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Avnet Inc. (NYSE:AVT)

Q3 2008 Earnings Call

April 24, 2008 2:00 pm ET

Executives

Vincent Keenan - Vice President of Investor Relations

Roy Vallee - Chairman of the Board and Chief Executive Officer

Raymond Sadowski - Chief Financial Officer

Harley Feldberg - President of Electronics Marketing

John Paget - President of Technologies Solutions

Analysts

William Stein - Credit Suisse

Jim Suva - Citigroup

Brian Alexander - Raymond James

Matthew Sheerin - Thomas Weisel Partners

Steven Fox - Merrill Lynch

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. Please go ahead.

Vincent Keenan - Vice President of Investor Relations

Good afternoon and welcome to Avnet's Third Quarter Fiscal 2008 Corporate Update. If you are listening by telephone today and have not accessed the slides that accompany this presentation, please go to our website, www.ir.avnet.com and click on the icon announcing today’s events.

In addition to disclosing financial results that are determined in accordance with Generally Accepted Accounting Principals, or GAAP, the company also discloses non-GAAP results of operations that exclude certain items.

Reconciliations of the company’s analysis of results to GAAP can be found in the Form 8-K filed with the SEC today and several of the slides in this presentation and on Avnet's investor relations website.

As we provide the highlights for our third quarter fiscal 2008 please note that we are exclusively structured integration and other items involved the current and prior year period in the accompanying slides. Additionally in discussing pro forma sales or organic growth prior period are adjusted to include acquisition. In respect of our recent offer to acquire Horizon Technology Group plc, we know that this offer is regulated by the Irish takeover rules and these rules. Under this rules we required to have a representative of our financial advisors Banc of America Securities to present the situation of this call and we are not in a position to disclose any material new information first questioning significant new opinion open above the information continued in the offer announcement of April 18.

Before we get started with the presentation of 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 SEC.

In just a few moments, Roy Vallee, Avnet's Chairman and CEO, will provide Avnet's third quarter fiscal 2008 highlights. Following Roy, Ray Sadowski, Chief Financial Officer of Avnet will review the company’s financial performance during the quarter and provide third quarter fiscal 2008 guidance, after which I will follow. Also here today take any questions may with related to Avnet’s operations is Rick Hamada Avnet’s Chief Operating Officer, Harley Feldberg President of Electronics Marketing and John Paget, President of Technologies Solutions. With that, let me introduce Mr. Roy Vallee to discuss Avnet’s Third Quarter fiscal 2008 business highlights.

Roy Vallee - Chairman of the Board and Chief Executive Officer

Thank you Vince and hello everyone, thank you all for taking the time to be with us and for your interest in Avnet. Before we get started with results for the quarter, I would like to once again express my and our management teams disappointment with our performance this quarter. The impact of lower than expected revenue in some product categories was compounded by other issues at our technologies solutions operating group creating a significant short fall to your expected earnings. We believed that most if not all of these other issues were proved to be shortlived. The compensate for the revenue weakness we begin to take corrective actions at the end of March and in the process of taking other targeted actions in the June quarter that should facilitate the resumption of progress toward our financial goals. Although no one can be sure a future revenue growth in the current economic environment we remain committed to achieving our stated financial goals and we will continue to manage our business accordingly.

In the March quarter, total revenue of $4.42 billion grew 13.3% as compared with prior year quarter, and earnings per share excluding restructuring and other items grow 4.1% over the year ago quarter. We are disappointed with the rate of EPS growth this quarter which does not reflect the financial goals that we have set for ourselves.

While some specific issues at technology solutions contributed to this weaker than expected earnings performance. The bigger factor was lower than expected revenue growth in certain product categories namely enterprise servers. Although we do not see a broad based industry slowdown, it is clear that macroeconomic issues are having an impact on our rate of growth in some areas of our business.

As a result, we are taking targeted actions to adjust our cost structure at certain business units that has been negatively affected. In addition, we have some acquisitions integrations underway that we expect to benefit from in the June quarter. As with all our integrations we will deal to our policy of best people and best practices and are confidence that with the infusion of new talent we will become a stronger and better company.

A positive note, we generated a $156 million of cash from operations this quarter and $498 million over the last four quarters. This performance when combined with our already strong balance sheet provide us with the financial flexibility to pursue value creating acquisitions that further increase our global scale and scope advantages and accelerate the creation of shareholder value. As an example, we recently announced an offer to repurchase Horizon Technology Group and distribute Enterprise IT products in the UK and Ireland. Horizons leading position with key technology venders and a growing professional services practice offer an opportunity to boost our Avnet’s competitive position in Europe. The fair actions which is anticipated to be completed by the end of June supports Avnet’s returns on capital rate and is expected to be accretive during by approximately $0.10 per share in fiscal year 2009 excluding integration charges. And however this was a challenging further, I would like to point out that despite the slowing organic growth we have encounter this fiscal year, we have generated economic profit for each of the past six quarters, excluding restructuring integration and other items.

Our industry leadership position and focus on value based management has allowed to weather some market related challenges and continue creating shareholder value. Based on our existing level of revenue, the actions we’re taking should get us back on our desired rate of progress towards achieving our financial goals and we will continue diligently manage margins and return across our port folio of businesses.

For the third quarter a fiscal year 2008, technology solutions explains week organic growth in enterprise servers which was compounded by lower rebates resulting in a surprising and significant impact on its profitability. For the quarter, operating income margin of 2.3% decline us compared with prior year quarter and fell well below our stated financial model. We have been analyzing the issues determining the necessary actions and executing those actions as soon as appropriate. Let me review the major items for you. Softness in some product areas, most notably enterprise servers resulted in lower sales and gross profit dollars in the quarter. Looking at it on a geographic basis, a rough split of the TS profit shortfall was 60% in the Americas and 40% in EMEA. In the Americas region, overall weakness in servers was exacerbated by one of larger business units where we saw revenue pushups at the end of the quarter resulting in lower revenues and rebates.

At TS and EMEA, lower sales measured in euros drove lower rebates which when combined with a rebate program change by a large IT supplier resulted in gross profits in that region being significantly below our expectations. Based upon support from both suppliers, we believe that the rebate programs and goals for the June quarter are appropriate.

TS profitability was also impacted by higher than forecasted expenses in the EMEA region, due primarily to integration synergy cost savings from our latest acquisition taking a quarter longer than originally expected to achieve. And due primarily to negative organic growth in some business segments of TS, EMEA. Planned progressed towards our financial goals have fallen behind. As a result, we are taking cost production actions where appropriate and we expect to substantially complete the integration of Acal in the June quarter.

Please remember that TS had delivered 18 consecutive quarters of year-over-year operating income and operating income margin expansion prior to this quarter’s shortfall. Although this was a particularly challenging quarter, we are optimistic that we can regain those margins once our integration and restructuring actions have been completed. And while our Americas region has historically been more profitable than our EMEA region, we continue to believe that our strategy in TS EMEA will result in it achieving our long term target for return on capital of at least 12.5.

It wasn’t that long a ago that our EM EMEA region was also struggling with profitability issues that they had to integrate in a acquisition streamline processes and expand geographically. And just as EM EMEA has grown to be a major contributor to Avnet’s overall success, we expect TS EMEA to do the same thing in the not to distant future. We plan to continue to invest in that growth opportunity and build on our position as the leader in value added IT distribution.

In the March quarter, technology solution sales of 1.8 billion was up 23.2% year-over-year on a reported basis and up 18.3% when adjusted to exclude the impact of changes in foreign currency exchange rates. On a Proforma basis to account for acquisitions completed in prior periods TS sales were 10.2% higher than a year ago. While overall revenue in dollars was inline with management expectations, as I stated earlier there were specific shortfalls at a product level that negatively impacted gross margin and operating income. All three regions delivered positive year-over-year revenue growth as the Americas, EMEA and Asia were up 2.9, 72.4 and 78.9% respectively.

On a Pro forma basis adjusting for acquisitions EMEA grew 21.4% and Asia was up 32.4%. Strong double digit growth in storage, solutions, networking, software and services was somewhat offset by negative growth in servers.

We also saw a strong growth in processors and memory modules on a year-over-year basis, although I would remind you that last year was a relatively easy compare for those products.

Looking ahead to the June quarter we expect slightly less than normal seasonality for the technology solutions business which is expected to grow sequentially due to the SUN Microsystems fiscal year end. While we are not convinced that the pushups experienced at the end of March are part of a larger trend due to the strength we see in other products. We are a bit cautious and we will be closely monitoring the market for any signs of a board based slowdown.

Turning now to the results for electronics marketing. The third quarter of fiscal 2008 can be characterized as another quarter of steady improvement in key finical metrics despite the sluggish demand environment. In the Americas region where we are now delivering modest year-over-year growth both operating income margin and return on working capital grew sequentially and year-over-year. Operating income margin improved 28 basis points as compared with the year ago quarter and our working capital was up 104 basis points, above our 30% target for both the quarter and the fiscal year-to-date.

Even though sequential sales growth of 3.2% at EM Americas was a bit a below normal seasonality and our expectations for the March quarter, our team did an excellent job improving gross profit margin and managing expenses driving year-over-year operating income drop through to 82%.

In the EMEA region EM continues to face a challenging market as year-over-year pro forma sales growth and local currency declined for April straight quarter.

Despite this challenging environment, our team has done a good job by focusing on profitable revenue, expense control and asset velocity. Even though EM EMEA revenue was down 6% of local currency, gross profit margin was up 48 basis points and operating profit margin was 7 basis points higher as compared with the year-ago quarter.

Working capital velocity was up both sequentially and year-over-year which when combined with the improvement of operating income margin drove return on working capital a 102 basis points higher as compared with the third quarter fiscal 2007, due more than 30% for the quarter.

In Asia, where we recently strengthened our position in the IP&E market with our acquisition of YEL, year-over-year organic growth has continued in the high single digits for the past four quarters. As a result of the scale and scope we have created in EM Asia, year-over-year operating profit margin has expanded in every quarter of fiscal year 2008.

This performance when combined with disciplined working capital management has resulted in steady year-over-year improvement in velocity and return metrics. EM Asia's operating income margin increased 7 basis points year-over-year which when combined with improved working capital velocity drove return on working capital up 78 basis points.

Through nine months of fiscal 2008, EM Asia's working capital velocity has improved 14% and its return on working capital has grown 378 basis points as compared with the comparable period in fiscal 2007.

In summary, our EM team around the world has been doing a good job of driving performance and generating positive economic profits in the face of sluggish organic growth. This steady improvement is evidence of our strong market position and the value we are delivering to our customers and suppliers.

In third quarter fiscal 2008, EM revenue of 2.62 billion was up 5.8% sequentially on a reported basis and up 3.8% pro forma after adjusting for the YEL acquisition which was completed on the first day of the quarter.

This sequential growth was slightly below normal seasonality with all three regions finishing below our expectations. On a year-over-year basis EM revenue was up 7.3% in delivered dollar and 2.5% excluding the impact of changes in foreign currency exchange rates.

The Americas region delivered another quarter of year-over-year growth with sales up 4.3% as compared with year-over-year growth of 3.7% in the December quarter. On a reported basis, the Asia region grew 13% as compared with third quarter of fiscal 2007 and 6.6% on a pro forma basis.

As I mentioned earlier, the EMEA region continues to be the most challenged with year-over-year revenue declines in constant currency for the fifth consecutive quarter. After adjusting for the acquisitions of Flint and Medtronic in the first half of fiscal 2008, EMEA pro forma revenue grew 4.6%.

Looking ahead the fiscal Q4, we currently expect all regions to experience typical seasonal trends which would produce another quarter of mid single EM growth rates year-on-year. Customers have remained cautious with their purchases, channel inventory appears lean, and stable lead times provide little incentive to order beyond current consumption.

Similar to December, we exited the quarter with a one-to-one book-to-bill-ratio and we continue to monitor incoming orders, cancellations and push outs for any signs of the current macroeconomic environment is meaningfully impacting our business.

While there are legitimate concerns about market growth, we are confident that our focus on delivering value globally through our design and supply chain services will continue to benefit us, as evidence by the fact its several suppliers had changed their channel strategy and we ordered Avnet with a greater share of their business.

Now, I would like to turn the commentary over to Ray Sadowski, Avnet's Chief Financial Officer. Ray.

Raymond Sadowski – Chief Financial Officer

Thank you, Roy. Hello everyone. Let's begin with a review of our operating results for the third quarter fiscal 2008 as compared with the prior year quarter. Please note that we've included a reconciliation to GAAP net income at the bottom of the slide to account for the restructuring, integration, and other items recorded in both the current and prior year third quarters.

In the March 2008 quarter, sales were 4.42 billion were up 13.3% in reported dollars and up 8.4% in constant dollars as compared with the year-ago quarter. Organic revenue growth was roughly 7.1% over the year-ago quarter.

Gross profit of $578.7 million was up by $43.9 million, or 8.2% as compared with the third quarter fiscal 2007, due primarily to the impact of acquisitions and the year-over-year weakening of the U.S. dollar against the Euro.

Year-over-year consolidated gross profit margin was down 61 basis points. However, electronic marketing gross profit margin was up 25 basis points year-over-year due to continued focus on the growth of profitable revenue.

EM America's gross profit margin was flat year over year. EM in the Europe and Asia saw margin improvement. Technology Solutions gross profit margin was down 150 basis points year over year primarily due to the rebate issues that we addressed earlier and other factors.

Operating expenses of $401.1 million were up by $47.4 million, or 13.4% year-over-year, largely due to the acquisitions that occurred during the year and the impact of the weakening of the U.S. dollar against the Euro.

We expect the impact of ongoing acquisition integrations, and the corrective actions addressed by Roy earlier will have some positive impact in the June quarter, further benefit in the September quarter, but the full benefit being realized in the December quarter.

Operating income of $177.6 million decreased $3.5 million or 1.9% as compared with the prior year quarter. Operating income margin declined 62 basis points year-over-year to 4%. Again the decline in both operating income and operating income margin was due to some sales weaknesses compounded by the rebate issues.

Below the operating income line, year-over-year interest expense was down $1.2 million due to low average short term debt outstanding and lower short-term interest rates. Other income was down 1.9 million sequentially and 3.8 million higher than the year-ago quarter primary due to foreign currency gains and the income from our share earnings from Caleb LLC, which is accounted for as a non-consolidated investment.

The sale of Caleb LLC to Insight Enterprises Inc. was closed on April 1st 2008 and we received approximately $60 million in cash during the fourth quarter which resulted in a fourth quarter fiscal 2008 non-operating gain of approximately $39 million.

In addition, we could receive potential future proceeds from amounts to be held in escrow and potential earn-outs up to approximately an additional $30 million in cash.

Taxes or income before restructuring integration or other items decreased $3.9 million year-over-year due primarily to a low effective tax rate. The effective tax rate on the March 2008 quarter was 100 basis points up sequentially and we currently estimate that our effective tax rate will be between 30 and 32% for the fourth quarter of fiscal 2008.

Excluding restructuring integration and other items, net income in the third quarter of fiscal 2008 increased by $5.4 million or 4.9% to $114.8 million increasing diluted earnings per share to $0.76 up 4.1% as compared to $0.73 per share in the year-ago quarter.

GAAP net income increased $2 million to 107.2 million or $0.71 per diluted share as compared with net income and earnings per share of 105.2 million and $0.70 respectively in the prior year quarter.

I would like to remind you that as a services company, the vast majority of our expenses are variable in nature. As we had communicated to you last week and today, we'll continue to expand and contract appropriately to closely align our expense structure and working capital investments with market conditions.

This next slide looks at key productivity metric of expense dollars to gross profit dollars over the last four years. The bars represent the individual quarters while the trend line depicts the performance over a trailing 12-month period at the end of each quarter.

On a trailing 12 month basis, our ratio of expense to gross profit dollars improved 69 basis points from 67.6% at the end of last year’s March quarter to 66.9% in the current quarter. At the operating group level, electronics marketing improved year-over-year relevant fourth quarter expense to gross profit ratio by 20basis points. However, technology solution increased its ratio by a 134 basis points due to the items discussed earlier relating to both gross profit and expenses.

The third quarter fiscal 2008, the ratio of operating expense to gross profit dollars increased 317 basis points year-over-year, due to the reasons discussed earlier at technology solutions.

Similar to last slide we’re providing both quarterly and a trailing 12 month trend line which put rate operating income margin over the last four years. The trailing 12 month operating income margin remains flat year-over-year at 4.3%.

As we look at the third quarter fiscal 2008 on a standalone basis, operating income margin of 4% decreased 62 basis points over the prior year. At electronics marketing, operating income margin improve 6 basis points to 5.9%, while technology solutions operating income margin of 2.3% was down significantly by 185 basis points as compared with the year go quarter.

As we mentioned earlier we’re taking corrective actions to address to the client and an operating income margin. The impact of these adjustments should have some positive impact on operating expenses in the June quarter. However, we also expect business mix will have an impact on the overall improvement of these as TS and EM Asia should represent a greater percentage of the enterprise revenue in our June Quarter.

TS and EM Asia have both a lower gross profit margins and operating margins, but at higher working capital for largely annual returns as compare with a rest electronics marketing. Going into the fourth quarter we expect the increase in technology solutions revenue for the fiscal year end at Sun Micro systems were along largest suppliers.

For the third quarter fiscal 2008 return a capital decline 123 basis points to 10.2% as compared with 11.4% in the third quarter fiscal 2007. On a trailing 12 month basis, return on capital employee decline 88 basis points to 11.6% in third quarter fiscal 2008.

As we communicated at our analyst y day in December, we’re committed to our long range plan of 12.5 to 14% in a 2 to 3 year of timeframe. Just as we communicated this week about our acquisition of Horizon Technology Group, we will continue to pursue value creating acquisitions as long as they meet our three key criteria cultural, strategic and economic fit so that we can drive share holder value creation in increased or scaled advantages.

As depicted on this next slide, cash flow from operations that was cash flow generation before checking to account cash used or acquisition capital expenditure and another items was 400 to 898 million for the last four quarters.

In the third quarter fiscal 2008, we generate 156.4 million of cash from operations due to the combination of earnings and prudent working capital management. In with relatively soft revenues we are able to increase inventory returns and working capital velocity over the prior year.

Our sequential basis immature was up $140 million with currency and acquisitions accounted for close to 60% of that increase. Excluding at acquisition and change in foreign currency exchange rate immature was up %15 million at EM and approximately $9 million at technology solutions. And the enterprise level the net days were flat as compared to third quarter fiscal 2007 and we have not seen a deterioration elation over receivables despite raw publicize concerned in the credit markets.

Again with another solid quarter of significant cash flow generation, we continue to strengthen our balance sheet and improve our credit statistics. While trailing 12 month basis at the end of the third quarter fiscal 2008 that EBITDA remained at 1.5 and EBITDA coverage was 11.5. Since we exited the quarter with $381 of million and over one billion of liquidity we can look forward continued tightening in the credit markets and I want to position to continue to fund growth and pursue value creating acquisitions as long as a meet our criteria.

Looking forth average fourth quarter fiscal year end 2008 management expects no more seasonality at EM with anticipated sales to be in the range of 2.60 billion to 2.70 billion, and sales per technology solutions to be slightly below your most seasonality, and sales between 1.95 billion and $2.05 billion. Therefore average consolidated to sales of fore cast to be between $4.55 billion and $4.75 billion for the fourth quarter fiscal 2008.

Management experiences fourth quarter fiscal year 2008 earnings to be knowing just $0.79 to $0.83 per share. This EPS guy discussed not include the amortization of intangible assets or inflation charges related to acquisitions that have closed or will close in the June quarter and restructuring charges, which will be offset by the previously announced gain of a sale of the company's interest in Calence LLC. This guidance is identical to that given last week and is based upon an additional week of analysis and positive sales results for the first three weeks of the quarter.

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

Question-and-Answer Session

Operator

Thank you. Ladies and gentleman, we'll now be conducting a question-and-answer session. (Operator Instructions). Our first question comes from William Stein with Credit Suisse. Please proceed with your question.

William Stein

Thanks, good afternoon. I am trying to address the push-out in the rebate. Again I know we discussed it kind of I think a few days ago, but were these related to the same supplier in both US and Europe, different supplier one in each region, or are we seeing this in a mix of customers across the supply base?

Raymond Sadowski

Hi, Will its Ray. The revenue weakness in servers is across multiple suppliers and across both the Americas and the EMEA region. The specific customer push-outs that were referenced regarding the Americas were with one of our largest suppliers and the change in the rebate program in Europe was with a different, but a large supplier as well.

William Stein

Okay, great. One other, on the weakening price servers, is that industry standard, in other words are you also seeing a mixed shift away from one to the other; and was that part of the rebate issue or was this across both types industry standards and proprietary?

Harley Feldberg

There was a deeper decrease across all the server bands. We did not see a significant change in the mix between industry standard and enterprise in this issue.

William Stein

Okay great. Thank you very much.

Raymond Sadowski

You are welcome.

Operator

Thank you. Our next question comes from Jim Suva with Citigroup. Please proceed with your question.

Jim Suva

Hi, thank you very much. For the push-outs, do those then come in and get booked and closed in the first part of April here or do they get pushed outside the end of June and I have got some follow-ups?

John Paget

Yeah, Jim this is John Paget. We've already seen a fair number of those push-outs being booked and shipped already in this month; certainly tracking some of those others. But at this point we're beginning to see those closing and move forward into the quarter.

Jim Suva

Great, on SG&A, I guess it came up more than what I would have thought especially considering that you know things kind of fell apart here in the last part of the quarter. Can you talk about SG&A? Why wasn't it more flexible? Whey weren't you able to be more nimble around that and what should we expect kind of going forward on SG&A line?

Roy Vallee

Hi Jim, it is Roy. I want Ray to see if we can dig out for your. I don’t know, if we have got handy here Ray, what portion of that increase will be attributable to currency and what portion would be attributable to MNA and therefore of what's left as organic changes in operating expense?

Jim Suva

Okay. And then maybe later on during the Q&A, he can try me with that. I thought you only closed one thing during the quarter and that was YEL. But maybe I am misspoken. So let me ask my question while they look that up and then move it on to the next caller. But for June the EPS outlook despite all the changes and things like that, it still looks like we are going to be down year over year despite sales growing up year over year. How do I reconcile that with when you talk about how are able to re-negotiate more favorable terms in rebate. It still seems like you are getting a short end of the stick here with again EPS being down year over year yet sales being up year over year, plus your restructuring and cutting costs.

Raymond Sadowski

Yeah so, Jim let's walk down the P&L okay. So, sales are sales and we've given the guidance. You guys have that number. Gross margins, if we talk at the EM level gross margins were actually up slightly and our big challenge was at TS and the real issue in the margin was rebate related. Certainly, when you look at gross profit dollars, you would say it is volume and rebate related, but on the gross margin, it is rebate related.

Jim Suva

I want to make sure we are all talking about the June quarter. The June quarter outlook?

Raymond Sadowski

Yeah I’m with you.

Jim Suva

Okay.

Roy Vallee

So as we look at the June quarter we believe that the rebates that are in place now are fair and reasonable, they are appropriate. What we don’t now of course is what will our sales be and what will the mix of those sales be and therefore we don’t know if our TS gross margins will come all the way back to where they were prior to the March quarter. So we have baked into our forecast some improvement, but not a 100% recovery at the gross margin line. And then as you go to operating expenses, what’s happening is yes we’ve got some integrations that still need to occur and the synergy cost savings extracted that is happening during the June quarter, which will not actually get the full benefit as Ray said until December. But some impact in June more in September and then full impact in December.

And then the last piece and I apologies for the complexity but I’m trying to walk you through this. In addition to all of that we simply are getting lower sales then we had anticipated in local currency from Europe and in certain product categories for America. And that’s were the restructuring actions are taking place. But the actions that will be executed this quarter once again will have a light impact in June, a bigger impact in September and we would think a full impact by the December quarter.

Jim Suva

Okay

Roy Vallee

So you should expect EPS to move back in to a growth mode as we get gross profit margin normalized and we complete both the integrations and the restructuring actions that we have announced.

Jim Suva

So that’s September or December?

Roy Vallee

Both. You’ll see a large impact in September. There maybe some spill over based upon things like notice periods and works councils in Europe and that sort of thing.

Jim Suva

Hey, John did competition in the server area did it increase since rebates and buyings didn’t come through. Are you seeing a more competitive environment?

John Paget

We haven’t seen a significant increase in the competitive environment, no.

Raymond Sadowski

So another way to answer that Jim is that we have a mature growth margin. Which you might think of as the transaction gross margin and knowing how the net that includes the rebates of all with some other adjustments. And we have not seen a significant change in our material gross margin. Its essentially flat the big change is in the net gross margin.

Jim Suva

Yeah, I just want to know if competition heated up since you weren’t making the volumes?

John Paget

No, in many cases for example in America, this is just sort of a reminder that there is a system in place in America that apply to the vast majority of our server revenues whereby resellers can only elect to change distributors on a periodic basis. In some vendors it’s annual in other vendors its every two years. But the resellers essentially can’t shop the servers from distributor to distributor. On the other hand Europe they can but the stickiness of it involves our marketing programs our technical support the things that we are doing in cooperation with the reseller or in partnership and it makes switching difficult at the enterprise level. Nothing possible, but difficult.

Jim Suva

So you haven’t seen [interim micron] tech data start to be more competitive in this area?

Roy Vallee

Once again Jim that we don’t directly compete with them.

Jim Suva

Right.

Roy Vallee

And in most of our categories, certainly we do in some of the industry standards server categories the differences we would be building at integrated solution versus selling the products up there.

Jim Suva

Great. Thank you, gentlemen.

Raymond Sadowski

Okay Jim. Just responding to your question relative to expenses. If we look sequentially expenses increased by roughly $12 million. And of that $12 million about 4 million-4.2 million related to currency. So it’s just a translation effect of currency. And then roughly 7 million related to acquisitions all right and so the acquisitions, keep in mind the biggest one being Acal which we acquired towards the mid part of December and therefore only have a little bit expenses in there. And then a full quarter of expenses in this quarter as well as some of the smaller acquisitions. So, virtually all of the increase quarter-to-quarter sequentially was either currency or acquisition related.

Jim Suva

Thanks. That’s very very useful. Thank you gentlemen.

Raymond Sadowski

You’re welcome.

Operator

Thank You. Our next question comes from Brian Alexander with Raymond James. Please proceed with your question.

Brian Alexander

Yeah I’m afraid if we are beating a dead horse here Roy, but you started by saying that most if not all the issues will be short lived. And then you also said you think rebates levels for June are appropriate and reasonable. What has to happen for the margin shortfall related to the rebated piece which I think about 100 or 120 basis points? So its fairly significant. What has to happen for all of that to come back. Do you have to see growth re-accelerate to level that you are experiencing before? Is it not really dependent on growth and more dependent on these other variables that you get rebated on? Or is it continued negotiations with these vendors? I’m just failing to understand how we get back to where we were if the server environment remains depressed for a period of time.

Roy Vallee

Okay. I’m going a stab at that but I’ll ask Rick or John, if they want to either correct me or add some color to it. But here’s the view. So Brian lets step back first of all and remind everyone that some of the rebates. Let me back up even one more step. Rebates for technology solutions this is not electronics marketing for technology solutions on average approximate the total operating income for technology solutions, okay. Now within the rebate category there are fundamentally two kinds of rebates one that we described last week is infrastructure and one that was described as performance based.

The infrastructure is not variable based on revenue, okay. So the piece that is variable based on revenue for the most part gets re-established on a quarterly basis. So the goals get reset and then we have this anomaly last quarter the March quarter where we also had a program change aside from the goal resetting, okay. So when you asked the question what needs to happen, its kind of simply this from the time the rebates get set until the time the quarter is over we need realizes and normalize the environment. There’s needs to be not much change to the negative during that time frame. Once we get reset at a lower level and we can achieve the goals set forth in the rebate plans gross profit margins will be normalized, okay. So it is conceivable in the June quarter.

Let me say it to you this way if we do not encounter further weakness in either servers or other parts of the TS portfolio we should get to a more normalized gross profit margin. So as soon we get there, as soon as we get to that normalization from the time the rebate goals are set until the time the revenues are counted for the quarter that when we get back to a 100% achievement.

Brian Alexander

So you’re still very comfortable that this is not secular and once we kind of get back to normalized growth or least no more disappointments we’ll get back to the margin structure we are all accustomed to.

Roy Vallee

Brian again and I’ll now ask John to lift the chime in but we have seen very open and very collaborative dialogue with our key supplier partners. Theirs is no intent to harm us financially they still appreciate the value we’re delivering to them. We’re integral to their strategy and we feel like that the conversations that have taken place and the rebates their set forth in the June are fair and reasonable. If this was a secular shift we feel uncomfortable with either the program or the goals and we are not uncomfortable with either.

Brian Alexander

Okay, good. And then just a follow-up and I know we’ve talked about this in the past but maybe as you have done some digging over the last few days you’ve come up with a different answer if its applicable. But under the assumption that servers will continue to shift towards industry standard just remind us how the margin profile varies between industry standard and proprietary. I think in the past you’ve talked about the margin structures at the operating margin level being comparable. And I’m just wondering if that’s still the case?

John Paget

Brian I would say that is still the case. And I would just as we’ve talked about in the past. Industry standards servers we sell in an integrated solution, so as an example virtualization consolidation and the services and the intellectual property that we add to that bring back to relatively the same return.

Roy Vallee

And Brian one more thing. Industry standard serves as you know spans a big range of products right. From on place to multiple way enterprise hardware and we essentially don’t play one ways the two ways we being to get involved at four ways and that above and so, it’s the more complex, more technical hardware plus what John said about then in a solutions environment.

Brian Alexander

Great. And then just to shift gears, on the Horizon acquisition if we just look at the publicly disclosed numbers that they have out there, it seems very difficult to get them to that 12.5 hurdle rate. So what are you assuming to get them to that hurdle rate, it almost implies that the margin there would needs to double or maybe there are some assumptions about cross selling that we should be aware of?

Roy Vallee

So Brian unfortunately, and this is a unique case for us, this is a public company traded in island, we are literally being regulated on what we can say until we own the company. As soon as we own it, we will led forth for you that the integration strategies, the Synergic costs savings and our rationale for why we believe the numbers are the number, but at this point we are restricted from commenting.

Brian Alexander

Understood thanks Roy.

Roy Vallee

You are very welcome.

Operator

Thank you. Your next question comes form Matthew Sheerin with Thomas Weisel Partners. Pleased proceed with our questioned.

Matthew Sheerin

Thanks, I promised to ask no more questions on computing business. Since the question is actually on components and you’re pretty clear last week sorry on what you are seeing, but there is a little bit of a disconnect between what Arrow said yesterday regarding Europe on the components side where they are seeing and it looks like a pretty weak book-to-bill below one softening conditions where it worse, you folks although, I know you talked about some pricing issues surrounding the Euro and other competitive issues, it doesn’t seem like you’ve seen that kind of softening or non as bears on that market. So could you talk about what you are seeing and why that might be different from Arrow?

Roy Vallee

Sure Harley, I want you to take that one.

Harley Feldberg

Alright I am in. Clearly there are concerns that we are watching European market, as Roy mentioned in earlier script we’ve had a couple of quarters of declining revenue in local currency, but we just don’t see the market deteriorating at an accelerating rate at all quite frankly. You know it’s a difficult to answer Matthew, you asked me to comment on our competitors view. I would say that from what I can tell we are doing an excellent job of gaining market share in the market, we’re managing it very prudently, and we don’t see it with a degree of long you describe.

Matthew Sheerin

Okay thanks. And then again on components, you did announced that you announced a couple of key exclusive winds with some semi suppliers at late fall, and I know that some of your other competitors recently have lost some key lines namely in future electronics. So are you starting to see benefits from those improved relationships or will that come later?

Harley Feldberg

We are absolutely starting to see benefits from that and those benefit will accelerate moving into the June quarter?

Roy Vallee

And Math that’s part of what’s in our guidance for the June quarter. So we are guiding normal seasonality, but we have some uplift from these suppliers moves that is supporting us along with the impact of bizarre acquisition kicking in at the June quarter.

Matthew Sheerin

Okay and just lastly and more so for you Harley on the IP knee side, we are hearing some of the connector suppliers and maybe even some of the passer guys talking about passing along some raw materials price increases they’ve seen, are you starting to see that yet? And are you generally pretty successful in passing those prices along to your customers?

Harley Feldberg

Generally Math we are. We haven’t seen it to the degree that was discussed in one of the major calls I think frankly just couple of days ago. But I think they tend to talk about there largest customers, but we’re seeing some of it, and yes generally speaking, we are able to pass that on.

Matthew Sheerin

Okay.

Roy Vallee

Math, a no way to think about that is our gross margin and that product set and Harley (Inaudible) but I think its been pretty stable , as we watch the number were, our margins are flats. So therefore we are passing along what we are getting.

Unknown Company Representative

We are, we are. We see no deterioration in our gross margin over the last couple of quarter very consistently.

Matthew Sheerin

Great, thanks.

Company Representative

You're welcome.

Operator

Our next question is from Steven Fox of Merrill Lynch. Please proceed your question.

Steven Fox

Hi good afternoon, just to follow up on the question about European components on Harley’s comments. So I guessed the concern is that the industrial base Europe is becoming less competitive with their exports, and you're saying that that’s not an issue that’s coming up in your numbers at this point. Is that a concern yours or do you see some other trends? Can you just speak little bit more specifically on that question?

Harley Feldberg

Sure, how are you? This is Harley again.

Steven Fox

Hi Harley.

Harley Feldberg

One data point of value is that we did close the quarter with a one to one book-to-bill ratio in Europe. So we feel pretty good about our back log we feel very good about back log going into June. You know one of the areas that we are also growing is in IP&E we just mentioned with Math’s comment. So that’s good part of our growth in that region as well as globally. So that’s been included in our guidance as well.

Roy Vallee

And Steve our European leadership team, we've been talking about two concerns. One of them we can track we know for a fact which is average selling price erosion as measured in euros. The other one that you asked about relating to exports; we have been anticipating this problem. However, according to the published data that we've been looking at on a regional basis, we have not yet see a decline in exports from Europe our electronic equipment.

Steven Fox

Okay fair enough. Well I don’t know what to make the difference in the concern level. Is there anything in the customer base in Europe that would, between you and Harley that you could differentiate between?

Roy Vallee

I wouldn't think so Harley. And also Steve it could be first of all, there are some slightly different seasonal patterns between our two companies especially in Europe. You know Arrow for whatever reason has tended to have a little better December quarters and components in Europe. We tended to have a little better March quarters. And it might be how we deal with the January 1 scheduled order volumes. And then the issue that Math brought up earlier about some supplier change, that’s probably one of the factors. Recall also that in Europe we operate what we referred to as the speed boat model. That model may be allowing us to grow in some niche technical product lines that might also be making a difference. So I think it's really not anyone thing. It’s just a variety of things.

Steven Fox

Okay and then just a quick one for Ray. Total company growth excluding acquisition in currencies. Do you have a year-over-year growth number?

Raymond Sadowski

Total?

Steven Fox

Year-over-year -- organic growth after, not only after acquisition but also excluding the benefit in currencies for the total company. I know you gave it by different regions and segments, I didn’t roll up there?

Raymond Sadowski

Well didn't provide it on a Pro forma basis, but I will tell that from a total company perspective roughly 2.5%.

Steven Fox

Year-over-year?

Raymond Sadowski

Year over year

Steven Fox

Thank you

Operator

Thank you our next question is from (Shaun Connor) with FAF Advisors. Please proceed with your question.

Unidentified Analyst

Hi guys thanks for taking my call, just a couple of quick ones. First of all where your stock price is now versus even a month or two ago. At this point it make sense to start considering buying back your stock versus buying or doing additional acquisitions?

Roy Vallee

Shaun this is Roy. So a couple things one is, certainly the lower the stock price goes the more we think about a buy back. So I think that’s a obviously very fair question. On the other hand we're thinking about two other things which is one our acquisition pipeline, which is quite robust. It may be a strong as we've seen it since we actually started tracking in an acquisition pipeline. And to the extent that the acquisitions are in fact meeting and exceeding our hurdle rate for return on capital, we continue to think that that’s actually a better way to create shareholder value than the use the capital for a buyback. The other thing I will say is that we have a board meeting coming up in the May regularly scheduled. I'm sure this will be on the agenda for at least discussion topic. And whether its buy back or M&A we also are going to be a little bit cautious side related to liquidity, but we’re going to want to make sure that until we see a turn in the credit markets that our company is just rock solid from a liquidity point of view. So those are the things we are thinking about, we’re bias right now to try to be directing the answer, our bias is to continue to use our funds for value creating MNA as always we feel we can generate more shareholder value in that direction.

Unidentified Analyst

And just the follow up on the acquisition side of things, it seems like, I mean especially now that the pipeline has gotten more robust. The one concern is – is management getting to spread out or to thin out in the sense of, you can't focus on getting the synergies out of one acquisition. For instance, like maybe last summer when there was only one acquisition kind of going on, at that time it was much easier to worry about and get the synergies. Now you have got four, five six acquisitions going out at once. Hence, it's going to take a lot longer to draw those synergies out because you can't focus on just one?

Roy Vallee

Yeah Shawn again it's a very good and very fair question. Let me just make a point. The only acquisition in recent memory here where we have delayed the synergies is the Acal acquisition that we talked about here in the latest quarter. And the delay was not related to management bandwidth; it was related to market issues. We made a decision there that was in support of protecting the revenues.

Now, all that said, we do need to be very mindful of the number of acquisitions by group and by region. So in other words, if we will do a TS oriented acquisition in Asia, that doesn't have much of an affect on EM integrating Azure in Europe for example. But we are mindful of that. We keep that in mind and we want to be careful that we can actually execute everything we pull the trigger on.

Unidentified Analyst

And then just one last question, I'll let you guys move on. The one metric that you guys used to talk to a lot was kind of the incremental gross profit drop through, or how much gross profit, I mean, our taxes is a percentage of gross profit dollars and obviously I've moved up this last quarter when your gross margins probably didn’t cover, gross profit dollars didn't come through. Has your goal or your range changed as far as what that drop through you are expecting to get it through? And if you could just refresh us on what the goal is?

Roy Vallee

Yeah, the goal is when a business unit is operating at or above our return capital threshold, so that's at least 12.5% after tax return, then we look for a 50% drop through incremental gross profit falling the operating income.

At the enterprise level we have a substantial portion of our revenues, now in that category but we still have a meaningful piece that’s below. So as a result of that the enterprise drop through, all other things being normalized, if that’s possible, should be in the range of 60%. Ray does that sound right?

Raymond Sadowski

All right.

Roy Vallee

About a 60% drop through. And then Shawn I do want to, the risk of maybe adding a bit of confusion, I just want to point out an anomaly that's occurring right now due to this radical currency shift. So in Europe our EM business is up in dollars on a year-over-year basis, but the operating margins are essentially flat. In Euros we are down on a year-over-year basis and the operating margins are essentially flat.

So in other words, our team there is doing a very good job of managing through a difficult environment here for the last few quarters. However, the enterprise level drop through appears to be lower than we would like it to be due to the impact of currency in Europe.

Unconfirmed Analyst

Okay, great. Thank you guys for taking my question.

Roy Vallee

You're welcome.

Operator

Mr. Keenan, there are no further questions at this time. Would you like to make any closing comments?

Vincent Keenan

Yes thank you. As we conclude today’s quarterly analyst call, we will now scroll through the slide mentioned at the beginning of our webcast that contains 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 a downloadable PDF format at our website under the quarterly results section.

We would like to thank you for your participation in our quarterly update today. If you have any questions or feedback regarding the material presented, please contact Avnet's Investor Relations department by phone or e-mail.

Roy Vallee

Thanks everybody.

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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