Ingram Micro Inc. F4Q08 (Qtr End 12/29/08) Earnings Call Transcript

Ingram Micro Inc. (IM)

F4Q08 Earnings Call

February 18, 2009 5:00 pm ET

Executives

Ria Carlson - Chief Strategy and Communications Officer

Greg Spierkel - Chief Executive Officer

Bill Humes - Chief Financial Officer

Alain Monie - Chief Operations Officer

Analysts

Brian Peterson - Raymond James

Matthew Sheerin - Thomas Weisel Partners

Min Park - Goldman Sachs

[Joe Yu] - Citigroup

Matthew Whittaker - FTN Equity Capital

Presentation

Operator

Welcome to the Ingram Micro fourth quarter earnings report conference call. (Operator Instructions)

Now I will turn the meeting over to Ria Carlson, Chief Strategy and Communications Officer.

Ria Carlson

Thank you very much, [Roy], and good afternoon.

Joining me today are Greg Spierkel, our Chief Executive Officer, Alain Monie, our Chief Operating Officer, and Bill Humes, our Chief Financial Officer. Greg will lead off with an overview of the fiscal year and fourth quarter, followed by Bill with a financial review. Then we'll turn it back to Greg to provide business highlights and his thoughts about the future. Alain will answer questions and provide more color about the operations.

The financial portion of this call is accompanied by presentation slides which can be found with today's news release at the Investor Relations section of the Ingram Micro website at IngramMicro.com or by calling 714-382-2015.

In this call we will present non-GAAP financial measures. The non-GAAP results exclude the goodwill impairment charge of $743 million which is $660 million of $4.07 per diluted share after tax as described in today's news release. We believe that discussion of these non-GAAP financial measures in conjunction with our reported results under GAAP allow you to make more meaningful comparisons with analyst estimates and prior year results. Non-GAAP items discussed during this call will include operating expenses, operating income, net income and EPS.

Reconciliations of the non-GAAP financial measures are found in the presentation and reconciliation slides at the Investor Relations section of our website as well as the financial tables in our news release.

Before we get started with the call I have a safe harbor announcement. During today's discussion we will make statements that are forward-looking. These forward-looking statements and all other statements made on this call that are not historical facts are subject to a number of risks and uncertainties. Please refer to today's news release and documents filed with the Securities and Exchange Commission, specifically the risk factors listed in Item 1A of the Form 10-Q for the fiscal period ended September 27, 2008 for more information on the risks that could cause actual results to differ materially.

In addition, this conference call is the property of Ingram Micro and may not be recorded or rebroadcast without specific written permission from the company. The presentation slides and a replay of the call will be available for one week on the company's website at IngramMicro.com or by calling 800-678-3180.

Now I'd like to turn the call over to Greg Spierkel, our Chief Executive Officer. Greg?

Greg Spierkel

Thanks, Ria, and good afternoon, everyone. Against the backdrop of softening markets around the world, our team delivered solid operating results for the 2008 fiscal year. Full year sales hit the second-highest levels in our history at $34.4 billion, just shy of our $35 billion record in 2007.

Gross margins for the year were the strongest since 1998. Our countercyclical balance sheet, along with our operating results, generated more than $550 million in operating cash flows during the year and we continued to invest in important long-term assets that will strengthen our leadership position in logistics, services, and point of sale coverage.

This performance during trying times doesn't mean the year wasn't without challenges. Demand weakened in our two largest regions early in the year, exerting pressures on sales and productivity. We continue to pursue cost reduction actions that don't jeopardize our customer service and margins.

Asia-Pacific and Latin America, on the other hand, did not experience the economic downturn until later in the year, affording them the opportunity to adjust cost ahead of the downturn, which contributed to their record operating margins in the fourth quarter. This attention to cost control, along with our focus on improving gross margins, was evident in our fourth quarter results.

While sales were dampened by weak demand, gross margins and net income were better than expected. The quarter's outstanding gross margin performance was driven by a strong feeforservice logistics business, a greater concentration of higher-margin customers and products, and disciplined pricing. Our ability to exit underperforming business relationships and walk away from unprofitable business opportunities is really paying off.

By the end of the fourth quarter we reached the full anticipated run rate of cost savings from the restructuring program we announced in April 2008, resulting in an annualized savings of approximately $20 million. The benefits of this program, combined with weaker foreign currencies, additional actions and old-fashioned belt tightening reduced our operating expenses about 11% compared to a year ago. We still have more work to do here, but we're on the right track.

Our focus on profitability pushed worldwide operating margin above 165 basis points, not quite the levels of a year ago, but in the top three for this decade. Asia-Pacific and Latin America surpassed 200 basis points of operating margin, setting regional records. The other regions, which have been hardest hit by the recession, also made progress, with North America's operating margin within a few basis points of recent fourth quarter levels and EMEA at just under 100 basis points.

We've also done an outstanding job of managing our working capital during the downturn, with working capital days at the bottom end of our targeted range. Our discipline in this area helped to generate the company's highest-ever cash at year end position, even after repurchasing 14 million shares of company stock for approximately $221 million during 2008.

Along I'm pleased with how we performed in a difficult year, 2009 will prove to be even more challenging for the IT industry. Our year is off to a slow start, which I'll discuss at the end of the call, and we do not expect the economy to rebound for several quarters. We've proven, however, that Ingram Micro quickly adjusts in a difficult environment. We are addressing this recession head on so that we'll emerge with a strong portfolio of businesses when growth returns.

I'll now pass the call on to Bill for more detail on our financial performance.

Bill Humes

Thanks, Greg.

Before I walk through the quarter's results I'd like to discuss the goodwill impairment charge that is described in today's earnings release. As you probably know, many companies have recorded similar charges recently due to the deteriorating world economy and significant erosion of market capitalization. Ingram Micro's market capitalization declined in the fourth quarter and was well below book value. Most experts believe that it will take several quarters for the global economies to rebound. These factors led to the impairment of all the company's goodwill.

Of the total charge of $743 million, $243 million is in North America, $24 million is EMEA, and $475 million is in Asia-Pacific. There is no recorded goodwill in Latin America.

The negative impact on net income was $660 million or $4.07 per share. This is a non-cash charge and will not impact the company's normal business operations, liquidity or covenants for its credit facilities.

To aid year-over-year comparisons, my discussion of the quarter's operating expenses, operating income, net income, and EPS will exclude the impact of the goodwill impairment charge and is therefore non-GAAP.

We'll start with sales, which are found on Slide 3. Sales were $8.68 billion, reflecting a year-over-year decrease of 13%. About 6 percentage points of that decline were due to the translation affect of weaker foreign currencies. Sequentially sales increased 5%, a lower rate than historical seasonality due to the weakening of foreign currencies within the quarter.

On a regional basis, North America sales were $3.8 billion or about 44% of our worldwide sales. Data capture point of sale and fee for service businesses had double-digit year-over-year sales growth, while the classic distribution business was flat. Overall, the region's sales declined approximately 1% compared to the prior year as these areas of growth were offset by sluggishness in the consumer electronics market.

EMEA sales were $2.95 billion or 34% of total revenues. Sales decreased 21% compared to the prior year, with 10 percentage points due to the translation impact of weaker currencies. While the depressed economies and falling average selling prices were the main reasons for the sales decline, we also continued to walk away from unprofitable business. This has had a negative impact on sales, but we expect to increase our return on capital over time.

Asia-Pacific sales were 17% of total revenues or $1.49 billion, a year-over-year decrease of 23%, of which weaker regional currencies had a 10 percentage point negative impact. As in EMEA, the economies of this region continue to weaken and we have been proactive in our efforts to turn away or exist unprofitable business.

Latin America sales were 5% of worldwide revenue or $455 million. This represents a decline of 5%.

As depicted on Slide 4, gross profit was $514 million on 5.92% of sales. This includes $8.2 million or 9 basis points from the release of reserves related to the Brazilian commercial tax on software imports for the 2003 calendar year. The gross margin hit the highest quarterly level since the fourth quarter of 1998 due to the strength in IM logistics, a greater mix of higher margin business, and disciplined pricing. In the previous year, gross margin was 5.82% of sales, which also included a 4 basis point benefit from a similar release of the Brazilian commercial tax reserves.

Operating expenses on Slide 5 were approximately $369 million or 4.25% of sales. This included $6.8 million or 8 basis points of sales for costs related to expense reduction programs in North America and EMEA. In the year ago period, operating expenses were $407 million or 4.06% of sales. The year-over-year decrease in operating expenses is attributable to our expense reduction programs, lower sales volumes, the translation impact of stronger dollars, and lower share-based compensation expense.

On Slide 6 you'll see that operating income was $146 million or 168 basis points of sales. This included a net benefit of 2 basis points from the partial release of Brazilian commercial tax reserves, offset by expense reduction program costs. In the prior year, operating income was $176 million or 176 basis points of sales, which included benefits of $6.5 million or 6 basis points from the release of the Brazilian commercial tax reserve and a gain on the sale of our Asian semiconductor business.

In North America operating income was $63.7 million or 168 basis points of sales, which includes expense reduction program costs of approximately $300,000 or 1 basis point of sales. In the prior year quarter operating income was $68.9 million or 180 basis points. EMEA's operating income was $28.4 million or 96 basis points of sales, which includes expense reduction program costs of $6.5 million or 22 basis points.

While operating margin experienced a 114 basis point positive swing from the third quarter of 2008, it's still not at satisfactory levels due to the macro environment. In the prior year period, operating income was $64.7 million or 172 basis points.

Asia-Pacific operating income was $31.2 million or 210 basis points, with operating margins surpassing 200 basis points for the first time to hit a regional record. The region's ability to hold down costs while shedding or improving unprofitable business contributed to this achievement. In the prior year quarter operating income was $35.9 million or 185 basis points of sales, which included a $2.9 million gain or 15 basis points of revenues on the sale of the regional semiconductor business.

Latin America operating income was $21.5 million or 474 basis points, which includes the 181 basis point release of the Brazilian tax reserve. In the prior year period operating income was [$15] million or 335 basis points, which included a 75 basis point benefit from the release of the Brazilian commercial tax reserve. With and without these reversals, operating income hit a regional record in the fourth quarter of 2008.

Other expenses for the quarter were $14.3 million compared to $18.2 million in the prior year period. The decrease was primarily driven by lower debt levels and declining interest in the current year.

Looking at the fourth quarter taxes, there was a tax benefit of $47.2 million versus a tax provision of $43.7 million a year ago. The change in provision reflects deferred tax benefits of $82.9 million associated with the goodwill impairment charge, a substantial portion of which is not deductible for tax purposes, the lower level of earnings, and the release of certain tax reserves upon the completion of an income tax audit. These factors are partially offset by an adjustment to the valuation allowance placed against the company's deferred tax assets in certain European business units.

On Slide 7 you'll find that non-GAAP net income was $95.5 million or $0.59 per share, which includes the benefit from the Brazilian tax reserve release of $8.2 million or $0.05 per diluted share and expense reduction program costs of $6.8 million or $0.03 per diluted share. These items aggregated to a net benefit of $3.3 million or $0.02 per share.

In the prior year period, net income was $114.1 million or $0.64 per share, which included a benefit from the Brazilian tax reserve release and the gain on the sale of the company's Asia semiconductor business. These items aggregated to a net benefit of $6.5 million or $0.03 per share.

Please turn now to Slide 8 for a discussion of the balance sheet, which remains strong in the face of the economic turmoil.

Total debt was $478 million, $45 million lower than the end of 2007. Our debt portfolio is diversified by instrument type, maturity date, and geography, which helps minimize our funding risk for the volatile capital and credit markets.

Cash flow from operations for the year exceeded $550 million, up significantly from the nearly $330 million generated in 2007.

The cash balance at quarter end was $763 million, the highest year end level in the history of the company, as Greg mentioned. Although our business requires generally less financing as sales levels decline, this is nevertheless a testimony of the team's outstanding job of management working capital. You can get a better look at the quarter's working capital metrics on Page 9.

Days of sales were 36, an improvement of 1 day versus the end of 2007. Days of inventory were 28, a 1-day increase versus the prior year end. Days of payable were 41, 1 day lower than the prior year. Payables exceeded inventory by approximately $1.1 billion. This brought working capital days to 22, flat versus the prior year end and a 1-day improvement sequentially.

Our debt-to-capitalization ratio was 15% versus 13% at the end of last year. The increase over the previous year is due to lower book equity resulting from the goodwill impairment charge, which had a 2 percentage point impact on the debt-to-cap ratio.

That concludes my financial overview. I'll turn it back to Greg for a discussion of regional highlights and closing comments. Greg?

Greg Spierkel

Thanks, Bill.

I'll start my overview with North America, which delivered a solid quarter in a tough environment. Sales, although flat, were stronger than we expected. Both the fee for service and DCPOS units experienced healthy double-digit growth. The core U.S. distribution business was flat compared to last year, and local revenue growth in Canada was negatively impacted by the translation affect of a stronger U.S. dollar. Finally, sales declined in consumer electronics divisions due to the weak housing market and poor consumer sentiment.

The team did a very good job of lowering operating expenses during the quarter. They are determined to find a variety of ways to cut costs. For example, U.S. office-based associates were required to take a four-day holiday break, significantly reduce travel, and manage employee attrition. These expense actions, along with the benefits realized from headcount reductions announced in the second quarter of 2008 add a greater mix of higher-margin business such as data capture and fee for service logistics, resulted in a respectable operating margin of 168 basis points, within 12 basis points of a year ago.

The region's focus on serving its customers and vendor partners has helped it remain profitable in this volatile market. During the quarter the team was awarded Partner of the Year by Computer Associates, announced marketing programs to help partners improve results, and enhanced its line card with DC, POS and server offerings. While every customer segment is feeling the pinch, our strong financial position and innovative solutions are securing loyalty and trust in our partners.

Looking ahead, the U.S. economy is expected to deteriorate further, particularly in the first half of this year. Conditions are also softening in Canada and currency translation headwinds may temper growth in U.S. dollars from there. Spending on IT hardware in North America is expected to decline, so we anticipate softer regional revenues this year.

In light of this outlook, we are actively pursuing sales with better margin characteristics and taking proactive measures to further reduce costs. Yesterday the region announced a work force reduction, the details of which I will share in my closing comments.

I will now turn to our EMEA region, which was hardest hit by the recession. The team made good headway adjusting to the economy over the past three quarters. As we explained in earlier calls, the reorganization process in Europe is more difficult and protracted than in our other regions due to labor regulations. We've worked through these obstacles to create a leaner, more agile organization while refocusing our business mix on our profitable segments of customers. Along with the sequential uplift in sales in the fourth quarter, we began to see better alignment of expense reductions with the rate of sales decline and healthier gross margins, significantly improving profitability compared to the prior quarter.

However, the economic picture in Western Europe has not improved. Demand remains weak and average selling prices dropped significantly last year. In the fourth quarter our German operation was the only country that grew in local currencies. Spain and Italy were our weakest. While sales declined in Hungary, France, Switzerland and Nordics, profitability in these countries improved over prior quarters, benefiting from seasonal uplift and their cost reduction efforts.

All customer segments declined compared to the prior year, with SMB stronger than the others for the quarter. Strength in networking and supplies were offset by weakness in components and consumer electronics. The data capture point of sale business continued to do well, complemented by two acquisitions in France and Germany that closed during the quarter. The fourth quarter results included approximately two months from these two operations. Through these acquisitions we expanded our geographic footprint across Europe and secured the number two market position in this space. While DCPOS is a small part of our overall business, its contribution to gross margin is valuable.

Looking ahead, Europe's GDP is forecasted to further contract in 2009, with Germany, Spain and Italy expected to shrink at an even greater rate. Spending on IT hardware is expected to decline compared to the prior year. Accordingly, profitability with a close eye to protecting share remains our priority for 2009. We will continue our focus on the SMB segment while pursuing further expense reductions to align with the market.

In Asia-Pacific, 2008 was a story of two distinct half years. The beginning of the year was robust except for Australia, then in late May and early June we saw all the economies begin to soften. Our team was ready. They anticipated the downturn and learned from the experiences of their colleagues in North America and Europe. Cost containment actions were already in place and unprofitable business segments were being repaired or shed when regional demand slowed. This early preparation helped the region's profitability significantly, with operating margin breaking the 200 basis point barrier for the first time in the quarter.

Economic challenges have reached every country, with only Thailand and New Zealand experiencing year-over-year growth in local currencies for the quarter. All countries, however, delivered an operating profit. The steepest sales declines were in China as factory closings pushed unemployment to record highs and we continued to aggressively retreat from unprofitable business. Although Australia's growth was slowed considerably, it was able to improve its business mix to push operating profits above prior year levels. India also increased operating profits on a modest sales decline in local currencies.

As we look at 2009, the Asia-Pacific economies are not expected to rebound soon. Third-party researchers predict that IT hardware sales will contract in the region, so we do not expect revenues to rebound this year. We plan to focus on cost control, higher margin segments and improving or shedding businesses that are not meeting our targets.

Our final regional review is of Latin America, which was once again the performance leader. Operating income increased over the prior year period to hit a quarterly record. While fourth quarter sales grew in local currencies, the pace has slowed from the robust rates experienced in the last several quarters. Sales were solid in Brazil and Chile, while Mexico ended the year with strong sales in government and retail fulfillment. The Miami export business was a bit softer. Argentina completed its first year of operations but is still looking and working towards improving profitability.

For 2009, Latin America GDP growth is expected to be marginal, ending its boom period of the past five years. Spending on IT hardware is also expected to grow only modestly and the stronger U.S. dollar is expected to have a negative impact on revenue comparisons. The Latin America team, however, has done an excellent job of gaining market share, keeping expenses in check, and finding additional revenue sources through marketing programs and new products. I'm confident in their ability to maintain profitability in this environment.

In closing, I'm pleased with our achievements during the quarter and full year. The economy dealt us with a tough hand, but we were able to deliver near-record sales and strong operating results. As I mentioned earlier, I believe 2009 will be an even more challenging year. All of our regions are experiencing economic sluggishness, business and consumer confidence are the weakest in decades, and most economists do not expect a turnaround anytime soon. I would not be surprised to see negative growth for another three to five quarters, making this the longest contraction in the history of our industry.

While we're not providing guidance for the first quarter, demand so far this quarter is weak across the board and the stronger dollar is creating a translation headwind internationally. Based on what we have seen so far this year, we expect first quarter sales to decline in percentages in the low to mid 20s compared to a year ago, which includes the translation impact of relatively weaker foreign currencies.

Our team continues to make inroads towards aligning our cost structure, but we may not be able to keep fully up to pace with expected sales declines in the first half of the year. This will exert significant pressure on profitability levels in the first and second quarters.

We are proactively reducing costs to prepare for the continued sluggishness in this economy. In addition to the expense reduction plan we announced in the second quarter of last year, which has yielded annualized cost savings of more than $20 million, we are taking additional actions to address the anticipated market dynamics in 2009. These actions, which are primarily in North America and Europe, will be executed within the coming three to four months and will be fully operational as we exit 2009.

Savings are expected to be approximately $100 to $120 million on an annualized basis beginning in the second quarter and ramping up to a full rate by the end of this year. Costs are expected to be in the range of $45 to $65 million. The restructuring cost we recorded in the fourth quarter, as well as the related savings, are part of this new phase. Through restructuring actions and natural attrition we expect to reduce our work force by approximately 8% this year as compared to a year ago.

I'm often asked how the company is doing in the current environment. My response is that Ingram Micro is better positioned than most of our competitors and many companies outside our industry. We have a reputation as a respected leader in our industry based on excellent vendor and customer relationships and outstanding operational capabilities which make us the first choice for those seeing a distribution partner regardless of the economy.

Our robust and diverse product and service offerings help us cushion the downturn because we're able to capitalize on those with the highest potential. And of vital importance, we're dealing from a position of financial strength. Our cash and balance sheet metrics are best in class, which allows us to operate with financial flexibility. In today's tight banking markets, this is a valuable enabler. Our business model generates greater cash in a downturn because of reduced working capital demands.

As the fourth quarter has proven, our profit levels remain solid by virtue of our geographic diversity and financial discipline. Our strong financial position will become an even greater asset in this environment as vendors and customers clearly recognize our strength and reliability versus weaker players.

Our can-do culture and desire to win are tremendous assets. This recession reinforces our philosophy that fiscal conservatism wins long term. We have the flexibility and resources to make and take advantage of the opportunities created by this environment. Key to our success is that we remain firmly focused on enhancing value for our customers, business partners, associates, and shareholders.

Thank you. We will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Brian Peterson - Raymond James.

Brian Peterson - Raymond James

Your sales growth in EMEA in local currency actually improved a little bit year-over-year, and I'm just wondering if we've seen some easing? I know you guys have been pruning some customers there. Has that mitigated a little bit and maybe do we have more to go there in Asia?

Alain Monie

I'm not sure I got your comment. You mentioned that sales grew in local currency?

Brian Peterson - Raymond James

They improved a little bit year-over-year relative to the third quarter, the rate of decline.

Alain Monie

Oh, on rate of decline, yes. Well, you know, we continued to - in that geography we continued to look at our businesses on a return on invested capital metric and so we have started earlier last year in pruning and letting go businesses that were not sustainable. We have done a lot of the work there and we think that indeed the rate at which we are now going to let go additional business will decrease. However, the market environment itself is certainly not stronger, and so overall I would remain very prudent on the stabilization of this decline.

We are going to focus this year on the SMB market. That has better margins as well and we are going to capitalize on the data capture and point of sale categories to help us mitigate some of that impact that we had last year.

Brian Peterson - Raymond James

And just kind of a housekeeping question on the restructuring. You said the $100 - $120 million, is that incremental to the $20 million you guys talked about in the fourth quarter? And just maybe to get some of your assumptions on that, are you kind of assuming that demand deteriorates further in '09 or are you kind of assuming that things are at current run rate levels?

Bill Humes

Yes, overall the $100 - $120 million is incremental to the already realized annual run rates of the $20 million that we talked about and did in April onward. So that will be incremental cost savings and reductions that we are executing as we speak.

Greg Spierkel

And Brian let me just touch on here, I think, your question around demand deteriorating further in '09 over '08. Without question at this stage I would have to say yes. In the first half of last year we did not see that much of an impact except for Europe, where things were already starting to slow down in the IT universe. But as we enter this quarter and enter this fiscal year, as you can tell, we are providing some outlook on the revenue situation that we're dealing with in the marketplace and we're guiding in the low 20s decline year-on-year as a percentage of sales.

What we're seeing is that a very large number of our best and biggest partners are in a similar situation, so we don't feel we're losing any ground. And it's a function of slowing economies probably in the low double digits of negative growth in parts of Asia, Europe, Latin America, and North America, compounded by global companies like ourselves seeing a negative headwind of the currency change that's going on in all those major international markets versus the dollar.

Of note just today HP announced its results and the quarter they've just finished they were down 19% in IPG and PSG and 20% down in servers and storage, which represents the lion's share of what the channel works with with HP. Again, of note as well their guidance was in the 20% plus range down for those divisions if you exclude what's going on with their acquisition in EDS. And then if you look at other companies like Cisco, they're guiding 15% to 20% down right now. Seagate, 20% plus down. Intel, 20% plus down. So there's clearly a combination of slowing local markets and currency challenges that are in play in the marketplace as we speak. So no question there is some deterioration on '09 versus '08.

Brian Peterson - Raymond James

And just lastly, the balance sheet still looks pretty healthy and it sounds like you guys are easing up on share repurchases for the time being. How are you guys thinking about using your cash?

Greg Spierkel

Well, cash utilization and preservation, more importantly, is extremely important to us. And you're absolutely right; we've had a fantastic finish to the year. Our cash position is the highest level that it's been in basically since the turn of the 2000 period. Just an interesting comment, on a 13% revenue decline for the quarter that we just came through, our cash finished up 31% from the equivalent period - quarter - in 2007. And again, inventory management, asset management overall, are just fantastic. We're at low levels in terms of our normal range.

From a utilization perspective, we're keeping cash close to our chest for the right reasons, and I think there's lots of opportunity for us in light of that. One, if there are stronger clients, customers that want to do more business with us and have maybe less resources or parties to go to in the future, clearly we'll be in a better position to lend a greater amount or increase lines in that regard.

Secondarily, it does provide us lots of air cover if there's some businesses or divisions or capabilities that we believe are important to our longer-term future, so we can go out and acquire these companies without much concern from a cash perspective or ability of funds perspective. And you can see what we just did in the last year. We made three or four small acquisitions, all very specialized and targeted around directionally where we want to take things.

And finally, it also allows us to continue to invest in programs, infrastructure that we believe are important for the long term for the company and we don't have any concerns about our operating situation in the near term in light of the weak market and weak economy.

Operator

Your next question comes from Matthew Sheerin - Thomas Weisel Partners.

Matthew Sheerin - Thomas Weisel Partners

Greg and company, I just want to ask a little bit more about the guidance. I know that FX plays a big role, but if you could talk about North America, where you seem to be holding your own, have you seen a big drop off there in the last month or two?

Greg Spierkel

Yes. I mean, without going too specific on the answer there, Matt, you're absolutely right in the sense that Q4 we had essentially flat revenue in the quarter and then if you look at the other regions, we're pretty much telling you that sales were down except maybe for Latin America in local currencies.

As we go forward what I will say is that all regions, all four of our regions, are looking  at least the large three  are looking at low double to mid double-digit declines, and then you add the currency challenges. So every region is seeing some degree of market pressure and softening on the revenue front and not too far off of each other. Again, the differences are mostly the foreign exchange implications.

Matthew Sheerin - Thomas Weisel Partners

So it looks like your inventories are clear and I would imagine the inventories of your customers are clear, so it's clearly a demand issue at this point?

Greg Spierkel

Only a demand issue. Without question, we don't feel like we're losing any ground. There may be some segments where we have stepped away from unprofitable business, but there are other segments where we're being aggressive to capture share because there's slightly better returns for us and you're seeing that reflected in strong gross margins and reasonable operating income in light of a softening sales situation. So of course we're challenged like a companies with the cost structure versus sales scenario, and we're trying to address that as well.

Matthew Sheerin - Thomas Weisel Partners

Then on the cost side, I appreciate that you're not able to give precise profitability targets because of the big demand fall off here, but you talked about the big restructuring sort of playing out in the end of the second quarter. Your revenue's going to be down about close to $2 billion sequentially, so I would imagine in addition to the cost cutting effects already put into place you'll have some variable costs coming out sequentially because of the lower revenue rate, correct?

Bill Humes

Right. There generally is some portion or basis points of variable cost that will come out as part of the overall natural reduction or reduction in revenue, and then we're also making structural changes as we talked about.

Matthew Sheerin - Thomas Weisel Partners

Are there any short-term operating margin targets that you have internally that you might want to share with us?

Greg Spierkel

No. Again, we're clearly not - in a no-guidance environment, Matt. We are trying to give you some sense of where things are from a revenue picture. You know we will do everything we can to watch the expenses and we're showing that to some extent with the actions as well as the variable adjustments that we will make. And clearly we are holding on to, relatively, periods past. We're holding onto stronger margins as a company in light of the pricing pressure you can imagine is out there in the marketplace.

Matthew Sheerin - Thomas Weisel Partners

You talked about trying to keep your market share in Europe, particularly in the SMB business, and you also talked about lower ASPs in the products that you're selling. Does there continue to be pressure there among your smaller competitors and do you expect that to continue?

Alain Monie

Yes. The pressure continues in Europe. There's no doubt about it. Our focus, though, on the SMB market is because we feel that we have a very good position right now in that market and that we have the opportunity to regain share that may have been lost to a certain extent last year by refocusing on that market.

So the overall demand environment is down, yes, but our focus on SMB is going to be very clear.

Greg Spierkel

I would maybe just add to the back end of your question on the smaller relationships or competitors out there, our sense, again, as I think because of our strong balance sheet relative to a number of players out there, over the coming quarters, going into next year for that matter and 2010, we believe that there's share opportunity for us from players that you don't hear talk about much. And I think the vendor community will probably play, let's say, or make decisions with whom they want to work with that probably have less risk for them, so I think that works in our favor.

Matthew Sheerin - Thomas Weisel Partners

That actually was my follow up, just regarding your share gain potential because of the smaller competitors having balance sheet issues and also vendors probably wanting to consolidate in this kind of market. So I would figure through the next few quarters in all regions you'll have opportunities there.

Greg Spierkel

I would have to say that's what we're anticipating. Of course, people will hold on as long as they can. And we're not going to go do anything irrational just to change the dynamics of the market here, so we'll be pretty smart about it. And if some fall by the side, we'll be clearly there and ready to step in.

Alain Monie

But as you noted, Matt, I think that leverage is true not only for Europe but also for Asia and Latin America, where the sense of risk might be even stronger vis-à-vis our competitors, our local competitors there, so it's a good observation.

Operator

Your next question comes from Min Park - Goldman Sachs.

Min Park - Goldman Sachs

Can you first tell us how much currency you assumed in your low to mid 20s decline outlook?

Bill Humes

I would say we're not going to give specifics, but the impact that it had on Q4 is pretty much reasonably to be anticipated for Q1 levels or maybe even a little more, but it's in that range, that's for sure.

Min Park - Goldman Sachs

And Greg, you've provided a lot of detail on the trends in your geographies, but could you also provide some additional color on demand by product as well as your customer segments?

Greg Spierkel

Yes. I'll give you a sense of where we finished in the quarter on the demand front. From a product point of view we usually talk about four broad categories. Our peripherals category usually is 40% to 45% of our revenues, and that's where we finished the quarter. Systems are usually 25% to 30%, software usually 15% to 20%, and networking sort of 10% to 15%. Those are our typical ranges and we stayed within those ranges.

In the quarter that we just finished - Q4 - networking actually grew and we were minus 13% revenue, so we actually had growth on networking as a category year-on-year, and software fared better than our average as a company revenue, so you can tell the two categories were fairly strong.

Systems and peripherals, which are the two larger categories, fared worse on our overall sales primarily due to weakness in certain types of accounts - corporate accounts, large enterprise and, to some extent, retail - but also were depressed or down because of strong ASP declines, you know, average selling price declines. A good anecdotal point there is the HP unit that just announced results today as well, their units were down 4% in PSG, but revenue was down 19%, which is telling you a lot about average price declines that are going on in place with average selling prices.

Min Park - Goldman Sachs

And is that most driven by pricing or is it more mix?

Greg Spierkel

It's driven by I'd say a bit of both. Clearly, there's a mix of certain products coming into the marketplace, particularly in the PC space where netbooks are displacing to some extent notebooks. But you also have a lot of vendors that are being pretty aggressive in trying to capture share and are still driving some price changes through the system.

Min Park - Goldman Sachs

And just one last quick question. Can you just talk a little bit more about your credit exposure to your [borrowers] and if you've seen any pickup in bad debt expense over the past few months?

Bill Humes

Overall, as you know, accounts receivable, credit management and collections are absolutely a core competency of Ingram Micro. In this market obviously heavier monitoring and close attention to receivables and receivables portfolio is absolutely important and imperative and we've definitely been doing that, but we've always maintained very, very close monitoring and management of our credit portfolio.

I would say bad debt has ticked up, but not of anything noticeable in the sense of material elements. You also have to understand we have credit insurance outside of the U.S., North America, that covers a large degree of the receivables portfolio so that helps mitigate credit risk. And in North America we have a great experienced team, especially in field credit, that examines and visits customers, thousands of customers a year, to understand their business model, their cash flow.

So we've been able to manage through the environment over the last year fairly well and we expect to continue to manage through the environment fairly well, but it is a tough environment so we have to really have a close eye to it.

Operator

Your next question comes from [Joe Yu] - Citigroup.

Joe Yu - Citigroup

My question is on the general guidance that you've provided for the first quarter. Could you tell us how much of that is actually self-inflicted? You continue to exit some unprofitable business; I was wondering how much of the guidance is baking in?

Greg Spierkel

That's a very hard question to answer. As we've been saying quite clearly, over the last few quarters we have stepped away from certain revenues and certain clients, customers, and to some extent certain product categories that have been very commoditized and have not generated or are not creating return invested capital that we feel is good for the company. And we're comfortable with making that decision; have been.

So for the last few quarters we've tended to leave, I would say, a few hundred million dollars on the table against a backdrop of $30 plus billion in revenue, so we are walking away from business that we normally would have taken in the past but because of the market conditions we feel is inappropriate for us to go chasing.

Some of that is in play for the quarter that we're in, but it's not a large amount. We think that we've made a lot of the changes in the last three or four quarters, so I would say the vast majority of what we're seeing in terms of the outlook that we have on revenues is a function of the market and the currency challenges that are in front of everybody.

Joe Yu - Citigroup

On the fee for services, you highlighted that as a positive. Is there a certain trend in the industry that's actually helping you to grow that business faster than you expected?

Greg Spierkel

Well, you know, this is a business division that we established four or five years ago and has become a key contributor to our operating results and a key differentiator for Ingram Micro. We have the better part of 40 very important customers, some of which rely pretty extensively on Ingram Micro's logistics capability to serve the North American market. We do have a few small customers in a few other geographies in Europe and Asia, but the large majority of the, I'd say, extensive capability in the fee for service or the Ingram Micro logistics business division, as we call it, is based here in North America.

Those companies have become more reliant on us and have grown at a very healthy clip in terms of expectations against their peers in the marketplace they're serving. And some of them are IT companies; some of them are frankly outside the IT domain. So we're feeling pretty good about that business, and it had a very solid performance last year because, again, I think how good we perform as a company from a logistics point of view more business was getting pushed our way.

Joe Yu - Citigroup

And my last question's on vendor rebates in general. It seemed like in the second half of last year most of your competitors were complaining that vendors had way too high of a volume target for distributors in general. Could you give us any color on how you feel about our volume targets now?

Greg Spierkel

Well, you're absolutely right. There's no question that access to rebates and back end margin have been more of a challenge over the last two or three quarters because of the softening market. I think a lot of the vendors struggled to come to terms with lowering their goals and, like a lot of people in the industry, we've been chasing a downward draft on revenues and most people aren't willing to accept, if you may, the outlook that's as negative as maybe the actual situation is.

I would add that in the current period that we're in right now we'll probably have some of those challenges, but we have managed those very well. Look at our margins. You know, again, the last two or three quarters have been close to record or record quarters for us compared to prior periods and prior years on the gross margin front. So we are having a fair amount of discipline. The vendors are very much working with us to try to achieve common goals, even if the goals are slightly less, and more importantly, I think we're working very hard to improve our service and solutions capability so as we sell to customers it's not in a commoditized context where the margins would be lower but rather in a true solution capability. And that's been a lot of what we've been doing with services, with point of sale division, with logistics, and those things kind of offset the downward pressure on the margins that might be in play because of rebate goals.

Operator

Your next question comes from Matthew Whittaker - FTN Equity Capital.

Matthew Whittaker - FTN Equity Capital

A little earlier you took us through some of the demand trends you were seeing by product. I was wondering if you could do the same thing by customer segment?

Greg Spierkel

Okay, on the customer front you kind of heard it to some extent on our messaging through the presentation, but clearly a bias and focus as a company towards the SMB sector, so our VARs were really the strongest category. And the quarter that we just finished, we did see some real robust sales in what I would call e-tail sector, the electronic retailers. The direct marketers and the retail customers, though, the brick and mortar ones, were weak relative to our growth rates. System builders and corporate resellers were also weak relative to our overall growth rates. And then one other subsegment, if you may, within the VAR community, we were very strong with state, federal and gov ed, still robust there and obviously there's still decent funding behind a lot of those types of sectors.

Matthew Whittaker - FTN Equity Capital

And what percentage of your business last quarter was Hewlett-Packard?

Bill Humes

For the year was 23%. We don't have the quarter, but it's in the range - there's usually not a huge variation, but HP's around 23% of our overall numbers.

Operator

I would now like to turn the call over to Ria Carlson for closing remarks.

Ria Carlson

Thank you very much for your questions. This concludes our call. A replay will be available until February 25th by calling 8006783180 or at IngramMicro.com. Thank you again for joining us. Good day.

Operator

Thank you. That concludes today's conference. You may disconnect at this time.

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