Aug 8, 2007
TRANSCRIPT SPONSOR
Executives
Vincent Keenan - VP and Director, IR Roy A. Vallee - Chairman and CEO Raymond Sadowski - Sr.
VP and CFO Harley Feldberg - Corporate VP and President, Electronics Marketing John E. Paget - Global President, Avnet Technology Solutions
Analysts
Matthew Sheerin - Thomas Weisel Partners Brian Alexander - Raymond James Bernie Mahon - Morgan Stanley Steven Fox - Merrill Lynch Jim Suva - Citigroup Thomas Dinges - JP Morgan Harry Blount - Lehman Brothers
Operator
Welcome ladies and gentlemen and please standby. Our presentation will now begin.
I would now like to turn the floor over to Vince Keenan, Avnet’s Vice President and Director of Investor Relations.
Vincent Keenan - Vice President and Director, Investor Relations
Good afternoon and welcome to Avnet’s Fourth quarter and Fiscal Year-End 2007 Corporate Update. If you are listening by telephone today and have not accessed the slides that accompany this presentation, please go to our website www.ir.avnet.com and click on the icon announcing today’s event.
In addition to disclosing financial results that are determined in accordance with generally accepted accounting principles or GAAP. The company also discloses its non-GAAP results of operation that excludes certain items.
Reconciliation of the company’s analysis and results to GAAP can be found on the form 8-K filed with the SEC today in several of the slides in this presentation, and on Avnet’s investor relations website at www.ir.avnet.com. As mentioned in the third quarter with the acquisition of Access Distribution and reflecting recent industry trends, the company is recording supplier service contracts on a net revenue basis rather than on a gross basis.
While the change reduced technology solutions sales and cost of sales in the second half of fiscal 2007, it will have no impact on operating income, net income, cash flow or the balance sheet, thereby positively impacting margins. As we have provided the highlights for our fourth quarter and fiscal 2007, please note that we have excluded certain items from the prior period in the accompanying slides in order to facilitate comparison with the current periods.
These items include restructuring, integration and other charges resulting primarily from the acquisitions of Memec and Access and the divestitures of some non-core business. Additionally, in the pro forma results prior periods are adjusted to include acquisitions and exclude divested businesses, as well as reflect the revenue change from gross to net for the sales of supplier service contracts.
Before we get started with the presentation from Avnet management, I would like to review Avnet’s Safe Harbor statement. This presentation contains certain forward-looking statements which are statements addressing future financial and operating results of Avnet.
Listed on this slide are several factors that could cause actual results to differ materially from those described in the forward-looking statements. More detailed information about these and other factors is set forth in Avnet’s filings with the Securities and Exchange Commission.
In just a few moments, Roy Vallee, Avnet’s Chairman and CEO will provide Avnet’s fourth quarter and fiscal year-end 2007 highlights. Following Roy, Ray Sadowski, Chief Financial Officer of Avnet will review the company’s financial performance during the quarter.
At the conclusion of Ray’s remarks, Roy will wrap up with additional comments and provide first quarter fiscal 2008 guidance after which a Q&A will follow. Also here today to take any questions you may have related to Avnet’s business operations is Rick Hamada, Avnet’s Chief Operating Officer, Harley Feldberg, President of Electronics Marketing and John Paget, President of Technology Solutions.
With that let me introduce Mr. Roy Vallee to discuss Avnet’s fourth quarter fiscal year-end 2007 business highlights.
Roy A. Vallee - Chairman and Chief Executive Officer
Thank you, Vince and hello everyone. Thank you all for taking the time to be with us and for your interest in Avnet.
We are discussing the highlights of fiscal 2007. I really have to start by taking you back to early 2001 when we embraced value based management or VBM.
Our driving value initiatives were focused on creating shareholder value by managing the financial performance of all Avnet’s business units to a return on capital employed of at least 12.5%. From this return metric, we developed appropriate business metrics across the enterprise that became the basis for our operational and compensation plans.
We have made steady progress towards our financial goals and the fourth quarter of fiscal 2007 represents a significant milestone, as it is the first quarter since our VBM journey began that we achieved gross yield of 12.5% for the enterprise. Equally significant is the fact that all of our key financial metrics including operating margin excluding certain charges, asset velocity and return on working capital were within our target ranges.
This balanced performance across both the income statement and the balance sheet is further evidence that our VBM approach is building a business model and culture that can continue to create shareholder value for years to come. We set sales records for the year and the fourth quarter, but another important highlight of fiscal 2007 was the operating leverage that we realized even though growth in some of our businesses slowed.
Our pro forma basis after adjusting for the change to net revenue for the sales of supplier service contract of TS and the impact of acquisitions and divestitures, revenue grew by 5.7% over fiscal 2006. Operating income dollars which were not impacted by the change to net revenue accounting grew more than 3 times faster than revenue, as increases in productivity allowed over 90% of our gross profit dollar growth to drop through to the operating income line.
This allowed us to also set operating income records for the year and quarter excluding certain items. Strong execution at both operating groups combined to drive Avnet’s operating margin up 84 basis points over fiscal 2006 to 4.4% with 10 basis points of the improvement resulting from the change related to the sales of supplier service contracts.
With return on capital consistently well above our cost of capital another benefit of our VBM initiative is the cash generation inherent to our new business model. For those of you who were at our analysts’ day last December, you may recall that I highlighted several structural changes that have reduced volatility in the electronic component markets.
Ray Sadowski also devoted part of his presentation to reviewing how our higher asset velocity combined with improving margins allows us to sell fund growth, resulting in better cash generation through the cycles. Fiscal 2007 was an exemplary birth point as higher profits and stronger working capital velocity combined to generate free cash flow of $746 million before cash used for acquisitions.
Prior to VBM we only generated that magnitude of cash during severe cyclical downturns when working capital was declining in absolute terms in concert with sales. For fiscal year 2007, over 80% of the cash flow from operations was generated by profits after adding back non-cash items with the remainder coming from working capital efficiencies.
Since the bubble, we have used much of our free cash flow to pay down debt and de-leverage our balance sheet. But now with our investment grade credit statistics achieved we are using this cash flow to invest in value creating M&A.
And that leads right into our next highlight, the continued execution of our acquisition strategy. In fiscal 2006, EM substantially enhanced its competitive position and financial performance with the acquisition and integration of Memec.
Over the past 12 months, Technology Solutions expanded its position as the global leader in providing enterprise computing solutions from the worlds leading enterprise IT manufacturers, by announcing a strategic acquisition in each region. While each of these acquisitions brings unique attributes including talented employees, complimentary customers and new suppliers, all of them support our rosy threshold of 12.5%.
With TS consistently exceeding our return hurdle rate, we have been focused on growing this business and thereby economic profits. Collectively the three acquisitions amount Access, Azure and Magirus will enhance our competitive position in all three regions and add approximately $2.6 billion to Technology Solutions top line while accelerating economic profit dollar growth.
With our strong balance sheet and consistent cash generation we will continue to pursue value creating acquisitions that will expand our geographic coverage, broaden our product portfolio and/or increase our scale and scope competitive advantages. The combination of applying VBM principles to managing our existing operations and a disciplined approach to M&A is allowing Avnet to create more shareholder value than ever before.
We are clearly in Avnet’s value creation era. In fiscal 2007, Electronics Marketing once again realized year-over-year improvement in key financial and productivity metrics with contributions coming from all three regions.
While growth slowed from the high single digits in fiscal 2006 to the mid single digits in fiscal 2007, EM's focus on profitable revenue, coupled with expense and working capital productivity resulted in significant progress toward our long-term financial goals. After adjusting for the divestiture of some non-core businesses in fiscal 2006, EM increased gross margin 53 basis points from the prior year and 33 basis points as reported with all three regions contributing to the improvement.
As a result of the continuing focus on expense efficiencies, 90% of the incremental gross profit dollars flowed to EM’s operating income line. Operating income margins at EM of 5.5% for the year was up 95 basis points over fiscal 2006 and at 5.8% for the last two quarters was within our target range for 5.7% to 6.2% for the entire second half of fiscal 2007.
On the balance sheet, EM’s working capital at the end of the year as a percent of sales dropped 185 basis points year-over-year to a record low 20.5% of sales. Finally, EM’s operating income per employee increased over 30% for the second straight year.
This performance demonstrates that our focus on profitable growth, operational excellence and people development is having a transformative impact on our financial performance. Looking at the quarter for EM, the highlights read like a continuation of the fiscal year with expense discipline and working capital efficiencies contributing to further expansion and operating income margin and returns.
At 5.8%, operating income margin was up 31 basis points over the year ago quarter. This is the seventh consecutive quarter that EM has increased operating income margin year-over-year.
Through on going process improvements and further collaboration with our trading partners, EM reduced inventory by $48 million sequentially while growing sales slightly which resulted in record working capital velocity and a reduction in its cash cycle by more than 5 days from the fourth quarter of fiscal 2006. This increase in profitability combined with record working capital velocity resulted in 258 basis points year-over-year improvement in return on working capital with all three regions making significant strides.
For fiscal 2005, just two years ago EM was less than a half way toward our goal of 30% return on working capital. And with this most recent performance they are now well within reach of that target.
In the June quarter, EM revenue reflected typical seasonal trends and was up 0.9% sequentially. Year-over-year revenue grew 0.8% and was up 1.3% after adjusting for divestures in the year ago quarter.
The Americas region grew 3.6% sequentially and was down 3.4% when compared with the fourth quarter of fiscal ‘06. Asia, which began to pick up momentum after the Chinese New Year was up 10.2% sequentially and 7.3% year-over-year.
In the EMEA region after several strong quarters of growth revenue was down 0.6% year-over-year on a reported basis and up 2.3% on a pro forma basis. Excluding the impact of foreign currency translation and divestures, the EMEA region declined 4.6% year-over-year.
We are encouraged by the activity and our large EMS customers where sales were up globally by over 3% sequentially. This appears to indicate that the excess inventory situation and our large EMS customers which significantly impacted the Americas region in fiscal ’07, maybe improving.
While EM’s book-to-bill ratio for the quarter finished just slightly below one-to-one. We are encouraged by the strong showing for the month of July where our book-to-bill ratio ended at the highest level in the past year.
Turning to Technology Solutions. The fiscal 2007 highlights start with the Access… excuse me start with the acquisition of Access Distribution.
By integrating the world’s largest value added distributor of Sun Microsystems products, TS enhanced its position as the global leader in providing Enterprise Computing Solutions while adding other important complimentary franchise. The combination with Access is proving… is providing tangible cross selling opportunities as TS now has an expanded network of value added retailers, supported by a very talented team of people with deep technical expertise and enhanced capabilities.
The integration was completed at the end of June, and we have realized annual synergy cost savings in excess of $15 million. On the financial front, Technology Solutions had another strong performance in fiscal 2007, with revenue growing over 20% to $6 billion.
Pro forma revenue growth of 5.5% was dampened primarily by soft micro processor sales. On the bottom line, operating income grew 40.1% to a record $232 million for the fiscal year.
Operating income margins for the year grew 55 basis points to 3.9% with roughly 40% of the improvement resulting from the change related to the sales of supplier service contracts. If you were to assume that fiscal 2000 sales… 2007 sales were on a gross basis for all four quarters consistent with our financial targets were developed, TS’s operating income margin would have been 3.64% which is near the high end of our projected range of 3.2% to 3.7%.
We have continued to expand our TS global footprint with the completion of the Azure acquisitions and the announcement of the Magirus acquisition. The Azure acquisition which closed in April 2007 expands our value added distribution of Enterprise Computer Solutions into Singapore, Malaysia and other Asian countries.
With an annualized revenue run rate of $90 million and a highly skilled team dedicated to delivering comprehensive IT solutions, Azure provides a platform for Avnet to expand in Southeast Asia. The Magirus acquisition which is expected to close in early October will enhance Technology Solutions competitive position in Europe and the Middle East, making Avnet the largest value added IT distributor in the region.
Magirus will significantly increase our presence in the two largest European markets Germany and the U.K., while expanding our existing operations in six additional countries. With approximately $500 million of additional annual revenue, TS will have unique scale and scope advantages that further enhance our value proposition to our trading partners.
TS delivered its 16th consecutive quarter of year-over-year expansion of operating income and operating income margin. As operating income grew 70.5% to a record $68.7 million and operating income margin increased 42 basis points to 3.9% or 4 basis points adjusted for the benefit of the change to net accounting for sales of service contracts.
In the fourth quarter of fiscal 2007, Technology Solution sales of $1.77 billion were up 51.2% as compared with the year ago quarter on a reported basis and up 8% on a pro forma basis. At a regional level, organic revenue growth was 115% and 20.9% in Asia and EMEA respectively while the Americas was down 0.9%.Sequentially Technology Solutions grew reported revenue by 21.3% and pro forma revenue by 20.6%.
This strong sequential growth was driven by the Sun Microsystems year-end as pro forma sales of enterprise computer products were up by 23.9% with all three regions delivering growth both sequentially and year-over-year. We continue to see strength in the SMB market with demand for storage products and industry standard servers driving the year-over-year growth.
Now I’d like to turn the commentary over to Ray Sadowski, Avnet’s Chief Financial Officer. Ray?
Raymond Sadowski - Senior Vice President and Chief Financial Officer
Thank you, Roy and hello everyone. Let’s begin with an overview of our operating results for the fourth quarter of fiscal 2007.
This slide shows a year-over-year comparison with a dollar and percent change in the highlighted columns in the right. Please note that we have included a reconciliation to GAAP net income, at bottom of the slide to account for the restructuring and other items for both periods presented.
As previously mentioned, beginning in the March quarter of fiscal 2007, our method of recording revenue related to the sales of supplier services contracts has been adjusted to record those contracts on a net basis rather than on a gross basis while prior quarters remain as reported. In the June quarter reported sales of $4.24 billion was 17.3% higher than a year ago quarter.
Organic revenue growth adjusted for the change of our method of accounting, and services revenues related to supplier contracts and the impact of acquisitions and dispositions was 4% over the year ago quarter. Gross profit of $551.6 million was up by $69.7 million as compared with the fourth quarter of fiscal 2006, while gross profit margin decreased 32 basis points year-over-year to 13% in the fourth quarter of fiscal 2007.
Year-over-year gross margin decline was primarily due to a change in business mix and technology solutions proved to be a larger percentage of consolidated revenues with the addition of access. Remember, technology solutions has a lower gross margin electronics marketing, although, it does have significantly higher asset velocity and returns on capital.
Including Access TS revenue grew to 42% of enterprise revenue for 32% of the total in the year ago quarter. For the fourth quarter EM's gross profit margin increased 38 basis points year-over-year, while at TS gross profit margins decreased 18 basis points on a year-over-year.
Operating expenses of $355.8 million grew up by $25.7 million or 7.8% year-over-year excluding restructuring and integration charges in both the current and prior year fourth quarters, primarily due to the addition of Access distribution at the beginning of the calendar year. As of the end of the fiscal year, the Access business has been fully integrated into the organization, again ahead of our expectations.
We continue to benefit from ongoing improvements in productivity at both operating groups as they reduced their operating expenses as a percentage of gross profits and thereby improve their operating income margins. The continued focus on operational excellence initiatives is having a positive impact on our customer service levels, employee engagement and our bottom-line.
Operating income of $195.8 million was up 29% as compared with the prior year quarter excluding certain items from both periods. Operating income margin improved 42 basis points year-over-year to 4.6% benefited by roughly 20 basis points for the change in the services revenue treatment.
Although, the operating income line year-over-year interest expense declined 29.4% due to lower debt and a lower effective interest rate as a result of our cash flow generation and refinancing activities. Taxes increased $15.2 million due primarily to the increase in pretax income.
The effective tax rate for the year came in at 33% resulting in a 31% effective tax rate for the fourth quarter of fiscal 2007 due to the true up impact which added roughly $0.02 per share to our quarterly earnings. We currently estimate that our effective tax rate will be between 31% and 34% for fiscal year 2008.
Net income excluding certain charges in both periods increased by $36.9 million or 42.4% to $123.9 million driving diluted earnings per share to $0.81 for the June quarter as compared with $0.59 per share in the year ago quarter. GAAP net income increased by $65.9 million to $124.7 million or $0.81 per diluted share as compared with net income of $58.8 million or $0.40 per diluted share in the prior year fourth quarter.
As I noted earlier earnings per share in the current quarter were positively impacted by approximately $0.02 per share due to the decrease in the effective tax rate. Earnings per share was also impacted by increase in diluted shares outstanding from $115 million in the March quarter to $153.1 million in the June quarter.
This next slide looks at our key productivity metric of expense dollars to gross profit dollars over the last four years. The bars represent the individual quarters while the trend line depicts the performance over a trailing 12 month period at the end of each quarter.
On a trailing 12 month basis, our ratio of expense to gross profit dollars excluding restructuring and other charges declined to 72.8% at the end of last year's June quarter to 66.5% in the current quarter. The 625 basis points improvements since last year is further proof of the operating leverage we have built into our business model at both operating groups.
On a year-over-year basis, electronics marketing improved its expense to gross profit ratio by a 111 basis points, while technology solutions improved it's ratio by 488 basis points. Profitable growth and operational excellence strategies are being executed well by the Avnet team, as clearly shown by achieving a long-term financial metrics that Roy mentioned earlier.
Similar to the last slide, we are providing both quarterly and a trailing 12 month trend line which portrays operating income margin over the last four years. The trailing 12 month operating income margin improved from 3.5% in the fourth quarter of fiscal 2006 to 4.4% in the current quarter, benefited by approximately 10 basis points due to the change in net revenue treatment on the sales and suppliers services contracts.
As you look at the June quarter on a standalone basis, operating income margin income of 4.6% improved 42 basis points year-over-year, benefited by roughly 20 basis points due to the change related to the sales and suppliers service contracts with both operating groups contributing to the improvement. At EM operating income margin of 5.8% improved 31 basis points and in TS operating income margin of 3.9% improved 42 basis points as compared with year ago quarter, with the majority of the improvement coming from the change in service revenue treatment roughly, 38 basis points.
On this graph, we have shown return on capital employed which is a key metric in our value based management philosophy that we introduced more than six years ago. As is evident on this slide, over the past few years, we have made steady progress to achieving our stated target of 12.5% to 13%.
As we end of the fiscal year with a long-term business model range well ahead of our projected timeframe. From 3.2% at the end of September 2003, our trailing 12 month return on capital employed has increased by more than three times to 11.3% in the June quarter.
This multi year trend is all about our focus on profitable growth, operational excellence and returns on capital throughout our business. On a year-over-year, basis the quarterly return on capital employed increased 191 basis points for just over 12.5%.
As depicted on this next slide, pro forma cash flow that is cash flow generation before taking into account cash use acquisitions was $297 million for the quarter and $746 million for the trailing 12 months. In conjunction with the last components down cycle, which began in the second half of calendar 2004, we generated over $700 million of pro forma free cash flow on a trailing 12 month basis.
However, the combination of higher margins and faster asset velocity have improved the cash generation characteristics of our business model. With a significant cash flow generation, we have been able to fund several key acquisitions during the year and anticipate funding additional acquisitions with cash.
Based upon current interest rates and anticipated cash flow, we expect interest expense be roughly between $70 million and $80 million for the upcoming fiscal year. With our recent acquisitions and refinancing of our long-term debt completed during the year, we have continued our trend of maintaining what we believe to be investment grade credit statistics.
On a trailing 12 month basis, at the end of the June quarter, debt to EBITDA was at 1.6 and EBITDA coverage was at 9.9 times. Over the course of the fiscal year 2007, we have strengthened our balance sheet substantially providing us with a greater flexibility to fund growth and accelerate the creation of shareholder value.
Now, let me turn it back over to Roy, who will provide our outlook and guidance for the September quarter. Roy?
Roy A. Vallee - Chairman and Chief Executive Officer
Thank you, Ray. Looking forward to our next fiscal year let me provide some commentary on our guidance for the September 2007 quarter and for the entire year.
For Avnet's first quarter in fiscal 2008, management expects sales at EM to be in the range of $2.4 billion to $2.5 billion and anticipates sales for TS to be between $1.6 billion and $1.7 billion. Therefore Avnet's consolidated sales are forecast to be between $4 billion and $4.2 billion for the first quarter fiscal 2008.
As a result, management expects first quarter fiscal 2008 earnings to be in the range of $0.65 to $0.69 per share, up 18% to 25% as compared with last years first quarter. In addition full year fiscal 2008 earnings per share are currently expected to grow approximately 15% to 20% as compared with 276 in fiscal 2007, excluding certain items and the impact of acquisitions not yet completed.
Sequentially, non-GAAP earnings per share is being impacted by normal seasonality as well as by some additional items. Remember, historical normal seasonality includes sequential weakness at our higher margin EM Western regions and strength in our lower margin EM Asia business.
In addition, the following items are impacting our sequential guidance. One, earnings per share in the fourth quarter of 2007 was positively impacted by the year-end effective tax true up of approximately $0.02.
Number two, greater than expected profitability at EM EMEA including higher year-end supplier bonuses. Number three, historical seasonality being amplified by the impact of the acquisition of Access, which had a particularly strong June quarter coinciding with its largest supplier's fiscal year-end, resulting in a negative impact to our sequential result by approximately $0.02 to $0.03.
And four, stock based compensation expense to $0.04 in the first quarter versus approximately $0.02 in the fourth quarter. With that let’s open up the lines for Q&A.
Operator. Question and Answer
Operator
Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session.
[Operator Instructions]. Our first question comes from Matt Sheerin with Thomas Weisel Partners.
Please proceed with your question.
Matthew Sheerin - Thomas Weisel Partners
Yes. Thanks.
Good afternoon everyone.
Roy A. Vallee - Chairman and Chief Executive Officer
Hi Matt.
Matthew Sheerin - Thomas Weisel Partners
Question really just regarding Europe. It looks like it was down around 8.5% sequentially in your electronics marketing.
It looked like a little bit more than you were expecting and we were expecting. Could you tell us what is happening in Europe and what trends do you see going into the summer?
Roy A. Vallee - Chairman and Chief Executive Officer
Sure, Matt. I think I will flip that to Harley and let him take the first shot.
Harley Feldberg - Corporate Vice President and President, Electronics Marketing
Yes. Hi, Matt.
Yes, I think it was a little bit, little bit deeper than we had expected. But it doesn’t cause us any concern actually.
We see the business continuing at a very healthy rate up to and including the summer months.
Roy A. Vallee - Chairman and Chief Executive Officer
So Matt just slightly more than we would have expected but corresponding weakness in bookings but it does not appear to be impacting the summer and we are looking for normal seasonality on that region this summer.
Matthew Sheerin - Thomas Weisel Partners
Okay. And well you mentioned the book-to-bill was pretty high at the end of July.
Could you tell us at least approximately what it was and by region? Was it across the board or was it just by in Asia or U.S.?
Harley Feldberg - Corporate Vice President and President of Electronics Marketing
Well. Clearly the bulk of the strength, Matt, is coming from Asia.
And by the way if you look at cycles, really since the beginning of this decade Asia has been the leader of the cycles whether they be up or down. And we have seen continuing strength in Asia since the Chinese New Year.
So the largest positive book-to-bill is clearly in Asia. However, all three regions are positive book-to-bill.
Matthew Sheerin - Thomas Weisel Partners
Okay. Great, and then my last question for now is your guidance for FY ’08, the EPS guidance, what revenue growth assumptions do you have there?
And should we expect gross margin on a year-over-year basis to be down because you are going to have some more acquisitions on the computing side and then also as the EMS business comes back that should work against your gross margins right because that’s a lower gross margin business?
Roy A. Vallee - Chairman and Chief Executive Officer
So, yes. The growth expectation we have in the guidance that we gave is in the mid teens.
Now bear in mind that we owned Access for one half of fiscal year ’07. So, if you look at it more from a pro forma or organic growth rate, it’s in the high single-digits which we believe to be slightly faster than the overall market that we served.
We do expect revenue coming from these large EMS customers to continue to expand during the fiscal year ’08 period and that should have a negative impact on our gross margin, but should not have a negative impact on our operating margin. And as far as the TS EM mix map what’s based in is the mix as we know it today.
We have not factored anything for our acquisitions which have not yet been completed and that would include the Magirus transaction.
Matthew Sheerin - Thomas Weisel Partners
Got it. Okay.
Thanks a lot.
Raymond Sadowski - Senior Vice President and Chief Financial Officer
All right. If I could add to Matt’s question on the EMS.
Please also keep in mind that segment for us makes up about 10% of our total components revenue.
Matthew Sheerin - Thomas Weisel Partners
Okay. Thanks.
Roy A. Vallee - Chairman and Chief Executive Officer
You got it.
Operator
Thank you. Our next question comes from Brian Alexander with Raymond James.
Brian Alexander - Raymond James
Thanks. Roy just to pick-up on that last question when you referred to the organic or the pro forma growth that you are embedding in your guidance for FY ’08, you said if you back out the Access acquisition you are looking for high single digit growth.
Were you referring to the EPS growth or the top line growth?
Roy A. Vallee - Chairman and Chief Executive Officer
That’s the top line growth Brian, and the EPS growth we don’t try to differentiate between organic and inorganic because by the time it gets to EPS all the interest expense is in. If any equity was used it’s in the dilution of share count and we think EPS growth is EPS growth.
Brian Alexander - Raymond James
Okay. Now, I just wanted to clarify that the expectation was for high single digit organic top line growth.
Roy A. Vallee - Chairman and Chief Executive Officer
That’s correct and as we stated, we are looking at mid teens to 20% EPS growth year-on-year. And again, excluding transactions which have not yet been completed.
Brian Alexander - Raymond James
Right, I think when you originally gave the accretion for McGearis that was about $0.08 but that was for the calendar ’08 year. So, for the fiscal year it’s probably something around $0.05 or $0.06.
Is that what you are embedding in that guidance as well?
Roy A. Vallee - Chairman and Chief Executive Officer
Yes, I think that’s fair.
John Paget - Global President
Not in our guidance.
Roy A. Vallee - Chairman and Chief Executive Officer
Sorry, I think it’s fair to assume something like $0.06 for McGearis because although, we won't… frankly there are not a lot of synergies in McGearis because this is a carve out and we are buying predominantly only the assets that we want to retain. But in addition to that, just as a matter of coincidence, the transaction is scheduled to close just prior to the fiscal year end of Hewlett Packard and IBM, the two suppliers.
So, we are going to have a good revenue quarter in the first quarter of ownership and then by the second half, we should be well down our path towards integration. And then, just final comment that is not in the EPS guidance, that is incremental to the guidance that we have given.
Brian Alexander - Raymond James
Right. And then on the just on the expenses you did another great job this quarter controlling expenses.
And if you drill down on profitability by segment it looks like the corporate expenses were down about $5 million sequentially despite revenue being up. Can you just walk us through any actions you might have taken during the quarter to reduce overhead and is this the right baseline to be modeling going forward?
Raymond Sadowski - Senior Vice President and Chief Financial Officer
I think… hi Brian, its Ray. There is a number of actions that we are taking throughout the business from an expansion perspective that primarily related to the integration of Access.
So, if you look at just the corporate expenses and you exclude any restructuring items, I think on a go forward basis you will see corporate expenses move up a little bit, primarily because of the stock based compensation. We do book all of our stock based compensation on corporate and so with another year of stock compensation expense coming on… keep in mind that stock compensation expense covers most of the year.
And since the new accounting rules have come into play, we are adding new programs but no old programs are falling off because our programs typically below a four year average period of time. So, that’s causing an increase overall.
Brian Alexander - Raymond James
And then just finally on the improved book to build that you saw in July. Can you just talk about generally changes in end market you have seen within the components business?
I know telecom’s been a drag for you as well as the overall industry for the last few quarters. Is that something that you saw picked up in the month of July?
And can you just comment on industrial and some of the other end markets? Thanks.
Harley Feldberg - Corporate Vice President and President, Electronics Marketing
Sure, hi Brian, this is Harley. Overall, as we said previously it was to global EMS guidance.
Typically there is a pretty strong overlay with that customer base with our communications business. So, we did see a moderate increase, as Roy suggested earlier in that segment and that’s helping.
And that continues into the summer. So, our booking activity there is encouraging.
In Asia, we are seeing a very strong growth and it’s widespread across multiple industries there most of which can one way or another tie back to digital consumer.
Brian Alexander - Raymond James
Thank you very much.
Roy A. Vallee - Chairman and Chief Executive Officer
You are welcome.
Operator
Thank you. Our next question comes from Bernie Mahon with Morgan Stanley.
Bernie Mahon - Morgan Stanley
Hey good afternoon.
Roy A. Vallee - Chairman and Chief Executive Officer
Hey Bernie.
Bernie Mahon - Morgan Stanley
A question for you on… its kind of a two part question. So, over the last say three quarter, you have done a really good job in generating cash from operations.
I guess first, what would your expectations be there say from fiscal ’08. And then along the same lines, how much cash do you think you need on your balance sheet to kind of run the business?
And then with this excess cash you have, it sounds like you are going to be looking to make further acquisitions. And can you just talk about, geographically where you see the opportunities for acquisitions like are there a number of attractive acquisitions that you can make right now and also what segment I guess you will make them in?
Roy A. Vallee - Chairman and Chief Executive Officer
Okay. So, the cash flow in fiscal ’07 was pretty dramatic.
As we talked earlier, it was the kind of numbers we haven’t seen send some major downturn in revenue. I think if you normalize and look at our internal business plans we would expect the annualized cash flow to fall out in the $300 million to $400 million range and just keep in mind that any given quarter could be very volatile, because based on the size of our working capital, the change of one day could make $150 million of difference.
So, quarterly, I think it will be volatile, but on an annualized basis, we should be in the $300 million to $400 million range. As far as how much cash we need to operate the business, as you know, our balance sheet is counter cyclical.
So, we tend to not need to keep a lot of cash. However, managing all of that working capital all over the world requires a reasonable amount of float.
And when you add it all up, we think on average, it’s a $200 million to $250 million float that we need to keep in our accounts. Anything over that, you could I guess considered to be excess and then, off course, the question is, how are we going to put that to work?
As we stated our primary goal here is to invest it in value creating M&A. And it turns out that our pipeline for M&A is reasonable strong or fairly active depending on how you want to call it.
And Bernie, we have opportunities in all three regions and in both operating groups. And so, while we've got some priorities around M&A that provide us with growth as well as with cost synergies, we have a variety of sizes, geographical locations, and operating groups in our M&A pipeline.
Bernie Mahon - Morgan Stanley
Okay. So, it wouldn't be surprising at all to see over the next year say a handful of acquisitions, I mean that's not really out of the question.
Given, say 3% global GDP or 4% global GDP number.
Roy A. Vallee - Chairman and Chief Executive Officer
Yes. It’s hard to forecast M&A, because here you don’t know until it’s over.
Quite honestly, we have a very disciplined approach. We've got our three magic words of culture, strategy, and economics that must pass muster before we will complete any deal.
So, it’s really hard to forecast the number. But if your question is, would we be surprised a year from now if the number were a handful?
I think my answer would be, no. No surprise there.
Bernie Mahon - Morgan Stanley
Okay. Thanks a lot.
Roy A. Vallee - Chairman and Chief Executive Officer
You're welcome.
Operator
Thank you. Our next question comes from Steven Fox with Merrill Lynch.
Steven Fox - Merrill Lynch
Hi, good afternoon.
Roy A. Vallee - Chairman and Chief Executive Officer
Hi, Steve.
Steven Fox - Merrill Lynch
Two questions. First of all, on the Access acquisition, since you just went through the seasonally strongest period with it.
Can you talk about any other surprises positive or negative that cropped up? And Roy, I know it’s not a cost play that you did with this one, but is there any more costs that could come out in '08?
And then secondly, Ray, on the SG&A expense line, where do you think the SG&A can go as a ratio to gross profits in '08?
Roy A. Vallee - Chairman and Chief Executive Officer
Okay. I will let Ray think about that while we talk about the Access deal.
Steve, in terms of surprises, look there is degrees of surprise. I would tell you that revenues in the June quarter were maybe a little bit less than we had hoped for.
But on the other hand, profitability was a little bit better than we had hoped for. And so, all in all, we are very, very pleased with what we have seen so far in our second quarter of ownership.
So, now we will have a pre-significant sequential decline, but then Sun will also experience a reasonably strong December quarter and that will be part of our GFs sequential gain in the second quarter as we come out of the summer. I would say from a synergy point of view, Steve as you said, it wasn't really a synergy driven field per se.
We did remove… or we said we remove about 20% of the Access SG&A and still maintain the Sun business unit as a standalone business unit similar to IBM and HP. And so, we exceeded that by a few million dollars.
It’s still… it small though in the big scheme of things. If it’s $1 million dollars a quarter, it’s not a big event in Avnet's P&L.
And as far as any synergies going forward, I think that there, of course, there will be ongoing productivity and efficiency gains and further integrations with our business. But on a relative basis, I think they will be hard to identify in the Avnet P&L.
So, Ray, you're ready?
Raymond Sadowski - Senior Vice President and Chief Financial Officer
Sure. Hi, Steve.
Well, from an expense and GP perspective, if you look back over the last couple of years, as you probably know we went in '05 to almost 78% in '06 down to 73%, and the year just ended down to 66.5% expense in GP dollars. As we look forward to '08, we are right now estimating roughly 200 basis point improvement, which will get us down to about 64.6%, again, wouldn't factor any acquisitions or anything like that.
But that's roughly the magnitude that we looking at, again, as another Memec transaction came along or something like that certainly could change it. But based upon what we can see right now, we are looking for about a 200 basis point improvement over the entire year.
Roy A. Vallee - Chairman and Chief Executive Officer
And Steve just a reminder on that, remember what we said in the past businesses within our portfolio, who are achieving return on capital in excess of our hurdle rate. We will typically allow them to budget one half of their gross profit dollar growth for additional SG&A fuel if you will, and the other half goes to operating income.
So, as you model that you can see that this expense to GP ratio should continue to decline on a year-over-year basis with a theoretical goal out there at some point in the future of 50% expense to GP.
Steven Fox - Merrill Lynch
Great. Thank you very much.
Roy A. Vallee - Chairman and Chief Executive Officer
You are welcome.
Operator
Thank you. Our next question comes from Jim Suva with Citigroup.
Jim Suva - Citigroup
Hi. Thank you very much and congratulations.
Can you talk a little bit about… recently the credit markets and interest rates have been very volatile, can you talk about your appetite for acquisitions? Would you primarily use the cash on your balance sheet in cash flow, or would you be looking at potentially leveraging up the Company some more?
Roy A. Vallee - Chairman and Chief Executive Officer
So, maybe I should go first, Ray, what do you think?
Raymond Sadowski - Senior Vice President and Chief Financial Officer
You do.
Roy A. Vallee - Chairman and Chief Executive Officer
Okay. So, Jim, the primary economic metric that we use to gauge acquisitions is return on total capital.
And if you are a purist regarding that, you don’t really have a lot of concern about whether it’s equity capital or debt capital. The issue is that we drive the right return on capital, then the acquisitions will ultimately create shareholder value and that will ultimately flow-through to EPS.
So, that's my theoretical whiteboard answer. As a practical matter, based on our existing cash on hand and our projected cash flow, we would expect to fund the bulk if not all of our M&A activity through cash and the exception would be if we found a particularly large transaction in which case we would probably end up using some equity to preserve our credit statistics.
Raymond Sadowski - Senior Vice President and Chief Financial Officer
And to keep in mind, we do have… from a cash perspective, short-term of credit line, we have roughly $1 billion available. And so, dealing with what's going on in the credit markets today, we still have plenty of access to whatever cash we need to close a transaction.
And as Roy just said we are not really looking to use any equity to do a transaction. So, if we need to wait for the markets to stabilize in order to go into the marketplace and add some more permanent leverage.
We certainly can do that because our short-term facilities are pretty significant.
Roy A. Vallee - Chairman and Chief Executive Officer
And Jim, we tent to maintain at least $0.5 billion and typically more like $1 billion of liquidity at all times for that purpose.
Jim Suva - Citigroup
And then as a quick follow-up, your outlook for as it compares to Europe and the seasonal softness that we experienced now. As you sit there in your chair and you already know into August, does Europe look better than normal?
Does it look normal, worse than normal? How should we kind of gauge Europe right now demand?
Roy A. Vallee - Chairman and Chief Executive Officer
Well, I think in our…first of all, I would say five weeks into a thirteen week period. And Jim, we say this every quarter.
I report in our last month is. But when you talk about summer in Europe, the importance of September just can't be overstated.
So, it is a heavily back-end loaded quarter in Europe this quarter. All that said, I would tell you that… I think our computer business is very much inline with our expectations, and our components business… coming off the June quarter, we might be a little ahead of our expectations for the summer quarter.
Jim Suva - Citigroup
Great. Thank you and congratulations.
Roy A. Vallee - Chairman and Chief Executive Officer
Thanks again.
Raymond Sadowski - Senior Vice President and Chief Financial Officer
Thank you.
Operator
Thank you. Our next question comes from Thomas Dinges with JP Morgan.
Thomas Dinges - JP Morgan
Hi, good morning guys. A quick one for Ray, just a follow-up on the cash flow items.
Three out of the last four years, it looks like you usually consume just a little bit of cash in September, because you probably got tax payments and some bonus payments and so forth. Any reason to think that's going to be different this year?
Raymond Sadowski - Senior Vice President and Chief Financial Officer
I don’t think dramatically different. I am not sure we will actually consume cash, but it will certainly not be the robust cash quarter that the other quarters have been.
Thomas Dinges - JP Morgan
Okay. And then one for you, Roy, one of the things that has come up part on the acquisition funding is obviously the credit markets are a little tough for some of the non-strategic buyers like yourself in certain instances now.
Has that done anything on the acquisition front in terms of when you go head-to-head with any of those guys or perhaps it's maybe a little bit easier for you to get something done because you have got available dry powder right now? And then I have a last quick follow-on.
Roy A. Vallee - Chairman and Chief Executive Officer
Yes. Tom, so it is revenge of the strategic buyers right now.
So, we are back. I will tell you that in most of our deals, because of the nature and the size maybe all of the characteristics, we haven't seen a lot of private equity competition.
Typically when we do, it's just on the larger transactions, but interestingly is not. The observation I have is that once we engage and we go to work on a transaction, our hit rate is very high.
And so… and our projections on our M&A pipeline are such that we maybe in fact seeing less competition than in the last year or so.
Thomas Dinges - JP Morgan
Okay. And then one quick one on the TS business.
Obviously between yourselves and your largest competitors and you guys have consolidated many of the largest companies that are out there, especially when you include the Magirus transaction that's left to consolidate. But you have seen some of the broad line distributors at least sign up some franchise agreements.
And the view there is generally being they kind of go after new VARs and so forth. But what's kind of the view from the VAR community with some of the new entrance that you have out there in that business, because it's a close loop system.
I am just kind of curious to get your view what the VARs are thinking and kind of how the competitive… all the dynamic could change possibly in over the next two or three years in that market?
Roy A. Vallee - Chairman and Chief Executive Officer
Well, I have… my opinions about that but we have John and Rick sitting in the room who know what's going on. So, why don't we ask them to talk?
John, do you want to comment?
John E. Paget - Global President, Avnet Technology Solutions
Yes, sure. We continue to add product sets and suppliers and specific technology situations like voice-over-IP and we recently added VMware and the virtualization consolidation business.
So, we continue to push from a technology standpoint in growing those adjacent markets to the markets that we have, certainly utilizing the primary vendors that we have from an overall server software standpoint. So, I see us being in very good position to compete across all of the technology verticals that are going on in the marketplace where the growth segments are today.
Roy A. Vallee - Chairman and Chief Executive Officer
Rick, do you want to add anything?
Raymond Sadowski - Senior Vice President and Chief Financial Officer
No. I would just say anecdotally from the VARs, both us and our big competitor you mentioned have built a different kind of relationship way beyond just typical time and place utility or extension of credit line.
They expect value added distribution to really be a part of their developing their growth strategies. We don't grow, if they don't grow.
They understand that link. And the expectation of the service level, the involvement in the business et cetera is just something that the more volume oriented IT players have a hard time trying to invest in based on their models.
Thomas Dinges - JP Morgan
Okay. Thank you.
Roy A. Vallee - Chairman and Chief Executive Officer
Tom, this is Roy. I will make one last comment.
I think it's a very good question. The last comment I will make is bear in mind that the two A’s have been growing their business in the open sourced product area such as industry standard servers.
In addition to that, you have got companies like ScanSource and Wescon who have been operating in a specialist model, but in an open sourced environment. And I think if you look at the future for value add distribution, it's a lot more about focus a limited number of suppliers focused on a relatively limited number of customers and the kind of value as Rick was trying to describe, the kind of relationship that we build with that set of trading partners compared the role that are broad liner plays given hundreds of vendors and tens of thousands of customers.
So, we are feeling… as you see for 16 quarters in a row, we are not just surviving, we are expanding our Technology Solutions operating margin. And we feel comfortable that we have plenty of growth and plenty of value left to add.
Raymond Sadowski - Senior Vice President and Chief Financial Officer
And by the way Roy, just a final point. Europe has always been open source.
But Magirus was able to thrive and build quite a business there and we will be adding that. So, the closed source model mentality is really a North America phenomenon.
Thomas Dinges - JP Morgan
Okay. Thank you.
Roy A. Vallee - Chairman and Chief Executive Officer
You are welcome.
Operator
Thank you. Our next question comes from Harry Blount with Lehman Brothers.
Harry Blount - Lehman Brothers
Thank you, guys. A couple of questions.
First on the electronics side of the equation, have you guys seen lead time start to extend in any particular component segments that represents a little bit of a shift in direction.
Roy A. Vallee - Chairman and Chief Executive Officer
Hi, Harry. I would say that as a macro answer, the answer would be, no.
There is typically an expansion that will occur this time of year… each year as it relates to a build up to the holiday season. We are seeing some tightness and in some sporadic areas, but it can almost always be tied to a ramp up in Asia and we don’t see anything significantly different than what we have experienced over the last couple of quarters
Harry Blount - Lehman Brothers
Okay. And then on the Technology Solution side, probably for John.
We have seen some fairly mixed results out of the storage vendors over the last few quarters. The server side seems to be generally okay.
Software seems to be holding up generally okay. Any comments on just, in general, how you guys performed in that segment of the market your outlook there?
John E. Paget - Global President, Avnet Technology Solutions
Harry, our storage business continues to grow pretty significantly quarter-per-quarter, year-over-year as we are bringing that new technology to the marketplace and open storage. So, yes, we are seeing some of the vendors perhaps not performed up to expectations.
Our business continues to grow at or well above the expectations that we have.
Harry Blount - Lehman Brothers
Okay. And then lastly on the cash flow side equation, just wanted to come back to that question from earlier.
I guess I just doing some rough math on the cash flow based on your net income guidelines and taking some kind of expectations around D&A and CapEx and working capital. I guess I was coming up with a normalized cash flow number that might have been a little bit higher than the $300 million to $400 million that you guys were thinking about.
So, is there a back steps in the working capital side equation that you are expecting, or some other slide backwards?
Roy A. Vallee - Chairman and Chief Executive Officer
Harry, did you build an additional working capital for the additional revenue?
Harry Blount - Lehman Brothers
I did build some in Roy, but that I … probably take it offline I guess. But I did build some of that in, but I guess I didn’t build quite that magnitude in.
Roy A. Vallee - Chairman and Chief Executive Officer
I think the numbers should tie up if you look at income, growth offset that by working capital per sale, safe use of current level. Assume we are reasonably close to being efficient, and then a little factor for add backs for D&A minus some new CapEx, you should get pretty close.
Harry Blount - Lehman Brothers
Got it.
Roy A. Vallee - Chairman and Chief Executive Officer
We can circle back and go through it a little later.
Harry Blount - Lehman Brothers
All right. Very good.
Thank you very much.
Roy A. Vallee - Chairman and Chief Executive Officer
You are welcome.
Operator
Thank you. [Operator Instructions].
Gentlemen, there are no further questions at this time.
Vincent Keenan - Vice President and Director, Investor Relations
Okay, as we conclude today's quarterly Analyst Call, we will now scroll through the slide mentioned at the beginning of our webcast that contains the non-GAAP to GAAP reconciliation of results presented during our presentation along with the further description of certain charges that are excluded from our non-GAAP results. This entire slide presentation including the GAAP financial reconciliations can be accessed in downloadable PDF format at our website.
We would like to thank you for your participation in our quarterly update today. If you have any questions or feedback regarding the material presented, please contact the Avnet Investor Relations department by phone or email.
Thank you.
Roy A. Vallee - Chairman and Chief Executive Officer
Thanks everybody.
Operator
Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time.
Thank you for your participation.