Avnet's CEO Discusses F2Q13 Results - Earnings Call Transcript

| About: Avnet Inc (AVT)

Avnet Inc. (NYSE:AVT)

F2Q13 Earnings Call

January 24, 2013 2:00 pm ET

Executives

Vincent Keenan – Vice President-Investor Relations

Rick Hamada – Chief Executive Officer and Chair of the Avnet Executive Board

Kevin Moriarty – Chief Financial Officer

Harley Feldberg – President, Avnet Electronics Marketing Global

Ray Sadowski – Chief Administrative Officer

Phil Gallagher – President, Avnet Technology Solutions Global

Analysts

Shawn M. Harrison – Longbow Research LLC

Amitabh Passi – UBS Securities LLC

Scott D. Craig – Bank of America Merrill Lynch

Ananda Baruah – Brean Capital LLC

Sherri Ann Scribner – Deutsche Bank Securities, Inc.

Brian Alexander – Raymond James

Matt Sheerin – Stifel, Nicolaus & Co., Inc.

Jim Suva – Citigroup, Inc.

Steven B. Fox – Cross Research LLC

Brendan Furlong – Miller Tabak & Co. LLC

Operator

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

Vincent Keenan

Good afternoon, and welcome to Avnet’s Second Quarter Fiscal Year 2013 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 second quarter fiscal year 2013, please note that in the accompanying presentation and slides, we have excluded the gain on bargain purchase associated with an acquisition and restructuring, integration and other items for all periods presented.

When discussing pro forma sales or organic growth, prior periods have been adjusted to include acquisitions and the impact of divestitures. In addition when we refer to the impact of foreign currency, we mean the impact due to the change in foreign currency exchange rates when translating Avnet’s non-US dollar-based financial statement into U.S. dollars.

And finally, when addressing working capital, return on working 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’s 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 second quarter fiscal year 2013 highlights. Following Rick, our new Chief Financial Officer, Kevin Moriarty will review some additional financial highlights, our return on capital performance and provide third quarter fiscal 2013 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 is Ray Sadowski, Avnet’s, Chief Administrative Officer; Phil Gallagher, President of Technology Solutions; and Harley Feldberg, President of Electronics Marketing.

With that, let me introduce Mr. Rick Hamada to discuss Avnet’s second quarter fiscal 2013 business highlights.

Rick Hamada

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

After several quarters of a somewhat cautious technology spending environment, certain segments of our served markets demonstrated relatively better strength in the December quarter. At Technology Solutions, calendar year end spending on IT infrastructure was stronger than expected, while component sales in Asia also exceeded expectations for the second quarter in a row.

As a result, enterprise revenue grew 14% sequentially to $6.7 billion, and pro forma revenue was up 9.4% in constant currency, which is in line with normal seasonality after two quarters of below seasonal growth.

On a year-over-year basis, reported revenue was roughly flat and pro forma revenue declined 4.8% in constant currency. Gross profit increased $84 million, or 12% sequentially due primarily to the strong double-digit growth at Technology Solutions.

On a sequential gross profit margin decline of 19 basis points included the impact of the enterprise business mix shift is our lower gross profit margin TS business grew to represent 45% of enterprise sales as compared with 38% in the September quarter.

The combination of strong growth in revenue and our previously communicated cost reduction actions drove adjusted operating income up 60% sequentially and adjusted operating income margin up 95 basis points sequentially to 3.3%.

Adjusted operating income margin was down 67 basis points year-over-year due primarily to the temporary benefit from hard disk drive shortages included in the year ago quarter, as well as lower operating income margin at EM in the current year.

As a result of these factors, adjusted EPS increased $0.42, or 71% sequentially to $1.1. Despite the significant sequential improvement, adjusted EPS was down $0.14 from the year ago quarter, which included a positive impact of approximately $0.05 to $0.07 from the temporary benefit related to hard disk drive shortages in the second quarter of fiscal 2012. The remainder of the decline was due to lower net income, somewhat offset by the benefits of our share repurchase program.

Return on capital employed increased 403 basis points sequentially to a 11.8%, but was down 245 basis points year-over-year due primarily to the decline in net income as working capital velocity was essentially consistent with the prior year. Our sequential increase in net income combined with a reduction in working capital drove cash flow from operations to $326 million for the quarter, bringing the total to $690 million for our trailing 12 months.

In the December quarter, we experienced stronger than expected calendar year in spending at TS after an unexpected decline in our North America region across both EM and TS in the September quarter. While we are somewhat encouraged by these collective results, there are so many question marks regarding global growth trends and their impact on the technology markets we serve.

In this environment, we will continue to monitor our dashboards and react quickly to changes in demand across our served markets. The Avnet team has managed through cycles before and we are confident that our agility and strong customer focus will position us to leverage growth into improved financial performance going forward.

Now, let’s turn to the operating groups. In the December quarter, the Electronics Marketing’s revenue came in above expectations, driven by accelerating growth in the Asia region. Reported revenue increased 2.2% year-over-year, while pro forma revenue declined approximately 1% year-over-year in constant dollars.

On a sequential basis, reported revenue increased 0.5%, while pro forma revenue, which declined 1.7% in constant currency was within our normal seasonal range of flat to down 3%. Despite the seasonal top line performance, we continue to see supply chains at different stages of recovery by region coming out of the inventory correction of fiscal 2012.

Our Asia region, which experienced an increase in lower margin performance revenue tied to supply chain engagements grew pro forma revenue 2.7% sequentially and 10.9% year-over-year.

In our EMEA region, which dealt with several quarters of double-digit year-over-year declines in fiscal 2012, pro forma revenue and constant currency was down less than 1% year-over-year despite being down 8.5% sequentially.

Our Americas region, which was the lease impacted by the inventory correction declined 1.8% sequentially and was down 12.8% on a pro forma basis from the prior year quarter primarily due to our previously communicated decision to exit the lower margin commercial components business in Latin America.

EM’s gross profit margin declined 80 basis points year-over-year, primarily due to the temporary margin benefit from hard disk drive shortages in the year ago quarter, it pronounced geographic mix shift to Asia due to the uneven recovery and higher mix of low margin fulfillment revenue in the Asia region this quarter.

Gross profit margin decreased 23 basis points sequentially due to the previously mentioned Asia mix factors. EM’s operating income declined 19.9% year-over-year to $140.1 million and operating income margin decreased to 105 basis points from the prior year quarter to 3.8%.

The year-over-year decline in operating income margin was primarily result of the previously mentioned gross margin impacts along with a relatively slower recovery in the Western regions partially offset by the cost reduction actions taken in previous quarters.

On a sequential basis, operating income margin improved materially in the Americas region as a result of the cost reductions implemented in the September quarter, however, EM operating income margin declined 90 basis points sequentially due to declines in EMEA and Asia.

Return on working capital declined 358 basis points from the year ago quarter as a decline in the operating income more than offset a 6.8-day improvement in our cash conversion cycle. After adjusting for acquisitions and changes in foreign currency exchange rates, working capital decreased by 5.9% year-over-year and 5.7% sequentially primarily due to lower inventory levels.

On a pro forma constant currency basis, EM’s inventory decreased 7.9% from the September quarter with half of the dollar decline occurring in our Asia region. EM’s booking strengthened throughout the quarter and the book-to-bill ratio was above parity in all three regions for the quarter, which suggests customer inventory levels are aligned within demand.

With a book-to-bill ratio above parity for the December quarter, it appears that customers are starting to increase their purchases, but longer-term visibility remains limited given a relatively short lead-times in the supply chain. While Asia has been our strongest region fiscal year-to-date, we are confident that a continuing recovery in our core industrial markets in the west will help to drive further leverage in EM’s model and grow margins of returns back within our target range.

TS delivered a strong quarter on both the top and bottom line as better than expected calendar year on spending on IT infrastructure drove sequential revenue growth above normal seasonality after two quarters of below seasonal growth.

Reported revenue grew 36% sequentially to $3.4 billion and pro forma revenue grew 27% in constant dollars as compared with the normal seasonal range of plus 20% to 26%.

Our Americas region, which grew pro forma revenue 36% sequentially achieved well above seasonal growth as our data suggest that many other projects that were delayed at the end of September were completed in the December quarter.

In the EMEA region which has been dealing with weak demand for two years, pro forma revenue grew 20% sequentially in constant dollars, while Asia increased 11% sequentially.

On a year-over-year basis, reported revenue declined 2.3% from the year ago quarter, while pro forma revenue declined 9% in constant currency, primarily due to the EMEA region, which declined 18%. On a sequential basis, storage, software, and services grew over 35%, while storage and services led the portfolio elements that increased year-over-year.

Gross profit margin increased 32 basis points year-over-year and 49 basis points sequentially, primarily due to the revenue mix of higher margin products in the western regions. The significant increase in gross profit when combined with the cost reductions implemented fiscal year-to-date resulted in operating income growing 5.9 times faster than revenue sequentially.

Operating income margin increased 202 basis points sequentially to 3.6% with all three regions delivering meaningful improvement in both gross profit margin and operating income margin.

Operating income margin declined 27 basis points year-over-year as an improvement in the Americas region was more than offset by a decline in the EMEA region due primarily to recent acquisitions as the related cost synergies have not yet been attained and which are not expected to be fully achieved for several quarters, while our integration work is in process.

As a result of the sequential increase in profitability, return on working capital increased over 2,500 basis points sequentially due to still below year ago levels, due to lower profitability and a lower share revenue from the higher margin Americas region.

TS performance this quarter represents an important step in resuming progress towards our long-term financial goals. The significant improvement in margins and returns demonstrates the leverage in our model when we can generate profitable growth.

Even though the muted IT spending that characterized the previous two quarters could carryover into the new calendar year, we continue to invest in new growth opportunities that enhance the value we deliver and expand the breadth of projects, our VAR partners can address.

In the Americas region, the professional services acquisitions we made or gaining traction with our VAR base, while in EMEA, the integration of Magirus continues as we work on the planned expense synergies, while also focusing on cross-selling opportunities into our expanded customer base.

While it is difficult to predict where IT spending for trend in the current macroeconomic environment, we remain committed to build on this performance by focusing on higher growth segments and increasing the value we delivered to our trading partners around the globe.

Now, I would like to turn the commentary over to and officially introduce the newest member of our senior executive team, our new CFO, Kevin Moriarty, to provide more details on our financial position and performance. Welcome to your first call Kevin and please take it from here.

Kevin Moriarty

Thank you, Rick, and hello, everyone. I’m excited to be joining the Avnet leadership team, as Avnet is an established global brand and a market leader that enjoys the rich history of innovation and strong operational performance. Ray has done a phenomenal job existing with the transition of given the complexity of Avnet’s business around the globe and relatively short tenure in the job I may differ some of your financial questions to him during the Q&A.

With that said, let’s turn to some additional highlights from the second quarter of fiscal 2013.

Turning to slide 8, as Rick mentioned earlier, the strong financial performance this quarter drove cash flow from operations to $326 million in the quarter bringing the trailing 12 months total to $690 million. Through the first six months of fiscal 2013, we have generated $407 million of cash flow from operations and invested $171 million in value creating M&A and another $207 million in our share repurchase program.

We decreased our activity as the stock price appreciated, but still purchased $69 million of shares in the current quarter. As of the end of the quarter, we still have approximately $225 million of the company’s $750 million stock repurchase authorization available to invest when we believe it is appropriate to do so.

Now, let’s take a look at a metric that I have already learned, is both well understood and consistently monitored here at Avnet; economic profit. As you can see from this slide, economic profit returned to positive territory in the December quarter as the return on capital employed improved to 11.8%.

Across the business, the Avnet team did a commendable job, reacting to our disappointing September quarter. Our sequential improvement was primarily due to the improved financial performance at TS and a seasonally strong December quarter.

At EM, effective working capital management contributed year-over-year improvement in working capital velocity. These improvements are evidence of our portfolio management discipline as we continue to align our resources to market conditions.

While I continue to learn about the company and its unique capabilities around the globe, I look forward to increasing my interaction with all of you and providing my perspective on the merit of opportunities for profitable growth and how the finance team will continue to be a key partner to the business leaders here at Avnet.

Now, turning to slide 9 on the Q3 fiscal quarter; looking forward to Avnet’s third quarter fiscal 2013, we expect EM sales to be in the range of $3.625 billion to $3.925 billion and sales for TS to be between $2.325 billion and $2.625 billion. Therefore, Avnet’s consolidated sales are forecasted to be between $5.95 billion to $6.55 billion. Based upon that revenue forecast, we expect second quarter fiscal 2013 earnings to be in the range of $0.81 and $0.91 per share. The above EPS guidance does not include any potential restructuring charges, or any charges related to acquisitions and post-closing integrations.

The guidance assumes a $138 million of average diluted shares outstanding due to assuming earnings per share and effective tax rate in the range of 27% to 31%. In addition, the above guidance assumes that the average U.S. dollar currency rate for the third quarter of fiscal 2013 is $1.34 to the Euro. This compares with an average exchange rate of $1.31 to the Euro in the prior year end third quarter and $1.30 to the Euro in the second quarter of fiscal 2013.

With that, let’s open the lines operator for Q&A.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Our first question comes from the line of Shawn Harrison with Longbow Research. Please proceed with your question.

Shawn M. Harrison – Longbow Research LLC

Good morning. I was just hoping, good afternoon. I hope you can maybe expand a little bit in terms of just the book-to-bill ratio is being positive globally if you could kind of dissect that in terms of, where we are in January? And then just a little bit more in terms of the commentary on industrial turning, you’re actually seeing that, or is that kind of the expectation you begin to see that in the western regions in the March quarter?

Rick Hamada

Harley, you want to start now?

Harley Feldberg

Sure, good afternoon Shawn.

Shawn M. Harrison – Longbow Research LLC

Yeah.

Harley Feldberg

So the book-to-bill as we mentioned was, we completed December positive in all regions which was very encouraging. And through short period in January thus far, we are essentially at parity, slight deviations by region, but nothing really significant. So essentially, the positive booking momentum has continued for all intents purposes through the beginning of January.

I believe your second question was some perspective of what we are seeing in the broad industrial markets, which are obviously extremely critical to EM’s model, EM’s ultimate profitability. We see some encouraging signs. I think in this macro environment, it’s difficult to be overly euphoric obviously, so we are looking at the bigger picture.

But some of the signs we see that we find encouraging are of course deposit book-to-bill in each region, but especially in our western regions in both Europe and America, finishing off December in a positive way. December bookings continued stronger than we would have expected closing of the year into the holiday period, so that’s encouraging.

And there have been some signs, actually saw something this morning that some of you may have seen that shared some encouraging, again I wouldn’t say, encouraging life on ex or indicators coming out of Central Europe, which is one of our most critical geographies, some encouraging manufacturing data. So those are the signs we see that causes the generally positive.

Rick Hamada

Yeah, thanks, Harley. Shawn, I would just add and then maybe anticipating some more of the questions coming on the pipe. You may hear an overall theme in many of our comments; this supply is across the Board, EM and TS that we are trying to keep the quarter’s performance in perspective. I would share that that many of the previous lack of visibility, long-term, the questions around macroeconomic trends by region, many of these are very similar to what we’ve referenced in even in June and September quarters, but obviously the December quarter results were a different vis-à-vis our expectations than those two quarters.

So we are trying to keep it all in perspective and continue to work through those lingering questions to not get overly exuberant going forward. But as Harley said, positive book-to-bill was certainly a reversal of trend after two quarters of negative. We think that means the very lease supply chain downstream from us is in really good shape, and a good year-end spend was, it was a – we will take it as a positive for our enterprise computing business as well, but trying to keep it in balanced perspective.

And keeping in mind that that seasonal shift from September to December was probably part of the December story, we are trying to smooth that out and look at it on a more normalized basis as we assess our expectations. Okay, does this make sense, Shawn?

Shawn M. Harrison – Longbow Research LLC

That’s very helpful. And just as a follow-up, the restructuring actions, you accelerated things last quarter into this quarter, I guess how much of the savings are less to be realized here in the new calendar year, and how would you expect those to layer into the business?

Rick Hamada

So, from the September announced, we are a 100% done it at this point.

Harley Feldberg

At this stage Shawn from what we announced on prior calls, we’re essentially a 100% done. There will be a little more tweaking coming forward but nothing of a significant degree more targeted at this particular point in time.

Shawn M. Harrison – Longbow Research LLC

Okay. And I think that target amount was something of, potentially $40 million to $30 million if you sell bad and better, the smaller amount of things were kind of, maybe a little bit on the upswing. Is that the best way to characterize it?

Harley Feldberg

Well, I’m not sure we recorded that number, but…

Shawn M. Harrison – Longbow Research LLC

Okay.

Kevin Moriarty

It seems reasonable at that range turning upon what we see on a go-forward basis. That’s not the number we would quote, but again it’s not an average number depending upon what we see on a go-forward basis.

Ray Sadowski

Yeah. I might add Shawn, we certainly– as you would expect, we had plans ready depending on which way things were going. And based on what we saw happened through the December quarter and for the total December quarter, we didn’t have to reach here end of the door for any of those plans at this time.

Shawn M. Harrison – Longbow Research LLC

Okay. Thanks so much and Ray congrats on the retirement.

Ray Sadowski

Thank you.

Operator

Thank you. Our next question comes from the line of Amitabh Passi with UBS. Please proceed with your question.

Amitabh Passi – UBS Securities LLC

Hi, thank you. I had a question on margins for Technology Solutions. As we move into the March quarter, Rick, do you think margins could be flattish or even show some improvement on a year-over-basis? And then just on inventories, is there risk that you might be traveling too far back, inventories were down quite substantially in the quarter. And how are you thinking about inventories going into the March quarter?

Rick Hamada

Yeah, let me take the margins and I’ll – maybe I’ll let either Phil chime in or I’ll let Harley talk about inventory too Shawn, I mean Amitabh, I’m sorry. On the margin story here I believe when we were asked about the expand production and what do we solving for, the goals that we’ve had in mind consistently now and we maintain at this particular point is, we are trying to get EM back in its target range and TS back to year-on-year margin parity if not expansion by Q4.

So I think getting TS back to year-on-year in Q3 will be a little bit of a stretch, but certainly we want to have a soft landing of this 3.5% margin in the March quarter somewhere, not create too big of our GAAP to get back to that commitment on Q4. So that’s the way we’re thinking right now on the way we’re still planning and managing the business. I don’t know, Phil, you want to add anything of them?

Phil Gallagher

I think you said one kind of build on the last question and we still have work to do. We are happy with the quarter, but we need to get back to, we are going to shoot for parity hopefully a little bit more and particularly in the June quarter. And when the expense question I guess everyone wonder, we did take a quite a bit of expense out in Europe and or working on some more regular manage expense reductions as we move through this quarter, not to mention some of the synergies in the Magirus.

Amitabh Passi – UBS Securities LLC

Okay, probably inventory?

Ray Sadowski

Sure, I have a doubt.

Amitabh Passi – UBS Securities LLC

Okay.

Ray Sadowski

I’m very comfortable with where the inventories are today. As I’m sure, you’re aware, lead times continued to be very well and that we see no deviation of that over the short-term. If you look at the reports they are trying to track excess inventory supply chain overall, for example.

Today, that excess is very heavily skewed towards our suppliers. And those factors make us very comfortable that short of some very robust change in end demand. Our inventories are aligned properly. I will say to the question probably come up at some point, I do expect inventories to come up slightly in March, not significant amount, but clearly we’re running inventory prudently and with some degree in March and hopefully a continued health of the environment in the industrial markets going into June, we would expect them to come up modestly.

Amitabh Passi – UBS Securities LLC

Okay, great, thank you. And Ray, good luck.

Ray Sadowski

Thank you.

Operator

Thank you. Our next question comes from the line of Scott Craig with Bank of America. Please proceed with your question.

Scott D. Craig – Bank of America Merrill Lynch

Thanks, good afternoon. Hey, Rick or Harley, could you discuss a little bit with regards to the outlook for the EM business, sort of the mixed assumptions you are making from a geographical perspective?

And then secondly, Rick, when you look across the portfolio and you are up from an acquisition perspective, where do you see the best opportunities within the TS business to go forward like where do you want to add with sort of capabilities you need out here as you look over the next 12 months? Thanks.

Rick Hamada

Okay. Well, Harley, once you start with the geo mix and…

Harley Feldberg

Sure, hi, Scott. Our outlook looking forward, I anticipated this question, because the guidance may look slightly below what would be proceeded in the normal seasonality, and so I appreciate the opportunity to swing a little bit. Our outlook is for normal seasonality and excellent in each region, which is encouraging. The overall number is tampered a bit by the fact that we continued to scrutinize and in some cases, deselect business, you ever probably talked about in the past in an area of our business that we internally refer to as embedded consumer, commercial consumer products.

And we are going through that business on a regular basis, attempting to make what we can meet our long-term financial goals. But as we shared with you last quarter, some of it is not and therefore we are moving off of that. That projection for additional reductions in that area in the March quarter is what takes us out of what would be traditionally normal seasonality for the March quarter.

When I think about our activity that has occurred so far, the one asterisk I think I put on the answer would be that, at least through the very initial part of January, Asia is tracking a bit stronger than I had anticipated when we formulated the guidance with Europe and America is tracking right on where we expect. I’m cautious on over reading that sort of Asia data, only because we are not yet into Chinese New Year period.

So what I would suggest is, let’s see how we come through that period in a couple of weeks to the term if indeed Asia will be some additional upside this quarter as well from a revenue perspective. But other than that, several are seeing what’s consistent with what we project of normal seasonality with the slight deviation again being in the commercial consumer products.

Rick Hamada

Okay. And Scott, I will take a stat with the EMEA, TS EMEA acquisitions and I’ll let Phil add anything he wants to. So keep in mind that our most recent acquisition there Magirus was a real booster for us, particularly in the areas, tight key areas of storage and virtualization.

The concentration of our resources today are really focused on, I think of the Eastern European region as one section, we got Germany and the UK as the other big bets, and we’re working hard to optimize and get the model right for those core markets. And then longer-term, I would tell you that we are optimizing and digesting a bit now, particularly post-Magirus.

But longer-term I think Phil actually is really reinforcing global strategies to look at moving the needle on the software and services balanced by region and then globally as a cation point even for the December quarter, TS was at 61% hardware, if you look at hardware, software and services and if you remember couple of quarters ago, hardware was still running more in the neighborhood of 70%. So that’s what I would expect from a global influence. I don’t know, Phil, if you want anything else about any targeting or…?

Phil Gallagher

No, I think you answered well. I start, the Magirus is the big now right now. We’ve got to focus on the integration and operationalizing them, here is the goals that we set. It expanded our portfolio, as Rick pointed out, storage virtualization, we added Cisco. So it really, really helps us in some areas that we did not have before both from a technology standpoint, as well as geographically, particularly strengthening our position in a key market like Germany. So that’s the primary focus and it’s going well.

The other build on Rick’s point, definitely I look at expanding in the software and services space, adding more value around the hardware. And earlier this year, we announced very small acquisition, for example, Matelli. And something like that, Matelli, bring us IT estate management.

So helps with licensing, software licensing and managing the state, which is getting more of a services play, but expanding our market opportunity. So right now, our focus on execution, integrated Magirus, and part of rounding out some of our traditional hardware focus and the data center around services and software.

Scott D. Craig – Bank of America Merrill Lynch

Okay. Thanks, guys.

Phil Gallagher

Thanks, Scott.

Operator

Thank you. Our next question comes from the line of Ananda Baruah with Brean Capital. Please proceed with your question.

Ananda Baruah – Brean Capital LLC

Hi, guys, thanks for taking this question, a couple of things if I could. Could you also just sticking with TS, could you just kind of walk through, I guess any of the different trends that you saw through the regions, sort of other than just, I mean, I guess it sounds like budget flush into the very expected across the region those are the numbers actually if you guess. Is there any soft of nuances between the regions regards to customers where sort of dealing and what you saw moving, that would be helpful, and comments on pricing as well.

Rick Hamada

Phil, go ahead.

Phil Gallagher

Yeah. Hi, Ananda, how are you? Let me state that. I will touch on a little bit in the script, I mean from technology standpoint or commodity standpoint, storage was extremely hard for us. We saw our rate rose in all regions by the way in both sequentially as we said north of 35% and year-on-year close to the same numbers at a global level. So storage continued to maintain a good strength.

If you look at system, as Rick pointed out, services and software were up and gaining a greater portion of our portfolio, which is a good thing and that’s by strategy. I guess I’ll give you a few more of a regional view. On Asia/Pac, I’ll start there and we don’t talk about Asia/Pac a whole lot. We’re moderating the growth. There is still growth market for us. We’re starting to yield, drop-throughs. We’re actually managing the growth in Asia/Pac.

ASEAN has done very well for us. We’re seeing the return in Australia, where we’ve digested ITX over the last few years and now driving execution in Australia, which is a big part of our business. And frankly, still focused on China and the motto in China, we know it’s the growth market, but that will drive the appropriate value from that market. So that’s the one we’re focused on and the more if I can give us the most, I give us the growth, we got to make sure we get fair returns.

The Americas, I will touch on Latin America. So a terrific bounce back in Latin America. December quarter is a big quarter for them. So we saw mid 50% plus growth in Latin America, which was very positive and yielded a pretty good returns for us as well as we continue to learn to do business in that growth market.

And then North America was frankly shining star, and the teams done really nice job bouncing back pretty much across the Board. I can’t point any one vertical frankly that was laid up over another, but again just an overall nice performance.

Some of that might have been as we articulated in the script and it’s hard to come out with exact what will carried over from September end of the December quarter. It’s tough to estimate that we’ll say maybe $50 million to $60 million might have been a carryover from the short coming in September, but again tough to quantify. So even if you add that in the sequential in North America was very good.

Europe continues to be more of the frankly to mixed bag. We all know that the headlines in Europe with some of the challenges, but I’ve got to say we saw consistent performance sequential and year-on-year in Germany. So we’re making good strides in Germany. Eastern Europe, as Rick just pointed out, we’ve had a good consistent performance in Eastern Europe with year-on-year growth.

And if there was any market where we saw particular weakness would be in the UK, and we’re addressing that part of that market, probably some of that part of that is Avnet. We need to get the result and we’re making the leadership changes and doing what we think the right things to get back the growth that we need in markets such as UK, which is our largest market.

One other comment I want to make is in the PC components, we again had that in the enterprise business in Avnet. And then we saw roughly 11%year-on-year decline okay, and that was predominantly in Europe. So from the PC components we saw a decline there.

And then as you know, we continued to manage a portfolio. We exited Italy a year ago, so that had some revenue decline in Europe that wasn’t there or that was the year-on-year decline. That said they will privately obtain there. They’re making a lot of progress in the tough market. They are integrating the gears as we just pointed out with their hands full, but we’re definitely seeing the progress that we’ve targeted them for. Hopefully that helps on them.

Ananda Baruah – Brean Capital LLC

Yeah, that’s a great detail, very helpful. Just real quick direct, any comments on servers, I haven’t heard any server comments yet.

Rick Hamada

Well, new servers, an industry standard continues to lead sequentially. We had between 20% and 30% growth in industry standard servers. We actually in proprietary, we had growth quarter-on-quarter in the similar range. Year-on-year, industry standard grew positively where the power of the proprietary was flat to down about 5% year-on-year.

Ananda Baruah – Brean Capital LLC

Great, thanks a lot. Very helpful, thanks a lot. Congrats on a solid quarter.

Rick Hamada

Thank you.

Ray Sadowski

Thanks, Ananada.

Operator

Thank you. Our next question comes from the line of Sherri Scribner with Deutsche Bank. Please proceed with your question.

Sherri Ann Scribner – Deutsche Bank Securities, Inc.

Hi, thank you. I know it’s an uncertain macro environment. So I was curious if you could give us some detail on anything you are seeing on lead times and cancellation rates and conversely are you seeing anything in terms of restocking?

Rick Hamada

So Harley, I guess lead times ASPs and any activity in cancellation, reschedules.

Harley Feldberg

Sherri, hi, this is Harley. Very little eventful data I could report back to you. No significant changes to lead time, no significant change in ASP, in the aggregate, obviously there are individual differences and a very little will change from both, so now nothing particularly different that’s occurring currently.

Sherri Ann Scribner – Deutsche Bank Securities, Inc.

Okay. And you don’t have a sense that there is any restocking going on as of yet?

Harley Feldberg

I could read the bookings, when I look at bookings in the aggregate for the December quarter compared, for example, to the September quarter. It really is a quite positive story. Without having facts attached to it, I could read that to suggest that our customers, I believe as Rick enunciated in the script, are at a level where they are requiring additional inventory purchases to fuel any growth that occurs in first half of calendar 2013.

So our customers are behaving. The absence of a lot of backlog management and cancellations and the increased booking activity to me suggests that they are running their inventories at a point where they will be restocking with growth.

Sherri Ann Scribner – Deutsche Bank Securities, Inc.

Okay, thanks that’s helpful. And I just wanted to get a sense of I know you’ve taken the restructuring actions. How much of the restructuring actions helped your margins this quarter versus volumes? Thanks.

Rick Hamada

I’m not sure I have Ray or Kevin. I’m not sure we have that kind of calculation right on the tip of our tongue. But I know that Ray, we shared last quarter we were trying to make sure everybody aware of the puts and the takes because we have the change in equity comp and we said this is going to be, if you take the 90 million divided by four, 18 of which is going to be realized.

Sherri Ann Scribner – Deutsche Bank Securities, Inc.

Right.

Kevin Moriarty

You can look at it that way. But you also had some inflation going the other way.

Sherri Ann Scribner – Deutsche Bank Securities, Inc.

Yeah.

Kevin Moriarty

So it’s a tough number. I think we did get all the expenses out that we committed to the $90 million. So that’s certainly factored in the number, and certainly feel that year-over-year, we would see that entire impact. But going against that, as we talked about in the past the past, you have M&A impact…

Sherri Ann Scribner – Deutsche Bank Securities, Inc.

Yeah.

Kevin Moriarty

And the expense numbers, currency to some extent. So we can probably do the calculation, but we just don’t have an available. So we’ll take a look at it…

Sherri Ann Scribner – Deutsche Bank Securities, Inc.

Yeah.

Kevin Moriarty

And maybe get back to you.

Rick Hamada

Yeah, sure, we definitely have a lot of moving parts here, as you heard in the script. And we don’t do it that to obfuscate there. The detail is that we have a complex business to manage through, and as you would expect, we’ve got to make the decisions to keep it move in a right direction. If we look at though the $90 million as far as the committed and communicated expense total, our data, our internal spreadsheets, we have gotten that out, right, Ray?

Ray Sadowski

Yes.

Sherri Ann Scribner – Deutsche Bank Securities, Inc.

Okay, great. Thank you.

Operator

Thank you. Our next question comes from the line of Brian Alexander with Raymond James. Please proceed with your question.

Brian Alexander – Raymond James

Okay, thanks, good afternoon. Nice quarter and welcome, Kevin. Question for Phil, maybe just to go back to the strength that you saw in the Americas for TS; could you just comment if this was driven by a few large deals late in the quarter or would you say it was more linear and broad-based than that? And then just talk about what your VAR feedback is on the pipeline for the March quarter and just your overall confidence level in achieving normal seasonality in TS in the March quarter, given the strength that you saw in December.

Phil Gallagher

Yeah, Brian thanks and thanks for the kind words there. As far as the large deals, now we always had the difficult December quarter or the five week quarter that makes up a large portion of the total quarter, right on a five week month in total quarter. And yeah, we saw a big part of that in a last two weeks of December, right, which is not really a typical.

But it wasn’t any like major large deals I mean it was really pretty well across the Board if you look that our top brands if you will by supplier, it was positive when you look at it by commodity it was positive. So it wasn’t any real one over the other to began with in, which what we’re pleased about, okay. And as I said earlier, we might had a little bit of the hangover from September. But it wasn’t – what made the whole quarter.

Ray Sadowski

Yeah.

Phil Gallagher

Even if you took some of that out and did the math, we’d still have slightly above-normal seasonality in North America. So again I think, team just come out and we drove the strategies and out of the course it’s big quarter for some of our major suppliers. So obviously they do what we do well in that, that’s all good news.

As far as the VAR folks, it’s still early in the quarter. I will say that we’re at this point optimistic and confident with the guidance we put out. There is no indication earlier in January to not be comfortable with that. We are talking to the VARs obviously regulators and some big events come up as you are aware with some of our top brands in the next two to three weeks three weeks that we’ll be obviously be spending a lot more time with them.

But at this point, they are optimistic. I’ve been on the phone with quite a few of them, and they are feeling as good as they can this early in the quarter. So based on that that’s how we came up with our guidance. The March quarter is always an interesting one anyway, coming off December. It does start to set the tone for the balance of the calendar year. But right now, I already gave color on Europe and Asia and we roll it up, what we feel good with the guides we have right now.

Rick Hamada

Yeah, Phil I would share. And Brian, for the long-term Avnet watchers, I would share that December was actually a little more than 50% of the quarter, maybe we talk about that seasonality. But there really wasn’t a big pipeline of make a deals. It really was a pretty broad-based across the Board flush that took place, if you want to use that term. But December was a little more than 50%, and by the way that’s not too out of the norm for the calendar year-end.

Brian Alexander – Raymond James

Okay. Thanks, Rick. And just a follow-up, I think you guys talked about getting operating margins in the June quarter back to where they were a year ago, I think 3.7%. So that would imply, you need about a 50 basis point sequential improvement June versus March.

So just an update on your thought process there, whether that’s still doable, it doesn’t sound like there is more restructuring to come that is meaningful. And related to that, assuming normal seasonality in EM going forward, since that’s what we’re starting to see.

Rick Hamada

Right.

Brian Alexander – Raymond James

How quickly can you get back to that targeted range of 5% to 5.5% in a normal seasonal environment? Thank you.

Rick Hamada

I won’t let Harley answer that one. I’ll answer it for him. But we are consistent in our goal set that we are looking forward EM to get back to that 5%, 5.5% at the global level in Q4. And for Phil, I think it represents roughly getting back to 2.65% by Q4 as well, so all of our internal planning, expectations, and solution sets are targeted still on those objectives.

Brian Alexander – Raymond James

And that’s Q4 of fiscal, not calendar?

Rick Hamada

That’s correct, that’s June quarter of 2013.

Brian Alexander – Raymond James

Okay, thanks a lot.

Operator

Thank you. Our next question comes from the line of Matt Sheerin with Stifel, Nicolaus. Please proceed with your question.

Matt Sheerin – Stifel, Nicolaus & Co., Inc.

First question has to do with gross margin and margins overall in Electronics Marketing. I know that’s been weaker than normal, a function of mix, geographic mix certainly, and then also some pricing pressure. But Harley, as you look at seasonality and if we see a return to seasonality in Europe and North America, and although you did say Asia is strong typically, it grows at a slower rate sequentially in the March quarter and typically even has been down. So should we see improvement in gross margin?

And then on the pricing front, do you expect that to continue to be fairly aggressive, given that lead times are still short, so there is still sort of jump-ball type of business and less backlog where pricing is set?

Harley Feldberg

Yeah. Hi Matt, how are you? Yes, I am expecting a gross margin expansion in March, so that’s pretty simple answer. I think the second part of your question I interpret to mean, over and above the gross margin expansion, we will see by way of a favorable regional mix, when we start to see gross margin expansion due to a less restricting environment.

Matt Sheerin – Stifel, Nicolaus & Co., Inc.

Exactly.

Harley Feldberg

And then clearly is the $64,000 question. I believe we will. Remember something for distribution. The issue is never – I would answer the question on ASP, but it’s not the most relevant distribution question. And really is exactly as you portrait it, which is with less business to go around, pricing behavior, competitive behavior is more acute.

The thing that we really are looking to see is or maybe another way to think about the earlier question on the industrial market is the activity we need is we need an acceleration of revenues derived from our core demand creation, design win business and that’s the part that’s been quite frankly most stubborn.

When we look at our metrics, we measure design win activity, design wins, design registrations, down to the salesperson level and that activity was quite encouraging in December from an activity perspective, but the volume attached to that has not generated what we need.

So maybe the roundabout way to answer your question is, as we see that critical part of our business expand, not only due to regional mix, but actually due to our customers taking more products in areas where we’ve done a design and we earn higher gross margins as opposed to providing supply chain solution that is when our gross margins and obviously subsequently our operating margins will expand and we’ll see positive flow through from our model.

Matt Sheerin – Stifel, Nicolaus & Co., Inc.

Okay, great. That’s helpful Harley. And a couple questions for Phil on Tech Solutions. One, on that PC components business, Phil, which I know continues to be a drag, what’s your strategy there going forward? Are you looking at exiting additional markets there?

And then second, on the IBM announcement of adding Ingram Micro and Tech Data in North America on the high-end enterprise hardware, I know that’s not going to roll in until another 12 to 18 months, but could you give us your view there and the impact on your business?

Rick Hamada

Yeah, let me – thanks, Matt. We were wondering how long it would take for that second question to come out, Matt. We lost the under on that one. On the PC components, let me just say that the part of the issue with it is you have the swings back and forth and it becomes so unpredictable. And by the way in Asia/Pac it’s actually not, it runs a little bit more steady, and Europe in particular is where we had the bigger challenge. And today roughly, give you perspective, it’s roughly 7% of our TS total revenue with a higher concentration in Europe.

So I guess what I can share that we are absolutely studying that model, pretty much as we speak, okay. To be sure that we’re doing everything we can to extract whatever cost we can out of the model, so that we can manage the margins a little bit more predictably and get the returns, okay.

So it’s complicated, because it is across multiple regions, and in some brands inside the PC components, they are – in one region they are more consistent than they are in another with the different product mix between processors and disk drives and what not. So I guess you can sum it up, I would say, we are studying the model, we are working it to determine how strategic it becomes for us or not, okay.

Matt Sheerin – Stifel, Nicolaus & Co., Inc.

Okay.

Harley Feldberg

On the IBM, yeah, thanks for that question, we wanted to bring it up anyway. But bottom line is, IBM has been obviously in great discussion with ourselves, so this was not a surprise to us there, by far our largest partner and one of the most trusted partners worldwide. So the fact is they – we are looking for ways to drive incremental resellers into their model and this is what they felt they needed to go and do.

Like I said, we are not planning on any revenue or margin impact negatively, as you’ve pointed out it’s not something that’s going to start right away. We have the closed model still for the next 18 months or so and we have a good relationship with IBM as I pointed out and as good a relationship with our partners to see value in what Avnet brings.

So we are not modeling any impact at all to our business top line or bottom line. And in the grand scheme, by the way, rough numbers it’s less than 4% of our total revenues for TS worldwide, that’s even being discussed. So again, we trust IBM, a great partner and we will go continue to look to not only manage the importance we have, but we are also looking to expand our partner base with IBM as well. So we are not just playing defense, we will be on the offense, as well.

Rick Hamada

Yeah, Matt, this is Rick. I would just add to that. To reinforce those points, we are in the business of recruiting new resellers for IBM as well. We believe we have a compelling value proposition along those lines for any reseller or integrator considering that platform as part of their portfolio. And you can count on our continued support for this great partnership we have with IBM overall. And stay tuned and we’ll keep you posted on the details.

Matt Sheerin – Stifel, Nicolaus & Co., Inc.

All right, very good. Thanks a lot, Rick, and good luck.

Rick Hamada

Okay.

Operator

Thank you. (Operator Instructions) Our next question comes from the line of Jim Suva with Citi. Please proceed with your question.

Jim Suva – Citigroup, Inc.

Thank you and congratulations to you and your team there at Avnet. My question is when we think about your SG&A line, seeing how there has been a lot of mergers and acquisitions folded into Avnet, as well as restructuring, can you help us with some of the modeling on SG&A? We see it was nicely flat quarter-over-quarter. I don’t know if there is like some type of merit increases or something going on. If you can help us out with SG&A and kind of run rate and how we should think about that seasonally and quarter-over-quarter, not just for the next quarter, but maybe forward looking a couple quarters?

Rick Hamada

Yeah, I will let Ray and Kevin add some color there. Jim just to remind you – from a merit cycle point of view that generally happens on our fiscal year boundary, so that should not be part of the equation at this point, but either Kevin or Ray add...

Kevin Moriarty

Hi, Jim, this is Kevin. I think overall to your point about when you factor in recent M&A activity, also we have the impact of unfavorable foreign currency exchange when you look at the planning rate. Net of the ongoing productivity actions we expect SG&A to be flattish sequentially when we go into fiscal Q3.

Jim Suva – Citigroup, Inc.

Great. And then my follow-up question is, and this is, again, you had great results, so don’t take this the wrong way. But when should we actually expect earnings to grow year-over-year with all these restructuring kind of done that you’ve mentioned?

Rick Hamada

Real good question there. If you follow our thought process regarding getting back to year-on-year operating margin, then you got to figure out and decide what revenue number we have associated with that. You can do some calculations that way Jim, so I’m not trying to call when that happens. But keep in mind are the solution set that we are operating under today on targeting that EM back to their range and TS back to parity or year-on-year growth in op margin by that fourth quarter.

So then you got to do your assumptions regarding, where is the revenues and where is the share count at that point and those are couple of variables you got to make decisions on. But we want to be very consistent with the type of expectations we are setting from an enterprise performance point of view.

Jim Suva – Citigroup, Inc.

Great. Thank you and congratulations again to you and your team at Avnet.

Rick Hamada

Thanks, Jim.

Operator

Thank you. Our next question comes from the line of Steven Fox with Cross Research. Please proceed with your question.

Steven B. Fox – Cross Research LLC

Thanks, good afternoon. Just two quick ones, just could we get a sense for cash flows in the current quarter, based on the guidance you are providing?

And then secondly, you’ve covered a lot on TS. Just to be clear, there was a line in the press release where you talked about defining pockets of technology strength. Is that related mainly to services and storage? Is there anything else that you guys would highlight from an Avnet-specific standpoint that maybe is helping you gain share in the overall channel? I just was wondering if you could flesh that out a little bit. Thanks.

Rick Hamada

Steve, I’ll start with the second question and Kevin, you take cash flow. But I think as we called out in the script, the real bright spots over and above the very clear strong year-end close, Steven was really built around what we saw in storage, software and services.

Steven B. Fox – Cross Research LLC

Just to be clear, are those market-related or was there something that you felt like you were doing in order to take greater?

Rick Hamada

Well, I would tell you I’m not sure we have enough data points to make a categorical assessment on the relative performance at this point. I would just tell you, we feel pretty good about it. Now, we got to get all the data in from the suppliers, competitors et cetera, and we will ferret that out as it goes on. But it felt pretty good to us.

Phil Gallagher

We did, this is Phil, Just to add to that. Yeah, of course, the market cooperated with us, right. There is no question about that. But we also believe we had the – and you will see it again in May, we talked about it last year at the Analyst Day. But we have very specific strategies to go continue to expand services, continue to expand software and storage. As we all know, with big data and analytics and everything around that. We are making investments in those areas and we believe it maybe too early to tell to Rick’s point, but we said we are starting to get some traction with some of the value we are bringing to the markets, Steve.

Steven B. Fox – Cross Research LLC

Great. And just on the cash flow?

Kevin Moriarty

On the cash yeah, this is Kevin. On free cash flow, it will be tempered from what we experienced in our fiscal Q2. But we expect to generate approximately $100 million of free cash flow in Q3.

Steven B. Fox – Cross Research LLC

Great, that’s very helpful. Thank you.

Operator

Thank you. Our next question comes from the line of Brendan Furlong with Miller Tabak. Please proceed with your question.

Brendan Furlong – Miller Tabak & Co. LLC

Sorry, everything has been covered. Thank you very much.

Rick Hamada

Okay. Thanks, Brendan. He said everything has been covered, yes.

Operator

Gentlemen, there are no further questions at this time.

Vincent Keenan

Okay. Thank you for participating in our earnings call today. As we conclude, we will scroll through the non-GAAP to 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 the GAAP financial reconciliations can be accessed in downloadable PDF format at our website, under the quarterly results section. Thank you.

Operator

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

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