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Tech Data Corp. (NASDAQ:TECD)

Q2 2009 Earnings Call Transcript

August 21, 2008 9:00 am ET

Executives

Kristin Wiemer – Director of IR

Bob Dutkowsky – CEO

Jeff Howells – EVP and CFO

Analysts

Min Park – Goldman Sachs

Brian Alexander – Raymond James

Richard Gardner – Citigroup

Alberto Mann – Thomas Weisel Partners

Rich Kugele – Needham & Company

Ananda Baruah – Banc of America Securities

Bill Fearnley – FTN Midwest

Operator

Good morning. Welcome to Tech Data Corporation fiscal 2009 second quarter results conference call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. (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. Kristin Wiemer, Director of Investor Relations. Ma’am, you may begin.

Kristin Wiemer

Thank you, Doug. Good morning and welcome to Tech Data second quarter fiscal 2009 earnings conference call. I am joined this morning by Bob Dutkowsky, CEO and Jeff Howells, Executive Vice President and Chief Financial Officer.

Before we begin today’s call, I would like to remind the audience that certain matters discussed during this morning may contain forward-looking statements made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Please be cautioned that such forward-looking statements are based on the company's current expectations that involve a number of risks and uncertainties, and actual results could differ materially from such expectations. Risks, uncertainties and other factors affecting the company's business are contained in our filing with the Securities and Exchange Commission, specifically located in Part 2, Item 1A of the company's April 30th Form 10-Q filed on June 4.

Please be advised that statements made during today's call should be considered to represent the expectations of management as of the date of this call. The company undertakes no duty to update any forward-looking statements to actual results or changes in expectations. In addition, this call is the property of Tech Data and may not be recorded or rebroadcast, without specific written permission from the company.

I’ll now turn the call over to Tech Data’s Chief Financial Officer, Jeff Howells. Jeff?

Jeff Howells

Thank you, Kristin. Many of my comments will reference the supplemental schedules which are available in the Investor Relations section of our web site at www.techdata.com. Also during today's call, we will discuss certain non-GAAP financial measures for the prior year period. You may obtain additional information on these non-GAAP measures and reconciliation to GAAP in page 7 of today's press release, available on the Investor Relations section of our web site or Appendix A of the Supplemental Schedules.

For comparison purposes, non-GAAP results for the second quarter of 2008 discussed in this call will exclude $4.3 million charge for loss on disposable of subsidiaries and $16.6 million in restructuring charges.

Beginning with the first slide, worldwide net sales reached a record second quarter level of $6.2 billion, an increase of 9.8% from $5.6 billion in the second quarter of fiscal 2008. On a regional basis, second quarter net sales in the Americas were $2.8 billion or 45% of net sales, representing decline of 3.3% year-over-year.

Second quarter net sales in Europe were $3.4 billion or 55% of net sales, representing year-over-year growth of 23.9%, or growth of 7.4% on a euro basis.

On slides three through six, we summarize our operating performance. Worldwide gross margin for the second quarter of fiscal 2009 was 4.85% compared to 4.89% in the prior year second quarter. The company’s disciplined pricing, inventory management and sales practices have been a contributing factor to sustaining a relatively stable gross margin performance.

Second quarter SG&A expenses were $257 million or 4.17% of net sales compared to $226.7 million, or 4.03% of net sales in the second quarter of fiscal 2008. The year-over-year increase in SG&A expenses was attributable to stronger foreign currencies and the related translation impact, continued investments in certain strategic initiatives, as well as the company’s acquisition of certain assets of Nordic-based Scribona AB and the related consulting and integration costs.

Operating income for the second quarter was $42.2 million or 0.68% of net sales. This compared to operating income of $47.6 million or 0.85% of net sales in the same period last year on a non-GAAP basis. Consulting and integration costs related to the Scribona acquisition negatively impacted operating margin by approximately $3 million or five basis points in the quarter.

On a regional basis, operating income for the second quarter in the Americas was $39.5 million or 1.41% of net sales compared to $45.2 million or 1.56% of net sales in the same period last year.

In Europe, operating income was $5.7 million or 0.17% of net sales, including $3 million or approximately 0.09% of net sales in consulting and integration costs related to the acquisition of certain assets of Nordic-based Scribona AB. Non-GAAP operating income in Europe for the prior year period was $12.9 million or 0.18% of net sales.

Net interest expense was $5.1 million. The effective tax rate for Q2 was 36.1%. For third quarter fiscal 2009, we estimate a tax rate in the range of 30% to 32%.

As noted in previous quarters, in accordance with FIN 18 accounting pronouncement, quarterly effective tax rate may vary significantly depending on the actual operating results in the various tax jurisdictions. The annual effective tax rate is currently estimated in the range of 30% to 32%.

We recorded $800,000 from minority interests during the quarter, which represents our Brightstar Europe JV partnership losses incurred during the second quarter. Net income for the second quarter was $23.7 million or $0.45 per diluted share based on 52.4 million weighted average diluted shares outstanding. This compared to non-GAAP net income of $27.5 million or $0.50 per diluted share in the prior year second quarter.

Turning to our balance sheet on slides 7 and 8. Accounts receivable totaled $2.76 billion. Our allowance for bad debt was $66.6 million. DSO were 41 days which compared to 42 days in the first quarter. Inventories totaled $1.8 billion, yielding days of supply at the end of Q2 of 28 days. Accounts payable was $2.5 billion. Days payable outstanding at the end of Q2 was 39 days. Total cash conversion cycle for the second quarter was consistent with the first quarter at 30 days.

Net receivables sold under company's trade receivable purchase facilities that would have otherwise been outstanding at the end of the second quarter totaled approximately $208 million. Cash provided by operations during the second quarter of fiscal 2009 totaled $106.5 million. Total debt was $421.9 million compared to $383.2 million at the end of January.

The company continues to enjoy excellent liquidity and financial flexibility with a cash position of $468.3 million at July 31st. Net cash totaled $46.4 million at the end of the second quarter. Total debt to total cap was 18%. Funds available for use under our credit facilities exceeded $750 million at the end of the quarter.

During the second quarter of fiscal 2009, the company repurchased approximately 2.4 million shares of common stock at a cost of $83.2 million in conjunction with the company’s $100 million stock repurchase program authorized in June 2008.

Equity totaled $1.96 billion and as of July 31st, the company had 50.5 million shares outstanding, resulting in a tangible book value of $38.39. Capital expenditures totaled $10 million in Q2. The current plan for fiscal 2009 capitals expenditures remains at $42 million. Second quarter depreciation and amortization expense was $13.7 million.

On slide 9, our product and customer classifications show that the company's net sales by product segment in the second quarter were relatively consistent with the prior period. We estimate that peripherals account for approximately 40% of net sales; systems 30%; networking 15%; and software 15%.

The company's net sales by customer segment in the second quarter continued to be relatively consistent with the prior periods. VARs accounting for 60% of sales; direct marketers and retailers 25%; and corporate resellers 15%.

As in past periods, Hewlett-Packard was the only vendor that generated more than 10% of our net sales worldwide. In the second quarter, HP represented 29% of net sales compared to 27% in the prior year period.

Turning to the business outlook, the statements that I will make are based on current expectations and the company's internal plan. These statements are forward-looking as outlined in the company's periodic filings with the SEC. Actual results may differ materially.

For the third quarter ending October 31, 2008, we anticipate net sales to be in the range of $6.3 billion to $6.5 billion. This assumes a low single-digit decline year-over-year in the Americas and mid-to-high single-digit growth in Europe on a euro basis, including incremental sales associated with the acquisition of certain assets of Nordic-based Scribona AB.

We expect to incur approximately $1.5 million with no income tax benefit in consulting and integration costs related to the acquisition during the third quarter. Due to the recent strength of the dollar versus the euro, the actual reported sales could differ materially compared to the range indicated previously.

I will now turn the call over to Bob Dutkowsky for his opening comments.

Bob Dutkowsky

Thank you, Jeff. Good morning everyone and thank you for joining us on Tech Data's second quarter fiscal 2009 conference call.

When we spoke in May, just a few weeks into the second quarter, we discussed market uncertainty and heightened competitive pricing conditions, particularly as it relates to large volume opportunities in North America.

These factors held steady during the quarter, presenting challenges and requiring disciplined execution by everyone in our organization. Considering the environment, we performed well in the quarter with exceptional performance in many regions combined with shortfalls in a few. For example, all our sales in the Americas were short of our target. We approached the high-end of our consolidated second quarter sales outlook due to strong execution in Europe and a little help from the further strengthening of the euro. Also, our Latin America operations contributed nicely to the company’s second quarter performance, with sales growing over 40%. Demand for IT products in Latin America continues to flourish.

Now, let’s look at our results by region. In the Americas, net sales declined 3% year-over-year compared to our outlook of flat sales. However, we did see sequential growth of 4%. Keep in mind that our Americas region grew 16% in the prior year period. We generated an operating margin of 1.41% under our annual target of 1.5% but still a good performance in light of the softer demand in the quarter and the competitive pricing environment. It should also be noted that we did not optimize our rebate opportunities in the United States during the quarter due to what we believe were somewhat aggressive sales targets from vendors given current market conditions.

While we did miss some targets in the Americas, let me stress to you that we remain committed to growing our business responsibly and as a result we elected to pass on certain sales opportunities during the quarter that did not meet our profitability goals and were simply not in the best interest of our company. For example in the US, in just two large customers alone, we saw our competition price nearly $100 million in sales below our profitability targets. We chose to walk away from that business while we are taking measured steps to help drive improve operating income across all our operating units.

These actions include appropriately balancing our headcount for the current market conditions and tightly monitoring hiring levels in conjunction with sales forecasts. We are continuing with certain strategic investments like our SAP warehouse management system implementation which is driving efficiencies throughout our logistic facilities in the United States and Canada. We’ve also completed the majority of the training and rollout of our one-desk sales solution in the United States and reached full deployment in Costa Rica. So more than 8000 hours of training time which we invested in during the second quarter alone will drive long-term efficiencies in our sales organization as well as allow Tech Data to better optimize every sales transaction, a critical differentiator in the current business environment.

As we look at our performance across all products and customer segments in the Americas, there isn’t anyone particular segment that has been largely affected more than the others. The year-over year second quarter sales decline hit most product segments, with Peripherals showing a bit more of a decline in the US and Canada. When IT spending slows, it is normal that we see a slow down in the Peripheral segment first. A bright spot in our performance was the continued growth of the SMB space. Conversely, direct marketers and corporate resellers sectors were down. The diversification of our SMB customer base, which extends across thousands of SIC codes, continues to provide a valuable level of diversification to our operations.

Turning to Europe, we achieved our second quarter outlook and generated operating income of $5.7 million or 17 basis points, including integration costs of approximately $3 million or 9 basis points. This compared to an operating margin of 18 basis points in the prior year on a non-GAAP basis.

I am pleased to report Germany performed very nicely in the second quarter, posting double-digit sales growth, the highest organic sales growth performance of any of our European regions on a euro basis. This performance is a validation of our improving execution in the German region.

Overall, if we excluded the estimated sales related to Scribona, our European top line generated growth of a few percentage points. Recent indicators point to a relatively flat IT spending environment in Europe, so we’re pleased to see that our team delivered modest growth as we strengthen our foothold, selectively increase our market share and better leverage our infrastructure.

Unlike in the Americas, the IT channel in Europe is more dispersed and operates in diverse economies and IT spending environments. While we are seeing some regions that are slower than last year, there are other regions that are performing notably well. Overall, Tech Data Europe had a good second quarter in what has historically been a very challenging quarter for our company.

The integration of the Scribona operations, including the transition of approximately 200 employees and hundreds of customer accounts, was flawlessly executed by our European team. We’re extremely pleased with the performance to date, as our company becomes stronger in the Nordic where we’re now the largest IT distributor in the region.

The sales related to Scribona continued to build throughout the quarter as we optimized our coverage model and our inventory position for product lines that are new to the Tech Data portfolio. We incurred an additional $3 million in consulting and integration costs during the second quarter and anticipate the remaining Scribona integration cost to be approximately $2.5 million, which we’ll incur over the third and fourth quarters.

Like many industries, the rising cost of fuel and transportation of goods are impacting IT distributors. In conjunction with our efforts to improve operating income for the long-term, we are implementing new freight and handling fee policies in both the Americas and Europe. We began rolling the program out in Europe several weeks ago and we’ll begin the Americas the first of October. We aren’t alone in the industry as others are taking similar steps.

With the cost of fuel at record highs, these business changes make sense and it’s simply become a way of life in the current environment, from the airline industry to Internet retailers. We believe changes to freight and handling fee practices will drive better efficiencies in our organization, as well as the IT distribution channel as a whole, while minimizing the impact to our customers.

Our financial position remained strong, with cash of $468 million and a net cash position of $46.5 million at the end of the quarter. We repurchased over 2.4 million shares during the quarter, nearly completing our $100 million repurchase program authorized in June. Once completed, this will mark a total of 400 million in stock repurchases over the last three and a half years.

Now, turning to the specifics of our third quarter outlook, there remains continued uncertainty surrounding the global macro economic environment. We reflected that uncertainty in our sales guidance. While we remain watchful of our markets, we are also optimistic about the opportunities for our business in an environment that is well-served by the IT distribution model.

As we have said, the IT spending environment remains mixed. Some areas are slowing while others have continued to outperform the market as a whole. To that end, we remain encouraged by SMB, networking, mobility products like laptops and selected software opportunities, all of which continue to show signs of resilience.

In terms of our sales outlook for the third quarter, we are expecting net sales in the range of $6.3 billion to $6.5 billion. This assumes a low single-digit decline year-over-year in the Americas and a mid to high single-digit growth in Europe on a euro basis, inclusive of the recent sales additions related to the Scribona acquisition.

The current environment has certainly tested our ability to execute and remain disciplined in how we approach each sales transaction, manage margins and control SG&A cost. IT spending is flat across the globe and we don’t expect these conditions to change in the very near future. Therefore we must remain steadfast in our discipline and focus as we approach every aspect of our business.

Despite the flattest conditions, we believe good opportunities remain in the IT market, both in the Americas and in Europe and our Q2 performance validates that our team is engaged and ready to capitalize on these opportunities.

In closing, as we enter the second half of the year, we will maintain continuous dialog with our vendors and our customers, keeping a constant check on demand, we will continue to diligently manage our SG&A expenses, softly target sales opportunities that neither exceed our profitability requirement, and capitalize on more efficient margin opportunities that will drive improved operating income performance and shareholder value.

In closing, I would like to thank the entire Tech Data team around the world for their continued execution and discipline; our customers rely on their performance everyday.

With that, we'd like to open it up to your questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Min Park with Goldman Sachs. Please go ahead with your question.

Min Park – Goldman Sachs

Great, thank you. Just a couple of questions please, first can you just tell us how much of a shortfall in your Americas business is due to Tech Data walking away from non-competitive deals versus the overall softness in demand?

Bob Dutkowsky

Well, I mentioned just two specific examples in just two accounts where we walked away from around $100 million in sales. And so, we continue to be focused on where the profit opportunities exist and the price competitively, but we're not going to follow our competitors in some of the deals that they chase.

Min Park – Goldman Sachs

Okay, great. And then with respect to passing of freight costs to your customers, what gives you the confidence that you'll be able to pass on this cost while competitors remain more aggressive on pricing on core products and services?

Bob Dutkowsky

Well, I think first of all, as we tried to say that the idea of passing along freight to our customers is not unique to the IT industry – the IT distribution industry. In fact, the uniqueness of our industry is that we – this industry hasn't passed freight on to their customers. And so, this migration – the passing handling fees on to the customer, we think is a good thing. If you think about the opportunity here, we've added a handling fee to the orders and what that allows our customers to do is consolidate their orders together, place larger orders on Tech Data, and larger orders may cost more efficient. And so, although this is a – it could appear to be a slight price increase for customers, if customers consolidate their business together, place bigger orders on us, they win and we win. So, we think we positioned the freight increase in a way that the customer wins, Tech Data wins, and the overall IT industry gets stronger.

Min Park – Goldman Sachs

Okay, thank you.

Operator

Our next question comes from the line of Brian Alexander with Raymond James. Please go ahead with your question.

Brian Alexander – Raymond James

Thanks. I guess I'll pick up on the last topic on the freight initiative, Bob and Jeff. Do you view your initiative here as similar to what your competitors are doing or have you taken a different approach? For example, is the handling fee a unique twist that you think Tech Data is doing that others aren’t? And more importantly, if the industry is successful, how much should this help your operating margin, or is this more of an initiative to prevent additional margin pressure down the road?

Bob Dutkowsky

I'll try the first part of that, Brian. We've been recovering freight cost in Europe for several years now. So, it's not necessarily a new initiative for us around the total enterprise of Tech Data, but it is a new initiative here in the US, and it's one that we've been working on for a while, so that we had the proper policies and procedures in place as well as the right IT system backup. The programs that our competitors have embarked on I'm sure are well thought out as well. And again I think the key here is that this transition is good for the IT distribution industry and we remain committed to the program.

Brian Alexander – Raymond James

And how much do you – can you kind of give us a range, a ball park range of – if competitors follow and this is successful, what kind of improvement can we see in gross and operating margin, or is this more to keep things where they are?

Jeff Howells

Brian, I think it's more to going in profit issues to keep them either where they are, or keep them at where they need to be going forward meaning that as freight contracts are renewed and our freight vendors around the world look to pass through fuel surcharges to us, it's matching that cost increase with the handling fee and/or freight policy changes that we're making around our operations.

So, it's not completely in lock step, but the goal is to offset those cost escalations with the charging of either a fee or charging for freight, and the real hope is to minimize the overall cost of freight by getting our customers to aggregate more orders, increase the average order size, so that our gross margin dollars generated on the average order help cover the freight bill. Right now, some of the order sizes are so small, or hitting minimum freight cost per order, which are very costly on a relative basis to the gross profit dollars generated. So that's one of the main reasons here in the US that we went for a handling fee versus just charging for more freight or increase in the price, we think it's better for our customers and for the industry to keep driving for a more efficient model.

Brian Alexander – Raymond James

And then, if I could just follow up Jeff on currency, it looks to me like the delta on your guidance versus the consensus for the October quarter is really due to the movement of the dollar over the last several weeks. Do you agree with that, number one? And number two, what's your methodology in terms of how you factor currency into the guidance you just gave us, could you just say that if the dollar stays where it is, or I think you said continues to rally, there could be a material difference between your guidance and what you ultimately report. So what do you actually factor into your guidance?

Jeff Howells

Well, first of all, I don't know what the details of what the analysts had in Q3 or Q4. My gut would be when you and the rest of the analyst community posted their numbers, they were first anticipating some second half recovery in the IT spend market, and that's not as clear as it may have been when you first created your model. Secondly, as far as the rate, if you look at what you will be estimating our European revenue at, if the Euro moves from say 155 to 150 to 145, at each one of those clips there can be $70 million, $80 million, $90 million or $100 million of revenue, well actually more $80 million or $100 million of revenue in US dollars to decline. That means our business is going to be different in Europe. And that's why we stay and quote our sales objective in local currency. But if the average rate for Q3 is 1.45 versus 1.55 and that could be $152 million, $200 million difference right there in the revenue as it moves back.

As we've talked before though, currency is extremely material on sales, cost of goods sold, it has an impact on SG&A, and it has a lesser impact on operating income and/or net income coming out of Europe, because of our profitability levels there. So, the real caution is don't get too excited on what our ultimate revenue number is in US dollars. And this quarter versus last quarter, I mean, we've already seen a migration from whatever our average rate was last quarter of about – just shy of 155 to I think this – yesterday, it was 147 or something like that. So, it could be material on the top line, less material on the bottom line, but it will pull $0.01 out here and there.

Brian Alexander – Raymond James

Got it, thanks Jeff. Thanks Bob.

Operator

Our next question comes from the line of Richard Gardner with Citigroup. Please go ahead with your question.

Richard Gardner – Citigroup

Thank you. Jeff and Bob, I had two questions for you today. The first question has to do with the freight contracts and how often they reset. I'm just trying to get a sense of why we haven't seen the impact of higher fuel prices on your margins yet, given where fuel prices had been for quite some time. And could you talk about, is this a case where these contracts reset on an annual basis, so we might see some margin uplift here for a couple of quarters and then the margins go back down at the beginning of next year or how does that work?

Jeff Howells

Rich, there is no one-size-fits-all because we have contracts with a variety of carriers here in the US and in Europe and the other thing is they are competing for our business also. So, we’ve of course tried to negotiate everywhere not only currently but historically for the lowest impact possible and so it could be we have contract in a given country where we get a freight surcharge on a monthly or quarterly basis or there can be a notification period where we get three, six, whatever months of notice that the rate is going up to this.

So, there is no one size fits all. Yes, there has been some impact in the current P&L. But, there was impact in last year’s P&L compared to the fiscal year of ’07 P&L also. Concurrently, our sales teams especially in Europe have worked very closely with customers to work through the freight issues and our belief is this is not uncommon. In this environment, we've seen our distribution competitors in Europe all – or virtually all go forward with some type of a handling fee, freight charge adjustment, whatever the case may be. I think it’s more of an infancy here in the Americas, but it’s clear that we’re seeing on the Internet retailers changing their handling fees, changing their freight fees.

So, yes, it ultimately gets passed through and we think we’re doing it in a very effective and efficient way, and really trying to – as our normal process trying and get our customers to aggregate their individual product items on an order.

And the other thing here in the US in order to make that really happen, the freight policy and handling fees that we’ve announced have held our free-freight limits. So we’re keeping on that what they were historically, because they would think there – the right levels. So our customers can aggregate their orders, generate the free freight, off the top of my head, it’s about $2400 order in the US over the phone or $1000 electronically and they get free freight.

They would, under the new policy, potentially have a handling fee but that handling fee is quite de minimis if they hit those levels to the overall cost of the transaction. So we’re working through it. There’s no one size fits all and it is just a natural process that we think needs to root itself in the distribution industry.

Richard Gardner – Citigroup

Okay. But I guess the spirit of the question is do you feel like the timing of the actions that you’re taking is sort of to Brian’s question simply going to keep margins where they are as opposed to causing some near term volatility in the margins, reported margins?

Jeff Howells

We aren’t looking to make money off of our customers by doing this. We are looking to share the costs of the transportation uplift that we are seeing and will see in the market. This is not to create a more profitable enterprise, it's to specifically identify increased cost in the business that's been universally seen through all industries, identify it, share it through the transaction but try to minimize the impact on any one of our customers by really emphasizing aggregation of the products they need on to a single or fewer orders so that the impact is minimal to them. And honestly, what we are going to pay the freight carrier is minimized because if we get cheaper lighter products, that’s good but many of our products are cheaper and lighter but they’re not – we are not putting enough in the box to even hit the minimum freight cost of the box. In other words if we have a freight minimum that says it’s X pounds, we can add more [ph] product in that box to hit that minimum. So, more products can go in that box without increasing the freight of that individual transaction. That's one of the things that we hope we can work with our customers and make that happen.

Richard Gardner – Citigroup

Okay, great.

Bob Dutkowsky

The other thought of that Richard is obviously with our scale, we think we negotiate very good contracts with the carriers. And certainly by country and by region, we are aggressive with our negotiations with the carriers and get as we believe is good pricing as anybody in our industry.

Richard Gardner – Citigroup

Understood, thank you.

Operator

Our next question comes from the line of Matt Sheerin with Thomas Weisel Partners. Please go ahead with your question.

Alberto Mann – Thomas Weisel Partners

Yes, thanks. This is actually Alberto Mann calling in for Matt. I just wanted to go and look back at the July quarter by region and talk about the linearity, whether you start things get materially worse or stayed the same in the quarter, and then how that is trending into the October quarter and how that impacted your guidance?

Bob Dutkowsky

Well, Alberto, we don’t generally talk month by month because the data we would provide in a snapshot could lead to wrong conclusion. But I will say generally, we probably started slower and ended stronger in our two main regions, Europe and the Americas, so we felt better closing the quarter than beginning the quarter.

Alberto Mann – Thomas Weisel Partners

And did that continue into the October quarter or did things sort of fall off into the beginning of the quarter here in August?

Bob Dutkowsky

Well, it depends which geography – generally, things don’t fall off in August because you're talking coming out of a summer month of July. It’s just – for example, in our business, it changes region where one region of Europe comes back from holiday, another region goes on to holiday. In our business, the normal trend is around the world, get through August, get through the first or second week of September, and then the business starts escalating. Post Labor Day in the US and post the final holidays and children back to school in Europe.

Alberto Mann – Thomas Weisel Partners

Okay. Can you talk a little bit about the visibility whether it's gotten better or worse? I know, you mentioned that we had originally been looking for a bounce back in the second half of the year and it doesn’t look like that's going to really play out. Has the visibility gotten worse here or is it still the same as it was a quarter ago?

Jeff Howells

I think the visibility remains about the same. The types of projects that our customers work with – work on with their customers, usually have a six month kind of horizon. And so, when you talk to our customers, they see six month windows of opportunity and they're articulating to us that it looks like it will be about the same as it has been over the last few quarters.

Alberto Mann – Thomas Weisel Partners

Okay.

Jeff Howells

So that's our guidance of not anticipating if they get materially better or materially worse. We just see kind of carrying on in this environment and we're forecasting the business and we're scaling the size of the business with that expectation in mind.

Alberto Mann – Thomas Weisel Partners

Okay. And then just switching to the Brightstar initiative, I think you've mentioned previously that you expected it to get break-even in fiscal '09, is that still an expectation we should have?

Bob Dutkowsky

Yes, I think it'll be close to break even, and as we mentioned in, I think it was the last call, the Brightstar joint venture continues to build momentum. There are many business proposals out to carriers and customers and really the difference between when and how much depends on the velocity at which we win those contracts. We're very hopeful that we will have positive results out of some of those proposals. We certainly realize we won't win all proposals, but we had very good performance in the second quarter which again gives us good hope.

The joint venture is focusing more on certain countries than Pan-European right now, so we've worked through over five quarters what will work as we create this Greenfield operation and we're very positive as far as the exact – will it make or lose $1 million, $2 million, $3 million, it's not going to be material drag on the ultimate results.

Alberto Mann – Thomas Weisel Partners

Okay.

Jeff Howells

If you consider where the Brightstar joint venture came from to where it is today, it has gained very nice momentum in several countries and in fact one country, in particular, was breakeven in the quarter. And so the model is working and the growth that we anticipated, although very different than what we saw when we launched the JV is – we remain very optimistic and committed to the project and think that it could represent very nice upside for us in the long haul.

Alberto Mann – Thomas Weisel Partners

Okay, got you. My last question, you were quite aggressive in buying that stock in the quarter. Are there any plans to increase the buyback, now that it’s almost exhausted?

Jeff Howells

No current plans, but we evaluate it every quarter and we have no plan to – as of today to announce yet another buyback.

Bob Dutkowsky

In the quarter, we did the Scribona, the acquisition of the assets of Scribona, and we did a stock buyback. So, and we think we’re using the shareholders’ assets in a way that positions the company for the long-term.

Alberto Mann – Thomas Weisel Partners

Okay. Thank you.

Operator

Our next question comes from the line of Rich Kugele with Needham & Company. Please go ahead with your question.

Rich Kugele – Needham & Company

Thanks. Good morning gentlemen. In terms of the rebates, you commented that you thought that maybe the threshold from the vendors was little high in the second quarter. Has it changed at all for the fiscal third quarter, and I guess within that context, do you think that the gross margin should improve sequentially?

Bob Dutkowsky

Well, first of all, we negotiate with hundreds of vendors every quarter, so in some cases, the targets are realistic and the rebates are attainable and we focused on overachieving those. And then in other cases, they’re unattainable and we miss them. So it’s not unlike any other set of sales goals that just in the quarter just completed, a couple of the larger ones were more on the unreasonable side and therefore we missed them. We’re in dialog with the vendors everyday to make sure those goals and those rebates are as fair as they can be for the vendor and for us. The vendor pays up to drive growth, we deliver growth and we try to overachieve on every objective that’s setup and maximize the opportunity in every case.

Jeff Howells

On the second part of your question, I wouldn’t estimate the gross margins are going up to the extent that – just give you a little background, to extent, we can see that we’re going to be able to achieve a rebate that doesn’t mean that it all goes to our bottom line. What it does allow our sales and marketing teams to do is determine how they’re going to be able to price a product in the marketplace. So to extent that we don’t see the ability to earn that, we have to potentially be priced out of the market on some of those product categories, because if we can’t earn the rebate to supplement the total value, we just may not be interested in the business. So we’ll buy less, we’ll sell less, and potentially earn less. But the thing that we can’t take is if we didn’t earn a rebate, that rebate would have gone 100% to the bottom line. That’s not how we manage the process throughout the different product portfolios.

Rich Kugele – Needham & Company

Okay. That’s helpful. And then on the – just on the competitive pricing side, we’ve been talking for a while now about the – how some of these larger deals have been where the price competition has been. Are you seeing any indications that it could be spreading to the SMB side or do you have any expectations that it could?

Jeff Howells

Rich, you have to go back and look at how it all starts. If the overall market opportunity is shrinking or in this case going from a growth environment historically to a more flat environment, every deal becomes more precious to both the vendors and to our borrowers and therefore to the IT distribution channel. And so, when precious opportunities are in the market, price is one of the levers that all sides of that equation use. The vendor uses it, the borrower uses it, and the IT distributor uses it. And what we’ve seen over the last few quarters is that most of that pricing pressure has been focused on the larger deals. It’s not to say that the deals at the SMB level aren’t competitive also but most of the pricing pressure is at the higher end. And that’s why we’re – in the quarter we just reported that we had good growth in our SMB business again. We’re very focused on the growth of SMB and continue to make investments where you see the SG&A spend increase primarily targeted at leveraging that SMB space.

Rich Kugele – Needham & Company

Okay. And then just lastly in terms of your visibility and commentary you’re getting back on IT budgets, is it your sense that thus far in a year, people are under-spending their budget or their budgets have actually been cut? And as you look out for the balance of the year, I mean do you think if people are under-spending all year that maybe we still do have a flush at the end or it just went up being underspent?

Jeff Howells

Our visibility all the way out to the enterprises is not clear, so for us to comment on that would probably not be fair, but through the eyes of our customers, what we see is more deferral as opposed to cutting, and deferred decisions on deployments of new applications or new technologies. It doesn’t mean means that those projects have been cut out of the budget, it means that they’ve been deferred.

Rich Kugele – Needham & Company

Okay, great. Thank you very much.

Operator

Our next question comes from the line of Ananda Baruah with Banc of America Securities. Please go ahead with your question.

Ananda Baruah – Banc of America Securities

Hi guys, thanks for taking the question. Just a couple, if I could. Just on the margin, the operating margin, I can appreciate that there’s a lot of moving parts, just trying to get a sense of, is this kind of with I guess the totality of the action, are we at a new baseline here, I guess on a seasonal basis going forward? Can we expect the same types of I guess operating margin patterns beginning this quarter, sort of that you typically would coming off of a July quarter or is this sort of still a transition quarter, we'll have to see how things shake out, the balance of cost actions and volume and things of that nature?

Jeff Howells

That's a tough one to answer, but I think if you start with Europe as we saw last year, we saw sequential increase in operating margins and I am sure that is in your model because of the leverage we get by the increased sales in Europe in Q3 and then again another step up in Q4. As far as the Americas, where we are in the 140 range, there’s nothing in the near term that says that that will go back up to 150, 155. It doesn’t mean that we won’t shoot in our internal targets or still for the year to average 1.5%, but there is nothing specifically in the guidance that we’ve just given where we say we’ll be down low single digits on a year-over-year basis that’s going to drive that margin back up with a competitive marketplace that’s on an overall basis flat. To the extent that our competition eases up on some pricing because we saw some degradation in operating margin at competitors that they ease up, maybe there is some room for improvement. So, we’ll going to have to live through Q3 and Q4 and see what the overall market evolves to, but there is nothing specifically that's going to change rolling from July 1st to October 1st.

Ananda Baruah – Banc of America Securities

Got it. So, even if the price actions go through September 1, they begin in North America, and if they are kind of what you would consider to be successful in this environment, we still shouldn't expect to return to sort of the 1.5, 1.55 level?

Jeff Howells

I’m not sure the first part of what you’re saying the price change, we were just saying if competitiveness let up in the marketplace, there could certainly be an opportunity for us to bring our operating margins up. But, we while have indicated that we’re controlling our expenses, controlling our headcount, we are completing a few of our strategic investments in the Americas this year as planned. And so, we’re not pulling back on that spend either on the capital or the operating side. So, we’re in this for the long term and one or two quarters are not going to impact our strategic positions.

Ananda Baruah – Banc of America Securities

I apologize I was actually, I meant to say freight not pricing actions.

Jeff Howells

Again, that’s to recover a cost we think is going to be escalating as we move month-by-month through the remainder of this year.

Ananda Baruah – Banc of America Securities

And I guess just for clarification, I guess the margin pressure you got, the incremental margin pressure on the Americas business, would you say most of that is from kind of volume from stepping away from deals versus the impact of some pricing deals you didn’t step away from versus the impact from freight, I guess order of magnitude, what’s the right order to think about sort of the margin pressure in the Americas you guys saw?

Jeff Howells

Well, I’ll start and see if I may be able cover to it all, maybe Bob could add to it. First of all, it starts with what business you’re going to take. And as you can tell by the stability in our worldwide gross margin percentage, our teams around the world were focused on taking the business that met our threshold. That meant in some areas, especially the Americas, we didn’t take all the business that we had hoped to take. That lack of that incremental revenue generating incremental gross profit dollars that would flow through our P&L and only attach a small amount of incremental SG&A yielded an operating result that was under what we had generally targeted, hoped for, and quite frankly goaled ourselves on.

So, there’s no one answer, I think what we’re very proud of the fact though is that even in this competitive market, we priced and took and serviced business that allowed us to make the returns that we are responsible. So we did not overreach just to take, as I call it, profitless prosperity transaction that doesn’t make sense for the corporation. And quite frankly, if someone’s pricing product – hundred of millions of dollars of product below their cost on their product, we know it’s got to degregate their operating performance, so let them have it.

And so, there’s a lot of things going on, and in a difficult environment like this, I think our team did a tremendous job of taking the order and we are sitting here today, we will open up on everyday with the book of business from yesterday completely sold through and shipped. They’ve got a lot of decisions to make and it’s spread over thousands of sales associates and the composite aggregated to the right answer for the corporation, so it was good performance that we’re very proud of.

Bob Dutkowsky

And that’s why we talk about the deployment of IT tools like One Desk here in the Americas and the SAP deployment in Europe because that arms our sales teams at the point of sale with the most accurate data about the profitability by product, by customer. And so our sales teams are more prepared and will continue to improve their ability to optimize profitability at the point of sale. Those are tools that haven’t been in the hands of our sales organizations in the past, and so that’s why we’re so committed to finishing up on these investments that we started a couple of years ago. In the long run, our enterprise would be able to optimize the profitability of the deal at the point of sale better than anybody else in the industry. And with that capability, we think that we can continue to improve the profitability of the business and return to our shareholders.

Ananda Baruah – Banc of America Securities

And I guess on the European spending environment, at a higher level, how would you guys – because I mean I guess, it seems like you are guidance for flat to slightly up year-over-year euro revenue dollar growth. Would you consider it (inaudible) I think the consensus has been that's continued to soften. It sounds like maybe you guys think it feels a little bit more stable than perhaps it has over the last few months?

Bob Dutkowsky

Yes, I think the overall European market has softened some over the last quarter or so, but I also believe that Tech Data’s execution in Europe has improved. And as we said in our prepared comments, while others declined in Europe, we grew, we gained share and I think after several years of less than perfect execution in Europe, Tech Data in Europe is now executing. And that execution is being rewarded in the marketplace.

Our teams have worked tirelessly over the last four or five years to build an infrastructure that can meet the demand of our customers and we’re executing now. Certainly, our performance in Germany as we highlighted, the German region had the best overachievement of its sales targets of any other regions in Europe, and that’s not a statement that Tech Data could make a few years ago. So, even if the market is softer, Tech Data is performing better and our customers are rewarding us with that business in Europe.

Ananda Baruah – Banc of America Securities

Got it.

Jeff Howells

And also, say Ananda, if you look at the map, in Euros, the forecast that we just gave – if you take out Scribona out of Q2 and Q3 which show sequential growth much like we reported last year in the ballpark as it closes [ph] a little off. And that in an environment where we're seeing pockets of strength, pockets of weakness, countries that are growing, countries that are shrinking as far as the available IT market. I think it's a reflection of the fact that we are back, we are executing, and our team is doing an excellent job over there, and we have competitors that are shrinking in local currency. And ex acquisition, we're sitting here today saying the we're forecasting growth. Of course, we have to deliver it and nothing is guaranteed, but I think it's a pretty healthy task that we put out there in front of our team and I think they can deliver on it.

Ananda Baruah – Banc of America Securities

Okay, thanks. And just one last trickle in [ph] for me. With the raising of the threshold for free freight of customers, is there any possibility – I guess what's this thinking around the potential to sort of pull some sales forward? I don't know if it's this quarter or this quarter and next quarter, and maybe change the seasonality a little bit. So I guess what I'm thinking is folks kind of order ahead to get the free freight, but then two queues [ph] are reported on the line. They only need to order as much and so you might have a bit better sales this quarter and then maybe a bit softer sequentially as you move forward.

Jeff Howells

It’s a great idea, but it's probably not going to work that way. Part of our value proposition is we can deliver product when the customer wants it on 24-hours' notice. And so the customers typically don't buy ahead. They rely on us to be a reliable supplier of technology and partly what they're hedging is the declining prices of technology as well. Why would you buy at a month in advance, it's going to be worth less a month later? So they use our just-in-time delivery capabilities to their advantage and I just don't see them buying ahead.

Bob Dutkowsky

And maybe I misspoke or you misunderstood me, we aren't changing the free freight limits. I mean, our limits are holding and so we're just hoping our customers aggregate more. But if you look at, for example, the program we announced here in the US on a free freight order of $2,400, we're talking about a $2 handling fee completely immaterial to that individual transaction but it helps compensate for the incremental fuel surcharges that we are going to get on that order. So we're keeping pricing, we're keeping free freight limits, we're keeping a normal customer flow intact and so we're on a very fine-tuning method saying we just have to – this freight surcharge is something that our gross margins or fuel surcharge is something that are gross margin environment just doesn't allow us to absorb.

Jeff Howells

And then, to assume that the customer could aggregate this $2,400 order and put two of them together and have a $4,800 order, he still only gets the $2 handling charge and Tech Data's internal efficiency goes way up because we ship a larger order. So the customer can win and we can win. And so, that's why we think that it's the best design of the program that we could construct.

Ananda Baruah – Banc of America Securities

That's very clear, thanks a lot guys.

Operator

Our next question comes from the line of Bill Fearnley with FTN Midwest. Please proceed with your question.

Bill Fearnley – FTN Midwest

Yes, I'd like to take a different tact if I could on the rebates guys, when you mentioned you didn't hit your aggressive sales targets for the OEMs, when did the OEM goals redial especially on the largest problem ones that you were talking about? Do they redial this quarter or the half-year, fiscal year? And in addition, would you have competed and maybe secured a chunk of the $100 million in orders you passed on if you had hit the rebate targets? And I just have one follow-up.

Bob Dutkowsky

The rebates are negotiated quarterly so the Q2 rebates were opened and closed and we’re onto Q3 and we’re selling. If we had hit the rebates we've competed differently for the $100 million that I described in two customers? The answer is no, we wouldn’t have changed because the rebates wouldn’t have moved the economics to a position where we would have made money.

Bill Fearnley – FTN Midwest

And do you think the rebates – do you think the performance of this quarter maybe make some of those unreasonable rebates targets, does it make them more achievable or are you – viewed on a pure year-over-year basis, is there any consideration for sequential performance?

Bob Dutkowsky

Some vendors look at it year-over-year, some look at it sequentially. It’s not consistent. Every vendor has a different unique program that matches up with their product cycles and where they are in their markets and what customers and segments they want to target us at. Remember those rebates are intended to give us direction to go into certain market segments. So they’re different by vendor. You can’t paint them all with one brush.

Bill Fearnley – FTN Midwest

Okay, and if I could shift gears and ask the shipping question in a different way. When you change your shipping charges in the end, some of your competitors do as well, and some of them have been pretty vocal about what they’re doing and what they’re facing which is similar to you. Does that weigh on your revenue growth for competitive reasons for the next few quarters or do you see most of your competitors doing the same, so it’s a more level playing field here for the next couple of quarters in particular? Is there any revenue growth or any revenue shift here in your view, because one of your competitors mentioned that they think that there might be some revenue shift? I was curious what your view of it would be. Thanks.

Bob Dutkowsky

That’s always a risk and something that certainly could happen whenever you change any policy. You could lose revenue you had yesterday and gain revenue that someone else had yesterday. So, what's the net impact of that? We certainly can’t estimate. We’ll watch it very closely. But the thing that we hope will be successful here is the fact that this is a charge that is going through any business around the world. You’re paying a handling fee to take a piece of luggage with you on a personal or a business trip. You’re paying an incremental fee for most Internet websites today, handling fees going from $5 to $7 or the freight minimum.

It’s just a fact of business that somehow this fuel cost needs to ripple through, and unfortunately ultimately, to the end user of any product or service. And if we remain flat footed and do nothing, as this happens over time, we could be in a very negative position. Investors have told us they would rather we'd be smaller and more profitable than larger and less profitable. I’m not saying that would be an impact or a result of this policy, but sitting here logically, we’re going to have some business that’s going to move away from us and we’re going to have some business that moves to us if the economics worked better for that customer to do business with us than one of our competitors or vice versa. That’s a fact of life.

Bill Fearnley – FTN Midwest

But, I agree with you on the fact of life issue, but I guess I’m just curious as you’ve made these changes and you’ve telegraphed you’re going to be making the changes, are your sales people coming back and telling you that business is moving away from you, moving towards you or is it net neutral at least with what you’ve seen after some of the stuff that's appeared in the trade press?

Bob Dutkowsky

Bill, we have a competitor in one particular region in Europe that charges 100% of freight.

Bill Fearnley – FTN Midwest

Okay.

Bob Dutkowsky

So it’s different as Jeff was saying, it’s different by country, it’s different by region. We started the process quarters ago of trying to recoup as much freight as we could in Europe. The real change is here in the Americas and it’s way too early for us to tell you exactly how the market’s going to respond. But again, our mentality is we try to formulate a program that would benefit both Tech Data and our shareholders and our customers. And by giving the customer the ability to aggregate orders together and create bigger orders, that’s good for them and good for Tech Data.

Bill Fearnley – FTN Midwest

That’s helpful. Thanks guys.

Operator

Our last question is a follow-up question from the line of Brian Alexander with Raymond James. Please go ahead with your question.

Brian Alexander – Raymond James

Yes. It’s been a long call, so I apologize, I probably should have taken this offline. But last quarter, you warned of a lower gross margin due to the pricing environment in North America but you expected higher sales. And you actually held gross margin flat sequentially despite the lower rebates and your sales in the US were a little worse than you thought. I guess what I’m wondering is in terms of what drove the change and how this all played out, was it a change in management’s philosophy on what to accept and what to reject or was the philosophy the same and you just have more daily intelligence based on some of the new tools that you have? Thanks.

Bob Dutkowsky

I think it’s probably a combination of a little of both of those, Brian. I think our management structure in the sales organization – remember in the US, we restructured the sales organization back several quarters ago and I think the deployment of the newer more robust management structure in the US paid us some dividend in the quarter. They were able to see the opportunities more clearly and manage the portfolio of business and make those tradeoffs around which deals made sense for us and which ones didn’t. The One Desk deployment hasn’t completely been rolled out to the point where it's delivering that kind of value yet in the US, but we see that as a next logical step in the progression of our sales structure here in the Americas.

Brian Alexander – Raymond James

Great. Thanks guys.

Operator

This concludes Tech Data Corporation’s fiscal 2009 second quarter results conference call. A replay of the call will be available in about one hour at techdata.com. It will remain available until Thursday, August 28 at 5 PM. Thank you for attending today’s conference call and have a great day.

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Source: Tech Data Corp. Q2 2009 Earnings Call Transcript
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