Avnet - Q2 2013

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.

Vincent Keenan (VP of Investor Relations)

Good afternoon, and welcome to Avnet's second quarter fiscal year 2013 business and financial update. If you are listening by telephone today and have not accessed the slides that accompany this presentation, please go to our website and click on the icon announcing today's event. As we provide the highlights for our second quarter fiscal year 2013, please note that in the accompanying presentation and slides, we have excluded the gain on bargain purchase associated with an acquisition and restructuring, integration, and other items for all periods presented. When discussing pro forma sales or organic growth, prior periods have been adjusted to include acquisitions and the impact of divestitures.

In addition, when we refer to the impact of foreign currency, we mean the impact due to the change in foreign currency exchange rates when translating Avnet's non-US dollar-based financial statements into US dollars. Finally, when addressing working capital, return on working capital employed, and return on working capital, the definitions are included in the non-GAAP section of our presentation. Before we get started with the presentation from Avnet management, I would like to review Avnet's safe harbor statement. This presentation contains certain forward-looking statements, which are statements addressing future financial and operating results of Avnet. Listed on this slide are several factors that could cause actual results to differ materially from those described in the forward-looking statements. More detailed information about these and other factors is set forth in Avnet's filings with the Securities and Exchange Commission.

In just a few moments, Rick Hamada, Avnet's CEO, will provide Avnet's second quarter fiscal year 2013 highlights. Following Rick, our new Chief Financial Officer, Kevin Moriarty, will review some additional financial highlights, our return on capital performance, and provide third quarter fiscal 2013 guidance. At the conclusion of Kevin's remarks, a Q&A will follow. Also here today to take any questions you may have related to Avnet's business operations is Ray Sadowski, Avnet's Chief Administrative Officer, Phil Gallagher, President of Technology Solutions, and Harley Feldberg, President of Electronics Marketing. With that, let me introduce Mr. Rick Hamada to discuss Avnet's second quarter fiscal 2013 business highlights.

Rick Hamada (CEO)

Thank you, Vince, and good afternoon, everyone. Thank you all for taking the time to be with us and for your interest in Avnet. After several quarters of a somewhat cautious technology spending environment, certain segments of our served markets demonstrated relatively better strength in the December quarter. At Technology Solutions, calendar year-end spending on IT infrastructure was stronger than expected, while component sales in Asia also exceeded expectations for the second quarter in a row. As a result, enterprise revenue grew 14% sequentially to $6.7 billion, and pro forma revenue was up 9.4% in constant currency, which is in line with normal seasonality after two quarters of below-seasonal growth. On a year-over-year basis, reported revenue was roughly flat, and pro forma revenue declined 4.8% in constant currency.

Gross profit increased $84 million, or 12% sequentially, due primarily to the strong double-digit growth at Technology Solutions. Our sequential gross profit margin decline of 19 basis points included the impact of the enterprise business mix shift, as our lower gross profit margin TS business grew to represent 45% of enterprise sales, as compared with 38% in the September quarter. The combination of strong growth in revenue and our previously communicated cost reductions actions drove adjusted operating income up 60% sequentially and adjusted operating income margin up 95 basis points sequentially to 3.3%. Adjusted operating income margin was down 67 basis points year-over-year, due primarily to the temporary benefit from hard disk drive shortages included in the year-ago quarter, as well as lower operating income margin at EM in the current year.

As a result of these factors, adjusted EPS increased $0.42, or 71% sequentially, to $1.01. Despite this significant sequential improvement, adjusted EPS was down $0.14 from the year-ago quarter, which included a positive impact of approximately $0.05-$0.07 from the temporary benefit related to hard disk drive shortages in the second quarter of fiscal 2012. The remainder of the decline was due to lower net income, somewhat offset by the benefits of our share repurchase program. Return on capital employed increased 403 basis points sequentially to 11.8%, but was down 245 basis points year-over-year, due primarily to the decline in net income, as working capital velocity was essentially consistent with the prior year.

Our sequential increase in net income, combined with a reduction in working capital, drove cash flow from operations to $326 million for the quarter, bringing the total to $690 million for our trailing twelve months. In the December quarter, we experienced stronger-than-expected calendar year-end spending at TS after an unexpected decline in our North America region across both EM and TS in the September quarter. While we are somewhat encouraged by these collective results, there are still many question marks regarding global growth trends and their impact on the technology markets we serve. In this environment, we will continue to monitor our dashboards and react quickly to changes in demand across our served markets.

The Avnet team has managed through cycles before, and we are confident that our agility and strong customer focus will position us to leverage growth and to improve financial performance going forward. Now let's turn to the operating groups.... In the December quarter, Electronics Marketing's revenue came in above expectations, driven by accelerating growth in the Asia region. Reported revenue increased 2.2% year-over-year, while pro forma revenue declined approximately 1% year-over-year in constant dollars. On a sequential basis, reported revenue increased 0.5%, while pro forma revenue, which declined 1.7% in constant currency, was within our normal seasonal range of flat to down 3%. Despite this seasonal top-line performance, we continue to see supply chains at different stages of recovery by region coming out of the inventory correction of fiscal 2012.

Our Asia region, which experienced an increase in lower margin fulfillment revenue tied to supply chain engagements, grew pro forma revenue 2.7% sequentially and 10.9% year-over-year. In our EMEA region, which dealt with several quarters of double-digit year-over-year declines in fiscal 2012, pro forma revenue in constant currency was down less than 1% year-over-year, despite being down 8.5% sequentially. Our Americas region, which was the least impacted by the inventory correction, declined 1.8% sequentially and was down 12.8% on a pro forma basis from the prior year quarter, primarily due to our previously communicated decision to exit the lower margin commercial components business in Latin America.

EM's gross profit margin declined 80 basis points year-over-year, primarily due to the temporary margin benefit from hard disk drive shortages in the year ago quarter, a pronounced geographic mix shift to Asia due to the uneven recovery, and higher mix of low-margin fulfillment revenue in the Asia region this quarter. Gross profit margin decreased 23 basis points sequentially due to the previously mentioned Asia mix factors. EM's operating income declined 19.9% year-over-year to $140.1 million, and operating income margin decreased 105 basis points from the prior year quarter to 3.8%. The year-over-year decline in operating income margin was primarily a result of the previously mentioned gross margin impacts, along with a relatively slower recovery in the Western regions, partially offset by the cost reduction actions taken in previous quarters.

On a sequential basis, operating income margin improved materially in the Americas region as a result of the cost reductions implemented in the September quarter. However, EM operating income margin declined 90 basis points sequentially due to declines in EMEA and Asia. Return on working capital declined 358 basis points from the year ago quarter, as a decline in the operating income more than offset a 6.8-day improvement in our cash conversion cycle. After adjusting for acquisitions and changes in foreign currency exchange rates, working capital decreased by 5.9% year-over-year and 5.7% sequentially, primarily due to lower inventory levels. On a pro forma constant currency basis, EM's inventory decreased 7.9% from the September quarter, with half of the dollar decline occurring in our Asia region.

EM's bookings strengthened throughout the quarter, and the book-to-bill ratio was above parity in all three regions for the quarter, which suggests customer inventory levels are aligned with end demand. With a book-to-bill ratio above parity for the December quarter, it appears that customers are starting to increase their purchases, but longer-term visibility remains limited given the relatively short lead times in the supply chain. While Asia has been our strongest region fiscal year to date, we are confident that a continuing recovery in our core industrial markets in the West will help drive further leverage in EM's model and grow margins and returns back within our target range. TS delivered a strong quarter on both the top and bottom line, as better-than-expected calendar year-end spending on IT infrastructure drove sequential revenue growth above normal seasonality after two quarters of below-seasonal growth.

Reported revenue grew 36% sequentially to $3.0 billion, and pro forma revenue grew 27% in constant dollars, as compared with the normal seasonal range of +20%-26%. Our Americas region, which grew pro forma revenue 36% sequentially, achieved well above seasonal growth, as our data suggests that many of the projects that were delayed at the end of September were completed in the December quarter. In the EMEA region, which has been dealing with weak demand for two years, pro forma revenue grew 20% sequentially in constant dollars, while Asia increased 11% sequentially. On a year-over-year basis, reported revenue declined 2.3% from the year ago quarter, while pro forma revenue declined 9% in constant currency, primarily due to the EMEA region, which declined 18%.

On a sequential basis, storage, software, and services grew over 35%, while storage and services led the portfolio elements that increased year-over-year. Gross profit margin increased 32 basis points year-over-year and 49 basis points sequentially, primarily due to the revenue mix of higher margin products in the Western regions. The significant increase in gross profit, when combined with the cost reductions implemented fiscal year to date, resulted in operating income growing 5.9 times faster than revenue sequentially. Operating income margin increased 202 basis points sequentially to 3.6%, with all three regions delivering meaningful improvement in both gross profit margin and operating income margin.

Operating income margin declined 27 basis points year-over-year, as an improvement in the Americas region was more than offset by a decline in the EMEA region, due primarily to recent acquisitions, as the related cost synergies have not yet been attained and which are not expected to be fully achieved for several quarters while our integration work is in process. As a result of these, of the sequential increase in profitability, return on working capital increased to over 2,500 basis points sequentially, yet is still below year-ago levels due to lower profitability and a lower share of revenue from the higher margin Americas region. TS performance this quarter represents an important step in resuming progress towards our long-term financial goals. The significant improvement in margins and returns demonstrates the leverage in our model when we can generate profitable growth.

Even though the muted IT spending that characterized the previous two quarters could carry over into the new calendar year, we continue to invest in new growth opportunities that enhance the value we deliver and expand the breadth of projects our VAR partners can address. In the Americas region, the professional services acquisitions we made are gaining traction with our VAR base, while in EMEA, the integration of Magirus continues as we work on the planned expense synergies, while also focusing on cross-selling opportunities into our expanded customer base. While it is difficult to predict where IT spending could trend in the current macroeconomic environment, we remain committed to build on this performance by focusing on higher growth segments and increasing the value we deliver to our trading partners around the globe.

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

Kevin Moriarty (CFO)

Thank you, Rick, and hello, everyone. I'm excited to be joining the Avnet leadership team, as Avnet is an established global brand and a market leader that enjoys a rich history of innovation and strong operational performance. Ray has done a phenomenal job assisting with the transition, but given the complexity of Avnet's business around the globe and my relatively short tenure in the job, I may defer some of your financial questions to him during the Q&A. With that said, let's turn to some additional highlights from the second quarter of fiscal 2013. Turning to slide 8. As Rick mentioned earlier, the strong financial performance this quarter drove cash flow from operations to $326 million in the quarter, bringing the trailing twelve-month total to $690 million.

Through the first six months of fiscal 2013, we have generated $407 million of cash flow from operations and invested $171 million in value-creating M&A, and another $207 million in our share repurchase program. We decreased our activity as the stock price appreciated, but still purchased $69 million of shares in the current quarter. As of the end of the quarter, we still have approximately $225 million of the company's $750 million stock repurchase authorization available to invest when we believe it is appropriate to do so. Now, let's take a look at a metric that I have already learned is both well understood and consistently monitored here at Avnet: economic profit.

As you can see from this slide, economic profit returned to positive territory in the December quarter as return on capital employed improved to 11.8%. Across the business, the Avnet team did a commendable job reacting to our disappointing September quarter. Our sequential improvement was primarily due to the improved financial performance at TS and a seasonally strong December quarter. At EM, effective working capital management contributed to year-over-year improvement in working capital velocity. These improvements are evidence of our portfolio management discipline as we continue to align our resources to market conditions.

While I continue to learn about the company and its unique capabilities around the globe, I look forward to increasing my interaction with all of you and providing my perspective on the myriad of opportunities for profitable growth and how the finance team will continue to be a key partner to the business leaders here at Avnet. Now, turning to slide 9 on the Q3 fiscal quarter. Looking forward to Avnet's third quarter fiscal 2013, we expect EM sales to be in the range of $3.625 billion-$3.925 billion, and sales for TS to be between $2.325 billion and $2.625 billion. Therefore, Avnet's consolidated sales are forecast to be between $5.95 billion-$6.55 billion.

Based upon that revenue forecast, we expect second quarter fiscal 2013 earnings to be in the range of $0.81-$0.91 per share. The above EPS guidance does not include any potential restructuring charges or any charges related to acquisitions and post-closing integrations. The guidance assumes 138 million of average diluted shares outstanding, used to determine earnings per share and an effective tax rate in the range of 27%-31%. In addition, the above guidance assumes that the average U.S. dollar currency rate for the third quarter of fiscal 2013 is $1.34 to the euro. This compares with an average exchange rate of $1.31 to the euro in the prior year-end third quarter, and $1.30 to the euro in the second quarter of fiscal 2013. With that, let's open the lines up for Q&A.

Operator (participant)

Thank you. We will now be conducting a question and answer session. If you would 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 would like to remove your question from the queue. For participants with speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from the line of Shawn Harrison . Please proceed with your question.

Shawn Harrison (Senior Research Analyst)

... Good morning. I was just hoping, or good afternoon. I was hoping you could maybe expand a little bit in terms of just the book-to-bill ratios being positive globally. If you could kind of dissect that in terms of, you know, where we are in January, and then just a little bit more in terms of the commentary on industrial turning. Are you actually seeing that, or is that kind of the expectation you begin to see that in the Western regions in the March quarter?

Rick Hamada (CEO)

Harley, you wanna start, and I'll chime in.

Harley Feldberg (President of Electronics Marketing)

Sure. Good afternoon, Shawn.

Shawn Harrison (Senior Research Analyst)

Good afternoon.

Harley Feldberg (President of Electronics Marketing)

So the book-to-bill, as we mentioned, was positive in all regions for December, which was very encouraging. Through, you know, a short period in January so far, we are essentially at parity. Slight deviations by region, but nothing really significant. So essentially, the positive booking momentum has continued, for all intents and purposes, through the beginning of January. I believe your second question was some perspective on what we're seeing in the broader industrial markets, which are obviously extremely critical to EM's model and EM's ultimate profitability. We see some encouraging signs. I think it's in this macro environment; it's difficult to be overly euphoric, obviously, so we all are looking at the bigger picture.

But some of the signs we see that we find encouraging, are, of course, the positive book-to-bill in each region, but especially in our Western regions, in both Europe and America, finishing out December in a positive way. December bookings continued stronger than we would have expected, closing out the year into the holiday period, so that's encouraging. And there have been some signs. I actually saw something this morning that some of you may have seen, that, shed some encouraging, again, I wouldn't say euphoric, encouraging light on, export indicators coming out of Central Europe, which is one of our most critical, geographies, some encouraging manufacturing data. So those are the signs we see that cause us to be, generally positive.

Rick Hamada (CEO)

Yeah. Thanks, Harley. Shawn, I would just add, and then maybe anticipating some more of the questions coming down the pipe. You may hear an overall theme in many of our comments, and this applies across the board, EM and TS, that we're trying to keep the quarter's performance in perspective. I would share that many of the previous, the lack of visibility long term, the questions around macroeconomic trends by region, many of these are very similar to what we referenced in even the June and September quarters. But obviously, the December quarter results were a different vis-a-vis our expectations than those two previous quarters. So we're trying to keep it all in perspective and continue to work through those lingering questions, to not get overly exuberant going forward.

But as Harley said, a positive book-to-bill was certainly a reversal of trend after two quarters of negative. We think that means at the very least, supply chain downstream from us is in really good shape, and a good year-end spend, you know, it was. We'll take it as a positive for our enterprise computing business as well. But trying to keep it in balanced perspective and keeping in mind that that seasonal shift from September to December was probably part of the December story, we're trying to smooth that out and look at it on a more normalized basis as we assess our expectations. Okay, does it make sense, Shawn?

Shawn Harrison (Senior Research Analyst)

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

Rick Hamada (CEO)

So, Ray, from the September announced, we're 100% done at that point?

Harley Feldberg (President of Electronics Marketing)

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

Shawn Harrison (Senior Research Analyst)

Okay. And I think that target amount was something of, you know, potentially $20 million-$30 million if you felt bad and, you know, better, you know, a smaller amount of things were kind of, you know, maybe a little bit on the upswing. Is that the best way to characterize it?

Harley Feldberg (President of Electronics Marketing)

Well, I'm not sure we quoted a number, but,

Shawn Harrison (Senior Research Analyst)

Okay.

Harley Feldberg (President of Electronics Marketing)

It seems, it seems, you know, reasonable, you know, at, at that range, depending upon what we see on a go-forward basis. Right, yeah, that's not a number we would quote, but again, it's not an outrageous number, depending upon what we see on a go-forward basis.

Rick Hamada (CEO)

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

Shawn Harrison (Senior Research Analyst)

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

Harley Feldberg (President of Electronics Marketing)

Thank you.

Operator (participant)

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

Amitabh Passi (Analyst)

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

Rick Hamada (CEO)

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

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

Phil Gallagher (CEO)

I think you said it well, and kind of build on the last question, and we still have work to do. We're happy with the quarter, but we need to get back to, you know, we're gonna shoot for parity, hopefully a little bit more, and particularly in the June quarter. And on the expense question, in case anyone else is wondering, we did take quite a bit of expense out in Europe and are working on some more regular managed expense reductions as we move through this quarter, not to mention some of the synergies in the Magirus.

Rick Hamada (CEO)

Okay. Harley, inventory?

Harley Feldberg (President of Electronics Marketing)

Sure. Hi, Amitabh

Rick Hamada (CEO)

Hey.

Harley Feldberg (President of Electronics Marketing)

I'm very comfortable with where the inventories are today. As I'm sure you're aware, lead times continue to be very, very low, and we've seen no deviation off that over the short term. You know, if you look at the reports that try and track excess inventory and supply chain overall, for example, today, that excess is very heavily skewed towards our suppliers. And those factors make us very comfortable that short of some very robust change in end demand, our inventories are aligned properly. I will say, since the question will probably come up at some point, I do expect inventories to come up slightly in March.

Not significant amount, but clearly, we're running inventory prudently and with some degree in March and hopefully a continued healthy environment in the industrial markets going into June. We would expect inventory to come up modestly.

Amitabh Passi (Analyst)

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

Harley Feldberg (President of Electronics Marketing)

Thank you.

Operator (participant)

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

Scott Craig (Analyst)

Thanks. Good afternoon. Hey, Rick or Harley, could you discuss a little bit, with regards to the outlook for the EM business, sort of the mix assumptions you're making from a geographical perspective? And then secondly, Rick, when you look across the portfolio in Europe from an acquisition perspective, where do you see the best opportunities within the TS business to go forward? Like, where do you want to add? What sort of capabilities do you need to add here as you look over the next 12 months? Thanks.

Rick Hamada (CEO)

Okay. Well, Harley, why don't you start with the geo mix and

Harley Feldberg (President of Electronics Marketing)

Sure. Hi, Scott. Our outlook looking forward, I anticipate this question because the guidance may look slightly below what would be perceived as normal seasonality, and so I, I appreciate the opportunity to explain a little bit. Our outlook is for normal seasonality, and actually in each region, which is encouraging. The overall number is tempered a bit by the fact that we continue to scrutinize, and in some cases, deselect business. You will recall, we've talked about in the past, in an area of our business that we internally refer to as embedded consumer commercial consumer products. And we are going through that business on a regular basis, attempting to make what we can meet our long-term financial goals.

But as we shared with you last quarter, some of it is not, and therefore, we are moving off of that. That projection for additional reductions in that area in the March quarter is what takes us out of what would be traditionally normal seasonality for the March quarter. When I think about our activity that has occurred so far, the one asterisk I think I'd put on the answer would be that at least through the very initial part of January, Asia is tracking a bit stronger than I had anticipated when we formulated the guidance, with Europe and America tracking right on where we expect. I am cautious on overreading that short Asia data, only because we are not yet into Chinese New Year period.

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

Rick Hamada (CEO)

Okay. And, Scott, I'll take a stab at the EMEA, TS EMEA acquisitions and let Phil add anything he wants to. So keep in mind that our most recent acquisition there, Magirus, was a real, real booster for us, particularly in the areas, key areas of storage and virtualization. The concentration of our resources today are really focused on, think of the Eastern Europe region as one section. You got Germany and the UK as the other big bets, and we're working hard to optimize and get the model right for those core markets. And then longer term, I would tell you that we're optimizing and digesting a bit now, particularly post-Magirus. But longer term, I think Phil actually is really reinforcing global strategies to look at moving the needle on the software and services balance by region and then globally.

As a case in point, even for the December quarter, TS was at 61% hardware. If you look at hardware, software, and services, and if you remember, a couple of quarters ago, hardware was still running more in the neighborhood of 70%. So that's what I would expect from a, from a global influence. I don't know, Phil, if you want anything else about any targeting or?

Phil Gallagher (CEO)

No, I think you answered it well. Hi, Scott. The Magirus is the big one right now. We've got to focus on the integration and operationalizing the Magirus to the goals that we've set. It's expanded our portfolio, as Rick pointed out, in storage virtualization, we added Cisco. So really helps us in some areas that we did not have before, both from a technology standpoint as well as geographically, particularly strengthening our position in a key market like Germany. So that's the primary focus, and it's going well. The other, to build on Rick's point, definitely are looking at expanding in the software services space, you know, adding more value around the hardware. Or earlier this year, we announced very small acquisition, for example, Mattelli.

And something like that, Mattelli brings is IT estate management, so helps with licensing, software licensing and managing the estate, which is again, more of a services play, but expanding our market opportunity. So right now, we're focused on execution, integrating Magirus, and probably rounding out some of our traditional hardware focus in the data center around services and software.

Scott Craig (Analyst)

Okay. Thanks, guys.

Amitabh Passi (Analyst)

Thanks, Scott.

Operator (participant)

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

Ananda Baruah (Senior Vice President & Senior Analyst)

Hi, guys, thanks for taking the question. A couple of things, if I could. Could you also just sticking with TS, could you just kind of walk through, I guess, any of the different trends that you saw through the regions, you know, sort of other than just... I mean, I guess, it sounds like budget flush with a little better than expected across the regions. That's what the numbers actually suggest. But are there any sort of, any nuances between the regions with regards to what customers were, you know, sort of doing and what you saw moving? That would be helpful. And comments on pricing as well.

Rick Hamada (CEO)

Yeah, Phil, go ahead.

Phil Gallagher (CEO)

Yeah, let me... Hi, Ananda, how are you? Let me take that. We touched on a little bit in the script. I mean, from a technology standpoint, if you will, or commodity standpoint, storage was extremely hot for us. We saw great growth in all regions, by the way, both sequentially, as we said, north of 35%, and year-on-year, close to the same numbers at a global level. So storage continued to maintain a good strength. If you look at system, and by the way, as Rick pointed out, services and software as well were up and gaining a greater portion of our portfolio, which is a good thing, and that's by strategy.

Yeah, I guess I'll give it to you more of a regional view. Asia Pac, I'll start there, and we don't talk about Asia Pac a whole lot. We're moderating the growth there. Still a growth market for us. We're starting to yield drop through, so we're actually managing the growth in Asia Pac. ASEAN has gone very well for us. We're seeing the return in Australia, where we've digested ItX over the last two years and now driving the execution in Australia, which is a big part of our business. Frankly, still focused on China and the model in China. We know it's a growth market, but we've got to be able to derive the appropriate value from that market.

So that's the one we're focused on the most, that can give us the most, that can give us the growth, but we've got to make sure we get fair returns. The Americas, well, I'll touch on Latin America. We saw a terrific bounce back in Latin America. December quarter is a big quarter for them, so we saw, you know, mid-50%+ growth in Latin America, which was very positive and yielded pretty good returns for us as well, as we continue to learn to do business in that growth market. And then North America was, frankly, a shining star, and the team did a really nice job bouncing back pretty much across the board.

I can't point to any one vertical, frankly, that would light up over another, but again, just an overall nice performance. Some of that might have been, as we articulated in the script, and it's hard to come up with the exact what would have carried over from September into the December quarter. You know, it's tough to estimate that. We'll say maybe $50-$60 million might have been a carryover from the shortcoming in September, but again, tough to quantify. So even if you add that in, the sequential in North America was very good. Europe continues to be more of a, frankly, the mixed bag. We all know the headlines in Europe with some of the challenges.

But, you know, I got to say, we saw consistent performance, sequential and year-on-year, in Germany, so we're making good strides in Germany. Eastern Europe, as Rick just pointed out, we've had a good consistent performance in Eastern Europe with year-on-year growth. And if there's any market where we saw particular weakness, would be in the U.K., and we're addressing that. Part of that's market, and probably some of that part of that's Avnet. We need to get that resolved, and we're making the leadership changes and doing what we think are the right things to get back the growth that we need in a market such as U.K., which is our largest market.

One other comment I want to make is in the PC components, we again have that in the enterprise business at Avnet, and that we saw, you know, roughly an 11% year-on-year decline, okay? And that was predominantly in Europe. So from the PC components, we saw a decline there. Then, as you know, we continue to manage the portfolio. We exited Italy a year ago, so that had some revenue decline in Europe that wasn't there or that was a year-on-year decline. That said, yeah, we're proud of the Europe team. They're making a lot of progress in a tough market. They're integrating Magirus, as we just pointed out, so they've got their hands full, but we're definitely seeing the progress that we've targeted them for.

Hopefully, that helps some.

Ananda Baruah (Senior Vice President & Senior Analyst)

Yeah, that's a great detail. Very helpful. Just real quick, to wrap it up. Any comments on servers? I haven't heard any server comments yet.

Phil Gallagher (CEO)

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

Ananda Baruah (Senior Vice President & Senior Analyst)

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

Phil Gallagher (CEO)

Thank you.

Rick Hamada (CEO)

Thanks, Ananda.

Operator (participant)

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

Sherri Scribner (Director and Senior Sell-side Equity Research Analyst)

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

Rick Hamada (CEO)

Harley, I guess lead times, ASPs, and any activity and cancellation reschedules?

Harley Feldberg (President of Electronics Marketing)

Sherri, hi, this is Harley. Very, very little. Very little eventful data I could report back to you. No significant change to lead time. No significant change to ASP, in the aggregate. Obviously, there are individual differences. In the aggregate, very little change for both. So no, nothing particularly different that's occurring, currently.

Sherri Scribner (Director and Senior Sell-side Equity Research Analyst)

Okay, and you don't have a sense that there's any restocking going on as of yet?

Harley Feldberg (President of Electronics Marketing)

You know, I could read the booking. Now, when I look at bookings in the aggregate for the December quarter, compared, for example, to the September quarter, it really is a quite positive story. Without having facts attached to it, I could read that to suggest that our customers, I believe, as Rick enunciated in the script, are at a level where they are requiring additional inventory purchases to fuel any growth that occurs in the first half of calendar 2013. So our customers are behaving. The absence of a lot of backlog management and cancellations and the increased booking activity, to me, suggests that they are running their inventories at a point where they will be restocking with growth.

Sherri Scribner (Director and Senior Sell-side Equity Research Analyst)

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

Rick Hamada (CEO)

I'm not sure I have the—Ray or Kevin, I'm not sure we have that kind of calculation right on the tip of our tongue, but I know that, Ray, we shared last quarter, we were trying to make sure everybody was aware of the puts and the takes because we had the change in equity comp, and then we said, this is gonna be... If you take the $90 million, divide it by 4, 18 of it was gonna be realized.

Amitabh Passi (Analyst)

Right.

Rick Hamada (CEO)

Yeah.

Amitabh Passi (Analyst)

You can look at it that way, but you also have some inflation going the other way.

Rick Hamada (CEO)

Yeah. Yeah.

Amitabh Passi (Analyst)

So it's a tough number. I mean, we did get all the expenses out that we committed to, the $90 million, so that's certainly factored in the number and certainly year over year, you'd see that entire impact. But going against that, and we've talked about in the past, you have M&A-

Rick Hamada (CEO)

Yeah

Amitabh Passi (Analyst)

-impacting the expense numbers, currency to some extent. So it's, we can probably do the calculation, but we just don't have it available. So we'll take a look at it-

Rick Hamada (CEO)

Yep.

Amitabh Passi (Analyst)

and maybe get back to you.

Rick Hamada (CEO)

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

Amitabh Passi (Analyst)

Yes.

Rick Hamada (CEO)

Yep.

Sherri Scribner (Director and Senior Sell-side Equity Research Analyst)

Okay, great. Thank you.

Operator (participant)

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

Brian Alexander (Senior Managing Director and Director of Equity Research)

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

Phil Gallagher (CEO)

Yeah, Brian, thanks, and thanks for the, the kind words there. As far as the, you know, large deals, now we always have the, the typical December quarter or the five-week quarter that makes up a, a large portion of the, the total quarter, right? Or five-week month in the total quarter. And yeah, we saw a big part of that in the last two weeks of, of December, right? Which is not really atypical. But there wasn't any, like, major large deals. I mean, it, it, it was really pretty well across the board. If you looked at our, our, our top brands, if you will, by supplier, it was, positive. If you look at it by commodity, it was positive.

It wasn't any real one over the other, to be candid with you, and which is what we were pleased about, okay? As I said earlier, we might have had a little bit of a hangover from September, but it wasn't what made the whole quarter.

Rick Hamada (CEO)

Yeah.

Phil Gallagher (CEO)

Even if you took some of that out and did the math, we'd still have slightly above our normal seasonality in North America. So, again, I think came out, the team just came out, and we drove the strategies, and of course, it's a big quarter for some of our major suppliers. So, obviously, where they do well, we do well, and that's all good news. As far as the VAR pulse, it's still early in the quarter. I will say that we're, at this point, optimistic and confident with the guidance we've put out. There is no indication early in January to not be comfortable with that.

We are talking to the VARs, obviously, regularly, and there are some big events coming up, as you, as you're aware, with some of our top brands in the next 2-3 weeks, that we'll obviously be spending a lot more time with them. But at this point, they're, they're optimistic. I've been on the phone with quite a few of them, and they're, they're feeling as, you know, as good as they can this early in the quarter. So based on that, that's how we came up with our guidance. And, you know, March quarter is always an interesting one anyway, coming off of December. It does start to set the tone for the balance of the, the calendar year.

But right now, I already gave color on Europe and Asia, and we rolled up what we feel good with the guides we have right now.

Rick Hamada (CEO)

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

Brian Alexander (Senior Managing Director and Director of Equity Research)

Okay. Thanks, Rick. And just to follow up, I think you guys talked about getting operating margins in the June quarter back to where they were a year ago, I think 3.7%. So that would imply you need about a 50 basis point sequential improvement, June versus March. So just an update on your thought process there, whether that's still doable, doesn't sound like there's more restructuring to come that's meaningful. And related to that, assuming normal seasonality in EM going forward, since that's what we're starting to see-

Rick Hamada (CEO)

Right.

Brian Alexander (Senior Managing Director and Director of Equity Research)

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

Rick Hamada (CEO)

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

Brian Alexander (Senior Managing Director and Director of Equity Research)

That's Q4 fiscal, not calendar?

Rick Hamada (CEO)

That's correct. That's June quarter of 2013.

Brian Alexander (Senior Managing Director and Director of Equity Research)

Okay. Thanks a lot.

Operator (participant)

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

Matthew Sheerin (Managing Director)

Yes, thanks. First question has to do with gross margin and margins overall in Electronics Marketing. I know that's been weaker than normal, a function of mix, geographic mix, certainly, and then also some pricing pressure. But Harley, as you look at seasonality, and if we see a return to seasonality in Europe and in North America, and although you did say Asia is strong, typically it grows at a slower rate sequentially in the March quarter, and typically even has been down. So should we see improvement in gross margin? And then on the pricing front, do you expect that to continue to be fairly aggressive, given that lead times are still short, so there's still sort of jump ball type of business and less backlog where pricing is set?

Harley Feldberg (President of Electronics Marketing)

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

Matthew Sheerin (Managing Director)

Exactly, yeah.

Harley Feldberg (President of Electronics Marketing)

And that clearly is the $64,000 question. I believe we will. You know, remember something, for distribution, the issue is never... I always answer the question on ASP, but it's not the most relevant distribution question. It really is exactly as you portrayed it, which is with less business to go around, pricing behavior, competitive behavior is more acute. The thing that we really are looking to see, so it may be another way to think about the earlier question on the industrial market, is the activity we need, is we need an acceleration of revenues derived from our core demand creation, design win business. And that's the part that's been, quite frankly, most stubborn.

When we look at our metrics, and we measure design win activity, design wins, design registrations, down to the salesperson level, and that activity was quite encouraging in December from an activity perspective, but the volume attached to that has not generated what we need. So maybe the roundabout way to answer your question is, as we see that critical part of our business expand, not only due to regional mix, but actually due to our customers taking more products in the areas where we've done the design and we earn higher gross margins, as opposed to providing a supply chain solution, that is when our margin, our gross margins, and obviously subsequently, our operating margins, will expand, and we'll see, you know, positive flow through it from our model.

Matthew Sheerin (Managing Director)

Okay, great. That's helpful, Harley. And a couple of questions for Phil on Tech Solutions. One on that PC components business, Phil, which I know continues to be a drag. What's your strategy there going forward? Are you looking at exiting additional markets there? And then second, on the IBM announcement of adding Ingram Micro and Tech Data in North America on the high-end enterprise hardware, I know that's not gonna roll in until, you know, another 12-18 months, but could you give us your view there and the impact on your business?

Phil Gallagher (CEO)

Yeah, let me... Thanks, Matt. We were wondering how long it would take for that second question to come out, Matt.

... On the PC, on the PC components, let me just say that the part of the issue with it is you have the swings back and forth, and it becomes just so unpredictable. And by the way, in Asia Pac, it's actually not; it runs a little bit more steady. In Europe, in particular, is where we have the bigger challenge. And today, roughly, give you perspective, it's roughly 7% of our TS total revenue, with a higher concentration in Europe.

So I guess what I can share is that we are absolutely studying that model, pretty much as we speak, okay, to be sure that we're doing everything we can to extract whatever cost we can out of the model so that we can manage the margins a little bit more predictably and get the returns. Okay, so it's complicated because it is across multiple regions, and in some brands inside the PC components, they're in one region, they're more consistent than they are in another, you know, with the different product mix between processors and disk drives and whatnot. So I guess you can sum it up by saying we're studying the model, we're working it, to determine how strategic it becomes for us, or not. Okay?

On the IBM, you know, yeah, thanks for that question. We wanted to bring it up anyway, but bottom line is we're IBM's been obviously in great discussion with ourselves, so this was not a surprise to us. They're by far our largest partner and one most trusted partners worldwide. So the fact is they were looking for ways to drive incremental resellers into their model and this is what they felt they needed to go do. I can tell you, we're not planning on any revenue or margin impact negatively. As you pointed out, it's not something that's gonna start right away. We have the closed model still for the next 18 months or so.

And we have a good relationship with IBM, as I just pointed out, and as good a relationship with our partners that see value in what Avnet brings. So we're not modeling any impact at all to our business, top line or bottom line. And in the grand scheme, by the way, when you know, rough numbers, it's less than 4% of our total revenues for TS worldwide that's even being discussed. So again, we trust IBM, a great partner, and we'll continue to look to not only manage the partners we have, but you know, we're also looking to expand our partner base with IBM as well. So we're not just playing defense, we'll be on the offense as well.

Rick Hamada (CEO)

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

Matthew Sheerin (Managing Director)

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

Amitabh Passi (Analyst)

Thanks, man.

Operator (participant)

Thank you. As a reminder, ladies and gentlemen, please limit yourself to one question and one follow-up question. Our next question comes from the line of Jim Suva with Citi. Please proceed with your question.

Jim Suva (Analyst)

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

Rick Hamada (CEO)

Yeah, I'll, I'll let Ray and Kevin add some color there. Jim, just a reminder, from a merit cycle point of view, that generally happens on our fiscal year boundary, so that should not be part of the equation at this point. But, Kevin or Ray?

Kevin Moriarty (CFO)

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

Jim Suva (Analyst)

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

Rick Hamada (CEO)

Real good question there, you know, if you follow our thought process regarding getting back to year-on-year operating margin, then you got to figure out and decide what revenue number we have associated with that. You know, you can do some calculations that way, Jim. So I'm not trying to call when that happens, but keep in mind, our, the solution set that we are operating under today on targeting back, EM back to their range and TS back to parity or year-on-year growth and op margin by that fourth quarter. So then you got to do your assumptions regarding, you know, where's the revenues and where's the share count at that point, and those are, you know, a couple of variables you got to make decisions on.

But we want to be very consistent with the type of expectations we're setting from an enterprise performance point of view.

Jim Suva (Analyst)

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

Rick Hamada (CEO)

Thanks, Jim.

Operator (participant)

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

Steven Fox (Founder and Senior Analyst)

Thanks. Good afternoon. Just two quick ones, though. Just can we get a sense for cash flows in the current quarter based on the guidance you're providing? And then, secondly, we've covered a lot on TS. Just to be clear, there was a line in the press release where you talked about finding pockets of technology strength. Is that related mainly to services and storage? Is there anything else that you guys would highlight from an Avnet-specific standpoint that maybe is helping you gain share in the overall channel? I just was wondering if you could flesh that out a little bit. Thanks.

Rick Hamada (CEO)

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

Steven Fox (Founder and Senior Analyst)

Yeah. And are, are those, just to be clear, are those market-related, or was there something that you felt like you were doing in order to take a greater

Rick Hamada (CEO)

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

Phil Gallagher (CEO)

Yeah, we did. This is Phil. I'll just add to that. Yeah, of course, the market cooperated with us, right? There's no question about that. But we also believe we have the... And you'll see it again in May, and we talked about it last year at the Analyst Day. But we have. We're very specific strategies to go continue to expand services, continue to expand software and storage, as we all know, with big data and analytics and everything around that. We're making investments in those areas, and we believe maybe too early to tell the Rick's point, but we think we are starting to get some traction with some of the value we're bringing to the market, Steven.

Steven Fox (Founder and Senior Analyst)

Great. And, just on the cash flow-

Kevin Moriarty (CFO)

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

Steven Fox (Founder and Senior Analyst)

Great. That's very helpful. Thank you.

Operator (participant)

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

Brendan Furlong (Analyst)

Sorry, everything's been covered. Thank you very much.

Rick Hamada (CEO)

Okay. Thanks, Brendan.

Vincent Keenan (VP of Investor Relations)

He said everything's been covered.

Operator (participant)

Gentlemen, there are no further questions at this time.

Vincent Keenan (VP of Investor Relations)

Okay, thank you for participating in our earnings call today. As we conclude, we will scroll through the non-GAAP to GAAP reconciliation of results presented during our presentation, along with a further description of certain charges that are excluded from our non-GAAP results. This entire slide presentation, including the GAAP financial reconciliations, can be accessed in downloadable PDF format at our website under the Quarterly Results section. Thank you.

Operator (participant)

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