 2 shows year-to-date worldwide sales of $17.9 billion, a decrease of 8%. Looking at our regions, the Americas sales declined 11%, European sales decreased 5% in U.S. dollars but increased 4% in euros on a year-to-date basis. However, year-to-date after adjusting for the prospective changes to sales, the exit of Brazil and Colombia, and the effect of foreign currency, worldwide sales increased 2%, Americas sales declined 4%, and European sales increased 7%, both in dollars and euros.

Slide 3 summarizes our operating performance in the quarter. Worldwide gross margin for the third quarter is 5.10% compared to 5.23% in the prior year third quarter. The change of presentation of warranty services and fulfillment contracts positively impacted gross margin by approximately 17 basis points. The year-over-year decline is attributable to competitive pricing pressure and product mix in both regions as well as the impact of implementation of certain modules of SAP in the U.S. during the second quarter.

SG&A expenses were $238.7 million or 3.95% of net sales compared to $255.2 million or 3.87% of net sales in the prior year third quarter. The decrease in SG&A expenses was primarily attributable to a weaker euro and lower expenses resulting from the exit of in-country operations in Brazil and Colombia at the end of fiscal 2012. The change in presentation of warranty services and certain fulfillment contracts increased SG&A as a percentage of net sales by approximately 13 basis points.

Operating income for the third quarter was $69.5 million or 1.15% of net sales compared to $89.6 million or 1.36% of net sales in the prior year third quarter. The year-over-year decline in operating income is attributable to sales shortfall in the Americas as well as impacts on the gross margin of competitive pricing and product mix in both regions. On a regional basis, operating income in the Americas for third quarter was $33.7 million or 1.43% of net sales compared to $52.6 million or 1.89% of net sales in the prior year third quarter. The change of presentation of warranty services and fulfillment contracts increased Americas operating income as a percent of net sales in the third quarter of fiscal 2013 by approximately 6 basis points. The decrease in operating income was attributable to lower sales and the impact on gross margin of competitive pricing, product mix, and changes made to certain vendor programs. The Americas operating performance was further impacted by the effect of the implementation of certain SAP modules in the second quarter.

Operating income in Europe for the third quarter was $39.4 million or 1.07% of net sales compared to $39.7 million or 1.04% of net sales in the prior year third quarter. The change in presentation of warranty services and certain fulfillment contracts increased Europe’s operating income as a percent of net sales in the third quarter by approximately 3 basis points.

Interest expense for the quarter was $4.4 million compared to 8.4 million in the prior year third quarter. The decrease in interest expense is primarily attributable to the repayment of the $350 million convertible subordinated debentures in December of 2011 and funding our Q3 fiscal 2013 financing requirements with lower rate revolving credit facilities and 3.75% senior notes issued in September of 2012.

The company’s effective tax rate for the third quarter was 25.5% compared to 29.2% in the prior year third quarter. As noted in previous quarters in accordance with FIN 18 accounting pronouncement, quarterly effective tax rates may vary significantly depending on the actual operating results in various tax jurisdictions. The annual tax rate is expected to be 27 to 28%, relatively consistent with the prior year.

Slide 4 shows our operating highlights for the first nine months of the fiscal year. Worldwide gross margin was 5.19% compared to 5.26% in the prior year period. SG&A expenses were 720 million or 4.03% of net sales compared to 775 million or 4% of net sales in the prior year period. Operating income for the nine months was $209.7 million compared to $244 million in the prior year. As a percentage of net sales, operating income for the first nine months was 1.16% compared to 1.26% in the first nine months of the prior year period.

Slide 5 summarizes the other key metrics, including net income and earnings per share. Net income attributable to shareholders of Tech Data for the third quarter was $45.9 million or $1.21 per diluted share based on 38 million weighted average diluted shares outstanding. This compares to $53.5 million or $1.26 per diluted share in the prior year third quarter based on 42.6 million weighted average diluted shares outstanding. The year-over-year decline is attributable to aforementioned decreases in sales and operating income partially offset by lower interest expense and lower non-controlling interest resulting from the acquisition of our European mobility joint venture partner’s 50% interest in September. A lower average share count from share repurchases further minimized the impact on the operating performance shortfall on earnings per share.

Turning now to the balance sheet, please refer to Slide 6 and 7. Some of the highlights include the company’s cash position at the end of the quarter was $516 million. The allowance for bad debt was $54.3 million. Days sales outstanding were 42 days compared to 40 days in the prior year period. Days of supply at the end of Q3 were 32 days compared to 29 days in the prior year period. Days payable outstanding at the end of Q3 were 49 days compared to 47 days in the prior year period, and our cash conversion cycle for the third quarter was 25 days compared to 22 days in the prior year period. Cash provided by operations during the third quarter totaled $33.1 million. Total debt was $420 million. Total debt to cap was 19%.

Funds available for use under our credit facilities were approximately $689 million at the end of the quarter. Accumulated other comprehensive income, which consists of currency translation and other applicable taxes, was $280 million at the end of the third quarter compared to 202 million at the end of the second quarter, a sequential increase of $78 million.

At October 31, 2012, the company had 37.8 million shares outstanding and $154 million of goodwill and acquired intangibles, which resulted in tangible book value of $44.52 per share.

Capital expenditures totaled $8.3 million in Q3 and our plan remains the same for fiscal 2013 capital expenditures reaching approximately $40 million. Third quarter depreciation and amortization expense was $13.5 million.

On Slide 8, you’ll see our product and customer mix for the 12 months ended October 31, 2012, which remained relatively consistent. In Q3, we had two vendors that generated more than 10% of our sales on a trailing 12-month basis. HP represented 21% of our sales in the quarter compared to 25% in the prior year third quarter; and Apple represented 12% of our sales in the quarter compared to 9% in the prior year third quarter.

Turning to recent transactions and our business outlook, as Bob indicated in his opening remarks, on September 11, 2012 we completed the acquisition of Brightstar Corporation’s 50% ownership interest in Brightstar Europe Limited, which was a consolidated joint venture between Tech Data and Brightstar Corp. The terms of the agreement included a payment of $165.6 million in cash for Brightstar Corp.’s equity in the joint venture, reflected as its non-controlling interest within the company’s consolidated balance sheet, and the repayment of all loans advanced by Brightstar Corp. to the joint venture. Upon the closing of the transaction, we recorded a decrease of approximately $85.9 million to additional paid-in capital within shareholders equity comprised of approximately $85 million purchase price premium paid to Brightstar Corp. for its share of the joint venture and approximately $900,000 of direct costs incurred with the transaction.

Also upon completion of the transaction, our joint venture partner’s portion of the mobility operations operating performance, which has been reflected as net income attributable to non-controlling interest, was eliminated. Going forward, given the mobility business’ overall profitability, we anticipate this to contribute positively to the company’s net income and earnings per share. The acquisition of Brightstar Corporation’s 50% interest and repayment of all loans advanced by Brightstar Corp. were funded with the company’s available cash.

In addition, on November 1 we completed the SDG acquisition previously announced in September. The company paid approximately $365 million or €281 million for SDG. Proceeds from our recent $350 million public debt offering and available cash were used to fund the acquisition. The purchase premium of approximately $222 million or approximately €171 million, which is subject to final purchase price adjustments, is comprised of approximately $140 million or €108 million related to a preferred supplier agreement and customer list to be amortized over five and 10 years respectively, and approximately $82 million or €63 million attributable to goodwill. We expect to incur integration and acquisition costs over the next four to five quarters.

As a reminder, SDG generated third party sales of approximately $1.75 billion or €1.4 billion for the 12 months ended March 31, 2012, categorized by product group as 40% data center products including servers, storage and networking products; 20% software, predominantly data center focused; and 40% broad line products, including PC and peripherals. This sales breakdown will be important for modeling the anticipated margin contribution of the acquired business. The transaction also includes a preferred supply agreement whereby the seller, through its IT reseller business, will have annual purchase commitments to Tech Data for a period of five years, which we estimate will add incremental annual sales of approximately $500 million or €400 million. For modeling purposes, assume the same breakdown of the business.

We expect the SDG acquisition to have a minimal impact on fiscal 2013 earnings after including amortization, acquisition and integration costs. We expect the transaction to be accretive to fiscal ’14 earnings, albeit at a slightly lower operating margin than our current European operating margin target due primarily to integration costs. However, we expect to see the full benefit beginning in fiscal 2015.

For the fourth quarter of fiscal 2013 on a reported basis, the company expects year-over-year low single-digit sales growth and sequential improvement in gross and operating margins. On a regional basis in Europe, excluding the impact of SDG, the company expects year-over-year sales growth of low single digits in euros. In the Americas, the company expects a year-over-year low double-digit sales decline due to the continued impact of the implementation of certain SAP modules in the U.S. during the second quarter and the exit of Brazil and Colombia at the end of fiscal 2012. Included in the fourth quarter of the prior fiscal year are our sales for Brazil and Colombia of approximately $20 million.

All of the above year-over-year comparisons are impacted by the fiscal 2013 change in presentation of vendor warranty services and certain fulfillment contracts and general market conditions. We estimate the change in presentation of warranty services and fulfillment contracts will reduce worldwide sales by approximately $200 million in the fourth quarter of fiscal 2013. On a regional basis, the amount next quarter is estimated to be approximately 3% of Americas sales and approximately 2% of European sales in Europe. We also assume an average U.S. dollar to euro exchange rate of $1.28 to €1 for the fourth quarter.

I will now turn the call back over to Bob for a few additional comments.

Robert Dutkowsky

Thanks, Jeff. In closing, despite Europe’s difficult economy, our European team managed to grow its business and improve operating income in euros, and while their performance wasn’t enough to completely offset the Americas shortfall, recent investments such as the buyout of our European mobility JV together with capital structure enhancements enabled us to minimize the impact to earnings per share. This speaks to the value of the Tech Data model. Our geographic and product diversification, together with a flexible business model and the best workforce in the industry, enabled us to adapt and to operate profitably even in challenging times.

While our recent financial results have been below our expectations, understanding the breadth of our significant accomplishments during the fiscal year is fundamental to valuing the opportunities that lie ahead of us. Completing the U.S. implementation of our SAP ERP system, acquiring the other 50% of our European mobility joint venture and acquiring SDG, enhancing our capital structure by issuing public debt at an attractive rate, and buying back $185 million of our stock has allowed us in the last nine months to build a stronger company for the future. We are a company that is executing in the reality of the short term while at the same time preparing for the long term, poised to capitalize on opportunities that will help us to better serve our customers, strengthen our vendor partnerships, and reward our shareholders.

As we look ahead to the fourth quarter, our number one priority is to continue the improvement of service levels in our U.S. operations in order to regain our customers’ confidence and business as quickly as possible. Taking into account the number of internal and external market factors impacting our operations, it is clear that our recovery in the U.S. will take longer than we anticipated, but we’re committed to get back on track in a disciplined and responsible manner. We made good progress in Q3 and we expect to make sequential improvements over the next four to five quarters as we work to regain selected market share by leading with our time-tested value proposition of service, product availability, credit, technical support, and flawless logistics.

Finally, I’d like to say thank you to our vendors and customers for their business and for their continued support, and to my Tech Data colleagues for their continued hard work and dedication. With that, we’ll open the call up to your questions.

Question and Answer Session

Operator

Thank you. We will now begin the question and answer session. [Operator instructions]

Our first question comes from Matthew Sheerin with Stifel Nicolaus. Please proceed with your question.

Matthew Sheerin – Stifel Nicolaus

Yes, thank you and good morning. So first question is sort of a multi-part question related to your gross margin guidance. You’re looking for some sequential improvement. Are you expecting it still to be down on a year-over-year basis, because it looks like you’re down still about 17 basis points or so from where you were in January of 2012. And then related to that, on the improvements, is that mostly product mix or volume-related impact, or would you see positive results from the improvements you’re talking about in North America on the SAP?

Jeffrey Howells

Matt, this is Jeff. On the gross margin, it would be more likely than not that we would not achieve last year’s gross margin percentage target, but our goal is to continue to improve over the prior quarter as we regain share responsibly in both markets. In the reality of the world, we’re selling different products this year at a faster pace than last year. That’s compounded by the fact that we have begun the year, as our competition has, experiencing programs that our vendors allow us to earn rebates under that were more aggressive than the market, and so that is starting to work itself out as targets get more in line with the reality of the market. But as we’ve said numerous times in our opening comments, the combination of the change in the products, our change in the goals of vendors, as well as the implementation of the last few modules of SAP in the U.S. led us to potentially price too aggressively on what we call the front-end of our business, and still with that pricing not achieve the total opportunity in the back end. So we’re going to watch it and monitor it very closely and responsibly move forward.

Matthew Sheerin – Stifel Nicolaus

Okay. And just as a follow-up, you did talk about this using the term responsibly. Does that mean that you’re not—obviously you could probably get some of that share back more quickly on more aggressive pricing, so what’s your strategy or thoughts behind pricing versus taking lower volumes as you improve there? And then also just on the SAP, have you implemented the similar modules in Europe?

Robert Dutkowsky

Yeah Matt, this is Bob. So first of all, the SAP question – as I said in the prepared comments, the system that we are implementing in the U.S. is fundamentally the same as the system we’ve implemented in Europe across all of the operating units there. In fact, when we’re done with the U.S. implementation, excluding the SDG acquisition, more than 90% of our revenue will be running on one core system, which we think is a big competitive advantage over the long haul. We’ve been implementing this system now for nearly 10 years and we’re 90% complete with it, so we think that that gives us a strong base to build off and allows us to execute very well.

Look at the execution of our European business in Q3, where we grew revenues and gained share, and we like to attribute a piece of that excellence in execution to that core SAP system. That’s the same fundamental system that’s being deployed here in the U.S., so from an SAP perspective we’re excited and confident about what the future holds as we complete the rollout. And as I said in my comments, the short-term bump in the road is going to be well worth the long-term benefits that we’ll gain, and you can again reference our European performance.

We’ve talked about responsible growth for a long time as a company, and in order to deliver responsible growth we have to rely on our core value proposition of service, technical support, credit, product availability, and lead with that and that will drive a return to appropriate share levels with the right profitability. It’s a model that we’ve executed for a long time, and we’ll stick with that model.

Jeffrey Howells

I’d like to just add to Bob so it’s completely clear – in Q2, we turned on the last two or three modules of SAP in the U.S. We’re not in the process of adding more or rolling out more – it’s done. We’ve been converting the SAP over the last four or five years in the U.S. area by area, module by module; so when he quotes that 90% of our worldwide revenue pre-SDG is up and running on the same system, from here on out it’s just worldwide enhancements on that 90% and then improving the familiarity with that tool here in the U.S. But there’s no further conversion or anything else to do here in the U.S.

Matthew Sheerin – Stifel Nicolaus

Okay, thanks very much.

Operator

Our next question comes from Jim Suva with Citi. Please proceed with your question.

Jim Suva – Citi

Great. Thank you for your time this morning. A quick question – you gave a lot of details on your key vendor relationships with HP as well as Apple. Can you walk us through a little bit about is there any difference economically to Tech Data with servicing a slightly different mix, currently and going forward, than historically? You know what I’m getting at is, for example Apple, which was below 10%, is now above 10%. Can you get the same dollars profitability through your customers in that relationship and margin percents, both on the hardware and the services, or is it different? Can you just help walk us through that?

Jeffrey Howells

Yeah Jim, the gross margin that is available on products varies by manufacturer. It varies between those two that you just used as examples. It varies within the portfolio of HP, for example, and that’s why we’ve diversified our business around the world to bring in more value-added products over the last five or six years within their range of products and competitor vendors’ range of products that our team can add more value to in tech support and customer service; hence, we generally generate a higher composite gross margin on those. Products that need less tech support or are more commodity-based have, generally speaking, a lower gross margin opportunity. It’s the blend of all those that comes up with our composite margin.

One of the impacts on our margin on a year-over-year basis is the rapid rise of Apple as a part of our portfolio, this quarter being 12% of our revenue as it was last quarter compared to 9% in the prior year and I think it was 6, 7%--maybe 7% in Q2 of the prior year. That mix does have pressure on the gross margin, but then the next element in operating a distribution company is what’s the operating efficiency of serving that product line or that customer set. And for us and Apple, it is a very reasonable product line to serve because of the velocity and the order size that the products go out in the current environment. There is not a whole lot of demand for one-off Apple products. There is a demand for multiple, for many, for millions of dollars on a single PO of the products that are on their line card, so that helps us with the overall gross profit dollars generated on the transactions.

If you go through our entire line card, there is wide diversity in the profitability of the product line, both at the gross margin level and the operating margin, and we blend it and mix it, and that’s the key to diversification, to have that diversified portfolio to end up with the correct average at the end.

Jim Suva – Citi

Okay, thank you. And just a quick follow-up, so I’m correct – am I clear, then, that definitely the gross margin or the operating margin dollars can be higher, but the margin percent would structurally be lower?

Jeffrey Howells

It could be on a vendor. The best example that we generally use is software versus hardware, for example. Software, we may be able to execute transaction at a tighter gross margin but produces a very attractive operating margin because it’s licensing that we do electronically that excludes the receiving, put away, pick-pack-and-ship parts of the operations, so there’s less costs that attach. Same if you sell a million dollars of software versus a million dollars of blade servers versus a million dollars of tablets – they’re three different economic transactions for Tech Data, all with different varying costs attached, different gross margin profiles, and different operating income profiles which all blend together to our reported results.

Jim Suva – Citi

Great. Thank you very much for the details.

Operator

Our next question comes from Brian Alexander with Raymond James. Please proceed with your question.

Brian Alexander – Raymond James

Thanks, good morning guys. Jeff, I wanted to clarify your comment on gross margin. I would imagine that SDG is fairly accretive to overall gross margins, given the higher enterprise mix of 40%. So if I assume something like 7% gross margin for SDG, then it would imply on a sequential basis that maybe you’re expecting gross margin to be down excluding the acquisition, so I’m basically taking your comment that gross margin probably doesn’t get above the 5.27% of last year’s January quarter, and I’m just backing into the core business. I just want to know if that’s kind of what you’re saying on a sequential basis, whether you’re not expecting gross margins in your core business ex-SDG to improve, if that makes sense.

Jeffrey Howells

It’s not what we’re assuming. We are assuming that we will have improvement in our core business sequentially, and I think the difference in your philosophy or your theory is that what the gross margin opportunity is with the full SDG portfolio – 40% value, 20% software, 40% broad line distribution. So remember – broad line distribution, software, tighter gross margins; value distribution will be the higher. That’s the blended mix of both the acquired revenue through the distribution engine as well as in general that the revenue opportunity in the preferred supplier agreement we have there.

Brian Alexander – Raymond James

Okay. Maybe just a follow-on with SDG, is there any way you could be more explicit with what your anticipated restructuring costs and amortization expense might be for fiscal ’14 so we can just get a better sense for what that true underlying operating margin for the business is, given the mix profile that you just outlined? And then following on to that, what would you expect the pro forma tangible book value for the company to be given the purchase price premium that you had for that acquisition and it closed after the end of the quarter?

Jeffrey Howells

Okay, let me see if I can keep track of all those. First of all, the amortization we gave the two assets, the primary assets will be amortized in their lives of five and 10 years respectively. Until we finish the purchase price allocation, which we’re busily working on now and hope to include in the 10-Q to be filed, just use the average of those lives over the total. You’ll get a ballpark estimate that will be about in line with what we anticipate the amortization will be.

As far as the integration costs, $900 million a year of SG&A, we don’t believe that a few million dollars here and there in a given quarter are things that a company should make excuses or highlight over; so with that kind of a backdrop, you can assume that we don’t expect to spend an exorbitant amount of money integrating. However, the benefit of SDG is reaped after we pull it into our IT systems and our logistics infrastructure and get the leverage of our existing cost structure with their revenue base, bringing on board their talented individuals in the front office of the operation and some other aspects of the business. So we’re bringing temporarily over a cost load through agreements to remain within the logistics infrastructure and the IT infrastructure of the selling company, but we didn’t acquire that. So our plan is to convert that over the next three or four quarters into the Tech Data infrastructure which, quite honestly, is a lot of work but not that difficult. What I mean by that is we are already up and operating in each and every one of those countries, and so we’ll just move it over country by country; then, we will reap the benefit of that acquired revenue, and that’s where the fiscal year ’15 profitability will be clearly evident of the acquired revenue.

The other thing that will be eventually reported but it’s not indicative of the operation is the fact that what we acquired was run as part of a consolidated entity, and while we and they were able to create statutory reporting and financial statements and information, clearly it was run for the benefit of the entire group, not to highlight profitability in their reseller business or the distribution business. So the real key to us is not what was reported historically; it’s what we will do after we integrate it within the Tech Data family and reap the benefits. So as we’ve said, it will be slightly dilutive to our operating margin target in Europe next year, but it will be clearly accretive to the target in the following year.

Other than that, we’re still getting our hands around the details. Be clear – under law, we can only do so much until the day we actually close on the transaction to formulate or to finalize each and every one of our plans, and so we have highs, lows, mediums of the opportunity. We believe that our team has done an excellent job analyzing the opportunity and negotiating the purchase price, but there’s a lot of work to be done.

Your final question was on the impact on the book value, and it’s that premium that I indicated in the commentary over the 38 million shares, and so I think it brings our book value down to about just under $39 a share - $38.75, something like that.

Brian Alexander – Raymond James

Okay, thanks Jeff.

Robert Dutkowsky

Brian, one other comment on SDG – remember that the businesses we acquired have coverage models in France, the U.K. and the Netherlands, and those were geographies where Azlan was not as strong. So the overlap that exists between Tech Data and SDG is not that great. We added some new vendors. We obviously added a set of very talented, highly skilled people, and we were able to retain some very strong managers and leaders. So the leverage that we’ll get, aside from the steps that Jeff describing integrating into the physical facilities and IT systems, the human capital side, the vendor relationship side, the customer side gives us a lot of incremental leverage that we’re excited about.

Brian Alexander – Raymond James

Okay, thank you. Thanks, Bob.

Operator

Our next question comes from Rich Kugele with Needham & Company. Please proceed with your question.

Rich Kugele – Needham & Co.

Thank you. Good morning, gentlemen. A couple questions – I guess first on the inventory side, it did tick up just a little bit. Usually you’re managing it very closely, but given the environment, are you comfortable with that level and the mix of the product you have?

Jeffrey Howells

Yes. It did tick up. We had about 32 days of inventory, probably a couple days more than we anticipated. I think that what people need to understand is Tech Data just reported through the October quarter. Many of our vendors and competitors reported through the September quarter. October quarter was not as strong as it is historically, and so we have some incremental inventory. Clearly two days of inventory at Tech Data can disappear within three days, four days as sales resume, so the quality of inventory is solid, clean, no problem; in fact, there are certain products which we are dying to get more of, as you can well imagine. But no, there’s no issues there, but I will say October ended a little softer than we anticipated.

Rich Kugele – Needham & Co.

One of your comments, Jeff, about the aggressive vendor goals, given the environment, have any of those changed for Q1 to more achievable levels?

Jeffrey Howells

Yes, we believe that the opportunity is coming more in line as we go into Q4 and hopefully into next year on a relative basis compared to the goals in Q2 and Q3. Each and every vendor has a story and an opportunity, but clearly Q1 there was more optimism in the market in general. Q2 goals, which were set off of Q1, still had that optimism, which dissipated. People were uncertain about Q3, so goals were still relatively high and aggressive, and so Q4 appears to be potentially more realistic but, of course, they’re not necessarily that easy. But yes, it is getting better.

Rich Kugele – Needham & Co.

Okay. And then just lastly, you’ve already commented about the pricing dynamic. I can’t actually think of a time when Tech Data has been accidentally aggressive on price. Beyond just improving the systems, do you think that the environment also needs to improve from a demand perspective in order for you to kind of reset pricing, because once you’ve cut price, that’s kind of the new price, right? So as things go out over the next couple quarters, do you need to see demand improve before you can rebalance that?

Jeffrey Howells

Yeah demand, obviously the stronger the demand, the greater flexibility that a distributor has. But Rich, there are good business opportunities in the marketplace, both in the Americas and in Europe for us to apply our value proposition against. You can see we clearly gained share in Europe in Q3 with that value proposition, and our job in the Americas is to refocus that value proposition in front of our customers and with our vendors and to earn a fair payback for the work that we bring into the market. And we’re committed to doing that. The Americas team and the U.S. team in particular is myopically focused on improving that value proposition in the market, and quite frankly not to lead with price.

Rich Kugele – Needham & Co.

Okay, thank you very much.

Operator

Our next question comes from Ananda Baruah with Brean Murray. Please proceed with your question.

Ananda Baruah – Brean Murray

Hi guys, thanks for the question and good morning. A couple questions, if I could. Bob and Jeff, is there any way to sort of peel away how much of the softness in the U.S. and I guess the U.S. mix was related to the demand environment and pricing versus things that would be more under your control, like SAP and anything else. And then Bob, you mentioned that getting the SAP logistics to where you want is going to take longer than anticipated. Can you just give us any sort of, I don’t know, rough time frame when you now think you’ll have that where you want to be? And that’s the follow-up. Thanks.

Robert Dutkowsky

I’ll go first on the SAP status. As I tried to say in my prepared comments, we have made very good progress on improving our utilization and productivity of the SAP systems here in the U.S. Ananda, I’ll give you one example from one customer. We have one large customer that we have SLA agreements with, and in round numbers a performance of about 80 is good, and Tech Data obviously pre-SAP was always in the 80s. When we turned on SAP, our SLAs dropped down into the 40s, and that customer moved some business away from us. Recently, those SLAs have returned up into the high 60s, and the customer has exhibited confidence back in Tech Data and moved business back to Tech Data. It’s one anecdotal customer; it’s one set of measurements, but you can see kind of the dip in performance reflected through the eyes of that one customer and their SLAs that the activation of the SAP systems represented, and you can also see the measured improvement that we’ve had over the last few months. So take that as just one benchmark against our confidence that our systems and the performance of our teams are improving.

The split between the demand and kind of the market influences and our own performance issues, the first place I would look is at our vendor partners that have recently announced their results, and you can see the kind of softness that they’ve articulated in all of our key segments, whether it’s PCs, whether it’s peripherals, whether it’s data center technologies. The shining star in our galaxy right now – no pun intended – is mobility products, and that’s primarily driven around our strength with vendors like Samsung.

The other strong element in our portfolio is the tablet marketplace, and that segment continues to do very, very well. In both of those segments, we’re serving those markets and those customers very efficiently with our SAP system in both geographies. Where the SAP system impacts us the most right now in the U.S. is still in complex configurable orders, and as I said, we’re getting better all the time in that space. We’ve used some tools and techniques that have been perfected by our European team and deployed here in the U.S. to improve the productivity of our teams, but that’s the one soft spot that we need to continue to work on, that and our ability to manage the margin with the tools and processes and techniques that we have through the SAP system.

And as I said, each and every day, each and every week, we can see marked improvement in our performance, and we anticipate that that’s going to continue to be realized in our business here in the U.S.

Ananda Baruah – Brean Murray

Thanks, Bob. That’s very helpful, that explanation. And I guess just as a follow-up, you mentioned, Bob, that the quarter ended kind of softer than you had anticipated. HP just before you guys actually said that the quarter sort of—they kind of sounded like they were saying it was demonstrably softened to exit the quarter. Can you just talk a little bit more about what you saw sort of linearity-wise and put a little bit more context around that, since they’re a big partner of yours?

Jeffrey Howells

Yeah, this is Jeff. I’m not sure we’d put any more around it by a vendor situation, but I think clearly our European team had a better opportunity through their diverse product portfolio to close October than the Americas team. The Americas team, both because of the SAP and where we were, just didn’t pick up momentum towards the end of the quarter like we anticipated; however, as soon as we turn the page and Bob gives an example like he did of the customer that’s come back and said very recently, here’s where you are and now you deserve more business from us, we think that’s a positive sign.

So both geographies probably didn’t have what we would hope for, but it was probably more pronounced here in the Americas than it was in Europe.

Robert Dutkowsky

But there’s no question for us that October was a softer month than what we anticipated, and we’ve now reported our October.

Ananda Baruah – Brean Murray

Yeah. I guess one lastly and I’ll cede the floor – I mean, Bob, any comments around how the first three weeks of November have started relative to normal seasonality?

Robert Dutkowsky

No. You know, the customers are out there and the opportunities are out there, and I can assure you we’re engaged in both geographies fighting for the business.

Ananda Baruah – Brean Murray

Great, thank you.

Operator

Our next question comes from Osten Bernardez with Cross Research. Please proceed with your question.

Osten Bernardez – Cross Research

Good morning. Thanks for taking the questions. As a follow-up with respect to the end weakness we saw in the month of October, would you be able to point to what type of products you saw decelerated more than others during that time period?

Robert Dutkowsky

As we said, anything that had to do with mobility and tablets in the quarter performed well, and we saw that momentum continue in October.

Osten Bernardez – Cross Research

Sorry, I said decelerated more than anticipated, the weakness near the end of October.

Jeffrey Howells

Yeah, I would turn it around the other way, Osten, and say what we didn’t see was continued pick up in October. We generally see business start picking up in both geographies about mid-September and the momentum continues to improve through October for a variety of reasons – normal business flow in the Americas and maybe stocking in Europe to some of the retail opportunities. But I would characterize is more of we didn’t see pickup across the broad categories versus decline. And other than that, we don’t give specifics about our various vendors.

Osten Bernardez – Cross Research

Okay, appreciate that. And then as a follow-on with respect to SDG, should we anticipate that that business has seasonality similar to historic Tech Data’s seasonality in Europe?

Jeffrey Howells

Yeah, I think it’s clear that Europe in general has about that same seasonality, so as you model the SDG business I would use the same assumptions. All that being said, we’ve just given kind of an overall view of what we believe organic Europe will be like, and so while we think it will be a strong Q4, normally seasonally up, Europe in various segments won’t have the gangbusters that they’ve had in some years. But I mean, we gave organic growth estimates in Europe in euros, so we think the SDG business will have the growth also. So use about the same.

Osten Bernardez – Cross Research

And then finally just to be clear, looking forward into fiscal ’14 when we consider the expenses associated with restructuring SDG, should we anticipate that you won’t call out specific numbers on restructuring or integration costs on a quarterly basis?

Jeffrey Howells

No, we won’t call them out unless some quarter became extremely significant. In our normal operations of our business, whether we’re spending millions of dollars hiring people or spending millions of dollars in adjusting headcount or investing or whatever the case may be, we only call out unusual items. We believe the rest is the normal cost of operating the business, and in Europe we believe that we’re not going to spend an inordinate amount of money integrating SDG, and we’re not because the team negotiated a transaction whereby the infrastructure that we’re not going to keep mid and long-term, we did not acquire, and many times you have to acquire IT systems, fixed assets, logistics infrastructure that you’re going to shut down, close and shed over a short or mid-term period. That’s one of the beauties of this transaction, is the team negotiated to not acquire that, so we’re just renting it, if you will, in the transition period.

Osten Bernardez – Cross Research

Thank you very much.

Operator

Our next question comes from Lou Miscioscia with CLSA. Please proceed with your question.

Lou Miscioscia – CLSA

Okay. On Europe and the guidance you gave, it was I believe for your core business; and then when we’re modeling this, should we add in about another 500 million from the acquisition that closed?

Jeffrey Howells

Again, there’s ranges in both, and that’s why we gave an approximate for the Americas, worldwide, and it’s up to each and every analyst to determine where they think the Americas revenue is going with what they know about us and the marketplace compared to Europe. So I can’t say—I assume you’ll be in the range of what some will allocate, but—

Lou Miscioscia – CLSA

I’m really just asking for clarification on the acquisition revenue that would be incremental to your guidance in your press release.

Jeffrey Howells

No, we gave the guidance and that’s what’s incorporated in the guidance, so again, it’s up to each individual to determine how they want to model the business. We have ranges—

Lou Miscioscia – CLSA

All right. Let me switch over to Bob. Bob, last quarter you were pretty confident about resolving the SAP situation. Maybe if you can just go into a little bit more detail as to what happened there; and also when you look at others that have had SAP problems, earning that revenue back really took a while. Maybe you can comment on that?

Robert Dutkowsky

Yeah, I think that the process of improvement has been measured, and the example from the customer that I gave you, it’s clear that our teams in the U.S. have made progress on improving their execution and their ability to support our vendors and our customers. The speed at which that happens is sometimes very hard to predict. It’s the change management process, changing the way our people work and changing the way our customers and vendors interact with us from a systems point of view; and so we can build a plan that says technically this is all going to work out fine, and as we have tried to articulate, technically this implementation works very well. The change management piece, the human element is one that has different rates and paces for different people, and so we’re making good progress on all fronts. We have to bring our people along and bring our customer and vendor partners along with the transition.

And the other piece, Lou, that’s happened in that process as, for example, our customers have given us input about our website, we’ve enhanced our website a number of different times already since we deployed the system, and those enhancements make it easier for the customer to do business with us. And then we listened to more feedback and we made more enhancements, and so the process of enhancing and improving the system is an ongoing one. We like to think that in the next four or five quarters, as I said in my prepared comments, that much of the system and that change management process will be stabilized, and at that point then, the enhancements that take place to the system are ones that give us additional leverage and competitiveness in the market.

Operator

Our last question comes from Craig Hettenbach with Goldman Sachs. Please proceed with your question.

Craig Hettenbach – Goldman Sachs

Yes, thank you. Bob, thanks for the color on Europe. Can you just, as it relates to the January quarter, talk about any particular regions – you mentioned France and the U.K. were strong in the October quarter, just how you see things shaping up, any notable region highlights into the end of the year.

Robert Dutkowsky

You know, we have a busy quarter in front of us in all of the countries and regions across Europe, and the execution of our team in Europe, as we’d said in our prepared comments, is exceptionally strong. They are focused, they are targeted, and they are serving our customers and vendor partners very efficiently in Europe. So across the continent, we’re working really hard to drive the business.

Craig Hettenbach – Goldman Sachs

Okay, and if I can have a follow-up for Jeff, just as it relates to the balance sheet and buybacks, is the plan to kind of digest the SDG acquisition near term, or any thoughts around your flexibility for buybacks as you go forward?

Jeffrey Howells

Craig, I think we’ve already had a pretty busy year buying back almost $200 million of stock, buying out our joint venture partner, acquiring SDG, issuing $350 million of debt, and converting the U.S. to the final modules to SAP. So while we’ll discuss it every quarter with our board, I think the reality is we’re in pretty good shape for capital deployment this year and we’ll look into next year as to the next steps. But the next steps are clearly in Q4 and through the first half of next year to reap the benefit of the investments we’ve done, and overcome the challenges of the SAP final module installation here in the U.S.

So I can’t predict with complete accuracy what we’ll do, but I think we’ve deployed a lot of capital very effectively this year, so realistically there wouldn’t be any near-term push to buy back more shares.

Craig Hettenbach – Goldman Sachs

Okay, thank you.

Operator

This concludes Tech Data Corporation’s Fiscal Year 2013 Third Quarter Earnings conference call. A replay of the call will be available in about one hour at TechData.com. Thank you for attending today’s conference call and have a great day.

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