安富利 (AVT) 2012 Q4 法說會逐字稿

Our presentation will now begin. I would now like to turn the floor over to Mr. Vince Keenan, Avnet's Vice President of Investor Relations.

Good afternoon, and welcome to Avnet's fourth-quarter fiscal year 2012 financial update. If you are listening by telephone today and have not accessed the slides that accompany this presentation, please go to our website and click on the icon announcing today's event.

As we provide the highlights for our fourth-quarter and full fiscal year 2012, please note that in the accompanying presentation and slides, we have excluded a gain on bargain purchase associated with an acquisition and restructuring, integration and other items for all periods presented. When discussing pro forma sales or organic growth, prior periods have been adjusted to include acquisitions and the impact of divestitures.

In addition, when we refer to the impact of foreign currency, we mean the impact due to the chang in foreign currency exchange rates when translating Avnet's non-US dollar-based financial statements into US dollars. And finally, when addressing working capital, return on capital employed and return on working capital, the definitions are included in the non-GAAP section of our presentation.

Before we get started with the presentation from Avnet management, I would like to review Avnet's Safe Harbor statement. This presentation contains certain forward-looking statements which are statements addressing future financial and operating results of Avnet. Listed on the slide are several factors that could cause actual results to differ materially from those described in the forward-looking statements. More detailed information about these and other factors is set forth in Avnet's filings with the Securities and Exchange Commission.

In just a few moments, Rick Hamada, Avnet's CEO, will provide Avnet's fourth-quarter and fiscal year 2012 highlights. Following Rick, Ray Sadowski, Chief Financial Officer of Avnet, will review our progress on growing shareholder value and provide first-quarter fiscal 2013 guidance. At the conclusion of Ray's remarks, our Q&A will follow.

Also here today to take any questions you may have related to Avnet's business operations is Phil Gallagher, President of Technology Solutions, and Harley Feldberg, President of Electronics Marketing. With that, let me introduce Mr. Rick Hamada to discuss Avnet's fourth-quarter fiscal 2012 business highlights.

Thank you, Vince, and hello everyone. Thank you all for taking the time to be with us today, and for your interest in Avnet. In fiscal 2012, growth rates slowed in the technology markets we serve, after two years of double-digit organic growth, driven by an increase in global GDP growth, and the V-shaped recovery in semiconductors.

At Electronics Marketing, our fiscal year started with two quarters of below seasonal growth as the electronic components supply chain dealt with a typical post-upturn inventory correction as lead times contracted to more normal levels. Growth returned to the low end of seasonality in the second half of the year, which suggests the inventory correction has run its course, but customer demand is tentative, given the macroeconomic uncertainty, as evidenced by the unexpected decline in our sales late in the fourth quarter.

At Technology Solutions, year-over-year pro forma growth rates turned negative in the spring as macroeconomic conditions worsened and the slowdown in Europe spread to other regions. For fiscal 2012, Avnet's total revenues of $25.7 billion declined 3% in reported dollars, while pro forma revenue was down 4%, with EMEA being the weakest region at both operating groups.

As growth rates declined, we applied our value-based management and discipline across the portfolio, and initiated targeted restructuring actions in order to focus our resources on opportunities for growth and margin enhancement. Associated with these initiatives, we reduced expenses and exited some revenue streams in underperforming business units, while realigning resources in the parts of the portfolio where we experienced revenue shortfalls.

While we could not offset all of the gross margin loss from the revenue decline, we did mitigate a meaningful portion of the impact, as adjusted operating income of $958 millions was down 5% from record levels in fiscal 2011, and adjusted operating income margin declined only 7 basis points to 3.7%.

Adjusted net income, which was down 8.8% from the prior fiscal year, declined more than operating income, primarily due to a negative $15 million swing in other income, due to the costs related to foreign currency hedging, as exchange rates were more volatile in the second half of fiscal 2012. For the full year, adjusted earnings per share declined $0.26 to $4.06, due to the decline in revenue and the negative translation impact of changes in foreign currency exchange rates, offset somewhat by the positive impact of our share repurchases.

Looking at the balance sheet, working capital was roughly flat in constant dollars, as compared with fiscal 2011, while working capital velocity declined roughly three-quarters of a turn to 6.4 turns, which remains above pre-recession levels. Return on working capital of 23.9% declined 333 basis points, as improvements at TS were offset by a decline at EM, after a record-setting year in fiscal 2011.

As a result of our solid operating income performance, cash flow from operations totaled $529 million, and we closed the year with over $1 billion of cash on our balance sheet. Supported by this strong cash flow, we invested $318 million in our stock repurchase program, and another $313 million in value-creating M&A.

Turning to the fourth quarter of fiscal 2012, revenue came in at the low end of expectations at both operating groups, as a change in customer sentiment towards the end of the quarter resulted in June billings coming in lower than anticipated. Enterprise revenue of $6.3 billion was roughly flat with the March quarter, and organic revenue decreased 8.9% year-over-year in constant dollars.

Gross profit margin of 12% was up 10 basis points year-over-year, and essentially unchanged from the March quarter. Pro forma operating expenses in constant dollars declined $43 million or 7% year-over-year, as a result of the positive impact of cost reductions, and lower variable expenses associated with our lower revenue levels.

Even though our team did a good job managing through a challenging environment, given our revised outlook on growth expectations in the near term, we are in the process of taking additional steps to further align our resources, just as we have done throughout 2012. Consistent with our past practices, we will apply our value-based management discipline across the portfolio with a focus on maintaining the trajectory towards our long-term goals.

At this time, we have targeted incremental expense reductions in the range of $40 million to $50 million on an annualized basis. Adjusted operating income decreased 13.7% year-over-year to $233.9 million, and operating income margin was down 21 basis points, as an improvement at TS was more than offset by a decline at EM. On a sequential basis, both operating income and operating income margin were roughly flat.

Adjusted EPS of $0.99 was down $0.23 or 19% year-over-year, with approximately $0.06 of decline due the translation impact of changes in foreign currency exchange rates, which was offset by the positive impact of a similar amount related to our share repurchases. Cash flow from operations came in strong at $259 million, and return on capital employed of 12.5% was down 303 basis points from the year-ago quarter.

Looking back on the June quarter, it is apparent that slowing global growth is having an impact on the markets we serve. We are maintaining a strong balance sheet, and with our demonstrated cash generation capability, we will continue our disciplined approach to capital allocation that prioritizes organic growth strategies, value-creating M&A and return to shareholders in the pursuit of long-term shareholder value creation.

Now, let's turn to the operating groups. Electronics Marketing delivered a solid performance in fiscal 2012, even as the electronic components supply chain was going through an inventory correction, following the V-shaped recovery that peaked at the end of fiscal 2011. Revenue of $14.9 billion was down 1% from the prior fiscal year, and pro forma revenue was down 6%.

Gross profit margin declined 38 basis points, primarily due to the transfer of the Latin America hard disc drive business from TS and the geographic mix shift as the higher margin EMEA region declined from 32% to 28% of EM's total revenue. Operating income was $751 million, and operating income margin of 5% decreased 50 basis points from its strong performance in fiscal 2011.

Although return on working capital declined 590 basis points year-over-year, primarily due to lower operating income margin and a small decrease in working capital velocity, it remains above our historic levels. To add some perspective, given the number of red arrows on the slide you are viewing, when we established the operating income margin target range for EM of 5.0% to 5.5%, the goal was to achieve that level through cycles. Prior to the 2008-2009 recession, EM performed within the range in an up year but never in a year where organic growth was negative.

If you look at the past two years when EM had both an up year and a down year, operating income margin was within the range, even though individual quarters were outside the range. Given the demonstrated resilience of the EM model through a cycle, we are confident we can leverage our strong competitive position and scale and scope advantages to grow economic profit dollars going forward.

Now, let's take a look at the fourth quarter. EM revenue came in at the low end of expectations as the month of June closed weaker than expected. Our book-to-bill dropped below 1 to 1 in the month of June, after trending above 1 to 1 for four consecutive months. Revenue of $3.76 billion was essentially flat, as compared with the March quarter, which is consistent with the low end of normal seasonality. Reported revenue declined 5% year-over-year, and pro forma revenue was down 7.8% in constant dollars, with all three regions experiencing a decline.

Similar to revenue, gross profit margin, operating income margin and return on working capital were all essentially flat with the March quarter. Gross profit margin declined 86 basis points year-over-year, and operating income margin was down 78 basis points, due to the transfer of the Latin American hard disc drive business from TS, a geographic mix shift to lower-margin regions and negative organic growth. Operating income of $191 million declined 18% from a record level in the year-ago quarter, and operating income margin of 5.1% remained within our target range.

Turning to the balance sheet. Working capital decreased 3.1% sequentially, primarily due to a 5.7% decrease in inventory, partially offset by a decrease in payables. Excluding acquisitions and foreign currency, EM inventory declined 4.2% sequentially, and inventory turns increased 0.13 turns. Return on working capital declined 542 basis points from a near-record level in the fourth quarter of fiscal 2011, primarily due to the drop in operating income margin.

With the drop in EM's book-to-bill ratio to below 1 to 1 in the month of June, the book-to-bill for the quarter was 0.98 to 1. With stable lead times and reduced visibility, customers are being cautious in placing new orders as they manage their inventory and backlog. In this environment of slowing growth, we will continue to vigilantly monitor our dashboards and adjust expenses and working capital to ensure we maintain our margin performance and continue to generate economic profit.

As fiscal 2012 came to a close, spending on IT equipment slowed as global growth declined. While TS EMEA's revenue performance for the year was the weakest with four consecutive quarters of negative year-on-year growth, organic growth for TS at the global level flipped from positive on the first half of the year to negative in the second half, as growth rates declined in both the Americas and Asia regions. As a result, Technology Solutions' revenue of $10.8 billion declined 6% year-over-year in reported dollars, while pro forma revenue was down 1.4% in constant currency.

Gross profit margin improved 73 basis points, driven by a significant improvement in EMEA, where the team has been focused on higher-margin revenue as part of its strategy to improve profitability. Operating income grew 11.4% to $319 million, and operating income margin increased 46 basis points, with all three regions contributing to the improvement. Similar to operating margins, all three regions delivered a meaningful improvement in returns, as return on working capital increased 389 basis points over fiscal 2011.

Despite the slowing growth that characterized fiscal 2012, the TS team delivered steady progress toward our long-term goals across the portfolio. In the Americas region, operating income is within its target range and return on working capital is well above our stated goals. In Asia, where we have slowed the rate of reinvestment to focus on improving profits and returns, pro forma revenue grew double digits and both operating income margin and return on working capital improved year-over-year.

In EMEA, which has been focused on improving profitability, operating income margin improved to its highest level ever for a fiscal year and return on working capital was up 466 basis points, despite being challenged by six consecutive quarters of negative year-over-year organic growth in constant dollars. While TS EMEA made good progress towards its long-term goals this fiscal year, we are excited about the potential to accelerate that progress once we complete the recently announced acquisition of the Magirus Group.

With complementary suppliers in high growth technologies and a strong competitive position in key geographies, we will be able to leverage cross-selling opportunities and increase our scale in the region. Even though IT spending has contracted along with global GDP, we are well-positioned to build on our progress this year as we continue to leverage our solutions path strategy and help our trading partners accelerate growth in all three regions.

Looking at the June quarter, revenue unexpectedly came in at the low end of expectations, as we experienced a change in customer sentiment in the last two weeks of June, as high probability opportunities did not close as anticipated in both the Americas and EMEA regions. As a result, revenue of $2.54 billion was flat with the March quarter as compared with normal seasonality of up 3% to up 7%.

Reported revenue declined 13.8% year-over-year, while pro forma revenue was down 10.4% in constant dollars, with all three regions posting slower growth rates for the second consecutive quarter. On a sequential basis, growth in storage and networking was offset by declines in microprocessors and servers. Gross profit margin increased 26 basis points sequentially, and 118 basis points year-over-year, led by a meaningful improvement in the EMEA region.

Operating income of $67.5 million was flat with the year-ago quarter, despite the nearly 14% decrease in revenue, resulting in operating income margin increasing 36 basis points year-over-year. TS's return on working capital was also flat with the prior-year quarter, and down 247 basis points sequentially.

While growth has slowed recently, we continue to invest in new services and software capabilities to enhance our offerings and accelerate organic growth. With the acquisition of Ascendant Technologies in June, and the recently announced acquisition of Pepperweed Consulting, we are now able to help our VAR partners address increasingly complex and customized IT solutions needed by their customers.

When combined with our solution path practices focused on high growth verticals and technologies, we not only enhance our own organic growth strategies, but we increase the breadth and depth of opportunities that our trading partners can address. Now, I would like to turn the commentary over to Ray Sadowski to provide more color on our return on capital employed, and how that contributed to the Board's decision to enhance our share repurchase program. Ray?

Thank you, Rick, and hello, everyone. In fiscal year 2012, through a combination of strong operating income and diligent working capital management, we generated significant cash flow from operations of $529 million. This represents an increase of over 90% from the previous year and the highest level over the last three years. As we have stated in the past, our long-term capital allocation strategy is to invest in organic growth first, followed by value-creating M&A and when we have excess cash, return that cash to shareholders.

In light of the current value of our stock, our strong balance sheet, and consistent cash flow generation, our Board of Directors has authorized an additional $250 million for our stock repurchase program, bringing the aggregate amount to $750 million. During the fiscal year, we repurchased 11.3 million shares at an average price of approximately $28.90, and for an aggregate cost of $318 million, which fell in the fiscal year 2012.

In fiscal 2012, share repurchase activity had a positive impact of approximately $0.18 to the diluted earnings per share, which helped to offset some of the revenue decline and the negative impact from the change in foreign currency exchange rates.

In addition to the buyback program, we continued to invest in value-creating M&A as we completed 11 acquisitions during the year, that will enhance our competitive position and add over $900 million to our top line. I'd like to reiterate that investing for future organic growth will continue to remain a key tenet of our capital allocation strategy, and you can count on our continued disciplined approach to capital allocation.

Now, let's look at the economic profits and shareholder value creation. As you can see from this chart, the return on capital employed was essentially flat for the March quarter, but down substantially from the year-ago period, when our end markets were experiencing strong organic growth. With return on capital employed at 12.9% for fiscal year 2012, we are below our target range, but above pre-recession levels, and well ahead of our weighted average cost of capital.

Though our near-term visibility is limited, we are confident that our broad market exposure and portfolio management discipline will allow us to outperform on a relative basis, and help us achieve our long-term financial objectives. With a leadership position in the marketplace, a strong balance sheet and ample liquidity, we have the ability to continue to focus on investments that will create, drive and sustain long-term shareholder value creation.

Looking forward to Avnet's first quarter of fiscal year 2013, we expect EM sales to be in the range of $3.55 billion to $3.85 billion, and sales for TS to be between $2.25 billion and $2.55 billion. Therefore, Avnet's consolidated sales are forecasted to be between $5.8 billion and $6.4 billion.

Based upon that revenue forecast, we expect first-quarter fiscal year 2013 earnings to be in the range of $0.78 to $0.88 per share. The EPS guidance does not include any potential restructuring charges, any charges related to acquisition and post-closing integrations, or the impact of additional share repurchases. The guidance also includes a typical sequential increase in stock-based compensation, and assumes an effective tax rate in the range of 29% to 31%.

In addition, the above guidance assumed the average euro to US dollar currency exchange rate for the first quarter fiscal 2013 is $1.22 to EUR1. This compares with an average exchange rate of $1.41 to EUR1 in the first quarter fiscal 2012, and EUR1.28 to $1 in the fourth quarter of fiscal 2012. The year-over-year strengthening of the US dollar versus the euro is significant, roughly 13%.

Based upon the size of our business in Europe, our guidance assumes a decline in year-over-year sales and EPS of approximately $260 million, and $0.06 per share respectively, due to the translation impact of the stronger US dollar. With that, let's open the lines for Q&A. Operator?

(Operator Instructions)

Our first question is from Brendan Furlong of Miller Tabak. Please go ahead.

Quick question on the gross margin, more importantly the SG&A trend, and how we should see the operating margin trend through the balance of the calendar, and I guess the fiscal year.

Ray, want to jump on that?

SG&A trend for the next couple quarters?

Yes.

If we look going forward for a couple quarters, I mean, if you look out just in the first quarter, we would expect SG&A to rise probably in the range of about $5 million to $10 million. And that's composed of a number of different items. One that we mentioned already is the year-over-year impact of increase in our -- I should say the sequential impact, excuse me, of our stock-based compensation and that's roughly going from Q4 to Q1, about $12 million. In addition to that, we have a slight increase in pension costs, and more importantly, being the beginning of our fiscal year, we do have inflation increases tied to merit increases across the globe, which we do in the beginning of our fiscal year. And a rough estimate of that is about $25 million on an annualized basis, so about $6 million there about in a quarter.

So if you take all of those pluses and you make another adjustment for currency which should bring down expenses in the maybe $10 million range sequentially, the difference you'll come up with the benefit essentially of some of the reduction in cost that we've taken during the year which would be fairly significant. So a number of different moving pieces impacted by stock compensation as I mentioned, inflation also pulling the number up and then the offset a little by FX and offset to some extent by some of the savings. When you net all of that out, we're expecting a sequential increase in expense of roughly $5 million to $10 million.

Thank you. And I guess through the fiscal year, then, you're talking about aligning your business model with the current flow environment, how should we view the SG&A then in the following three quarters, just in general terms?

I think the following three quarters, you'll start to see expenses come down. Again, obviously a lot of this is impacted by what happens with currency, and M&A, by the way. So again, numbers that would impact moving forward, would be obviously any M&A activity as that gets baked into the numbers, as well as any impact of currency. If you exclude those items, you would expect to see expenses coming down, certainly in the second quarter to some extent, due to the normalization of the stock-based compensation, which as we've discussed in the past is fairly high in the first quarter, then levels off. That should come down as we go forward in the $5 million to $6 million range.

Then you get benefits kicking in going forward which would be a combination of the expense reductions we've taken last year as well as what we're just announcing today in the $40 million to $50 million range. Would you see expenses trending down as you go throughout the year, based upon all those factors, with one caveat which is keep in mind that December is typically a strong quarter for us. We're not giving guidance for December at this particular point in time. But based upon our normal seasonal uptick within our TS business, we would expect some variable expense to impact that and increase it to some extent. But again, overall you'll see expenses trending down as you go throughout the year.

Great. I'll hop off. Thank you.

Thank you. The next question is from Shawn Harrison of Longbow Research. Please go ahead.

I'm having some trouble I guess getting to the EBIT margin implied within the guidance. I understand that you have some seasonal increases in SG&A. But one way or the other implies a sharp decrease in profitability, either EM or at TS. Maybe if you could just help me out in terms of where the profitability will dip sequentially, because it looks as if you're seeing greater than normal incremental margin pressure.

Yes, Shawn, I'll take a stab, maybe turn it over to Ray or even Harley at this point. I believe this is a question we get every year at this particular time, particularly when it comes to the EM mix of the business. Q1 tends to be one of the weaker quarters for both business. At EM, what typically happens from Q4 to Q1 is a bit of a geographic mix shift from west to east which definitely has an impact, and so I don't know exactly what your model is showing, but we are showing sequential op margin deterioration for EM as part of our outlook. And a slight deterioration at TS, based on the fact of the revenue decrease is sequential. So that may be something that's missing from your overall equation.

I guess within that, would you expect TS EBIT margins to be down on a year-over-year basis? Because it looks as if EM would be down.

So for TS year on year, yes, think of it more as flattish.

TS would be flattish and EM would be down year-over-year.

Okay. And then just as a follow-up, I guess considering the cash flow generated this quarter coupled with the expanded buyback, what is your maximum appetite for share repurchase activity during the quarter, and have you been buying ahead of the call today?

Well, we've had an active program in place, Shawn, and as you saw with the fiscal year totals we have not completely spent the original $500 million authorization. So that has remained active through the quarter. And we maintained our disciplined approach. We will continue to maintain our disciplined approach. We haven't ever talked specifically about exactly what levels of formula we're using, but we do factor in proximity to our book value and we take a look at our internal financial projections, and take a look at future earnings, factor all that into the equation, and produce a schedule that gets more aggressive as the equity drops.

Not to put words in your mouth but given with the stock down today, we should expect you -- being closer to book value, we should expect you to be more aggressive quarter to quarter?

If the stock price is down quarter to quarter you could expect we're more aggressive quarter to quarter. That's correct.

Thanks so much.

Thank you. The next question is from Amitabh Passi with UBS. Please go ahead.

Rick, I think you talked about overall business softening in the month of June. Any updates in terms of how things are trending thus far in the quarter?

Yes. I'll add some and again let Harley and Phil jump in if they'd like to, Amitabh. From an overall level, what I would tell you that first of all the unexpected developments really materialized for us in the month of June. So it was really a late quarter set of developments. However, appears thus far, as you see with our guidance off that lower base, off the June quarter, our guidance may be termed as more normal seasonality going forward for both businesses. It appears more to us there was a reset done at the end of the June quarter.

Obviously an unexpected shortfall on revenues for us. But the outlook going forward doesn't appear that that's -- that any continued deterioration overall. So we've got a lower reset. That's why we've got to adjust the cost model and our resource allocation but we're not calling a stair step down at this particular point and that's factored into what you've seen in our guidance for both businesses going forward here. I don't know, Harley and Phil, if you want to jump in, a little more color.

I'll jump in. This is Phil. As best we can tell, we talk about the push-outs from last quarter and it did come right near the end of June. Best we can tell, the push-outs, they're not cancelled projects. We're taking them really closely. We'll monitor as we get through the quarter. Right now that's what's built in from a guidance standpoint. That's our sentiment. Speaking to the VARs, we don't carry all the backlog at TS as you know, we talk to the VARs, talk to the suppliers, we're feeling that the call right now is what we have in for the guidance and we'll just manage it closely as we get through the quarter.

Rick, if I could, this is Harley. Hello, Amitabh. As I think, to add a little color on EM, as I think about how June finished up and what we've seen so far through the first five weeks of the September quarter, what we saw in June was a weakened close to the quarter, weaker than we would have expected, weaker than we saw in March as an example. But what we have not seen are anything that resembles a significant adjustments to customer backlog. The behavior we saw felt much more like an ever-increasing degree of conservatism, very short-term approach towards material management taking an inventory, cautious approach towards their order books. So we've seen, as Rick said, fairly normal patterns so far this quarter, relative to our book-to-bill. It hasn't taken an additional step down, which I think as Rick categorized, it felt like a reset of a bit off of the modest close in June.

I think if I could add one more color point, thinking of the close in June, regional color, the book-to-bill coming out of the quarter and entering this quarter was probably no surprise to the group, strongest in Asia and Japan and a bit weaker in the best in America and Europe.

Got it. And then just maybe as a follow-up, Rick, any updated thoughts on potentially a dividend?

Our capital allocation priorities remain intact, Amitabh, and when we get to return to shareholders, which obviously we made an announcement along those lines today, we maintain an active conversation and dialogue on options for returning to shareholders, including dividends, but no specific update on that topic today.

Okay. Thanks.

Thank you. Our next question is from Ananda Baruah with Brean Murray. Please go ahead.

Firstly, just wondering if in TS, if you're seeing I guess vendors or hearing of vendors provide any extra incentives to the VARs, to go out and push product, given the softer macro environment, and if you're seeing any price pressure pickup or price aggression pickup in TS?

I'll answer that, Rick. Any time that the market gets a little tight you're going to see some more pressure on the pricing, so yes, we certainly see that. But that's not new. We need to manage through that. As far as additional incentives or programs into the VARs, I'm not aware of any other than the normal way business is done on the enterprise side. There's not additional rebates, et cetera, those types of things being thrown out there. At least not to my knowledge at this point.

Okay. Thanks. That's helpful. And I guess the comments for July seasonality seemed to pertain to EM a moment ago. Do those also pertain to TS? Have you seen the same reset in TS and the same start to the July quarter that you would typically see? Sorry, for the month of July.

Yes, we have, actually. July's coming off the year-end and then the summer month, it's typically not the strongest month of the year for us either, but it's not out of the range of where it's typically been.

Got it. Okay, thanks a lot.

Thank you. The next question is from Sherri Scribner of Deutsche Bank. Please go ahead.

Harley, I was hoping you could give us an update on the book-to-bill for the month of July. Did it stay at the -- I think you said it was 0.98 exiting the quarter for the quarter. Did it stay at those levels?

Through five weeks of the quarter, so including last week, our book-to-bill is 1 to 1.

Okay. And I think your competitor, Arrow, made some comments that they felt like business was improving. Are you guys seeing anything like that?

I would not categorize the business as improving, no.

But maybe stable at this point, reset level?

Yes, for sure.

Okay. Maybe, Rick, could you provide a little bit of detail on where you plan to take the cost actions and the restructurings, are there certain geographies that you're focused on, is it focused on TS or EM?

On balance it's across the portfolio, our approach will be to -- when we have a gap of $300 million in revenues, obviously someone didn't -- is not making their plan. We have --the gaps break down and we take a look where in our business those gaps are and those are usually our first targets for reallocation of resources if not reduction of resources. So we're very prescriptive about where we look for these, because we very much shy away from peanut butter approaches, where it's all of sudden, we have an all-hands meetings and everybody has to take out 2%, 3% or 5%. That's just not the way we do it overall. We've been active in actually identifying those areas since the close of the quarter, and some of those actions are starting to take place today. We want to be sensitive to pre-announcing any particular details around that, and we'll keep you posted as we realize those, but please understand that we do take a very prescriptive approach overall. The last thing we want to do as we're doing this is impact or otherwise hinder or handicap any existing good growth stories that are going on today. Of which there are always some going on, in all environments.

Thanks.

Thank you. The next question is from Craig Hettenbach of Goldman Sachs. Please go ahead.

Phil, Avnet as well as a number of companies have talked about weak server growth. Can you talk about the developments happening there and what things you'll be looking for in terms of signs of a potential pickup in servers?

Yes, thanks, Craig. It's been particularly for industry standard it's been a great run for many, many quarters, as you know. And we did see a decline this past quarter in both industry standard as well as proprietary. It's really tough to call when exactly that's going to pop back. I'm not bright enough to be able to give you an exact idea on that. I know there's certainly a lot of excitement, this came out of a conference with one of our major suppliers in that space. There's a lot of excitement around different technologies and stacks and products that they're putting out there. There's good demand building. When that kicks in, it's tough for me to say.

On the industry standard, you've got the Romley processor that's been out for six months from Intel that's being adopted, pushed out into the marketplace. It will take a little bit of time for that to take heed. Tough to call. Still huge number for us, just down this past quarter. But it was a good run for a while. We'll continue to track it and do what we can to help turn it around.

Craig, this is Rick. I would just add I think also in our internal conversations what's going on with the mix at TS, et cetera, it's crossed our minds that, remember coming out of 2008-2009, we had tremendous pent-up demand that reflected a very strong refresh that went throughout 2010 and to a certain extent into 2011. It wouldn't surprise us that if part of what we're seeing with the server year on year trends now are also partially influenced by tough compares based on I won't call it a V-shaped recovery, but it was certainly a strong performance coming out of the recession.

Thanks for that, Rick. If the I could ask a follow-up for Harley. After a pretty big correction in components in recent quarters, it looks like the demand side isn't there, so we're not getting that bounce back in the cycle, if you will. Anything you'd share in terms of where you think we are in a cycle, how it compares to prior cycles, or again things you're watching for in terms of inflection points?

It's really difficult to comment out very far beyond our current quarter for obviously all the well-known macro issues. When I think of the things that we track tactically like cancellations, reschedules, supplier behavior, gross margin, ASPs, the type of words I tend to use when I talk internally are stability, modest growth, those type of words, and that's what it feels like, at least for the horizon we can see. I can't give you, nor would I speculate on anything substantial that would cause that to change in either direction at this point. We just don't see that. So we're going to manage the business that way. We worked on improving our asset velocity all through fiscal 2012 with good results, as Rick and Ray have talked about, we work on the productivity of our expense investments. So we're managing the business that way. It feels very stable. We may be in a period for a while that ranges in that 0.98 to 1.05 type of book-to-bill and that's what our short-term view is.

Craig, again, I'll just add, go back a year ago for EM as well. I think Harley a year ago June quarter was 0.98 book-to-bill, but at the time we had pretty clear indications there was a supply chain correction coming off two great years. I would tell you to date, Craig, it feels a lot more as a demand driven phenomenon as opposed to any distortions or anomalies in the supply chain right now.

Okay. Thank you.

Thank you. The next question is from Brian Alexander of Raymond James. Please go ahead.

Maybe just another question on the weakness in June in EM for Harley, just more color on what parts of the business you saw the weakness more pronounced from either a customer segment or an end market perspective, or was it fairly broad-based globally?

Hi, Brian. Knowing our business as you do, the strength, the core of our business is that broad industrial automation, broad customer sets, much of it -- in all regions, but much of it in America and in EMEA. And that clearly is the area where we're seeing very, very conservative behavior, very, very modest growth projections coming out of that set of our core business. So the growth engines, as you'll see in some of our suppliers' announcements and in our own Asia and Japan growth is coming from much more from the digital consumer, from commercial space, consumer space than our core industrial business. So it is, indeed, that broad industrial base where we are a big supplier of products like analog and microcontrollers and all of those, where we are seeing the biggest challenge today. And that was what did not materialize into the growth we were expecting coming out of June.

Do you think any of the weakness that you saw could be some share shifting back and forth between yourselves and your major competitor, they were coming off a weak Q1, and I think they ended up 4% sequentially in components versus you coming in at the low end of guidance and flat sequentially. Seems to be some see-sawing back and forth. Did you see any pricing pressure along those lines?

The data that we track that would allow me to answer that question, obviously rather than speculating on the composition of their numbers, would be share in common core product lines, and we share a high percentage of common product lines that make up a high percentage of both of our revenues, something in the 70 to 80% range. And in that set of core suppliers, there was no share shift in any region.

Okay.

At a geo level, Harley, if we look at the last two quarters, any distortion in share really has been kind of focused plus or minus on what's going on in Asia.

I'm sorry, Rick.

If we're looking at that, the competitive on a regional -- just broad geographic basis, it appears the distortions have been mostly in Asia as opposed to broad-based global.

Yes, if you take out the core product lines.

Correct.

There has been no share shift in the core product lines. The regional variance between the two companies Brian's talking about was all in Asia and it wasn't in any of our core products.

I think I know what drove that for them. Last question, just assuming normal seasonal revenue trends over the next few quarters in EM, which you're guiding to for September, at least, I guess when do you think you'll be back above a 5% operating margin, in line with your long-term target, because it looks like you'll dip below that next quarter. Thanks.

Again, Brian, I will ask forgiveness not to forecast outside of September. There's just too much unknown today. Clearly, I think either Rick or Ray said this in the beginning. September in a normalized year tends to be our low point from a margin perspective. And there's nothing that I see in the windshield today that says that we're not going to have that kind of performance moving forward.

Okay. All right. Thanks a lot.

Thank you. Our next question is from Matt Sheerin of Stifel Nicolaus. Please go ahead.

Most of the questions have been asked here. Let's talk about the microprocessor business. You talked in the news release about weakness there. I know that, I think AMD's your biggest supplier there. How big a percentage of your revenue is from microprocessors, and then also on the disc drive business, where you had seen some strength, because of pricing and constraints in two or three quarters, have you seen any incremental weakness in that business?

Phil, you want to start?

Let me go first. Hi, Matt, this is Phil. Some of the processors are shared between the operating groups. I'll give you that commentary was specifically to TS, that Rick talked about in the opening comments. It is a mix. I won't limit it to just AMD, Matt. In Europe, in particular, we still have processor or PC channel products, okay, so it's not just the processors.

It's the memory goes with it and the disc drives and it's roughly 15% to 20% of our revenue base in Europe still. So one of the questions comes out, we look at the mix issue, it's 15% to 20% is in PC products and the balance is enterprise. And we saw a pretty significant drop in that business in the past quarter, which is why we noted it in the script. So again, specific to your question, 15% to 20% in products inside of TS, Europe, related to PC. Biggest part of that is the microprocessor supplier you mentioned and that was a pretty significant drop-off.

Disc drives are also down?

Disc drives were also down and Rick can comment on that. And also some of the associated memory products, Matt, that you know that go along with that, those PC type products that we have as well and it just had a drop-off last quarter, which is pretty significant.

I would just add our business in the Americas with EM is -- the volume business part of HDDs are down but our integration business, embedded business in systems is doing quite well for us overall, Matt. We've always had a mix there.

Got you. Okay. And then just on the gross margin question, backing into the numbers, given the revenue and the SG&A guidance, looks like gross margin will be flat to up, which is somewhat understandable, given that computing will be down at a greater rate than components, even though the components will be less than seasonal. But given the mix there, and I assume that Europe is going to be down at a greater rate than the other regions, wouldn't there be some gross margin pressure in the component business as well?

Yes, there would be, Matt. The mix shift -- the geo mix shift affects gross and operating for EM on a sequential basis.

Brian talked, had asked a question about the pricing pressure. Arrow talked a little bit about some commodity pricing pressure in components. Sounds like Harley that you're not really seeing that.

Not to a noteworthy degree, no.

Okay. All right. Thank you.

Thank you. Our next question is from Jim Suva of Citigroup. Please go ahead.

Maybe a clarification question, and maybe I got the numbers wrong on your prepared comments. But if I'm looking at SG&A, what you guided to, I think you said up $5 million to $10 million quarter-over-quarter. If that's correct, and I look at your business being run year-over-year to get rid of seasonality, to get rid of merit increases, to get rid of timing and stock options, I guess I'm a little surprised to see, if I'm correct, that SG&A would be up year-over-year while sales are being down year-over-year. Can you help me connect or bridge that gap?

Yes. It's Ray, Jim. If you look year-over-year, our expenses will be slightly up and you have to recognize there are three major components to that. One is M&A. So if you're comparing the expense dollars we had a year ago for the fourth quarter, I'm sorry, for the first quarter of fiscal 2012, all of the M&A activity adds a significant amount of expense dollars, roughly in the $30 million, $35 million range. In addition to that, you have going the other way to some extent a fairly significant amount of currency. The currency impact of the Euro we're using for the first quarter fiscal 2013, $1.22 versus what it was a year ago, the average rate was $1.41, a fairly significant increase. That will pull expenses down to some extent.

But those two items there, the M&A will increase expenses, FX will not quite offset that so you see a little bit of an increase there, roughly in the $5 million to $10 million, when you net those two together. All right. So that's a piece of it there. When you look at the remainder, you add that out, you would see the expenses are coming down a little bit, roughly in the $40 million to $50 million range and that $40 million to $50 million is essentially the benefit from our cost cutting actions taken to date and a little bit that you're seeing in Q1, again, we're just taking the actions in Q1 now, so you're not seeing a significant impact in Q1. You'll see them in subsequent quarters.

Okay. That helps. I guess just with the M&A you think it impacts sales some more. That's why I was kind of referring to the sales year-over-year versus the SG&A year-over-year. I get it. The follow-up then I have is I think you said in your prepared comments also about you slowed some of your Asia investments. I wasn't sure, does that mean slowing down the amount that you're injecting into your existing businesses or slowing your M&A pipeline in Asia or can you just clarify a little bit on that comment?

Yes, Jim. It was in my prepared comments. This is Rick. We referred to our TS Asia business where we've established a certain level of critical mass. It's an over $1 billion run rate business today, and as we grow the critical mass, we'd like to increase the harvest rate and manage a little more judiciously, reinvesting in that business, both organically and M&A. We're not excluding any incremental investment. We're just being a little more judicious about it there as we're trying to increase the harvest rate on both profitability and returns.

Great. Thank you very much for your time, gentlemen.

Thank you. The next question is from Steven Fox of Cross research. Please go ahead.

Thanks. Good afternoon. Just a couple questions real quick. In terms of cash flow, Ray, for the next quarter, can you give us some help relative to the guidance, what kind of cash flows we could be look looking at? Go ahead, I'm sorry.

At this stage, typically we have, if you look back historically, Q1 is not a strong quarter for us from a cash flow generation perspective. However based upon different trends today, our expectation is that we would be positive cash flow from operations, and as you know, it's very volatile number overall but I would say right now in the range of $75 million to $100 million, based upon what we know today. But as you know, working capital has a big impact on that. So again, just take it as being a very rough range.

Fair enough. Secondly, from a big picture standpoint we've sort of this year seen some stops and starts to IT demand on the TS side. And so it raises the question of what it's telling us about the remainder of the year. You've given guidance in the summer quarter. Are these early signs we could be in for a slow December quarter? Any sort of insight into what your customers are saying for the balance of the year. I understand it's qualitative, but it would be helpful. Thank you.

This is Rick. Let me give -- try to offer some color here. I think as you heard on multiple occasions during this call here, we really don't want to try to forecast December. What I would tell you is that maybe to help bolster our general positioning of conditions now, that there's been a reset but not a major sort of continuing deterioration. If we go back to the most recent shock to the system, which was back in 2008-2009, there we had customer behavior dramatically altered for IT and it was much more at that time around cash conservation, people were getting budgets cancelled, they were getting extended.

Seems more a liquidity crisis driven type of thing, which drove that particular set of behaviors at that time. Everything that we're seeing now is much more about cloudiness, murkiness, uncertainty and therefore we're just going to delay this decision and just kind of wait to see what happens a little bit. It's not -- don't have to do it this quarter, so we're going to just take a little bit of time to kind of see if the visibility could get a little better for us and we could feel a little more confident about taking a plunge on this investment overall. I don't know if that helps you on the December quarter question. But there is a contrast thus far based on what we've seen here versus, again, the most recent dramatic shift in the behavior.

That is helpful. And then very quickly, Ray, not that anyone's kicking you out the door but any update on the CFO search?

I'll leave that one to Rick. I won't get into that. I'm pretty replaceable

The number one objective result of that search will be a high-quality successor for Ray, and we're working through it. It's an important decision. It's actively being worked. And we'll keep you posted as any developments come to fruition.

Okay. Fair enough. Thanks.

Thank you. And our final question comes from Mona Eraiba with TCW. Please go ahead.

Rick, you mentioned the servers and the microprocessors. You are more exposed to the traditional server suppliers. What's happening in the cloud? Are you starting to focus on that area or do you think that's related since building data centers for cloud computing seems to be still going very strong.

Correct. Hi, Mona. I'll maybe ask Phil to make some comments as well. I would tell you first of all on the microprocessors, yes, we're much more about enterprise, data center products, server storage, networking, and the tools and middleware around that. That absolutely is our sweet spot. I would tell you the cloud is offering two opportunities for us. First of all, in some cases we're providing the equipment for cloud implementations and hosting centers, et cetera. In other cases, we are now expanding our services and offerings to offer cloud services through our VARs to their end users, both in the area of computing power, incremental and excess storage capacity, and looking at offering hosting opportunities for their clients that would like to be able to set that up for their own data center. So that's the multiple, multifaceted play that we're taking advantage of. I don't know, Phil, if you want--

You said it well, Rick. I think the biggest focus for us right now where we're seeing the largest growth with the cloud is going to be the private cloud. You could argue we've been doing that for many, many years, and that's continuing to grow. If you look at the different products that we're now building and integrating for our partners and our suppliers, they're actually integrated cloud solutions for the private cloud. The big area for folks, and continued growth as Rick just pointed out is in the professional services space, helping our VARs enable the customers, the end users out there to come up with what is the right cloud solution, and how can we help them do that.

We announced an acquisition the other day, Pepperweed. They're an HP provider of services and software. Their primary focus is in the cloud. They're going to work with our VARs and our end users to help pop up cloud solutions. We're going to be coming at it from inside the brands, providing our own service offerings around the cloud. You'll continue so see more alliances that we'll announce in the future where we can provide Avnet cloud services as well.

Do you think the weakness in that area maybe it is because of a structural shift away from the traditional players?

It's hard to call, Mona. I would tell you that I think that the relatively higher growth rate in industry standard servers has been an indication that is becoming a preferred building block in some of these implementations, but on the overall basis, why servers are down year on year is not a cloud issue at this point, no direct indications on our dashboard to point to that kind of a shift causing or contributing to that at this point.

Thank you. Just the reason I'm asking because Intel continues to see strong demand for their server-related products while other suppliers, system suppliers, the traditional service providers see sluggish demand. I was wondering if that's contributing to the structural shift here in the industry?

It's a great question. And we'll continue to share with you what we're seeing and we'll break it down by industry standard and total category for you.

Thank you very much for taking my call.

Thank you. We have no further questions at this time. I would like to turn the floor back over to management for any closing remarks.

Thank you for participating on our earnings call today. As we conclude, we will scroll you through the non-GAAP to GAAP reconciliation of results presented during our presentation, along with the further description of certain charges that are excluded from our non-GAAP results. This entire slide presentation, including the GAAP financial reconciliations, can be accessed in downloadable PDF format on our website under the quarterly results section. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.