Avnet, Inc.
Q3 2012 Earnings Call Transcript

Published: 26 Apr 2012

[Operator:]

Please stand by. Our presentation will begin now. I would now like to turn the floor over to Vince Keenan, Avnet's Vice President of Investor Relations. Thank you, sir. You may begin.

[Vincent Keenan:]

Good afternoon, and welcome to Avnet's Third Quarter Fiscal Year 2012 Business and Financial Update. If you're listening by telephone today and have not accessed the slides that accompany this presentation, please go to our website and click on the icon announcing today's event. As we provide the highlights for our third quarter fiscal year 2012, please note that in the accompanying presentation and slides, we have excluded restructuring, integration and other charges from both the current and prior year periods and a gain related to the negative goodwill from an acquisition during the current quarter. When discussing pro forma sales or organic growth, prior periods have been adjusted to include acquisitions and the impact of a divestiture, as well as the transfer of the Latin America computing components business from TS to EM in the first quarter of fiscal 2012. 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-U.S. dollar based financial statement into US dollars. And finally, when addressing working capital, return on capital employed and return on working capital, the definitions are included in the non-GAAP section of our presentation. Before we get started with the presentation from Avnet management, I would like to review Avnet's Safe Harbor statement. This presentation contains certain forward-looking statements which are statements addressing future financial and operating results of Avnet. Listed on this slide are several factors that could cause actual results to differ materially from those described in the forward-looking statements. More detailed information about these and other factors is set forth in Avnet's filings with the Securities and Exchange Commission. In just a few moments, Rick Hamada, Avnet's CEO, will provide Avnet's third quarter fiscal year 2012 highlights. Following Rick, Ray Sadowski, Chief Financial Officer of Avnet, will review some other financial highlights, our return on capital performance and provide further fiscal 2012 guidance. At the conclusion of Ray's remarks, a Q&A will follow. Also here today to take any questions you may have related to Avnet's business operations is 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 third quarter fiscal 2012 business highlights.

[Richard P. 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. Similar to the first 2 quarters of fiscal 2012, the pace of recovery continued to vary by region. However, we did see some incremental signs of encouragement towards the end of the quarter. At Electronics Marketing, the supply chain inventory correction that negatively impacted the first half of fiscal 2012 appeared to be nearing an end, as sequential revenue growth returned to more normal seasonal trends and the book-to-bill ratio finished at parity for the quarter. At TS, which was coming off its seasonally strong December quarter, the continued focus on improving performance and the benefits from restructuring initiatives resulted in the third consecutive quarter of year-over-year improvements in both margins and returns. Despite the challenges presented by the sluggish macroeconomic environment, solid execution at both operating groups led to results that were in line with our expectations and demonstrated the positive impact that our value-based management discipline continues to have on our business. Enterprise revenue, up $6.3 billion, decreased 6% year-over-year in reported dollars, while pro forma revenue was down 7% in constant dollars primarily due to a double-digit decline in our EMEA region at both operating groups. This represents the first quarter in this fiscal year that pro forma year-over-year growth turned negative as the prior year third quarter was particularly strong. On a sequential basis, revenue declined 6% in reported dollars and pro forma revenue was down 7%, which was at the low end of normal seasonality of down 4% to down 7%. In the March quarter, gross profit margin increased 29 basis points sequentially to 12%, primarily due to the seasonal mix shift to our higher gross profit margin EM business. On a year-over-year basis, gross profit margin increased 21 basis points, driven by the third consecutive quarter of improvements at TS in both the Americas and EMEA regions. Operating expenses of $518 million declined $11 million or 2.1% from the year ago quarter as the positive impact of restructuring initiatives taken during fiscal 2012 was partially offset by new acquisitions. Excluding the impact of acquisitions and changes in foreign currency exchange rates, operating expenses declined $21 million year-over-year and $9.5 million sequentially or 4% and 2%, respectively. As a result of our targeted cost reductions over the past 9 months, we now expect to realize approximately $35 million to $45 million in annualized savings by the time we exit fiscal 2012. Although our team has effectively managed through the current environment, this quarter's adjusted operating income decreased 8% year-over-year to $235 million and adjusted operating income margin decreased 10 basis points to 3.8%. Adjusted EPS of $1.03 declined $0.07 from the year ago quarter due primarily to the impact of lower revenue, which was partially offset by higher gross profit margin, cost reductions and a lower share count. On a sequential basis, adjusted operating income declined 11%, and adjusted EPS was down $0.12 with approximately half of the EPS decline due to the temporary benefits related to hard disk drives that had positively impacted our December quarter. Working capital increased $210 million sequentially or 5.7%, due primarily to the impact of recent acquisitions and a reduction in accounts payable which was offset somewhat by declines in receivables and inventory. This increase, when combined with our seasonal mixed shift to our lower working capital velocity EM business, resulted in a slight decline in working capital velocity to 6.4 turns. At the operating group level, TS experienced its typical seasonal decline while EM improved its working capital velocity meaningfully. Return on capital employed and return on working capital declined 226 basis points and 237 basis points, respectively, from the near-peak levels in the prior year quarter. Through the first 9 months of fiscal 2012, even though our organic revenue was down, our gross profit margin is up and operating income margin is approximately flat with the comparable period in fiscal 2011. I am pleased with the results our team delivered this fiscal year while managing through the cyclical supply chain correction and uneven growth environment. As we have shared with you during past corrections, our goal is to adjust and adapt where needed while remaining focused on our longer-term competitive position in end markets. Given that the supply chain correction has been relatively mild, we believe our results demonstrate just that, and we stand poised to leverage future growth and to improve financial performance. Though it is hard to predict what the pace of economic growth may be going forward, the technology markets we serve continue to lead this recovery, and we are very well positioned to continue growing faster than the markets we serve and drive higher returns and shareholder value. Now let's turn to our operating groups. In the March quarter, Electronic Marketing's global book-to-bill ratio improved for the second consecutive quarter and finished the quarter at parity, with EMEA being the only region to end the quarter below 1

[Raymond J. Sadowski:]

Thank you, Rick, and hello, everyone. Before we move on to our economic profit performance, I would like to provide a brief update on our share repurchase program. As you probably noticed in our press release, our purchases this quarter declined significantly as the stock price was consistently in the mid-30s for most of the quarter. As we told you when we introduced the repurchase program back in August, we will maintain our discipline and only repurchase stock when the capital allocation affords appropriate returns. We'll continue to monitor our stock price and adjust our purchasing activity as appropriate. While the program to date has represented a good utilization of capital, we continue to see many opportunities to invest in both organic and value-creating M&A that can deliver higher returns and cash flow for multiple years. Now let's take a look at the economic profit and shareholder value creation. In the third quarter of fiscal year 2012, both return on capital employed and economic profit dollars declined sequentially due primarily to the impact of the seasonal decline in revenue. As you can see on the slide, year-over-year comparisons are also down, as return on capital was over 15% in the second half of fiscal 2011 concurrent with the peaking of the V-shaped recovery in the electronics components industry. Similar to how Rick highlighted TS's progress this quarter, I'd like to point to you the improvement from the September quarter when margins and returns bottomed. In that time frame, return on capital employed has increased 64 basis points to 12.8% and economic profit dollars grew nearly 30% to $37 million. Although we don't forecast macroeconomic conditions, sustained improvement in global economic growth would clearly accelerate our progress in reaching our profitability goals. We remain focused on improving our performance through the market cycles and generating additional shareholder value going forward. Looking forward to Avnet's fourth quarter fiscal 2012, we expect EM sales to be in a range of $3.75 billion to $4.05 billion and sales for TS to be between $2.55 billion and $2.85 billion. Therefore, Avnet's consolidated sales are forecast to be between $6.3 billion and $6.9 billion. Based upon that revenue forecast, we expect fourth quarter fiscal 2012 earnings to be in a range of $1.05 to $1.13 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 147.2 million average diluted shares outstanding used to determine earnings per share and an effective tax rate in the range of 29% to 31%. In addition, the above guidance assumes that the average euro to U.S. dollar currency exchange rate for the fourth quarter of fiscal 2012 is 1.31

[Operator:]

[Operator Instructions] Our first question comes from Scott Craig with Bank of America.

[Scott D. Craig:]

Just 2 quick questions here for you. Can you talk about the TS operating margin and sort of, as you look out over the next few quarters, the progress that you expect to make there? And then just secondly, in the EM business, I think you noted in your script that you saw an improvement on the book-to-bill throughout the quarter. So I just wanted to make sure that, that was the case as they kept ramping up through to the end of the quarter so that we actually finished the quarter and worked into early April probably above parity.

[Richard P. Hamada:]

Scott, it's Rick. I'll start with a couple of comments, turn over both to, I think, to Phil and Harley. On the TS operating margin, as we discussed back at the December Analyst Day, we're on a long-term journey and trajectory there to get to the stated long-term range for that business. A number of moving parts going on with that, but it -- we're still on a multi-quarter journey. And we're pleased with the progress for this quarter, but we still know we have a ways to go with that. So -- and I don't know, Phil, if you want to add anything to that?

[Philip R. Gallagher:]

I'll just add on the December Analyst Day that we talked, Scott, a lot about. Of course, if you look at the year-on-year compare, but we're really focused as was in the script on the July, August, September, it was a quarter that was looking like it was aligning, very similar from a revenue standpoint. We targeted to beat that operating margin for the July, August, September quarter as well year-on-year, and we achieved that. And we're very optimistic that, sequentially, as far as we'll go out, that will be the typical increase again in basis -- 20, 30 basis points or so of operating margin improvement, which will continue on its trajectory, to Rick's point, obtaining the ORPPs we talked about in December.

[Richard P. Hamada:]

Yes, so the journey continues to TS, Scott. We like the progress we saw here in this quarter. We've got a few to go. And Harley, on the book-to-bill, you want to add some color there?

[Harley Feldberg:]

Sure, Rick. Yes, your comment was accurate. The book-to-bill for March in total was stronger than we saw in December, and the strengthening did occur as the quarter progressed. And I think the last part of your comment was, and did it continue into April? And at least through 3 weeks, we have seen it continue in a positive way.

[Operator:]

Our next question comes from Matt Sheerin with Stifel, Nicolaus.

[Matthew Sheerin:]

Just wanted to follow up on Scott's question regarding EM. So you talked about negative book-to-bill in Europe. Is -- was that just for the quarter, but is that what you're seeing right now? Because it looks like you had fairly seasonal demand or order trends in the March quarter. And as you look at your component guidance, it looks like rolling it up, it's seasonal. Are you expecting seasonal trends across all 3 regions, or will Europe still be a lagger there?

[Harley Feldberg:]

Yes. I think what we said is that all regions finished the March quarter positive other than EMEA. But I would point out that where they did finish was stronger than what we had seen in December. And if memory serves me correctly, stronger than we saw prior to that as well. So the progression has been positive, though it didn't quite make it a positive for the March quarter. In April, it has exceeded 1

[Matthew Sheerin:]

And would you say, Harley, that visibility has improved or is it still fairly cloudy? Because generally speaking, semiconductor and component lead times are still pretty short.

[Harley Feldberg:]

Matt, our view is that, from our vantage point, it appears that most of the correction that was a derivative of inventory excess has played through. And one of the data points that we think helps illustrate it is that there -- we have seen a modest, I want to emphasize, a modest expansion of lead times. So we think that is telling us that primarily, we are probably at the bottom of that supply chain correction and now starting to see positive movement there.

[Matthew Sheerin:]

Okay, that's quite helpful. And just as a follow-up, tying that into your own inventory positions given that lead times are stable or maybe starting to stretch, is this sort of it in terms of your own correction in terms of inventories? Are you going to start layering on inventory or kind of remain at this turned level until you start to see either lead-time stretch or demand get better?

[Richard P. Hamada:]

Not exactly. As you know, our inventory strategies, obviously, are derived from many different data points, one being lead times. Based on what we know today and based on the modest expansion lead times I mentioned before, our principal goal remains the same, which is continue each quarter to focus on improving our velocity. We saw nice improvement in the March velocity metrics sequentially, so our goal for June will be continue to focus on improving that velocity. If you consider the fact that we're projecting some growth, it probably suggests an inventory estimate for the June quarter somewhere in a very flattish area.

[Operator:]

Our next question comes from Shawn Harrison with Longbow Research.

[Shawn M. Harrison:]

I wanted to just focus in on the EM margins. Here in the low 5s, given that we haven't had, I guess, normal quarters for the past 3 years heading into the June quarter, would the March quarter typically be the peak for operating margins within EM? Or should we see another seasonal uplift into the June quarter and that would potentially be the peak for the calendar year?

[Harley Feldberg:]

Well, I'm not sure, Shawn. I'm going to predict what would be the peak for a full calendar year. I would estimate margins in the June quarter will be similar to what we saw in the March quarter. But keep something in mind when you're doing your year-on-year compare is that there are a couple of drivers to that. One -- the principal one being that the region, for us, that has the highest margin, being EMEA, is a fairly significantly reduced portion of our overall portfolio as a ratio when compared to a year ago. And that likely is to be the case in the June quarter as well. So if you add that, plus some degree of currency effect, that really gives you, and of course, the revenue being smaller than a year ago, that gives you the principal drivers to the year-on-year. So again, I'm not sure I can -- I'm comfortable speculating on what we can do for the balance of the year but for March and June, that's how we see the numbers adding up.

[Shawn M. Harrison:]

Okay. And then just thinking about cash flow into the June quarter. With inventory holding stable sequentially, at least at EM, should we expect a decline in the cash cycle and working capital days so we should see a step-up sequentially in the cash flow?

[Raymond J. Sadowski:]

Yes. Shawn, it's Ray. Yes, that would be our expectation based upon the profitability levels. And as Harley just mentioned, with overall inventory trends, we would expect we'd be in a positive cash flow position for the quarter.

[Operator:]

Our next question comes from Jim Suva with Citigroup.

[Jim Suva:]

When we think about the current environment on the mergers and acquisition topic or field, with interest rates so low where they are and a seemingly recovering economic environment, is it fair to say that prices are starting to go up a little bit higher or the pipeline is starting to get a little bit more tighter? Or has anything changed on that front both

[Richard P. Hamada:]

So Jim, it's Rick. I would comment that M&A remains -- value-creating M&A, in particular, remains a very -- an integral part of our overall profitable growth story and strategy. We still have a small number of larger deals, a larger number of small deals and I cannot point any evidence that would suggest that any of the current, either fiscal policy or interest rate environment, is causing any particular changes in either the activity levels or the valuations associated with that.

[Jim Suva:]

Okay. Then as a quick follow-up, last year we had 2 very unfortunate natural disasters happening in Japan and Thailand. As a result of that, have you seen any shift or change from your customer base as far as people wanting more global ops? And if so, any potential share gains or any smaller companies realizing their risk mitigation that they have too much physical footprint, therefore, want to roll up and be part of Avnet?

[Richard P. Hamada:]

So, Jim, I appreciate the intro on it very, very much. It obviously makes logical sense to us, and we believe we're in a great position to assist those that would have that perspective. I'm not sure I have data in front of me where I can specifically point to any particular share gains or growth efforts just based on those strategic decisions. But the rationale, the logic you lay out certainly makes sense to us.

[Operator:]

Our next question comes from Ananda Baruah with Brean Murray.

[Ananda Baruah:]

I was interested in getting maybe, Phil, from you, a sense of what TS linearity was through the quarter, how we started out the April quarter? And any thoughts by geo would be helpful as well.

[Philip R. Gallagher:]

Yes, sure. As far as through the -- April, we're still going through it. But as far as how we look at the quarter, right now, each of our regions are right in line with our typical seasonality, which is in that 4% to 7% range, with varying degrees of variability there. But overall, we're feeling good about the quarter and what our current guidance is. And again, it's a little bit of a mix by region. Certainly, we're still watching EMEA very closely based on the economic indicators there. Asia-Pac, we're seeing growth there. We're as much controlled in the growth, frankly, in Asia-Pac. Some economic concern, but we're controlling that because our focus on operational and drop-through in Asia-Pac. And I'm very comfortable with our position in Americas and there's continued optimism on the climate here.

[Ananda Baruah:]

Great. And if I could just ask a quick follow-up on that. I think last quarter, you guys didn't have a clear view yet on the potential for a service cycle or for -- I'm sure you had demand, but you don't want to make comments here on the potential for sort of refresh cycle. Are you -- has your view changed yet? Do you have a cleaner sense of if we could have a meaningful service cycle this year?

[Richard P. Hamada:]

Probably not prepared to answer that really, Ananda. We're not -- there's certainly some things from a technology standpoint that are coming out there that we're updated on in the -- more in the industry standard around Intel and some of the dialogue around Romley. It's tough for us to make that call. How big an impact that's going to be, certainly there's a lot of talk about it and that could certainly drive or refresh it at a certain level. But beyond that, it's really tough to make that call for the year.

[Operator:]

Our next question comes from Brendan Furlong with Miller Tabak.

[Brendan Oliver Furlong:]

Just a quick question on the gross margins at the corporate level. Looks like, looking into the June quarter, it's going to hold pretty flat sequentially.

[Raymond J. Sadowski:]

Yes, that's correct. That's right.

[Brendan Oliver Furlong:]

Okay. And then I don't know if you addressed this on the call. If you did, I missed it, my apologies. On the TS, is there any market color you can give us in terms of server storage, software security? I want just a general sense of what's going out there -- on there in the technology market because some companies that have reported so far have been mixed, to say the least.

[Richard P. Hamada:]

Brendan, I'll jump in. Phil, you can add. We highlighted in the script, Brendan, that we continue to see strength in industry standard servers and services. And to anticipate a follow-up question, does that mean storage hasn't been a good story? No, we just didn't put it in the headlines. Storage was a solid upper-single-digit grower for us. And keep in mind, that's in a situation where TS globally was down about 5%. So a lot of familiar stories there, but we didn't capture storage in the headline just on a relative basis.

[Operator:]

Our next question comes from Craig Hettenbach with Goldman Sachs.

[Craig Hettenbach:]

If I could ask just on Europe. I mean, it looks like most of the business by geography is inflecting up and Europe is dragging a bit. Rick, any sense in terms of things you're watching for or any signs that -- to look for inflection in Europe, particularly on the demand side for systems?

[Richard P. Hamada:]

Yes. So, Craig, it's a good observation. And as we talk about the sequential guidance going forward, I think both Harley and Phil reinforced that going forward, the sequential guidance looks good for their European businesses. But year-on-year they're both also negative double-digit down, so they've got the lower base to come from. One pattern we've watched in the past has been, if you look at Europe, just self-contained within Europe, our European components business has generally been performing better than the systems business, which we attribute to the contributions from exports for our components business. And then we do watch the -- we're watching the TS business in Europe, in particular, as more indicative of what's going on with the indigenous demand, and then that would help support what's going on from an overall industrial base there. And then if EM continues to do well, we would continue to subscribe that the exports are driving that overall. So those are the various parts and pieces that we watch in between them. In general, we haven't had a lot of direct correlation between those businesses because of this export differential. But we do think TS is a very strong sign of what's going on in the region from a consumption point of view.

[Craig Hettenbach:]

Okay. And if I could follow up with Harley, can you talk about just pricing as the cycle has bottomed out and now turns up, have you seen anything? And then any implications to gross margin on the component side?

[Harley Feldberg:]

No, I don't think we've seen anything really significant from a pricing perspective yet.

[Craig Hettenbach:]

Okay. Do you expect it to stay stable or...

[Harley Feldberg:]

I believe it'll continue to stay stable.

[Operator:]

Our next question comes from Brian Alexander from Raymond James.

[Brian G. Alexander:]

Could you guys talk about the reasons for the deceleration in growth in Asia that you saw in both segments? It looks like EM was down almost 13% pro forma, which is almost as much as Europe was down, and TS Asia only grew 4% and had been growing double digits. How much of that is the slower macro in Asia versus potentially more competition that's causing you to slow the growth rate?

[Philip R. Gallagher:]

Yes. Brian, it's Phil. I'll go first and let Harley follow up on EM, as I start to answer the other question with regards to regional flavor. In Asia-Pac, part of it, probably some of the macroeconomic but on the TS side, frankly as we continued to grow and we've pretty much publicly stated that we're going to look to continue to start, when we get to a certain size, driving more drop-through and not just drive volume. Not that we're just trying to buy volume, but as we pave a new path for value distribution across Asia-Pac, we need to be sure we're frankly selecting and driving the appropriate growth and an appropriate type of business. So ours has been as much as of the market, as well as us kind of cooling down, getting our operations a little bit tighter, okay, and going from there. But we are still optimistic about Asia-Pac and are continuing to make the appropriate investments across the board.

[Harley Feldberg:]

Brian, it's Harley. As you know, our Asia business -- our Asia components business is, I guess you could loosely split it into 2 segments; one being those products we supply into Asia that ultimately end up in exports back to the West, a significant amount of that into America; and then the other part being for indigenous Asian growth. Both are down year-on-year. The larger piece of that would be down clearly would be the export-driven piece building product shipped back into the West. It is clearly the riddle in our overall global forecast. And at this point, it's particularly difficult to predict what we'll see going forward for the rest of the year, only because it's a little bit early. I'd probably like a May-June type timing to start to see what the build to back-to-school season looks like. We are seeing a positive book-to-bill. Asia was our highest book-to-bill in the March quarter, and that continues through the beginning of April, although that is what you would expect. So we appear to be heading into some growth, difficult to quantify when we will get back to year-on-year. Maybe the wilder card is indeed what's going to happen in China relative to indigenous growth and indigenous consumption. So I think the way I would probably categorize Asia is clearly, it's down from the euphoria we saw a year ago, but we're still seeing some growth. We still feel positive about the region, and I think we'll know a lot more, Brian, in the next 60 days.

[Brian G. Alexander:]

Okay. Let me just follow up on the EM operating margins. During the correction and at the bottom here, they're still above the low end of your targeted range of 5% to 5.5%. And then 2 quarters of the cycle, they were actually above the high end of your range. So I guess I'll just ask the question. Is 5% to 5.5% the right range for EM in the next cycle or do you think you can do better than that?

[Harley Feldberg:]

Well, my aspiration is, obviously, always to do better. But I don't think that was your question, was it? I will allow myself the disclaimer of saying we review that officially every December at our annual day. With that said, I would go out on a limb and say that if we continue to see modest improvement, if June does come in a bit better than seasonal and that continues through the year, and if the back-to-school is encouraging over May or June, I see no reason why EM can't get back to the high end, if not the top, of the range.

[Operator:]

Our next question comes from Amitabh Passi from UBS.

[Amitabh Passi:]

Just a clarification. I wanted to find out if there was any lingering positive impact from the HDD situation in the March quarter? Was it -- or did you really not see any benefit?

[Richard P. Hamada:]

Yes, Amitabh. Net-net, there really was not any benefit there.

[Amitabh Passi:]

Okay. And then Ray, perhaps a question for you. I'm still a little perplexed that we didn't see more aggressive buyback. I appreciate the fact the stock was in the low 30s. But assuming your earnings power approaching somewhere between $5 and $6, it still seems like you can get a high change return in your stock today even at current levels. So I just wanted to understand why we're not seeing you being more aggressive.

[Richard P. Hamada:]

Yes, it's a great point and it's under discussion, Amitabh. There's 2 important variables here. Number one is the current valuation of the equity and second is what our internal financial projections are. And as we committed when we announced last August, when we see a compelling value, then we'll be active in the market with the buyback. We still have, Ray, a little over -- not quite half of it to go at this point. And so we just want you to know we're continuing to watch it, and we're not stuck on a certain fixed absolute number because of the August announcement. We're watching our numbers, we're watching our projections. And when we feel it's a compelling value, we would feel free to execute again.

[Amitabh Passi:]

Okay. Just a clarification, the savings from your restructuring, did you say it was $35 million to $40 million annualized? And how do we think about that going through your P&L?

[Richard P. Hamada:]

$35 million to $45 million.

[Raymond J. Sadowski:]

It should be $35 million to $45 million on an annualized basis, and that's cumulatively from the actions we've taken so far this year. So a meaningful part of -- I have right in front me the exact amount, but a meaningful part of that has already flowed through the P&L. But we will have a little bit more coming through in Q4 and maybe a little bit more in the September quarter. But a lot is already going through, and that's what's helped our margins improve year-over-year.

[Operator:]

Our next question comes from Steven Fox with Cross Research.

[Steven B. Fox:]

Just a question on TS. Just stepping back from the numbers for a second and thinking through the rest of the calendar year, it seems like you're seeing some seasonal patterns that are normal in the last couple of quarters, but your growth is still pretty challenged. I was wondering how you would portray your customers at this point in terms of what they're looking to spend in the second half of the year? Do you see an improvement in terms of their ordering pattern for projects, et cetera? And whether that could drive an accelerated growth and get back to some decent year-over-year organic turns?

[Philip R. Gallagher:]

Best feedback I could give you is in the last several weeks, I've done a couple of roadshows myself with some of the team and visited 8 of our top partners across North America and also had a global counsel with some of our top partners worldwide. And the sentiment is very positive, okay? They're all very optimistic around the opportunities in the marketplace. By the way in services, I mean, things that Rick talked about earlier, the storage, the networking security. So if the sentiment is positive, how do I quantify that exactly? It's always difficult, but there -- the partners are very, very optimistic. And again, there was a few in from Europe and few in from Asia, and then the balance was from North America.

[Steven B. Fox:]

Outside of just the obvious technical requirements and into the second half, and just looking where technology is going, is there anything tangible that they're hanging their hats on for why you could see a second half pickup in enterprise spending?

[Raymond J. Sadowski:]

Well, a big part of it, I mean, there's a lot of conversation around mobility, right? So it's just one area -- I was going to touch on this earlier, but you got mobility, whether you're playing direct mobility in the handset is one thing, but what mobility's driving from a network infrastructure, security over to network that's driving more storage solution server, that's a big topic, a big opportunity that we're seeing in working with the different partners. And you're also seeing more converts to infrastructure, so a lot of opportunities in the areas of integration, okay? So that's also been a really hot topic for many of the partners and they're excited about some of the products that our suppliers are putting out on the marketplace. And then the other thing I would, the recent acquisition we made of Ascendant. We're excited about that as well because where they may lack and we can help them from a standpoint of scaling is in the services plate, okay? So how can we help them go drive in the services end more to drive the total solution. That's just a couple of hot points that came out of the different visits and the really consensus from the different partners.

[Richard P. Hamada:]

Yes, and Steve, this is Rick. I would just add, Evan having formally been in Phil's chair as well in that computer business, it really is very much a 90-day quarter-by-quarter-driven business. They often work on sales cycles that will span quarters. But very often, and particularly our clear visibility on what they're doing is generally focused around what they're trying to close for June. So we look at the forecast like you do as far as other broader-based economic projections on IT spend, et cetera, and we try to factor those into our strategic plans, of course. But when it comes to the dashboard that we built around this great business of TS, it really does tend to have a quarter-to-quarter focus.

[Operator:]

Our next question comes from Sherri Scribner with Deutsche Bank.

[Sherri Scribner:]

Just thinking about the improvements in the TS margins that you talked about happening over the next couple of quarters and clearly, you've seen some nice improvements there. It seems like Europe has really seen a big improvement. I'm curious how much more benefit you think you can get out of Europe as we move forward or are there opportunities in other geographies to improve the margins at TS as well?

[Philip R. Gallagher:]

Sherri, this is Phil. I'll take the first shot at that. We've seen actually margin expansion in all the regions, so that's a positive. Europe has clearly, as we stated in the script, has led the way and also had the biggest opportunity, to be very candid with you. And as we talked at Analyst Day, again, we're driving more careful revenue selection, okay? And making the -- i.e., for example, decisions like around Italy. The business mix we're continuing to work on. In fact, we're driving at discipline in the business and driving the -- and managing the business and to the market opportunities. So when you encode BBM, we're very focused on that, if you will, denominator to be sure we're getting the right drop-through on the business that is there. So always think there's still further opportunity for sure in Europe. And I'm proud of the team there, what they've done under tough circumstances. But they're -- no question, the trajectory, as Rick pointed out, overall, to the global targets we're moving in the right direction and we plan to continue to do that. With the organic growth on top, it certainly will help accelerate that. But we're going to play the hand we're dealt and continue to make the right decisions to drive the right goals.

[Sherri Scribner:]

Great. And then just thinking about sort of moving out of this inventory adjustment that we've been through over the past couple of quarters and now being at parity or above parity as we moved into April, what is your -- I guess, what is your appetite for holding inventory at this point in the cycle when we sort of are hearing that visibility is very limited and customers aren't really sure where their end demand is. I'm just trying to get a sense of are you comfortable holding inventory? You think your inventory levels will tick up after declining over the past couple of quarters or what are you thinking about?

[Harley Feldberg:]

Yes, Sherri, this is Harley. I assume that's an EM-directed question.

[Sherri Scribner:]

Yes, Harley.

[Harley Feldberg:]

Yes, I think that, as I said earlier, our principal driver is working on velocity. I added the disclaimer early that obviously any shocks to a market, for example what we saw in the HDD business with drives and what we seen at times over the years from all kinds of products going all the way back to Tantalum capacitors, will react to them in a way that obviously tries to advantage ourselves from a profitability standpoint, as well as availability to our customers. But today, the expansion in lead times is really too modest for us to react in a way that would distract us from our desire to continue to improve our velocity metrics to bring them back to where they were at a peak a year ago. So our appetite is always there to inventory when it's required. Today, we don't see signs that tell us that we should change our strategy and move off our desire to continue to improve our velocity.

[Operator:]

Our next question comes from Mona Eraiba with TCW.

[Mona Eraiba:]

I guess all my questions were answered. Could you give us more granularity about Europe overall for the system business? By country or by -- I know that the environment is tough, but what are the key trends that you see?

[Philip R. Gallagher:]

Yes. Mona, this is Phil. Probably what you're reading about, I mean, there's not -- it's not much different really. We're -- we, to provide you our perspective, we're seeing some improvement in Germany in our business. Eastern Europe has continued to do well for us on a relative basis through the balance of Europe. And I would say the U.K. for us, which is a large business, is somewhere in between that. We made the decisions in parts of Southern Europe, as we talked about earlier, in Italy. It's just a tough market for IT and for us to find the appropriate value and returns. And when we find that, we're going to make those decisions. But overall, we're not seeing much different than what the trends are you're reading about, and it's not by any specific product or technology from that standpoint.

[Mona Eraiba:]

And can I have a follow-up about hard drive? There was a lot of talk about the pricing in the first quarter. What did you guys see happening?

[Richard P. Hamada:]

Yes, Mona, it's Rick. What I've -- we've generally seen -- you've probably seen the same comments from our suppliers as well. Supply has come back a little quicker than anticipated. It seems that the units are catching up, particularly in the -- more the mobile and desktop space. I'd say it's very much recovered in that space. And the enterprise drive space appears to be a -- still a little bit of constraint and tightness overall. But the -- obviously the windfall, if you want to call it that, of $0.05, $0.06 that was attributed to the EPS performance for us in the December quarter, there really was -- that was completely dissipated and gone out of the equation from our participation in the hard disk drive business for the March quarter.

[Mona Eraiba:]

Okay, but you -- did the prices go back to the pre-flood level or is it...

[Richard P. Hamada:]

So on mobile and desktop area, I believe the prices have come down. I'm not sure if I could tell you they're all the way back down to where they were pre-Thailand floods. I don't know if Harley had given any color on that, but yes, they certainly have come back down.

[Operator:]

Our next question comes from Clifford Colson [ph] with UBS.

[Unknown Analyst:]

You made the comment that you'd buy back more stock if you thought it represented a compelling return. And I thought it might -- since it's one of the larger uses of cash for the business over time, I thought it might be worth discussing what your hurdle is for a compelling return because any shareholder who owns a stock presumably believes that it represents compelling return at the present price. So -- and you guys are actually making acquisition, so I hope you could spend a few moments discussing what your bar is for a compelling return.

[Richard P. Hamada:]

Well, I'll offer some comment, Cliff, and maybe ask Ray if you want to add anything on top of it. So hopefully, well known to all of our owners and investors is our commitment to try to maintain -- we're making investments where we can see a sustained return generally 250 to 300 basis points above our cost of capital. So we lay that out as a 12.5% ROCE target. And if you looked at that in terms of multiple, Cliff, then I think you could reverse-engineer into an, say at 8x multiple or below, you would be able to get a 12.5% return, that this is an inverse map along the way. So without going into specific numbers around that, as I said, we take a look at what the equities currently value. We take a look at our internal financial projections and we'll be making judgments and assessments when we believe that we have a range that makes sense based on those types of commitments and criteria. In the last round of our execution on this, we also took a look at the relationship to book value as another parameter or another influencer on our aggressiveness and level of activity. So I don't know, Ray, if you want to add anything?

[Raymond J. Sadowski:]

No. I think the only thing I would add is what we've talked about in the past is our prioritization of the use of capital, which is essentially to drive further profitable growth in the business overall. So it's always a weighting factor of the acquisition opportunities as they're out there and the returns that they can bring versus the stock price. And obviously, the stock prices, different levels of value, different levels of return, so to speak, depending upon what actual level the stock price is. And as we've indicated, as Rick has said, levels approaching book value and a little above that will be fairly aggressive as we demonstrated in the first and second quarter. But as the price starts to move up a little bit, we'll just really look at what the right perspective is from a valuation overall in terms of alternative uses of capital from an M&A perspective and organic growth opportunities.

[Richard P. Hamada:]

We clearly remain committed -- we continue to prefer creating future EBITDA and cash flow if and where possible with our capital.

[Unknown Analyst:]

Great. And if I could just follow up, the company has become increasingly delevered both in an absolute sense and as compared to Arrow. And I was hoping you could comment a bit on how under levered you think you are and how much dry powder that leaves you potentially for acquisitions or, I suppose, share buyback.

[Richard P. Hamada:]

So Raymond, do you want to jump in or...

[Raymond J. Sadowski:]

Yes, I don't know if we can quote some numbers here, but we certainly do recognize the fact that we are a little bit underleveraged. I think we're committed to a investment grade credit rating, it's something that's very important to us. And even looking at that, we recognize the fact that we're underleveraged to some extent. I won't throw out exact numbers, but we certainly have room to move and that does give us the flexibility to manage through any potential acquisitions out there. It's particularly challenging to use that kind of opportunity as an example to buy back stock, which I know some people think about. The challenge with that would put severe pressure on our ratings, increased leverage and use that to go buy back stock. So it's not a card we would typically play. We'll play the card up in terms of buying back stock out of free cash flow at appropriate levels as we just discussed. But certainly would take the opportunity to increase leverage a little bit if the right opportunity came along from an M&A perspective.

[Operator:]

Gentlemen, there are no further questions at this time. I would like to turn the floor back to you for closing comments.

[Vincent Keenan:]

Thank you for participating in our earnings call today. As we conclude, we will scroll through the non-GAAP to GAAP reconciliation 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 reconciliation, can be accessed in downloadable PDF format at our website, www.ir.avnet.com 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.