安富利 (AVT) 2014 Q3 法說會逐字稿

Our presentation will now begin. 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 third-quarter FY14 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 third-quarter FY14, please note that in the accompanying presentation and slides, we have excluded certain items including intangible assets, amortization expense, and restructuring integration and other items for all periods presented in our non-GAAP results.

When discussing organic sales or organic growth, prior periods have been adjusted to include acquisitions, divestitures, and reflect the transfer of certain operations from EM to TS. In addition, when we refer to the impact of foreign currency, 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.

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 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 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 third-quarter FY14 highlights. Following Rick, our Chief Financial Officer, Kevin Moriarty, will review some additional financial highlights, our cash flow performance, and provide fourth-quarter FY14 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 Gerry Fay, President of Electronics Marketing.

With that, let me introduce Mr. Rick Hamada to discuss Avnet's third-quarter FY14 business highlights.

Thank you, Vince, and hello, everyone. Thank you all for taking the time to be with us and for your continued interest in Avnet.

Our Avnet team delivered a third consecutive quarter of year-over-year organic growth driven by our Electronics Marketing group, where organic revenue grew 7.2% in constant currency and it's seasonally strong March quarter. This growth was somewhat offset by a softer than expected close in our Technology Solutions group, despite coming off the strong performance in the December quarter. As a result, our revenue grew 6.1% year-over-year and reported dollars to $6.7 billion and organic revenue was up 3.5% in constant currency.

Revenue declined 10% sequentially as compared with normal seasonality of down 4% to down 7%, primarily due to the expected decline and high-volume supply chain engagements at EM Asia and the weaker close as noted at TS. Gross profit increased 6.5% year-over-year to $804.9 million, and gross profit margin was roughly flat with the year ago quarter, as an increase at EM was offset by a decline at TS. Gross profit margin increased 61 basis points sequentially, primarily due to the seasonal business mix shift as EM grew to represent 62% of enterprise revenues as compared to 56% in our December quarter.

Adjusted operating income increased nearly 10% year-over-year to $223.8 million and adjusted operating income margin increased 12 basis points to 3.3%, primarily due to an improvement at EM. The impact of the seasonal operating income declined at TS partially offset by the increase at EM resulted in adjusted operating income declining 15% sequentially and adjusted operating income margin decreasing 20 basis points. As a result of these factors, adjusted EPS increased $0.08 or 8% year-over-year to $1.03.

Return on capital employed decreased 214 basis points sequentially to 10.7% due to the seasonal business mix shift as noted earlier and was down 34 basis points year-over-year. Cash flow from operations was a strong $358 million for the quarter as working capital declined 6% sequentially in constant currency, highlighted by a decline of 13% in accounts receivable in line with our expectations after the strong December close for TS.

As a result, our trailing 12-month cash flow from operations increased to $471 million, and our net debt declined $307 million sequentially. While we have made steady progress during the first three quarters of our FY14, our year-over-year organic growth rate slowed as a result of the lower than expected revenue at TS this quarter.

We will continue to evaluate our go to market strategies, and as always, maintain our discipline in allocating our valuable and limited resources to the most promising growth opportunities. With an outlook that incorporates seasonal growth at both operating groups in the June quarter, we are looking forward to accelerating progress towards our long-term targets across our portfolio.

Now let's turn to our operating groups. In the March quarter, Electronics Marketing built on their progress as organic revenue increased 7.2% year-over-year in constant currency and both margins and returns expanded year-over-year for the third consecutive quarter. Sequential revenue was roughly flat with the December quarter as compared with normal seasonality of plus 4% to plus 7%, primarily due to the expected decline and high volume supply-chain engagements at EM Asia that had contributed to a December quarter that was above normal seasonal levels.

At the regional level, EMEA delivered it's typically strong March quarter, growing sales 13% sequentially in constant currency, while the Americas region was down 1% and Asia declined 10% coming off its strong December quarter.

On a year-over-year basis, reported revenue increased 8.8%, primarily due to the strong growth in Asia and EMEA regions, which increased 11% and 9% respectively on an organic basis in constant currency.

EM's gross profit margin increased 58 basis points sequentially due to the seasonal geographic mix shift as the higher-margin Western regions increased from 58% of total revenue in the December quarter to 62% in the March quarter. On a year-over-year basis, EM's gross profit margin increased 12 basis points as an increase in the EMEA region, which was primarily related to the acquisition of MSC, was partially offset by a slightly higher than expected mix of high-volume supply-chain engagements in the Asia region in the current quarter.

The year-over-year growth in revenue in gross margin expansion along with expense reductions implemented during the past six quarters combined to drive operating income up 17% year-over-year and operating income margin up 33 basis points to 4.7%. Operating income margin increased 55 basis points sequentially, driven by improvements in both the Americas and EMEA regions.

Return on working capital increased 116 basis points year-over-year, and economic profit increased 63%, driven by the growth in operating income while working capital velocity was essentially flat with the year ago quarter. On a sequential basis, EM's return on working capital increased 245 basis points, driven by the improved profitability in the Western regions.

Our EM team has done a good job managing their balance sheet, as working capital declined 3.5% from the December quarter while sales were down 0.5%. After adjusting for acquisitions and changes in foreign currency exchange rates, EM's working capital increased 7.1% year-over-year to support their organic growth. Working capital velocity and inventory turns have been relatively consistent through our first three quarters of FY14, which is also a reflection of the relatively short and stable lead times that continue to characterize the component supply-chain.

In addition to the strong financial performance this quarter, EM is also positioning for future growth as the integration of MSC is proceeding as planned. While MSC's component distribution business is being integrated into EMEA's existing structure, we will also have a new business unit branded MSC Technologies that will leverage MSC's broad offering of embedded and displaced solutions across our combined customer base.

With deep technical expertise supported by specialized development in manufacturing resources, we are confident this edition will expand our served markets, accelerating our growth in the region where customers are looking for advanced solutions and capabilities. With our book-to-bill above parity in all three regions and an outlook indicating seasonal growth, we are positioned to leverage topline growth into another quarter of expanded margins and returns as we approach our financial targets for this operating group.

Turning to TS, despite a strong December quarter, particularly in our Americas region, our March quarter revenue at TS came in below expectations, due to a weaker than expected close in our Americas region and somewhat softer demand in our computing components business in EMEA.

At the global level, reported revenue declined 22% sequentially to $2.55 billion, as compared with the normal seasonal range of down 16% to down 20%. At the regional level, the Americas declined 26% sequentially after growing 44% in the December quarter while EMEA and Asia were more in line with normal seasonality with declines of 18% and 15% respectively.

When compared with the year ago quarter, reported revenue was up 2% while organic revenue declined 2% in constant currency with all three regions experiencing a modest decline. On a year-over-year basis, growth in networking and security, as well as services, was partially offset by a decline in servers.

TS gross profit margin declined 24 basis points year-over-year as a decline in our Americas region was partially offset by an increase in EMEA. On a sequential basis, gross profit margin increased 19 basis points, driven by improvements in EMEA and Asia.

As a result of the lower than expected revenue in our higher-margin Americas region, operating income declined 11% year-over-year to $60.9 million and operating income margin was down 35 basis points. We are, however, encouraged by the performance of our EMEA region where our core enterprise IT distribution business approached positive organic growth after adjusting for the portfolio decision to exit certain markets.

These actions when combined with expense reductions implemented during FY13 drove TS EMEA's operating income margin up 65 basis points from the year-ago quarter. Even though we were disappointed with the weaker than expected close at TS Americas this quarter, we continue to work with our partners to discern the status of the projects that were part of our active pipeline in the final weeks of the March quarter.

With TS currently expecting seasonal growth in the June quarter, we anticipate companies will continue to invest in technology to maximize their investment in the data center as they look to grow their businesses. In this environment, we will continue to focus our resources on providing solutions for high-growth opportunities to ensure we resume 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.

As is typical in the March quarter, the seasonal business mix shift to the higher-margin EM business influenced our sequential performance, and as Rick mentioned earlier, the strong year-over-year growth helped to mitigate the softness of TS and Americas. Despite TS experiencing two quarters of atypical linearity, especially at the end of our quarter, our team did an effective job of managing working capital, which resulted in strong cash flow from operations of $358 million for the March quarter.

The cash generation was driven by a 6% sequential decline in working capital as accounts receivable declined 13% and inventory went down 2% after coming off a December quarter where we consumed $28 million of cash for operations. These factors help drive cash flow from operations over the trailing 12 months to approximately $471 million.

During the quarter, we paid at maturity the $300 million of notes of the 5.875% notes which help to reduce our interest expense by 7.4% year-over-year. Overall, our balance sheet remains healthy and we ended the quarter with over $960 million of cash on hand and over $1 billion dollars available on our credit borrowing facilities.

Consistent with our capital allocation priorities, we paid another quarterly dividend of $0.15 per share which brings our total dividends paid to $62 million through the first nine months of FY14. We also brought a small number of shares at an average price of $39.50 through our disciplined share repurchase strategy and have approximately $223 million available in our share repurchase program. Despite coming in below our expectations in the March quarter, we remain confident that our competitive position, strong balance sheet, and ample liquidity will allow us to improve profitability that will create drive and sustain long-term shareholder value creation.

Now let's turn to our outlook. Looking forward to Avnet's fourth-quarter FY14 and our outlook, we expect EM sales to be in the range of $4.05 billion to $4.35 billion, and sales for TS to be between $2.55 billion and $2.85 billion. Therefore, Avnet's consolidated sales are expected to be between $6.6 billion and $7.2 billion.

Based upon that revenue forecast, we expect adjusted EPS to be in the range of $1.04 to $1.14 per share. This guidance does not include any potential restructuring, integration, or acquisition charges or the amortization of intangibles. The guidance assumes $140.6 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 US dollar to euro currency exchange rate for the fourth quarter of FY14 is $1.38 to the euro. This compares with an average exchange rate of $1.31 to the euro in the prior year fourth quarter and $1.37 to the euro in the third quarter of FY14.

Stepping back from the quarterly results, if you were to assume the midpoint of guidance for our June quarter, our FY14 revenue and adjusted EPS would be $27.35 billion and $4.19 respectively. This would represent annual growth in revenue and EPS of 7.4% and 15.4% respectively in FY14. This performance demonstrates the leverage in our model, and we remain committed to continue to drive leverage that will expand margins and returns as we continue progress towards our long-term goals.

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

(Operator Instructions)

Our first question comes from Shawn Harrison from Longbow Research.

Hi, everyone.

Hey, Shawn.

I was hoping you could just really dumb it down for me with TS in terms of what happened in the Americas exiting the quarter. Was it that Avnet lost share, in terms of programs that were supposed to close, and it went to other partners? Was it partners fell short in making sales? Was it something else? Really dig down in terms of whether this is something that could've been avoided, whether there's a market slowdown going on, or whether there something else?

Yes, Shawn, this is Rick. Let me offer some commentary to start.

As you would imagine, we anticipated that question right out of the chute. First of all, the TS Americas, our linearity for the quarter was absolutely on track to our guidance for 12 weeks. It was the 13th week that let us down, and it was a matter of not getting the bookings on, specifically, identify pipeline that was there and under normal closing rate circumstances would have been consistent with our overall guidance.

So as you could imagine, we're paying very close attention to what's going on with that pipeline. Some of it moved into this quarter, some of it actually got booked early in the quarter, and we're continuing to monitor all of our leading indicator activities with the partners: the quotes, the configurations, the proposals that are being developed. It was a matter of the identified pipeline did not get booked in the desired timeframe. That's the quick answer.

I guess to that, is that a market dynamic where overall IT spending is slowing and so that says something for the rest of the calendar year, or was this just a timing dynamic?

We -- at this point, given our indicators for the current quarter, we haven't seen a major change. First of all, it was a very America-specific. Asia and EMEA had much more seasonal, normal sequential seasonality. We can't point to the weather or anything else early in the quarter. It was a late quarter phenomenon, and the deals that were identified and in the pipeline have not disappeared. So that's what's going on.

Rick, this is Phil.

We certainly anticipated the question, as Rick pointed out. We're still tracking those. Those projects, if you will, by partner are not gone. As Rick mentioned, many did get booked and closed in the beginning of April. To your point on share, we track our share by supplier and by brand extremely closely. We do not see any share loss in the Americas as best as we can track it today.

Right. And we speak to also on a share basis, we're not aware of any major changes from a VAR customer perspective, any transitions or share losses there. It was the identified pipeline and under anything approaching normal close-rate circumstances, we were highly confident heading into week 13.

Okay. And I guess moving on into the June quarter, there have been a goal to get the core EBIT margin in EM close to 5% exiting the year. Is that still possible?

Gerry, why don't you go ahead.

Yes, it is. This has consistently been our goal, and this quarter without MSC we were at 4.8%, so going into the June quarter we continue to expect that goal to be met. So no change there.

Okay. Thanks very much.

Thank you. Our next question comes from William Stein from SunTrust.

Hi. Thanks for taking my question.

So, the big pushback that investors have expressed with regard to Avnet is that in this TS segment that there are two things that can hurt you. One is the adoption of cloud computing architectures, and the other is what IBM is doing in the Channel. So I'm wondering if you can help us understand whether you have a clear enough view that what went wrong in the most recent quarter is or is not related to either of those issues.

Hey, Will. Another good question. I'll start with the second one first and then back into the cloud issue, too.

So IBM and the Channel, I'm not sure I understand. Obviously, there are moving parts going on with that key partner today, but there was an announcement earlier this week that one of their significant new investments in software, we announced a Channel support program for that new offering, so we continue to expand with our key partners as they continue to deploy their capital to take advantage of growth opportunities in the marketplace, as well. So I'm not sure that there is any sort of negative connotations in IBM and Channel that I went directly point a line to.

On the adoption of the cloud, it is a long-term secular trend that we are absolutely looking at, as well as the overall patterns of IT consumption. When it comes to private cloud and hybrid clouds, we feel well-positioned. It's the dislocation to the public clouds that would represent a challenge. But what I would tell you is, that's not going to show up in the last week of the quarter.

We really believe that's going to show up more, and actually what's going on with the aggregate pipelines of the projects we're tracking with our partners, and if that starts to get impacted, and all of a sudden we're expecting higher close rates to get to numbers, that's going to be more of how we respond to that part of the program. And, oh, by the way, hopefully we're integrating more hybrid solutions into our total pipeline as part of the solution for those customers.

We can't point to any changes in IT consumption patterns that would show up in the last week of the quarter as a major factor that contributed to what happened this March.

Maybe just clarifying the first part. The IBM issue, the company added a couple volume distributors, and also, I think, is in the process of selling its x86 business. Do you think that that contributed to the shortfall in the quarter?

This is Phil.

On the first part of that question with the buy-in distributor, we've seen zero effect, negative effect on our current business. That's an Avnet statement at this point in time.

And the second part was on the Lenovo divestiture. And we did note in the script, servers in general were down. No question about that. Can't attribute that at this point to the Lenovo divestiture. We're actually very engaged with the Lenovo executive management in all regions of the world.

Now, could that be some distractions in the market with that? Sure. We'll work with IBM and with our partners to ensure then that it's going to be as seamless as it possibly can be. And then we'll make sure our partners have the solutions they need -- in their lifeguard to be sure they can provide the solutions that they're giving their customers today.

And Will, having been through some of these transitions before, we're seeing the same priorities here along the lines of a high degree of focus on maintaining partner and revenue continuity during this transition, and so as Phil said, we really can't use that as a downside rationale at this point.

Other than servers overall.

Servers overall were weaker.

One brief clarification, if I can, how much of TS do you typically do in the last week?

Well, I don't know if we ever got that specific, but we have typically said on a 445 calendar, we are typically 25%, 25%, and 50% in that last five weeks, and over 50% of that in the last two weeks.

Great. Thank you very much.

Thank you. Our next question comes from Brian Alexander from Raymond James.

All right. Maybe a different approach on TS, Rick. Is it possible maybe you just miscalculated how sustainable the December strength that you saw would be in the March quarter?

I ask because your December quarter was, I think, about 1200 basis points better than the midpoint of seasonal while March was only 400 basis points worse than the midpoint of seasonal. So when you average the quarters together, it doesn't really look that bad, especially when one of your largest suppliers in the storage business is carrying more backlog.

I am just wondering if thing really did weaken or maybe the expectations were just a little too high?

It's an excellent point. We've done the same analysis internally here.

Once again, if the evidence of the shortfall had had some more linearity where we could've pointed to it -- the fact that it was late in the quarter despite the fact there was a strong December quarter, again, when we lay out this guidance in late January as part of our call, not only that, we were feeling a little bullish because there was little bit more spillover than we had expected.

It's an excellent point. We have looked at the same smoothing it out to take the spikes out of it, but the fact of the matter is we put some guidance out there and did not achieve it and it was not evident in those first 12 weeks. It really, the linearity it really took a turn in that last week.

Okay. So maybe just two clarifications slash follow-ups.

The deals that you think slipped out of the quarter that didn't close, are those factored into your June guidance? It looks like they're not.

And then the other question, to follow-up on EM margins. If you do get to the 5% in June, what's your confidence level in holding that margin beyond the June quarter given that I think seasonality and regional mix go against you in September and December, so I'm wondering if you can get the 5% in June? But maybe it slips from there, or you think you can hold it?

I'll add the continuity in TS and Gerry, you can talk about the 5%.

Bryan, yes, if you look at our guidance for June -- the midpoint of our guidance for TS for the June quarter is -- you could argue it is at the upper end of normal seasonality. I think we said plus four to plus seven, and this is plus six.

At the same time, we're trying to respect the signal at March, make sure we understand it, and we haven't booked 100% of that spillover as we sit here on April 24th. So we're just trying to be -- again, as every quarter we're trying to put the best information we have together and give the best story of what we see happening in the marketplace, and that's what you see represented from here.

Gerry, do you want to talk about the 5%?

Sure. Brian, this is Gerry.

If you look at the 5%, that's really a fiscal year goal for us, so as you know, coming into the first quarter of a fiscal year for us is usually weak. The first half is usually weak due to the mix shift.

The 5% goal, I would say, is a target for us for next fiscal year to achieve that across the fiscal year, but I would not expect that to -- we would not expect to achieve that in the first quarter. So we're going to continue to look at our cost structure, and if we get some market tailwinds on industrial growth and lead time expansion, we think the 5% for the year is doable.

Thank you very much.

Thank you. Our next question comes from Amitabh Passi from UBS Research.

Thank you.

Rick, I'm curious how you would characterize the demand environment, if you normalize for the timing issue and the pressure and servers. I'm curious as you have conversations with your partners and customers, what is the general sentiment with respect to the IT spending environment? Do you feel like it's firming up, is it about the same, is it still choppy? Any incremental insight and color would be helpful.

This is Phil. How are you doing?

Hey, Phil. How are you?

Fine, thanks.

As we pointed out earlier, there was definitely a gap in the servers and we're working to plan around that, as always. But we just did a complete preparation for the call, obviously, a complete Channel check, if you will, of our own with all of our brands and their top partners. You know, there is optimism around this quarter. There is optimism around their current pipelines.

Again, we're confident with the guidance as see it right now. The choppiness that we saw came, as Rick pointed out, very unexpectedly. We're tracking that by carrying it over. The balance of the brands, we did a complete check and there is no concern or red lights flashing out there.

To do a highlight, in respect to the cloud, we are seeing great opportunities in the hybrid area. Converge continues to be a real strong suit for the marketplace out there, and our brands and our partners align very well with that, because that's where we're seeing some really nice growth and opportunities. But as a general statement, the confidence level from the partners is pretty good.

Amitabh, this is Rick.

I'd just say that it would be great -- we don't have such a metric, but if we had a thing called a partner sentiment index, I would tell you right now, this is unscientific, but I'd say it's stable.

Excellent.

Kevin, maybe just one for you for the model. As we think about OpEx going into the June quarter and beyond, maybe on an absolute dollar basis, how should we be thinking about OpEx trending over the next couple of quarters?

I would say, Amitabh, for our upcoming fiscal fourth-quarter, we're sequentially expecting a 3% increase on the topline, so we're estimating somewhere between the 580 to 590 range for the fourth quarter. Obviously, there's our fiscal year-end, so there's going to be a number of puts and takes as we close out our fiscal year. But that, I think, is the range we should be thinking about.

Obviously, as we go forward with MSC and other activity, we are expecting -- and I'll give more color as we get ready for the June quarter, but we'll continue to update that from the timing of the MSC activity integrating that. That's how I would frame it.

Just as a reminder, are there any other restructuring savings you are anticipating beyond June?

There is, obviously, things we've carried out in our December quarter, -- this quarter -- and I would range it in the $5 million to $10 million run rate benefits, as we get ready for the September quarter.

Okay. Cool. Thank you.

Thank you. Our next question comes from Ananda Baruah from Brean Capital.

Hi. Thanks for taking the question.

I apologize if I missed it, but can you go over what the growth is in storage was for the quarter and then you called out networking and a couple other technologies in the CFO review. Could you go through and give us what the order of magnitudes were in the bigger buckets?

Yes, Ananda. This is Phil. How are you doing?

In storage, we didn't call it out. We saw slower growth than typical in storage, but when you take the top brands and you average it out, we still have roughly a what's called a low single-digit positive growth in the storage bucket.

And we are seeing accelerated growth particularly around the flasher rates and new flash storage in some of the new brands we brought on there. They tend to be growing at a faster rate, which is bringing the overall average up.

And was there -- I guess the business that you saw that didn't get revenued at the end of the quarter, was there -- what was the makeup of that business? Was it representative across your offerings? Did it tend to lean one way or the other?

It was pretty much across the offerings. It wasn't any one in particular. Again, led mostly in and around the top server suppliers.

Got it.

Let me just ask a question, try it this way. What's your best guess? What are you guys thinking off-line what happened?

That's a very open-ended question, Ananda. What I would tell you is we're doing the same thing you're doing. We're watching our dashboards very closely to discern cyclical versus secular, stay close to it, and make sure that we're responding appropriately with all of the levers that you would expect us to be managing. So we're giving you the best information we have as of April 24th, but, of course, we're managing this business 7 by 24, 365 days a year, and that's the way we'll continue to operate.

Got it.

So we're sort of three weeks into the quarter now and you guys haven't seen anything unusual since we've entered April, it sounds like.

That's correct.

Okay, okay. Well, that's very encouraging. Well, thanks a lot. I appreciate it.

Thank you.

Think you. Our next question comes from Sherri Scribner from Deutsche Bank.

Hi, this is [Kitty Sheti] calling on behalf of Sherri Scribner.

So I just wanted to get an understanding of what your current assessment of Channel inventories and supply chain conditions are. Are you seeing customers being cautious restocking inventory?

Yes. I think that given the fact that lead times have been very stable, we haven't seen any change in customer ordering habits at this point. You know, with lead times at the low-end, they feel like they can get inventory when they need it, so we haven't seen restocking going on. So I would tell you I think inventories in the supply-chain today are very lean.

Okay. Thanks. That was helpful.

I know you did touch upon this previously, but if you can just shed some color on what your view on the cloud impact is on the business?

So as quick as I can summarize, my opinion would be, so when it comes to private cloud/hybrid cloud, there is a lot going on with our current offerings, and in some cases where our bars are migrating to becoming service providers. And we're growing some new customers in the areas of pure play service providers, as well. All of that, we believe, is having a beneficial effect on our business, and as part of the mainstream offering, I think the big, if you want to call it, the threat that is a concern is, so how much of the current solutions, hardware, software, and services flow is actually going to be displaced by the -- particularly, by the small/medium business customer going around the VARS in the current Channel to be able to self provision in the public cloud.

As I said earlier, I think what we're going to watch for there is what happens to our total pipeline of activity and the total amount of projects that we're actually watching, versus the projects that disappear from the pipeline because they found other ways to service it. Again, thus far, no material impact there, and, hopefully, reinforced by our normal seasonality expectation year guidance for the June quarter that's causing us to alter our normally expected patterns.

Okay, great. That was helpful.

And as we identified customers moving to the cloud, that's why we've expanded our portfolio and our services offerings around the cloud. With our partners and with our suppliers. So we're transforming the business at the same time.

Okay.

Thank you. Our next question comes from Mark Delaney from Goldman Sachs.

Thanks very much for the opportunity to ask a question.

I was hoping first to ask the question on servers a little bit differently. Can you help us understand if there's any differences in the weakness that you are seeing in the server market between x86 and proprietary servers, and if there's any differences between your different suppliers of where you are seeing the weakness?

Well, we don't typically call out by supplier, Mark. This is Phil.

In this past quarter, we'll get year-on-year. They were both equally down, so there wasn't really one more than the other. But, both industry-standard, as well as proprietary, were down.

Okay. Can you remind us how much exposure you have to the IBM x86 server business, either in terms of revenue, profits, or both?

I think we made a comment last quarter on the overall percentage. I can't remember what it is off the top of my head, Mark. We'll get that for you and follow-up if that's okay.

I want to say it's roughly 5% to 6% of TS revenue, but obviously much less in terms of GP dollars.

Yes, we can confirm that. Between 5% and 7%.

Thank you for that. And if I could just ask one more.

You also mentioned weakness in the competing components business. I'm wondering if there's any additional steps that you can take either in terms of revenue selection, your strategy there, or cost controls that can help to improve the competing components business going forward.

This is Phil. We are doing that. We've done quite a bit of revenue selection. Particularly, when you get into some of the volume drive business, and we're constantly moderating the expenses in that business to allow us to yield greater returns.

And keep in mind in the March quarter in the PC components business is typically a pretty soft quarter coming out of the strong December quarter in that business.

It's a high return business for us too, Mark.

Understood. Thank you very much.

Thank you. Our next question comes from Matt Sheerin from Stifel.

Yes, thanks.

A couple of questions on electronics marketing. You had a very strong December quarter, due in part to the volume supply chain agreement. As you look forward, do you expect similar agreements this year? In other words, does the seasonality of your business change because of that?

No, I wouldn't say the seasonality has changed. First of all, we don't see that business as strategic. We see it as opportunistic, and it is accretive to our economic profit.

At the point in which it's not, we would exit the business. But it does have some cyclical effects, but this year, as you know in Q2, it was very big. We don't expect to see that going forward and we'll continue to manage the business accordingly.

You don't expect to see it. Okay.

In the North America business in EM has seen no growth, and it's still down significantly from where you were three years ago. What is your thought there? Is it just that the core industrial markets that you sell into are still somewhat lackluster? Are you seeing a shift to offshore? What do you think is going on there? What is going to jumpstart that market?

Matt, great question. I think you hit most of the issues. The first one is the industrial base is still very flat in the Americas. We're not seeing much growth. Most of the growth we see in the Americas market is around high-end automotive that we don't really plan.

We do continue to see off shoring, but we also see projects going to Mexico instead of going to China. So a lot of the projects that start are staying here, but a lot of projects starts are slow at this point. There's not much in the way of growth in our core industrial base, and that's really what's driving the effect at this point.

Our team in North America, Gerry, has responded, because they've got that margin expansion, despite the limited growth. Hopefully, an example of managing their business appropriately.

I think if you look at even this quarter, we did some margin deselection that helped our overall profitability. So we continue to look at our portfolio and weed out those items that don't make sense.

And the book-to-bill was positive in North America, as well as the other regions, right?

Globally, we're positive book-to-bill, and in every region we're at seasonality from a book-to-bill perspective.

And for the March quarter, it was above parity for all three.

Okay. And what is it now?

Again, globally, it's above parity, and in all regions it's at seasonality.

And just lastly, if I can, for Phil, on the whole question of the IBM Channel issue with Ingram and Tech Data now playing in the high-end server space in North America, my understanding is that both of those distributors have an opportunity to compete against your existing customer base beginning this summer. Where as the last year they were going after their own customers.

Do you expect any impact there, and do you see any potential pricing or margin pressure as you try to keep those customers? Or is that really not an issue, because it's really about the services component of your business?

I think the latter part, really critical, the value that we bring to those partners is still much appreciated by those partners and IBM, Matt. We've seen to date zero impact on revenue or margins, and we expect no change to the program beyond the summer. So we believe (inaudible) it's going to continue to be stable, called a closed market at this point in time for those guys and we'll see how that plays out. We are not anticipating any change.

Have you had any conversations with some of your larger reseller customers about, you know, the opportunity for them to expand to other suppliers? Has it become a point of negotiation or anything like that?

You mean with regards to -- clarify, with regards to --

Yes, basically moving to your competitors.

No. We've really not. We've had no partner turnover at all.

Okay. Thanks.

Thank you. The next question comes from Jim Suva from Citigroup.

Thanks very much. When we think about your server segment, and, obviously, with IBM selling it's x86 business to Lenovo, there's a lot of uncertainty there. Could you maybe help us not in dollar amounts, but maybe rank order your exposure to the server OEM's?

And what I'm getting at is, assuming something changes with one of them, is it just a zero-sum game at best, or is there an opportunity or chance or risk that if you sell less of a certain OEM server that it goes to another one and Avnet has less or more of an economic positioning there.

Yes, Jim. This is Rick.

Let me take a stab and see if I can hit the mark for you here. So I think we've shared in the past that actually, when we look at our commodity break out, hardware software services, the trends that are going on there. And then in hardware we've talked about the trends. I think it was perhaps a year ago, maybe six quarters ago, we talked about storage became the single largest commodity within our hardware segment.

Keep in mind that the server segment overall is only one part of a total solution, and so as you talk about the server switch-offs between proprietary to ISS and then ISS to a variety of players. That's one example of, sort of, market share shift taking place. But at the same time, as Phil highlighted earlier, we are introducing some new players with some newer technologies, particularly in some of the storage solutions, particularly in some of the software, and in particularly some of the services where we've actually in some service offerings ourselves.

So it's really difficult just to say it's a zero-sum game at the server level. What we're watching is what's happening on zero or one plus one equals three and what's going on with the solutions now that the server is becoming less and less percentage, if you want to think of it that way, of these overall hybrid solutions that seem to be the predominant or preferred building blocks for today's data center or service provider centers. The converged solutions really are becoming the preferred solution, and the server component of converged solutions tends to be a smaller and smaller percentage. Make sense, Jim?

Very well aware of that. My point is, if one OEM struggles, are you stronger footprint with certain other OEMs and less strong footprint with some other OEMs in case we see a shift in the marketplace?

I think it's down by brand. We typically don't talk about suppliers specifically, but in this case, Jim, we think we're well covered. We have IBM and IBM is staying in the server business. Let's be clear on that, at least in the high-end. So we'll going to continue with that.

And again remember, the Lenovo deal is not a done deal yet. So we are selling quite a bit of IBM. We're going to have Lenovo through the transition. We already have it in some regions, small but in some regions around the world.

We've got HP, who's come out with some great innovation that competed well in the server market. We've got Cisco, who's doing very well in the server market, as well. And we have Oracle.

So maybe this goes back to Matt's question a little bit. Do we have partners coming to us that maybe we are 100% with one partner and want to make sure they've got coverage with others? Absolutely. We're going to do everything we need to do to protect Avnet's revenue and protect our partners' revenue.

We are always loyal to our brands, but at the point where it is going to cost us a partner or any customer solution that is going to cost Avnet revenue, we are going to go in and make sure that we have the solution that partner needs. We think we've got the line cart covered well, and to Rick's point, it's driving much more around the total solution with software, storage.

The server, I think Rick, you would answer that different by 10 years ago, there was much more exposure to server in our total revenue and profitability 10 years ago then certainly there is today. So we think we got it pretty well mitigated.

Okay. And then my follow-up.

Are you resetting or going back to try to get reset for your rebates on storage and servers since they're both underperforming where you'd like them to be?

So, Jim, our incentive programs with our suppliers are in constant communication, I would say. There are two quarterly. We look at what makes sense. We try to find win-win scenarios for both the supplier of the Avnet. And for that matter, it's win-win-win with the partner sometimes.

Nothing out of the ordinary there. It's very true that that last $100 million of revenue in the quarter is a good drop through overall. But no, there's been no particular major issue or disruption there in those overall incentive stacks that are part of our plans and partnerships.

Okay, because if storage is growing much slower than historical, and servers are now both proprietary in ISS negative growth. You'd think that the rebate levels would need to be renegotiated at a lower level to be keep the economics of Avnet pushing the products.

That certainly makes sense, and the growth we're experiencing in networking and security, in those areas, including software, offer us incremental opportunity, as well.

Thank you. Our next question comes from Steven Fox from Cross Research.

Hi, good afternoon, guys.

Just a question on the guidance for the coming quarter. Just to make sure I'm clear on the margin side. Are you saying that the EM business should hit 5% margins this quarter at the midpoint of the range? I thought I heard something along those lines.

Secondly, can you give a little help on the TS margins this quarter? It seems to me like, based on the revenues you're talking about, that you're either understating the margin potential for the quarter or there's some other one-time items going on that are maybe a drag to some profits that I'm not aware of.

Yes, Steve, this is Rick. Let me take a start and I'll let Kevin or Gerry chime in.

On EM, our consistently communicated goal was to get them back to a 5% operating at the global level without MSC, because we knew MSC was going to take some time to get our integrations done, get our synergies extracted, and I think we've set a very clear expectation again consistently that we believe the MSC business will be accretive to the EM global margin in the first quarter of our FY15. So that 5% was always ex-MSC and I think Gerry reinforced earlier in an answer, we're still on track and that's the way we're thinking.

For TS, our long communicated goal had been to drive and manage towards year-on-year out margin expansion. We disrupted that momentum this quarter, came in at 2.4. We were shooting for more like 2.7 to 2.8. And fourth-quarter a year ago at TS, if I remember correctly, was 3.0. We do not believe we're going to get all the way back from 2.4 to 3.0 in one quarter at TS. Of course, we're monitoring very closely the trends based on that week 13 experience.

However, looking ahead to September quarter and getting back to that commitment, to year-on-year margin expansion as we get to the long-term goals, that's the way we've been thinking about the business. Hope that answered your question, but maybe the GAAP you're thinking about is, are we really talking back to 3% at TS in June quarter, and that's not the way we're thinking, based on the guidance we provided.

Yes, that actually fills in the blanks for me. I appreciate it.

And then just as a follow-up to what happened at the end of the quarter. Just to confirm, you guys weren't also seeing any pricing issues or any kind of mix issues that would hurt your revenues? I just want to make sure we are clear on that.

That's absolutely right, Steve. You know, pricing issues and ASP's are much more of an EM conversation than typically what we experience on TSI.

Okay. Thank you very much.

Thank you. Our next question comes from Louis Miscioscia from CLSA.

Thanks. Not trying to beat you up here, but let me see if I can look at this a little bit of a different way. So if we go back and look at TS over the last eight quarters, I could've gone back longer, starting in June of 2012, that quarter actually was below what the expectation was or below normal seasonality.

September of 2012 on the calendar year basis was materially below. December bounced back as materially above. Then the next three quarters were all in line with seasonality, and then the next one was actually above and now below. So I guess my point would be that we've been consistently inconsistent with being in line with normal seasonality. So two were above, three were in line, and three were below.

Just wondering if there's any way that you all can, maybe you all can't do it in this call, can try to look back into it, because we are looking for a pattern to try to help us understand a model that's better that is something else going on here that maybe we can pull out or extract that would help us all.

It's a great point. I can confirm for you that we are looking -- actually, in both of our businesses, to make sure that the type of -- that the overall goals that we set, even when it comes to the patterns of seasonality, we're giving it our best efforts to make sure that we try to help determine and discern if we had any fundamental changes, if the year-ends are typically going to be bigger followed by a little weaker.

We'll dig into it and let you know. Just to confirm for you though, we do look at that and scrutinize that and consider it an important part of our overall external communications.

Okay, great. Much easier question.

What's the run rate of interest expense of the combined interest income and interest expense, because it seemed like it came down a little bit. Wonder if we could now model that flattish going forward? Or what can you give us from an absolute standpoint?

Hi Lou. This is Kevin.

I would suggest run rate right now be a couple million dollars lower from what we experienced in the third quarter.

Okay. And then flattish going forward?

Directionally, yes. Obviously, it all depends on working capital requirements, our borrowings, et cetera in terms of where we are from a net net position, but I would model that for the near-term.

And Kevin, that's primarily related to the tranche we paid off in March.

Yes.

Okay, great. And the last question that sort of goes back CS anyway. If the large storage company, EMC net have actually said that their customers are causing, obviously, both of them brought down 2014 guidance.

Evaluating and looking at cloud/object storage, AWS, whatever it might be, you said that you don't think the customers that are buying your stuff through you all are doing that. Is that because maybe they fall into more of the SMB category in comparison to large enterprise? Why would your answer be a bit different than theirs?

Lou, this is Rick again.

I think in the past we've indicated that we do believe it's perhaps a difference in dynamics between large enterprise and SMB, but as we've said from an impact point of view, we'll be watching that total pipeline of activity that leads us to start to build models around the expected amount of close, the expected time frames, et cetera, and we'll let you know as we see any changes there overall.

We don't typically provide annual guidance as some of those suppliers do, but if we go back to your point about quarterly patterns, if we see anything that indicates to us that we've got a secular trend in place, we'll be forthcoming about it, as well as the response and how it impacts our business as part of the communications.

Okay. Thanks guys.

Thank you. We have no further questions. I would like to turn the call back over to our speakers for closing comments.

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 charges that are excluded from our non-GAAP results. This entire slide presentation, including GAAP financial reconciliations, can be accessed in downloadable PDF format at our website under the quarterly results section. Thank you very much.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.