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Income Micro, Inc. (NYSE:IM)

Q2 2008 Earnings Call

July 24, 2008 5:00 pm ET

Executives

Ria Carlson - Chief Strategy and Communications Officer

Greg Spierkel - CEO

Alain Monie - COO

Bill Humes - CFO

Analysts

Brian Alexander - Raymond James

Matt Sheerin - Thomas Weisel Partners

Min Park - Goldman Sachs

Richard Gardner - Citigroup

Bill Fearnley - FTN Midwest

Ananda Baruah - Banc of America Securities

Operator

Good afternoon and welcome to the Ingram Micro second quarter earnings report conference call. (Operator Instructions) Now I will turn the meeting over to Ms. Ria Carlson, Chief Strategy and Communications Officer.

Ria Carlson

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 the highlights of the second quarter followed by Bill with the financial review. Then we will turn it back 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 www.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 to today's news release and documents filed with the Securities and Exchange Commission, specifically the risk factors listed on Item of 1A of the Form 10-K for the fiscal year ended December 29, 2007 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 www.ingrammicro.com or by calling 800-678-3180.

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

Greg Spierkel

Good afternoon everyone. This quarter tested our team with economic and competitive pressures and I am impressed with how well we rose to the challenges to deliver solid results. Sales and income exceeded our guidance and analyst estimates, revenue hit a second quarter record and gross margins were at the highest second quarter level in a decade.

Every region remains solidly profitable. While weaker economies in our largest regions had an impact on demand, sales grew 8% in US dollars. In EMEA sales declined in local currencies due in large part to the macroeconomic environment as well as our deliberate efforts to walk away from unfavorable business. Similar market forces affected sales in North America and Asia Pacific which grew 7% and 8% respectively.

Asia Pacific’s exceptional growth of last year has been dampened by the global economic environment and to a lesser extent the earthquake in China. The economic malaise has not spread to our Latin American business which generated 28% sales growth. Softer demand created by more competitive markets with pricing pressures widely reported throughout the industry we managed this dynamic well given a gross margin improvement of 12 basis points through good pricing discipline, growth in our higher margin business units and adjusting our mix towards segments with a better margin profile.

I’m proud of the gross margin achievement as it affirms our value to customers and our teams’ focus on sustainable profitability. Operating expenses continue to be an area of focus and we’re taking action in a number of areas. The expense reduction programs we announced last quarter in North America and EMEA are progressing well. We accelerated our timeline in Europe after receiving formal clearance earlier then we expected.

This resulted in higher program costs of $7.7 million in the second quarter compared to the $2 million to $4 million estimated in our guidance. Moreover in light of rising fuel costs we are introducing incremental freight charges across most of our account base. This initiative is expected to be fully implemented worldwide by the end of the third quarter and will primarily benefit the gross profit line.

These actions along with continuous improvement throughout the business should drive operating income growth over time. For the second quarter operating margins were relatively flat compared to a year ago. The economy remains a concern but our efforts to diversify into services and adjacencies are helping us weather the storm.

We continue to excel in a difficult environment and I am pleased with our performance. Our execution is sound and I’m confident that we will emerge from the economic downturn as an even stronger force in the market. I’ll now pass the call to Bill for more detail on our financial performance.

Bill Humes

Thanks Greg, we’ll start with sales which are found on slide three. As Greg mentioned sales hit a second quarter record of $8.82 billion. This is a year-over-year increase of 8% of which approximately six percentage points are attributable to the translation impact of stronger foreign currencies.

Sequentially sales increased 3%, greater then normal seasonality due largely to last quarter’s early Easter holiday. On a regional basis North America sales were $3.52 billion, an increase of 7% over the prior year period driven by the addition of DBL Distributing at the second half of June last year and solid growth in Canada.

This region accounted for about 40% of our worldwide sales. EMEA sales were $2.96 billion or 33% of total revenues, a year-over-year increase of 6%. The translation impact of relatively stronger European currencies was approximately 13 percentage points.

Asia Pacific sales were $1.9 billion or 22% of total revenues, a year-over-year increase of 8%. The translation impact of relatively stronger regional currencies had a six percentage point effect on comparisons to the prior year. And Latin America sales were up 28% versus last year to $438 million representing 5% of our total sales.

As depicted on slide four gross profit was $487 million or 5.53% of sales, a 12 basis point improvement over last year. This was the highest second quarter gross margin in 10 years. The gross margin achievement is the result of good pricing discipline within a competitive environment and strength in our higher margin businesses. In the year ago quarter gross profit was $443 million or 5.41% of sales.

Operating expenses on slide five were approximately $394 million or 4.47% of sales. This includes $7.7 million or nine basis points of sales for cost related to expense reduction programs in North America and Europe. In the year ago period operating expenses were $357 million or 4.36% of sales which included a charge of $15 million or 18 basis points of sales to reserve for estimated losses related to the SEC inquiry disclosed previously.

The year-over-year increase in operating expenses is attributable to several factors; the translation impact of strong foreign currencies, the costs associated with our expense reduction programs, labor costs related to higher volume in our fee for service business and incremental expenses related to our strategic investments, such as the ongoing development of our systems and processes, ramp up of our services and infrastructure solutions businesses and the addition of DBL.

As I mentioned previously DBL was acquired in late June last year which had a negative affect on the prior year comparisons. The expense reduction program costs relate primarily to severance related items in North America and Europe. In North America we streamlined administrative and back office roles while in Europe we are rationalizing and reengineering certain roles and processes at the regional level.

Of the $7.7 million in program costs in the second quarter $6.6 million are related primarily to severance costs and included as restructuring charges. The remaining $1.1 million are included in selling, general and administrative expenses as they are primarily consulting costs and accelerate depreciation related to the expense reduction programs.

Although we were able to accelerate the planned restructuring and cost reduction actions in the second quarter we still expect another $7 million of further charges in the third quarter as we complete this program. We continue to evaluate additional expense reduction opportunities which may result in additional costs and related benefits in future quarters.

On slide six you’ll see that operating income was $93.2 million or 106 basis points of sales which includes the previously discussed expense reduction program costs of $7.7 million or nine basis points of sales. In the prior year 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 related to the SEC matter.

North America operating income was $44.4 million or 126 basis points of sales compared to $38.5 million or 117 basis points in the prior year quarter. Second quarter operating income includes expense reduction program costs of $900,000 or three basis points of sales. As previously discussed operating income in the prior year quarter included a charge of $15 million or 45 basis points of sales related an SEC matter.

EMEA’s operating income was $15.7 million or 53 basis points of sales which includes expense reduction program costs of $6.8 million or 23 basis points. In the prior year period operating income was $22.9 million or 83 basis points.

Asia Pacific was the operating margin leader with 172 basis points. Operating income increased 5% to $32.7 million versus $31 million last year. The team has done a good job of keeping expenses in check as sales growth began to slow in certain markets within the region.

Latin America more then doubled its operating income to reach $7.2 million compared with $3.5 million a year ago. Operating margin increased 63 basis points to 165.

Other expenses for the quarter were $10.8 million compared to $15.1 million in the prior year period. The decrease was primarily driven my lower debt levels, declining interest rates and higher foreign currency gains in the current year.

Our effective tax rate for the quarter was 28.5% and we expect our effective tax rate will be 28% in the third and fourth quarters.

On slide seven you’ll find that net income was $58.9 million or $0.35 per share which includes expense reduction program costs I described earlier of $5.5 million after-tax or $0.03 per share. Please keep in mind that our guidance did not included these charges. In the prior year period net income was $52.4 million or $0.30 per share which included the SEC charge of $9.2 million after-tax or $0.05 per share.

Now let’s turn to slide eight for a discussion of the balance sheet for the second quarter. Our cash balance at the end of the quarter was $748 million up $168 million versus the end of the previous year. Total debt was $480 million about $43 million lower then the end of last year. Late last week we entered into an agreement for a syndicated term loan facility of $250 million. At the same time we entered into an interest rate swap that will fix the interest rate at about 5% on the majority of this facility.

This arrangement gives us additional capacity in an uncertain credit market while securing a favorable rate for the next several years. Payables exceeded inventory by approximately $1.3 million versus $1.6 billion at the end of 2007.

If you turn to slide nine you’ll find the related working capital metrics at quarter end. Days of sales at 37 were flat when compared to the end of 2007 and one day better then the end of last year’s second quarter. Days of inventory were 28, one day higher then the end of 2007 and flat versus the prior year second quarter. We also delivered a significant improvement of four days compared to the end of the first quarter.

Days of payables remain flat compared to year end of 2007 as well as the second quarter of the prior year. This brought working capital days to 23, up one day over the prior year end but improved at three days versus the first quarter of this year. Our debt to capitalization ratio was 12% versus 13% at the end of 2007.

To conclude my comments I’d like to give you an update on our $300 million share repurchase program which was announced in November. During the second quarter we purchased approximately 2.8 million shares for an aggregate amount of $47.7 million. Total shares purchased since the inception of the program through mid July are 10 million shares for an aggregate amount of $169 million.

With that I’ll turn it back to Greg for a discussion of regional highlights and closing comments.

Greg Spierkel

Thanks Bill, I’ll start my overview with the EMEA region. Our European operations have been hardest hit by the softer economic environment. Sluggish demand, increasing inflation, and weak business and consumer confidence are more pronounced here then in our other regions.

We’ve taken swift action to cut expenses by significantly reducing the size of our regional headquarters. As I’ve mentioned earlier we’ve been able to accelerate these actions due to quicker then expected labor approvals. These efforts will create a leaner, more responsive organization. This region is also the first to introduce broader freight recovery charges which took effect early last week.

I’m pleased with the progress they’ve made and we should be able to see greater benefits from these actions in the third quarter. From a country perspective, Italy, Austria, Switzerland, and the Nordics grew in local currencies compared to a year ago. Italy is making steady progress after a period of three quarters of profit decline and is benefiting from a more stable political environment.

The other countries including our cornerstone operations of Germany, France and the UK are experiencing declining sales from the tough economy and our deliberate pull back from businesses generating poor returns. The most challenging market has been Spain where the construction industry has cratered and the economy has stalled with a soaring inflation rate that reached a 13 year high this month.

While the economy has affected nearly every product or customer category, we believe we are holding share with most of our major vendors in the region. At the same time we are making progress in new product areas such as digital signage, and our Google partnership to distribute its enterprise search engines throughout the region.

Overall the EMEA region and team are making the right moves in a difficult environment. I’m impressed with their diligence, speed of response, and readiness to adjust further should conditions worsen in the coming months.

I’ll now move to North America, as you may have heard from many of our peers pricing became more competitive in the region during the quarter. We have taken a selective approach raising prices on some lines while matching prices on others where it makes strategic sense, walking away from some unprofitable accounts and paying more attention to those areas that generate favorable returns.

As a result we found a good balance between share maintenance and gross margin improvement. Sales outpaced the regions’ IT market growth driven by the strength of the Canadian operation and the var customer segment as well as the acquisition of DBL. The data capture point-of-sale division also had a strong quarter both from a sales and profitability standpoint. Avid sales declined as a result of falling prices on large screen televisions and the dismal housing market and weak consumer sentiment.

The regions’ expense reduction program announced last quarter is progressing according to plan. Approximately 60 positions will be eliminated through downsizing of administrative offices and the consolidation of the DBL warehouse in Arizona into our existing distribution centers in California and Pennsylvania. We expect these actions to be largely completed in the third quarter.

Across customer segments vars and system [builds] were our strongest categories while retail and corporate resellers were the weakest. We continue to enhance our value through a robust portfolio of services and total solutions including staffing assistance, business process outsourcing, and professional development. EPN Dynamics for example recently introduced online trading and certification courses to help our customers cut down on travel time and transportation costs.

And in our data capture point-of-sale division we began offering services such as equipment maintenance and installation. Our development of services offerings solidify customer retention, supplement our gross margin and build expertise in new business models. It’s this type of innovation that reinforces our leadership position regardless of the environmental challenges.

In Asia Pacific we’re beginning to see the impact of softer economies in our larger countries. The Australian economy has been acting much like Europe for most of the year. China and India are growing at a slower pace then the exceptional levels of last year. The region responded quickly with good management of expenses, generating the highest operating margin of the regions.

Outside of these three big operations the smaller countries continued to perform well. Singapore, Malaysia, New Zealand, and Thailand, all grew sales and income on local currencies. In June the region established a foothold in data capture point-of-sale with the acquisition of the distribution business of Cantechs Group, which generated revenues of approximately $15 million in 2007.

This was another small but strategic acquisition that enhances our value in the Chinese market while providing a platform for further development in the data capture point-of-sale space throughout Asia. The region’s biggest news in the quarter was May 12 earthquake near Chengdu, China which killed nearly 70,000 people.

We have an office in Chengdu, and fortunately our associates remain safe and unharmed. The quake has had a short-term negative impact on sales as government agencies rightfully direct resources to more critical needs such as water, shelter and food for the region.

While growth in the Asia Pacific region was tempered over the last two quarters we continue to be excited by the prospects in the region. We expect ongoing market development in China and India will require IT investment for many years. Our focus for the near-term is to find opportunities that will generate solid growth with healthy profitability and returns.

I’ll conclude my regional roundup with Latin America which more then doubled its operating income on 28% sales growth. Despite the region’s geographic proximity to North America we’ve not seen any sign of economic weakness in this region. All countries contributed to the region’s performance. Brazil is experiencing strong sales growth especially in software and networking.

Mexico benefited from healthy sales of gaming consoles and increased penetration of second tier cities and states. Our overall market share continues to improve in Chili and our export division is making further inroads into key growing economies such as Peru, Columbia and Ecuador.

Argentina continues to ramp up as a new Greenfield operation and is poised for a profitable second half. Latin America is composed of emerging markets that tend to be volatile but continue to show exceptional growth. We have benefited from an experienced stable management team that is generating excellent results from this promising region.

In closing I’m proud of our performance in a difficult period. We are not allowing the economic environment to steamroll our business and we’ve taken definitive actions to become a stronger organization. Our past strategic decisions to diversify our profit streams into services and adjacencies are helping us and our expense reduction program will make us more agile and productive in the coming quarters.

For the third quarter we do not see signs of an economic improvement. A large country in our Asia Pacific region are now experiencing softer demand environments similar to those in North America and Europe. Latin America however remains solid. Our expense reduction actions will begin to take hold in the third quarter and our new freight recovery policy will be implemented worldwide.

We will continue to favor profitable accounts and opportunities but we will also be competitive where it makes sense. Our focus will continue to be improving our returns and the value we create for our shareholders.

We expect third quarter sales to be within the range of $8.5 billion to $8.8 billion. This reflects a year-over-year comparison ranging from a decline of 1% to a growth of 2% and a sequential comparison ranging from flat to down 4% as we move into our traditionally slower summer season. For net income we expect from $52 million to $61 million or $0.31 to $0.36 per diluted share based on approximately 169 million diluted shares outstanding and a 28% effective tax rate.

This includes expected third quarter costs of approximately $7 million or $5 million net of tax related for the expense reduction plans we announced last quarter. We expect this program will generate approximately $18 million to $24 million in annualized savings. We will also continue to look for more ways to reduce cost and enhance profitability.

As Bill mentioned we are currently evaluating new expense reduction actions which may result in additional program cost and related savings but we cannot reasonably estimate the cost, savings or timing of these new actions at this time.

These actions as well as our continued focus on superior execution and profitability will serve us well in the current environment and for many years to come. While the economic conditions are not ideal they are not clouding our vision on what’s important. As we have done during past downturns we will emerge as a stronger company, in a better position to extend our leadership position.

As I say often internally, let’s not lose sight that Ingram Micro is currently delivering on its second best year in profits ever in spite of the environment.

We’ll now take your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Brian Alexander - Raymond James

Brian Alexander - Raymond James

You’re guiding revenue down about 2% sequentially typically you haven’t guided revenues down sequentially in the third quarter, obviously it’s a very difficult environment, but as Asia and Latin America have become a bigger piece of the pie that’s been able to allow you to grow sequentially so I’m just asking as we look forward to Q3, should we be thinking that the more mature regions are what’s going to drag you down sequentially while Asia and Latin America continue to grow as they have in the past?

Greg Spierkel

You’re right, we are guiding down by a couple of points on average if you look at the mid point, but as we have said through the call here what we are seeing that’s a little bit different is that Asia as one of the three big regions is also seeing a little bit more softness and we’ve been I think more careful in what type of business we’ve been trying to capture in the region. It clearly is still growing faster then North America and Europe but as you’ve seen in the first two quarters Europe has been negative in local currency growth, North America has been more modest with single currency growth somewhat supported by the acquisition of DBL and Asia for the first time showed some slowness in growth from what we seen last year.

Latin America continues to be sort of the darling in the mix. Unfortunately it’s the smallest region but its still growing at a very healthy clip so I think it’s a function really of the two bigger geographies still seeing some market pressure and some questions in the future and with Asia being a little bit more cautious given the market dynamics and what we’re putting in play and the profitability that we’re trying to chase.

Brian Alexander - Raymond James

On the freight charges, just a little more detail on how expansive that effort will be, you mentioned that you started in Europe recently but is that a global effort, what kind of customer segments, geographies this is going to play out and then remind us of your traditional policies for paying for inbound or outbound freight so we can get a better sense of exactly what’s changing and how much this could ultimately help margins.

Greg Spierkel

The freight initiative is going to be a global initiative. It is being rolled out as we speak; varying degrees by different geos mind you. Europe as we said started the beginning of last week we started announcements in country, in region, throughout the region in Europe as of really Friday the prior week and Monday of last week depending on where the holidays were in Europe for certain national holidays. We have also started to some extent in Asia and I say to some extent in Asia most of the countries in Asia are going along with this change in the policy. One or two countries there was already significant freight recovery so there won’t be changes in maybe one or two countries but by and large this is being rolled out throughout Asia as well as we speak.

North America the program is starting over the next few weeks. We are rolling out through this obviously earnings call the statement. Our own organization will be in touch with the broad base of customers throughout North America here in the next two weeks and then we will initiate the policy changes through the back end of August and September through the balance of the operations.

There will be some touch points as well in Latin America, again where there’s some opportunity to recover. So this is fairly broad based. There are very few countries that will not be touched. All the larger countries, all the larger operations will get touched. Today from a policy point of view, by and large we try to recover freight. There are some instances where we’re not getting full freight recovery as you can well imagine the transportation industry and the freight forwarders that we work with are pushing through some degree of increases given the oil situation. So we feel it’s appropriate and prudent as a large player in this industry to take the first step in this regard.

And we believe that this is going to help us from a margin point of view. Hard to determine exactly the amount. We have some goals but we’re not going to share them at this stage, but we’re clearly of the view that this will help the margin situation as we go forward.

Brian Alexander - Raymond James

How committed, to the extent that your competitors don’t follow are you absolutely committed to this and you’re willing to lose sales?

Greg Spierkel

We are committed, very committed. We are hopeful that the market environment will be conducive to what we are doing. Clearly there’s going to be some degree of risk here with the top line. But frankly this is the right thing to do. This is the cost challenge for I think the industry as a whole so all I can say is that we’ve very committed and we will stay the course. We will see what it means for us. It does create some degree of risk but we’re ready to live with that.

Operator

Your next question comes from the line of Matt Sheerin - Thomas Weisel Partners

Matt Sheerin - Thomas Weisel Partners

Just in terms of the outlook, are you seeing normal seasonal trends in Europe or are you expecting that to continue to weaken on a seasonal basis?

Greg Spierkel

On the Europe piece it is definitely our quietest period. As you know if you if you’ve followed us over the prior years, July and August are clearly big vacation months for most business in Europe and I expect the normal seasonality that we have typically seen which is those are our two quietest months by far on an annual basis in Europe. They will continue to be that way and our early three weeks into July that has been the case.

Typically we have a mad rush as everybody comes back for the school season in September and it’s a five week month for us where the business tends to step back up and really pull the quarter in. That same pattern if you may is very much in play. I would not say that we’re seeing further degradation overall from the local currency challenge that we’ve had in sales year-on-year so there’s been no change from that perspective. No further weakening but no further strengthening either.

Matt Sheerin - Thomas Weisel Partners

So your guidance basically is factoring in expectations for a normal September yet it seems like you probably don’t have a lot of visibility into that right now given the economic climate?

Greg Spierkel

You’re not far off the mark in making that comment although we’ve had enough trends and patterns over the last five to 10 years that give us some degree of confidence that as people come back, sales will step back up. But it could still also be down in local currency relative to prior years. So I think again we’re seeing that same sort of pattern of the first two quarters manifest itself going into Q3.

Matt Sheerin - Thomas Weisel Partners

Just to clarify in your comments regarding Asia, it sounds as though you’re looking for Asia to actually be down year-over-year for the first time in awhile.

Greg Spierkel

No I’m not trying to guide that way, I think it’s a case that as you’ve seen in the current quarter that we’ve just finished, local currency growth as we said was 2% US dollar based, 8%. So definitely a step down from last year and the year before. Part of that as I mentioned is on the back of us stepping away from some business that is not profitable or hitting the hurdle rates that we believe is important to us and you saw that manifest in Q2 where we had very profitable results overall in Asia so we’re very pleased with the profitability levels there.

But we’re being cautious and we’re being prudent to go capture the right type of business for us while there’s frankly a little bit more growth in that region then the other two major regions. We’re just being smarter about the business that we’re capturing.

Matt Sheerin - Thomas Weisel Partners

Just regarding the headcount reduction could you give us a number of how many people you plan to cut and then particularly in Europe where there’s more cost cutting going on is there a percentage of headcount reduction that you could tell us?

Greg Spierkel

I can’t give you a hard number but let me tell you what we have shared and maybe be a little clearer on where we are on the overall cost reduction efforts. In Europe where we announced things at the end of Q1 where we got clearance through labor groups and regulatory authorities we went through that faster then we anticipated. We are taking through a period of about a month and a half 60 to 70 heads out of our headquarter operations in Europe, so about a third of the headquarter operations are being reduced or taken out of the headcount totals there.

Elsewhere we’ve taken two major actions with reductions and charges related to it, the first being in North America again, administrative staff essentially in our North American operations. Second is the closure of the DBL warehouse in Arizona and reallocation of the warehousing distribution capability back into our already existing infrastructure in California and Pennsylvania.

So in that reduction there again somewhere in the order of around 60 heads there plus 60 in the administration staff. So that’s what we’ve publically talked about. The other number that I won’t be at liberty really to share with you but that we’re working towards is through regular attrition in the business we’re expecting our headcount to continue to step down a little bit over the coming months. We’re not rehiring back at the same rate as the attrition rates that we see in the company. In light of the market environment it’s the right thing to do. It’s an easy way to move this thing forward and save on charges or costs for the company through that process.

Bill Humes

On the first set of the actual cost reduction activities where we talked about headcount reductions we still expect savings on an annualized basis to be $18 million to $24 million. That’s probably majority of savings within Europe with the rest in North America and there should be pretty much a full ramp up by the end of Q4.

Operator

Your next question comes from the line of Min Park - Goldman Sachs

Min Park - Goldman Sachs

Can you please tell us how much of your sequential gross margin decline can be attributed to the more aggressive pricing environment and what the pricing dynamics look like right now?

Bill Humes

We don’t give that specific detail but the sequential decline in gross margin if you look at historically we’ve generally had a step down in gross margins from Q1 to Q2. That’s largely driven off of the IML levels of business. As you’ll recall IML has its strongest quarters in Q4 and then Q1 is the second strongest quarter. Into Q2 that’s slightly step down. That being said our IML business is doing fairly well so if you look on a year-over-year basis its one of the factors that’s driving the improvement in year-over-year gross margin.

So the down tick is largely driven by that but yet also pricing of course was competitive—what we’ve talked about but we are very disciplined in that regard in the way we attack the marketplace and in some areas actually even raise prices.

Min Park - Goldman Sachs

Do you think pricing is more broad based now or just all relegated to more of the larger contracts that you’ve talked about in the past?

Greg Spierkel

As we’ve said I think the pricing environment is a little sharper, a little bit tougher when you’ve got growth rates that are frankly much lower then they were last year in the whole industry. So that’s definitely a factor out there in the business and for all businesses I think. And so from where we sit we’re trying to capture growth where its appropriate and profitable growth so that’s why in some markets like Asia we’ve seen again our growth rates be probably a little less then the overall IT industry or close to the IT industry but we’ve been very surgical, very smart I think about what we’re capturing there.

The areas that are the most challenging are the real commodity based product categories. Bit broad categories such as desktops, printing in general, monitors, those tend to be the areas where there’s less product differentiation, less solution orientation. So that’s the area that we’re trying to be more vigilant with and more careful on the types of business we’re capturing.

Min Park - Goldman Sachs

In the June quarter we continue to see very strong PC demand from actually multiple geographies, though Dell is showing a solid rebound in unit growth, can you tell us if distribution is continuing to see their fair share of overall PC growth or are you starting to see some [inaudible] for distributors in general?

Greg Spierkel

You’re right IDC Data Quest have both posted solid PC unit growth, mid double-digits in the 14% 15% range on the global level so that’s a healthy PC market. There is still price declines on average 10% to 15% as well so the revenue opportunity isn’t as great as clearly the unit opportunity so that dynamic is still very much in play and there’s probably been more price declines on laptops on a year on year basis then desktops.

There is nothing that I see or we see as a team that I would say there’s more disintermediation going on. I think again if you look at us and other members of the global technology distribution counsel which are the large distribution companies, generally if you aggregate our volumes and our revenue growth rates we tend I think the industry still tends to be showing at least until the most recent quarter, growth rates that are equivalent to the growth rates of the overall industry if not a little higher. So we’re holding our own as a sector. Clearly things are shifting at times with different types of products but generally holding our own as a sector depending again on what product category you’re looking at.

Bill Humes

The systems category was the strongest growth category for us again in Q2.

Operator

Your next question comes from the line of Richard Gardner - Citigroup

Richard Gardner – Citigroup

I wanted to come back to the Q3 guidance and get a sense of exactly what is factored into that guidance. It looks like it factors in some pretty substantial deterioration in the demand environment sequentially. Is it that or is it that you are going to be extra disciplined about the business that you pursue. Is it significantly related to the fact that you don’t know what the impact on revenue is going to be from the freight recovery actions that you’re taking. Can you just help us understand exactly what was encompassed in the guidance?

Greg Spierkel

There are a lot of variables here. Demand by far was the largest variable in here. We clearly monitor run rates. Have a pretty good handle on those run rates and we usually try to give what we think is a balanced guidance on where we think the industry and our company is going within that industry. So demand would be the largest factor. Clearly our discipline by stepping out of certain types of either accounts or product categories is also a factor. Clearly there is a bit of a question to some extent on the freight but we’re not leaning heavily on that because it’s going to be more back ended in the quarter in terms of getting implemented. So from that point of view harder for us to judge at this stage.

We’ll probably have a better idea when we come through Q3 results and start to see what the momentum of that is implicating for us and the sector as a whole. But it is really more demand and our decisions about what type of business that we want to go capture. And to some extent the mix of what countries we’re in and what operating units, how we’re doing. So again more interested in making sure that we’re holding onto the solid profitability on a year on year basis that’s driving our judgment and our day to day focus on where we think the quarter will end up.

Richard Gardner – Citigroup

It sounded like in Asia Pacific you’re seeing a combination of weaker demand maybe more focused on the developed parts of Asia like Australia, but you also mentioned pricing pressure and pricing discipline on your part I was just wondering if you could give more color about where you’re seeing the biggest demand slowdowns in the region versus where pricing pressure or pricing discipline are bigger factors.

Alain Monie

It is indeed a mix of different elements there depending on which market you’re talking about. In Australia, we have seen a weaker demand there as well as increase in pricing as we are seeing now in the other major geographies. But I would say that in Asia in general the pricing pressures given the environment have not been I would say as clear as in the other regions. I would put the pricing pressure there less of an issue. I think what it is more is the growth rates that China and India for instance are experiencing which compared to last year which were exceptional growth rates, some around 30%, this year we’re seeing a slowdown. I would put it more on that side then on the pricing side.

Richard Gardner – Citigroup

You really haven’t seen any big step up in price aggression in China or India yet?

Alain Monie

Not that we could point at at this stage. Again the environment is changing as we speak given the evolution of the market environment.

Richard Gardner – Citigroup

You mentioned some areas where things were most challenging, desktops, printing, monitors, I think that was specifically related was a pricing comment, could you talk about standouts both in terms of weakness and strengths in terms of demand by product category?

Greg Spierkel

From a product category point of view, we tend to have four broad categories which we talk to all the time. Interestingly enough not a huge volatility on either side of the 8% that we saw overall on the global level. Systems being the one that was a few points above our overall growth rate, and then the others were very close or just below the overall growth rates of the company, being software, networking and peripherals all just below or at that 8% rate. So there was actually a pretty narrow band.

As you go from country to country, region to region that varies a little bit but that’s as much clarity that we try to provide on a typical quarter here.

Operator

Your next question comes from the line of Bill Fearnley - FTN Midwest

Bill Fearnley - FTN Midwest

On the gross margin line, you were talking last quarter you were confident with gross margins around 540 or above, any comments on your view there for the third quarter directionally on gross margin and for third and fourth quarter in particular?

Greg Spierkel

Well again we had a fantastic Q1 as you know; we had a very strong Q2 so I think you can see the discipline around margin management in the company here and the type of business that we’re capturing. As far as the go forward look we don’t split that out specifically but I feel confident that we’re going to be above the 540 number. I think it is a bit of a function of how the market is evolving and we’re going to work hard to make the right decisions here as a team to pick good business and the right kind of overall mix for the company but we’re staying true to our 540 and above view of the world at this stage.

Bill Fearnley - FTN Midwest

On the SG&A side, you’ve already done some cost actions which you should see some benefit from in the third quarter, what sticks out on the SG&A side. I understand your guidance is taking down revenue a little bit but is freight, are you getting hit with freight charges that you’re not recovering, are there systems issues that are making you less efficient then you thought you would have been, what are the bigger components of the pressure on the SG&A side?

Greg Spierkel

Well it’s a mix of a number of things. Headcount clearly we’re trying to address and that’s the lion share of our overall cost of the company. It tends to be in the range of 60% 65% of our operating costs. While we’ve taken actions totaling about 180, 190 people with our specific charges against that that we talked about, we are also going to continue to monitor and drive down through attrition additional headcount reduction through the balance of this year.

I expect our headcount to come down through the balance of this year, exact numbers we won’t share with you but we’re going to work through that. But that is an area where I think there’s still a bit of challenge for the company and frankly we have more work to do in our own minds here as a management team largely because it does take, when you start seeing a softness in sales, there’s a lag in terms of following the headcount attrition opportunity that exists. So that is still being worked.

That said, there’s still a number of other areas where there’s clearly cost implications for us. Freight is one of them, I would also say that we’ve been clear that we are continuing to invest for the medium term, medium term being areas where we think we have to invest over several quarters for what we view is going to important business opportunity for us for several years and that is around areas such as services, whether that’s managed services, whether that’s integrated solutions group that we have put together for high end enterprise customers that we’ve just started on that voyage last year so we’ve been investing in headcount and programs and systems around that.

We’ve also been investing in infrastructure around systems to improve our systems for the longer term. So all those other elements which are 25% to 30% of the rest of our costs, there are some areas as well that we can touch on there. And some of which are working and some of which we feel are appropriate to continue to spend for the long-term. So it is a mix of all of the above.

Bill Fearnley - FTN Midwest

So from a calendar perspective then you talked in the press release and here on the call you have other actions, would you be in a position then to discuss those at the Analyst Meeting or do you think it will take you a little longer that you’d have to go into earnings the next earnings call to talk about what your next steps might be and what the new operating margin model look like.

Greg Spierkel

Yes I would say this, from where we stand, as soon as we feel we have something tangible and that we need to talk about, we’ll be obviously clear with everyone here on the call. So as the business environment evolves, we’ll see how aggressive we need to be. If the market dynamics remain softer for a few quarters we may be more aggressive. If conditions start to improve a little bit as we get to the back end of this year going into next, maybe we’ll have to be a little less aggressive. Short term there’s clearly a bit of overall pressure on the operating margins, but don’t lose sight again of what I said in my statement, this is our second best year ever from a profitability point of view and we’re on track to deliver that in a market environment that’s frankly more fragile and weaker then last year.

From that point of view we’re trying to make the right judgment calls but we’re also trying to signal that we may need to take some additional steps; we’ve got some ideas about other things that we can do and we’ll share them as soon as we feel it’s right and appropriate depending on the market situation.

Operator

Your final question comes from the line of Ananda Baruah - Banc of America Securities

Ananda Baruah - Banc of America Securities

I just wanted to go back to revenue, you seemingly had a pretty okay quarter in the June quarter albeit off of a weaker March quarter, the guide down against normal seasonality to slightly negative for the September quarter, I want to make sure I understand where the softness is coming from incrementally. I get that Europe is a bit softer but I bring my European numbers down even somewhat I’m still not quite getting to the mid point of the guidance. Could you just talk to the linearity you saw through the quarter in the US and in Europe. The US was relatively solid this quarter is there something that went on in North America that closed the quarter or some of the other regions that closed the quarter that are going to have those regions be a bit weaker in the September quarter then might readily be apparent?

Greg Spierkel

The challenge here is a mix of a few things and you’re right the European region, we’re in a situation as we have been and we’re trying to be clear here that again without being too specific the negative local currency growth dynamic is still at play in the current quarter that we’re in. As far as linearity through the quarter we just finished, we basically saw the typical pattern that we have seen in prior quarters so there hasn’t been a huge difference. Although again the month of June was a bit stronger then we anticipated but the first two months were relatively normal compared to the movements that we see all three months go through, but again just a little bit more firmer in the June month.

But one month does not make a trend and I think as we’ve tried to share with you the three big regions now, we’re not having one and particularly the Asia region is not showing the same growth characteristics in part because a couple of the local economies there, Australia and New Zealand, we’re not seeing as much growth as we did in prior years. We got a bit of a challenge compared to last year where we had a pretty solid growth pattern out of Asia.

Ananda Baruah - Banc of America Securities

Would a natural read through then be that maybe the first three weeks of July in the bigger regions, North America, Europe and Asia all maybe incrementally weakened from how the June quarter closed?

Greg Spierkel

No I don’t think so, I think this is a normal pattern where we clearly because its quarter end with most of the vendors that we’re working with which is, there’s a lot of deal activity that tends to come through with quarter end, so that pattern we saw and it typically gets a little quieter and of course we’re dealing with particularly in Europe the very quiet months of July and August relative to how September steps up. I don’t think it’s a pattern where we said; oh gee the business is that much softer now. Again keep in mind we had a very robust Q3 last year out of Asia and that makes for a, and that might have helped prop a little bit the growth rate from Q2 to Q3 for last year versus what we’re seeing this year.

Bill Humes

Q2 is relatively strong also from the Easter holiday that helped us a bit by with about a day-ish in that range of positive impact quarter to quarter.

Ananda Baruah - Banc of America Securities

On the gross margin I wanted to understand the spirit of how we should expect the various things that you’re doing to at least anecdotally impact operating margin as we move through the second half of the year, at least through the third quarter. It sounds like some things have been accelerated in Europe some of the actions you’ve spoken about doing, but I’m getting the feeling that we still shouldn’t expect a whole lot of impact from those things until towards the end of the year collectively and that perhaps the biggest support to operating and gross margins as we move through the third quarter is really going to be from what you’re doing on the freight side of things, is that accurate?

Bill Humes

It’s a summary of a lot of different issues; obviously freight as it’s implemented across the Q3 should have an impact. That has to be offset by whatever the potential revenue impact may or may not be and that has other considerations and dynamics. Obviously we continue to manage through a very competitive marketplace; we’re very disciplined in that regard. We maintain share where we believe it’s strategic and we also raise prices or match prices where it’s also determined appropriate.

There’s multiple dynamics going on. We also have investments in our various strategic initiatives in the infrastructure technology services division and managed services as well as some of our consumer electronics division, DBL and [Avid] that have higher gross margins. So those will continue to generate solid gross margin enhancements. And you’re right on the sense of the operating expense savings that we get from our actions, those will roll partially into Q3 and then more so full run rate into Q4 and into Q1 of next year.

Ananda Baruah - Banc of America Securities

I believe last quarter you spoke of really not seeing full run rate on the cost savings until beginning of 2009 is it something that could hit sometime in Q4?

Bill Humes

We should be close to full run rate into Q4 as we talked about earlier, we were to accelerate some of the European actions so rather then potentially full run rate in Q1 I’d say we’d be approaching more full run rate on the actions that we have announced into Q4 with maybe some slight incremental into Q1 of 2009.

Operator

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

Ria Carlson

Thank you very much for joining us today. Our call is concluded. Our replay will be available until July 31 at 800-678-3180 or at www.ingrammicro.com. Thanks again and have a great day.

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Source: Ingram Micro, Inc. F2Q08 (Qtr End 06/28/08) Earnings Call Transcript
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