Avnet - Q3 2017

Transcript

Operator (participant)

Please stand by. Our presentation will now begin. I would now like to turn the floor over to Vincent Keenan, Avnet's Vice President of Investor Relations.

Vincent Keenan (SVP and Investor Relations)

Good morning and welcome to Avnet's Q3 fiscal year 2017 business and financial update. As a result of the sale of Technology Solutions business, which was completed in February 2017, Avnet reports the TS business as a discontinued operation and prior periods have been adjusted for comparability. As we provide the highlights for our Q3 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 in 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, 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 an update on the quarterly highlights as well as address our decision to move to a global ERP system.

Following Bill, our Chief Financial Officer, Kevin Moriarty, will review key financial metrics, including additional color on our fourth quarter fiscal 2017 and full year fiscal 2018 guidance. At the conclusion of Kevin's remarks, a Q&A will follow. With that, let me introduce Mr. Bill Amelio to discuss Avnet's Q3 fiscal 2017 business highlights.

William Amelio (CEO)

Thank you, Vincent. Hello, everyone. Thank you for taking the time to be with us and your interest in Avnet. At the end of February, we completed the sale of Technology Solutions business to Tech Data Corporation for $2.1 billion of cash and approximately $250 million of Tech Data stock. This transaction marks a significant strategic step in our transformation as we focus our energies and our expertise on being the best component and solutions partner for our customers and our suppliers. When you consider the sale of TS combined with the additions of Premier Farnell and Hackster.io, Avnet is developing unparalleled capability in helping our customers move from idea to product and from product to market.

With over 6,000 engineers within our design communities and over 2 million customers globally, Avnet is positioned at the sweet spot of the industry, able to offer tailored solutions to small, medium, and large customers in ways only Avnet can. This capability provides suppliers with access to the largest number and broadest range of customers in the world. Our revenue growth for the quarter came in at the high end of our seasonal norm, driven by continued excellent performance in EMEA and from Premier Farnell. Of note, our digital revenue for the quarter reached a healthy $700 million annual run rate as our digital investment continued to pave the way for increased customer flexibility and opportunity. Our digital strategy is one of the key components of our transformation, and we are already seeing positive results from these efforts.

In terms of profitability for the quarter, we saw a similar pattern with margins and operating income improvements driven by strong contributions from Premier Farnell, with continued strength in EMEA. In just a moment, Kevin will provide more details and color on our operating performance and our forecast. Now I'd like to turn to the news we communicated this morning regarding our ERP platform. After extensive evaluation, expert opinion, and thoughtful deliberation, we have made the decision to migrate to a global system, which we believe will better position Avnet for future growth and success. This important strategic move will require non-cash charges that will negatively impact our results over the next two years. While disappointing, we believe the timing is prudent and the transition is necessary. Let me provide some background. Late last year, we hired a new Chief Information Officer, Kevin Summers.

He is charged with leading our global IT organization. Kevin brings a wealth of experience both deploying and improving global ERP systems at large multinational companies. Given now that we're solely focused on a component distribution business with a recently added digital capability, his team was tasked with evaluating our current systems in each region, then proposing a global IT strategy for a go-forward strategy. Based on his assessment and with the input of industry experts, our systems, we concluded, were not optimized to support our future business requirements. In addition, we have validated our due diligence findings that Premier Farnell legacy systems will require investment in order to fully connect to our whole Avnet ecosystem. This led us to make the decision with confidence that now is the right time to develop a global ERP system that will incorporate Avnet's emerging digital business model.

With the growing importance of digital content in product life cycles, it is critical that we meet the needs of our valued customers and suppliers as everyone in the technology supply chain demands greater efficiency. Once deployed, a global ERP system will deliver substantial benefits, including a superior customer experience, broader market reach for our suppliers, and lower operating costs and improved global analytics. As we have shared with you throughout 2017, we have been working tirelessly to address issues related to our ERP deployment in the Americas region. During the implementation phase of our global ERP, we will support the Americas region by providing dedicated resources to continue to automate processes and deliver the highest quality experience our customers and our suppliers have come to expect from Avnet.

Although we're just embarking on this project, our initial estimate is the cost will be between somewhere between $75 million-$125 million, and will take up to 24 months for us to successfully complete. During this process, we commit to keeping you updated on our progress and key developments. I want all our stakeholders to know that we spent significant time evaluating the best course of action given the magnitude of this decision. With our current IT infrastructure and the increasing demands of the technology supply chain, we are confident that this is the best course of action in order to ensure profitable growth for Avnet in the future, as well as the best experience for our customers, our suppliers, and our employees. With that, let me move to providing an update on our strategy.

In September, we engaged an outside firm to perform an analysis of Avnet's global operation with the intent of identifying areas where we could add more value for our suppliers and our customers, as well as ways to streamline the operation in order to better position Avnet for the future. With that work as a blueprint, we began a bottoms-up transformation process in the fall of 2016 to identify value-creative areas focused on commercial and engineering excellence, best-in-class global practices, and business simplification. As a result of that effort, we developed a group of core initiatives that, when implemented, will have a meaningful impact on both our top and our bottom line. We have begun implementing many of these programs, and Kevin will provide an update on the financial impact later in the call.

As part of this effort, we have accelerated investments in our digital tools and services to leverage our online community that we've developed with Hackster.io, MakerSource, and Premier Farnell. From tools that provide engineering-proven block diagrams to our online optimization tools to help with component selection, we are rolling out new services that will enhance our customers' experience and improve their speed to market. We believe our end-to-end capability through the product life cycle is a differentiator in the marketplace and will lead to additional growth in the future. In our core components business, we'll continue our investment in targeted growth areas. We have a wealth of technical experience within Avnet, and we plan to direct more of those resources towards customers and suppliers in high-growth markets. This includes automotive, industrial, and the Internet of Things.

We plan to leverage Premier Farnell's design and prototype capabilities in Asia and our Integrated Solutions Group to create a global offering focused on helping customers as they move from design to production. We continue to focus on solution selling, featuring more modules and Avnet-branded products that have proven popular with our customers for trying to solve common design problems. We're also working with our suppliers to expand our line cards globally and further strengthen our demand creation go-to-market strategy. We recently announced the expanded relationship with Xilinx, where EBV, our industry-recognized demand creation leader in Europe, will be replacing another programmable device competitor with Xilinx technology, thereby expanding Xilinx's reach into that region. Finally, I want to highlight a key addition to our leadership team. I'm sure most of you saw last week's announcement that Phil Gallagher is rejoining Avnet to help lead our core distribution business.

Phil is a highly respected executive with three decades of experience in our industry, most of which most recently he was at TTI, but the lion's share of his experience is, of course, with Avnet. When I presented Phil with the opportunity to come back to Avnet and share with him our vision and our strategy, he saw the potential and decided to rejoin the team. Phil will strengthen our supplier and customer relationship focus and ensure our commercial excellence is executed globally. Our vision and strategy are sound, and our position is truly unique.

With the capabilities and assets of Premier Farnell, Hackster.io, the growth of our digital tools, and the scale and breadth of our core distribution business, Avnet is truly differentiated, positioning itself where the market is going by possessing the tools needed to help customers and our suppliers move from idea to product and from product to market. Now I'd like to turn the commentary over to our CFO, Kevin Moriarty. Kevin.

Kevin Moriarty (SVP and CFO)

Thank you, Bill, and hello, everyone. As I walk through my comments, I will be referencing the slides on the webcast. Starting with slide seven, in our fiscal Q3, revenue grew 10.6% quarter-over-quarter in constant currency at $4.4 billion, and organic revenue increased 1.8% in constant currency. Organic revenue grew 3.4% sequentially in constant currency, which is just above our seasonal range of -1% to +3% in our March quarter. As Bill noted earlier, our EMEA region delivered above seasonal sequential growth of 16.2% in constant currency and was up 12.3% quarter-over-quarter, representing the 15th consecutive quarter of quarter-over-quarter growth. Premier Farnell exceeded our expectations and delivered double-digit operating margins, which was a key contributor to our digital revenue reaching a $700 million annual run rate.

Gross profit margin increased 142 basis points quarter-over-quarter due to the addition of Premier Farnell and increased 46 basis points sequentially as a result of the geographic mix shift to the higher-margin Western Region. Adjusted operating income grew 4.8% sequentially, driven by the strength in EMEA and a full quarter of Premier Farnell results. Adjusted operating income dollars grew 6.8% quarter-over-quarter, and operating income margin declined 7 basis points from the year-ago quarter as the positive impact of Premier Farnell was offset by a significant decline in the Americas region due to lower gross profit margin and higher expenses related to our ERP deployment. Our gross profit margin in the Americas region declined due to supplier program changes, a higher mix of fulfillment revenue, and inefficiencies related to our ERP deployment.

Adjusted earnings per share of 88 cents increased 7 cents from the year-ago quarter, primarily due to the increase in operating income related to the addition of Premier Farnell in the current quarter. Transitioning now to slide eight on our outlook for the fourth quarter in fiscal year 2018. Before I address our outlook, I would like to take a moment to review with you the financial impact of our decision to pursue a Global ERP. During the system deployment period, we will continue to spend approximately $3-$4 million per quarter to support improvements in our Americas region. In addition, we will spend another $1-$2 million of expense per quarter in support of the Global ERP implementation.

Given we will be replacing our Americas ERP when the new system is complete, we are required to accelerate depreciation, which will result in additional non-cash charge of approximately $18 million per quarter over the next 8 quarters. This accelerated depreciation will be excluded from the pro forma results we report, while the regular depreciation will continue to be reflected in our pro forma results. Looking forward to Avnet's fiscal 2017 fourth quarter, we expect sales to be in the range of $4.35 billion-$4.65 billion. Based on this revenue forecast, we expect adjusted EPS to be in the range of $0.72-$0.82 per share. This guidance does not include any additional acquisitions, amortization of intangibles, potential restructuring, integration, above accelerated depreciation, and other expenses and certain income tax adjustments.

The guidance assumes $127 million average value to shares outstanding, an effective tax rate in the range of 22%-26%. In addition, the above guidance assumes an average US dollar to euro currency exchange rate of 1.08 to the euro. This compares with an average exchange rate of $1.13 to the euro in the fourth quarter of fiscal 2016. The midpoint of our revenue guidance represents a sequential growth rate of 1% as compared with our normal seasonality of flat to +4%. The sequential decline in EPS reflects the negative impact to our gross profit margin from supplier program changes and an increase in expenses related to stranded overhead after the divestiture of Technology Solutions.

As a result of the new supplier program changes in the March quarter, we are initiating a $40 million cost reduction to partially offset the decline in gross profit dollars that will impact our profitability in fiscal 2018. While we are confident our transformation plan will continue to deliver profitable growth in the future, the addition of recent supplier program changes has escalated the need to reduce and redeploy resources to where they can have the most impact. While these near-term headwinds will have more pronounced impact on the H1 of fiscal 2018, we are committed to offsetting the gross profit margin profit dollar loss through the remainder of the fiscal year. As a result, we expect revenue to be in the range between $17.3 billion and $17.7 billion, and EPS to be in the range of $3-$3.50 per share. Transitioning to slide nine.

In an effort to provide as much context as we can to help frame out the financial impact, we have developed the sales and EPS walk through fiscal year 2018. On slide nine, which takes a look at revenue, the combined impact of supplier program changes is a $1 billion decline, which will impact the H1 of the fiscal year. Offsetting some of the decline is organic revenue growth and transformation initiatives that range from $600 million-$700 million over the course of our fiscal year. Finally, the inclusion of full year of Premier Farnell revenue, along with related organic growth, will add another $400 million-$500 million of revenue. As a result, we expect fiscal 2018 revenue to be in the range of $17.3 billion-$17.7 billion, with the organic growth accelerating through the year.

Based on the midpoint of these ranges, we expect to offset the $1 billion revenue impact of the supplier program changes. Transitioning to slide 10. The next slide provides an EPS walk with an additional detail on both the negative and positive impact to our fiscal 2018 outlook. In fiscal 2018, the supplier program changes impact not only revenue, but also our gross profit margin as multiple suppliers have changed terms and/or conditions for both demand creation and fulfillment programs. As a result, we estimate the EPS decline related to supplier program changes could be between $1.09 and $1.25 per share. Offsetting that decline is a $0.25 positive impact from the lower interest expense and share count as a result of the debt paydown in February and the shares we repurchased in the March quarter.

In addition, we expect to realize another $0.18-$0.22 of improvement in EPS as a result of the restructuring program we announced today. Our transformation initiative, which will ramp as the year progresses, is expected to add another $0.35-$0.45 per share. Finally, the combination of a full year of Premier Farnell, organic growth, and the Premier Farnell synergies will add another $0.35-$0.45 per share, resulting in a full year EPS estimate of $3-$3.50 per share. Given the negative impact of the supplier program changes occurring in the H1 of the fiscal year, and many of our positive programs ramp through the year, we approximate that 40%-45% of our EPS will be realized in the H1 of the fiscal year, with the remainder in the H2 when revenue shifts to our higher-margin Western Region.

Now turning to slide 11 on our balance sheet and liquidity. As Bill mentioned earlier, we received $2.4 billion of cash and approximately $250 million of tax assets when the transaction closed in late February. We used approximately $1.8 billion of the cash to pay down $1.5 billion of our floating rate debt and another $300 million to pay down higher-interest Premier Farnell debt. We also returned $163 million of cash to shareholders through our dividend and share repurchase program. Cash flow from continuing operations accounted for $163 million use in the March quarter as we built working capital to support the revenue growth. After using proceeds from the sale of TS to reduce our debt, our net debt declined from $2.36 billion at the end of December to $628 million at the end of March.

Our credit statistics improved materially as our leverage ratio, or debt to EBITDA, declined from 3.5 times to 2.2 times, further supporting our investment-grade credit rating. We also locked in our gain on the Tech Data shares and will have another $250 million of cash available within the next year. As a result of the sale of Technology Solutions, we have a strong balance sheet with ample liquidity to fund our growth initiatives and consider capital allocation alternatives. Our credit facility and accounts receivable securitization combined provide $1.3 billion of available liquidity in addition to the $250 million we will realize from the sale of our Tech Data shares. Our fixed-rate debt has a blended interest rate of approximately 4.8%, with no long maturities until calendar year 2020.

As we have stated consistently, we remain committed to maintaining our investment-grade credit rating and believe we have the balance sheet and liquidity to execute our growth strategies and invest in our Global ERP system. In closing, I want to be clear. We're disappointed that our financial performance will be negatively impacted in the near term and we're committed to working hard for our customers, suppliers, and all our shareholders. These decisions are never easy, but they're necessary to position the company for success in the future. I want to thank all of our employees for their tireless effort for stepping up and being part of the solution. We're acutely focused on meeting the Americas customer and supplier needs as we focus through our ERP issues, and we will provide as much support to the team as required to ensure their success.

We're committed to additional cost rationalization that we announced today, and we will do everything in our control to accelerate meaningful progress. It's important to keep in perspective the seeds we've planted as part of the transformation strategy are, in fact, bearing fruit. We will continue to move core growth-oriented projects into implementation phase that will produce increasing benefits as we move through fiscal 2018. Combining Premier Farnell and Avnet has resulted in a truly unique distribution model with clear, differentiated offerings that put us at the forefront of the digital transformation that is impacting technology supply chains today. Going forward, we'll remain transparent in our communications and provide updates on our growth plan and our progress towards our financial commitments. Given the magnitude of today's news and our focus on the task at hand, we've decided to postpone our investor day scheduled for May 24 to a later date.

It's our goal at that point to be able to provide more detail on the initiatives that we've introduced today, as well as a meaningful progress update so we can present a clearer picture of how we have come so far and where we're headed. Despite the new challenges, we are more convinced than ever that we have the right strategy, a unique value proposition that spans the entire product lifecycle, and the best team in the industry to drive future success. We sincerely appreciate your attention and thank you for your interest in Avnet. With that, let's open up the lines for the Q&A operator.

Operator (participant)

Thank you. At this time, we will 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 a question queue.

You may press star two if you would like to remove your question from the queue. Some participants using speaker equipment 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 Param Singh of Merrill Lynch. Please proceed with your question.

Paramjit Singh (Financial Solutions Advisor)

Hi, thank you for taking my question. So, you know, first of all, you know, wanted to talk about the top line here. You know, I understand the $1 billion in loss from vendor movement to competitors. What was the geographic exposure of the different losses? I mean, you know, was the ADI mostly US, or was it also in Europe? And then what was the organic—what was the driver for the organic growth in EMEA that had some follow-ups here?

Kevin Moriarty (SVP and CFO)

Sure. Very nice, Kevin.

I'll start with the last part of your question. In Europe, we've built a very strong presence in auto, industrial, medical equipment, and markets, and those are really the real markets for us. Obviously, other verticals as well, but those are the ones really performing well. As I look at your first question, it primarily would be in our Western regions of Europe and the Americas. Hey, we're still rolling off the high-volume fulfillment business that we'll wrap in the June quarter in Asia.

Paramjit Singh (Financial Solutions Advisor)

Okay. And then, you know, it's good to see feedback of the company. You know, what initiatives are you bringing that's going to be different from what, you know, in his prior role at Avnet when he was on the component side and then versus what Gerry was doing?

William Amelio (CEO)

Yeah, one of the key reasons that I asked Phil to come back is, one, to be a part of this new transformation that we're doing. Secondly, was the unique ecosystem that we're developing with Hackster, Premier Farnell, and Avnet. There's no better person that could help stitch that together and build the kind of relationships we need across the industry to make it successful. Phil's primary focus, of course, will be to drive commercial success and build tight relationships with both customers and suppliers.

Paramjit Singh (Financial Solutions Advisor)

Okay. Then moving on to your ERP implementation, maybe I wasn't clear on the cost that'll actually be recognized in the P&L. So maybe you could highlight for me what would be the actual cost recognition on a non-GAAP basis, and then what additional inventory would you expect to hold while that ERP implementation is going to take place?

William Amelio (CEO)

Let me take the second question, and I'll pass the first question to Kev. The second question, we're not intending to have any more inventory. In fact, we will continue to improve our working capital position going forward.

Kevin Moriarty (SVP and CFO)

Yeah. Param an operating expense standpoint, we expect to continue to have, on an ongoing basis in the Americas, approximately $3-$4 million of expense per quarter as we work through the next fiscal year. In addition, expect to incur $1.2 million of expense on the global system as we work through the fiscal year. And again, that's a per quarter amount. And then as it relates to the depreciation, on a quarterly basis, we'll be recognizing approximately $5 million, which is just the normal depreciation expense on the system. In addition, we will be pro forma-ing out approximately $17-$20 million per quarter related to the accelerated depreciation.

Paramjit Singh (Financial Solutions Advisor)

So, okay. And then lastly, you know, just so I understand correctly, basically all the benefit that you're getting from a higher mix of digital and Premier Farnell is mostly being offset by the overall revenue loss and the stranded cost that you have from Tech Data sale and then B, because of the loss of share to competitors on the component side, core side.

William Amelio (CEO)

Well, the majority of it is because of supplier line card losses, as we stated, the $1 billion of revenue and the corresponding gross profit that goes with it.

Paramjit Singh (Financial Solutions Advisor)

Okay. And what buyback expectations do you have near term? Is that part of the $3-$350 guide? I know you did some already, and you're talking to $126 million in shares, but anything in addition that's not—that's part of the $500 million that you have left that's causing that guide? Yeah.

Kevin Moriarty (SVP and CFO)

The guidance for next year that we provided today does not include any additional share buyback. But clearly, as we look forward, we're going to see how things settle, and we're going to sustain our previously committed comments on being disciplined in our approach. But clearly, as it comes back to book value and as we look forward, we clearly, it's under serious consideration for us to continue to invest in our stock.

William Amelio (CEO)

Yeah, there's no question. We've got approval to invest more, and as Kevin pointed out, we'll do it in a disciplined fashion, and we'll be as aggressive as we can.

Paramjit Singh (Financial Solutions Advisor)

Thank you. I'll get back in line.

Operator (participant)

Now, the next question comes from the line of Adrienne Colby of Deutsche Bank. Please proceed with your question. Question.

Adrienne Colby (Equity Research Analyst)

In your press release, you'd commented that Premier Farnell's operating margins exceeded 10%, which suggests a sequential step down in your core EM operating margins in the quarter and a level that is well below 4%, although it sounds like the effects of the supplier losses and the changes to the supplier programs are ahead of you. I was just hoping you could address what's driving some of that erosion and how we should be thinking about operating margins in the core business going forward.

William Amelio (CEO)

I'll give some color commentary, and then Kevin will give some more specifics. Clearly, we've already started to see the impact of some of the supplier consolidations this quarter, and most notably in the Americas regions, because the mix of the supplier issues happens not smoothly across every region.

So therefore, we saw more of a hit in the Americas region, as well as ongoing issues we've had with the challenges with the ERP system.

Kevin Moriarty (SVP and CFO)

As Bill safely points out, primarily, if you look at the commentary I provided in the script, there was an impact beginning in the March quarter. It does accelerate as we move forward. Then as you think about the gross profit percent in the neighborhood of, say, 30-40 basis points sequential impact as we move forward here in terms of the core business.

Operator (participant)

I would like to notify the audience. We ask that you please ask one question along with one follow-up allowed due to time measurement. Thank you. Our next question comes from the line of Matt Sheerin of Stifel. Please proceed with your question.

Matthew Sheerin (Equity Research Analyst)

Yes, thanks. I'll try to keep just the two questions here.

So when we look at the $1 billion of revenue going away from the vendor relationships, what's the timing of that? Does that start rolling off next quarter or into the September quarter? And in terms of the gross margin impact you just talked about, is that all related to those vendors because their mix perhaps was higher and helped your margin, or are there also issues with existing suppliers where you have, you're continuing the relationships, but the mix of that business is changing because of changes of the relationships?

Kevin Moriarty (SVP and CFO)

Hey, Matt, this is Kevin. I'll take the first question. Some impact as we work through the fourth quarter, but it clearly accelerates as we get into our September quarter on the loss from the suppliers. And that's the way to be thinking about it.

William Amelio (CEO)

The same question. I think it's fair to say across the board, we've been working with all of our suppliers. There's been a low-growth environment that we've been living with for several years, and we're starting to, of course, see our way out of it because our book-to-bills are improving. However, there's been margin squeezes with some of our existing vendors that we have to work through as well and take the corresponding costs out to maintain our margins. And that's why it will take us a bit of time this year to get ourselves right-sized again. That's why we announced the additional cost reductions.

Matthew Sheerin (Equity Research Analyst)

Okay. And then on the cost reduction program, what's the sort of the dollar amount that you're looking to take out when you add it all up between the Premier Farnell synergies, the lowering the headcount or resources that support the product lines that are going away, as well as the corporate overhead associated with the Tech Data business that you just sold?

Kevin Moriarty (SVP and CFO)

Matt, I would range it in the neighborhood of, in aggregate, of our operating expense around 4%-6% as we look forward. 4%-6%.

Matthew Sheerin (Equity Research Analyst)

And that's over the course of the next year or so?

Kevin Moriarty (SVP and CFO)

Yeah, over the next of the course year and for some of the Premier Farnell expenses that we've referenced in the past, some of that will slip into fiscal year 2019, just given the international aspects of it.

But for the most part, that's what we're planning on, is roughly 4%-6% of operating expense cost out.

Matthew Sheerin (Equity Research Analyst)

All right. Thanks so much.

Kevin Moriarty (SVP and CFO)

You're welcome.

Operator (participant)

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

Adam Tindle (Equity Research Analyst)

Okay. Thanks and good afternoon. I just want to start on revenue with the question there on the fiscal 2018 revenue guide. Bill, it'd be helpful for us to understand why these customer losses occurred, and are there any more customer losses beyond the $1 billion we've seen so far? And then secondly, what gives you confidence that the core business will grow kind of mid-single digits organically during an ERP transition phase? Just have a follow-up after that.

William Amelio (CEO)

Yeah. First of all, I think you mean suppliers, not customers, right?

Adam Tindle (Equity Research Analyst)

Yes.

William Amelio (CEO)

Okay.

Well, we spent a lot of time with all of our top suppliers and got validation that we've got solid relationships with them. We don't see any more on the horizon. But in any business, there's always some level of risk. And I can't predict 100% certainty that there is never an issue out there. But however, we touched every one of them more than once in the past quarter. One of the reasons I brought Phil on board is to, in fact, solidify that relationship even tighter.

Adam Tindle (Equity Research Analyst)

Okay. Revenue growth.

Operator (participant)

Our next question comes from the line of William Stein of SunTrust. Please proceed with your question.

William Stein (Managing Director and Senior Equity Research Analyst)

Thanks for taking my questions. Bill, it's sort of a magnification of the last question. We're pretty widely aware, I think, aware of ADI and more recently maybe Cypress and the change in policy from TI.

I'm sort of struggling with trying to understand what's causing this trend. Is there any link between this issue on one hand and the ERP issue, or is it independent from that? And is there any chance that this trend could reverse and somehow you get some of these losses back? And you already answered why you think that it's not going to continue because you've spoken to the suppliers, but maybe you can answer the other two parts of that, please.

William Amelio (CEO)

Yeah. I kind of put it in this perspective. If you think about and view all the customers on a continuum, largest customers, the smallest customers, most suppliers view that and can put a line somewhere and say, some of the accounts, the bigger ones, are the accounts that always go direct, and the other ones are for distribution. It's typically the way it works.

In growth times, what you see occurring is that line moves out, moves closer to the axis, meaning that there's less direct customers because it's harder to keep up with the growth of your existing customers. When there's limited growth, that line moves out a bit to the right into an exaggerated case to what we've seen happen with TI, where they've essentially taken all their accounts direct and gone into a fulfillment model and used digital as a way to get after some of the smaller customers. We have validated with literally all of our suppliers the need for continued demand creation. So I don't believe that's a trend that will happen in the long term. In fact, we've seen a lot of suppliers come growth and demand even more help with respect to demand creation as we're starting to see growth come back in this industry again.

So we're pretty confident about that. With respect to some specifics with some suppliers, let's take an example like ADI. They wanted to get an ability to be able to have additional margin go their direction. So one of the ways to do that is consolidate to one distributor. In their case, they had already been an acquisition with Linear Tech, which was 100% with our competitor, and it was a much easier move for them to do a consolidation away from us versus to us. Now, on the flip side, take a look at Broadcom. We've had a fantastic relationship with Broadcom. In fact, we're getting more—we're seeing more TAM to DTAM come our way. I think I've announced that on several calls that we've seen a significant amount more than we had expected. So we still see some upside with respect to that relationship.

I think that this is one of these things that happen in the industry, that there's ebbs and flows, and we'll see suppliers go either direction. And I'm confident that we'll continue to make announcements like we made with Xilinx just recently. We've expanded our relationship with Xilinx, and we added EBV to that line and gave them access to our European market. So I'm pretty confident that you'll see more improvements here as we move forward.

William Stein (Managing Director and Senior Equity Research Analyst)

Okay. Thank you.

Operator (participant)

Our next question comes from the line of Shawn Harrison of Longbow Research. Please proceed with your question.

Shawn Harrison (Equity Research Analyst)

Hi. If I do the math right and you get to a run rate approximating $1 of EPS exiting next fiscal year, it implies an EBIT margin in the low 4% range, which is lower than I would have thought even with all the moves.

So I guess the question I have is twofold. Number 1, what is the target long-term EBIT margin for the business after you take the cost out and the ERP and everything else? And second, do you have an ROIC goal associated with that? Because I can't believe that at a 4% EBIT margin, you're earning an appropriate spread on your cost of capital.

Kevin Moriarty (SVP and CFO)

Shawn, it's Kevin. I think what I would point to is for the businesses themselves, the legacy EMEA core business, as we look at it, clearly we're still thinking in the neighborhood of 5%-5.5%. Now, obviously, we're going to work on the cost structure to ensure that that happens, as well as some things Bill referenced earlier. What you have to factor in is the ongoing corporate cost as well in terms of how to get to the total.

So as we look at it, somewhere in the neighborhood of 3.5%-4.5% is all in what we would be thinking as we look longer term to address it. In terms of return on capital, our goal is clearly to exceed our weighted average cost of capital. So as we look forward, based on some of the internal things we are working on, we would look to be somewhere between 11% exiting next fiscal year. And then as we kind of move forward, we're going to look to strive to be back to the 12%-12.5% range over the next two to three years.

Shawn Harrison (Equity Research Analyst)

I'm sorry, Kevin. I was confused on the 3% to 3.5% to 4% EBIT margin post-corporate cost, because I think corporate costs are running 50 basis points a quarter, correct? And so you'd be well above 4%?

I'm missing the math there on how we bridge.

Kevin Moriarty (SVP and CFO)

No, I'm sorry. I was providing the net number, including corporate cost.

Shawn Harrison (Equity Research Analyst)

So you're thinking long-term you're at 4% EBIT margin?

Kevin Moriarty (SVP and CFO)

That's what we're striving to be, yes.

Shawn Harrison (Equity Research Analyst)

Okay. Second, just in terms of total ERP cost, if we go back, either starting with what you've done globally, then the North America program, and then everything going forward, if you could separate those two buckets, what are both of those going to cost you to date and then go forward in terms of just total dollars of spend?

Kevin Moriarty (SVP and CFO)

Well, we have in the past quarters talked about $3-$4 million a quarter to keep up with the current system. We had planned to add that roll-off in June and given some of the developments that have occurred and our decision now to move to a global ERP system.

That $3-$4 million will continue until we sunset the evolved system in 24 months. On top of the capital expenditure that we'll be going with the new Global ERP system, you can assume about a $1-$2 million additional expense that we'll have in the numbers until we have that implemented.

Shawn Harrison (Equity Research Analyst)

What was the cost, though, to implement the ERP system in North America that isn't working in terms of the CapEx?

Kevin Moriarty (SVP and CFO)

Approximately $150 million.

Shawn Harrison (Equity Research Analyst)

All right. And that's just being written off now with the accelerated depreciation, the way to read it.

Kevin Moriarty (SVP and CFO)

Yes.

Shawn Harrison (Equity Research Analyst)

Okay. Thank you.

Operator (participant)

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

Stephen Fox (Equity Research Analyst)

Thanks. Good morning. Just looking at some of the flow charts you provided, it looks like you're targeting roughly 4% organic sales growth into your next fiscal year.

So I was just curious, one, if you could dive into how you get to that type of organic growth a little bit more. And then secondly, I think if I heard right, that's before considering Premier Farnell's organic growth. So if you can give us some color on what type of organic growth we could expect from Premier Farnell, that would also be helpful. Thanks.

Kevin Moriarty (SVP and CFO)

Sure. Hey, Steve, it's Kevin. So when you look at our semi components TAM and markets for the next fiscal year, as well as certain initiatives that we have ongoing, the broader market is looking to grow approximately 4.5%-5%. So we have tempered that as we think about next year.

Specifically, where you look at the verticals where we perform well in, let's say, the Western regions and globally, specifically in the areas of automotive, industrial, medical equipment, as well as now the broadening aspects on integrated solutions and other areas where we are really dedicating specific resources, that gives us confidence to the midpoint of the range that I shared today.

Stephen Fox (Equity Research Analyst)

And then in terms of just Premier Farnell, what type of organic growth would that be if it was standalone?

Kevin Moriarty (SVP and CFO)

I think in the neighborhood of probably similar in the neighborhood of 3%-4% would be a way to think about it.

Stephen Fox (Equity Research Analyst)

Okay. And then just one quick follow-up. So on one hand, you're talking about some more success with Xilinx in terms of utilizing your programming capabilities in Europe.

On the other hand, it seems like maybe there's some stranded programming capacity now in the U.S. in Phoenix. I'm not sure if that's correct, but can you just sort of talk about how that capacity maybe gets reallocated over the next 12 months? Thank you very much.

Kevin Moriarty (SVP and CFO)

Well, no, there's no stranded programming capability. We'll fully utilize and we'll run on our capacity. We've had Xilinx in the line card in Americas, and it continues to be on the line card in Americas.

Stephen Fox (Equity Research Analyst)

Great. That's really helpful to know. Thank you.

Operator (participant)

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

Mark Delaney (Managing Director and Senior Equity Research Analyst)

Yes. Good afternoon. Thanks very much for taking the questions. I do have two questions. The first question is to help us better understand the $1.09-$1.25 EPS impact from issues related to suppliers.

Maybe you can just help us understand how much is related to the $1 billion of revenue loss and how much is pricing. On pricing, can you just give us a sense of the breadth of suppliers that are seeing more favorable pricing? Is it just TI or some of your other larger suppliers getting better pricing terms as they come up for renewal? Like Xilinx just renewed. I'm just curious if you could just help us understand, again, the breadth of semi-suppliers seeing better pricing. Then I have a follow-up question too. Thanks.

Kevin Moriarty (SVP and CFO)

Caller on. Sure. Mark, it's Kevin. I would say it's roughly split 75%-25%. So 75% from the lost revenue and then say 25% tied to supplier programmatic changes.

On the breadth of customers getting better pricing, is it just TI or is that spread to other people, again, like Xilinx or other large suppliers?

William Amelio (CEO)

Yeah. I would say there were programmatic changes with many of the suppliers, but the biggest impact, of course, is with supply line losses like ADI, Cypress, and the like. So that gives a bigger impact.

Mark Delaney (Managing Director and Senior Equity Research Analyst)

Okay. That's helpful. And then for my second question, just to understand how you guys are thinking about valuation in terms of when you would step in for buybacks. I know gross book value, which is, I think, between $40 and $41. I mean, that's historically a level the company has thought about for doing more buybacks.

Just with the lower guidance, I think ROE, just by my quick math at this point, is something like 7% or 8% in fiscal 2018 and below the cost of equity. So something like the tangible book value in the kind of $28-$29 range, is that a metric you guys are going to now look at more closely, or is gross book value still the level that you guys are thinking of?

Kevin Moriarty (SVP and CFO)

We're going to be consistent with our path approach and look at all the respective metrics met around the book, tangible book, as well as just what we think from a DCF standpoint.

Mark Delaney (Managing Director and Senior Equity Research Analyst)

Thank you.

Operator (participant)

Our next question comes from the line of Jim Suva of Citigroup. Please proceed with your question.

Jim Suva (Senior Managing Director and Senior Research Analyst)

Thank you very much. Quick clarification, then I'll ask my question immediately right now.

Did you say you will be building inventory into the ERP change, or your ERP system will allow you to continue without building inventory? And then my question is, on these program shifts from your suppliers, did you have a chance to negotiate on price and margins, or was it basically a done deal? Because the magnitude of the loss is so big, you would think that your company would want to be able to have a discussion, or was the discussion done? Because on one hand, you talk about great firm relationships. On the other hand, losing $1 billion of sales is nothing to laugh about, and you really got to wonder about the relationship. So kind of help us better understand about how that all happened. Okay.

William Amelio (CEO)

On your first question on inventory, yeah, the point we made was, or the point I made was, that we don't need to be doing a big build-up of inventory because we're using the approach that we've used over in Europe, where we've done a pretty seamless implementation of SAP, as well as in Asia. So we have had big successful implementations of SAP, and we've done it without adding inventory. That's what we'll do as we roll out the global strategy. So you have an opportunity to do it either in a big bang or a slower roll-out. We have chosen to do a slower roll-out branch by branch as we go across the Americas in the future. With respect to your second question, I'd say it was a mix.

There were a couple that I'd say were surprises to the company, and other ones where we were in deep negotiations with the suppliers, and we didn't win the bake-off.

Jim Suva (Senior Managing Director and Senior Research Analyst)

Okay. Thank you very much.

Operator (participant)

There are no further questions over the audio portion of the conference. I would now like to turn the conference back over to Moriarty for closing remarks.

Kevin Moriarty (SVP and CFO)

Yes. This is Kevin Moriarty, and I just want to clarify something I made a comment on related to a question from Shawn. We are targeting 4%-4.5%. We obviously need to do more work before we update all the targets. I misspoke and netted something that I should have not. So that was my mistake. And we are targeting 4%-4.5%.

Vincent Keenan (SVP and Investor Relations)

Thank you for participating in our earnings call today.

Our Q3 fiscal 2017 earnings press release and related CFO commentary can be accessed in downloadable PDF format at our website, www.ir.avnet.com, under the quarterly results section. Thank you.

Operator (participant)

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful rest of your day.