Avnet - Q1 2017
October 27, 2016
Transcript
Operator (participant)
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.
Vince Keenan (VP of Investor Relations)
Good morning, and welcome to Avnet's Q1 fiscal year 2017 business and financial update. As a result of the pending sale of TS and having met applicable accounting requirements, Avnet is reporting the TS business as a discontinued operation. Additionally, the YoY comparisons reflect adjustments to the Q1 of fiscal 2016 for the transfer of the Embedded Computing Solutions business from TS to EM. As we provide the highlights for our Q1 fiscal year 2017, please note that in the accompanying remarks, we have excluded certain items, including intangible asset amortization, restructuring, integration, and other items, and certain discrete income tax adjustments from all periods covered in our non-GAAP results.
When we refer to constant currency or 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 statements into U.S. dollars. When we refer to organic sales, we have adjusted the prior period to include the impact of acquisitions and other items. In addition, when addressing return on capital employed, return on working capital, and working capital velocity, the definitions are included in our Form 8-K filed today. Before we get started with the presentation from Avnet management, I would like to review Avnet's safe harbor statement. This call contains certain forward-looking statements, which are statements addressing future financial and operating results of Avnet. There 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, Bill Amelio, Avnet's CEO, will provide Avnet's Q1 fiscal year 2017 highlights, including an update on our strategic transition. Following Bill, our Chief Financial Officer, Kevin Moriarty, will review some financial highlights and business model updates, as well as provide Q2 fiscal 2017 guidance. At the conclusion of Kevin's remarks, a Q&A will follow. Also here today, to take any questions you may have related to Avnet's business operations, is Gerry Fay, President of Electronics Marketing, and Patrick Zammit, President of Technology Solutions. With that, let me introduce Mr. Bill Amelio to discuss Avnet's Q1 fiscal 2017 business highlights.
Bill Amelio (CEO)
Thank you, Vince, and hello, everyone. Thank you again for taking time with us and for your interest in Avnet. In our Q1, fiscal 2017, we took another major step in strategic transition of Avnet when we announced the sale of Technology Solutions operating group to Tech Data Corporation. When we evaluated the sale relative to our internal plans and other strategic alternatives, we decided this transaction was in the best interest of our employees, our customers, suppliers, and our shareholders. Total consideration of $2.6 billion consists of $2.4 billion of cash and approximately 2.8 million shares of Tech Data common stock. The transaction, which is subject to regulatory approval, is expected to close in the Q1 of calendar or Q2, first or Q2 of calendar 2017.
As a standalone electronic component distributor, Avnet will now have an improved business model with higher margins and returns. The significant cash consideration we expect to receive at closing will allow us to pay down debt in excess of the amount that we borrowed for Premier Farnell's acquisition and leave us with a strong balance sheet and expanded capital allocation alternatives, including the potential for increased share repurchases. It will also enhance our ability to invest in organic growth and value-creating acquisitions as we target higher growth markets in the technology marketplace. Going forward, we will continue to adhere to our capital allocation approach, which focuses on growth while consistently and continually returning cash to shareholders via our dividend and disciplined share repurchase program.
As a result of the pending sale of TS, accounting regulations require us to report as discontinued operations in the current quarter, and Kevin will cover TS in more detail later on the call. While we will not include TS in our guidance and results going forward, I would like to highlight that we expect to realize a gain on the sale of TS of between $3.75 and $4.75 per share, depending on the final tax rate and final accounting adjustments. In summary, the sale of TS allows us to focus on electronic components business, which we just added unique capabilities with the acquisition of Premier Farnell, while providing significant capital to strengthen our balance sheet and fund future growth. Now, let me turn to Premier Farnell.
We accelerated the review process and completed the acquisition on October seventeenth, and at the end of the month, expect to use approximately $180 million of offshore cash and $660 million of new debt to finance this transaction. Integration planning is underway, and based on our initial meetings, our team is extremely excited about the opportunities they see to leverage the digital platform and the talented employees of Premier Farnell. Combining Avnet Electronics Marketing and Premier Farnell will create a unique distribution model that can serve an expanded customer base with the broadest suite of products and services in the marketplace. More importantly, we will have more opportunities to accelerate growth in a combined customer base as we can address the entire product life cycle from idea generation all the way through volume production.
Premier Farnell's customers will be able to leverage our design chain services when they run into complex issues, and then utilize our supply chain services when they're ready to ramp up production. Avnet's customers in all three regions will have access to a digital platform with extensive product specifications and information, as well as a wide choice of components to consider in their products. We will be able to reach engineers earlier in the design cycle, which will be critical as more innovators and startups do the majority of the design work online before reaching out to a field application engineer. Premier Farnell will also provide a positive financial impact as our customer base and small order size results in higher gross margins and operating margins than our core business.
We expect to realize $70 million-$80 million of synergies once the integration is complete, with the majority being cost synergies, including some at Avnet, as we will reduce our internal investments in web-enabling tools. As we cross-sell into the combined customer base and realize more revenue synergies, the impact of Premier Farnell will increase our returns. We currently expect to realize a return of capital of 11%-11.5% in year three, which is well above our weighted average cost of capital of 8.5%. While the acquisition of Premier Farnell creates a compelling value proposition for our shareholders, we're equally excited about the compelling value proposition that the combination of Avnet and Premier Farnell provides to our customers and our suppliers.
Once the integration is complete, Avnet will possess a unique distribution model with a truly differentiated offering that will put us at the forefront of the digital transformation impacting the entire technology supply chain. The next slide depicts one of the primary benefits of Premier Farnell's acquisition. That is an expanded customer base and reach into the idea generation and design cycle. The triangle in the center of the diagram depicts EM's traditional role in the product life cycle of our customers. While we play a significant role in the production phase of technology supply chain depicted on the right, we have limited presence in the early design phase, particularly at the idea stage, where critical component choices are made.
In addition, of Premier Farnell will significantly expand our presence to the left of the diagram, which is critical to our future success in high growth markets like the Internet of Things, or IoT. It essentially opens up the aperture of our sales funnel to address more opportunities with much lower cost to serve models. Another benefit of the Premier Farnell acquisition is their customer base is made up of 420,000 registered users. These customers will no longer have to explore alternatives when it comes time to move to volume production. They will be able to take advantage of Avnet's supply chain services to seamlessly move from prototype to production and accelerate their time to market. We also see opportunities to leverage our embedded board solutions as innovators creating IoT devices will require standard designs with hardware and software already integrated and tested.
Avnet will be the only component distributor with true end-to-end solutions, underpinned by a global digital platform with unique features and services. Our intent is to build on this position to accelerate growth, increase our margins, increase our returns, and generate increased shareholder value in the future. Now I'd like to turn the commentary over to Kevin to provide more color on our financial performance and our financial impact of these two transactions. Kevin?
Kevin Moriarty (CFO)
Thank you, Bill, and hello, everyone. As Bill mentioned earlier, beginning with the current quarter, we will treat Technology Solutions as discontinued operations in our financial statements. With that said, I will focus my commentary on the EM and TS results in order to be consistent with the guidance we gave in August, prior to the switch to discontinued operations. I will be referencing the slides sent out earlier today, so I'm gonna start on slide 7. In the September quarter, Avnet's total revenue declined 13.3% YoY to $6 billion. If you exclude the extra week of sales in the prior year quarter, organic revenue declined 6.9% in constant currency.
Adjusted operating income of $193 million declined 19.7% YoY, with approximately half of the decline due to the extra week in the prior year quarter, while adjusted operating income margin declined 25 basis points to 3.2%. Adjusted earnings per share of $0.91 was $0.02 above the midpoint of our expectations, as better than expected operating income at EM and lower corporate and other expense offset the greater than expected decline in operating income at TS. Adjusted EPS declined $0.21, or 19% from the year ago quarter, with over half the decline due to the positive impact of the extra week in the prior year quarter. Cash flow from operations was slightly negative this quarter as working capital increased 3%, driven by a meaningful decline in accounts payable at TS.
I would, however, point out that our trailing twelve-month cash flow from operations increased $34 million to $258 million, and cash flow from continuing operations was $111 million in the current quarter. EM's revenue declined 9.3% YoY to $4.3 billion, and was 3% above the midpoint of our expectations. Adjusting to the extra week in the year-ago quarter, EM's revenue declined 3.4% in constant currency, primarily due to our decision to exit select high-volume supply chain engagements in the Asia region. Sequential growth at 3.5% was above seasonal at EM this quarter, although some of the positive variance was due to the ERP disruption in the June quarter, which negatively impacted sales in the Americas region.
EM's operating income declined 14.3% YoY to $186.5 million, with over 50% of the decline related to the extra week in the year-ago quarter. Operating income margin declined 26 basis points YoY to 4.5%, and was up more than 50%, 50 basis points sequentially, with the ERP disruption in the Americas region being a factor impacting the direction of both of these numbers. Revenue at TS declined 21.2% from the year-ago quarter to $1.9 billion, and was below expectations and normal seasonality. After adjusting for the extra week in the year-ago quarter, TS's revenue declined 13.8% in constant currency, driven by a decline in legacy data center products.
Operating income at TS declined 38.9% YoY to $43 million, with approximately one-third of the decline driven by the extra week in the year-ago quarter. Operating income margin was down 66 basis points YoY to 2.3%, as an improvement in Asia was offset by declines in the Americas and EMEA regions. As Bill referenced earlier, we took another major step in the strategic direction of Avnet with the acquisition of Premier Farnell, and the announced sale of TS. On the next few slides, I discuss the positive impacts of both of these transactions on our pro forma financial statements, along with expected synergies and expense reductions. Turning to slide 8, we look at how Avnet's business model would change after the acquisition of Premier Farnell.
The first column on this slide represents EM's fiscal 2016 results, including the transfer of the Embedded Computing Solutions business from TS at the beginning of fiscal 2017, and 100% of corporate expense. The second column is Premier Farnell's results for the six months ended July 31, 2016, annualized. The third column represents our expectations of synergies, comprised of revenue and cost synergies we expect to realize as a result of the acquisition of Premier Farnell. The fourth column represents expenses that will transfer with the sale of TS, cost reductions previously anticipated from our Avnet Advantage program, and other efficiencies and cost reductions. The fifth column calculates a pro forma income statement using the midpoint of the regions for synergies and cost reduction.
As you can see, post the two transactions, we are projecting Avnet will have over $18 billion of revenue and operating income of approximately $800 million, representing operating margin of approximately 4.5%. Two other changes I would highlight in this column is that our interest expense would increase as a result of the debt related to the acquisition of Premier Farnell, and our effective tax rate would drop to approximately 25%. Adjusted net, net income would be over $500 million, and using our current share count, adjusted diluted EPS would be approximately $3.90 per share.
In addition, there is a potential accretion of another 12-15 cents of EPS if we were to return to our historical leverage ratio by paying down $1.5 billion of debt with the cash proceeds from the sale of TS. While I would caution that these projections are estimates and could change based on market conditions, I believe it presents a positive pro forma financial impact of the two transactions on Avnet's profitability going forward. Most importantly, this base case does not include any future growth from our fiscal 2016 results. As we fully integrate Premier Farnell and roll out new strategies focused on higher growth markets, there is the potential to improve upon the scenario as we realize the full potential of our new business model. Now, turning to slide 9.
This provides another view of how the strategic transition of Avnet will positively impact both pro forma growth and operating income margins. In fiscal 2016, Avnet recorded gross profit margin of 11.6% and adjusted operating income margin of 3.4%. The sale of TS will have a positive impact on both of these numbers. The acquisition of Premier Farnell, which will increase operating income margin, will have a bigger impact on Avnet's gross profit margin. Given their small order size generates gross margins in excess of 30%, Avnet's gross profit margin would increase between 130 to 140 basis points. Conversely, the expense synergies and planned cost reductions would boost operating margins between 60 and 80 basis points once they are fully implemented.
Overall, pro forma gross margins would increase between 210 and 230 basis points to approximately 14%, while operating income margin could expand 80 to 120 basis points to approximately 4.5%. The increase in pro forma operating margin would also have a positive impact on return on capital, which averaged around 12% at EM over the past two years. With this business model incorporating higher margins and returns, we are confident we can leverage future growth and to increase shareholder value. Turning to slide 10. When the sale of TS closes, we expect to record a pretax gain on sale of between $775 million and $875 million, depending on final balance sheet adjustments.
After adjusting for taxes and fees, the midpoint of the net gain would be approximately $500 million. As you can see on this slide, the positive impact of the proceeds, netted against the assets that will be removed from our balance sheet, would increase our pro forma book value from $37 per share to between $40 and $42 per share, an increase of approximately 10% when the TS transaction closes. I'm now going to turn to slide 11. Another benefit we would expect to realize is a strengthened balance sheet with a strong cash position. With the close of the Premier Farnell acquisition, our total debt increases $900 million to $3.4 billion. While our leverage ratio will be temporarily elevated from now until the sale of TS, we will be conservative with how we manage our balance sheet.
With the completion of the sale of TS, we expect to receive approximately $2 billion of net cash after paying taxes and fees, which would result in a cash balance of close to $3 billion. Given our commitment to maintain our investment grade ratings, our intention is to pay down a significant portion of debt to reduce our leverage ratio, as well as to reduce interest expense. The end result would be a strong balance sheet and liquidity, which would leave us with capital allocation alternatives, where we could return cash to shareholders without impairing our ability to invest in organic or inorganic growth. We take a disciplined approach to buybacks that treat them as a form of internal M&A, and we will maintain that discipline as we decide the optimal way to deploy the capital from the sale of TS.
In summary, turning to slide 12, we have accelerated the strategic transition of Avnet in a very short time frame. After the two transactions are completed, Avnet will have a differentiated distribution model that spans the entire product life cycle. The addition of Premier Farnell will position us to lead in digital transformation as customers and suppliers look for innovative partners in the evolving technology supply chain. Our business model will have higher margins and returns that will allow us to leverage growth to increase shareholder value. We will also have a strong balance sheet and liquidity to fund both organic and acquisitions. As technology reaches deeper into more products and innovation proliferates through the Internet of Things, we are very excited about the future as we begin to write a new chapter in Avnet's long history serving the technology marketplace.
Turning to our Q2 outlook. Beginning with this quarter, our outlook will exclude the TS operations, given the announced sale. Our outlook includes the acquisition of Premier Farnell, which closed on October seventeenth. Therefore, looking forward to Avnet's Q2 of fiscal year 2017, we expect Avnet's sales to be in the range of $4.2 billion-$4.5 billion. Based on this revenue forecast, we expect adjusted diluted EPS to be in the range of $0.69-$0.79 per share. This guidance does not include any additional acquisitions, the amortization of intangibles, any potential restructuring, integration and other expenses, and certain income tax adjustments. The guidance assumes 130 million average diluted shares outstanding and an effective tax rate in the range of 23%-27%.
In addition, the above guidance assumes an average U.S. dollar to euro currency exchange rate of $1.09 to the euro, consistent with the Q2 of fiscal 2016.
...With that, let's open up the lines for Q&A. Operator?
Operator (participant)
Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Please limit your question to one question and one follow-up. Thank you. Our first question comes from Parm Singh with Merrill Lynch. Please proceed with your question.
Parm Singh (Financial Solutions Advisor)
Hi, thank you. So, you know, firstly, on the EM business, what kind of revenue synergies would you expect from the cross-selling opportunities? And, you know, what other expansion can you get from there? And then I have a follow-up.
Gerry Fay (President of Electronics Marketing)
Well, if you look at the total, this is Gerry, Parm. If you look at the total synergies we expect to achieve by the end of the second year, between $70 million-$80 million. That's, there's a mix between cost synergies and sales synergies. As we pointed out in the script, most of it's coming from cost synergies at this time. We're not gonna really break down those into separate detail, but there's a mix between cost synergies and sales synergies in that number.
Parm Singh (Financial Solutions Advisor)
And then, you know, obviously, the first use of cash for you is debt paydown, but would you expect to use some of the remaining cash for buyback afterwards or eliminate any or, you know, what's the debt number would be ideal for you, or how much you want to pay down? Any clarity would be great.
Kevin Moriarty (CFO)
Sure. Parm, Kevin, I think, let me start with the latter part of the question. You know, we historically have averaged anywhere from 2 to 2.5 times leverage. And I think as, as we move forward, that's where we would like to be, just given to allow us the flexibility that will be required. I think the question you're asking, and will come up a few times, I'm expecting, is that post the sale of TS, you know, we're gonna have many variables to consider. We don't need to maintain significant excess cash, given our countercyclical balance sheet. So we are clearly gonna be looking at alternatives for returning cash to shareholders, including a potential share buyback.
The actual method of return will include, you know, will depend on the timing, where the stock price is, and other factors, and we clearly are gonna be updating you. We're actively in conversations with our board. But again, we will continue to maintain our disciplined share buyback approach because we do view it as an internal form of M&A.
Parm Singh (Financial Solutions Advisor)
Then one more quickly, if I could. You know, your TS business far much worse than, you know, than expected. Margins were down by 100 bips, almost. The question is, you know, with that business underperforming and, you know, obviously going to be discontinued, but is there any chance of Tech Data coming back to you and renegotiating the price on that? Because operationally, it's much weaker than people expecting it three or six months ago.
Gerry Fay (President of Electronics Marketing)
We have a locked deal in place, and we have certain deliverables we got to deliver, and that is not a probability. It's going to happen.
Parm Singh (Financial Solutions Advisor)
Okay.
Gerry Fay (President of Electronics Marketing)
It's a deal.
Parm Singh (Financial Solutions Advisor)
All right. Thanks, guys. Really appreciate it.
Operator (participant)
Our next question comes from Ms. Sherri Scribner with Deutsche Bank. Please proceed with your question.
Sherri Scribner (Analyst)
Hi. Thanks. I appreciate the additional detail on the combined company, post the deals. I guess, looking at the pro forma margin profile that you've laid out, is that something we should expect, two years after the TS deal closes? When should we think about those, those targets as being realistic? Is it fiscal 2018 or is it fiscal 2019, or how should we think about that?
Kevin Moriarty (CFO)
Sherri, I would expect towards the, as we work through fiscal year 2018, we'll clearly be making continued progress as we deliver on the synergies. But think about it, probably in fiscal 2019, 18 months-24 months out.
Parm Singh (Financial Solutions Advisor)
Okay.
Gerry Fay (President of Electronics Marketing)
Yeah, Sherri, if you think about synergies, really nothing in the December quarter. We'll start seeing some of them in the March quarter, and then, as Kevin said, getting to full run rate over the 18-month period.
Sherri Scribner (Analyst)
And then-
Gerry Fay (President of Electronics Marketing)
I had one additional comment on chart eight, that we, in the investor deck, don't have any growth assumptions assumed in that pro forma that you see on the right-hand part of the chart.
Sherri Scribner (Analyst)
Okay. The December, March comments, just to clarify, was fiscal 2018, right, Gerry?
Gerry Fay (President of Electronics Marketing)
Yes.
Sherri Scribner (Analyst)
Okay. And then I guess a bigger picture question for you, Bill. If you look at the EM business, it's grown to sort of the 4%-5% revenue range. What do you view as the growth profile of the business going forward with the Premier Farnell business included? What are your market opportunities? How much do you think that business can grow? Thanks.
Gerry Fay (President of Electronics Marketing)
Well, I'm not yet in a position to tell you what the exact growth parameters will be, but clearly, we want to outpace the market growth because we think now we're going into an entirely different space, which will allow us to cast a much wider net with a lot more customers. Just adding Premier Farnell alone gets us 420,000 additional users, and we see that expanding over time, and we have a very effective, low cost to serve model. So we see this as a way for us to really turbocharge our results. But as I said, right now, I'm not in a position to say what we think that growth rate will look like exactly.
Sherri Scribner (Analyst)
Okay, thanks.
Operator (participant)
Our next question comes from Mr. Matt Sheerin with Stifel. Please proceed with your question.
Matt Sheerin (Managing Director)
Yes, thanks. Just following up on Sherri's question regarding Premier Farnell. Of those 420,000 users, I assume that they represent a smaller number of actual customers. But have you been able to look to see what the overlap with those customers are and figure out, as those customers convert from prototype to volume, how much you're capturing, and the opportunity there?
Gerry Fay (President of Electronics Marketing)
...We just had the team over there for the last week, and that's exactly the top of the agenda, and we see really great opportunities. We're not yet in a position to say exactly how many customers will convert, but the great news is we have the ability to turn that on instantaneously so that whenever they want to go from pilot to production, they're coming to Avnet.
Matt Sheerin (Managing Director)
Okay. Two other questions. Just one bigger picture regarding the significant consolidation of the semiconductor industry. You know, we've seen some news about Texas Instruments, which is one of your big suppliers, continuing to move more demand creation business on a direct basis. How does that impact you? You saw Qualcomm NXP today and other mergers. How is that affecting your business? And then the second question, just regarding your working capital metrics going forward, given that EM traditionally has had more inventory and longer cash cycle days, and then you work in Premier Farnell, how does that impact your working capital going forward?
Gerry Fay (President of Electronics Marketing)
Matt, it's Gerry. I'll take the first part of the question. So, as you mentioned, it's a, it continues to be a, a frothy environment with our suppliers. We normally don't discuss supplier-specific programs, but as you can imagine, when suppliers change their demand creation programs with a distributor in a negative way, there are other suppliers wanting to take competitive advantage of that. That's the beauty of being a distributor with a broad line card. We generally grandfather periods for the new designs, that gives us time to offset much of the margin loss.
When you see the investments we're making around our digital strategy to help customers shorten their time to market, provide embedded solutions to allow customers to differentiate through their software, and enabling customers to take advantage of our ability to take them from the edge to the enterprise, this is where we think our margin growth in the future is gonna come from. We can provide best-in-breed solutions to our customers by giving them choice and enabling technologies that few of our suppliers can match. So we think that, you know, there's gonna be continued change amongst our suppliers, and if we continue to add value to both the remaining suppliers and our customers, that we, we think we can continue to grow both revenues and profits. Kevin, you want to take the working capital question?
Kevin Moriarty (CFO)
Sure, Matt. Historically, as you know, I think our net days for continuing operations average, average around 70-80 days. I think when you do the math, we're currently greater than 80 days due to the ERP implementation in the Americas region and the decline in high volume supply chain engagements that had the higher returns. We do expect the net days to decline as the fiscal year progresses from current levels, but overall, net days, I would, you know, think slightly that they'll probably be closer to 70 days as we kind of go forward from here, including Premier Farnell.
Matt Sheerin (Managing Director)
Okay, thanks a lot.
Operator (participant)
Our next question comes from Mr. Louis Miscioscia with CLSA. Please proceed with your question.
Louis Miscioscia (Managing Director)
Okay, great. Thank you. Can you go into a little bit more detail on TS? Obviously, you mentioned legacy data center stuff, or maybe give us a little bit more of a product type of review of the trends, given obviously, how weak TS was.
Patrick Zammit (President of Technology Solutions)
Okay, so Louis, it's Patrick. So we have experienced decline primarily in North America on servers and legacy storage. So we continue to do very well on flash storage, and now our flash storage is getting close to 50% of the total storage, but the legacy storage continues to decline, although at a lower rate. The big impact this quarter came from the server business, both proprietary or x86 type servers. We got also some market data, and we see that in distribution in North America, the market has been declining on those two technologies. In EMEA, we also see a decline from the market on servers and storage, but for so far, we've been able to compensate by gaining share.
Louis Miscioscia (Managing Director)
Okay, great. That's, that's helpful. And does it seem to be a economic thing, or just that the customers are shifting from buying that to buying the newer products?
Patrick Zammit (President of Technology Solutions)
So, I mean, if I look at the market data, it's the market declining. So is it because they, they are continuing to move to cloud, or is it... So for the moment, what we have been told by our partners is that you had a lot of customers who are still questioning which technology they want to pick up for the future, so they are delaying purchasing decisions. So we've seen this quarter, how things materialize, but I would say it's it's more customers continuing to figure out, okay, which technology is the right right one for them going forward. And hybrid cloud, for sure, is playing a more and more important role in the decision-making process.
Louis Miscioscia (Managing Director)
Okay, great. On Premier Farnell, the $70 million-$80 million of synergies, is that mostly taking out the extra headcount, or excuse me, headquarters expense that they have? Or maybe you could just be a little bit more descriptive of where you're getting actual synergies.
Gerry Fay (President of Electronics Marketing)
Sure. It's Gerry. If you think about it, first of all, they were a public company, so we had public company costs on the Premier Farnell side that will come out. And then on top of that, we will look at our back offices where there's opportunities there. And as Bill said earlier, you know, there's opportunities between investments we were making on the digital side that we won't have to make anymore. So there's synergies between both Premier Farnell and Avnet to where we get some positive cost synergies that we've baked into our assumptions.
Louis Miscioscia (Managing Director)
... Okay, great. Last question for me is that, with the amount of cash you're coming in, it would be more accretive to try to fund more to stock buybacks and realize your debt position is rather high and has to come down. But any more just thoughts on maybe the breakdown or the possibility of actually a share buyback in addition, which would probably be more accretive as per our math?
Bill Amelio (CEO)
Yeah, well, there's no question about it. Look, this is one that we'll be discussing with the board. We got time to do this because, you know, as we discussed, the sale won't close until the Q1 at the earliest, and Q2 at the latest. So, we'll give you more detail on exactly what we're going to do. But clearly, if our stock is undervalued, we're gonna buy back some shares. That will be on the agenda to talk about.
Louis Miscioscia (Managing Director)
Okay, thanks, guys.
Operator (participant)
Our next question comes from Mr. Adam Tindle with Raymond James. Please proceed with your question.
Adam Tindle (Managing Director)
Okay, thank you. First question for Kevin. It would seem like netting the $2 billion in TS proceeds versus the pro forma net debt for Premier Farnell of just over $2 billion would give you basically minimal net debt when we account for all of these things. And you just laid out over $800 million of pro forma operating income on that pro forma slide. So I'm just trying to understand how you arrived at the $500 million available for capital allocation alternatives. Is it fair to say that there may be some conservatism built in given the leverage levels that it implies on a net debt-to-EBITDA basis?
Kevin Moriarty (CFO)
It, it does, as well as, obviously, we're gonna have continuing cash flow from operations, so, correct.
Adam Tindle (Managing Director)
Okay. Maybe following up to that, Kevin, how can we think about... I know earlier was asked about pro forma working capital, but pro forma ROIC, when we account for the sale of TS, going forward, is there a metric that you can give us to think about?
Kevin Moriarty (CFO)
Yeah, what I would tell you is that as we work through the next couple of years, I am expecting us to kind of go, you know, north of the 11% return on capital and then mature over the next two years, three years, between 11%-13%, as we look at the respective profile of the company.
Adam Tindle (Managing Director)
Okay. Now, if I could just get one for Bill real quick. When you, Bill, when you factor in the sale of TS, acquisition of Premier Farnell, and use of excess cash, do you ultimately expect those events to be accretive or dilutive to EPS?
Bill Amelio (CEO)
Our objective is to make them accretive.
Adam Tindle (Managing Director)
Okay, fair enough. Thank you.
Operator (participant)
Our next question comes from Mr. William Stein with SunTrust. Please proceed with your question.
William Stein (Managing Director)
Hi, guys. This is Joe Meares dialing in for Will. First, can you just give us an ERP status update? It affected components revenue growth in Q3. So is that behind you now, and are there any effects on inventories there?
Gerry Fay (President of Electronics Marketing)
Yeah. Hi, it's Gerry. So think about it in terms of revenue. We actually exceeded expectations this quarter in revenue, expense, and profit, so I want to give a nice great job to our Americas team. As you can see, we reduced inventory in Q1, and we will do so again this quarter. Based on the learning from our assessments on the new system, we're gonna make some additional investments to improve our system capabilities even further. We had about $3 million in expense in Q1 related to the ERP project that were due to roll off in the December quarter, and what we've decided to do is build this into our plan for the balance of the fiscal year to support these enhancements.
William Stein (Managing Director)
That's helpful. Thanks. And then just as a follow-up, I guess, what's your appetite for M&A post the close of the TS sale once you guys are back in your target net leverage range? I know you mentioned buyback as probably potentially use of cash, but just trying to gauge your current pipeline and ability to engage in more M&A while you're integrating Premier Farnell. Thanks.
Bill Amelio (CEO)
Well, well, clearly, we'll still have power to be able to spend on some acquisitions as well. So we've got a rich pipeline, it's a robust pipeline that we're looking at, but we wanna make sure that we make the prudent calls between buying back our stock, taking a advantage of the acquisitions that are out there, ensuring that they're at the right price, and they meet the right strategic intent that we would look for them to do, as well as investing in organic growth as well. So those are the areas that we'll consider as we move forward. So we still have, as I said, a few quarters before the cash comes in, and we have to make that call.
William Stein (Managing Director)
Got it. Thanks. That's helpful, guys. Appreciate it.
Operator (participant)
Our next question comes from Mr. Shawn Harrison with Longbow Research. Please proceed with your question.
Shawn Harrison (VP and a Senior Research Analyst)
I guess, morning, it's Shawn Harrison. A lot of clarifications, if I may. What is normalized CapEx as we, you know, get into fiscal 2018 with the combined companies?
Kevin Moriarty (CFO)
Shawn, what we're currently looking at is somewhere on a go-forward basis in the neighborhood of up $90 million-$110 million. Clearly, we just, with Premier Farnell, we're, we're up, you know, we spent some time, we're studying that, but right now, that's the way we're thinking about it, in the $90 million-$110 million for remaining total Avnet go forward.
Shawn Harrison (VP and a Senior Research Analyst)
Okay. Second, the comment on, you know, maybe a larger buyback, waiting until you receive the cash, does that mean that the buyback you would typically do every quarter is on hold as well, until you close the, the TS sale?
Kevin Moriarty (CFO)
Yes, Shawn. As we're working through this, we're gonna be temporarily, our leverage ratios are gonna be pretty high. So, you know, as I mentioned on the call, we're gonna be quite conservative on managing the balance sheet. And as we look forward here, obviously depending on the cash flow from operations and things of the sort, but right now, given where our leverage profile is, until the TS sale concludes, that's the way we're gonna be managing. Thanks.
William Stein (Managing Director)
Okay, and then two last clarifications, if I may. What would be a synergies run rate you're targeting exiting fiscal '17 for Premier Farnell? And then if I look at the, I guess, the normalized interest expense before you begin to pay something down, what would that be for the combined entity? And do you have kind of a rate on the debt that you're looking to pay down once you get the TS proceeds, maybe what the average cost of that debt is?
Gerry Fay (President of Electronics Marketing)
So, Shawn, it's Gerry. Think about the synergies from a perspective, probably, and, and, you know, I'm kind of just trying to lay this out for you. Think about a year from now getting about half the synergies done, and then the 18-month time frame getting to the full run rate of synergies for Premier Farnell.
Kevin Moriarty (CFO)
And, Shawn, I'll take the second one. So if you look at where we concluded interest expense for the current quarter, it was $27 million. Clearly, with the payoff of the September note and now adding on the Premier Farnell debt, in the current quarter, I would range in the neighborhood of $29 million-$30 million for interest expense. Thereafter, because, again, that's also for Premier Farnell, it's a partial month, and thereafter, I would expect interest expense to be in the neighborhood of $31 million-$32 million. Again, I'll update you in January, but that's kind of the way we're thinking about it go forward.
In terms of the other timing issues, in terms of paying down the debt, and that's all stuff that, again, we'll continue to update you on, but we are currently thinking about the $1.5 billion pay down of debt.
Shawn Harrison (VP and a Senior Research Analyst)
Is there, I guess I could look at your structure, but, I mean, the average cost of that debt somewhere around 5%-5.5%?
Kevin Moriarty (CFO)
Actually, what I'm thinking about from a blended rate standpoint would be somewhere between 3.9% and 4% after the sale of TS.
Shawn Harrison (VP and a Senior Research Analyst)
Okay, perfect. Thank you.
Kevin Moriarty (CFO)
You're welcome.
Operator (participant)
Our next question comes from Mr. Steven Fox with Cross Research. Please proceed with your question.
Steven Fox (Managing Director)
Hi, good morning. Can you discuss the current December quarter guidance a little bit more detail? Specifically, what revenue range are you assuming for Premier Farnell, and what type of organic growth would that imply? And, where are their margins, you think, in this current quarter, and are there any dis-synergies in the Q1 out of the box as you integrate it into Avnet? And I have a follow-up.
Kevin Moriarty (CFO)
So I look at, you know, when you go from our fiscal Q1 into our fiscal Q2, recognize that it's seasonally strong in our Asia region, given just the commercial change that occurs as getting ready for the end of the calendar year. And that's pretty normal for us as we go between the quarters. So on the margin profile, that's, that's what I would expect. And Gerry, comment on terms of revenue and-
Gerry Fay (President of Electronics Marketing)
Yeah, so if you think about it, think about the Premier Farnell revenues in the $230 million-$260 million range. If you look at their gross margins, I know on the last call, there was conversation about their gross margins and concern around that. Actually, their gross margins, if you look at their last six months results have improved, and we expect that improvement to continue. And so, I think when you look at margins, to Kevin's point, this is the quarter of the year where Asia is the biggest piece of that, so that drives kind of Avnet's gross margins down. We won't see a similar impact at Premier Farnell.
Steven Fox (Managing Director)
Okay, so in terms of the number you just gave, Gerry, in terms of the Premier Farnell revenues, that's a full quarter run rate, or that's from October 2017?
Gerry Fay (President of Electronics Marketing)
Yes, from October.
Steven Fox (Managing Director)
Okay. And you're saying the gross margins for Premier Farnell have improved, but into the December quarter, they're not improving as much, or? I'm just trying to get directionally-
Gerry Fay (President of Electronics Marketing)
No, I think, I would say, I would think about it maintaining the margins that they've had over the last six months.
Steven Fox (Managing Director)
Okay. And then are there dis-synergies with the, with the first couple of months out of the box that maybe drag on this quarter's EPS?
Gerry Fay (President of Electronics Marketing)
No, I don't think so. If you think about the strategy we've laid out, we're pretty much going to keep the two businesses separate at this time. So there's not a lot of what I would call heavy integration work going on. There's work to put our systems together to be able to pass information back and forth. But when you think about full-scale integrations of alike companies, we're not doing that in the case of Premier Farnell. So I think both management teams' attentions will be, will be focused on running their core businesses.
Steven Fox (Managing Director)
Great. And then just a longer-term question on Premier Farnell. Now that you've had a few months to sort of study the business and now it's part of Avnet, can you talk about what type of range of growth you would project for the business going forward? How it may be different from what the company's produced over the last 12 months or even the last three years, and why that would be?
Gerry Fay (President of Electronics Marketing)
Yeah, we won't, we won't project growth rates out into the future. That's not something we normally do, but I think you can look at some of the flux that Premier Farnell has gone through over time. They're now going to have a very stable management team between Premier Farnell and Avnet. So I think settling that team down and getting them focused, I think you can look at growth rates that are going to be very similar to the Avnet core business. And I think if you look at what's happening in the Maker space, there's an opportunity for actually Premier Farnell's growth to exceed the core distribution growth that we see at Avnet.
Steven Fox (Managing Director)
Great. Thanks a lot.
Operator (participant)
Our next question comes from Mr. Mark Delaney with Goldman Sachs. Please proceed with your question.
Mark Delaney (Analyst)
Yes, thanks very much for taking the question. The first question is on the Premier Farnell synergy that you talked about. You outlined in the slide deck about $100 million of revenue synergies from Premier Farnell. Can you talk a little bit more about how you derive those? And then, given the guidance for $70 million-$80 million of synergies within 18-24 months, mostly from costs, can you talk about why the revenue synergies of that, you know, roughly $100 million, why that takes longer than that 18-24 months to achieve the majority of it?
Gerry Fay (President of Electronics Marketing)
Well, first of all, Mark, it's Gerry. If you look at what the plan is, the revenue synergies really come from taking leads early on in the design process and bringing them over to Avnet for us to be able to capture those customers. Just think about demand creation at Avnet. It takes somewhere between 12 and 18 months for a new design to come to life. So if you think about, we find a lead at Premier Farnell today, if somebody's starting a design, that's even earlier in the process. So think about time to full scale production from there, it's probably more like 18 months-24 months. So when we look at the leads from Premier Farnell, that will get us to a customer early and help speed their time to market.
To really ramp that revenue, it's gonna be a good 18 months before we start to see any impact from that.
Mark Delaney (Analyst)
Okay, that's helpful. And then follow up for the outlook for the EM segment revenue in the December quarter. If I subtract out that $230-$260, I think you said for the Premier Farnell contribution, implies core EM down low single digits in the December quarter, which I know seasonality has evolved, but I think that's below seasonal. So maybe you can just help us understand a little bit better what you're looking for in the EM business sequentially on an organic basis in the December quarter.
Gerry Fay (President of Electronics Marketing)
Well, remember, we talked about exiting a large portion of our full-scale, our large-scale fulfillment business. That's gonna change our seasonality going forward. So if you think about it, this business was somewhere between 6%-8% of our total business. Now think about it from a 1% or 2% going forward. So I think the thing to focus on here is if you look at the core EM business YoY, we're actually declining less than we did in the quarter last year. And I think the thing I would focus on is we're gonna see improvement in our, our profit percentage this quarter. So I think it speaks to the strength, and it speaks to the decision we made to get out of that, high-volume fulfillment engagement.
We shift our business back to the West, and based on our newest win with Broadcom, that business is gonna start really kicking in this quarter. So I think from a growth perspective, when we go back and revise what our seasonality is gonna be going forward without the fruit business, I think you'll see that this will be a more favorable quarter.
Mark Delaney (Analyst)
That's helpful. And one last one for me, a strategic question, actually related to somewhat to the topic you just brought up. But given all the industry consolidation, do you think there's gonna be an increase in the number of exclusive agreements that take place between you and your semi suppliers? I know you announced the Broadcom exclusive agreement recently. I know you probably don't want to talk too much about a specific customer, but if you could just talk about whether or not that's a trend that you expect going forward and what the financial implications may be. Thank you.
Gerry Fay (President of Electronics Marketing)
Yeah, it's hard, it's hard for me to speculate what our suppliers will do, but I do think that, no matter what decisions our suppliers make, if you look at, our scale and scope, our investments, and now our ability to completely focus on the components business, I think, you know, if any of those decisions do get made, I think we're in a very good position to be selected. So I don't wanna speculate what our suppliers might do. It's a very volatile time in the industry, but at the end of the day, I kind of like our odds, given the fact that, you know, we're gonna have some powder to be able to invest both organically and acquisitively.
If you look at that and you look at our complete focus on components, I think that puts us in a good position if suppliers do make those decisions.
Operator (participant)
Our next question comes from Mr. Jim Suva with Citibank. Please proceed with your question.
Jim Suva (Managing Director)
Thank you very much. I have two questions. I'll ask them at the same time. First of all, on the ERP situation, that was a challenge in the past, has that 100% fully been resolved, or if not, what's the timeline? And if it's been resolved, did you regain some of the share that you lost, or how should we think about that? And then my second question is, going back earlier, there's a question asked about some of the chip companies changing the economics of the channel. I think specifically, you know, Texas Instruments was mentioned, but without talking about a specific company to, you know, remain confidential with that, it does seem like there are some value-added shifts going on.
Could you kind of readdress that and help people understand the reactions, the puts or takes, with that? Thank you.
Gerry Fay (President of Electronics Marketing)
Sure, Jim, it's Gerry. I'll take the question. So let's start with the ERP system. If you think about it, our core business is performing as it did before the ERP system implementation, so we feel very good about that. As I said earlier, you know, some of the learnings we took from, you know, our systems work that we've done over the last quarter to get back to where we needed to be, have led us to some areas of potential improvements we can make to those systems. So we're gonna continue to invest there. I would say from, you know, if you think about share, I won't talk about specific share numbers, but I think if you look at our performance in the Americas, I'm not sure we actually lost any share, what I would call ongoing share.
We hadn't lost any major customers, so I feel pretty good about the job the team has done, and I can't say enough about our Americas team when they worked through that problem last quarter. So I would say we're getting back to a level of normalcy there. Now I'll shift to talk about the supplier piece. You know, as you see, the amount of acquisitions by our suppliers continues to go up. I think when that happens, they look at their distribution channel. And to the earlier point, you know, one of the advantages I think we have as a broadline distributor is the fact that, you know, when an acquisition happens, it's not just those two companies that are getting together that look at their strategies.
A lot of our other suppliers start to look at their strategies and how potentially they're gonna go to market going forward. So there's always puts and takes, and, you know, so far, we've been able to manage through that successfully. And I would say, going forward, given the fact of our scale and scope, our ability to invest, that we're gonna be one of the likely partners going forward as our suppliers make those decisions.
Jim Suva (Managing Director)
Thank you very much for the detail.
Operator (participant)
Gentlemen, there are no questions. At this time, I'd like to turn the call back to Vince Keenan for closing comments.
Vince Keenan (VP of Investor Relations)
Thank you for participating in our earnings call today. Our earnings press release and related CFO commentary can be accessed in downloadable PDF format at our website, www.ir.avnet.com, under the Quarterly Results section. Thank you.
Operator (participant)
Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.