Tech Data Corporation (NASDAQ:TECD) Q4 2018 Earnings Conference Call March 8, 2018 9:00 AM ET
Bob Dutkowsky - Chairman, Chief Executive Officer
Chuck Dannewitz - Executive Vice President, Chief Financial Officer
Arleen Quinones - Corporate Vice President, Investor Relations
Adam Tindle - Raymond James
Matt Sheerin - Stifel
Ananda Baruah - Loop Capital
Param Singh - Bank of America Merrill Lynch
Jim Suva - Citi
Lou Miscioscia - Pivotal Research Group
Shannon Cross - Cross Research
Good morning. Welcome to Tech Data Corporation’s fiscal year 2018 fourth quarter earnings conference call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question and answer session. To ask a question, please press star, one. 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 Arleen Quinones, Vice President of Investor Relations. Ma’am, you may begin.
Thank you. Good morning and thank you to Tech Data’s earnings conference call and webcast to review our financial results for the fourth quarter and fiscal year 2018. I am joined this morning by Bob Dutkowsky, Chairman and Chief Executive Officer, and Chuck Dannewitz, Executive Vice President and Chief Financial Officer. For a detailed look at our fourth quarter results, please review our financial highlights summary slide presentation posted this morning on the IR portion of our website located at www.techdata.com.investors.
Unless otherwise specified, all growth comparisons we make on the call today relate to the corresponding period of the previous fiscal year.
Before we begin, I would like to remind all listeners that today’s earnings press release and certain matters discussed on today’s call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on the company’s current expectations and are subject to risks and uncertainties. These risks and uncertainties include but are not limited to those factors identified in the press release and in our filings with the Securities and Exchange Commission, including those filings related to our acquisitions of Avnet’s Technology Solutions business as well as our most recent annual report on Form 10-K which identifies important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. Please be advised that the statements made during today’s call should be considered to represent the expectation 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.
Also, throughout this conference call, we will reference both GAAP and non-GAAP financial measures which exclude certain items contained in our GAAP financial results. A detailed reconciliation between results reported in accordance with GAAP and non-GAAP financial measures can be found in the press release and on the Investor Relations portion of our company’s website.
Please note that during today’s call, we will refer to Technology Solutions business acquired from Avnet on February 27, 2017 as technology solutions, or as TS. We have provided certain estimates of pro forma sales growth rates and product performance based on combining the standalone operating results of Tech Data and Technology Solutions for the periods prior to the acquisition date. This pro forma information is provided for informational purposes only and does not represent what actual results would have been had the acquisition been completed at the beginning of the prior fiscal year, and it is not necessarily indicative of the results of operations that may result in the future.
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 will now turn the call over to Tech Data’s Chairman and Chief Executive Officer, Bob Dutkowsky.
Thank you, Arleen, and good morning everyone. Thanks for joining us today. Our strong fourth quarter performance completes a historic and transformational year for Tech Data.
During fiscal 2018, we closed the acquisition of Technology Solutions and introduced the new Tech Data, a global company that is redefining technology distribution with a unique end-to-end portfolio of products and services, highly specialized skills, significantly enhanced earnings power, and a strong cash flow profile. Fiscal ’18 was also a year of significant strategic and financial progress, posting our highest sales, non-GAAP earnings and cash flow from operations in Tech Data’s history. This strong financial performance enabled us to pay down $850 million of debt and attain our post-acquisition target leverage ratio well ahead of our 18 to 24-month plan. In addition, for the trailing 12-month period, we earned an adjusted return on invested capital in excess of our weighted average cost of capital.
We achieved all of this while also attaining our synergy targets for fiscal ’18 and reaching a number of key integration milestones. Among our worldwide teams, many accomplishments this past fiscal year were the launch of the new Tech Data brand in markets around the world and the introduction of a new corporate strategy. We also established laser focused go-to-market organizations in all three geographies, ensuring that each is aligned with the company’s strategic priorities. Importantly, during the fiscal year we also integrated some of our largest country operations, combining sales and back office functions, facilities, certain systems, logistics, and harmonizing company policies and practices.
I’m very proud to say that Tech Data delivered on our fiscal year ’18 commitment, and as you can see from our results, the channel continues to respond positively to the new Tech Data. Our customers and vendors are excited about the value we bring to the market today as well as the future promise of our company. We are the premier global end-to-end IT distributor with unmatched capabilities and a products and services portfolio that spans from endpoint devices to specialized technologies to the most advanced data center solutions. The new Tech Data is connecting the world with the power of technology and this brand promise gives us great confidence as we look to the future.
I will share some additional information on how we performed during the year against our strategy later in my prepared remarks, but now I’ll turn the call over to Chuck who will review our financial and operational results for Q4, as well as our outlook for Q1. Chuck?
Thank you, Bob. Good morning everyone and thank you for joining us today. As Bob indicated, fiscal year 2018 was a historic and transformational year for our company, a year where we not only delivered on our commitments but also made tremendous strategic and financial progress. Our Q4 and fiscal year ’18 results clearly demonstrate the significantly enhanced earnings profile and cash generating power of the new Tech Data and our ability to deliver strong results for our shareholders.
Turning now to our Q4 consolidated and regional results, on a reported basis worldwide sales were $11.1 billion, up 49% year-over-year. The year-over-year increase in worldwide and regional sales is primarily due to the addition of Technology Solutions. On a pro forma basis, we estimate that worldwide sales were up low single digits in constant currency. In Q4, Apple represented 19% of worldwide sales with no other vendor partner representing 10% or more of our sales. On a regional basis, sales in the Americas increased 59% to $4.3 billion on a reported basis and 58% in constant currency. On a pro forma basis, we estimate the Americas sales increased by low single digits in constant currency.
At a product level, notebooks, desktops, networking products, network security, TVs and cloud software performed well while sales in storage products, servers and tablets declined. In the U.S., sales to resellers serving public sector end users showed strong growth, especially within the state and local, federal and education verticals. Also in the U.S., sales in our U.S. SMB sales division grew by double digits again in Q4.
In Europe, Q4 sales increased 37% to $6.5 billion on a reported basis and 24% in constant currency. On a pro forma basis, we estimate Europe sales were up by mid single digits in constant currency. At a product level in Europe, sales of smartphones, software subscriptions, data center hardware, and consumer electronics were up while sales of notebooks, desktops and printing products declined.
In the Asia Pacific region, sales were $338 million. Our Asia Pacific results are entirely due to the acquisition of TS as Tech Data had no operations in the region prior to the acquisition. From a product perspective, sales of storage, security, cloud, and data and analytics were up while sales of networking and servers declined.
Worldwide gross profit was $616.9 million, an increase of $245.8 million or 66%. Gross margin was 5.56%, an improvement of 56 basis points. The increase in gross profit dollars and gross margin percentage are primarily due to the addition of the higher margin TS business.
Worldwide non-GAAP SG&A expense, which excludes $21.5 million of acquisition related intangible amortization expense increased $152 million or 61%. As a percentage of sales, non-GAAP SG&A expense increased 26 basis points. The increase in non-GAAP SG&A expense is primarily due to the addition of TS. The increase in non-GAAP SG&A expense as a percentage of sales is primarily due to the higher cost to serve TS’ more complex advanced solutions business.
Worldwide non-GAAP operating income was $216 million, up $93.8 million or 77%. Worldwide non-GAAP operating margin improved 31 basis points to 1.95%. The increases in worldwide and regional non-GAAP operating income dollars and operating margin percentages are primarily due to the addition of the TS business.
On a regional basis, the Americas non-GAAP operating income grew $37.7 million to $85.1 million, an increase of 80%, and as a percentage of sales grew to 1.98%, an improvement of 23 basis points. In Europe, non-GAAP operating income grew $52.7 million to $130.4 million, an increase of 68%. As a percentage of sales, Europe’s non-GAAP operating income was 2.02%, an improvement of 37 basis points. In our Asia Pacific region, non-GAAP operating income was $7.5 million or 2.21% of net sales.
Stock-based compensation expense was $8.2 million in Q4, which includes $1.2 million of acquisition and integration related expense.
Interest expense in Q4 was $27 million, higher by $11.6 million primarily due to higher debt balances used to fund the TS acquisition. In addition, Q4 interest expense includes approximately $2 million related to value-added tax assessments and additional costs associated with the early repayment of $300 million of long term bank debt.
Our non-GAAP effective tax rate for Q4 was 29%. This rate excludes our non-GAAP adjustments, including income tax expense of $95 million incurred as a result of the 2017 U.S. Tax Cuts and Jobs Act that was enacted in December 2017. This income tax expense is comprised of $101 million related to the transition tax on foreign earnings offset by a benefit of $6 million related to the re-measurement of our net deferred tax liabilities at a lower tax rate. The transition tax on foreign earnings will be paid in increasing installments over the next eight years. We estimate that tax reform reduced our non-GAAP effective tax rate in Q4 by approximately one percentage point and our fiscal year non-GAAP effective tax rate by approximately 50 basis points.
Non-GAAP net income was $134.7 million, an increase of $47.7 million or 55%, and non-GAAP earnings per diluted share were $3.50, a 43% improvement.
Turning now to some of our balance sheet and cash flow metrics, throughout fiscal year ’18 our teams did an excellent job managing our working capital. Our cash conversion cycle in Q4 was 14 days, an all-time low. This was favorable by seven days sequentially and one day compared to the prior year quarter. During the quarter, we generated operating cash flow of $657 million, bringing our fiscal year cash flow from operations to $1.1 billion, and we exited the quarter with a cash balance of $956 million.
Moving forward, we anticipate our cash conversion cycle to return to a more normalized range of 18 to 22 days, and we remind you that one cash day equates to approximately $100 million.
During Q4, we paid off $300 million of our long term bank debt, bringing our total debt repayment in fiscal ’18 to $850 million. We exited Q4 with a total debt to adjusted EBITDA ratio of approximately 2.4 times, delivering on our commitment to obtain a post-acquisition leverage ratio of approximately 2.5 times, well ahead of our 18 to 24-month anticipated time frame when we announced the TS acquisition. Going forward, we remain committed to managing our debt levels so that we maintain our investment grade rating.
At the end of Q4, we had $2.9 billion of equity and a 36% debt to total capital ratio. For the trailing 12 months, we earned an adjusted return on invested capital of 12%.
As Bob stated earlier, we’re making excellent progress on our integration efforts. With the actions taken and identified to date, we achieved our commitment of $50 million in annual cost savings for fiscal ’18 and remain well on track for another $50 million by the end of fiscal year ’19 for a combined annual cost savings of $100 million.
In regards to one-time costs related to achieving these synergy targets, we now estimate approximately $165 million of one-time costs exclusive of one-time transaction costs related to the acquisition. This increase from our original estimate of $150 million is primarily due to higher IT-related costs.
Before I review our guidance for Q1, there are two key changes that will impact our financial results on fiscal ’19: the aforementioned U.S. tax law changes and the adoption of the new revenue recognition standard AFC 606. As a result of the tax law changes from the Tax Cuts and Jobs Act, for fiscal ’19 we expect our effective tax rate will be in the range of 26% to 28%. The lower effective tax rate takes into consideration a number of factors, with the most significant being the 21% U.S. statutory tax rate and the U.S. taxation of a portion of our foreign-based earnings. In addition to lowering our effective tax rate, U.S. tax reform also gives us increased access to our cash outside of the U.S., enhancing our financial flexibility. At this time, we’re currently evaluating the use of our foreign cash as well as our optimal financing structure.
The other change impacting our fiscal ’19 results beginning in Q1 of fiscal ’19 is that we have adopted the new revenue recognition standard ASC 606 on a full retrospective basis. Adoption of this standard results in lower net sales than reported under the prior revenue recognition standards primarily due to the netting down of certain software sales. We anticipate the adoption of the new standard to result in a reduction in net sales for fiscal 2019 of approximately 7%. We expect this change will not have a material impact on gross profit, operating income or net income dollars, but is expected to increase our gross margin and operating margin percentages due to the lower sales pace.
Turning now to our guidance for the first quarter ending April 30, 2018, which includes the impact of both ASC 606 and the U.S. tax reform. We anticipate sales to be in the range of $8 billion to $8.3 billion. As noted previously, this reflects a reduction of approximately 7% as a result of the new revenue recognition standard. At the midpoint of the sales guidance, we estimate this represents low single digit pro forma growth in constant currency. We anticipate earnings per share to be in the range of $0.37 to $0.67, and non-GAAP earnings per share to be in the range of $1.30 to $1.60. This guidance assumes 38.6 million weighted average diluted shares outstanding and an effective tax rate in the range of 27 to 29%. This guidance also assumes an average U.S. dollar to euro exchange rate of $1.22 to one euro.
Our Q1 guidance reflects the increasingly competitive market environment that we began to experience in the latter portion of last year’s Q2 and that continued through the remainder of fiscal year ’18. In addition, late in fiscal year ’18 we were notified by a few key vendors that they intend to alter their programs to align more closely to their current operating environments. The impact of these changes results in lower margin opportunities for their distribution partners. Some of these changes began to take effect beginning in Q4 of fiscal ’18 and will roll out over the course of fiscal year ’19.
As a result of these market dynamics, we are updating some of the modeling assumptions we provided at our investor day this past October. Please keep in mind that we are not providing fiscal year ’19 guidance, simply high level modeling assumptions you may wish to consider. In addition, we are not otherwise updating the assumptions provided at our investor day and do not plan to update any of these items going forward.
For fiscal ’19, we anticipate flat to low single digit growth in non-GAAP operating income. In addition to this, as noted previously, we expect to realize approximately $50 million of synergies in fiscal ’19. Finally, we expect to achieve greater operating leverage and therefore significantly more earnings power be realized in the second half of the fiscal year.
I will now turn the call over to Bob for additional comments. Bob?
Thanks Chuck. We’ve spent the last year unveiling the value of the new Tech Data and we are now operating under a single brand with a unified vision, global team, and solutions portfolio that are unrivalled in the industry. We remain very excited about the future of our business powered by the exceptional service, insight and world-class execution of the new Tech Data.
The IT market is in a constant state of transition. As workloads migrate across technology platforms, it is fueling growth in next generation technologies and delivery models such as the cloud, hyper-converged infrastructure, software-defined solutions, IoT, and analytics, security and the services that support the entire technology continuum. The new Tech Data, with deep skills and domain knowledge and enhanced earnings power, is better positioned than ever to invest in these areas to capitalize on the opportunities they present and to help our customers navigate an increasingly complex technology landscape. To accomplish this, we’re focused on four primary strategic objectives: investing in next generation technologies and delivery models, strengthening our end-to-end portfolio, transforming Tech Data digitally, and optimizing our global footprint.
An example of the progress we made in fiscal ’18 advancing our strategy is in the cloud space where we aligned our global cloud offerings and built out our cloud infrastructure. During the year, we successfully launched our StreamOne cloud marketplace in 47 new countries, which extends our cloud marketplace reach to 67 countries supporting eight languages. The cloud remains one of our fastest growing segments and expansion of our cloud platform contributed to the strong double digit growth in new cloud orders in fiscal ’18.
In our view, the cloud is a true end-to-end environment and is a key delivery platform for next generation technologies. The breadth and scale of our global cloud offering coupled with our end-to-end portfolio and deep expertise in new and emerging data center technologies clearly positions the new Tech Data as a global channel leader for deploying public, private and hybrid cloud solutions.
During fiscal year ’18, we also introduced our global life cycle management services portfolio in North America to help manage the technology product and customer life cycle from design, integration and installation, to service, support, and IT asset disposition. Our extended services capabilities are a significant step in our growth strategy as services present us with an expanded set of customers and create a number of cross-selling opportunities by leveraging the strength of our end-to-end offerings to win new business in the market.
An example of this is a recent agreement with an all-Flash storage vendor to manage their supply chain logistics. By leveraging our global logistics network and comprehensive integration and product support services, Tech Data will deliver complete solutions to the vendor’s reseller customers. This allows the vendor to focus on what they do best - innovation in software development. Business wins like this clearly highlight how Tech Data’s world-class logistics engine combined with our end-to-end product and services portfolio drives growth for our vendor partners and delivers complete solutions to our mutual customers.
Last week marked the one-year anniversary of the Technology Solutions acquisition, and I’m pleased to say that Tech Data has never had a more dynamic set of business opportunities available to us than we do today. With each passing day, we identify ways to bring even more value to our channel partners through greater use of automation and digital marketplaces. Our global footprint also allows us to explore new ways to optimize our operations. We have best practices in each region and we can now share those best practices in more countries around the world, all in an effort to enhance our efficient, variable low cost route to market for our vendor partners.
As we enter the new fiscal year, we have a clear road map and the best team in the industry. Our operational teams are focused on executing our strategy while maintaining disciplined cost controls and gaining profitable market share in key geographies and product segments. Our integration teams are progressing as planned and we are well on track to deliver our synergy targets.
At this time, we anticipate demand to remain relatively stable in the markets we serve. As Chuck indicated, we expect the competitive environment we experienced throughout the latter half of fiscal ’18 to continue. However, we are confident in Tech Data’s ability to manage through these market dynamics and execute. As I’ve indicated many times before, the IT market is transitioning rapidly. This means we must continue to invest in skills, capabilities and in our coverage models. At the same time, we will continue to optimize our cost structures and digitally transform our company in order to operate more efficiently, improve productivity, and provide a superior customer experience.
History shows that our flexible business model and variable cost structure enables us to align our resources with the market opportunities and realities of the market, all of which we believe will continue to improve our financial profile and create value for our shareholders.
In terms of capital allocation, our primary focus in fiscal ’18 was to de-leverage our balance sheet in order to retain our investment grade ratings. Going forward, we will continue to pay down debt and return to our historical more balanced approach in deploying capital, including a continuation of organic investments, targeted M&A, and share repurchases.
I want to take this opportunity to thank our customers and vendors for their partnership and continued support, and a very special thank you to my Tech Data colleagues around the world whose hard work, dedication and commitment delivered the most transformative and profitable year in Tech Data’s history.
With that, we open the call to your questions.
Our first question comes from Adam Tindle with Raymond James.
Okay, thank you and good morning. Just wanted to start on the fiscal ’19 framework for operating income dollars. It looks like the Q1 guidance implies somewhere around maybe a mid-teens year-over-year decline in that metric, so just trying to get a sense for what happens throughout fiscal ’19 to really catch up and achieve the flat to low single growth, ex-synergies. I know the business is back half weighted, but I’m just trying to understand because I wouldn’t think that would change year-over-year.
Adam, this is Chuck, and good morning. Historically Q1 has been our most difficult quarter because of the leverage, the lower sales volumes compared to our cost base. As we move throughout Q2, Q3 and Q4, the sales volumes pick up and that leverage comes through to our operating income dollars. The other thing that we’re very good at is aligning our resources, both our cost structures as well as pointing our resources to the most highly profitable areas of our company, so that’s how we get comfortable. Seasonality-wise, it is back end loaded with significant earnings coming in the back half of the year.
Okay. Just looking at revenue ex-the 606, I think it still implies for Q1 at or maybe slightly below seasonal trends in the quarter, which is different from what we’re hearing from a lot of the large vendors that are more bullish on IT spending. I know you’re not alone in the channel on this - some of your customers and other distributors are talking about guidance like you’re providing here, so maybe for Bob, just trying to understand why it seems like the vendors are somewhat dislocated from what we’re hearing in the channel on IT spending.
Yes Adam, it’s Bob. First off, keep in mind that we don’t sell all of the products that the vendors take to the market, so they may have a product or an offering that they see as growing that they still sell direct. Some of the products that they move into the channel sometimes are ones that don’t grow as aggressively or at the upper end of the curve, and that’s the reason that they move them into distribution, so I think that’s the primary reason why the disconnect exists.
They also will move customer segments to distribution that maybe don’t grow as fast as a segment that they take direct, so it’s a combination of those factors why you might see a vendor community see more growth than the distribution community. I don’t think it’s reflective of any kind of disconnect that might exist between the two, as opposed to it’s just the way the channel strategies are designed.
By the way, Adam, it’s been like that forever. This isn’t a unique moment in time. That’s just the way that channel and the direct works together.
Right, that’s helpful. If I could just clarify one last thing on the vendor program changes that you’re talking about, how much of that is Tech Data-specific versus something that should impact all distributors, and does it go to the reseller level as well? Any clarity would help, thank you.
Yes, when a vendor modifies a program, typically it’s a reflection on how they anticipate their business is going to perform over the course of that upcoming year, and they’ll tune their programs for not only distribution but for the VAR channel, all the way down to the retailers. When they tune a program for one distributor, that means that they tune them for all distributors, just like if they tuned a program for VARs, it’s for all VARs, so this is not a Tech Data issue, it’s a moment in time where the vendors are adjusting programs.
Again Adam, same answer to the earlier question - this happens all the time. It happens with virtually all of our vendors. Vendors will take up the profitability opportunity for the channel when they want to gain share or when they have a product that they want to move into the market more aggressively. They’ll take down the ability to earn profit in the program when they want to pull back, or their profitability doesn’t look as good. So this is not a unique environment or a unique moment in time, it’s just the reality of the combination of vendors that we have the privilege to serve.
Our next question comes from the line of Matt Sheerin with Stifel.
Yes, thanks. Good morning. I just wanted to add to Adam’s question, just regarding the vendor program changes. Is that primarily on the enterprise side in the TS business, or is it in other pockets of your business, including client devices?
It’s both; but again, Matt, it happens all the time. It just so happen as we look out over the course of the year and we look at the programs that were announced to us, they happened to touch vendors that we have large percentages of performance with, so they’re impacting Tech Data maybe more than they would a distributor that doesn’t have a big relationship with a particular vendor.
Okay. Could you maybe quantify in terms of the magnitude of the vendor changes? Are we talking about representing, what, 30% of your line card, or 50% of your line card? It sounds like--and are we talking about multiple vendors?
Yes, it’s a few vendors, and we don’t disclose the details of those programs. Those are between Tech Data and the vendors, but it’s a few of our vendors that have announced changes that we believe will impact our performance.
In the past, I know you’ve managed your portfolio very well in terms of walking away from certain opportunities or, as you said, shifting resources, so do you have any leverage at all with the suppliers in terms of changing what you do?
Oh, sure. Over the course of the year, the programs continue to be modified and the vendors will announce their program to us, and then we’ll match our resources that we apply against that vendor, and if the vendor wants us to put more attention to their products, they’ll modify the program again. These are living, breathing relationships that take place over the course of the year, but when we model out the impact of the changes we’ve seen announced so far, you can see that it will have an impact on our Q1 performance.
Okay. All right, thanks a lot.
Our next question comes from the line of Ananda Baruah with Loop Capital.
Hey, good morning guys. Thanks for taking the question. Congrats on a really solid quarter. Just a couple more in regards to the guidance. It sounds like the entirety of the impact to op income dollars for fiscal ’19 is from the vendor changes and not from the ASC 606 changes, but I just wanted to clarify that.
Ananda, this is Chuck, and you’re 100% correct. ASC 606 does nothing in regards to operating income dollars or our profitability. It’s purely a re-class to net versus gross, and it impacts your operating margin percentages and operating income percentages but not the dollars or our EPS. So you’re 100% correct, and it’s not only the vendor programs that we saw in Q4 that were announced but it’s also the competitive environment that we began to see in the latter part of Q2 and through the balance of the year versus what we had seen in the prior Q1 quarter, and that’s why the year-over-year decline in Q1 as compared to Q1 of last year is more pronounced.
Chuck, thanks for mentioning that. Can you just talk to what areas in the marketplace that you’re seeing that - you know, technology sub-segments, any context would be helpful where you’re seeing the competitive environment really begin to make a bigger impact.
I think it’s safe to say, Ananda, that it’s across the board. It’s not one competitor or one geography, it’s a competitive market that we work in. But again, as we say every quarter on this call, we live and breathe in a very competitive market and we understand it, and we’re very confident in our ability to bring our value proposition into the market to compete. So there are moments in time when competition ebbs and flows and we have dealt with that competitive environment for a long time, and we’re very comfortable in it.
Bob, to that point, you guys have done just a fantastic job over the last 10 years of repositioning the portfolio and really being kind of on the cutting edge of what market demand trends have been. This is a market statement, not a vendor specific statement, but it feels like the handset market sort of softened out in a new way calendar ’17, and it feels like it could be starting like that as well. If it ends up being the case that the handset market ends up being more flattish now going forward, can you give us a peak into what you guys would look to stimulate? You’ve always done a good job of doing that as a response to that.
Yes, so there’s a few actions that we would take in that environment. You call out handsets, but this is--you know, you could call out any product category or segment and we would respond the same way. First off, we would assess the competitiveness of that market, do we have the right products on our line card? If not, we will go out and try to recruit new products to bring to our line card that would strengthen our set of offerings inside of a segment like that. Secondly, we would look to new customers and try to take the products that we have on our line card to places that we don’t sell today, and then thirdly we would look very carefully at our cost and expense structure around the opportunity and balance that against our perceived upside that exists. Those three steps, we do that all the time across all the segments, all the geographies, product categories, verticals. That’s a constant process that we work inside Tech Data.
As Chuck said, balance our costs and expense to the opportunity and put the right resources on the right opportunities in the market - that’s part of what we do every day.
That’s really helpful, Bob. Appreciate that. Last one from me - with regard to cloud demand and the different context in which you guys impact it or are impacted by it, can you just give us a sense of any changes in the cloud demand environment that you saw throughout the quarter and then through the first month of this quarter? That’d be really helpful, thanks.
Cloud demand has continued to steadily grow, and as we said, it’s one of the growth engines that we’re focused on. That’s why we’re really excited about how much further we’ve been able to deploy StreamOne, our cloud engine around the globe. Secondly, clearly the cloud deployment will continue to grow in a hybrid fashion with on-prem computing supporting cloud deployments, so Tech Data is perfectly positioned to take advantage of the hybrid cloud growth market because we have both cloud offerings and on-prem offerings. The breadth of our portfolio really gives us a strong competitive advantage in the marketplace.
I’ll sneak one real quick one in on that. Are you seeing hybrid cloud demand accelerate, are you seeing the growth become stronger for the deployment?
Yes that, and coupled with the growth around hyper-converge and that technology combined is where we see the growth. A lot of the on-prem hybrid computing is now being deployed in a hyper-converged fashion, so the strength of Tech Data’s line card in the hyper-converge space is something that differentiates us in the marketplace.
That’s great. Okay, thanks a lot. I really appreciate it.
Our next question comes from the line of Param Singh with Bank of America Merrill Lynch.
Hi, thanks for taking my questions. If I look at the FX guide you’ve given at 1.22 compared to what it was in October when you gave your full-year ’19 guide, it would just imply that your operating income for ’19, ex-any synergies, should be down year-over-year. Is that all related to the program changes, or is anything else in that mix? Then I have a follow-up.
Param, this is Chuck. Yes, the overall guidance, and we’re really not giving guidance, we’re giving you some assumptions for you to consider - to be clear, it’s not fiscal year guidance as we’re not giving annual guidance. Included in that is the competitive marketplace that we’ve seen over the last several quarters as well as the program changes, and it also includes the FX benefit, so it’s all wrapped into that new modeling assumption that we’re providing.
The other add that I would put in there, Param, is as we’ve said in our prepared comments, we will continue to organically invest in growth areas that we know are where the future opportunities sit for Tech Data. So although with the combination of TS and Tech Data we have a very strong end-to-end position in the marketplace, the combination also allows us to see even more clearly where targeted investments can differentiate us even further. So I think you have to factor in there the idea that there will be organic investments to continue to add to our value proposition.
Okay, great. Then for my follow up, you mentioned a slightly higher expense on a GAAP basis on IT. What are the issues you’re facing with IT in integrating Avnet’s business and then [indiscernible] extra expense, and is that impacting your business in any way?
No, the additional expense is just a revised estimate of what we had when we initially looked at the acquisition. It really has nothing to do with issues in regards to the IT conversions or changing over from the Avnet system, so I would not read anything into that other than it’s a new estimate and a revised estimate of our original thoughts.
Understood. I guess just one quick one, can you talk about the supply chain opportunity that you have with the all-Flash vendor? Is that a pure all-Flash play, and then what’s the revenue and possibly margin expansion opportunity with them or with other potential vendors going the same route?
Yes, it is a Flash vendor that delivers value to their customer primarily through software, yet they need a hardware appliance to be able to take that technology into the marketplace, so Tech Data will build that appliance now in our integration center and deliver the product out into the channel on behalf of the vendor. It’s a very unique value proposition that Tech Data was able to build with this vendor, and the thing that I think is most exciting about it, Param, is there are literally hundreds of vendors that look that way. The vendor--those vendors become a very interesting customer opportunity for Tech Data. We typically don’t think of vendors as customers, we think of them as partners, but this is an opportunity and this particular vendor and the relationship we have turns them into a customer, and we’re really excited about the opportunity we see there.
Great, thank you.
Our next question comes from the line of Jim Suva with Citi.
Thank you very much. Your revenues were much better than expected this quarter, but the EPS drop-through, I think people would have liked to see better drop-through. Was the disconnect there due to the vendor change that you cited, or due to product mix and the vendor changes really happen next quarter?
Jim, this is Chuck, and good morning. The real drivers of the lower margin percentages was mix, as we noted earlier in our comments. We had very strong smartphone device sales in Europe, which have a lower margin opportunity, and then also the competitive nature that we called out of the marketplace.
Having said that, I would like to point the cash conversion cycle that those lower margin products pull through. We had all-time record Q4 cash flows and for the year had $1.1 billion of cash flow and a record cash conversion cycle, so you can see even with the lower margin that we’re achieving the right return for our shareholders.
Okay, and then typically you have--you mentioned one customer over 10%, but typically you had two or three, and the other two that you didn’t name actually have been gaining share. It’s just interesting to see that you didn’t have multiple above 10%. Can you help us understand why that is, or are there some shifts going on?
Sure, it’s a couple factors. One is the overall strength of the major vendor in our overall portfolio, and then the addition of the TS - Technology Solutions business, that overall mix makes those other vendors drop out of the 10% or greater threshold. It’s nothing more than that.
Okay, got you. That makes sense. Thank you so much for the clarity and the detailed follow-up, I appreciate it.
Our next question is coming from the line of Lou Miscioscia with Pivotal Research Group.
Okay, great. I got on the call a few minutes late - I apologize about that. It’s a busy morning in tech. When I’m looking at the slides from the analyst meeting for revenue, non-GAAP operating income, synergies, interest expense, tax rate, could you just reiterate - so it sounds like you were coming out with a low single digit organic growth I wasn’t clear on operating income. Synergies, I heard you updated that; and then interest expense, I guess, and didn’t catch the tax rate.
Well, we did give the tax rate. The tax rate for this next year is between 26 to 28%. We had given 30 to 32% in the modeling assumption for fiscal ’19, we have about a 4% benefit from the U.S. tax reform act that’s going to be flowing through during fiscal year ’19. Interest expense, again we’re not updating other items in regards to modeling assumptions, but we paid down $300 million of our debt at the end of this year and I think it would be safe to be in that range that we have provided before.
Okay, and then I’m sorry, operating income?
We gave our operating income - we said it was going to be flat to up low single digit growth year-over-year.
Okay, great. To circle back, I guess, on some of the questions, and I clearly understood the answers, Bob, that you’ve given and also you, Chuck, but with the macro so strong, and I understand that some of the OEMs are keeping their better products, I still would have thought that maybe there would be more top line growth. Any comment, especially you called out strength, is there anything that’s really holding that back down from either a geographic or product perspective?
I’ll comment first and then let Bob interject as well. One of the things that historically Tech Data has done extremely well is to mix our portfolio to those higher profit opportunities, so while there is maybe more growth in the marketplace, we are de-selecting those non-profitable segments as well as growing in the segments we wish to highlight. Our growth is an overall mix of growing some faster than the market and de-selecting out to get to that low single digit growth.
I think Chuck summarized that effectively, Lou.
Okay, all right. That’s it for me, thank you.
If you’d like to ask a question today, you may press star, one. Our next question is coming from the line of Shannon Cross with Cross Research.
Thank you very much. I was curious from a component perspective how you’re thinking about what you’re seeing from the vendors in terms of the flow-through of higher prices due to the component market. Do you think that had any impact on how they’re thinking about their rebate programs and if they’re pushing you for more margin because they’re not getting it from the products, given what’s happening to their bill on materials? Anything you could give there would be great, thank you.
Yes, we don’t really have a lot of insight backwards into the vendor that way, Shannon, but if the vendor’s cost or profitability are under duress, they’re going to look to every program they can find to try to put their profitability back in balance. The programs that they offer into the channel are one of those levers that they’ll often pull. So you can look at the profitability of many of our primary vendors because they’ve reported within the last 30 to 45 days and you could see many of their profit profiles are under duress. That could be back into the component side, but I offer that only as an observation, not with any fact around it.
What are you seeing from an end customer--I mean, you’ve talked about it a bit on this call, but just from an end customer perspective, are you finding--I know you said it’s competitive out there, but are you finding customers willing to pay up a little bit for some of the price increases that the vendors have pushed through? Again, I think we’re all trying to balance what we’re hearing in terms of macro with what we’re seeing in terms of the growth numbers that you’re guiding to, so I don’t know, maybe end customer commentary.
Yes, we don’t interact with that end customer to the degree that I could give you anything with any credibility. I’ll tell you, you can see from the top line sales growth that we had in the quarter, that the opportunity--there are opportunities for revenue in the marketplace, and what Tech Data has to manage to is the mix of that revenue. Do we take the right mixture of revenue to create the right profitability profile, and then how hard do we want to compete against our competitors for some of that business? We mix and match that every single day. We process over 50,000 transactions every day inside the company. Every one of those are balancing off the profitability and the use of cash to make a decision whether that’s business we want to pursue, and that’s where the power of our IT systems come into play to help our teams make those decisions on a real-time basis.
My final question actually sort of flows into some of the incremental investment you talked about in IT. Can you give any more color on where those dollars are going and what you expect to achieve from it? Thank you.
Yes, one of the things that we had to do in the integration process is move the SAP deployment that Avnet TS had from Avnet TS systems onto Tech Data systems, and that process has taken a little bit longer than what we modeled. It doesn’t imply that there is an issue with it, it’s just the complexity of moving systems and data to that degree is something that we’re doing very carefully, so the process has run a little bit longer and we’re spending a little bit more money than what we modeled. That’s primarily the delta that Chuck described.
Great, thank you.
This concludes Tech Data Corporation’s fiscal year 2018 fourth quarter earnings conference call. A replay of the call will be available in about one hour at techdata.com. Thank you for attending today’s conference call and have a great day.