Avnet - Q2 2017

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 (Head of Investor Relations)

Good morning, and welcome to Avnet's second quarter fiscal year 2017 business and financial update. As a result of the pending sale of Technology Solutions and having met applicable accounting requirements, Avnet began reporting the TS business as a discontinued operation in the first quarter of fiscal 2017, and prior periods have been adjusted for comparability. Additionally, the year-over-year comparisons reflect adjustments to the second quarter of fiscal 2016 for the transfer of the Embedded Computing Solutions business from TS to EM. As we provide the highlights for our second quarter fiscal year 2017, please note that in the accompanying remarks, we have excluded certain items, including intangible asset amortization expense, 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. In addition, when addressing return on capital employed, return on working capital, and working capital velocity, the definitions are included in the non-GAAP section of our press release. 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 second quarter fiscal year 2017 highlights. Following Bill, our Chief Financial Officer, Kevin Moriarty, will review some additional financial highlights and provide third quarter 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 are 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 second quarter fiscal 2017 business highlights.

Bill Amelio (CEO)

Thanks, Vince, and hello, everyone. Thank you for taking time with us and your interest in Avnet. It was an exciting and very busy quarter at Avnet as we continued our strategic transformation to become a standalone electronics component distributor, with the broadest suite of products and services spanning the entire product life cycle. After completing the acquisition of Premier Farnell on October seventeenth, our teams went to work evaluating how best to leverage the strength of both companies to accelerate our growth. While we intend to keep Premier Farnell separate in the market to maintain their unique value proposition in the small order space, we will link digitally the front end of both companies to provide customers a seamless experience as they move from idea, to design, to prototype, and on to volume production.

Our goal is to deliver the Avnet experience by allowing designers to tap into our deep technical and supply chain expertise through our digital platform with new tools and innovative services. On November fourteenth, we further enhanced our digital platform with the acquisition of Hackster.io. Hackster.io provides engineers and makers with a web-based forum to learn how to design, create, and program internet-connected hardware. With a growing community of close to 200,000 users, Hackster.io further expands our reach into the idea phase as technology spreads into more products, especially through the Internet of Things. Our goal is to build an ecosystem for their design challenges, as they will allow our FAEs to be more productive, which will become increasingly important as our workload grows with the new leads from our digital platform.

We also introduced a new web-based tool that allows engineers to quickly perform parametric searches and populate their bill of materials with accurate, and cost, and product availability data. Together, these tools will not only help customers speed their time to market, but will also allow us to improve the efficiency of our demand creation resources and convert more leads into design wins and revenue growth. Before I turn the call over to Kevin, I'd like to acknowledge the contribution of our Technology Solutions team. The TS business has been an important part of Avnet's success for many years. Even though there was more work to do to prepare for the carve-out of TS operations, the team stayed focused on running the business and delivering a strong December quarter. TS sequential revenue was near the midpoint of their seasonal range, and operating income margin improved materially.

I'm confident they will continue to realize future success as they become part of Tech Data. Now, I'd like to turn the commentary over to Kevin Moriarty, who will provide more color on our financial performance. Kevin?

Kevin Moriarty (CFO)

Thank you, Bill, and hello, everyone. Now, I would like to review the financial results for Avnet's continuing operations, which is essentially the combination of our Electronics Marketing business and Premier Farnell. In the December quarter, reported revenue of $4.3 billion was approximately $75 million below the midpoint of our guidance, as a result of a decision to reclassify $92 million of Embedded Computing Solutions revenue to discontinued operations. This business, which was included in our guidance, was part of the $450 million of annual embedded revenue that we transferred from TS to EM at the beginning of our fiscal 2017, when we were consolidating our global embedded business.

Given one of the key suppliers to this business was on the Technology Solutions line card, it made more sense to move this business back to TS after we evaluated the customer and financial impacts resulting from the sale to Tech Data. As a result, the business being transferred to EM is closer to $100 million per year on a go-forward business. Turning to the income statement. Our December performance validates the financial performance and benefits of the Premier Farnell acquisition, as both gross profit and operating income margin expanded from the year ago quarter. On the top line, Premier Farnell exceeded our expectations this quarter and contributed to a 2.7% year-over-year increase in revenue. Organic revenue declined 2.9% year-over-year in constant currency, primarily due to our decision to exit select high volume supply chain engagements in the Asia region.

If you exclude this decision to exit lower margin business, organic revenue grew approximately 4% from the year-ago quarter. At a regional level, our EMEA region continued to see strong growth as reported revenue, including Premier Farnell, increased 21%, and organic revenue increased 11.6% in constant currency, the fourteenth consecutive quarter of organic growth. In our Americas region, reported revenue grew 7.5% from the year-ago quarter, while organic revenue declined 2.1%, primarily due to a decline in the embedded business. Excluding the decision to exit select high volume supply chain engagements, our Asia region was essentially flat with the year-ago quarter. Now turning to gross profit.

Gross profit dollars increased 16.1% from the year ago quarter to $586 million, and gross profit margin expanded 158 basis points to 13.7%, primarily due to the addition of Premier Farnell and improvements in our Asia region. Adjusted operating income increased 7.9% from the year ago quarter to $164.5 million, primarily due to the addition of Premier Farnell, as well as a 15% increase in the EMEA region. Adjusted operating income margin increased 18 basis points to 3.8%, primarily due to the inclusion of the higher margin Premier Farnell business. Excluding Premier Farnell, the EMEA and Asia regions increased operating income margin over 30 basis points year-over-year.

Adjusted earnings per share of 77 cents increased 2 cents from the year ago quarter, as the increase in operating income was partially offset by higher interest and other expense, which had a 4-cent negative impact on EPS. The year-over-year comparison of our results from continuing operations were negatively impacted by several one-time acquisition charges. Operating income from continuing operations declined 8.7% year-over-year due to a $24 million increase in restructuring, acquisition, and amortization expenses related primarily to the Premier Farnell acquisition. On the bottom line, net income from continuing operations was further impacted by $32 million of hedging and bridge financing costs related to the acquisition of Premier Farnell. The cash outlay related to the Premier Farnell acquisition was reduced by approximately $75 million as compared to the original bid price due to our hedge strategy.

As a result of these charges, GAAP diluted earnings per share from continuing operations declined 67% to $0.25. In the December quarter, our working capital increased 2.3% sequentially due to the addition of Premier Farnell. If you exclude the impact of Premier Farnell, working capital declined 9.7%, led by a 13% decrease in the Americas region, where working capital had been elevated during the ERP implementation. Cash flow generated from continuing operations was approximately $192 million in the December quarter, and Avnet's total cash flow from operations was approximately $240 million. As a result of the strong cash flow generated from operations this quarter, Avnet's trailing twelve-month cash flow from operations increased $122 million sequentially to $380 million.

On October 17, we used approximately $100 million of offshore cash and $660 million of debt to fund the acquisition of Premier Farnell.... On November 14th, we issued $300 million of 5-year notes at a rate of 3.75%. We used the proceeds of those notes to pay down the acquired Premier Farnell debt, as well as some floating rate debt. We still intend to use approximately $1.5 billion of the proceeds from the sale of TS to pay down additional floating rate debt in order to reduce our credit statistics to a level that solidly supports our investment grade rating. These series of actions will leave us with a strong balance sheet that, when combined with our cash generation, will allow us to fund future growth and consider ways to return additional cash to shareholders.

Going forward, our intention is to maintain the same capital allocation priorities we have pursued in the past. Number 1, maintain and grow our dividend. 2, invest in organic growth. 3, pursue value-creating acquisitions that enhance our competitive position. And fourth, return excess cash to shareholders via our disciplined share repurchase program. Now turning to our outlook. Looking forward to Avnet's third quarter of fiscal 2017, we expect Avnet's sales to be in the range of $4.3 billion-$4.6 billion. Based on this revenue forecast, we expect adjusted EPS to be in the range of $0.80-$0.90 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 US dollar to euro currency exchange rate of $1.07 to the euro. This compares with an average exchange rate of $1.10 to the euro in the third quarter of our 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 that your line is in the question queue, and you may press star two if you would 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 pull up for questions, and please limit your questions to one question and one follow-up. Our first question comes from the line of Sherri Scribner with Deutsche Bank. Please go ahead with your question.

Sherri Scribner (Equity Research Analyst)

Hi, it's Adrienne Colby for Sherri. Thanks for taking my question. My first question would be just, your comments suggested that Premier Farnell revenues came in ahead of expectations, which would suggest sales north of the $230 million-$250 million range that you had suggested last quarter. I'm just wondering what drove some of that upside and how we should think about the cadence of sales going forward? And also, if you could comment if margins were more in line with your prior projections.

Gerry Fay (President of Electronics Marketing)

Sure. This is Gerry. What I would say is, yes, they, Premier Farnell performed quite well last quarter. They've met the high end of expectations. As I said on our call last time, they had arrested their margin erosion and now have actually improved their margins. So we look to see continued margin improvement from Premier Farnell going forward.

We're also on track with the synergies that we talked about last quarter call as well, and we're pretty excited to see some real good potential there.

Sherri Scribner (Equity Research Analyst)

Great. And just as a follow-up, I was wondering if you could comment if you're seeing any effect on your business, or you anticipate any effect on your business from the new White House administration policies, for example, from tax benefits?

Kevin Moriarty (CFO)

Sure. Hi, this is Kevin. I guess what I would say, and as you know, and as I've been reading, I would describe the topic as a very fluid situation, and I'm not gonna speculate. So areas we are watching closely are overall tax rates, taxation on past unremitted earnings and future foreign earnings, destination-based taxes, interest expenses, deductions in areas like cash repatriation. The one thing I would point out is that, for Avnet, often recall that we are not the direct importer of goods.

Sherri Scribner (Equity Research Analyst)

Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Matt Sheerin with Stifel. Please go ahead with your questions.

Matt Sheerin (Senior Equity Research Analyst)

Yes. Hi, this is Alvin Park speaking on behalf of Matt Sheerin. Just in terms of Premier Farnell, could we just get some color on the geographic mix of it?

Gerry Fay (President of Electronics Marketing)

Yeah, sure. This is Gerry. The geographic mix, about 50% of the business is in Europe, 30% in the Americas, and the balance in Asia.

Matt Sheerin (Senior Equity Research Analyst)

I see. Okay, thanks. And in terms of, seasonality with the Premier Farnell, I mean, do you see, significant changes going forward from what you provided in the past? I mean, any color we could see in terms of going forward seasonality in the business?

Gerry Fay (President of Electronics Marketing)

I think what we'll be looking at seasonality, and we'll update that in our investor conference that's coming up in May.

Matt Sheerin (Senior Equity Research Analyst)

Thank you.

Operator (participant)

Our next question comes from the line of Louis Miscioscia with CLSA. Please go ahead with your questions.

Louis Miscioscia (Managing Director)

Yes, getting out of the Asia high volume business, I guess throughout the years, we've heard, you know, I guess different vendors like yourself in this area, you know, take some of this business and then, you know, when obviously you discard it, you say, "Geez, it wasn't really worth it. It was not, you know, the margins just weren't good." So would you venture to say that now that you're getting out of this, that in the future, you'll materially shy away from future kind of sales in this area?

Gerry Fay (President of Electronics Marketing)

...No, I think as I've always said, Lou, we saw that business as opportunistic. As you know, we continue to look at the financial returns we get, particularly on big deals like that. So it had gotten to a point where the financials did not make sense anymore for us, and we moved away from that business. We also did that planfully. As you remember, we had a big Broadcom win recently, and we knew that that business, which we felt was much more profitable for us and much more strategic, would offset more than offset the loss in our high volume fulfillment business. So, if you look at that and you look at some of the change with our margins increasing, we think we made a good decision in that space.

Bill Amelio (CEO)

So as we look at—this is Bill. As we look at any business that we take, we look at how fast we can turn the business from an inventory point of view, as well as the margin profile, and we want to make sure we have the right returns. If that tends to then drop down to a point where it doesn't meet our returns, then that means we will exit business.

Louis Miscioscia (Managing Director)

Sure. I guess I understand that. I'm just trying to get to that very often when business first comes in, everyone's all excited about it and it's good, and then a couple of quarters later, it becomes bad. And then for us to not consider it, I'm just... So it sounds like you would actually do something like that again, even though you've had sort of a bad experience here.

Gerry Fay (President of Electronics Marketing)

Yeah, I wouldn't classify it, Lou, as a bad experience. I mean, we had that business for years. We didn't have it for quarters. So it was, you know, it was business that we looked at because of the strategic relationship we had with a partner. And over time, as we managed that business, as you can imagine, business runs through cycles, and the margins got tight and the inventory expectations changed. And so we just looked at that and decided from a strategic perspective, it didn't make sense for us anymore. We look at our portfolio all the time, and make changes in and out based on the financial, you know, realities of the situation. So in this case, this is business we had for a long time, and the financials didn't make sense anymore.

So we always look at our portfolio to balance it out based on the opportunities that exist in the marketplace.

Vince Keenan (Head of Investor Relations)

Yeah, and Lou, this is Vince. I would just highlight, we didn't have a lot of dedicated headcount. It was mostly freight and factoring, so it's not like headcount goes up and down because of this. As Gerry said, it was very select.

Gerry Fay (President of Electronics Marketing)

Yeah. And it was-

Louis Miscioscia (Managing Director)

Okay, great. Just trying to move on to getting a couple of numbers, if we could. From an absolute standpoint, what, how should we think about SG&A, interest expense over the next couple of quarters, and maybe how fast synergies can kick in on cost cuts, as you bring in Premier Farnell?

Kevin Moriarty (CFO)

Sure. Lou, it's Kevin. What I would point to in terms of the, looking out for the, say, our third quarter SG&A in the range of $440 million-$455 million. When I think about Premier Farnell, what I would say is, we closed the transaction, as everyone knows, on October seventeenth, and we really have now really begun integration in earnest, because at the time, we didn't want to run afoul of the UK takeover rules. I think what Bill highlighted, you know, when we think about the revenue and the synergies that we had highlighted in our October call, we pointed to $90 million-$110 million of revenue synergies.

I think based on the early results and the engagement across the organizations, we really feel that that is an achievable range at this time. On the cost side, we highlighted on the October call in the neighborhood of $55 million-$60 million of expense synergies. Teams have been working on that, and right now, what I would say is we again think that that is an achievable target. As we get to the end of the March quarter, we would expect to have realized approximately $10 million-$15 million of annualized savings. But again, we continue to make very good progress thus far on our integration planning and the execution of our plans.

Louis Miscioscia (Managing Director)

Okay. And then interest expense for, I guess, this quarter, and then obviously after the deal closes and you're able to buy back that $1.5 billion that you've mentioned.

Kevin Moriarty (CFO)

Yeah. What I would say for continuing operations, think in the range of, in the next couple of quarters, in the range of $26 million-$28 million. And then as we go forward on an annualized basis, once we pay down the debt, we could probably reduce that annualized number in the neighborhood of $24 million-$30 million.

Louis Miscioscia (Managing Director)

Okay, thank you.

Bill Amelio (CEO)

Our next question comes from the line of Adam Tindle with Raymond James. Please proceed with your questions.

Adam Tindle (Managing Director)

Okay, thank you. You guys talked about a few benefits to EM in terms of less high volume Asia. You have the Broadcom win, you have the addition of Premier Farnell, but it looks like the March EPS guidance is implying just kind of modest operating margin improvement year over year. So could you just maybe walk through the puts and takes that led you to this, and perhaps any quantification of the ERP issue impact to revenue and/or costs?

Kevin Moriarty (CFO)

Sure. Hi, Adam, it's Kevin. I'll, I'll start. I think what I would start with is when you look at the gross profit %, obviously we're going to be shifting more this quarter to the Asia—sorry, to the Europe region. The gross profit %, will continue to, we think, sequentially improve. I think the point you may be getting at is on the operating expense side, it will take time for us to really get to the realization of the synergy benefits associated with Premier Farnell. So we're expecting to exit the quarter with some benefits, but I think over the next successive quarters, we would expect to continue to realize and recognize more of those synergy savings.

Adam Tindle (Managing Director)

Okay, but even after those synergies, Premier Farnell is still accretive. So, I mean, that's, that's what I'm a little bit confused about.

Kevin Moriarty (CFO)

Sure. And I would also point out that in this quarter, we also instituted a merit program, given it's the beginning of the calendar year, so there's a merit increase as well that you may not have been factoring in.

Adam Tindle (Managing Director)

Okay. Maybe on the capital structure, Kevin, how can we think about the right capital structure for continued operations, particularly given your comments on the strong cash generation that it's displayed? I know you talked about the $1.5 billion debt pay down, and we just take the existing balance sheet and take this off, plus the remaining cash from the TS sale. I think your debt will be just under $2 billion, and your cash will also be just under $2 billion. So maybe talk about how you're thinking about capital structure.

Kevin Moriarty (CFO)

Sure. What I would point to is, you know, we've, we've been very public on our commitment to maintaining our investment-grade rating. And the key thing that we focus on is our gross debt to EBITDA, not net. It's just more how the rating agencies look at it. So as you commented on our intent right now is to pay down a meaningful portion of debt. And as we move forward, we definitely are looking at alternative capital allocation alternatives. Returning cash to shareholders, we don't think would be impeding our ability to invest in organic or inorganic growth.

But when we look at the buyback, we are definitely going to be taking the continued approach, post the sale of TS, to sustain our disciplined approach on the buyback, and then the actual method of the returns will depend on where the stock is and trading and the timing and other factors that we're going to consider. So again, our goal is to sustain, given our business model, somewhere between 2 and 2.5 times of leverage. Just given, again, we think it's important for us as a company, given where we play in the supply chain, and it's really ultimately our goal is to maintain our investment-grade credit rating.

Adam Tindle (Managing Director)

Okay, thank you.

Operator (participant)

The next question comes from the line of William Stein with SunTrust. Please go ahead with your questions.

William Stein (Analyst)

Great. Thanks for taking my question. It relates to the cost savings that you're undertaking to deal with the sale of TS. You have this sort of stranded corporate expense that I assume, you know, I would assume going forward, you might not report segments, so that might just sort of go away, but you still have that big expense, and I'm sure there are expenses in the segment as well, that you're targeting, reducing as well. Can you remind us again of what the cost savings plan is and whether you've already achieved any of that savings in the quarter that you just reported or in the guided quarter, and so we can figure out how much is left?

Kevin Moriarty (CFO)

Well, it's Kevin. I'm going to point back to what we had shared in our October call related to kind of broader expense reductions that we're looking to attain, partly through the Avnet Advantage program, but just also associated with the TS divestiture. And we referenced at that time approximately $70 million-$90 million of expense reduction on an annualized basis. Now, in the current quarter, and as we're guiding, from a timing standpoint, there really is no near-term benefit in a meaningful way that we're guiding to with the numbers we've provided today. Clearly, we are working on it, and once the TS sale concludes, we'll be going forth with some actions.

Bill Amelio (CEO)

So you got to remember, too, we have some TSA agreements that we have in place, so some of that stranded costs will be with us for a while, but we will be compensated for that based on the cost of that service that we give to Tech Data after the sale has closed.

William Stein (Analyst)

Understood. So the 70-90 is still in front of us, and then you have the integration savings from Premier Farnell as well. And so maybe the follow-up is,

Bill Amelio (CEO)

That's exactly, that's exactly right.

William Stein (Analyst)

Yeah. Okay, got it. So there's still a lot of savings in front of us. And then when we think about, you know, what you've gone through in the last few years, operationally, one of the big things is integrating these ERP systems. Is that all done now? And then with Premier, are they on a different system? Is there a lot of work to do there? And maybe just update us on that thinking.

Bill Amelio (CEO)

Sure. As we reported, we've had our issues with the implementation of ERP in Americas. We're just about through the issues. We've had some that we still are struggling a bit with our embedded business, and that's only with the complicated configured order issues that we have. The rest of it's running relatively fine, but we also indicated that we still will have some additional expense in the range of $3 million-$4 million a quarter for some period of time until we work out all the details and all the kinks associated with our embedded business. Secondly, on the Premier Farnell, that area is one where we will absolutely spend some time with their IT strategy.

There'll probably be some investments that we'll make there with respect to upgrading some of their systems, and that'll be in front of us, but that will be included in part of our overall budgeting that we do, and I don't see that as one that you have to model any differently than what you've modeled in the past.

William Stein (Analyst)

Thank you.

Operator (participant)

This is our next question from the line of Shawn Harrison with Longbow. Please go ahead with your questions.

Shawn Harrison (Senior Equity Research Analyst)

Hi, morning. I guess this question is for, for Gerry to start off with, but maybe can you just kind of speak to some of the booking trends you, you saw globally as you moved through the December quarter and now through January? It seems like that we're, we're maybe getting some industrial momentum in the world, and wanted to just see if, you know, what you're seeing in the book-to-bills highlights any of that.

Gerry Fay (President of Electronics Marketing)

Sure, Shawn. We closed the quarter with a book-to-bill ratio of 1.07 to 1, and our current book-to-bill is actually stronger, and it's positive in all regions. This is somewhat to be expected given the fact that we're running up the Chinese New Year, so this is a pretty common seasonal phenomenon. But if you think where we ended the quarter, we've had now about three quarters in a row of positive book-to-bill at the end of the quarter. And I do think if you look at regionally, we've seen industrial strength in EMEA and Asia. The Americas is still fairly flattish from an industrial market perspective. So that's how I would characterize it.

Shawn Harrison (Senior Equity Research Analyst)

Okay. And then, Bill, as a follow-up, I guess now that you've-- it's, we're about, I guess, six months or so into your tenure as CEO, is you, you brought on Premier Farnell, now you have Hackster. If you can maybe just comment on, you know, how you view the portfolio right now. You know, are there additional holes you see that, you know, need to be filled? And maybe, you know, how you can address those areas. Is it organic? Do you, do you have to look at M&A to, to fill any additional holes in the portfolio?

Bill Amelio (CEO)

No, we're pretty excited about where we sit right now, and we, we have work to do for us to make these seamless connections between Hackster into Premier Farnell and then into volume production and volume shipments into Avnet. And however, we will continue to look at opportunities as they present themselves, especially in areas where we think there's potential to disrupt the models of distribution, and therefore, we'll make the necessary investments. Other place I'd say you could potentially see us do acquisitions in, in the design area, where we have opportunities to be able to reduce time to market of our customers and get the appropriate tools, whether they're digital or whether they're design skills that may augment what we do today.

Shawn Harrison (Senior Equity Research Analyst)

All right. That's helpful. And Kevin, if I may, just one clarification. The $70 million-$90 million, that—did that include some synergies that would have been associated with TS and are going to transfer to Tech Data? I guess how much of that $70 million-$90 million really stays with Avnet?

Kevin Moriarty (CFO)

It's all of it, Shawn, that we'll set... Meaning in terms of the reductions that we're going to need to make in the cost structure.

Shawn Harrison (Senior Equity Research Analyst)

Okay, perfect. Thank you.

Operator (participant)

Our next question comes from the line of Steven Fox with Cross Research. Please go ahead with your questions.

Steven Fox (Analyst)

Thanks. Good morning. First question, I just was wondering if you could provide a little bit more color on Europe. It sounds like the core Avnet business was up healthy double digits, and you also got some gross margin expansion year-over-year. So, can you give us a sense for what markets were driving that, and how that business looks into the new year, and whether the gross margins improvement was all related to volumes, or if there were more cost savings going on? And then I had a follow-up.

Gerry Fay (President of Electronics Marketing)

Sure, this is Gerry. I'll take that one. So in Europe, I congratulate our European team. They continue to perform quite well. We saw growth in automotive and industrial automation, particularly in the German marketplace, and then medical and renewable energy markets were strong for us also. I think if you think about gross margins, you know, the team continues to do a very nice job of managing their business, given the realities today of supplier consolidation and things like that. So again, our European team continues to be strong, and our book-to-bill is supporting that. So I look for continued growth out of our EMEA region going forward.

Steven Fox (Analyst)

Great, that's helpful. And then just, to make sure I'm clear on the Premier Farnell improvements, on their standalone basis, that was all, actions that they had undertaken. Can you give us a sense for how far along those are, or whether you would get some more benefit from, some of those, cost actions in this current quarter? Thanks.

Gerry Fay (President of Electronics Marketing)

So I think Kevin teed it up pretty well. What we can expect coming in the next quarter, getting to a $10-$15 million run rate in the March quarter. As we shared with you on our October call, there are two forms of synergies from the transaction. Kevin talked about the revenue synergies at about $90-$110 million. And then we have worked well through the integration planning with PF at this point, and so we see, you know, a clear path to get to the expected $55-$60 million of expense synergies going forward. So we feel good about the plan. You know, Premier Farnell had done some things before the acquisition are now paying off for them.

So, I think if you look at what they've done, the synergies between our two companies, we feel really positive about the future of both PF and Avnet together.

Steven Fox (Analyst)

That's helpful. And then just to clarify on those comments, so is it safe to say that all of the actions that PF, Premier Farnell, was planning before they were acquired, are completed?

Gerry Fay (President of Electronics Marketing)

I would say the ones that they had identified to complete in the time frame before the acquisition were completed.

Steven Fox (Analyst)

Okay. Thank you very much.

Operator (participant)

Thank you. Our next question comes from the line of Mark Delaney with Goldman Sachs. Please proceed with your questions.

Mark Delaney (Senior Equity Analyst)

Yes, good morning, and thanks very much for taking the questions. First question was on the embedded business and additional business that you moved that from continued operations into discontinued operations. Kevin, I know you said $92 million had been included in guidance and ended up not being counted as part of continued operations. What's the EPS impact associated with making that move for that amount of revenue? And then related to that, can you help us understand what the plan for that additional business is going forward? Is that a business that you're now looking to divest, or what should we be thinking about there? Thank you.

Kevin Moriarty (CFO)

I'll take the first one. It was. It's really negligible, very minor impact on an EPS standpoint for the quarter.

Gerry Fay (President of Electronics Marketing)

Then I'll, I'll answer the second part. So if you look at the business that we had, that it was primarily with one big supplier, a TS supplier today, and we did work with them to see if they would give the EM business going forward a franchise agreement, and it didn't make sense given the size of the business. So I think it was felt between both Tech Data and Avnet, the best place for that business to go to support it long term was to transition it to Tech Data as part of the overall transition.

Bill Amelio (CEO)

... And I, I'd say from a portfolio point of view, we're giving a fresh set of eyes on every piece of our business and ensuring that we have a strategic way to grow it. And if we don't have a strategic way to grow it, and it's not meeting our returns, we will make the appropriate decisions.

Mark Delaney (Senior Equity Analyst)

Okay, that's helpful. For a follow-up question, I was hoping to just better understand some of the business dynamics in EM as you guys try and increase your mix of demand creation. I guess it's a two-part question. One, can you just help us understand how much of your EM business today is demand creation and where that may go going forward now that you have all these new tools? And then the second part of the question, Bill, you talked a bit about doing some front-end integration. I'm just trying to understand in terms of the tools that Hackster has and Premier Farnell and Avnet, you know, how much integration work does there need to be and in the front-end offerings, or can you deploy those on an independent basis relatively quickly?

Bill Amelio (CEO)

We can deploy them on an independent basis relatively quickly. That each one are standalone, but what we want to be able to do is make sure that the digital platform seamlessly transfers leads from one part of the company to another part of the company. So that's where some of the magic will come from, and we have spent the last 18 months in Avnet, really developing our digital platform, and all of the work that we've done there will apply to what we're going to do in Premier Farnell as well as Hackster. So we're pretty excited about the new ecosystem that'll be put in place. It'll allow us to be able to cast a wide net to capture lots of customers with a very low cost to serve model.

As they grow from a small, tiny company to something that's much larger, we'll be able to then serve them with our field application engineers more effectively.

Gerry Fay (President of Electronics Marketing)

On the question, on the percentage of overall revenues and demand creation, it's a little over 30% today, and our goal is to continue to increase the percentage overall.

Mark Delaney (Senior Equity Analyst)

Thank you very much.

Operator (participant)

Thank you. Our next question comes from the line of Jim Suva with Citi. Please proceed with your question.

Jim Suva (Managing Director)

Thank you very much for all the details so far. It's quite useful. I have a couple questions; they're probably quite easy. You talked about Premier Farnell doing better than expected in the integrations and such, but yet your total sales looks like it came in on the lower end of guidance. So can you help me understand the range that you gave out and, you know, kind of bridge why you came in at the lower end? And then my follow-up question is, I believe that Texas Instruments and some of the chip suppliers are going through some changes to the economics that they're giving to the distributors. Can you help us understand, has that occurred with you yet? Are you fully adjusted to it, or is that yet to come, or how we should think about those changes? Thank you.

Gerry Fay (President of Electronics Marketing)

Okay, this is Gerry. So I'll take the first question, then I'll answer the second question about Texas Instruments and other suppliers. You know, as we said earlier, our embedded business suffered more than our core business due to the impacts of some of the ERP challenges we had, and Bill highlighted, particularly around our more highly complex integration business. We see that business, though, in the seasonal range this quarter, but remember, we're coming off, as we talked about, a lower Q2 number. So while seasonal growth, so that kind of talks about some of the improvements we're making, but from a seasonal perspective, it looks seasonal, but it's from a lower base, so that's why the number may look a little bit muted. When it comes to Texas Instruments or other suppliers, you know, there's very limited impact this quarter.

You know, we normally don't discuss supplier-specific programs, but as you can imagine, when suppliers change their programs and demand creation, there's opportunities that pop up from other suppliers. So there's also usually a grandfather period those changes occur, so that gives us time to either move our resources to higher margin opportunities with those suppliers, or at times, we have to reduce those resources. When you see the investments, though, that Bill's talked about around our digital strategy, we think that's going to help customers shorten their time to market and enable customers to take advantage of our capabilities. So we believe we can also offset the margin by providing solutions to our customers. So that's really how we see things going forward. That's why we continue to invest in demand creation with some of the tools that Bill highlighted earlier.

Jim Suva (Managing Director)

Thank you for the details. Much appreciated.

Operator (participant)

Our next question comes from the line of Param Singh with Bank of America. Please go ahead with your questions.

Param Singh (Analyst)

Hi, thank you for taking my call. So firstly, want to get some color on the margin. You know, if I look at your guide, you're, it would imply you're still below your peak margins you got, you know, a little over a year ago, and given the mix of Premier, I would have expected that to be much higher, probably closer to 5%. And then, longer term in that segment, what would you expect margins to be outside of the synergies you're talking about? Which means, what benefit can you get from improving current operations or legacy operations? And then I have a follow-up.

Gerry Fay (President of Electronics Marketing)

This is Gerry. I'll take the question. So if you look at gross margins over time, we actually first of all we have a mix change, as you can imagine, with we've you know you look at what has happened in Asia in our high-volume fulfillment business. So that going down, that improves the Asian margins overall and shifts more of our mix back to the West. I did speak and highlight about our embedded business, which you know we've had some struggles with due to the ERP implementation, so that's muted our core margins a little bit. And you know as you pointed out, Premier Farnell's margin improvements help offset some of that.

Param Singh (Analyst)

Okay. And then, actually, taking a step back, on the revenue line, so one, your book-to-bill is 1.07, and you're seeing a better number, so wouldn't your revenue be, guide should be a little better, even though you're at the high end of seasonal? And then when would you expect the negative headwind from Asia fulfillment to overlap? And I have one more question.

Gerry Fay (President of Electronics Marketing)

... Yeah, so I'll start with the Asia fulfillment fees first. That should lap in Q4, our fiscal Q4 this year, so that should be totally out of the number. If you look at it, it was down 1% sequentially and 72% year-over-year, so you have to bake that into the number. And when it comes to guidance, I think, you know, as you pointed out, we're guiding to the high end of the range. And given where the book-to-bills are, we feel that that's a comfortable place for us to be and demonstrates what's happening in the marketplace today.

Param Singh (Analyst)

Okay. And then my last question was, you know, obviously, your cash conversion cycle is pretty elevated right now. How much of that is because of the ERP? How much of that is Premier? And when do you expect to get back to a 70, you know, something cash conversion cycle range? I think, I guess, this might just be for Kevin.

Kevin Moriarty (CFO)

Sure. So again, yeah, we definitely benefited this quarter from the drop in the working capital. But I do want to thank the broader organization and team for delivering the cash flow from operations this quarter. What I would point to, I would say, going forward, as we get into the next fiscal year, and, probably we'll be operating somewhere in the range of 55%-65% of net income on a cash conversion cycle.

Param Singh (Analyst)

Got it. Got it. And on a days basis, could you give some clarity on what were two factors bringing it up? Like, what level out of the 86, what was ERP and what was Premier?

Kevin Moriarty (CFO)

Well, I think generally what I would point to is Premier Farnell. EM just naturally has a higher working capital number of days associated with just a higher level of inventory. And what I would point to is, if you do the math, we're probably elevated above 80 days right now on working capital. But our goal is to clearly, even with Premier Farnell, to drive that back down to the historical range, somewhere between 70-75 days.

Param Singh (Analyst)

Okay, got it. Thank you, guys. Appreciate it.

Kevin Moriarty (CFO)

Yep.

Operator (participant)

Okay, thank you.

Gerry Fay (President of Electronics Marketing)

Thank you.

Operator (participant)

There are no further questions at this time.

Gerry Fay (President of Electronics Marketing)

Thank you for participating in our earnings call today. Our second quarter fiscal 2017 earnings press release and related CFO commentary 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, and thank you for your participation.