Ingram Micro Q2 2007 Earnings Call Transcript

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Ingram Micro, Inc. (IM)
Q2 2007 Earnings Call
July 26, 2007, 5:00 PM ET

Executives

Ria Marie Carlson - Corporate VP of Strategy and Communications
Gregory M. Spierkel - CEO
Kevin M. Murai - President and COO
William D. Humes - EVP and CFO
Jason Gursky - JP Morgan

Analysts

Min Park - Goldman, Sachs & Co.
Matthew Sheerin - Thomas Weisel Partners
Brian Alexander - Raymond James
Richard Gardner - Citigroup
Andrew Hargreaves - Pacific Crest
Ben Radinsky - Bear Stearns

Presentation

Operator

Good afternoon. Welcome to the Ingram Micro Second Quarter Earnings Report Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions]. 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 Ms. Ria Carlson, Chief Strategy and Communications Officer.

Ria Marie Carlson - Corporate Vice President of Strategy and Communications

Thank you very much and good afternoon everyone. Joining me today are Greg Spierkel, our Chief Executive Officer; Kevin Murai, our Chief Operating Officer; and Bill Humes,our Chief Financial Officer. Greg will lead off with a review of the second quarter. Bill will provide a financial review, and Kevin will provide an update on our operations and regional highlights. Greg will then conclude the call with our view of the third quarter. 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.

Before we get started, 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 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-K for the fiscal year ended December 30, 2006 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 re-broadcast 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 would like to turn the call over to Gregory Spierkel, our Chief Executive Officer. Greg?

Gregory M. Spierkel - Chief Executive Officer

Thanks Ria and good afternoon everyone. As we move into the second half of 2007, I am pleased with what we have achieved thus far. Sales for the first six months are at an all time high, while our strategies for growth and diversification are setting the foundation for even stronger returns in the future. Before I begin my review of the results however, I would like to discuss other news that we issued today. Kevin Murai, our President and Chief Operating Officer will be leaving his position at the end of the year to take care of his extended family in the Toronto area. Kevin is an outstanding leader and has been a valuable Ingram Micro associate for nearly 20 years. I will miss him but I understand and admire his dedication to his family.

While it is difficult to replace Kevin, I am pleased that we have a team of strong leaders who are ready for greater responsibility. As of last week, Alain Monie, currently the President of our China, sorry, our Asia-Pacific region will be promoted to President and Chief Operating Officer. He will work side by side with Kevin for the next five months to ensure a smooth transition. Kevin, I have the utmost respect for your talent and leadership, I have thoroughly enjoyed working with you, and I wish you the best for you and your family.

Kevin M. Murai - President and Chief Operating Officer

Thanks for the kind words Greg. This has been a very difficult decision for me. I've spend almost 20 years with the company, here I have had a great career, I think more importantly though I have developed strong relationships and friendships with so many people and I can truly say that Ingram has really become a big part of my life. But I have had to balance work wise and my family being in Toronto and now I need to make the decision to be back with my family. And I do want you all to know that my departure has nothing to do with the company, it's truly driven by my personal reasons. So over the next five months I will be working with Alain Monie to ensure a smooth transition. On Alain, I have worked with him for a number of years and over that time I have developed a tremendous respect for his management and his leadership abilities and I am confident that he will make an outstanding President and Chief Operating Officer.

I do want to thank our business partners and members of the investment community, I have enjoyed working with all of you and I appreciate your confidence and support over the past few years. To our Board of Directors, my colleagues and especially all Ingram Micro associates, I want to thank you for your counsel, for your leadership but most importantly for making the last 20 years a real pleasure to be here, I will miss you all. And finally I would like to thank you Greg for your friendship, it has been a real privilege to work here and I know that under your leadership the company will continue to be very successful going forward.

Gregory M. Spierkel - Chief Executive Officer

Thank you Kevin. As we have said this is not time for good byes yet and I too want to publicly thank you for your hard work, leadership, and many years of performance by supporting the company. I think we have said this before your contributions will benefit the organization for years to come and I think we all feel that way here at the company. With that now though I would like to turn it back to the financial results.

For the second quarter we delivered another sales record for the fourth in the last five reporting periods. Sales grew 11% over the prior year period primarily driven by a strong performance in Asia-Pacific which earn the distinction of generating the highest operating margin quarter this year. Sales growth far exceeded the pace of the local markets and operating income was nearly double the levels of a year ago. Every country is growing and profitable with the three main anchor countries India, China, and Australia performing particularly well. As you know we entered Asia market early recognizing it would not be easy. We are pleased to see that our risk appetite and sound management created an engine for profitable growth for the company. I'm also encouraged with what I'm seeing in Europe, the month of June and the beginning of July have been strong after a slow April and May. As Kevin will describe later in the call Germany has made significant progress towards recapturing the market share lost in the warehouse system upgrades and is now back on track.

Most of the other European countries are also performing well, it looks like Europe has turned the corner. Demand is improving and the hurdles of last year are behind us. In the Americas our story continues to be about the investments and progress we are making in expanding our business. North America continues to diversify its business portfolio acquiring DBL Distributing, launching an infrastructure solutions division, building its managed services initiative, and signing a distribution agreement with Google. Latin America is expanding into Argentina. Although these estimates and these opportunities dampen year-on-year operating income, we firmly believe this is the right time to invest in our growth and expect these actions to bear fruit in the near future. While I am pleased that the net income was within our guidance range, I believe it could be better. The improvements and investments we are making have the potential to bring us upside in the coming quarters.

Currently, we are positive about what we see in front of us. July is off to a good start and we have moved past the operational challenges of earlier this year. In the broader arena IT distribution is gaining more prominence as vendors and resellers continue to recognize the value of our industry. One of our key trade magazines captured the mood this month when it published the headline that read IT distribution business has never been better. That's the news an industry leader wants to bring to its shareholders.

Add to this our success in enhancing our distribution business with new specialties and capabilities and the long term outlook that becomes even brighter. I believe we are doing a good job of balancing demands of our core business with the diversification initiatives. We have had a good first half of the year and I am optimistic about the second half. My thanks to our entire team for making it happen. Now, I will turn the call over to Bill for more details on our financial performance. Bill.

William D. Humes - Executive Vice President and Chief Financial Officer

Thanks Greg. Let me begin my discussion with sales which are on slide 3. Worldwide sales were $8.19 billion, a second quarter record and an 11% gain over the year ago quarter as Greg mentioned. The translation impact of the relatively stronger European currencies contributed approximately 3 percentage points over the prior year. Sequentially, sales declined less than 1% which is better than our normal seasonal pattern. On a regional basis, North America sales where $3.3 billion, essentially, flat versus the prior year or 40% of total revenues. As we described at last quarter warranty sales on behalf of our vendors are now recognized as net fees rather than gross revenues in cost of sales as reported in the prior year period. We saw a negative impact on year-over-year sales comparisons of approximately 5%. European sales were $2.78 billion or 34% of total revenues, an increase of 16% versus a year ago. The translation impact of relatively strong European currencies contributed an 8 percentage point positive impact on comparisons to the prior year.

Asia pacific sales were $1.76 billion, an increase of 31% over the prior year and 22% of our total sales. Finally Latin America sales were up 4% versus last year to $344 million representing 4% of our total sales. Gross profit was $443 million versus $392 million a year ago. Gross margins found on slide 4 was 5.41%, approximately 11 basis points higher than a year ago driven by the net reporting of warranty sales as-well-as our successful efforts to expand into higher margin categories and businesses.

Operating expenses on slide 5 were approximately $357 million or 436 basis points of sales. This includes a charge of $15 million or 18 basis points of sales to reserve for estimated losses related to an SEC matter as we disclosed on July 2nd.

In the year ago period operating expenses were $304 million or 411 basis points of sales. The increase in the expense ratio compared to the prior year period is attributable to net reporting of warranty sales which had an 8 basis point impact. In addition our investments in strategic initiatives, stock-based compensation, and efforts to recapture share in Germany offset improvements made to the overall cost structure of the core business.

On slide 6 you will see that operating income was $85.7 million or 105 basis points of sales which includes the charge of $15 million or 18 basis points of sales that I just described. Operating income in the prior year period was $88 million or 119 basis points of sales. In the regions, North America operating income was $39 million or 117 basis points of sales. A $15 million charge had a 45 basis point impact on the region's operating margin. North American operating income in the year ago period was $53 million or 160 basis points of sales. European operating income was $22.9 million or 83 basis points of sales versus $19.6 million or 82 basis points a year ago. Expenses related to the recapture of German market share dampened income growth but most of those challenges are now behind us. Asia-Pacific's operating income increased 93% and 56 basis points to $31 million and 176 basis points of sales respectively as the region delivered an outstanding performance with excellent operating leverage.

Latin America's operating income was $3.5 million or 102 basis points of sales compared to $6.6 million or 200 basis points in the prior year period. Kevin will provide additional color on the regional results later in the call. Interest and other expenses for the quarter were $15.1 million, an increase from $13.3 million in the prior year primarily due to higher interest rates. Our effective tax rate for the quarter was approximately 26% as a result of the profit mix changes across geographies. And we expect that our effective tax rate will be approximately 27% in the third and fourth quarters.

Slide 7 illustrates our net income performance. Net income was $52.4 million or $0.30 per share, which includes the SEC charge of $15 million or $9.2 million net of tax and $0.05 per share. This compares to last year's net income of $53.8 million or $0.32 per share.

Now let's turn to slide 8 for a discussion of the balance sheet for the second quarter. Our cash balance at quarter end was $558 million, an increase of $225 million versus the end of last year. Total debt was $589 million, about $80 million higher than the end of last year.

At yearend, we also had $69 million of receivables that were sold under a factoring facility. Payables exceeded an inventory of approximately $1.2 billion. If you turn to slide 9, you will see the relative working capital metrics at quarter end. Days of sales at 38 were up a day versus a year ago primarily due to the greater mix of retail business. Days of inventory at 28 were up a day versus a year ago but a day lower than the previous three quarters. Payables were 42 days, a one day improvement versus the year ago period. This brought working capital days to 24, within our stated range, but up a day versus the year ago period. Specialty businesses and growing customer segments such as retail has a slightly different working capital dynamics. We see working capital management as an area of continued focus and in fact we delivered a two-day improvement in working capital versus the end of last quarter.

Our debt to capitalization ratio was 16%, relatively flat with the yearend. That concludes the financial review. With that I will turn it over to Kevin for discussion of regional highlights. Kevin?

Kevin M. Murai - President and Chief Operating Officer

Thank you Bill. Let me start my overview with North America. As you heard earlier the region's performance was not as strong as we have seen in recent quarters but I am pleased with the team's efforts towards improving the core distribution business while diversifying into higher margin adjacencies. Dell's growth was modest with softness in the government and large corporate segments partially offsetting the strength in the retail and specialty businesses. The data capture and point of sale division had another strong quarter with good growth and a healthy contribution to the region's profitability. Avid continues to grow at a double digit pace. Our managed services unit is adding new customers and our first quarter investments in VPN Dynamics and Securematics are making smooth transitions to the Ingram Micro family.

We expect our most recent acquisition DBL Distributing which was completed in late June at a cost of $96 million to contribute in upcoming periods. The acquisition is expected to be nominally accretive to this year's earnings per share building to $0.03 and $0.06 of accretion in 2008 and 2009 respectively. We believe these specialty units are effective uses of capital providing a unique competitive advantage and greater sources of profitable growth. The region also actively expanded its core business portfolio launching the Infrastructure Technology Solutions division last month. The division is focused on helping our customers more effectively sell higher end solutions such as Blade servers, storage software and related services all to the SMB market. The new division is lead by respected industry veteran formally with Avnet. Also enhancing the core business were new or expanded vendor relationships including agreements with Google and Oracle. With Google, Ingram Micro was selected to distribute appliances that help businesses more effectively search documents on their internal systems.

Google agreement is worldwide in scope starting in the united states and expanding to other countries overtime. And with respect to Oracle, Ingram Micro has expanded it's existing relationship broadening the vendors reach into the valuable SMB market through products designed for VARs.

Our commitment to the success of our vendors continues to be recognized. In May, Juniper named us it's 2007 distributor partner of the year. Our achievements with Juniper have been a source of pride for us. We have grown their business without negatively affecting other vendors in the space. And because of this we are particularly pleased with this recognition. I commend the North American team for building new growth opportunities while continuing to enhance its core capabilities. We expect great things from them as we look down the road. I also have high expectations for the team in Europe which has done an admirable job of managing through challenges over the past few quarters. We are now ready to move past these obstacles and resume our trajectory for profitable growth.

Key achievement for the quarter was the progress made in recapturing share loss during the migration to a new warehouse management system in Germany. I'm pleased their efforts have been successful. We have made solid progress toward returning market share to prior levels. The system is functioning well and Germany is back on track as we begin the third quarter.

We are now concentrating on optimizing the new system to create competitive advantage providing better service with greater efficiencies for our customers. Outside of Germany, most of the other countries also performed well driving increases in the sale and operating income. Spain continues to grow well above market rates with France and the UK also doing well.

Italy and Hungry continue to be opportunities for improvement with both adjusting to evolving market dynamics and a slower demand environment. Our efforts to diversify in a region are taking hold. Symtech, the Nordic data capture company we acquired last year is contributing profitably to the region and we plan to expand our region and space over time.

We've moved ahead with our consumer electronics strategy by organically expanding our portfolio to include televisions, MP3 players, cameras, and Games consoles throughout the region. This is supported by marketing programs, reseller and associate training and retail related services. And we are adding to our geographic footprint through our Joint venture with MB technologies, a distributor serving the African continent.

As Greg said earlier, we believe that Europe has turned the corner. Over the last year we faced market disruption and company specific issues but still delivered profits exceeding those of most of our competitors.

Now, with an improving demand environment and our German business ready for achievement, we hope to have a bit of wind at our backs. July is shaping up well and we are looking forward to continued success.

Moving into Latin America, the region continues to manage through the volatility of its emerging market. Modest sales growth was primarily attributable to 3 factors: a highly publicized future price drop in certain white box components which cooled current sales as the market waited for more favorable pricing, a reduction of government technology spending in Mexico and tough comparisons to the prior year period. These factors along with investments made toward expansion into Argentina had an impact on operating income when compared to last year's high levels. We are excited about entering Argentina with it's promising political and economic environment in which the IT market is expected to grow approximately 9% per year.

We are also ramping up our software sales in Brazil after gaining more clarity on the commercial tax issues we discussed last quarter. I am optimistic about the opportunities in Latin America. As we said in prior quarters it's an emerging market that is somewhat volatile. We can't expect to see 200 basis points operating margins every quarter but our history has shown that they are achievable. We're confident in our excellent management team and look forward to their future success.

Let me conclude my regional ramp-up with the Asia-Pacific region which earned its stripes as the quarter's operating margin leader. As Greg said earlier, our years of investment in Asia are now paying off in a big way. Sales for the quarter grew 31% and operating income nearly doubled that of the year-ago period. Every country grew sales at a double digit rate and delivered operating income gains versus the prior year.

Growth was fueled by strong demand but also by our own efforts to drive the business forward. In China for example we're adding 100 employees to support our push into the networking business. India improved processes and controls to improve profitability. Australia launched a successful value business based on infrastructure solutions. New leadership in New Zealand made swift changes to improve performance. As a result our growth far exceeded the pace of the local market and operating margins hit record highs for the region.

As we look ahead in Asia-Pacific, the future appears bright. We've built a foundation for future success and the market is cooperating. But we aren't resting on our laurels, we're adding new product segments and vendors in certain countries revealing new markets within our existing geographies and improving our e-commerce tools and service capabilities to improve the customer experience. We intend to continue our current success while becoming better prepared for the future. My thanks to the Asia-Pacific team for their outstanding achievements. In three years they have gone from breakeven to top performer. Now I will turn the call back to Greg for closing comments.

Gregory M. Spierkel - Chief Executive Officer

Thank you Kevin. We had a good first half, and we plan to build on this momentum as we look towards the end of get year. For the third quarter of 2007, which ends in September the 29th, we expect sales to range from $8.3 billion to $8.5 billion. This reflects year-over-year growth of 11% to 13%, and a sequential increase of 1% to 4%, a bit stronger than historical seasonality. For net income, we expect $67 million to $71 million, or $0.38 to $0.40 per diluted share. This is based on approximately $178 million diluted shares outstanding, and a 27% effective tax rate.

I am pleased with our guidance which reflects strong sales, another quarterly record above analyst median estimates as reported by First Call. It also indicates good operating leverage from income growth of up to 21%. Our outlook is based on a solid demand environment, superior operational execution, and contributions from our strategic initiatives. We will continue to improve the core business while expanding into adjacency and specialty areas that enhance our margin profile and mitigate the risks of concentration. You are seeing the benefits of this strategy with our Asia-Pacific performance this quarter, and we expect comparable success for the investments we are making today.

As we look beyond the next quarter, it may be helpful to remember some of the points we made in our last month's analyst day. Over the next three to five years, we expect sales to grow greater than the overall IT market with operating income growing stronger than the rate of sales. Our long-term ROIC goal is 15%. I am confident that we have the structure, strategy, and management team to meet or exceed these goals, and I look forward to generating greater value for our shareholders and other stakeholders.

Before I take your questions, I'd like to wish Kevin and his family health and happiness in the years ahead and I'd like to thank our associates for their innovation, dedication and perseverance. I am proud of their commitment to industry leading results. With that I would be happy to take your questions.

Question And Answer

Operator

Thank you. At this time we are ready to begin the question and answer session of today's call. [Operator Instructions]. Our first question comes from Min Park, your line is open. Please state your company name and you may ask your question.

Min Park - Goldman, Sachs & Co.

Goldman Sachs. Just a couple of questions please. First, while your North American revenue growth was better than the reported number after taking account the change in the accounting for warranty sales, what percent year-over-year is a bit closer than what you have been seeing more recently. Can you tell us if there is anything company specific that's causing the slowdown, is it more of a function of the macro environment?

Gregory M. Spierkel - Chief Executive Officer

We believe it's probably more a function of the overall macro environment. As I said before Min, we have seen relative softness in the Government and large corporate segments but we have seen relative strength as well in our retail business and also in our specialty units in the Avid division and in the data capture point of sale division as well. But I do believe that overall we are doing fairly well in the market, kind of maintaining our share there but it is a bit spotty in demand overall.

Min Park - Goldman, Sachs & Co.

And following, you mentioned that you are seeing improvement in the month of June, as seeing a good tail wind in July. Can you tell us how North America exited the quarter and what you are seeing for that first month in the quarter?

Gregory M. Spierkel - Chief Executive Officer

Actually our comment on relative strength in June and the first part of July was related to Europe... our European business and in particular what we have been seeing in Germany. I think overall in North America... as the quarter progressed kind of as expected, we did see a bit more strength later on in the quarter but overall I would tell you it wasn't much different that what we would have expected to see.

Min Park - Goldman, Sachs & Co.

Okay. And just lastly, can you help us understand what's happening with your margins in Europe? We would have expected you to deliver better margins year-over-year since you are not seeing HP's consolidation as the headwind this year?

Gregory M. Spierkel - Chief Executive Officer

Yes, and in Europe first of all I think we had a good performance overall in Europe. We had Spain and the UK and France actually perform well both on top line as well as their overall profitability performance. In Germany where we have been focused against recapture of market share we have had to apply additional resources against mitigation in service levels on warehouse management system, that is back to normal. But in addition that incremental costs just to regain market share back now we did see a recapture of most of that share late in the quarter in June. We do expect to see that going forward and in addition to that we do expect to see I guess a mitigation of some of the costs that we've had to expend in Germany, start the taper off through the second half of the year. But overall the activities in Germany did dampen overall margins for the business and in addition to that Italy and Hungry still represents opportunities for us.

Min Park - Goldman, Sachs & Co.

Great. Thank you very much.

Operator

Thank you. Matt Sheerin, please state your company name. You may ask your question.

Matthew Sheerin - Thomas Weisel Partners

Thomas Weisel Partners. Thanks. Just a follow-up on the question regarding your revenue guidance. Could you remind us the revenue run rate for DBL. I think it's around $300 million and will you see a full quarter's worth of that in the September quarter?

William D. Humes - Executive Vice President and Chief Financial Officer

Yeah, Matt this is Bill. Last year in 2006 DBL had about $300 million in revenue. It's growing in the mid teens essentially, I would expect on a year-over-year basis. So you can do the math on the individual quarterly, we won't disclose separately but it's roughly... it's pretty estimatable. And we acquired that right at the end of June, so what we ended up getting is all the balance sheet but really no P&L in the June quarter. And then so it will be basically a substantial... sequential increase.

Matthew Sheerin - Thomas Weisel Partners

Okay, so if you back that out your guidance still suggests that you are doing a little bit better than seasonal, it sounds like Europe is part of that because you are getting some market share back in Germany, does Asia continue to look strong for you going into the September quarter or is there some seasonality there?

Gregory M. Spierkel - Chief Executive Officer

It's Greg here, I would say Asia definitely is looking solid for rest of the record that we've had over the last three or four quarters which has been very healthy double digit growth that we believe is one that we can sustain, one because the market is doing well but two, as we feel very good about our performance there. The company has been I think growing significantly above market and there is nothing [indiscernible] healthy trajectory that we've had out of that region recently.

Matthew Sheerin - Thomas Weisel Partners

Great, could you just drill down a little bit more on why you have been so successful there in a relatively short period over the last few quarters or so by product area, market segment, and are you seeing increased competition or at some point any threats out there whether it be pricing or anything else?

Gregory M. Spierkel - Chief Executive Officer

It's been a function of first and foremost matter of us making the integration with tech specific work and work well. Lot of credit we've picked up I think what we thought was a very strong management team with very complementary products, in some cases, where we overlap each other too much, and different strengths from a product perspective, and a customer base. You know, clearly the momentum that we are seeing recently is a function of that good integration, which was significant in the countries like India and Australia, where we both had a very large operations, and we are finding ourselves in a situation where we have got very healthy growth across IT products, and telephony products interestingly enough out of India so we are managing, because of some new products, and a new product category to do very well with that there. And clearly there is a lot of growth and expansion capability in what's called upcountry in India, which is outside the major metropolitan areas and we have a very good footprint. We are in sales offices in over 40 cities and over 30 distribution points. So that gives us a huge advantage compared to maybe some of our competitors are not as strong, or as broad and can't invest as much as we can. So a lot of vendors, and a lot of opportunities coming to us as a result of the good work and the infrastructure we have put in place there. And I wouldn't want to lose sight either of two or three other things that are happening in the region. In some of the smaller countries, they just don't get the mention nearly as much, whether that is Singapore or Malaysia or Thailand or New Zealand, we are seeing our company operate at levels better than our competitors. Again because the portfolio what we call carrier is fairly broad, the vendor community is extremely supportive of us, and the last I mentioned is really also made a big difference in the last year, year and a half from where we here lets say two years ago, three years ago, is that our China business, as we have mentioned to the Street and to all of you on calls, we went through a very significant change there two years back. And in fact pulled back on the size of the operations to get good controls and systems in place, and we put a great foundation in place with... leading that change, and since that change over the last 6 to 8 quarters, we have had excellent growth. Again, same situation as India, the breath of the portfolio increasing, the breath of country, cities sorry and territories is increasing, and that's giving us a chance to accelerate I think what we are seeing other companies do in the region.

Matthew Sheerin - Thomas Weisel Partners

Okay, and just lastly regarding Asia, do you still have a strong presence in the components, and processors, and other PC components, and how is that business doing?

Kevin M. Murai - President and Chief Operating Officer

We do. It's doing well in probably the countries like China and India where there is still a fairly large wide box market, but I would say more of our growth is coming from finished systems whether that's laptops who have become very competitive on a worldwide level from the major OEM's or in networking, even software is starting to grow at healthier pace than we would have seen a few years ago as more, and more companies comfortable with buying software as opposed to coping it. So there are a number of facets that are helping us in that regard through the region.

Matthew Sheerin - Thomas Weisel Partners

Okay, thanks a lot.

Operator

Thank you. Brian Alexander, please state your company name, and you may ask your question.

Brian Alexander - Raymond James

Thanks, its Raymond James. First of all best of luck to you Kevin, it has been great working with you over the years.

Kevin M. Murai - President and Chief Operating Officer

Great, thank you Brian.

Brian Alexander - Raymond James

And I guess, the first question I have relates to European profitability just to better understand. So the warehouse issue which sounds like it's kind of fully resolved, and you are starting to get efficiencies out of the German warehouse system, what was the impact if there is anyway to quantify the margins in the quarter, and could you help us think about whether that was more of a gross margin impact as you had to price more aggressively to regain market share, or is it more of an OpEx issue because you still had some extra cost that you had to incur?

Kevin M. Murai - President and Chief Operating Officer

Yeah, I mean it was really both. There are investments that we had to make to recapture share of both that gross margin but again investing in some marketing programs to drive incremental growth in our business as well. So, it's hard to actual quantify and break out exactly what that impact was to overall European results except, I do want just reiterate again though that I mean overall our business in Europe in many countries was very, very good, and in addition to the strong growth that we had in certain countries and some of the uptake that we saw through the quarter in Germany, we will also continue to have opportunities though as we take a look at our Italy and Hungary businesses. And that's really been the story on the margin in Europe is starting of with the improvements that we been making slowly in Germany but also a little bit dampened by Italy and Hungary.

Brian Alexander - Raymond James

Okay. And then just as a follow up, when you say that you are turning the corner in Europe are you making comments more around Ingram's specific situation that is turning the corner, are you making comments more around the market turning the corner because given that it is July and usually seasonally slow around this time of the year I guess I am surprised to hear that you are just picking up now?

Kevin M. Murai - President and Chief Operating Officer

Yeah, that comment really is an Ingram Micro comment. I think, we are feeling pretty good about where we have come from over the past say three and half quarters, in particular the German situation. Now in addition to that though we have seen slightly stronger than typical demand at this time of the year in Europe too, so having that little bit of wind at our backs is certainly going to help our business too.

Brian Alexander - Raymond James

And my final question just relates to Dell and what they might do from a two step distribution strategy. I don't know if you have any additional insights relative to last quarter that you can share in terms of your expectation as to whether they embrace two step distribution in particular geographies as they expand their channel strategy

Gregory M. Spierkel - Chief Executive Officer

Brian, it is Greg here. I mean nothing really overshadowing, and you clearly... as you know Dell is an important relationship for us, one of our larger customers through the software and peripheral supply that we have into their company and we been following and monitoring like everyone is. Their recent entry into the retail space and their ongoing touching if you may have a certain portion of the S&P customers that we support across North America and they have been more public about that in the last month or two. I suspect Dell will see how things go with the retail opportunity, I expect Dell will continue to asses all routes to market. They haven't... they haven't made any avert signals to go into two tier distribution, but if you are reviewing everything and I suspect you are reviewing everything and at some point they may surprise us all but at this stage there is nothing else we can say because there is nothing else that we are aware of that they are doing in two tier right now.

Brian Alexander - Raymond James

Okay, thanks Greg.

Operator

Thank you. Richard Gardner, please state your company name and you may ask your question

Richard Gardner - Citigroup

Its Citigroup. I would like to also say best of luck to you Kevin. I have two questions first of all, I wanted to understand in Europe whether going into the third quarter there's additional temporary cost associated with the German issue that is going to come out or is the margin improvement that we are going to see in Europe for the balance of the year primarily a function of operating leverage on the investments that you have been making there?

Kevin M. Murai - President and Chief Operating Officer

I think Richard we will probably see some incremental cost but probably to a much smaller extent than what we are seeing through Q2. We do expect that in the second half of this year though we are going to absolutely leverage the investments that we have made so, not just in the market share win backs in Germany but also in fine tuning and optimizing that warehouse management system and driving higher levels of productivity and longer-term taking the cost equation down from there as well.

Richard Gardner - Citigroup

Okay and then Kevin I also wanted to ask you, your commentary on the U.S. this quarter was... it sounded a little bit different than last quarter. I think on last quarter's call you talked about U.S. demand being weak early in the quarter or North American demand but then rebounding during the month of March. It sounds like demand may have slackened again at some point in the June quarter. Can you help us understand what Q2 was like in North America relative to Q1 and which parts of the business got better or worse, and sort of what the linearity of the quarter looked like?

Kevin M. Murai - President and Chief Operating Officer

Yeah, on the linearity question I guess it is a little bit more difficult to answer because we do have our own linearity just based on our own calendar of our quarter itself. But really I think what we saw in the second quarter that perhaps may have created some softness relative to Q1 was in the government area and then continued softness in the corporate marketplace. Those were probably the biggest areas that we saw relative weakness.

Gregory M. Spierkel - Chief Executive Officer

Interesting Richard, Greg here, one other quick comment too. Of all the geographies we are operating in right now with the four major regions, the North America markets for the first time that I can recall in a while is the slowest growing in the IT sector and its somewhat reflective of our results that we are seeing right now too.

Richard Gardner - Citigroup

Okay and then just finally when you talk about weakness in corporate, is that primarily large corporate, same as you saw last quarter or have you seen some weakening in the small to mid size business area in June as well?

Kevin M. Murai - President and Chief Operating Officer

It's primarily large corporate. This small to mid size business I think is doing relatively well. The growth is going to change quarter-to-quarter, it still continues to be one of the strongest segments that we have. I do believe though that as we continue to implement or not to implement as we continue to move down the path of our new infrastructure technology division, that's going to help to spur growth for us in particular in more of that corporate space with the higher end products serving there as-well-as being able to serve the SMB markets to.

Richard Gardner - Citigroup

Okay, all right. Thank you.

Kevin M. Murai - President and Chief Operating Officer

Thanks Richard.

Operator

Parry Glant [ph] your line is open. Please state your company name and you may ask your question.

Unidentified Analyst

Thanks, couple of things first on more the financial side and the housekeeping side of the equation. If I take a look at the slide 6, I see the add back on the $15 million charge but if I also want to really make it comparable year-over-year and adjust for the warranty change in accounting as well, would I be correct in commenting about $1.74 margin on that by adding about $6 million back on the opline for the $165 million on the top line?

William D. Humes - Executive Vice President and Chief Financial Officer

This is Bill. Parry, the SEC charge was basically 18 basis points overall. I think you are referring to North America operating margin.

Unidentified Analyst

Yeah, North America specifically, I'm sorry. Because it looks like a 45 bips set back on the SEC charge then if I add, try to adjust for the warranty accounting in North America, it looks like it might take the op margins of about 173 or 174 number?

William D. Humes - Executive Vice President and Chief Financial Officer

No the warranty actually had a positive impact on overall North America by about three, no five basis points overall on operating margin. So, essentially if you were to do your math you would add back the 45 basis points from the SEC charge and then subtract the incremental from the operating margin.

Unidentified Analyst

Got it and then just in terms of stock-comp, is the current quarter level of stock comp about the right number to think about for the rest of the year?

William D. Humes - Executive Vice President and Chief Financial Officer

Yeah, roughly. I mean they bounce around by about $1 million or shy of that and the increase largely is due to two factors one, at the beginning of the year we implemented a new retirement provision within our overall long-term incentive scheme plan for certain aged and tenured employees as well as we had to true up some of our forfeiture assumptions that you have to put in to the overall model in Black Shoals. So at this point I think it's roughly about right within give or take a $1 million.

Unidentified Analyst

Okay and then at a higher level, first on you guys made a decision to accelerate some investments, I think you highlighted here earlier in the call Germany, North America, Argentina, etcetera where is the decision point coming, what will be the factors that would cause you guys to perhaps accelerate some additional investments may be keeping up margins little lower in the back half of the year like you did in the first half of the year?

Gregory M. Spierkel - Chief Executive Officer

I think, Parry it is Greg here. As a team we've been making some investments in the acquisition front that are going to I think favorably work for us, clearly bringing better margins into the portfolio, it has been something that we've can conscientiously investing in over the last year or two to counter balance if you may the ongoing pressures in what I call the volume of commodity side of the portfolio. But that also brings with it to some extent some incremental cost because those are higher margins and usually slightly higher cost to build those revenues into the company. So I think those will be factors that will help us in the back half of the year and I think overall just improvements in our performance that we have got some of the first half of your challenges out of our way. We really do feel that most of the challenges that we were managing through Q3 or Q4 of last year going into the first half of this year are out of our way. So while the market is always interesting we have got most of the internal challenges out of our way right now which is good for us.

Unidentified Analyst

Okay and now on the product mix side of the equation any particular areas that you guys would highlight as areas of broad strength or broad weakness, obviously the PC unit numbers that have been prior... previously disclosed look pretty solid maybe any other broader comments could be helpful?

Kevin M. Murai - President and Chief Operating Officer

Yes, again we have four key broad product categories that we always talk about. We stayed within those norms of ranges again, peripherals being 40% to 45% of our business. Peripherals grew slightly less than our overall company rate and then the other three categories of systems, software, and networking all grew just slightly more. So it was interesting this quarter there was no real stand out category as you may although there is individual vendors or individual products in there but really they were all cupping the 11% growth rate that we had a few above and one area just below but very close to that 11% growth rate.

Unidentified Analyst

And lastly, the last question from me is, obviously there is a lot of concern in the marketplace about the sub prime market and potential impact on the financial vertical as well as the broad retail and consumer verticals in aggregate. I know you have made a number of comments on North America in general but do you have a sense of if we look at those three areas in aggregate what kind of an exposure you guys might have as a percent of revenue in North America?

Gregory M. Spierkel - Chief Executive Officer

The housing sector clearly has thought we are going to have an impact on the psychology and with days like we just came through with the stock market today or this week for that matter, I don't think its going to help the outlook in the medium term or the short term quarter two out. But we have been fortunate in one sense, the Avid business which we haven't mentioned so far has been pretty solid for us in light of a soft marketplace, a home marketplace that is. So we are still growing at a healthy double-digit rate albeit a little lower than it was a year ago but its still very healthy and we review that pretty carefully which says the high end of the consumer market is still opening up their wallets and still providing us ample opportunity. But the more volumes in commoditized space I think is a bit more sensitive right now, and that's probably factoring in on the overall retail sector as we are selling into that sector.

Unidentified Analyst

Thanks.

Operator

Jason Gursky, please state your company name and you may ask your question.

Jason Gursky - JP Morgan

It's JP Morgan. Just one last comment I guess for Kevin, congratulations on both your career at Ingram and on your decisions to move on and spend sometime with family.

Kevin M. Murai - President and Chief Operating Officer

Thank you, thank you Jason.

Jason Gursky - JP Morgan

A couple of book keeping questions for Bill, CapEx was quite a bit lower this quarter than what it was last quarter, maybe just a little bit of an explanation as to why the slow down and what we ought to expect for the rest of the year? And then on the tax rate what you might expect for 2008?

William D. Humes - Executive Vice President and Chief Financial Officer

Sure Jason, overall our total CapEx for the six months is about $24 million which is right along the lines of what we expected overall in our plan if you looked at our 10-K and previous year's disclosure. We talked about an expected up to $60 million in CapEx. And of course that... the amount of expenditures and what end [ph]... the timing is all dependant upon what you are buying and when. So... but I would still expect that this time that we should be within our overall expectations of the $60 million and if we are not we will tell you at that point in time but we are looking... we are tracking right along our expectations. And then your second question was what?

Jason Gursky - JP Morgan

Your tax rate for '08.

Gregory M. Spierkel - Chief Executive Officer

Overall it's at 27 for the rest of this year and I think 27 is probably a good rate to model for '08, of course as we get closer to '08 and we develop our own internal budgets and everything that will evolve based on the mix of businesses and other strategies we may implement but 27 is probably a good rate for now.

Jason Gursky - JP Morgan

Okay and then just the follow up. Greg maybe just some qualitative commentary from you on what... where you think the demand in Europe is coming from, just kind of a currency driven phenomenon going on, was there some investment that is now getting caught up that wasn't being made over the past several quarters in the region. Just kind of why you think this demand is now starting to firm up a little bit over there?

Gregory M. Spierkel - Chief Executive Officer

That's a good question and it's interesting because about 3.5, 4 years ago we saw pretty good movement of the Euro versus the Dollar and that provided a bit of a catalyst. I think that there is some tailwind in the marketplace in Europe because of the currency situation. It's very hard to measure and know for sure but most components and products are US denominated in terms of cost level and clearly that means for a less or a lower priced Euro base product once it gets sold into that region. So I suspect that's helping, but I wouldn't have any tangible hard numbers to give to you, but we are seeing really in the last month or two some pretty positive signals from the demand and our own progress in most of the countries in Europe.

I think also you are getting a situation where Europe is seeing some real growth and a lot of people aren't seeing this yet, but we are hearing a lot of it. As a result of selling and servicing Eastern Europe much like the emerging markets of Asia, the 6 to 8 new countries of Central Europe and Russia are feeding an interesting new business opportunity in growth out of the supplying countries, which is Western Europe. And so there is an export phenomena, and as a result infrastructure spend to support a new business coming out of Eastern-Central Europe is I think helping Western Europe right now.

So I think those are the two kind of macro level factors that seem to be providing. What we see on a day-to-day basis, a more positive outlook right now than where we were three, four months ago.

Jason Gursky - JP Morgan

Okay, great. Thanks guys?

Operator

Thank you. Andy Hargreaves. Your line is opened, please state your company name, and you may ask your question.

Andrew Hargreaves - Pacific Crest

I want to come back to the US real quick. It seems like the direct marketers were all seeing pretty strong growth. So do you think that's the situation where you are just exposed to some verticals that they are not for some reason, or are US VARs losing some share?

Gregory M. Spierkel - Chief Executive Officer

I think our VAR business still is relatively solid, and strong. Really it's more of the... it's really more the corporate space that we have seen relative... corporate and government space that we've seen have seen relative weakness in. But as we look at that space, because there is probably a lot of crossover in markets served, at least end markets served between the direct marketers and our VARs, that comparison is probably not too far off.

Andrew Hargreaves - Pacific Crest

Okay, can you give us... you mentioned consumer electronics in Europe, were you are taking about the private label business there?

Gregory M. Spierkel - Chief Executive Officer

Could you repeat the question, you kind of crossed out on us a bit there?

Andrew Hargreaves - Pacific Crest

Yes sorry, you were taking... you mentioned briefly consumer electronics in Europe, were you taking about the private label business there or are you talking about something different?

Gregory M. Spierkel - Chief Executive Officer

No, actually private label components of that obviously included in what we are doing in consumer electronics but the comment was really a little bit broader against how we are continuing to expand our overall product portfolio on consumer electronics in Europe. Spain is like continuing to expand our offering of digital Cameras, of MP3 players, and even now getting into televisions as well. That's really... that was really the comment on consumer electronics.

Gregory M. Spierkel - Chief Executive Officer

Okay, okay thanks. And then just a little detail on the return on capital target, and I apologize if I missed this. But how much just qualitatively are you expecting to come from P&L improvement and how much from balance sheet changes, balance sheet improvement?

William D. Humes - Executive Vice President and Chief Financial Officer

Hey Andy, this is Bill. I'd say that given where we are on working capital and the fact that we have essentially best in class working capital metrics, obviously that leads to the biggest portion of upside opportunity coming from operating margin improvement. So although I would say working capital of course is an area we will continue to focus on and probably can shave some of the ROIC increase out of that, the lion's share will come from operating margin improvement over the years.

Andrew Hargreaves - Pacific Crest

Thank you.

Operator

Thank you. At this time we have time for one last question. Ben Radinsky, your line is open. Please take your company name and you may ask your question.

Ben Radinsky - Bear Stearns

Thanks. It's Ben Radinsky from Bear Stearns. First a couple of housekeeping questions. What was the translation impact in Asia-Pacific; do you have that handy?

William D. Humes - Executive Vice President and Chief Financial Officer

Hey, Ben, it's Bill. It just wasn't... it wasn't material. And so the large amount of the Asia-Pacific growth was really organic, the Asia-Pacific currency strength and you didn't have a material impact on that growth.

Ben Radinsky - Bear Stearns

Okay. And then what was the... if you pro formaed revenue for warranty expense, what would sales have been for the warranty changed?

Gregory M. Spierkel - Chief Executive Officer

You will hear on our release and other things, it had about a 5 percentage point impacts on the year-over-year growth for North America and roughly a 2 percentage impacts on the overall worldwide growth on a year-over-year basis.

Ben Radinsky - Bear Stearns

Okay. And then when will the SEC charge be finalized, you have an estimate for that?

Gregory M. Spierkel - Chief Executive Officer

Don't have an estimate. We have... as we've said in our July 2 notice on this, we've been in discussions with the SEC, we believe we've assessed the right figure and impact that this should have on the Company. It's up to them to come back to us in the coming months and that's really something that's not under our schedule. It's really determined by their pace of workload and everything else and case load that they have. So we're sitting on the sideline and we have done everything we feel that we can at this stage.

Ben Radinsky - Bear Stearns

Okay. And then the last one is, can you just give a little color on DBL? Is that... I know that that's much more retail oriented than Avid is but can you talk about qualitatively what the margin structure is there and does is fit in with the Avid strategy or is it really a separate silo?

Gregory M. Spierkel - Chief Executive Officer

Okay, I think it's a good compliment overall to our consumer electronics strategy and when you take a look at the overall CE market what we've done in particular here in North America is really rounded out that offering with DBS. We've got out of it on the very high end home theater. We have got a lot of product in the IT and CE convergence space to our core Ingram Micro business.

DBL really does provide... I guess... provides us with I guess a couple of things: number one is it does fill in a lot of the accessories part of the CE offerings, some related to convergence, some not. And in addition to that it also brings us a lot of strength and independent retail. So it's a good mix, it's a good compliment to what we already have in product line. I think it's a great compliment in terms of the customer sets we are able to address and operating margins we didn't talk specifically about but as with the other adjacent businesses we've looked at obviously we are looking at net new markets that offer us with higher margin businesses both on the gross margin as well as operating margin lines.

Ben Radinsky - Bear Stearns

Okay, great. Kevin, good luck to you.

Kevin M. Murai - President and Chief Operating Officer

Thank you very much.

Operator

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

Ria Marie Carlson - Corporate Vice President of Strategy and Communications

Thank you very much for joining us today. A replay of this call will be available until August 3rd at that number, it's 800-678-3180, or on ingrammicro.com. Thank you again for joining us. Bye, bye.

Operator

Thank you. That concludes today's conference, you may now disconnect from the audio portion.

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