Four takeaways from Tech Data's results
Analysts are concerned about Tech Data's profit margins following its Q2 results. We delve into the distributor's latest numbers
Revenues were up 10 per cent to $8.9bn (£6.86bn) for Tech Data in Q2, but the market was unimpressed by the shape of the distribution giant's latest figures.
Analysts used the earnings call to put probing questions to CEO Rich Hume concerning Tech Data's long-term profitability following the completion of its blockbuster acquisition of Avnet Technology Solutions (TS).
We pick out four key takeaways from Tech Data's Q2 results.
Tech Data's share price takes a big hit as profit margins tank
The Florida-based distributor's share price tumbled dramatically by 17 per cent in after-hours trading on Wednesday night and Thursday morning following the publication of Tech Data's financial results.
At first glance, one would be forgiven for wondering why its latest figures prompted such a reaction from the stock market - revenues were up 10 per cent globally to $8.9bn, including a 13 per cent jump in Europe to $4.5bn, while GAAP operating income grew by seven per cent to $110.4m.
Dig a little deeper and a different picture emerges. In Europe, operating margins were just 0.64 per cent of overall sales. Global gross profits grew by just two per cent to $527m, causing gross margins to sink from 6.37 per cent to 5.93 per cent.
Speaking to analysts on an earnings call transcribed by Seeking Alpha, Rich Hume admitted that the margin-rich Avnet TS business - which Tech Data has spent the last 18 months integrating - was markedly outpaced by its Endpoint business segment.
He attributed declining profit margins to this imbalanced business mix in favour of its lower-margin PC and laptop sales, coupled with lacklustre software maintenance sales which came in flat for the quarter.
The CEO again pointed to particularly fierce competition in Europe as a major contributor to margin pressures.
"Obviously there is a better financial opportunity in Advanced Solutions versus Endpoint, but Endpoint is where the demand has been quite robust right now," he said.
"Europe in particular has been a challenging market. Again, when we take a look at both of our businesses, both are growing overall, but the Advanced pieces are not growing quite as fast as the Endpoint piece is and that's what's causing the mix issue."
Responding to another analyst, Hume added: "I think that we would absolutely like to have more growth within our Advanced business and that would help our margin profile for sure. You should be assured that the management is focused on driving more towards higher value, both internal to the Endpoint as well as in between Endpoint and Advanced. So when you take a look at the way our investments are lined up for the future, they are all aligned with moving to higher value. So that's what we're intending to accomplish as we move through time."
Tech Data imposes cost-cutting scheme to save $80m a year
Margin pressure has been an ongoing concern for Tech Data. The distributor had previously flagged declining profits, blaming vendor programme changes, a "challenging environment" in some countries as well as necessary investments in its infrastructure.
Tech Data has now implemented a cost-cutting programme in order to create a more "cost-efficient" organisation and reinvest to "accelerate the company's strategic priorities".
The programme - named the Global Business Optimisation Programme (GBO) - will seek to improve Tech Data's go-to-market models globally, digitise processes and drive "increased centralisation and standardisation" throughout Tech Data.
The goal is to create annual savings of between $70m and $80m over the next 18 months to two years. Around half of these savings will be set aside to reinvest in the business - which could include M&A - while the second half will go towards its bottom line.
Hume said he expects the majority of savings from the programme to come in FY2020, with the remainder coming in FY2021.
"The reason it spans over this period is, digitising our business and taking advantage of that digitisation and automation, as some of our projects are a bit longer in cycle. That being said, we do anticipate the predominance of 60 per cent or thereabout, if not a little bit more, of those savings to happen in the FY2020 timeframe.
"As it relates to Europe, certainly we're focused on making sure that we're repositioning that model such that it will be successful moving into the future. So you can assume that we've got our eyes on that business as we go through this programme".
Four takeaways from Tech Data's results
Analysts are concerned about Tech Data's profit margins following its Q2 results. We delve into the distributor's latest numbers
Software maintenance business lacklustre because a "major vendor declared itself a distributor"
Another reason why margins shrivelled in Q2, according to Hume, was because one of Tech Data's largest software vendors "declared themselves as a distributor".
Software maintenance margins were flat for the quarter - a business segment that usually provides Tech Data with a much-needed margin boost.
The vendor in question is most likely Dell EMC - which declared itself a distributor of VMware software last year. The move has effectively cut out some VMware distributors, with top-level Dell EMC partners now able to buy VMware software directly from Dell.
"The reason we were flat and not growing is that… one of our major vendors had declared themselves as a distributor. As a result, we've seen some shift out of the distribution channel and into more of a direct motion. That would probably have mitigated some of the growth that you would normally have should things have stayed stable from a sourcing perspective," he said.
Avnet TS business now in "execution" mode
It's taken Tech Data the best part of 18 months to integrate the Avnet TS business, which now accounts for the lion's share of its Advanced Solutions business segment.
Tech Data's largest European countries, the UK and Germany, finally completed integration efforts this year and are now trading as one brand.
Hume spoke enthusiastically about the opportunities afoot for Tech Data following the merger's completion, and will look to grow the Advanced Solutions footprint and execute on all of its hard work in bringing the two mammoth companies together.
"When you come to the integration phase there is a period of time where you are selecting leadership or realigning your coverage within the market… I think that we've reached the point with Advanced Solutions where we've got a very stable business and we're looking forward and to accelerate and grow that footprint as we move through time," he said.
"When you think about what we've accomplished in the last 18 months with completing the integration end-to-end, getting the management team in place, getting the leadership in place, realigning the sales coverage model, getting all the IT systems lined up so we can have a more efficient business moving forward. All of that work takes management time and focus.
"And as we said earlier, we're pretty much complete with regard to the integration. So now we've kind of turned the focus on executing, purely executing the model that we've put in place. So we're pretty comfortable that we're going to be able to get done what we need to in that business as we move forward."