Avnet - Q4 2014

Transcript

Operator (participant)

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

Vincent Keenan (VP of Investor Relations)

Good afternoon, and welcome to Avnet's fourth quarter fiscal year 2014 business and financial update. If you are listening by telephone today and have not accessed the slides that accompany this presentation, please go to our website and click on the icon announcing today's event. As we provide the highlights for our fourth quarter fiscal year 2014, please note that in the accompanying presentation and slides, we have excluded certain items, including intangible asset amortization expense, restructuring, integration, and other items, and certain discrete income tax adjustments for all periods presented in our non-GAAP results. When discussing organic growth, prior periods have been adjusted to include the impact of acquisitions and divestitures.

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

In just a few moments, Rick Hamada, Avnet's CEO, will provide Avnet's fourth quarter fiscal year 2014 highlights. Following Rick, our Chief Financial Officer, Kevin Moriarty, will review some additional financial highlights and provide first quarter fiscal 2015 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 Phil Gallagher, President of Technology Solutions, and Gerry Fay, President of Electronics Marketing. With that, let me introduce Mr. Rick Hamada to discuss Avnet's fourth quarter fiscal 2014 business highlights.

Rick Hamada (CEO)

Thank you, Vince, and hello, everyone. Thank you all for taking the time to be with us and for your continued interest in Avnet. Fiscal 2014 marked a return to top-line growth on both a reported and organic basis, as we closed out our fiscal year with quarterly revenue and earnings per share at the high end of expectations. In our fourth quarter, enterprise revenue grew 6.9% year-over-year to $7.05 billion, and organic revenue and constant currency grew 5.2% sequentially at the high end of normal seasonality. At EM, where our team delivered year-over-year organic growth in all four quarters, organic revenue grew 6.7% year-over-year over the prior year quarter in constant currency, driven by our Asia and EMEA regions.

In our TS business, which dealt with an uneven recovery in fiscal 2014 as market conditions varied by region, growth in our Americas region was offset by a decline in our EMEA region, which resulted in essentially flat revenue on an organic basis as compared with the year-ago quarter. On a sequential basis, enterprise revenue grew 5.2% in constant currency at the high end of normal seasonality, driven by stronger than expected growth in TS Americas and EM Asia. Gross profit increased 4% sequentially to $837 million, while gross profit margin declined 17 basis points, with both operating groups realizing a sequential decline. On a year-over-year basis, gross profit dollars increased 8.6%, and gross profit margin increased 17 basis points, as an increase in the Western regions at EM was partially offset by a decline at TS.

The strong sequential growth in revenue, when combined with our continued expense management discipline, drove adjusted operating income up 9.94% sequentially to $244.9 million, and adjusted operating income margin up 12 basis points to 3.5%, with both operating groups contributing to the improvement. On a year-over-year basis, adjusted operating income increased 5.9%, primarily due to an increase at EM. Below the operating income line, interest expense declined $4.3 million from the year-ago quarter, as we realized a lower average borrowing rate subsequent to the payoff of our notes in March. Other expense also declined $5.4 million from the year-ago quarter, primarily related to an improvement in the net impact of changes in foreign currency transactions.

As a result of these factors, Adjusted EPS increased $0.12, or 11.8% year-over-year, to $1.14. On a sequential basis, adjusted EPS increased 10.7%, primarily due to the increase in adjusted operating income at both operating groups. Return on capital employed increased 105 basis points sequentially to 11.8% due to the increase in profitability and an improvement in working capital velocity. Working capital velocity improved 0.4 turns, even as we grew working capital to support our sequential growth in revenue. Despite this growth in working capital, our inventory turns and Days Sales Outstanding remain consistent with our 2013 levels, and we are comfortable that our working capital is well aligned with our expectations for market growth. Now, let's turn to our operating groups.

Electronics Marketing closed out the fiscal year with another strong performance, as our team delivered a fourth consecutive quarter of year-over-year organic growth and operating income margin expansion. In the June quarter, sequential growth was above expectations, with all three regions contributing. Revenue grew 4.4% sequentially in constant currency as compared with our normal seasonal expectation of flat to up 4%. At a regional level, sequential revenue increased 8.0% in our Asia region, 4.5% in our Americas region, and was roughly flat in constant currency in our EMEA region. On a year-over-year basis, reported revenue increased 8.8%, while organic revenue was up 6.7% in constant currency, which represents our fourth consecutive quarter of at least mid-single digit year-over-year organic growth.

Asia, which delivered a fourth consecutive quarter of double-digit year-over-year organic growth, increased 15.2%, while EMEA was up 6.6% in constant currency, and the Americas declined 3.5%. EM's gross profit margin decreased 15 basis points sequentially, primarily due to higher relative growth in our Asia region, which grew to represent 38.8% of total revenue versus 37.6% in the March quarter. On a year-over-year basis, EM's gross profit margin increased 31 basis points as improvements in the Western regions, including the addition of MSC in EMEA, were partially offset by a decline in Asia related to a higher percent of selected high-velocity fulfillment engagements as compared with the year-ago quarter.

The year-over-year increase in revenue and gross margin expansion, along with the continued expense management discipline, combined to grow operating income at nearly twice the rate of revenue growth. Operating income grew 16% year-over-year to $207 million, and operating income margin decreased thirty basis points—excuse me, increased 30 basis points to 4.8%. This operating income margin expansion was driven by improved profitability in our Americas and EMEA regions. At the global level, EM expanded operating income margin year-over-year throughout fiscal 2014, led by our Americas region. In the fourth quarter, if you exclude the MSC acquisition, where we had not yet realized the full benefit of our planned synergies, EM's operating income margin would have been 4.9%, approaching EM's targeted range of 5%-5.5%.

In our Americas region, our team grew full-year operating income margin 90 basis points year-over-year through a combination of revenue selection and disciplined expense management. At EM Asia, which accounted for over two-thirds of our sequential revenue growth, our team did an excellent job leveraging that growth, as operating income grew more than twice as fast as revenue. Return on working capital increased 108 basis points year-over-year, and economic profit grew 48%, driven by the growth in operating income. On a sequential basis, EM's return on working capital increased 192 basis points, with both the Americas and Asia regions increasing over 300 basis points. Working capital increased 4.2% sequentially to support our revenue growth, and working capital velocity improved 0.3 turns from the March quarter.

With our book-to-bill continuing above parity, seasonal growth expected in the September quarter, and our strong competitive position, we believe we are poised to leverage future growth into additional shareholder value going forward. Now, let's move on to TS. Technology Solutions Americas experienced an encouraging rebound after a weaker-than-expected close to the March quarter, as revenue increased a seasonally strong 13.8% sequentially, and organic growth was up 4.8% from the year-ago quarter. With Asia up 4.6% sequentially and EMEA down 4.2% in constant currency, TS revenue increased 6.6% sequentially in constant currency to $2.7 billion, as compared with a normal seasonal range of +3%-7%.

When compared with the year-ago quarter, reported revenue was up 4.2%, while organic revenue and constant currency was flat, as the growth in the Americas was offset by an 11.9% decline in EMEA, with over half of this decline attributable to our computing components business. On a year-over-year basis, growth in software, services, and storage was partially offset by the decline in computing components. TS gross profit margin declined 13 basis points sequentially, as improvements in the Americas and Asia regions were offset by a decline in EMEA. On a year-over-year basis, gross margin was down 12 basis points, as improvements in Asia and EMEA were offset by a decline in the Americas region due to product mix and the transfer of the lower gross profit margin computing components business from EM to TS at the beginning of the fiscal year.

Operating income grew 21.7% sequentially, and operating income margin improved 32 basis points, led by significant improvements in our Americas and Asia regions. On a year-over-year basis, operating income margin decreased 30 basis points due to declines in both the Americas and EMEA, which were partially offset by an improvement in Asia. Return on working capital increased 461 basis points sequentially, driven by improvements in the Americas and Asia regions. As we look back on fiscal 2014, TS navigated uneven market conditions by region, which is reflected in our results. In the Americas region, where year-over-year organic growth of 2.7% was somewhat muted by the weak close in March, our team grew operating income 5%, while continuing to invest in new services to expand our data center solutions capabilities.

Our Asia team delivered strong results as a combination of revenue selection and expense efficiencies expanded operating income margin year-over-year in all four quarters, and operating income dollars grew 72% over fiscal 2013. In our EMEA region, which has shown less consistent progress towards our long-term goals, we are taking incremental actions to align resources to current market conditions, including the acceleration of planned efficiencies associated with our recently completed consolidation onto a single ERP platform. Over the past 18 months, TS EMEA has successfully completed a phased integration that reduced the number of ERP platforms in this region from four to one. With this project complete, we now have more opportunities to streamline our structure and processes to be more efficient in our back office and how we support our go-to-market strategies.

Looking ahead to fiscal 2015, we believe trends in IT spending will continue to reflect a cautious and incremental approach as enterprises look to maximize their IT investments while evaluating new technologies and data center options. We are well positioned to help our customers navigate the expanding range of alternatives, as we have broadened our capabilities by incorporating new technologies, services, and partners. In this environment, we will keep driving increased leverage and margins where growth is strongest, while refocusing our valuable resources on emerging opportunities. Now, I would like to turn the commentary over to Kevin Moriarty to provide more color on our financial position and outlook. Kevin?

Kevin Moriarty (CFO)

Thank you, Rick, and hello, everyone. With a return to organic growth in fiscal 2014, we increased our working capital year-over-year in all four quarters. In the June quarter, working capital increased 3.4% sequentially, driven by a 4.8% increase in accounts receivable related to the strong close at the end of the quarter, particularly in the Americas region at TS. After adjusting for acquisitions and currency, working capital increased 11.5% from the year ago quarter, with most of the growth balanced between accounts receivable and inventory. Cash flow from operations was $34 million for the quarter and $237 million for the full fiscal year.

Our cash flow from operations for the full year was impacted by a $576 million increase in working capital to support the over $2 billion of top line growth. Although the rate of growth for working capital is higher than the revenue growth in fiscal 2014, I would point out that in fiscal 2013, we reduced working capital after the first quarter, including a $241 million annual reduction in inventory in response to slowing growth, excluding acquisitions and currency. In fiscal 2014, we had to rebuild our working capital in support of strong growth, particularly in EM Asia and EM EMEA.

Despite adding over 286 million of inventory to support growth, EM's inventory turns were very consistent throughout the year and improved 0.1 turns as compared to fiscal 2013. At TS, where the team experienced more volatility in seasonal performance through the fiscal year, with December above normal seasonality and March below, the team did an effective job managing accounts receivable as Days Sales Outstanding declined 0.3 days from fiscal 2013, even as they had to deal with atypical linearity at the end of the quarters. This performance highlights the impact our value-based management discipline had on our balance sheet. In fiscal 2014, we modified our capital allocation priorities to incorporate a more consistent return of cash to shareholders with the initiation of a dividend.

For the full fiscal year, we returned over $90 million to shareholders. Since we have initiated our disciplined share repurchase program in fiscal 2012, we have returned over $600 million to shareholders in the form of share repurchases and dividends. In addition, after the quarter closed, we entered into a new credit facility that increased our borrowing capacity by $250 million to $1.25 billion and extends the maturity to 2019. We enter our new fiscal year with a strong balance sheet and over $2.3 billion of liquidity, including over $900 million of cash on our balance sheet. Now, I'd like to turn to our outlook for the first quarter of fiscal 2015.

Looking forward to Avnet's first quarter of fiscal 2015 and our outlook, we expect EM sales to be in the range of $4.1 billion-$4.4 billion, and sales for TS to be between $2.3 billion-$2.6 billion. Therefore, Avnet's consolidated sales are expected to be between $6.4 billion-$7 billion. Based upon that revenue forecast, we expect Adjusted EPS to be in the range of $0.93-$1.03 per share. This guidance does not include any potential restructuring and integration charges or the amortization of intangibles. The guidance assumes 141 million average diluted shares outstanding and an effective tax rate in the range of 26%-30%.

In addition, the above guidance assumes that the average US dollar to euro currency exchange rate for the first quarter of fiscal 2015 is $1.35 to the euro. This compares with an average exchange rate of $1.32 to the euro in the prior year first quarter, and $1.37 to the euro in the fourth quarter of fiscal 2014. 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, and a confirmation tone will indicate that your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. In the interest of time, we ask that you please limit your question to one question and one follow-up. One moment, please, while we pull for questions. Thank you. The first question comes from the line of Sherri Scribner with Deutsche Bank. Please proceed.

Sherri Scribner (Analyst)

Hi, thank you. I apologize if I missed it, but could you give us the book-to-bill ending the quarter? And also, can you just tell us a little bit about what you're seeing in terms of lead times in the EM business and inventory levels? Inventories seem to be a little bit higher than I would expect as we go into sort of a little bit of a softer quarter, but maybe some detail on that would be helpful. Thank you.

Rick Hamada (CEO)

Yeah, Gerry, go ahead and jump in.

Gerry Fay (President of Electronics Marketing)

Sure. Book-to-bill, we ended June at 1.02 globally. Right now, all regions are positive, currently at 1.05. If you think about inventory, from an inventory perspective, if you look at our sales were up 4.5% sequentially, inventory was up about 5%. Given the book-to-bill, and remember, Sherri, our large fulfillment business in Asia steps up this quarter because we ship to the back end, or the beginning of the fiscal year, with Asia being stronger. So we're building some inventory for that, which has very high velocity. And also, due to the summer vacations in Europe, we take inventory in earlier. So our inventory will finish in line with our sales by the end of the quarter.

Rick Hamada (CEO)

Lead times, generally, I think she mentioned.

Gerry Fay (President of Electronics Marketing)

Lead times, you know, we've seen some uptick in lead times around military connectors and discretes, but all in all, there's been no big change in lead time across the board.

Sherri Scribner (Analyst)

Okay, that's...

Gerry Fay (President of Electronics Marketing)

Very stable.

Sherri Scribner (Analyst)

Perfect. That's very helpful. Thank you. And then just, can I ask a model question about the tax rate going forward? It seems a little bit lower than I was modeling. Should we look to use this 26%-30% range going forward? Thanks.

Kevin Moriarty (CFO)

Sherri, it's Kevin. Yes, obviously, a lot of it's gonna be predicated in terms of the geographic mix of our revenue, but I'll continue to update as we go forward. But the current model, I would say that's a good rate, blended rate to be using.

Sherri Scribner (Analyst)

Thank you.

Operator (participant)

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

Brian Alexander (Director of Equity Research)

Yeah, maybe just to follow up, within EM on Europe, I think you guys have seen four straight quarters of pretty solid growth, on a year-over-year basis. Just curious how you're thinking about, demand trends in Europe, specifically going forward. There was some weak data out of Germany last night. Not sure if you're seeing any of the geopolitical issues starting to impact your business over there, and then I have a follow-up.

Gerry Fay (President of Electronics Marketing)

We don't have a large amount of business today due to the geopolitical impacts today. So I think, as you know, from a perspective of affecting Europe overall, not gonna be a big impact. As you saw, the PMI for Germany is a little weak, but we continue to be strong. We continue to take DMS share in Europe, so our European business continues to be strong and our outlook for the fiscal year continues to be strong.

Brian Alexander (Director of Equity Research)

Okay, and then maybe shifting over to TS, if we compare your operating margins to your closest competitor, I think there's over a 200 basis point gap, which I think might be the widest for a June quarter, Rick.

Rick Hamada (CEO)

Okay.

Brian Alexander (Director of Equity Research)

I, I realize, I realize there's differences in regional mix and product mix, and that probably explains a lot of it, but maybe you can help us size how much of that gap you think is due to each of those factors, regional mix, product mix, versus something that is more structural, and are you considering exiting some businesses to drive up margins and returns? Then related to that, more specifics on the action plan that you're taking to reduce costs and how much you think that'll help margins. Thanks.

Rick Hamada (CEO)

Yeah, Brian, quick, multifaceted question. As you could imagine, Phil and I do spend a lot of time digging exactly into those elements. What I would tell you is that, I don't know if I have ratios for you, but if you look at the, the geo mix difference, the commodity mix difference, that includes both software and services versus hardware mix, also includes the PC components mix that we have. And then you take a look in the mirror, and you also say, we've got execution challenges as well. I believe, so Latin America and Asia are separate issues that don't compare. I believe we compete very well in the North America market. Strong market for us, good growth, good execution there, and trying to expand the services and opportunities in that marketplace.

And then, frankly, in Europe, we've got execution challenges as part of the overall issue. We did highlight the fact that we have been working on changing the conditions in Europe, including this major platform consolidation we've just finished. And we're not pointing that out as an issue to, to talk about any of the past results. What we're talking about is we now have something different over there to be able to attract, and accelerate, the planned synergies and efficiencies associated with that type of consolidation overall. So I freely admit and acknowledge, there are some structural issues from a geo and a commodity mix, but at the end of the day, we also have some execution issues, but I think the biggest gap for us there is in the European market.

Brian Alexander (Director of Equity Research)

Thanks.

Operator (participant)

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

Matthew Sheerin (Managing Director and Senior Equity Research Analyst)

Yes, thanks. Just following up on Brian's question regarding Tech Solutions. So, help us explain the weakness in the components business in Europe. It seems like everyone with PC exposure is actually benefiting from some PC refresh. Is it just that the markets that you're selling into are weak? You know, what's going on specifically in that components business?

Rick Hamada (CEO)

Yeah, and Phil, I'll jump in, you can add on it. Matt, it's, we believe the, more of the white box business that we service with, primarily with our components business, has been weaker than the overall general PC market. 'Cause you're right, there's been a lot of, lot of headlines in the tech space regarding, the impacts from the, you know, XP and the refresh going on there, et cetera. That certainly did not manifest itself for us. And as we pointed out, over half of the year-on-year decline that we saw in our European overall business was strictly related to that PC components business. And oh, by the way, Europe was the most, dramatically affected, Phil, of the three regions.

Phil Gallagher (President of Technology Solutions)

Yeah.

Rick Hamada (CEO)

So, it just has to do with the type of customers, the concentration and the type of customers that we have, which did not take advantage of some of the more recent spikes in opportunity that have been referenced on other calls.

Matthew Sheerin (Managing Director and Senior Equity Research Analyst)

Okay. So, given that, we may be at least, if not a peak, at some sort of plateau in terms of near-term PC demand, and you're down year-over-year in that business, could you give us some more specifics about what you're doing specifically to that business? Are you looking at divesting someone, some of it, downsizing? And you talked about some restructuring initiatives in EMEA, in Tech Solutions. Could you be more specific about some targets that you have there, whether it be headcount or OpEx reductions?

Rick Hamada (CEO)

Yeah. So Matt, we'll talk specifically about... I'll ask Kevin to comment specifically on the quantities in EMEA. First of all, understand that computing components business built around processors, memory, hard disk drives, primarily into, again, that self-builder, white box, OEM marketplace. And we are able to scale expenses and inventory up and down very, very quickly with that business overall, because it is a lower margin, high velocity part of the overall portfolio. We did announce last year and talked about bringing a global structure to that business, because we've had more consistent success in Asia, more limited success in the West. We actually asked our Asia leader to step up and take and manage this on a global basis. That has been underway throughout fiscal 2014.

However, again, you take a look at the current results, and you make adjustments accordingly. With that business, again, the adjustments can be made relatively quicker, always subject to all the proper notifications, et cetera. But, it expands and contracts with that business quicker because it's a lower cost model, again, higher velocity, just the way it's designed and built. Kevin, to speak specifically, what we've got targeted for TS EMEA on the reductions?

Phil Gallagher (President of Technology Solutions)

Sure. Hi, Matt. We're targeting $15 million-$20 million annualized reduction, and we have half of that identified to date. Timing-wise, given certain regulatory approvals, I would expect limited Q1 impact, but as we work through our fiscal year, we'll get more progressive, as we work through our fiscal year.

Matthew Sheerin (Managing Director and Senior Equity Research Analyst)

Okay. That's very helpful. And just one last one, if I may, regarding Electronics Marketing. You had nice year-over-year improvement in operating margin. I know you've talked about a 5% number and getting there, ex the acquisition you did in Europe in the December quarter. Where are we in terms of hitting that target? And do we need another, you know, seasonally strong quarter in terms of mix for Europe, which means that you're not going to get there in the next couple of quarters?

Gerry Fay (President of Electronics Marketing)

Well, Matt, as you know, thanks for the question, Gerry. We fell just short at 4.9 without MSC this quarter, so we're right on the cusp of it. We continue to affirm our goal of 5%-5.5%, and with some tailwinds in FY 2015, we'll be very close for the fiscal year. Given our regional mix, we believe this is a very aggressive but doable goal. We're also focused on remaining the industry leader in operating profit income dollar generation in the component space. And, we're going to continue to grow our Asia business. Our Asia business provides us nice economic profit, and, we believe we're out executing in that region, so, we continue to affirm our goals.

Matthew Sheerin (Managing Director and Senior Equity Research Analyst)

Okay, thanks very much.

Operator (participant)

Thank you. And the next question comes from the line of Louis Miscioscia with CLSA. Please proceed.

Louis Miscioscia (Managing Director)

Okay, thanks. I guess hitting on TS again, even with, I guess, taking out the component decline, you know, some have seen, I guess, more strength over in Europe in comparison. Was there anything that you could add to that? You know, Asia's been a bit more choppy. Maybe if you could give us a little bit of color, country by country there?

Phil Gallagher (President of Technology Solutions)

Can you go by region?

Rick Hamada (CEO)

Well, yeah, to start, Matt, I mean, Lou, on TS EMEA, when we look at decomposing the core business versus that components business overall, we again, we reported we were down 11.9 organically. The core business, the core enterprise IT business was down, we think, mid-single digits, and our components business was down, double digits. So that's, that's how that mix came out overall. Phil, you want anything else to add?

Phil Gallagher (President of Technology Solutions)

Yeah, let me just add on that. By country, it's a little much. I can give it to you by region, sub-region, if you will, in Europe. On the positive side, we continue to see growth in Eastern Europe. It's been one of our stronger positions in the region. The Central, where we've had some challenges, came back last quarter, was about flat to up a bit. And our bigger challenge in Europe this past quarter, frankly, was in the North. Just putting it out there. And we had some challenges in the North, and we're addressing those. We think we lost a bit of share in the North, and again, the team's addressing that.

But it's, you know, as far as, you know, we look at market share, it's always tough to get market share by brand on the TS side, but as we assess it, you know, there were some ups and downs, but there was not a, you know, across-the-board share loss. We had some nice positive gains, and then we had some losses as well. But it's definitely rough in Europe, and while we're taking the actions we're taking, by the way, it's a bit of a mixed bag, but certainly not all negative by any stretch. And to emphasize Rick's point, you know, half of the organic growth loss was in the computer components, so we're down about 5%-6%.

Louis Miscioscia (Managing Director)

Okay, and then countries in Asia?

Rick Hamada (CEO)

Hey, Lou, you know, I don't know if we've ever gotten to that particular level, but if you take a look at the four quarters for our TS Asia business. What we've asked them to do, the last prior couple of years, we had worked hard on getting the footprint built out and doing some geographic expansion. The last year, very similar to what we saw in EM Americas, actually, we're okay with a slower growth rate, but let's work on now the profitability and returns. And it was great to see TS Asia deliver, again, four consecutive quarters, year-on-year op margin expansion. We like the trajectory we see there.

If you'll remember back to the way we try to manage the portfolio, anyone that we're working on getting to long-range targets, we generally expect, you know, a sequential set of year-on-year improvements on their march back towards those LRFTs. That's the agenda that we've asked the TS Asia team to march to, and that's what they're delivering at this point.

Phil Gallagher (President of Technology Solutions)

Rick, can I add to that?

Rick Hamada (CEO)

Yeah.

Phil Gallagher (President of Technology Solutions)

If you notice, in the last several years, we've really put the brakes on acquisitions in Asia Pac as well, as we wanted to really work on the foundation, where we've also, by the way, have undergone some SAP work, which has been very positive, enabling us to work on the foundation. So in Asia Pac, you can probably grow as fast as you want and not get the return. So we've tapped the brake on the pedal.

We've slowed the growth down intentionally to drive the drop-through, if you will, and to get the returns on the investments, which we're seeing. Just at a high level, if you know, break down for Asia, the two regions that are the strongest for us are ASEAN, okay, in general, performing well, anchored by Singapore. In Australia, we saw nice returns in Australia in the past quarter as well. Intentionally have slowed down China, and China slowed down as well, and the balance of the region was relatively minimal. But ASEAN and Australia, New Zealand are the two strengths we have there, and we're seeing good progress.

Louis Miscioscia (Managing Director)

Okay. Thank you.

Operator (participant)

Thank you. The next question comes from the line of Steve Fox with Cross Research. Please proceed.

Steven Fox (Managing Director)

Thanks. Good afternoon. Could we step back a little bit and just look at the business as a whole, Rick? I'm just curious, based on what you talked about for prospects, maybe going out for, into next year, seems like you're talking about maybe a low to mid-single digit type of end market that you're selling into. Can you talk about your ability to maybe grow faster than that type of market, where maybe you have bigger opportunities that we might notice? And then secondly, if that is the case, what is the possibility of you guys continuing to grow operating profits at a higher rate than sales and generating more cash flows in fiscal 2015 than 2014? Thanks a lot.

Rick Hamada (CEO)

Yeah. Hey, Steve. So, great question. You know, keep in mind, if we look at the fiscal years now, more recent fiscal years, for us, fiscal 2012 and 2013 were, roughly speaking, -4% organic growth. And now fiscal 2014, the fourth quarter results happened to be, I think, a strong finish to a year that had 8% reported and 5% organic. I don't know exactly how to tell you what the served market growth was overall, but I would say that five, I believe, is either keeping pace or maybe a little above what the overall served market numbers were for the year. And as you also know, looking at your spreadsheets, that was heavily concentrated in the growth with our components business overall.

So number one, a more balanced growth approach in getting our IT business back on track growth-wise, I think would help contribute to that. This new normal that we talk about right now with the mixed signals and one day a PMI in this region's up, and the next day, the PMI in this region is down, et cetera, we do believe that is the new normal. And if we stay in this more extended, you know, 2014 kind of period here, where it looks like, you know, low-to-mid, maybe single-digit growth, then working on our leverage to make sure that we're turning any top-line growth into faster bottom-line growth, that's exactly the, what you've seen, again, play out at EM Americas and TS Asia in this past year overall.

So fundamentally, starting with any growth is a great place to start. If we have more limited growth, we will continue to leverage the bottom line. And from a, from a components versus IT, Gerry talked about, you know, positive book-to-bill. I don't know how many quarters that's been, Gerry, but that's been quite an extended time, right? And on TS, we continue to highlight that the overall IT environment continues to be cautious and customers looking at incremental spending based on evaluating a lot of new technologies, a lot of new choices, a lot of new options.

And then don't forget, even in the Americas, in the March quarter of this last fiscal year, we had one of those late quarter disruptions, which, you know, it just, it gives a -- it continues to signal us to continue to be cautious about that overall IT spend environment. So if you look at the big picture, look at the last two or three fiscal years, boy, it feels good to be back on growth in 2014. And we, we think the, the outlook is, very similar as we head into 2015 from what we've seen this last year.

Steven Fox (Managing Director)

Great. And then just, just on cash flows, just to double-check that in terms of what kind of growth we could see out of cash flows. And then last thing, just to confirm, it seems like Asia components would increase as a percent of sales, again in 2015, and that's part of your thinking?

Rick Hamada (CEO)

Yeah. So Gerry, the mix issue?

Gerry Fay (President of Electronics Marketing)

Yes, yes. So, Asia will continue to grow as a part of our business, but if you really look out, as a total percentage of the business across the year, it's gonna be very stable compared to this year. So our mix over the next year will look very much like our mix did at the end of the year, this year.

Rick Hamada (CEO)

Right. We just have the, for the first half of the year, the strong-

Gerry Fay (President of Electronics Marketing)

We have the first half, where Asia is stronger, and then the back half, the West gets stronger. But if you compare the two years, growth by region and the percentage it is of our revenues will be about the same.

Rick Hamada (CEO)

Very stable. And, Kevin, you want to comment on cash flow?

Kevin Moriarty (CFO)

Yeah. Hi, it's Kevin. I would say, over time, you know, given that we expect to continue to generate greater profit, you know, as the company continues to grow, and we have the disciplined value-based management embedded in our culture-

I think we, we would expect to continue to be a strong cash flow operator generator, subject to the timing volatility based on the working capital requirements, depending on the growth environment, and the needs of the business. So as I, you know, look forward, I would feel comfortable in this $400 million range from cash flow from operations on an annual basis. But again, it all depends on the growth environment we're in and the working capital requirements of the business.

Steven Fox (Managing Director)

Thanks, guys.

Rick Hamada (CEO)

Thanks, Steve.

Operator (participant)

Thank you. And the next question comes from the line of Sean Harrison with Longbow Research. Please proceed.

Sean Harrison (Analyst)

Hi, everyone. I'm gonna beat TS EMEA to death. But I guess, as I think about the past 24+ months, it seems to have moved from, you know, dynamics in the West to, you know, Central Europe, with maybe not having the right product SKUs, to now, problems in the North or, you know, computer products maybe undergrowing the market. But as you get through this restructuring, you know, do you think you have the right product set in place, the right management team in place, what you need to succeed in the region so that, you know, six months from now or 12 months from now, we're not having a repeat of the same conversation?

Rick Hamada (CEO)

Sean, it's an absolutely fair set of questions, and my answer would be, we will look at all elements of the mix to make sure we've got a winning formula on it. You know, it's the inconsistency that we own up to. If you remember last quarter, we were very proud to report that TS EMEA was on its track with year-on-year op margin expansion. We felt that was a positive sign. We're looking forward to continuing that. We did not continue that into the fourth quarter, which causes us to once again go back to the drawing board on the overall adjustments. But I think it's still indicated in the subregional mix. There, it's not a uniform story. There are some pockets of success, there are some clear areas of work.

But as far as the key partners that we have, key go-to-market strategies overall, the partnership with the VARs and the integrators, the customer satisfaction ratings that we track ourselves, hold ourselves accountable to, et cetera. I mean, we look at the entire balanced scorecard, and we will address where it needs to be addressed, and then we will continue to report out and let you know where we stand on the results and the plans for the impacts that'll be associated with this, such as the cost reductions and the accelerated efficiency.

So we own up to it. We understand the issue and the point. We understand, by the way, the extended period of time that we've had this inconsistent set of results. Hopefully, based on some other demonstrated abilities and other elements of the portfolio, we have some credibility regarding our ability to get this on the right track.

Sean Harrison (Analyst)

I guess, to the cost reductions, are you putting those in place, assuming that the level of revenue run rate you have right now is sustainable, or are you putting more cost reductions in place just in case you get a, you know, a little bit of a incremental, you know, negative dynamic into the back half of the year?

Rick Hamada (CEO)

I will tell you that, we're building our models with very conservative growth assumptions for that region.

Sean Harrison (Analyst)

Okay. And then, I guess, hopefully, two very brief follow-ups. Just interest expense we should have for the back half of the year, or for the first part of the fiscal year. And then just seasonality has to have changed within EM, given the fulfillment business. Maybe you could just talk about, you know, what we should see fulfillment grow year-over-year, for, you know, the September quarter and into the December quarter.

Rick Hamada (CEO)

Yeah, Kevin, you want to start?

Kevin Moriarty (CFO)

I'll start with interest expense, Sean. It's assuming roughly around $24 million for the first two quarters of the fiscal year.

Sean Harrison (Analyst)

Thanks, Kevin.

Gerry Fay (President of Electronics Marketing)

From a seasonality perspective, I think our seasonality holds up even with our current mix at this point. I don't see much of a change in seasonality. The only outlier to that potentially is our high volume fulfillment business that we have in Asia, which is opportunistic and driven by that customer's demand. So that's the only outlier that potentially changes seasonality. But other than that, our seasonality model stays intact.

Sean Harrison (Analyst)

Maybe I just real quick to that, the opportunities within the fulfillment business, is it going to be greater this year, or you, you're just assuming, you know, what happened last year occurs again this year?

Gerry Fay (President of Electronics Marketing)

I would say at this point, it's gonna be fairly similar from a numbers and a growth profile perspective, but again, it's based on that customer's demand, so that could change.

Rick Hamada (CEO)

Yeah, Gerry and Sean, I just want to jump in and continue to reinforce, we are extremely selective about those engagements. You know, they meet, and in some cases, actually, enhance our return profile. We are not out soliciting and looking for these as part of our overall growth plans. They're presented to us as opportunistic, and we look to make sure it is meeting and exceeding our overall return goals, or we're not interested. So I want to just reemphasize, we're very selective about these engagements.

Sean Harrison (Analyst)

Very fair. Thanks, Rick.

Operator (participant)

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

David Ryzhik (Senior Associate of IT Hardware)

Hi, this is David Ryzhik, on for Ananda Baruah. Thanks for taking my question. What was the software services and storage growth in the quarter? And what percentage of total TS does that represent? And I had a follow-up.

Rick Hamada (CEO)

Yeah, Phil, go ahead.

Phil Gallagher (President of Technology Solutions)

Yeah, Dave, this is Phil. How you doing? We were in the software and services combined in the, let's call it the, you know, 15%-20% range, okay? And there's a mix now as a percentage of the total revenue, we're roughly in the 47%-48% for software and services.

David Ryzhik (Senior Associate of IT Hardware)

Great. And, could you, just drill down a little bit on, server and storage performance in the quarter, specifically with servers, if you can just give a little color on industry standard versus proprietary, and, with storage, traditional storage versus, emerging storage solutions? Thanks.

Phil Gallagher (President of Technology Solutions)

Sure. Let me—this is Phil again, Dave. Let me give you some high-level viewpoints on the servers. Servers overall for us, again, each region has a different level, but roughly, flattish. We saw proprietary servers down slightly, okay? Not too bad actually, this quarter. And industry standard servers were up modestly. So net-net, servers, you know, although becoming a lesser part of our total portfolio, okay, in about flattish. The thing I do want to note, though, is that where we are seeing a pickup in servers is in the higher value side of the equation in converged.

So as converged infrastructure continues to grow, you know, we're putting more and more servers that are embedded in that total converged solution, and that, I think, is starting to offset the traditional, if you will, industry standard for, you know, server fulfillment, you know, which is a much lower value prop. So the mix within the servers, okay, as converged continues to grow, is positive. When you look at the storage, if we look at the, what I'll call the focused storage players, overall, we actually saw, I'll call it the pure basket player with storage, roughly combined +5%-10% growth.

So although the growth is coming down a little bit from where it was a year or so ago, that's 'cause the denominator is getting a little bit higher, and storage has become a bigger part of our business, we're still very pleased with the growth in storage, and we'll continue to see that moving in the future. As far as some of the emerging players, we don't, you know, comment on any one brand or any supplier, but, suffice it to say, there's definitely some nice traction in some of the emerging storage suppliers, particularly when you get into the flash arena.

David Ryzhik (Senior Associate of IT Hardware)

Great. Thanks, guys.

Operator (participant)

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

Austine Bone (Equity Research Analyst of Semiconductors and IT Supply Chain)

Hi, this is Austin Bone filling in for Mark Delaney. Just real quick, if you could, provide us with how you're thinking about capital allocation into fiscal 2015, if you see any increases to buyback and/or dividend?

Rick Hamada (CEO)

Yeah, Austin, this is Rick. So, our priorities remain very consistent. Obviously, the dividend's on top of that stack at this particular point. We continue to want to deploy capital where we can for profitable growth, whether that be organic and M&A, and we continue to evaluate and have a standing authorization on our buyback, which we continue to implement in a disciplined fashion, where we evaluate our entry point based off always looking at our current financials, triangulating on an analysis of DCF. We look at forward PE, we take a look at proximity to book value. And based on all of that, there'll be a standing offer in place, so to speak, to take advantage of when we believe our equity is a compelling investment. So priorities are consistent.

Dividend's still top of the stack, growth next, opportunity to invest in our own equity. We think of it as an alternative form of M&A, think of it that way, and we'll keep our disciplined approach there, and we'll continue to update you quarter to quarter on what kind of usage that leads to.

Austine Bone (Equity Research Analyst of Semiconductors and IT Supply Chain)

Great. Thank you. And then, as a quick follow-up, how is the book-to-bill trended quarter to date, and how does that compare to normal seasonality?

Rick Hamada (CEO)

I would say that, as I explained earlier, book-to-bill is currently strong. It's, it's up over the June quarter at this point, but it's fairly normal to what we see from a seasonality perspective at this point.

Austine Bone (Equity Research Analyst of Semiconductors and IT Supply Chain)

All right. Thank you.

Operator (participant)

Thank you. The next question comes from the line of Jim Suva with Citigroup. Please proceed.

Jim Suva (Managing Director)

Thank you very much. And, realizing that, you know, how priority of your cash is for organic growth and then also, you know, dividends and buyback, can you kind of talk a little bit about the M&A opportunities that you see there? I mean, over the past, say, five years or so, your company has done a lot of strategic acquisitions, whether it be by geography or in Technology Solutions or your, you know, solutions group or software and services that you've done or the repair reverse logistics.

Can you help us understand better your M&A appetite going forward about is it geographic focused? Is it, you know, solutions or software focused? What are basically the areas in your portfolio you see that you may need to bulk up there? Because it just seems like you've done a lot of it, and maybe I'm missing some things, but it seems like you've got a really strong portfolio, currently. Thank you.

Rick Hamada (CEO)

Yeah, Jim, it's a good set of questions. You know, let me try to paint a picture, see if it answers your question for you. So historically, you take a look at the, you know, the tremendous amount of acquisitions that we've done over time, you know, in the not too distant past, some key drivers were consolidation, particularly in the Western and more mature markets, and building out our geographic footprint for both businesses. Started earlier in components, for sure, but we, we were on the same track for our computer business, through the mid-2000s, et cetera. So neither one of those plays, I would say, is 100% done, but, there's been a lot of consolidation, and we built out a very strong geographic footprint.

Looking ahead, what I would tell you is that we're looking for opportunities to expand our served market with logical adjacencies. And I think our most recent transaction for our components business in Europe, in MSC, is a good indicator of what we're looking for here, because not only was there an element, remember, about half that business was pure consolidation from a component distribution perspective. We expanded the served market with some higher-end, new high-end technical and engineering services for the embedded systems market. That creates new opportunity for us there and helps expand the served market overall. And ultimately, we'll be looking to see how we can scale that perhaps on a broader basis for EM even out of the European markets overall.

So think of what we're trying to do now is still look for opportunities for consolidation. We'll be selective about geo expansion, but a lot of the more strategic moves, particularly in services and software for TS and looking for expanded services, perhaps at EM, will have a bias for opportunities that help build some accretion to our growth profile or to our margin profile, fully understanding that valuations change with those dimensions as well. However, we'll still maintain our disciplined return on capital approach to any of those deployments of capital, as we do with any other deployments. So that does that paint a picture for you? It makes sense?

Jim Suva (Managing Director)

Yes. Great. Thank you very much.

Operator (participant)

Thank you. As a reminder for other participants who wish to ask a question, it's star one on your telephone keypad, and it may be necessary to pick up your handset before pressing the star keys.

Rick Hamada (CEO)

All right. No more questions. We'll move to closing comments.

Vincent Keenan (VP of Investor Relations)

Thank you for participating on our earnings call today. As we conclude, we will scroll through the non-GAAP to GAAP reconciliation of results presented during our presentation, along with a further description of certain charges that are excluded from our non-GAAP results. This entire slide presentation, including the GAAP financial reconciliation, 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 we thank you for your participation.