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Ingram Micro Inc. (IM)

May 23, 2012 1:45 pm ET

Executives

William D. Humes - Chief Operating and Financial Officer

Damon S. Wright - Senior Director of Investor Relations

Analysts

Benjamin A. Reitzes - Barclays Capital, Research Division

Benjamin A. Reitzes - Barclays Capital, Research Division

Let's get started with Ingram Micro. So everybody, I guess, is out of the Verizon keynote. So let's get started.

Today, we have Damon Wright with Investor Relations, as well as Bill Humes who's now -- who's taking on the additional role of COO from -- as well as keeping the role of CFO. So now I think you're in charge here or have a hand in everything.

William D. Humes

Just about -- yes across the board. Yes.

Benjamin A. Reitzes - Barclays Capital, Research Division

Okay. So we're going to get right into Q&A. As you guys know, a huge distributor, almost invented the category. And I don't know which came first. But we're just going to go right to questions.

I know it's an interesting an operating environment right now. But do you mind just kind of starting out with some of your longer-term goals, kind of, get us focused on the long term. And then let's drill down what happened recently in the short term. You have some pretty interesting long-term targets that are -- have the potential to drive some earnings upside from here.

William D. Humes

No, absolutely. Thanks, Ben. Overall, as we communicated at our Analyst Day back in November of 2011, we have certain goals, I mean, I'd say the financial goals, the key ones for EPS level of $2.60 to $3.10 earnings per share, which is really driven by an operating margin achievement level on a consolidated basis of 155 to 175 basis points of operating margin on a full year basis, with an ROIC of approximately 300 to 500 basis points above weighted average cost of capital. Right now, weighted average cost of capital is about a little bit shy of 9, probably mid 8s if you consider all different factors.

So those are the overall goals. They were dependent on -- and there was a couple of assumptions that were included in there or a revenue growth expectation over the 3 years before 2015 and including 2015 of 4.5% to 6.5% revenue growth run rate. Which if you look at overall global demand and global spend, especially back in November. That was roughly around mid-single digits where IT demand was forecasted by the IDC as the gardeners of the world. And we did expect a gross margin level of 5.4% to 5.65%. Overall, we were -- when we set those targets for gross margin, which kind of built into our overall operating margin, we're coming off of what I would say a gross margin low for us in the third quarter of 2011 of about 4.95%. So that impacted some of our target setting at that point in time. Since then, we've made some great progress on that.

Now overall, so those are our overall targets. I would imagine the next question would be what are your key drivers there.

Benjamin A. Reitzes - Barclays Capital, Research Division

You got it.

William D. Humes

Sure. So I'm a good a setup man for that. As I talk about on the overall leverage side of things from the 4.5% to 6.5% revenue growth expectations, we do expect to deliver about 25 to 35 basis points of operating margin leverage by really holding OpEx fairly consistent to just slightly above half the rate of sales growth. So obviously, if there's a lower level of revenue growth, it's a little bit more challenging to drive a lot of operating leverage. But if there's higher growth rate towards the 6.5% range of revenue, then having OpEx growth monitored and managed at that reasonable level is fairly well controlled and very confident in being able to do that.

We also look at -- there's a big portion of investment in our different areas of business and adjacencies. So when Alain Monié, the new CEO, came in, this has helped even further accentuate this, is that really driving more inertia and growth and critical mass in our higher-margin adjacencies.

So for instance, our Auto Identification Data Capture/Point-of-Sale business, we've grown that to a little bit over $600 million in 2011. We believe we are the second largest globally in that areas, with ScanSource being the #1. It's growing -- obviously, it's growing higher-than-normal IT growth. It really drives a significant level of productivity, the technology software and hardware that's involved in the auto identification data capture space. And the operating margins and gross margins are much, much stronger than our core business.

Then let's continue to focus on things like the adjacencies and data center and Value business. We have got a substantial amount of, I'd say, business that we sell in a -- that would be considered in products senses -- our value business so a well -- a good degree over $10 billion in value-determined business. But it's sold, to a large degree, in a volume way.

So the play in that regard is really driving some of the services and solutions and a consultative support that help drive the gross margins and ultimately operating margins up in that area of business. So that one is not only just a growth area business, but also an operating margin area business.

And then, driving our Ingram Micro Logistics and Ingram Micro Mobility businesses to -- really would drive the one of the services element of Mobility and the services element of Logistics. Both of which, over time, will drive higher operating margins than the average and help us achieve it.

So we estimate that on a normal, kind of, normal expectation organic, kind of normal organic with maybe small tuck-in acquisitions, that will give us 10 to 20 basis points of operating margin.

Then as we've talked about pretty readily, we do have, and we are and have been implementing SAP. And with SAP, we have been incurring a lot of additional costs in the sense of both deployment costs, as well as duplicate infrastructure. So we're running the whole infrastructure of SAP, as well as the infrastructure for our previous COBOL technology mainframe called impulse. So we have redundant IS expenditures in the sense of the infrastructure and deployment costs, which ultimately, when we're done deploying SAP, we will be able to rip out with high degree of confidence around 15 to 20 basis points of operating margin leverage. This is all coming off of a trailing 12 months after -- off of September's operating margin of 122 basis points. So that gives you a relative benchmark.

And we get -- we've got a -- had couple of business, that we talk pretty openly about that we've -- have some challenges in. And so fixing those businesses, which is Australia, which lost a little bit less than AUD $60 million last year on an operating margin basis. And then Brazil which also lost, not nearly that much, but lost some good degree of money as we continue to invest in the processes in the complex but high demand environment there.

Getting those businesses at least just back to breakeven, it has a 10-to-15 basis point benefit for us. So we can drive some 10 to 15 basis points from just getting to breakeven. Then if they get back to where they used to perform in operating margin levels, that is more like the herd average and you can probably add another 10 to 15 basis points on top of that. Just when I was putting this overall bridge and the levers of getting to the upper margin target, I wanted to make sure we are conservative and just getting -- just showing what was bleeding and fixing the bleeding and not necessarily adding profits to it. But there is some upside there.

And lastly, we do have a lot of structural, other areas of cost savings, cost benefits. As many of you know, we've -- we do have a global operations, global logistics business, as well as global warehouse management. And all on top of that we -- so we have a lot of, I'd say, optimization areas of potential benefit where we can drive standardization and network optimization-type savings. So there's going to be some savings driving unit costs of shipping and unit costs out of our warehouse and ops labor and as well as our fixed infrastructure. Second of all, other things like cost structural areas of -- we're considering and deploying a shared services strategy for extracting out repeatable processes around the globe that is done in individual countries to pulling them out into a centralized lower-cost labor spots, in different spots. We already have, about 1,200 people in Manila doing shared service operations activities. That's mainly for North America, but also includes Asia too. We're going to build another site and potentially a third site as well, to cover basically the rest of the globe, where we can extract higher cost labor, get lower cost activities that are repeatable and do it one location and then also drive standardization and optimization and savings through that -- through those centers there. So that's an area of savings as well. And then strategic sourcing it's -- which is really taking our global leverage of buying power. And also putting some smart and tactical-type experts towards doing RFPs and finding the best ways to use product and then buying it in that way such that we get the leverage of our global company versus individuals in a subsidiary buying pens, paper, supplies, corrugated material, box filler, all by local vendors. We can drive some benefits of scale by making that much more of a global effort, if not at least regional, but more global as our aspects. So that should drive a good -- another good 15, 20 basis points of operating margin overall. Kind of the sum of those different savings areas.

And then just to make sure that we are comfortable with hitting the levels, we've built in a portfolio of contingency of about 20 to 25 basis points of -- if one of the other areas doesn't hit the quite levels or demand isn't quite high as we wanted to, we had some contingency plus we built in some additional money to invest in greenfield and organic options and alternatives which also gives us a little bit of cover in the sense of conservatism.

So, hopefully in the end in 2015, we'll have achieved all of the high ends or at least achieved a lot of the midpoints in our operating levels. And used and been able to also invest in certain technologies and capabilities for longer-range, past 2015 and achieved our -- achieved and/or exceeded our range of operating margins and there go EPS and ROIC.

Benjamin A. Reitzes - Barclays Capital, Research Division

I'll tell you that's a lot of -- those were a lot of initiatives. But when you go through them, that means way more than the 40 to 45 basis points that you need to get to the op margin goal. When you total them all up, what was it? Is it 80 basis points?

William D. Humes

Well if you total them all up, yes, it's in that realm. But all of them have a range. So you're probably looking at a 50-to-80-basis-point range of positives. And then we have some investments and some contingencies too. So I would say the contingency, ignore the portfolio contingency as a kind of comfort level hedge to hit some of the other items. And then we're going to invest in organic expenses for growing some of our greenfield operations.

Benjamin A. Reitzes - Barclays Capital, Research Division

Now , I hate to ask you this question. But after some of these tough earnings reports, since you've reported even, it seems like you may have to dip into that contingency plan pretty soon. So I guess the question is how are you prepared for even an incremental downturn over this quarter maybe even the next? And given your portfolio, what leverage do you have to pull to, kind of, stay on that track that you've just outlined?

William D. Humes

Yes. I mean, I would say overall, when our goals were longer term, there's -- 2015 so that's one positive element there. In Q1, it ended up being -- it was a pretty good quarter for us. We hit our expectations and we are driving for our progress. I'd say some of the things that we're doing to expedite the sense of urgency around execution on our IM Logistics business which is really starting to perform well. It's got a great pipeline, invest in our adjacencies so the data center and mobility and the bark of the business and data centers is -- will help supplement some of those demand areas that may soften. And in the meantime, obviously, in the shorter range or intermediate time range, if demand ends up being softer. One, yes, you're right, we won't be able to lever as much leverage on the upside from revenue. But we'll have to take some -- incremental OpEx new actions and continue to be constrained OpEx, except for the areas where want to really invest in for the longer range.

Benjamin A. Reitzes - Barclays Capital, Research Division

All right. And -- let's just, kind of, skip down a little bit, Are there any potential demand catalysts do you see this year? Sounds like Windows 8 is frankly, not much of a catalyst, but maybe, Damon, you disagree?

Damon S. Wright

Yes. I think that when we look at incremental catalysts, the main questions we get around Romley, Windows 8 and Ultrabooks. They're all still very early or not quite to those cycles yet. So I think from incremental this year, we aren't expecting anything, I mean, is there a potential, yes, slightly. But we'd look at it more of a longer-term 2013, 2014 opportunity for us. When you look at kind of this spending environment, and particularly the SMB market that we're focused on. Those customers are really trying to drive the last bit of value out of their existing products, out of their existing technology, so I think it's going to be more of a gradual ramp-up and something that's longer-term incrementally for us.

Benjamin A. Reitzes - Barclays Capital, Research Division

Yes. Dell, last night acknowledged that tablets are eating into their business and really kind of backed the whole consumerization of IT, do you see some abnormality [ph] or not for the first time. Do you feel you have enough tablet exposure if PCs kind of are on their way towards x growth which seems apparent?

William D. Humes

Yes. I mean, we have a very nice level of sales in tablets globally. So...

Benjamin A. Reitzes - Barclays Capital, Research Division

Are you as getting as much as you need?

William D. Humes

Yes, we've enjoyed a significant amount of growth in tablet sales in 2011. And continue to see that in 2012. So to the extent of the new cannibalization of some, of laptops, PCs versus tablets, I would say yes, of course on the consumer side, I think it is. I mean, if people can stretch out their laptop a little bit more, but then buy, on a consumer side buy the tablet, one they're a tablet, they're going to make a choice on the tablet or have made the choices on tablet. That's why I said, soft phenomenal growth, but largely on the consumer side in tablets last year.

Benjamin A. Reitzes - Barclays Capital, Research Division

Are you getting enough of them from the major guy that probably is the one people want?

William D. Humes

Yes, we got -- we have no issues there.

Benjamin A. Reitzes - Barclays Capital, Research Division

And a little bit more about your Mobility. Your mobility strategy, are you, what else are you selling? And because tech data, yesterday, we went into a lot of what they're selling. They're obviously not selling the iPhone. They sell a lot of Samsung. What about you guys?

William D. Humes

We definitely sell some Samsung. We sell tablets in India. India ends up being has a significant market share on smart handhelds and other handhelds. Our strategy on mobility is continue to enhance. We've gained a critical mass of some key vendors in the overall tablet sales, as well as some handsets. We need to continue to grow that. But more importantly, we're also going to develop the services around there. That's the piece that we really are looking to build, looking and investing in the sense of activations, in the sense of refurbishments, returns, replacements, programming, config, those are all the types of techno -- the capabilities that we're willing to and I'm very interested in to continue to develop and grow, of which at this point in time, we're fairly light there. So that is ultimately where we would look for organic as well as potential...

Benjamin A. Reitzes - Barclays Capital, Research Division

From what I hear Android is going to provide a lot of those opportunities in the refurbs, returns and configs. I was just kind of kidding, but not really. Okay. So in terms of other things, we've had a major issue in Australia and we've talked about adding -- is it 10 to 15 basis points if they just go back to break even?

William D. Humes

Yes, that and Brazil.

Benjamin A. Reitzes - Barclays Capital, Research Division

Yes. Okay. And brazil -- so how long until we get there?

William D. Humes

Our goal, ultimately, we've talked about earlier in Q -- in our Q1 release is really to ultimately exit Q4 of 2012 at a break even run rate. In Q1 of 2012, we lost around $10 million to $11 million of operating margin, which is better than Q4 and better than the year-over-year time period. So we've made some good progress. Our revenue was less down than it was in Q4, where we continue to work on driving new efficiencies and process and deploying new technologies and functionalities within the SAP system and doing training and working with our customers to regain it. That being said, we still have a much longer road to hoe down or -- so what we continue to do is we do expect gradual improvement into Q2. And then Q3 as we finalize some of the deployments of some of the enhancements that we need on customer-facing areas of the SAP technology, as well as some of the partner connectivity and the e-commerce functionality. As we do that, hopefully we're gradually winning back share or we're winning back some of the customer revenue. As we look at towards the back end of the year, we'll have to evaluate how successful we've been with the regain of the revenue, how things are running with the system and look at costs. But in the end, exit rate goal is still the goal for 2012 and hopefully 2013, where we really want to shoot for profitability.

Benjamin A. Reitzes - Barclays Capital, Research Division

Any concerns that APAC gets hurt by what's going on China. You have some really big Asia exposure and are you seeing a slowdown in that region that could offset some of this progress?

William D. Humes

Well, I think maybe across the board, Asia is a very diverse and this aggregated marketplace. In New Zealand and Australia, act more so like a European economy than they do an Asian economy. And to tell you the truth, Australia has been fairly impacted and sluggish as an overall macro environment. Now for the rest of Asia, it's still going fairly strong. The demand -- IT demand outlook is still fairly solid. Right now, it doesn't have the blistering growth in the sense of the overall IT general spend as it had 3 or 4 years ago. But is definitely higher than most marketplaces, if not all. So it continues to spur a lot of demand, a lot of growth and there's some pretty good revenue growth that we're experiencing. Whether that -- if that changes a little bit, I think it would only be for the shorter term. And I think it's Asia, as well as Latin America being the emerging markets that we have great presence in, will be the -- will be growth engines for many years to come.

Benjamin A. Reitzes - Barclays Capital, Research Division

Now how about Europe, the big issue there for you guys has been the European retail exposure and the margins there. Tech Data was, kind of, able to hold their sales up there without all these onetime things. But it seems like the retail exposure to you guys are a little bigger, maybe on a pound-per-pound basis. Would you say -- how are you dealing with that on the retail side?

Damon S. Wright

So we do have more retail exposure in Europe than the other areas of our business, which have to do with how, kind of, fragmented the infrastructure is there. And we act as a hub and spoke for a major retailer over there. The big -- it's really fragmented also by country and how we're seeing the performance there, kind of the big engines for us is Germany, France and the U.K. are doing relatively well. France a little less so in the most recent quarter, as there's been some non-clarity around the elections, which is now been resolved and we'll have to see which way that goes. But to those engines we're doing well, again and SMB particularly has been a relative bright spot. Again on a relative basis for Europe as well. We've got a lot of focus there. We've seen some good improvements there, particularly in the U.K. and some of these focused programs and businesses we're doing. Overall, I think in Europe, we're not expecting things to be much different then. We were down 8% in Q1, had a 4% FX headwind there. We're not expecting things to get incrementally better, but we're not expecting to see them fall off the cliff either. It's kind of the way we're planning at those parts.

Benjamin A. Reitzes - Barclays Capital, Research Division

Both from a revenue and margin standpoint?

Damon S. Wright

That's correct. Yes.

William D. Humes

I would say that overall the European macro environment is the wild card obviously for everyone. And -- but as, we'll continue to drive our internal improvements and operating performance. Watch the costs very closely and make adjustments where necessary. And we're getting some good mix of, since the SMB market is a little bit stronger than the Retail business. We have some good focus on programs that is driving some of the profitability.

Benjamin A. Reitzes - Barclays Capital, Research Division

[indiscernible] Clearly, sometimes I think of certain problems like what the Australia issue but also other things like the European retail issue. Is there a certain kind of worst case you could get to that you already have figured out? Or...

William D. Humes

No. I'd actually say that for the most part, a lot of the profitability on the Retail business once we went through the kind of our changes and evolutions in the systems back in -- and profitability of that business from 2008, 2009 is much better performing than it was 4 years ago. That being said, it is the weakest piece of the business in the sense of demand. So rather than margin based, it's more of a demand based, because it is the softer piece of business's

Benjamin A. Reitzes - Barclays Capital, Research Division

[indiscernible] margin, I guess it's the revenue that doesn't matter as much. The other thing I just wanted to say is a final question, there's some pretty weak parts of IT. We talked a lot about printing recently and Romley, so we heard about PCs last night from Dell. Do you feel like you have overexposure or underexposure in these weaker areas? We talked about some of the growth areas, but how are you dealing with these weaker areas?

William D. Humes

I'd say just for the most part...

Benjamin A. Reitzes - Barclays Capital, Research Division

Servers [indiscernible] too for you right?

William D. Humes

Yes. We're pretty balanced, I think, across the board in access to technology and with our vendor line card. I mean we've got the broadest line card across all distribution companies. So and we're pretty balanced in that regard. Inventory-wise, we're decent in the sense of the inventory levels. Q1 -- when we came out of Q1, it's always a little bit higher than normal. But our exposure overall I think to the softer areas is managed. I mean we have very little printer business. Peripherals is where that exists. So I think servers -- the higher-end servers continue to be at least fairly in demand as people look at data centers and that becomes more accessible to the small and medium business. So what they end up doing is buying less servers, but they hire ASPs and sort of a -- just kind of left hand, right hand in the sense of total revenue. But I think we're fairly well suited.

Benjamin A. Reitzes - Barclays Capital, Research Division

Good. I think that we're out of time. We got to go to the Liberty 3. I invite you all to come. And thank you so much, thanks, Damon. We appreciate it and thanks for all your support over the years.

William D. Humes

Great. Thank you. Appreciate everyone for being here.

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