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Avenet, Inc. (NYSE:AVT)

Raymond James IT Supply Chain Conference

December 13, 2011 2:25 p.p. ET

Executives

Rick Hamada - President and COO

Analysts

Brian Alexander - Raymond James

Presentation

Brian Alexander

(abrupt start) everybody. Brian Alexander, head of the tech research team. One of the analysts at Raymond James here to introduce Rick Hamada, CEO of Avenet. And he'll talk for about five or ten minutes. Their Analyst Day is tomorrow for those of you that don't know. And then we'll move to fireside. Rick?

Rick Hamada

Very good. Thank you, Brian. Good afternoon, everybody. Thanks for your time. Appreciate your interest in Avenet. Really I have I think – going to just tee up two or three slides to get the conversation started and then move through there.

My IR team always requires me to make sure I have my Safe Harbor statement in place here today so that's Slide 1. Number two, kind of gets to the – if I have to do the elevator pitch on Avenet overall, I would highlight technology is still a good place to be and we'll show some data specifically on what we think the TAM growth looks like for the next few years. We add to the organic growth opportunity, a disciplined approach to value creating M&A. Number of examples of that. In fact there was another announcement out yesterday at a small business and continue to make sure M&A is a big part of our overall growth story.

We then apply to all operations, our value-based management approach, focus return on capital and particularly incentivizing our team to continue to optimize the growth of economic profit dollars. The more we do that the more we strengthen the balance sheet. We are committed from a capital structure point of view to maintaining an investment grade balance sheet, which implies certain assumptions regarding our coverage and leverage ratios, which are well within those ranges today.

And we're very proud not only of the track record but of the broader overall leadership team that continues to work on creating that shareholder value via those results. Won't go through all the history of the top leadership team overall, but a week ago Monday I celebrated 28 years with Avenet even though I'm still coming up now in my first six months as CEO.

Here's a snapshot of what we believe is going on for the total available market for Avenet broken into the subcomponents of semiconductors as well as for the IT market. For 2011, roughly a $1.3 trillion sandbox. But looking more importantly perhaps out at '12, '13 and '14 even off the most revised estimates we have for the served market growth going forward. Some of these have been updated as late as October and November from the group of sources that you'll see highlighted and noted at the bottom. We believe that we've got a 5% to 6% secular growth rate opportunity in the markets that we serve.

Again providing the basis for organic growth, upon which then we continue to add selective M&A to try to keep the growth rate above that market rate. If we take a look at what's going on with our key businesses today, we are – the structure for Avenet starts with two worlds we call Electronics Marketing and Technology Solutions. So components and computer products. And then below that we essentially break into three sub regions; Asia Pacific, Americas and EMEA. You'll see a couple of other highlights on there including EM Japan and TS for Latin America but those are the big major regions we drive both income statement as well as balance sheet accountability down to that level. So we hold those leaders accountable for not only their profit performance but their return on capital and you'll see on the vertical axis now, where are these businesses performing relative to their long-range goals for return on capital and what do we believe the three-year market CAGR rate is.

The size of the bubble is indicative of the critical mass or the total revenue in that particular region overall. The green bubbles represent our EM businesses and the blue represent our TS. It's good to see on balance the majority of our portfolio operating at or above their long range planning targets for total returns. For those that follow us quite well, we've talked a number of quarters now about the improving performance profile for our TS EMEA business, which is key to getting the TS margins back up to our range that we want. Associated with that are the higher growth regions where we've built out a global footprint for TS in Latin America and Asia to get those performance profiles up as well. But as you can see based on their placement on the chart, there's some higher market growth rates available there, which we're very excited to be participating with.

And the EM Japan, the only part of the EM portfolio below the range today. It's about a $600 million part of a $15 billion components distribution business. There we're taking the opportunity to take a look at opportunities for consolidation that we believe will lead to some more critical mass in that marketplace as we believe the global pressures – or the pressures of a global economy tend to create opportunity for us in that particular market. All right? So that's a little bit about Avenet. Little bit about what we think will grow. Little bit about our overall performance and then the final slides, little touch on current market conditions, which I'm sure some of the questions will get into.

This outlines and highlights the guidance we provided on our October 27 call, reviewing Q1 and talking about December quarter overall. For our components business globally, the midpoint of guidance was slightly below normal seasonality. We believed and continue to believe that there had been a supply chain correction going on in electronic components supply chain overall. We worked through that with a negative book-to-bill in the June quarter followed by a negative one in September. And we talked about some stability starting to show in the October numbers overall. Stable ASPs and lead times continue to be normal to low (inaudible) so there's no protabation from those particular impacts at this point.

For our TS business, guidance – in the low end of normal seasonality. The midpoint of normal sequential guidance would be plus-25% for that business. And we've got it in at as you can see there, just between 22%, 23% when the low end would be around 22%. We're still seeing good growth in our storage business, industry standard servers and to a certain extent our software business as well for TS. And I think that's the quick highlights overall and, Brian, I guess I'll join you here now and take some questions.

Brian Alexander

So the down 5% sequentially in the Electronics Marketing business, components business, slightly below seasonal and not to get you to officially update guidance here but how do we reconcile that with what we're hearing from some of the larger semiconductor suppliers within the last week? I'm sure you've seen TI and Altera reducing guidance by as much as 6% or 7%. So how much of that is further erosion in end demand and if so, where is that? Versus maybe Avenet and some of your competitors taking down inventory levels or is your customers taking down inventory? So inventory versus demand.

Rick Hamada

Right. It's a great question. And by the way, we stated associated with that guidance that we had or we are intending to reduce inventory at about the same rate as sales for EM on the December quarter. So if we're down 5% sequentially, we want to take inventory down by 5%. And that, I think that's really the answer to the question, Brian. We are continuing to adjust. We felt there's going to be a two to three quarter adjustment throughout the supply chain here. So if we're taking inventories down, that's a direct impact to our suppliers in addition to the direct OEM and EMS customers that they have as well.

Now I can't speak to has something new developed for their particular indicators because in looking at our dashboard the types of comments that we made coming out of October where we said we were seeing more signs of stability in our business regarding equilibrium with book-to-bill, that’s pretty much where we sit today. And so therefore we're not – we haven’t had any surprises like that, which would lead us to any other conclusion at this point.

Brian Alexander

And is that true across all regions? Or are there nuances within regions that maybe Europe's a little bit softer but Asia is stronger?

Rick Hamada

So the improvement has been at the global level for EM and it applies all three regions and isolation have also improved. But relatively speaking Americas and Asia are doing a little better than Europe overall but Europe is still looking better than they did from September.

Brian Alexander

Okay. And so the plans are to continue to reduce inventory in line with whatever sales decline you ultimately experience.

Rick Hamada

That is correct.

Brian Alexander

As we head into next calendar year how are you thinking about the EM business relative to normal seasonality, which for you is normally up sequentially quite a bit in the March quarter?

Rick Hamada

Yeah. So I'm going to give you a few if's here. But certainly we come in with the revenue guidance where we've got it. And if we actually experience for the full December quarter a book-to-bill ratio closer to parity, right? And certainly improved from the 0.88 we saw in September, all those conditions converge, we're probably feeling better about a more normal seasonal March quarter than we would if any one of those factors – if the revenue didn't come in or if the book-to-bill deteriorated, et cetera. You really have to look at the total quarter results to be able to answer what kind of outlook we have for March.

Brian Alexander

Okay. I was going to move to computing but if anybody has any questions specifically on Electronics Marketing, feel free to raise your hand. Okay. Computing backend loaded quarter, always in December. I think – remind me, 30% gets shipped in the last two weeks or something like that.

Rick Hamada

Right.

Brian Alexander

But you've got enough, maybe visibility in terms of pipeline conversations with some of your solution provider customers that are in the room. What are they telling you about enterprise spending as we finish the year and how are you thinking about that business in 2012?

Rick Hamada

Yeah. So the – as far as the linearity of the quarter, the conversations with the VARs, the quote, the proposal activity, the config activity, and all the pipelining we're doing to make sure they're in a position to capture those December orders and make them happen, that all looks very normal to us at this particular point. Very consistent with, again, the type of guidance we laid out in October. So again no major new developments there. It's really early to call what's going on with the 2012 or even for that matter March quarter at TS. The normal seasonality there would be down to 15%, 20%. You come off that year-end boost and as we certainly don't know anything at this point, but it's not a matter we don't know the negatives. We don't know enough about the positives either. Everybody is so focused in that business on making sure the December quarter happens and closing the year that less conversation taking place about where the customers are setting their budgets for 2012 et cetera.

All that said, not aware of any particular influence outside of overall macro economic concern that continues to be on people's minds but we are big fans of the philosophy that says that IT spend ends up pegging as a multiple of GDP growth. And therefore as long as we've got GDP growth we're going to expect some IT investment growth. The macro is the big wildcard and I think it's on a lot of our minds as we continue to consider what type of 2012 we're going to have.

Brian Alexander

Something else on their mind might be the HTD situation. After buying Bell, I think you're the largest disk drive distributor in the world. Drives go into a lot of the products you sell on the enterprise side. So just what are you hearing from suppliers there and how is that affecting your business and from an unit-end pricing perspective?

Rick Hamada

Yeah. So keep in mind that, yes, Bell added quite a bit of HTD business to our portfolio but remember overall it's about a billion dollars out of our 25, 26. So let's call it, it's less than 4% of our overall revenues. On a units basis, Brian, we play in the neighborhood of maybe three to three and a half million units per quarter and remember I think current numbers right now are total demand is projected to be 170 million to 180 million units and the total supply this quarter because of Thailand's in the 120 to 125 is the latest numbers I had heard. So we're all staying very close to those set of numbers.

For the December quarter we found ourselves starting with a very good inventory position and a good pipeline of product that actually has come in. So we feel real good about our situation for the December. We're trying to get a lot better guidance like everyone else I think in the industry on what's happening for March and June as Thailand recovers and we find out what kind of supply situation there's going to be there. Because not only does it affect the opportunity we have for December, we are prioritizing making sure we take care of our best customers in the embedded system space and the OEM space who are counting on those rights for bigger systems. And in fact things we learn about the March supply could cause us to want to carry over some inventory that we currently have to make sure we've got those supported, right?

So for December quarter based on higher ASPs and some of the price changes taking place in the marketplace even netting against some of the – there will be some supply impact, that overall doesn't look like any material impact to our business. But we're really trying to get a line on what the supply expectation is for early 2012 and then factor all of our decisions accordingly.

Brian Alexander

So is it maybe too early to get a great read on that as far as –

Rick Hamada

It's a very dynamic situation, right. Yeah.

Brian Alexander

Switching over to margins, if we look at your profitability by segment versus your main competitor, you're a little bit behind on the components business, maybe 20 basis points but you're more than 100 basis points behind them on the computing side.

Rick Hamada

Right.

Brian Alexander

You alluded to some of this in your introductory comments. I guess the question would be how much of this is permanent or temporary in your mind? How much is structural? How much is really just driven by mix? And do you think you can close that gap over the next three to four quarters?

Rick Hamada

So we are very focused on closing the gap in the sense that our long range margin model for that business is 3.4 to 3.9. And as you know, Brian, we came in at about 2.5% globally for that business in the September quarter. So we have got some work to do and as you saw in the bubble chart it starts with TS EMEA. But also longer term the high growth segments we've got in Latin America and Asia we believe offer some great growth opportunity and they're hitting the interim goals on their way towards those LRPTs. The urgency in Europe not only due to the critical mass and the size of that business but also we weren't hitting the interim goals on the way to the long range goals. And that brought a little more sensitivity to us overall.

We also in our European business, we do – we like the gross margin profile we have today. So if you've got a gross margin you like, but you're not getting any market growth because it's a slower growth segment then guess what. You've got to get to work on your cost model and that's been part of a work in process for our business. Even coming off the Bell Micro integration and synergies, there's had to be more structural work done to that business. And those decisions are taking place.

Brian Alexander

What's the right way to think about trough and peak earnings for your business over a normal cycle, which I know we usually don't see normal cycles anymore. But if investors are trying to kind of vision average earnings power over a cycle, where would you kind of put the upper and lower bounds around that?

Rick Hamada

Yeah. Those that know us and watch our model know that the leverage is in the expense model, right? And so what happens is any conversation about peak or trough, tell me what the revenue change is going to be in what timeframe and I'll give you an estimate of what kind of trough we would have. If you take a look at '08, '09, which there are no indications we've seen anything like that today, but our peak to trough drop in revenues was roughly 16%. We had to take our expenses down 16% and it took a while to do that so there was a little bit of a lag but on that 16% revenue drop, the associated earnings drop was more in the 30%, 40% range. I can't remember the exact number. I should have that but I don’t. So leverage works both ways.

So anything about peak to trough tell me we're going to be down 10% in three quarters and I can project. If it's – we're going – 5% over six quarters, I can –. And all of that impacts our ability to respond and what kind of implications it has in the short-term as we adjust and keep our model. Also keep in mind many of you know the distributor offers – one of the silver linings is a counter cyclical balance sheet. So in a downturn we will generate cash so we're not in a situation where we have to horde cash for a rainy day. And that's always been one of our silver linings.

Brian Alexander

So let's talk about capital structure and capital allocation. Your debt to EBITDA is less than 2x. Years ago you ran at multiples of that when you were making a lot of acquisitions. So not that we want to go back to that level, but if I take it net of cash you're closer to 1x, which is fairly low. So I guess the question would be how do you think about the optimal capital structure? Why not have more leverage? And then fold that into how you plan to deploy the capital particularly if we're generating a lot of cash in a slow growth environment?

Rick Hamada

Yeah. So we would take advantage of that if we have a need for it. We've recently by the way expanded our (air) securitization line. And we recently announced I think it was mid-November a new billion dollar revolver that keeps us – for that ability to manage working capital intra quarter in and out. We've got those facilities in place. As I said earlier in the comments I believe our commitment to capital structure is maintain that investment grade profile and you could say we are underleveraged at this particular point. But at the same time if we don't need the capital for a particular reason right now, why don't we just save the dry powder and take a look for the opportunities to go forward.

Our capital allocation strategy is still prioritized with organic growth and M&A. Then we get to return to shareholders and then there we can have the debate between buybacks versus dividends. We announced a buyback as you knew on our August call. First time in 10 years, the magnitude of $500 million. I think through our October call we mentioned we've already spent about $125 million of that. And we were trading in the neighborhood of our book value around $26 a share for a lot of that time. And we indicated we were going to be aggressive acquirers at that range and as we move away from that back into the 30s and above then we probably are much less aggressive acquirer.

Brian Alexander

Less aggressive or not acquirer?

Rick Hamada

Well there's a certain point where we switch it off as well but as I said, we didn't share our exact formula there but there's a point where it would actually completely cut off.

Brian Alexander

And what's the thought process and discussions with the board around a dividend? Is that something that you see as a potential within the next one or two years? Or no.

Rick Hamada

It is a potential. It's an active dialogue. We have a couple of biases regarding dividends. For right or wrong but this is the way we're thinking about it. Should we commit we would view it as a perpetual commit. We're not fans of special dividends or even structure such as payout ratios, et cetera. We would like it to be a perpetual commit and then secondarily, we'd like it to be of a certain materiality. Let's just say for lack of a better starting point, 2%. So as opposed to saying $0.10 a share so we can call ourselves a dividend paying stock, we think there should be a certain materiality associated with that.

So if you do the math and take a look at our outstanding shares you'd say, okay. How comfortable is Avenet committing that this much of our cash flow is going to go to dividends in perpetuity not to mention should we grow the dividend over time. Should we build that into our plans. And making sure we've very, very comfortable with that and we've got the ability to support it through cycles without any restraints or inhibitions for the priorities of capital allocation for growth. That's what we're working on.

Brian Alexander

Okay. Just before I turn it over to the audience for any questions, Vince wanted me to ask if you could give us a sneak preview on what you're going to talk about at the Analyst Day tomorrow.

Rick Hamada

Yeah. Vince and I talked about it and we decided we're going to hold the news for tomorrow. So. The Analyst Day gives, Brian, as you know gives us that one chance a year hopefully where we can step out of the quarter-to-quarter and day-to-day and try to look a little bit longer, what Avenet's trying to do. And that's why we're here and hopefully we'll get a chance to do that. But with all the current conditions and this crazy marketplace we call home, who knows. But that's what we're trying to do.

Brian Alexander

Worth a try. Mark?

Question-and-Answer Session

Unidentified Analyst

You talked about the book-to-bill (inaudible) in October. Can you talk about some of the other things that you look at, the cancellation rates, the delivery schedules. (inaudible) what are the key points that you look at to decide (inaudible)?

Rick Hamada

Right. So, yeah, Mark. To you point when we start at quarter at EM we're going to target to ship 3.5 billion. We're not trying to book 3.5 billion in order, right? We come in with a certain backlog, supply chain. And there have been some push outs but there's been no abnormal activity in the terms of major cancellations or major developments that put any of the guidance we let out at risk. It's just all been within the tolerance levels that we kind of planned for and as we talked about the October comments, just we continue to see signs of stabilization coming off that 0.88 performance in September. \

Unidentified Analyst

(question inaudible)

Rick Hamada

ASP is relatively stable and lead times actually if anything continuing just to come in a little bit.

Brian Alexander

Steve?

Unidentified Analyst

(question inaudible)

Rick Hamada

Well the big starting point there is where are we with the days and velocity as we end December and assuming that we were at a normalized level at the end of December based on all the results that come in, then it takes investment to support growth in the EM business right. The goal's never been to get inventory to zero. It's just a matter to maintain the proper turns and velocity that keeps us at our return level that keeps us at the 12.5% ROC or above. So it really is where is the velocity starting point and velocity took a little bit of a hit coming out of Q4 into Q1. We think if we bring the inventory down with sales this particular quarter it's flattish to maybe a little bit of improvement so therefore if that happens that way, we may not have a linear increase with inventory off. I think it's plus four to seven is normal seasonality for our EM business in March quarter. But maybe instead of going up four to seven, we go up two to three. So in other words we're not going to be cutting inventory on a normal seasonal March coming off December in just about any scenario. I wouldn't believe that to be the case.

Brian Alexander

Ted?

Unidentified Analyst

(question inaudible)

Rick Hamada

We've had that question a couple of times. We've actually socialized it with a few of the VARs and you can't put a specific stamp on it and say it's been a positive boost here for this particular year-end. We may know some of that actually as it closes. But thus far, we haven't seen a noticeable jump in pipeline or activity just because people are trying to beat the deadline on it.

Brian Alexander

Any other questions in the audience? Maybe just touch on M&A strategy. You had this acquisition yesterday. Your main competitor's been going this IT asset disposal track, which seems like maybe you are now as well. Is that something you see as a much larger opportunity and just kind of where might you generally be focused from an M&A perspective?

Rick Hamada

So we continue through both of our – the core businesses of EM and TS across all three regions there are active pipelines. There's a small number of larger deals, Brian, and a large number of small deals. But it's part of our disciplined process, what we call our rainmaker process, to work with each of the regional presidents on a systematic basis and very structured process regarding improving MDAs, LOIs, when are we going to do due diligence. All those types of things. And so that takes place in the mainstream business.

Outside of that we've talked about pursuing adjacencies particularly in the more mature advanced economies where there's slower overall growth and taking a look at reverse logistics as an overall segment. We've made a number of acquisitions in that area. The most recent ones were a broadband integrated center cell. We announced one I think last week or two weeks ago called Pinnacle Data and then the one yesterday was Nexicor. And we're going to crawl before we walk and walk before we run but we're trying to take a look at opportunities where we can leverage some of our existing core competencies, perhaps just in a little different direction. But still having some common, maybe some supplier linkages.

We've got an opportunity where we think there's a good profit model and a good opportunity perhaps to do some consolidation where it's a very fragmented industry today. But still a multi billion dollar revenue and multi million dollar profit pool that we could be a participant in. So that's what we're doing with this series of acquisitions and events. We're keeping an eye on it. It's still, it's under a $500 million business for us today so it's not really moving the needle yet. But as we learn we're particularly interested in looking at opportunities for scaling it as we get there. We think some of the key drivers in this area are the greening of IT ecological concerns, but also in some cases on some of the devices that we get involved with it's about customer convenience and it's also about the lifecycle of some of those products particularly in the consumer space. There's such a quick lifecycle overall, creates an opportunity for a lot of motion and activity that we may be able to provide some services for.

Brian Alexander

Last chance for questions. Six months as CEO, 28 years at Avenet. I don't think you plan to do much differently than you're predecessor for the company but maybe reflect on what you've learned the first six months and to the extent that you think certain changes are needed or a certain direction. If you could just elaborate on what you've learned so far.

Rick Hamada

Yeah. I have learned a ton. I don't know if I can sum it up in 30 seconds or less but I will tell you that for my first 27.5 years at Avenet, I was living and dying on quarterly results. And as a CEO it's still very important to me but I would say the one thing that’s really hit me is also thinking longer term about Avenet. Getting Avenet positioned for some of these longer term trends of the future and how's the cloud going to impact our business. And what's going to happen when we've got geographic expansion completely covered now and then how does the business move around the world. And where are the opportunities and adjacencies. I really enjoy spending more time thinking about that longer term future for Avenet because there's a great team in place taking care of the day-to-day. And Roy and I worked on it very, very hard to have a very seamless and smooth transition, which I believe thus far, knock on wood, that it's exactly the way it's gone. And very, very pleased to see those set of developments overall.

There's – again so many things come to mind as far as the key lessons overall. There's really a great foundation at Avenet. Very particularly proud of the culture. Very proud of the team. People that we've got in place today. But I've also let the team know, look. You can count a lot of continuity from Rick, but let's not be thinking business as usual at Avenet. Think about it in rough terms. During Roy's 13 years as CEO, rough numbers, he took us from $6 billion to $26 billion. That was a heck of a journey. So the next chapter starts at $26 million and goes to some number. So what's it going to take to do the next leg of the journey. And some of the things we did from 6 to 26 still apply but we're going to have to do some things differently to get to the next level. And that's the kind of messaging and the kind of expectations I've been setting with the team regarding what's Rick going to achieve.

Because I'll tell you that question is as popular inside the company as out. That's another thing I found out. And I'm trying to find that right balance of a lot of continuity but not business as usual. And that's the best way I can put it.

Brian Alexander

Great. Well thank you for your time, Rick.

Rick Hamada

All right. Thank you.

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