安富利 (AVT) 2014 Q1 法說會逐字稿

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

Good afternoon, and welcome to Avnet's first-quarter fiscal year 2014 business and 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 first-quarter fiscal year 2014, please note that in the accompany presentation and slides we have excluded restructuring, integration, and other certain income tax adjustments; intangible assets amortization; and gain on legal settlement, [warrants] and purchase, and other; for all periods presented.

When discussing organic growth, prior periods have been adjusted (technical difficulty) impact of acquisitions, divestitures, and the transfer of certain operations from EM and TS. In addition, when we refer to the impact of foreign currency or constant dollars, we mean the impact due to the change in foreign currency exchange rates when translating Avnet's non-US-dollar-based financial statements into US dollars.

And, finally, when addressing working capital velocity, 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 this 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 are set forth in Avnet's filings with the Securities and Exchange Commission.

In just a few moments, Rick Hamada, Advent's CEO, will provide Avnet's first-quarter fiscal year 2014 highlights. Following Rick, our Chief Financial Officer, Kevin Moriarty, will review some additional financial highlights and provide the second-quarter fiscal 2014 guidance. At the conclusion of Kevin's remarks, a Q&A will follow.

Also here today to take any questions you may have related to Avnet's business operations are Phil Gallagher, President of Technology Solutions; and, during this transition quarter, we have both the current and former Presidents of Electronics Marketing, Gerry Fay and Harley Feldberg.

With that, let me introduce Mr. Rick Hamada to discuss Avnet's first-quarter fiscal 2014 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. Our team kicked off our new fiscal year with a solid performance, as both operating groups leveraged year-over-year revenue growth into expanded margins and returns. The momentum we saw in parts of our business in the latter part of fiscal 2013 carried into fiscal 2014, as we delivered a fourth consecutive quarter of seasonal revenue growth at the enterprise level, and year-over-year growth rates continued to improve.

Enterprise revenue increased 8.1% from the year-ago quarter, to $6.35 billion. And organic revenue increased 3.5% in constant currency. Asia continued to be our strongest region, as year-over-year organic revenue growth was positive for a fourth consecutive quarter. Gross profit increased 7.4% year-over-year to $735 million, while gross profit margin declined 7 basis points, as an improvement in gross profit margin at TS was offset by a decline at EM.

Even with a $475 million increase in revenue, our SG&A operating expenses declined approximately 1% year-over-year, as the cost reductions initiated in fiscal 2013 reduced expenses by approximately $35 million this quarter, which was offset by approximately $30 million of operating expenses of acquired businesses, and another $1 million related to the impact of foreign currency exchange rates. These cost reductions, along with ongoing portfolio actions, resulted in strong operating leverage, as adjusted operating income grew approximately 5 times faster than revenue from the year-ago period.

In our September quarter, adjusted operating income grew $55 million or 38% year-over-year, led by our Americas region, which accounted for over half of the increase. Adjusted operating income margin increased 68 basis points to 3.1% year-over-year, with both groups contributing to the improvement. As a result of these factors, adjusted EPS increased $0.28 or 45.2% year-over-year to $0.90, with approximate $0.02 of the increase attributable to the benefit from the accretion related to our share repurchase program.

On a sequential basis, adjusted EPS was down 11.8% from the June quarter due to the seasonal revenue declines in the higher-margin Western regions, and our typical September quarter increase in SG&A related to equity compensation.

Return on working capital increased 458 basis points from the year-ago quarter to 19.8% due to the increase in profitability, and a 0.1 turn improvement in working capital velocity. This represents the first time in seven quarters that both operating income margin and return on working capital expanded year-over-year.

As is typical in a September quarter, we used $126 million of cash for operations primarily related to an increase in working capital, bringing our trailing 12 months cash flow from operations to $489 million. With our improving performance and overall financial profile, we were also pleased to announce our decision to issue a dividend during our first quarter.

We felt there was an appropriate time to incorporate a more consistent element of returning cash to shareholders to complement our historical and currently active share repurchase plans. Even though we have now experienced four quarters of seasonal growth, the pace of recovery remains inconsistent across our end markets. In this environment, we will continue to focus on profitable growth opportunities and drive further improvement in our financial metrics going forward.

Now let's turn our attention to our operating groups. In the September quarter, electronics marketing delivered a second consecutive quarter of positive year-over-year growth, as organic revenue growth in constant currency improved to 8% after growing 2.6% in the June quarter. At a regional level, year-over-year organic revenue increased 11.1% in our Asia region; grew 7.7% in constant currency in EMEA; and was up 1.2% in the Americas.

Revenue of $3.94 billion came in above our midpoint of expectations due to better-than-expected growth in our Asia region. On a sequential basis, organic revenue increased 1.2% in constant currency, which is at the high end of our normal seasonal range of plus 1% to minus 3%.

EM's gross profit margin decreased 51 basis points year-over-year, primarily due to continuing competitive pressure in our EMEA region, and a geographic mix shift as the lower gross profit margin Asia region grew to approximately 41.7% of revenue from approximately 38.5% in the year-ago quarter.

On a sequential basis, EM's gross profit margin declined 38 basis points primarily due to the previously mentioned geographic mix shift to Asia. The year-over-year increase in revenue, when combined with the impact of cost reduction initiatives implemented in fiscal 2013, drove operating income up 17.9% year-over-year, to $175.8 million.

Operating income margin increased 38 basis points year-over-year, as improvements in our Americas and Asia regions were partially offset by a decline in EMEA. Operating income margin was roughly flat from the June quarter, as our continuing expense management offset the seasonal sequential decline in gross profit.

Looking at the balance sheet, EM grew working capital approximately 5% from the June quarter, as increases in accounts receivable and inventory were partially offset by an increase in accounts payable. All three regions increased their investment in inventory this quarter after a stronger-than-expected close in the June quarter, as well as an inventory build in our Asia region related to a high-volume supply chain engagement that will be fulfilled in the December quarter.

Even with the sequential increase in working capital, EM's working capital velocity improved 0.25 turns from the year-ago quarter, and days of inventory declined 4.4. The increase in operating income and improved working capital efficiency drove return on working capital up over 300 basis points year-over-year, as economic profits quadrupled over the year-ago quarter.

As EM Asia has grown faster than the other regions, you have often heard us refer to a geographic mix shift that has a dilutive impact on EM Global's gross profit and operating income margins. Although there is a negative impact to margins, our Asia region is having a positive impact on both returns and economic profit as a result of our VBM focus.

In the September quarter, EM Asia generated record revenue and operating income. And, if you exclude Japan, their return on working capital was above their long-term target. We expect that as growth improves in the Western regions, the improvement in both margins and returns will accelerate. While year-over-year growth rates are starting to improve, we are still operating in a technology supply chain characterized by relatively short and stable leadtimes, leading to conservative customer buying behavior.

Our book-to-bill ratio closed the quarter just below parity, which is consistent with a typical September quarter. The modest pace of recovery has yet to have a meaningful impact on leadtimes, and we continue to face competitive headwinds on gross profit margin in the Western regions. We do expect that if demand in our Western regions continues to improve, we will experience some increase in leadtimes, which has historically led to a recovery in gross profit margins.

Given the current environment, we will continue to focus on profitable growth, and continue to be vigilant in our management of expenses and working capital.

Now, moving on to TS. Technology solutions revenue was at the lower end of expectations this quarter, partially influenced by our revenue timing assumptions related to our fiscal calendar quarter-end. Reported revenue of $2.4 billion decreased 8.1% sequentially, while year-over-year organic revenue declined 3% in constant currency.

At the regional level, organic revenue grew 2.3% year-over-year in our Asia region, while our Americas region was down roughly 1%, and our EMEA region decline 13.1% in constant currency. Organic revenue in constant dollars declined 11.1% sequentially, just below our normal seasonal range of down 5% to 10%.

On a year-over-year as reported basis, growth in services, storage, and software was partially offset by a decline in servers. TS gross profit margin increased 65 basis points year-over-year, driven by portfolio actions focused on revenue selection and an increase in higher-margin services offerings. Gross profit margin increased 16 basis points sequentially, with all three regions contributing to the improvement.

The cost reductions initiated in fiscal 2013 had a meaningful impact, as TS grew operating income 61.9% year-over-year, and operating income margin increased 86 basis points to 2.6%. This represents the second consecutive quarter that TS has expanded operating income margin year-over-year, driven primarily by our Americas and Asia regions.

After a particularly challenging first quarter in fiscal 2013, our TS Americas region made a strong recovery and expanded operating margins every quarter, to the point where the first quarter of fiscal 2014 is consistent with peak performance in prior September quarters. This increase in TS operating income margin drove return on working capital up 632 basis points year-over-year.

With the transfer of a portion of EM's reverse logistics operations to the TS services businesses this quarter, we are further integrating our customer-facing resources to leverage our VAR network and tap new revenue opportunities. We also created a global organization within our Global Computing Components operations to leverage our global scale and supplier relationships, as we re-vamp our go-to-market strategies to drive greater growth and profitability.

We are also excited about our position in converged solutions, as we can combine our broad line card with a suite of expanded services to accelerate growth in software, education, and lifecycle solutions. As we enter our seasonally strong December quarter, we are well positioned to capitalize on profitable growth opportunities and continue progress toward our long-term goals.

Now, I would like to turn the commentary over to Kevin Moriarty to provide more color on our financial position and outlook.

Kevin?

Thank you, Rick, and hello, everyone. Our team delivered another solid quarter, as revenue met expectations and the cost reduction initiatives taken in fiscal 2013 had a significant impact on bottom-line results at both operating groups. As is typical in the September quarter, we used some cash for operations, as working capital grew faster than income. Working capital increased $291.6 million or 7.6% sequentially, driven by a $246.4 million increase in inventory, and a $94.1 million decrease in accounts payable, offset by a $48.9 million decrease in accounts receivable.

If you adjust for acquisitions and the impact of foreign currency, working capital increased 4.9% year-over-year. However, even with this noted increase in working capital, our working capital velocity improved from the year-ago quarter, and days of inventory have declined.

Turning to our expense efficiency. While our revenue increased $475 million from the year-ago quarter, our SG&A operating expenses declined approximately 1%, as the approximate $140 million of annualized cost reductions initiated in fiscal 2013 were more than offset by the operating expenses related to acquired companies; and, to a lesser extent, the impact of foreign currency exchange rates.

We exited the quarter with $866 million of cash, and net debt of approximately $1.2 billion. As Rick mentioned earlier, we modified our capital allocation strategy to prioritize a dividend as a way to return cash to shareholders. In addition, we still have approximately $225 million remaining in our stock buyback program, which gives us additional flexibility in enhancing returns to our shareholders.

While we have introduced a dividend, we still have ample liquidity to invest for future growth. As an example, we recently completed the first step of our acquisition of MSC, which will strengthen our position in semiconductor distribution, and allow us to tap the embedded systems marketplace for new growth opportunities in Europe. Going forward, we will continue to monitor our portfolio of businesses and react quickly to changes in market conditions to deliver consistent progress towards our long-term goals.

Now, let's turn to our Q2 outlook. Looking forward to Avnet's second quarter of fiscal 2014, we expect EM sales to be in the range of $3.8 billion to $4.1 billion, and sales for TS to be between $2.85 billion and $3.15 billion. Therefore, Avnet's consolidated sales are forecasted to be between $6.65 billion and $7.25 billion.

When adjusted for acquisitions and the impact of foreign currency, the midpoint of guidance for EM and TS would represent sequential growth rates of down 3% and plus 24%, respectively; as compared with a normal seasonal range of down 3% to 0% for EM, and up 20% to plus 26% for TS.

Based upon that revenue forecast, we expect second-quarter fiscal year 2014 EPS to be in the range of $1.05 to $1.15 per share. This above EPS guidance does not include any potential restructuring charges, or any charges related to acquisitions, [in both] closing integrations, and the amortization of intangibles.

The EPS guidance assumes 139.7 million average diluted shares outstanding, and an effective tax rate in the range of 27% to 31%. In addition, the above guidance assumes that the average euro to US dollar currency exchange rate for the second quarter of fiscal 2014 is $1.35 to the euro. This compares with an average exchange rate of $1.30 to the euro in the prior-year second quarter, and $1.32 to the euro in the first quarter of fiscal 2014.

With that, let's open up the lines for Q&A. Operator?

(Operator Instructions). Shawn Harrison, Longbow Research.

Hello. First question, just wanted to walk through the leverage expected on the sales growth into the December quarter. It looks as if, if you're holding your margins flat sequentially, TS margins would be down year-over-year. Maybe if you could correct me if I'm wrong in that sense. And if TS margins are going to be down a little bit year-over-year, why is that happening?

Shawn, it's Kevin. Actually, no, TS operating margins are expected to be slightly up to flattish.

On a year-over-year basis?

(Multiple speakers) Yes, I think -- Shawn, let me maybe anticipate I think where the conversation is going overall. We've seen some of the early notes as well, and want to make sure we clarify this to the best extent we can for everybody.

Kevin is right, first of all. On TS, I would expect more flattish year-on-year margins. I think part of the missing part of the equation is that we are, now as a 51% owner of MSC, we are going to be consolidating revenues at the top line. So we're going to pick up 100% of the revenues. And there will be an adjustment on any profitability for MSC, keep in mind that while it's going to start out for us being, we believe, growth, as well as gross margin accretive, the true operating margin accretion from the acquisition will come post our synergies and integration plans.

And, of course, they will not start until we are finishing the two-step acquisition process, and get to 100% ownership, most likely at the end of this quarter. So, I think part of the disconnect is that part of that revenue growth at EM is not coming with the expected profitability, due to the fact of this -- the timing of this particular transaction.

Okay. That was going to be my follow-up a bit on that transaction. But if you could highlight the revenue size of that business right now. And if you were willing to talk about either the gross margin or at least kind of where you think the operating margins should be, once you integrate then, when it would happen.

Let me let Gerry and, maybe even Harley, chime in on that a little bit, Shawn.

Well we see the Company will generate revenues in the excess, as you saw in that calendar year last year, of $450 million. So our projections for revenue this quarter are $110 million.

Okay. And then just on the profitability profile, where is it maybe right now? Or where do you expect it to end up, once you (multiple speakers)?

Right now we see it as breakeven for this quarter. And then as we work to get out integration plans in place over the next couple of quarters, as we move into fiscal year 2015, we see it being fully accretive at that point.

Okay. Did I miss it? Was there an accretion forecast, or is it just accretive to --?

No, it starts out -- so, it's accretive at the gross margin level immediately. It will be accretive at the operating margin level once it is integrated.

Okay. But it's below EM margins, just because of the mix of the business?

Well, not only that. We're also picking up 100% of the revenue, and we have to divest 49% of (multiple speakers), yes.

We currently will be (technical difficulty) 100% of their revenue. But we're only a 51% owner for the quarter, so there's of 49% minority interest we have to treat.

I guess upon full consolidation, will it be accretive to the EM margin profile?

Absolutely.

Yes it will.

Okay, thank you.

Brian Alexander, Raymond James.

Maybe just to follow up on that, and to clarify the EM margins -- if you were to exclude the MSC acquisition for the December quarter, where would you see EM margins trending sequentially? It looks like they would still be down on a sequential basis. I realize you're guiding revenue down, but if you could just talk about where you think EM margins will land in December, and how we should think about them beyond that quarter?

Sure. Hello, Brian. It's Kevin. EM margins sequentially have historically been down approximately 10 to 20 bps. And that's primarily due to the geo mix from our first quarter to our second quarter.

So you would expect that kind of normal decline in this December quarter, excluding the acquisition?

Yes.

Okay. And then just on the EM revenue guidance, down 3% -- if we adjust, again, for the acquisition and currency -- that's the low end of seasonal. Most of your suppliers are guiding below seasonal, so just wondering how we should reconcile that. Perhaps the end markets that are more important to Avnet, like industrial, are holding up better than the broader market. Or maybe your plan to reduce inventory from the elevated September levels would dampen your suppliers' growth, but not affect your own growth. So I'm just trying to reconcile your guidance versus the guidance of a lot of your suppliers. Thanks.

Yes, Brian. As you know, it's not a one-for-one match with any of our given suppliers. But if you look at some of the suppliers who have a broad market base, like a Molex, they are actually looking at a plus 1 to plus 2. So, for us, we believe, at this point, that if you look at some of the other results, if you back out some of the markets we don't really play in, their seasonality and our seasonality looks pretty much the same. So we don't see a significant difference.

The suppliers we've talked to seem cautious about the prospects for growth for the balance of the year. But if you back out some of those one-offs that they mentioned in their earnings call, it looks pretty seasonally typical to us.

All right, thanks a lot.

Amitabh Passi, UBS.

Hello, thank you. I just had a question on the operating margin for EM. I think, Rick, maybe a quarter or two ago, we were still striving to get to 5% exiting this year. Do I assume, with MSC, that's probably a tougher goal to achieve? And then I had a follow-up.

Yes, Amitabh, we would twist it the other way. What we would say is the goal to get back to 5% for the core EM business without MSC by the end of the year is intact. And of course heading into FY15, after synergies and integration with MSC, the whole thing is hopefully in that profile. But we are continuing to hold to that commitment we had made earlier -- an expectation, we had said, on the core business, ex-MSC.

Got it, okay. And then just as a follow-up, Rick, I was very intrigued by some of the regional performances. You saw strength in EM in A-Pac. Curious what drove that. And then weakness in TS in EMEA; seems like things again turned south a little bit there. So I would love to just get your commentary on TS EMEA, and EM A-Pac in particular.

Yes, so let me just turn it over. We'll start with Gerry again. And maybe I'll let Phil speak to TS.

So, Gerry?

Yes. In the September quarter, we had good growth in our mainstream segments around communication, consumer, industrial, and automotive. And then from a geographic standpoint, it came for us mostly from China and Taiwan. If you look at the China PMI for October, it was very strong, so we continue to think we're going to see strong growth there. And if you look at our growth compared to some of our competitors in that space, we actually are growing a little faster than they are. So we think we took share this quarter.

Interesting, okay.

Yes, Amitabh, this is Phil Gallagher. How are you doing?

I'm good.

Good. You saw what we will call the success and growth in both the Americas, North America and A-Pac. We were disappointed with Europe a bit. Again, Europe becomes a mixed bag for anyone, really. It's not one region, as you know; it's broken up. If you look at, for example, Germany and Eastern Europe, we were very pleased with our performance.

It was really isolated to Southern -- specifically, more France and the UK, which we didn't expect a lot out of the Southern piece, as we're building that up. But we were a little disappointed in our performance in the UK, which was part market and part execution. You take that out, we did well; but we need to fix that, and that's what we're working on.

Okay, thank you.

Don Craig, Bank of America Merrill Lynch.

All right, thanks. It's Scott Craig. Good afternoon. So, from a margin perspective, Rick, in TS, I know you've laid out some goals to hit by the middle of 2014. Can you just update us on that? And then, secondly, can you go into a little bit more detail on the inventory side of things? And I guess this sort of goes back to one of the prior questions where some of your vendors, component suppliers, have talked about challenging times and are below normal seasonality; where you guys have built up inventory to fulfill what seems to be some pretty solid demand, particularly in Asia. So just trying to triangulate those few comments. Thanks.

Yes, sure. So, Scott, let me ask Kevin and/or some of the others to jump in. On the TS margin story, obviously our long-term goal in the range of 3.4 to 3.9 on a fiscal year basis, through cycles, remains intact. We've got now two quarters where TS has had year-on-year expansion. We are looking, as we said earlier, probably very flattish here for December to match last year. And then my expectations would be -- and I think Phil's would match -- as we enter into Q3 and Q4 of fiscal 2014, try to keep that track record of year-on-year expansion intact as we work back towards our goals. So that would've been my answer there.

Inventory, which is usually pretty much an EM story, as well -- I don't know, Gerry, if you want to jump in a little bit more on the inventory color.

Sure. We had a strong June, and had some replenishment that went on. But, frankly, we could have done a better job here. And I'm looking at Harley when I say that. (laughter) When you look at the FX effect on some of the inventory we had for a large fulfillment customer in Asia, it's not really too far off. But we'll continue to work that down this quarter. And we see our Q2 ending inventory level will be similar to our Q1 ending inventory level. But it really depends on what happens with our book-to-bill in the regions.

Scott, let me elaborate -- this is Phil -- on the TS a little bit. While we were a little disappointed on the top end, and we explained that in the script a little bit what caused that, that drove a little bit less on the operating income dollar. But when we look at the operating margin percent, we are actually on target for what we planned for Q1. And with the plan and the forecast for Q2, through the first half of the year, we'll be on the target that we set for fiscal 2014, and ahead of fiscal 2013 in operating margin percent.

And then, by the way, for everybody who are very detailed modelists on the TS operating margin, I would add that we did consolidate some of the global computing components business under TS to start the fiscal year. That meant there was part of a transfer from EM previously was some of the higher-velocity but lower-margin products, such as hard disk drives, et cetera. So even of flat year-on-year margin for Q2 is somewhat a positive story, given that mix issue -- a little higher mix of some of those lower-margin products as the total TS global portfolio. Okay?

Good, thanks.

Sherri Scribner, Deutsche Bank.

Hello, thanks. I wanted to dig a little bit into the demand trends in the TS segment. It looks like TS was a little below your guidance this quarter, and I know you're guiding for relatively normal seasonality. But we've heard from a number of the suppliers that they've had relatively weak results in some of the -- on the service side, at least, we've seen some slowdown. So I was hoping you could give us a little more detail on what you're seeing in that end market, and why you think you're going to see regular seasonality for TS in December. Thanks.

Sure, Sherri. And you're right, we're a little bit off the guidance in September quarter. That was partially the fiscal close versus the calendar close. You do a little bit of math there on our end, we would've been much closer to the guidance. We had a very good Monday, which now rolls into our October quarter. So we did the best we could to plan on that, and it just came in there -- I was thrilled that the team did such a great job, and we kept that business, and booked and billed it for the October quarter. Would have like to have that a little bit in the September quarter. So that's playing into it a little bit.

The other piece is, we do play in the enterprise. That still a good and nice portion of our business; but we're also the SMB, and particularly around the M. I think our portfolio is much more diverse and expanded, with a longer tail. As we do the rollouts across the regions, by brand, we're pretty confident at this point with that guidance.

I think the other thing that's exciting for us -- and we ultimately will get the cloud question, if not today during this call, then on a later one -- is there is also a diversity of customer set off of new opportunities there; with VARs converting to MSP; the MSP to the marketplace, coming more into the channel through our distribution, which is also playing a nice opportunity along with the system integrators. So, when you look at what these suppliers might be forecasting, there might be a bit of a different customer set than what we would be.

Also, some of them looked at the emerging market as a downplay. We're actually seeing that pretty good right now, particularly in Asia-Pac. And it's also not as large a piece of our business as well; so the turn is little bit south. It's not as big a piece of our business as it might be at some of the others. All right? Americas, looking pretty good. Europe is the one we got our eye on, and we did count that into the guidance.

Sherri, this is Rick. I would just add that there's been some growing questions around is there a differential between the SMB and the large enterprise and what's going on here. Some of the commentary from some of our key suppliers had highlighted a particular weakness in the government sector, particularly US government sector. And then there's some others that highlighted this concept of push outs again.

And remember, a year ago, we saw that kind of behavior, and they didn't. But the last couple of quarters, a couple of our big partners have talked about some customer behavior change and push outs, et cetera. We did not see that in September. And I don't know if that's a difference in phenomena between a medium SMB customer and a large enterprise. But certainly we didn't have anywhere near the impact some of them have referred to in our customer behavior at this point. And I think a lot of it's related to some of the points Phil made.

Just to tie in to that government comment, roughly how much of your business does have government our federal exposure; at least directly, or through some of your customers?

So, US -- so, (technical difficulty) Americas [both], 5% to 10% (multiple speakers).

Yes, best we can calculate that, Sherri -- based on through the partners and service the government, and they're direct -- it's somewhere in the 5% to 10% range of our total revenue.

Okay. (Multiple speakers).

That's with the Americas statement.

Okay. And that's just TS, or it's the whole business?

It's TS.

That's TS, yes. There's different exposure for EM in defense and aerospace, but not really GSA.

Okay. Thank you.

Mark Delaney, Goldman Sachs.

Great. Thank you very much for taking my question. I was hoping we could talk a little bit more about some of the forward-looking indicators of your margins within the EM segment. I understand there's some regional mix shift issue that's going on right now, and then maybe some pricing pressure in EMEA. But if you look at your designed-in work, can you update us on how that's tracking? Which -- my understanding would be that when your engineers are helping design in products, that it has a higher margin associated with that. And so if you're doing well there, maybe as we get into a more robust part of the macroeconomic cycle, you'll see some better margins.

Gerry?

Yes, Mark. Great question. We continue to be positive about our design wins, but we need to see some growth for those to turn into revenue. As you know, we're the market leader in demand creation, but until those industrial projects really go into production, we're seeing a delay in the revenue cycle there. Then if we talked a little bit about -- I think we've talked about gross margins. Our gross margin pressure continues, but our margins in the West are really beginning to stabilize.

And if you look at our Q1 performance, it was really solely down to a reflection on our mix. So, while we need demand to pick up to see a significant change, I am encouraged that our margins in the West are starting to stabilize.

Thank you. That's helpful. And then for my follow-up, Kevin, you talked a little bit about still having some dry powder on the buyback. Can you help us think about at what point you may want to execute upon that?

Sure. We did not buy back any shares in the first quarter, but we still do have approximately $225 million outstanding on the previous program. As we have highlighted in the past, we have a disciplined approach in place, and we buy when it becomes compelling value, based on intrinsic value. So we're going to continue to update -- to evaluate the price, relative to our internal projections. And we will continue to follow our disciplined approach as we move forward.

Rick, anything you want to add, or --?

Yes. Mark, this is Rick. We have a schedule in place. We have a strike price that we get in. And from that price down, we get more aggressive. And then that price up, we get less aggressive. So we are holding consistent. And the valuation has been modified over the last few quarters, and we'll report out for you each quarter whether or not we hit those levels.

That's helpful. If I could sneak one last one in on capital allocation. I know at your Analyst Day, you guys talked about trying to be a little bit more focused on margins as you think about doing any acquisitions. And I'm wondering that, now that you have that philosophy in place and you look at the potential deals, are you still finding opportunities that you think can be attractive? Or is there a less robust M&A pipeline, given your more stringent criteria to do a deal?

Yes. I wouldn't say the criteria has limited the pipeline, Mark. I think MSC is an example of following up on that theme that we have set the tone at for the May meeting. We will -- if M&A happens when it happens, both groups in all regions of our world have an active pipeline. Our standard rainmaker process, we work through it like any other pipeline. And we'll continue to keep you posted on when the deals come through at the appropriate levels.

Thank you.

Matt Sheerin, Stifel Nicolaus.

Yes, thanks. If I can, I wanted to go back to the margin question on EM. And I know that you've talked about gross margins expanding when leadtimes stretch and the cycle takes another step up. And here we are, probably four or five quarters now into a very low-growth environment. You've got Asia growing faster than the Western markets. You still have pricing pressure. So, looking at that 5% operating margin number in this low-growth environment, if we don't get an acceleration due to macro or other issues, how are you going to expand margins?

Well, Gerry, let me -- I'll turn it over and just jump in. So, Matt, I think that we have, again, consistently set expectations on the EM core business, that with normal seasonal patterns as we enter the fiscal year, we would expect that. Now, normal and seasonal not only includes certain growth expectations for Q3 and Q4, it also includes a geographic mix shift, because we tend to see a tilt back to the West as we get into the early part of the calendar year.

Currently, we're nearly 42% Asia. And because we've got the returns coming out of Asia we don't want to slow that down as well. But ultimately it will be what happens in that geographic balancing as we enter the latter half of the year. That's one of the biggest factors.

I'm sorry, Gerry probably (multiple speakers) your thunder, but --

No, that's okay; that's fine. One of the things I do want to say is -- hats off to our Asia team, because that's not an easy place to grow profits and they've done a very good job there. But, as Rick said, if we get some normal seasonal growth in the West and some lead time extension because of that, and our Asia business continues to perform, we think we can approach that long-term profit goal of 5% in the back half of FY14.

Well, I guess my question there is, what gives you the sense that we are going to get any acceleration in terms of the mix and leadtimes?

Well, Matt, even if we don't accelerate, keep in mind we've had -- we had the last four quarters of book-to-bill have all been around parity; three slightly above; one just below, at 0.99. And take a look at the typical margin expansion for EM in a Q3 versus Q2. Go back and look at your charts. So, we don't really need a big boost in the growth, we just need normal seasonal patterns, growth-wise. And of course, March sees is always revenue growth, because there's just low shipping days; that's part of the issue.

And then you have the rotation back to the West. And take a look at the normal op margin expansion for EM -- if there is anything that's normal anymore. So I understand that point. But just take a look at the typical op margin expansion for EM in the Q3 timeframe. Take a look at where we are at. And then, all of a sudden, hopefully it will not seem as a bridge too far to cross.

No, that's fair. But you have pushed out that 5% target, and that's why I was asking that question. But I certainly understand. And then just on the follow-up, could you update us on your IT initiatives with the IT upgrade -- I know this is a multi-quarter event -- and where you are, and what's left?

So, Matt, there's a lot left, because how do you start with the list? I think most recently we referred to a consolidation of our platforms for our TS EMEA business onto a single instance of SAP. We are now basically 90% done with that. That's been happening over the last year, by the way, although we didn't believe it's had any measurable negative effect on the business, and not contributing to the circumstances there. We believe the team has executed very well.

And the last piece of that would be the full Magirus integration, which I think we've highlighted earlier. We had some delayed synergies out of Magirus, due to the fact that we will not have our third deployment and final consolidation for the TS EMEA platform until Q3. Yes, March quarter. And by the way, when that is executed and done, it will be another $7 million to $10 million of synergies that have been delayed out of that acquisition.

So, I think that's the latest piece of the puzzle that we've updated. But globalizing our platform, which is an ongoing, business as usual at Avnet. And not only in the ERP -- we look at areas like [HROS]; we look at CRM; we looked at our WMS. It's just part of our doing business. And when there are major developments -- and for that matter, major accomplishments along that continuum -- we will keep you posted.

Okay. Is there anything big in terms of heavy lifting this quarter --components or other business?

No. No, no, there isn't. The real heavy lifting was really computer business in Europe the last six months. And that's off and running at this point.

Okay, thanks. And, Harley, best of luck.

Thank you, Matt.

Jim Suva, Citi.

Thank you very much. And if I understand the pending acquisition -- I guess it's the acquisition that's happened, just the follow-on of the additional integration of MSC -- it seems like that because you recognize the full revenues in the December quarter, but you have to pay out to the minority, that you're not getting the EPS flow-through. And if that's the case, it appears, then, that the March quarter, your EPS flow-through would be much greater than normal. Is that the way to think of it?

Yes, Jim. So, actually, you're right. But I want to be more clear about -- so, even if we were 100% owners today, it would not be accretive on a profitability basis, because there are some synergies. About half the revenues at MSC were component distribution, and then half are the more specialized, embedded solutions. So, even if we were 100% owners today, it would not be accretive on the bottom line. The fact that we also have to deliver, if there was any profits there today, we'd have to give 49% away below the line. That's the difference in the impact.

So it's really -- for MSC to be bottom-line accretive, we have got to get our integrations done and get our synergies extracted. And that will happen during the March quarter -- assuming successful conclusion, by the way; don't want to take that for granted -- but assuming successful conclusion here at the end of Q2. And then we get to work on the integrations. It's probably 100% realized as we enter FY15, to tell you the truth.

Gerry or Harley, anything else you'd want to add along?

Yes, no, I think that's right, Rick. I think, depending upon the implementation schedule, we expect to realize the majority of it, with synergies in the first quarter of fiscal 2015.

So then, that would mean a flow-through September 2014, or basically a year from this quarter reporting, you would see much larger-than-normal flow-through to EPS accretion. Is that appropriate?

On the MSC revenue, absolutely.

Okay. Thank you. And then for cash flow perspective, should we be looking at an additional cash flow outflow in the December quarter for the 49% for this acquisition?

Jim, it's Kevin. Nothing significant.

Okay, great. Thank you very much for your clarification.

Steve Fox, Cross Research.

Thanks. Good afternoon. Just a few clarifications. First of all, on the buyback. My understanding was that your interest in buying back the stock was closer to book value. Has that changed, relative to the comments you are making today?

Yes, Steve, we've never been very specific. What I will tell you is that our assessment of intrinsic value looks at multiple methodologies. We look at proximity to book; we look at DCF; we look at forward P/E, based on our own internal financial projections. And we kind of triangulate from multiple dimensions to land on what we believe represents, as Kevin said, a compelling value. And we leave our standing orders in accordingly.

Okay. Fair enough. And then I'm sorry to beat a dead horse on the acquisition but, Kevin, when you report next quarter, are you going to show a minority interest line? Or are you saying that you're going to X out the minority interest that you pay up through the operating income line? Because it seems --

It will come through as probably other income and expense, as part of that line item.

Okay. And for this quarter it's a zero, right? And going forward, it could show up (multiple speakers) profit?

Once we own 100%, it will go --

It should only be on minority interest this quarter.

That's correct.

Yes.

Okay, got it. And then finally just a big-picture question, because I heard some mixed commentary around the technology solution business. Outside of what you're talking about with seasonality, I'm trying to understand how you're describing the business environment. And it seems like you're saying there's some contrast versus some of your key vendors. But any more color around what you think is going on, from a true end demand standpoint, and growth.

And then if you could -- Phil, if you could just tie in your typical comments around product segments, that would be helpful.

Yes, I'll start, and I'll turn it over to Phil for more detail as well, Steve. So I think two things are on my mind on the big picture here for the TS outlook. First of all, the SMB versus large enterprise; I think we talked about that earlier. And then second, keep in mind, with our suppliers across the board, there are winners and losers on a supplier basis as well. So there are some share gainers, and some share losers sometimes among those. So sometimes those reports can be mixed.

And with our broad portfolio and some growing trends in areas -- well, obviously for us, it continues to be services and software outgrowing hardware, as an example. So there's mix shifts between the suppliers and there's mix shifts between that commodity segments, on a broad basis.

And, Phil, anything else you want to add?

No, I think that's right, Rick. And that kind of ties back to Sherri's question. The customer tail, if you will, is much longer and broader for us from an opportunity standpoint. There's also the ecosystem is changing quite a bit. It [favors] offering us a new opportunity, as I mentioned, with ISVs; system integrators; the excess piece, if you will, the [vendor] service providers. So it's actually not a new market, but it's an expanded market for us.

Storage continues to be strong. Services, as we noted in the script, continue to outgrow hardware as well. And this whole area converged is offering us a new opportunity, and we've got the bases really well covered there with our brand new line card and [others]. We're the only ones in the industry that can offer all of the converged opportunities and solutions out there.

And we continue to see that growing very nicely, which is exciting. And you asked about the mix. And go back several years; we see a change here. Hardware is in rough and tough, 60% of our business today. Software is pushing 19%. And services, both Avnet-branded and resold, is approximately 21.5% to 22%. So that's quite a shift from years ago. And I think that's indicative of what's happening in the marketplace.

(Multiple speakers). Yes, it does. Thank you very much.

Louis Miscioscia, CLSA.

Continuing on that, you mentioned storage, services, and converged systems is strong. Maybe anything else on what wasn't as strong, or below expectations, in the quarter in the TS category?

Yes. Servers were certainly a bit weaker. We had to bring it down somewhere, right? It's storage and everything else is up. So, server is still down. Not down as much as we've seen in the past, led by the proprietary. Matter of fact, if you go to the [mixed bag] in proprietary, some of our regions actually did grow on proprietary, which was good news.

But what's happening in that space, that space is changing quite a bit as well. There's the volume-based server business, and that's what we're seeing declining. But you start to look at -- again, back to the converged -- and the server is just an element of a solution. You look at some of the converged solutions today -- whether it's Vblock, FlexPod, IBM Pure, HP Cloud Matrix -- the server is just an element of the solution.

And then you've got -- the software has become the bigger piece. The storage has become a bigger piece. Of course you've got the networking. So, it's playing, I think, a different role in our business. And as storage continues to grow, servers tend to become a lesser percentage of our total business, but still a very important percentage. So if there's one area, that would be it -- that was still softer than the rest.

Okay. Let me ask a cloud-related question that we actually talked about back in the GTDC in May. So, if a software-as-a-service solution starts to get sold by some of your VARs and supported by you all, wouldn't that end up being a -- lowers the dollar transaction sale? Because if you're selling an entire bundled, converged hardware/software/services package, you get all the money up front. Where if you're selling a cloud solution, especially software-as-a-service, that is generally rented by the month.

So wouldn't that have a material effect? And how are you all thinking about the impending cloud wave coming?

Yes, Lou. Actually, we are excited about what's coming. I would tell you the truth. It represents -- think of it -- we're thinking at a very high level as another version of CapEx to OpEx, on a customer behavior or a customer financial model preference basis. And there will be an element of that in the future, for sure. By the way, Avnet as a customer is looking at the same thing from our own internal IP infrastructure, so we're believers. We get it.

And there's this move from CapEx to OpEx that, as Phil said, part of the offset for us is that we're becoming an arms dealer to some of these service providers, as well. Actually some of our VARs are making the transition and bolting on some service provider -- and some -- none of them are, I'd say, at this point, becoming SaaS providers yet. But we're adding a variety of services, sometimes with an extension to what they've done for network management, as a starting point, et cetera.

So, as the cloud continues to grow, there are multiple plays for us. And net-net, at this particular point, it has not manifested itself as a material disruption or impact to what we would consider to be some of our normal seasonal patterns, nor of the product-oriented CapEx business.

However, I think we're in a great spot to offer some of these new financial models and be an aggregator behind this indirect, variable cost salesforce known as the VAR to help some of these future application-as-a-service providers get to market, particularly there at mid-market where the VARs have had the strong customer relationships for quite a while.

Two additional comments, Rick. One is the -- this is where our financial services piece is playing a new play in the cloud. As our partners may now -- they want to take the revenue all upfront; it becomes an annuity for us; we'll help finance it. So that's an element that's an opportunity for us, and it's very profitable.

I think the other thing I just want to make a comment -- when you go back and look at the acquisitions we've made, and you talk about services, some of the acquisitions we've made are actually service providers, if you will -- consultants, if you will -- for our partners, to help enable them to go offer cloud solutions to our collective end customers; again, through the partnerings.

So it's really expanding the aperture of opportunity for us to offer more services to our partners to the end customer. So, we're embracing it; it's here; and we see it as an opportunity.

Okay, thank you.

William Stein, SunTrust.

Great. Thanks for taking my question. Just two quick ones. First, on the inventory build that we saw in the quarter -- I think you addressed that by saying that you'd expect it to be flat on a dollars basis at the end of this quarter, which would signify a good decline on a days basis. Is that correct? And is this something that we should expect on a seasonal basis to happen next year in this quarter as well, because of a new customer engagement? Or is this just a slippage of order, or maybe taking inventory in too quick?

It's Kevin. For these sequential inventory build, I think for the core EM business, that flattish comment -- so, obviously, with MSC coming on board, we will have an impact from the acquisition.

And the -- is this -- you talked about an engagement with a customer in Asia, or maybe it's multiple customers. Is this a new part of the business that we should expect to [come in] the seasonality in inventories? Or am I reading that wrong?

Hello, Will. It's Harley. Let me make a comment or two on the inventory, if I could. I would not read the inventory increase in September quarter as a story at all, quite frankly. I know there are a lot of contrasting signals out there, with a couple of suppliers getting somewhat more tentative -- really over the last month, with their comments, and some of the guidance coming in a little lower; and even with us, at the lower end of what we consider a normal seasonality.

So I understand that the inventory increase looks a little bit disconnected from those comments. I would not read a story into that. When we dissect where our increase in the September quarter came from, as Gerry correctly said, it came in a little bit higher than we would have predicted and we would've liked, but it's not a concerning figure. Our velocity metrics are still strong.

A good portion of it is due to our prediction that some of the large fulfillment deals that we are managing in Asia will continue to show some strength through December, at a rate higher than we would've thought probably going back to July-August. So that's a good portion of it.

But the other portion, I think as Gerry alluded to, is if you look at our metrics for June, we came in at a days of inventory level and a velocity level really lower than anything we've seen in a couple years.

And so some of what you saw in September was really adjusting for that very low level of June. Much of the inventory will, again, come in, go out, in the December quarter. But some of it really is just readjusted pipelines. But I what not read that at all as a signal that we are seeing strong macro growth ahead of us. It really is just management of our pipeline.

Harley, that's helpful. I appreciate it. And one more, if I can, that kind of relates to this, and that is the linearity of orders in the components business. Checks that I've done recently suggest things might have slowed down in September, only to pick up -- either at the tail end, or maybe the beginning of October. And I'm wondering if you can offer Avnet's view on this.

It's interesting, Will. Gerry and I have met with a couple of suppliers, actually, this week. And there was some sentiment that sounded that way. We did not actually see that our self, but I have heard that from a few suppliers. And I am suspicious that, as Gerry said early, our results and our seasonality doesn't map exactly across suppliers. Some are better than others.

And I think I saw [XT] this morning talk about essentially flat December. So, some of them map well; others do not. But we didn't see that slowdown. And, as Rick said initially, our book-to-bill for the full quarter was just a speck under parity. And I think, as Gerry said, through the first three weeks of the quarter, they've popped back up to about 1. So we don't see that. But I have indeed detected that, as well as you have, with some of our key suppliers.

Great. Thanks, and best of luck.

Thank you.

Gentlemen, there are no further questions at this time.

Thank you for participating in our earnings call today. As we conclude, we will scroll through the GAAP to non-GAAP reconciliation of results presented during our presentation, along with a further description of certain amounts that are excluded from our non-GAAP results.

This entire slide presentation, including the GAAP financial reconciliations, can be accessed in downloadable PDF format at our website, under the quarters 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.