安富利 (AVT) 2002 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen. And welcome to Avnet's fourth quarter and fiscal year 2002 corporate update. My name is John Hobitz, and I'm vice-president, director of relations for Avnet. Our presentation format as a bit different this quarter so I would like to take a moment to outline some of the features that are available to you today during the presentation.

If you're 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. For all our parents participants the slides will move automatically as we advance through the presentation. We have also included several additional features which can all be found on the left side of your screen. We're happy to accept questions via e-mail and have provided quick access through a link on your screen situated to the left of the slides. We will receive your e-mails during the presentation and answer as many of them as time allows during our Q&A sessions. Also at the end of our presentation a survey will appear automatically on your computer screen. For each completed survey, Avnet will donate $1 to the New York firefighters 9-11 disaster relief fund. If you'd like to provide your contact information as directed in question 10 of the survey, we will also be happy to provide you with a summary of the survey results.

Now before we move on to the formal introductions, I'd like to review Avnet's Safe Harbor Statement. This presentation contains certain forward-looking statements within the meaning of section 27 A of the securities act of 1933 and section 21 E of the securities exchange act of 1934. These statements are based on management's current expectations and are subject to uncertainty and changes in factual circumstances. The forward-looking statements include statements addressing future financial and operating results of Avnet; actual results may vary materially from the expectations contained in the forward-looking establishments. The following actors, among other others, could cause actual results to differ materially from those in the forward-looking statements: changes in business conditions and economy in general, changes in market demand and pricing pressures, allocations of products by suppliers, failure to obtain and retain expected synergies from newly acquired businesses, and other competitive and regulatory factors affecting the business of Avnet generally. More detailed information about these and other factors is set forth in Avnet's filings with the Securities and Exchange Commission, including the annual report on Form 10-K for fiscal 2001 and the most recent quarterly report on form 10-Q. Avnet is under no obligation to and expressly disclaims any obligation to update or alter any forward-looking statements whether as a result of new information, future events or otherwise.

To begin, Ray Sadowski, our Chief Financial Officer, will provide a brief overview of Avnet's financial results. Roy Vallee, Chairman and CEO of Avnet, will then make several comments regarding the financial and operating performance of the company during the quarter, as well as comment on broader issues related to of a Avnet and the industry. At the conclusion of Roy's remarks we will move on to our question and a session. Also with us today and available to take any questions that you may have related to our business operations are our three operating group presidents: Andy Bryant, president of electronics marketing; Rick Clamada, president of computer marketing; and Ed Cammins, president of applied computing.

With that, let's move to Ray for a financial overview.

Thanks, John and good afternoon, everyone. I would first like to provide a broad overview for of our operating results for the quarter. For analysis purposes, we have segmented out all special charges in order to provide a clear comparison the operating results between the third and fourth quarters of fiscal year 2002. For those with viewing access to our slides, special charges have been broken out in column two. And amount to $79.6 million pretax, as noted in our press release, $21.6 million charged to cost of sales, and $58 million charged to operating expense. For the comparison excluding special charges, I will be referring to columns three, four and five of the chart you are currently viewing.

Avnet's fourth quarter fiscal 2002 revenues were $2.14 billion with net income before special charges of $.7 million or one cent per share for fully diluted share. Quarter to quarter sequential revenue decreased by approximately $70 million, or 3%. The decrease in sales was due primarily to the significant decrease in microprocessors and disc drive sales in the applied computing group. These sales declines were more than offset -- were offset somewhat, excuse me, by slight revenue growth in our other businesses. As a result overall gross profit margins improved, due primarily higher level of more profitable business mix. Even with the higher gross profit margins, the drop in sales resulted in a decrease in gross profit dollars. However, this decline in gross profit dollars was more than offset by the decline this operating expenses, resulting in higher sequential operating profits of $3.2 million. Including the benefits of reduced interest expense, and higher other income, primarily interest income, pretax income increased by $4.7 million, and net income improved by $2 million sequentially.

Avnet recorded sales of $2.14 billion for fourth quarter of fiscal 2002, a 15.5% decrease as compared with the fourth quarter of fiscal 2001. Quarter to quarter revenue fluctuated ma relatively tight bands throughout the year. While the lack of growth was disappointing, it was reflective of the relative stability in the industry; and while things did not get better, they did not get significantly worse. While the revenue levels remained relatively flat throughout the year, even declining somewhat in the last two quarters, earnings per share have improved since the September quarter with Avnet returning to profitability before special charges within three quarters of the September 11th. This is reflective of the growing operating leverage present in the business model.

An important part of this leverage has come to the management of our gross profit margins, a key factor in returning to profitability on essentially flat revenues. Our gross-profit margin increased to 14.19% in the fourth quarter of fiscal '02 the second sequential improvement. As you'll see later in the presentation, the decrease in margins from the fourth quarter of fiscal '01 was due primarily in the shift in the mix of business. EM's percentage of Avnet's total sales has declined from 62% in the fourth quarter of fiscal '01 to 56% in the fourth quarter of fiscal '02. However, EM's percentage of Avnet's consolidated revenues has been steadily increasing over the last couple of quarters, resulting in a positive trend in consolidated gross profit margins.

Another important part of our operating leverage has come through expense controls. Over the past five quarters we have steadily reduced expenses. Beginning with the March quarter of 2001, total operating expenses were reduced from $353 million to $278 million as of the fourth quarter of fiscal 2002. We anticipate that approximately one-half of these expense reductions, which would derive from acquisitions synergy cost savings, are permanent. The net effect of our efforts to improve gross margins and reduce expenses has resulted in a 106 basis point improvement in operating profit since the September quarter's low. More important the sequential improvement in operating profit margin has achieved on slightly declining quarterly revenues from the September to June quarter.

Another important part of productivity gains in our business has been achieved through working capital reductions; working capital fell sequentially by over $160 million, or 7%, adjusted to exclude the foreign currency exchange fluctuations since the March 2002 quarter. This working capital decline was due primarily to a sequential reduction in inventories of over $136 million in constant dollars.

In line with other measures to build and maintain our balance sheet Avnet has focused heavily on reducing its total debt. Since the December quarter of fiscal 2001 we have reduced debt by approximately $1.5 billion; in the fourth quarter, using cash generated from working capital reductions, we reduced debt by an additional $150 million in delivered dollar. These efforts have reduced interest expense and further increased Avnet's operating leverage.

And now to further comment on Avnet's operating results and strategic initiatives going forward, I am pleased to turn the floor over to Roy Vallee, Avnet's chairman and CEO.

Thank you, Ray and good afternoon, everyone. I want to begin by saying that I'm very pleased with the efforts made by our team worldwide this quarter, and, of course, our return to profitability during the quarter. This is a great way to end fiscal 2002, and a firm footing to begin our fiscal 2003.

On a year-over-year basis we finished fiscal 2002 down 30%, or $4 billion from the prior year. And as Ray noted earlier down 3%, or $70 million over the prior third quarter. As I've noted before, this unprecedented market environment has been challenging. Even though we're not satisfied with our current level of performance, I am proud of our team's resilience and our efforts in weathering the storm. The sequential decline in revenue of 3% during the fourth quarter is clearly indicative of an industry that continues to bounce along the bottom of a broad technology industry economic trough.

Some positive signs emerged, however, during the quarter. Electronics marketing grew slightly for the second consecutive quarter, and computer marketing also grew revenues by 3 1/2% during the quarter. However, group revenues in applied computing fell significantly by over 20%. While applied computing did show growth in the sales of invented systems into the non-PC OEM solutions business, sales into the pc builders segment fell precipitously. As we noted in our press release, revenues for microprocessors and disc drives sold into the pc builder market declined sequentially by approximately $100 million, due primarily to substantial excess inventories in the white box manufacturing supply change chain. While Ed Cammins can talk more to this point in Q&A, if need be, it appears that excess inventories in the pc sector are stabilizing, and we expect to resume growth in the microprocessor and disc drive segments during the current September quarter.

One of the drivers behind the fourth quarter's improved performance at the enterprise level relates to the mix of business. We finished the fiscal year with essentially the same operating group revenue mix with which we began. The predominant revenue generating being our electronics marketing group with 56% of total enterprise revenues in the fourth quarter. EM yielded higher margins overall, and as enjoyed increasing gross profit margins for the past three consecutive quarters. Computer marketing increased its share of enterprise revenue by three percentage points year-over-year, and it improved gross margins for the second consecutive quarter. The combination of higher and more profitable mix has contributed to our improved sequential performance, despite margin pressure in applied computing in the microprocessor and disc drive businesses.

During the quarter, we continued to see growth in our Asia business. EM Asia revenues grew sequentially by over 16%, representing all of EM's growth, and on a fourth year to year comparison grew revenues by over 35%. Revenue by region had a meaningful change during the fiscal year. On a fourth quarter year-to-year comparison, the Asia region grew from 6% of total revenues to 9%. And our near region remained flat at 32%. The America's region slipped from 62% down to 59% of total revenues. This is a reflection of two issues in particular. First, it illustrates the fact that the Asia region is the primary growth driver at this point in the economic cycle. Second, it indicates that this region of the world is, in fact, becoming a more important part of the technology supply chain. While I expect that revenue growth will resume here in the U.S., it is likely that Asia will continue to grow as a percentage of enterprise revenues. And we are prepared for that likely scenario. We are well positioned in the DRC including our acquisition of Sunrise Electronics one year ago, and we're investing in that area of the world to meet the needs of the indigenous customers as well as our multi-nationals transferring production from America and Europe.

I've often stated the obvious. We cannot control the markets we compete in. But we will continue to manage the things that we can control. Due to the weakness in microprocessors and disc drives and because we did not see meaningful revenue growth in our other businesses during the fourth quarter we continue to take expense out of our business. Since the December 2000 peak when the markets we competed in began to deteriorate substantially, we have taken over $300 million and analyzed SG&A out of the business.

I want to emphasize again that we're not satisfied with the near break-even performance at these levels of revenues. We will do whatever is necessary from an expense control position to ensure profitability at whatever level of revenues we experience going forward. And rest assured that we're balancing this tactical focus with a intent to capitalize on the next growth cycle in the technology markets we serve.

Now, regarding the balance sheet, further capital reductions are less likely as we begin to see improvements in sales. However, we did manage to reduce working capital by $160 million in constant dollars during the fourth quarter and by over $1.7 billion since December 2000. This endeavor has enabled us to reduce total debt by approximately $1.5 billion over the past six quarters, as Ray mentioned earlier. Currently our asset velocity ratios are in line with historic levels and we do not anticipate significant additional improvements in this area until revenue growth resumes. I'm pleased with our team's efforts to remove nonproductive working capital from our business.

A few comments about our liquidity position. We currently have about $900 million in liquidity available to us, with $450 million of our long-term debt maturing in about a year. Based upon the current low value of our equity the next appropriate move for us to construct a debt offering to replace the maturing long-term bonds. The recent negative launch that was placed on Avnet's debt by both Moody's and Standard & Poors rating agencies was initiated based upon coverage issues, which we believe should be rectified in the near to mid term with continued improvements in both the industry economics and Avnet's operational performance. Both agencies are well aware of the strong commitment to our balance sheet and our desire to maintain an investment-grade rating short term with a intent to improve our ratings over time.

So it is again worth emphasizing our primary financial objective here at Avnet. We are truly committed to creating shareholder value for our investors. We're focused on improving returns on capital employee. And we have initiated and continue to drive an enterprise-wide value-based management cultural change process directed at educating our team on Rosie, teaching employees about their individual role in improving this metric, and assisting employees for actual improvement in Rosie, and measuring and reporting to you our progress. Through strategic planning and the execution of our business plans over time, we intend to accelerate earnings growth, and we strive to create a more stable earnings growth. Executing our Rosie initiativehas already placed a heightened focus on asset utilization, which only serves to reinforce the strength of our balance sheet and our balance street strategy.

As we close our prepared remarks and look forward to the September quarter's performance, we anticipate that our operating units will experience the typical seasonality that accompanies the summer quarter. Based upon our expected mix in business revenues, sales and earnings are expected to be roughly flat as compared with the June quarter. We expect that the December quarter would yield improved financial results from where we are currently benefitting from the historic seasonal strength that normally accompanies the calendar year end. And beginning in calendar year 2003, we expect to see continued gradual improvements in the technology markets we serve. Therefore, based upon what we know today regarding both the economic and political climate, operating leverage in the business model, our internal budgets and our expectations for moderate growth into calendar '03, we are comfortable with current consensus estimates for fiscal year 2003, which average 50 cents per share.

In closing, it is our intent to file the management certifications required by the Securities Exchange Commission, prior to the required due date, which in the case of Avnet is the date we file our Form 10-K. Due to our June fiscal year end, we are required to file our form 10-K on before September 26, 2002. Avent is a leader in corporate governance practices, and we support all efforts to restore confidence in our capital market system. And with that let's open up the lines for Q&A.

Ladies and gentlemen, at this time we will be conducting a question-and-answer session. If you would like to ask a question, please press star 1 on your telephone keypad. To remove your question from the queue, please press star 2. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Again to ask a question please, press star 1 on your touch-tone keypad, and if you are using speaker phone, please pick up your handset before pressing the star keys. I will pause for a brief moment. Our first question comes from Steven Fox with Merrill Lynch Global Securities. Please state your question.

Good afternoon, Roy.

Hi, Steve.

Can you talk a little bit about your outlook by segment for the quarter in terms of the normal seasonality. Remind us as you get into the December quarter what you think a normal seasonal quarter will look like by, say, components and CMG?

Sure, just walking through it, at electronics marketing we would expect revenues to be roughly flat; as you know there's a soft period there for Europe. However, Asia tends to be strong and, of course, as we've already talked there's growth going on in Asia and our share of business there is rising, so we're looking at roughly flat revenues for EM. As we mentioned in the script, we expect our revenues at applied computing to rise in microprocessors and disc drives, and in aggregate I think we're expecting applied computing to grow in the 10% range. And then in computing marketing, seasonality says we typically have a softer quarter in the summer than we do in the June quarter and so our expectations there are for revenues to be down between 5% to 10%. When you roll all that together, it comes up to roughly flat revenues at the enterprise level.

Then when you look out to the December quarter how would you describe normal seasonality by business segment?

It turns out that -- let me reverse the order. Computing marketing, Rick's business, you know, I want to say always, Rick, I don't know if there's ever been an exception, but if not if not always, almost always has a seasonal pick up. Last year in specific, it was three 23% sequential. We don't have a lot of experience with applied computing, but based on the experience we have it appears that applied also has a seasonal pick up, and it's similar to computing marketing. Last year it happened to be identical at 23% up, sequentially, and then at EM usually we get a pickup under normal conditions. You know, it's in the low to middle single digits on a sequential basis just due to the improvements out of Europe, another strong quarter from the Asia perspective and typically a slightly up quarter here in America.

And then last question. You know, I'm not sure if I quite understand the loss at AAC. It sounds like your lowest margin products caused the sales decline, so why was there an operating loss during the quarter? Am I missing something?

Yeah, the market that we serve -- let me give you the good news first. And then I'll give you the bad news. The good news is there where we sell embedded systems into non-PC OEM's, so this is medical instrumentation, robotics, industrial-type customers, we had slight growth in revenue and in gross margin. So that business is just fine. But the business of microprocessors and disc drives, not only was down a hundred million in revenue, but the gross margins on the business that we did do was also down. The markets were pretty terrible in the June quarter. So we had the combination of less revenue and lower margin on the revenue that we had.

Thank you very much.

Our next question comes from Yasmine Duvetti from Goldman, Sachs and company.

Good afternoon, gentlemen. A couple of quick ones here, if we could start with maybe getting a better handle on the operating leverage in the business, and I know there were some comments made earlier about it. As I'm looking at my model and trying to get a handle on the SG&A line, it looks like your revenues, if I go back in time, are approximately where you were running at end of 1999. In that time frame you were running SG&A approximately 10% lower than where you are today. And I know the mix of business has changed and there were other factors, but could you give us a sense if business were to stay flat and let's say you were to see below seasonality in the fourth quarter, what are you contemplating in terms of the SG&A controls?

Yeah. We have some contingency plans in place, Yasmine, and we are continuing to develop them. To be very candid, from a SG&A reduction perspective, we are now running the business on a quarter by quarter basis. We're looking at the sales as well as the bookings and the quote it a activity and making business decisions in terms of how much deeper to go into the SG&A. You are exactly correct in your analysis. According to where we were with SG&A back when revenues were at this level, we have roughly about 10% more SG&A that we could take out of the business just to get back to that level. The balance, of course, is when our -- when are sales going to pick up and how much of that SG&A do we need in the business in order to take advantage of that sales growth. That is really the only thing that is precluding us from addressing those expenses immediately. In terms of our ability to get there, if we continue to be disappointed by the revenue, the answer is we can't. We still have a SG&A, ray, where are we? 65%, --

just about 65% of our g and a expenses what we could characterize as variable cost so we still have a significant amount of variable cost that potentially could come out of the business should sales not increase. If I understand your question, the summary answer is that we are continuing to evaluate the revenues on a quarter-by-quarter basis. We have some plans in place already, and we are continuing to develop contingency plans and given that the revenue environment does I am -- improve we will continue to address our cost line?

Just one quick followup, Roy, that was very helpful and I'll let somebody else take the floor. Was there any impact on the quarter from either revenues. Could you sort of quantify that?

I'll give you a broad brush and if you'd like more I'll ask ray to pursue this. But on the top line, the revenue benefit was a little under 1%, and on the bottom line because most of the impact of fx this quarter was regarding Europe and our bottom line there is relatively small, we had a slightly negative impact to EPS but it was, you know, develop small.

Thank you.

You're welcome.

Our next question comes from Kevin McCarthy from Credit Suisse First Boston. Please state your question.

Hi, thanks. Just a follow-up on the sg and a question. Just doing the math I get about a 10% sequential growth in December. For your revenues would look like about $10 billion. Could you get SG&A down to about 10 and a half% on that number if that math is right on revenues?

In what time frame, Kevin?

Say for the full fiscal year, maybe as an exit rate?

I think, I think that as an exit rate that's very doable.

You see where the SG&A is now. And as you look forward, first of all, I think there is some amount of expense, you know, we talked about reductions in staff of 775 people. Some of that occurred, of course, during the June quarter and that's part of what you're seeing in this SG&A decline quarter-on-quarter. Some of that will actually be executed and still into the current quarter. So we do expect some additional expense decline this quarter slightly. So you know the rate we're at now. When you start moving the other way, start growing sales, the fact that we're at a break-even be around about performance means that we're in essence in excess capacity from sga perspective. We have more people in the business than we need to run the business. What that means as we grope sales we're not going to need to grow SG&A at a proportionate rate. In the early days the immediate increase in expense will be primarily at attribute be to operation will cost physically moving the goods, paying the transportation carriers and to some extent incentive compensation on the sales compensation programs. So what you're going to see is that a small portion of incremental gross profit dollars will fall to SG&A and the majority, vast majority will fall to operating margin and revenues decline that mix will shift a little bit to the point where at maturity we typically would tend to spend about 50% of incremental gross profit dollars on incremental SG&A with the other 50% falling to operating margin.

Right, I understand. I guess I was trying to size the two years ago, you did an about $10 billion in sales and again on the math, on your discussion of how the business recovers I get a number that approaches that for the current fiscal year. And two years ago when you did the $10 billion sales rate you were at about a 10 and a half% SG&A so I'm try to get a sense of the timing. Do you consider that a recovery revenue or is that a number where you would consider going in and making another change to the head count structure?

I don't think it's a bind narrow question because it depends on where the revenue comes from. If it was all coming at a particular group we may still be taking remedial yale actions in one -- remedial actions in one of the other groups, Kevin. But I think generally speaking if we began to experience revenue growth across all three of our groups, we would probably be inclined to stop cutting expense and start redirecting resources towards capitalizing on the revenue growth.

Okay.

okay,?

Just one other, if I may. I was curious on your comments you guys have made great progress on cash I know versions cycle and the other asset velocity metrics you mentioned but then you said something along the lines that you don't see much more room for improvement unless sales were to grow again. What are the the issues or mechanical issues that would prevent a continuation of that nice path you've been on even with, you know, flat or modestly growing revenue environment?

Right. If you look at, -- if you break it down into its components and, for example, you look at receivable days, we're in a range there that is I would describe as typical or normal. And so it's difficult for us to project that we're going to be actually able to shrink receivables from this point. If you move to the inventory which is obviously the other major component, we're approaching historical norms in terms of asset velocity. What's impairing us from improving that is our ability to get the slow-moving inventory or nonproductive inventory out of the mix while still maintaining enough of the fast-moving inventory in the mix. And so, you know, I've actually been signaling for a couple of quarters now but I thought the heavy lifting was fundamentally over in terms of working capital decline. And our team is still found a way to grind some out but, you know, I just think that our requirements now to add fast-moving material are going to offset our ability to move on the slow-moving material and here's going to be relatively flat here for the near term.

Great. Thanks very much.

You bet.

Our next question comes from Julie Santurrelo with Morgan Stanley. Good afternoon,.

Hi, Julie.

I wonder if you could go into more detail on the growth drivers in Asia. Is it impressive number and I'm trying to understand how that breaks out between end market or local growth versus perhaps an inventory build up in the region as production moves there versus perhaps share gains.

Okay. So I'm going to let and did I answer that from an electronics marketing perspective. Ed has a relatively small business in Asia that is primarily focused on AMD micro processors and some motor rollo board level products and Rick's business is only in Australia so I think the real issue is our electronics component business and do you understand Julie's question.

Sure. The multi-national companies represent the majority of the growth. Particularly with contract manufacturing. And then some indigenous growth in the PRC so we're really having a lot of contrast with the multi-national customer base.

And with the acquisition of sunrise, was some of that part of the creation?

That's a very, very exciting and represents a good share of the growth.

Julie, it's interesting. You know, when we acquire a company like that obviously our presence in the market expands overnight and there's quote-unquote a share gain. But then what we've been doing is adding product lines, right, Andy you, you've added some significant franchise like ZI links and the prc.

That's correct.

And we're emergency gent capital resources and increasing the staff. So organ growth following on the platform that was created with the acquisition growth.

Okay. Thank you.

You're welcome.

Our next question comes from Thomas of J.P. Morgan. Please state your question.

Good afternoon. I was hoping you could comment, one, on the line near component that you're expecting in the September quarter, specifically, in the month of July, have you -- started to see what you would consider the seasonal up take especially is as you mentioned in applied computing, has that come through or are we expecting to see some more pull flew in September? And also if you could comment, I think this is more a question for Rick, if you could give us a sense as you did on the last call of sort what you're seeing out there from the enterprise level in terms of aggregate demand for servers and storage and so forth as to has the pipeline continued to fill up and it's just a matter of getting some folks to loosen some purse strings, and we'll get to see some more purchasing in there or have we seen any did he grad dividends in demand at all for year end products?

I'm going to ask both Ed and Rick to comment and let me explain. If you look at the September quarter, typically electronics marketing and computer marketing are fairly back-end loaded. They're very dependent on the month of September, and part of our commentary here today is based upon what you what we saw in July relative to previous Julys but also April and January of this year. So we're looking for a strong ramp through the quarter which is quite a normal phenomenon. Now Ed's business in those processors and disc drives, historically, has a little different pattern and so, Ed, why don't you comment on what you saw in the month of July and what you're seeing so far here in August.

Okay. Thanks, Roy. And, Tom, to answer your question, first of all, there is a Seasonality to the microprocessor storage piece, we'll call it the PCOEM business and the three strongest months have traditionally been September, October, November, interesting enough and it's that back-to-school season thing that becomes Seasonality for us. Hard to say this year what's going to happen because the market has been a bit skittish. However, when we look at the July numbers, and again a little hard to tell because it is a summer month, but -- we did see a slight uptick from both April, which was the first month of last quarter, and from July last year. So that's pretty good news. On the storage side, we're seeing just a hint of a tightening of product. So that's also good news. So at this point, I would say that we're still looking like we're on course for an improvement in the September quarter.

And then, Rick, if you take into consideration, sales, bookings and pipeline, what conclusions can you draw or observations can you make about enterprise demand?

Okay. Roy. Good afternoon, everyone, and good afternoon, Tom. From an overall aggregate business point of view what I've seen quarter to date is very much in line with the expectations I've set around the a 5% to 10% sequential impact quarter over June. If I speak to pipelines and trend, it's still a very, very tough spending environment. There are good pipelines out there, but the spending as we spoke I think last quarter is still very much around the have to to projects, projects consolidation, upgrade and augmentations, not much experimentation and new investment outside of, you know, maintaining or sustaining core business processes. So whether I look at it from an aggregate point of view that way, sequentially from a chronological standpoint or even looking at the product mix from hardware and networking, et cetera, all of those reflect a very stable environment. But, again, when I think that we can be more comfortable in getting back to a more seasonal, recognizable seasonal pattern.

Okay. Thank you.

Our next question comes from Brian Alexander with Raymond James associates. Please state your question.

Thanks, and good afternoon, guys.

Hi, Brian.

In the applied computing business, could you give us an update on what percentage of those revenues are cpu's and drives versus embedded and do you have any plans to de-emphasize the cpu and drive portion of that given the focus on Rosie and the lower margin products?

Let me make a point. Brian, in the slide that accompanied the webcast, we actually provided a graphic that gave four quarters, John?

Correct.

Of aggregate pc and drive volumes. So that, Brian, the answer to your question changes by quarter; does it not, Ed.

Sure.

If we said percentage of your business is pc or microprocessor and drive?

It is changed by quarter and, of course, this particular quarter it changed somewhat dramatically. But if you look at it over a period of time, Brian, the pc, oem end of the business has run in the roughly two-thirds of the business range. Into a top line basis much less on the bottom line. The go-forward strategy. Actually if you look back about a year, what you'll see is the embedded systems piece, did take somewhat of a hit along with the economy and some of the issues that we're facing the rest of the company. And I'm very pleased with the very slight comeback but the uptick we saw in that in the June quarter. Our objective really, I probably would turn your question around and say it's not our objective to de-emphasize the pc, OEM business but conversely we are investing and growing and adding lines to our embedded systems business which will have the effect of changing the mix-up ward on the higher margin end of the business.

Okay. Thanks.

Brian, just add just a little color to that and say that sales of microprocessors into the pc, oem market, we are comfortable from a return on capital perspective. Sales of disc drives into the non pc, oem marketplace, we are also comfortable with the margin structure and the return on capital. And so going forward, we will continue to work towards growing our microprocessor business profitably and we will work towards profitable growth in our drive business.

Right.

Is that fair?

That's absolutely fair. And I would also point out that both microprocessors and storage are feeder sources for our embedded systems business. And the position that we enjoy with those suppliers gives us a strong position relative to the use of those products in higher margin solutions.

Thanks, and then just a follow-up on the gross margins for the combined company. I thought you said earlier that sequentially you were up in both cm and em in gross margins. I wanted to clarify that because given the mixed shift, the favorable mixed shift in applied computing if that were the case I would have expected the gross margins for the combined company to go up even more than 15 points sequentially so I want to clarify that.

You and I would have expected the same thing but what actually happened is that despite that improvement in product mix, applied's gross margins declined sequentially due to the very soft gray market that Ed's team was selling into for the quarter. So the gross margin on the remaining revenue was low enough that Ed's overall gross margin declined and that was essentially overcome by higher margins at cm and em driving the enterprise margin up slightly.

So they were both up sequentially cm and em?

That is correct.

Thank you.

Our next question comes from Matt Sherin of Thomas Weisel partners.

Could you give us a little more color on the electronics business where you saw some strength, aside from geographic regions that you talked about and if you could also give us an idea of, you know, lead times for certain products, pricing, overall and then also sort of what are the order patterns, a lot of your customers still living sort of in a hands-to-mouth type of environment or is that starting to change a little bit?

Okay. In terms of strength, Matt, are you thinking in terms of customer segments, for example,?

That's right. In product areas too.

Okay. And then any specific product segments. Well, I think I'm going to turn that over to Andy. I guess, Andy, why don't you talk in terms of --

Let me start with some of the positive trends are for the second consecutive quarter as an example in the Americas, our unit volume has risen. So we're starting to see stability in afp, average selling price and the semiconductor part of the business. We also saw a rise in our contract manufacturing business of approximately 3% sequentially over the prior quarter. And lead times are still generally six to eight weeks, another substantial increase to lead time. So we're really operating in what I'll call stable environment. Roy, you may want to --

I think that's exactly right. And I think regionally, Matt, there was not a lot of of difference between what we saw in America and what we saw in Europe. They were pretty charitable on a sequential basis and the strength was in Asia. Andy, any product segment that were notably different from the others, any trends?

You know, flash is still very available, all memories are still very available. Just to gi give you a feel for IP and e products, connectors are still running eight to 10 weeks, very stable. Resist sisters, stable at six to eight weeks. Power supply is eight to 10 weeks so you can see that most of the lead time issues are very manageable. Where we do see some strength is in analogue and power. These areas where lead times are stretching 12 to 14 weeks primarily in Asia, but overall our coverage of a items is very strong, our ability to manage our turns at this point is very good, and we're really not experiencing any difficulty in getting product in.

That's great. And, Roy, just one follow up if I may, sort of a bigger-question, concerning the migration of manufacturing to Asia. As that continues, is there a concern that you may lose some of that business or are you positioned, you know, well enough in Asia, you know, with your operations there to take most of that business?

Well, I actually think we have two concerns, Matt. One is our market share in America and in Europe is higher than our market share in Asia. Asia tends to be a relatively fragmented marketplace which actually creates opportunity for Avnet on a longer-term basis but on a short-term basis it would apply that one dollar transfer, the chances are we'll come out with less business there. Now, that is mitigated significantly by the fact that the large EMS companies tend to be American headquarters and we have strong relationships and a linkage with those companies, an electronic linkage so that helps us compete against the indigenous distribute force for that business. The odm's overall which are really not so much involved in transfer business but are involved in market share shifts within the ems company we have their position pretty well with both our Taiwan and china-based businesses. So I think overall it's fair to say that we have some risk on the top line. However, we're working very hard to mitigate that and I wouldn't call it a dramatic or --

Yeah.

-- overly concerning risk.

We actually have a formal program to track the shift from America to Asia right now. And I'll tell you that it's in the tens of millions of dollars, but we're pretty comfortable with what we're able to win as some of the business shifts to Asia.

Matt, I have a second concern. The profit margin structure on that business in Asia tends to be lower than Europe or America. And the way we're managing that is to focus on the return on capital because Asia has a tendency to also be more efficient from a capital productivity perspective. And so the yardsticks that we use to measure performance in Asia are the same as America and Europe at the return on working capital and return on total capital levels. That's how we're imagining through it.

Okay. So longer term gross margins could come down a little bit then?

Yeah. If the mix continues to shift towards Asia, there is a concern that could happen.

Okay. Great. Thank you.

You bet.

Our next question comes from Rob Domron of SWS Securities; please state your question.

Hi, Roy.

Hi.

Could you give us a little more detail on the one-time charge splitting it out between the electronics and the Internet investments and also the severance and I guess I'm just curious why a year after the Kent transaction there's still a write down on Kent. I guess that's the first question. And do you still have any Internet-related investments on the books after this write-down that would be a second question. And then I think in the press release back in July, you mentioned $50 million of incremental savings from the cutting of the -- the head count another 775 people. Does that -- do we see that benefit in the September quarter. So if you could help us through those questions.

Okay. Good questions. I'm just going to flip in this to ray. The breakdown of the one-time charge.

Okay. Okay. Hi, rob, how are you?

God, ray. Breakdown of charges is follows, severance, or Internet related investments or Kent.

The severance piece was roughly $14 million end of quarter. As far as Kent is concerned, it's approximately 29, $30 million associated with a number of different items including inventory and to some extent receivables and a significant amount related to facility cost. I'll come back to that in a minute and give you further explanation. The Internet related expenses that's the balance which was roughly $35 million. As far as Kent's your concerned and your question why a year later, you will look generally speaking when you acquire a company such as Kent which was a very complex business for us, especially on the Kent data com side. If you look traditionally accounting rules they allow you to purchase accounting about a career to basically evaluate everything that you bought in a acquisition so that you can then make appropriate adjustments through goodwill. In this particular situation as you know, we did account for the pooling of the interests so, therefore, any adjustment had a we have must run through P&L. But it's really not that unusual when acquiring a business like a Kent to be evaluating what you bought for a significant period of time. If you look at Kent data comp business it was a relatively new business for us, a new business model and, therefore, required a lot of analysis and understanding of some of the details within the assets. And, therefore, we took, you know, about a year to evaluate everything that we bought, and part of it also included facility costs which as you merge the two businesses together, and begin the synergy benefits we discovered along the way that we could actually take out more expenses than we anticipated and that resulted in some redundant facility expenses that we just didn't need. In addition to that, we had some situations where despite the best efforts of our team to liquidate some things that we identified earlier in the process, we were not able to liquidate date that -- liquidate that at the prices that we anticipated and that includes not only inventory but fixed assets. When you shut down a facility you have quite a bit of equipment and this was a large acquisition and a lot of equipment and capital items within the business that we tried to basically remove at the greatest benefit to us as possible. And I think as we went through the process it became that we'd have to sell certain things that are less costly than we initially anticipated.

How about the Internet investments, is there anything left on the books from that perspective?

Yeah, the answer is small, but, yes, rob, but small. You know, obviously things like e connections, we have and taken all the way down to zero. But we're now down to sing will digit millions.

Yes.

Single digits millions left in the composite of the Internet investments.

Okay, and then of the last part of my question was the $50 million of annual annualized savings. Should we begin to see all that have in the September quarter or just part of that?

You actually saw some of that in the June quarter. That $10 million sequential decline included some expenses as they came out during the quarter. Rick, for example, took his action in April, and so we got most of his benefit. And then some took place in May, and then, of course, some in June. Ray, do we have anyway of estimating 12 1/2 million is in the June quarter as in the September quarter? The I would say we have maybe a little less of that already realized in the June quarter.

If you figure 60% of it is in the mix, 40% is coming here on the September quarter.

Okay.

Something like that.

That helps, thank you.

You bet.

Our next question comes from Keith Bachmann of sac capital, please state your question.

a Previous comment was that your's seeing strength in Asia. I thought the comment was through, from the ems vendors. And my question is ems vendors are transferring programs to Asia and so there's really no net growth from a component level perspective and I was hoping you could clarify the comment.

Yeah. The majority of that business you're correct, would be characterized as shift. When a flexion electronic moves the manufacturing plant from Latin America to china. But there's also a lot of business that we are participating in in Asia with odm's in Taiwan as well as the general consumer market which Avnet has not participated in in the past with some of the major contract manufacturers in Asia. So I think part of the reason we're experiencing some pretty good growth there is that we're actually in segments of the market that we previously did not participate in.

Is there any way you can -- you mentioned 16% quarter to quarter growth but how much is really growth versus geographic shift?

That's, you know, that's a really hard thing to pin down but I think when you look at em global revenue and it's flat it kind of speaks to the situation of the entire market but it would be hard to pin that down. We can go away way and try and get an answer for you.

Thank you very much.

Keith, I think it's going to be impossible, not only close to impossible, impossible to track that and so from my perspective the magic number is the global components growth rate. And, you know, we had a 4% kind of growth in the March quarter. We had another percent on top that have in the June quarter, and we're going to continue to watch em's global revenue and try to determine the overall health of the industry.

Okay. Thank you.

Roy, we have one e-mail question that I'd like to ask if we could real quick.

Sure.

Relates to the negative watch. Have rating agencies, moody's and S&P given us a time frame for completing the revenue and the second part of that what are the implications on liquidity of a downgrade.

Ray.

I think to answer the first question, we really don't have a time frame giving of given to us by the rating agencies. However, having said that we're anxious anxious to get that resolved so we hope that we'll end up with a result of our ratings being reaffirmed at the levels they're at today. In terms of if there is a downgrade, obviously there always is some sort of an impact on the downgrade. Our expectation would be that if we're downgraded slightly by either or both of the agencies, it will not result in any impact on lick liquidity. It will simply result in a increase in the cost of obtaining the funds that we have. At this particular point in time, we don't see anything on the horizon that would limit our availability to adequate -- to sufficient capital although clearly with a ratings downgrade, such cost of capital will increase to some extent.

Okay, John, does that answer your question?

Thank you.

Eleanor, back to you. Do you have any more questions in the cue.

Your next comes from Mark from Nottingham, capital.

We'll make this the last question.

Last question.

Hello, mark.

How are you? Thanks for the last question.

You bet.

We've been hearing from some of the connector companies that business has been improving a bit. And we've also been hearing from some people that the distributors have been a bit more active than they were in the past. Connectors tend not to be as cyclical in terms of inventory bills and reductions and stuff and so I guess the question is you've been talking about it but the question is whether the improvement if, in fact, you are seeing an improvement in the ordering from the connector companies, is is that a signal that you stopped reducing your inventories and passive components or is it that you're actually seeing a pickup in business?

Well, yeah. I think it's more the former to be quite honest, that the reality is that if you just take one step back from a 8 1/2 by 11 piece of paper, what you see is a graph that says revenue for our components business declined precipitously for three-quarters in a row from January through September of last year. And from that point forward, our revenues going out the door have been relatively flat. We've been in the small single digits plus or minus from that baseline. So, Mark, it causes me to say that the customers that we serve are relatively flat, and that's sort of the good news and the bad news. The business is stable, but the bad news is it's not growing rapidly. The reason that the component makers and specifically the connector makers are seeing more from us is that we have had two quarters in a row of slight growth, but also we've now had 18 -- we're coming up on seven quarters of inventory liquidation and as we've mentioned earlier, we'll back to our historic norms for inventory velocity. So it's been a burning off excess material within our company we're beginning to buy that which we're selling and I would add to that, slight, ever so slight growth which seems to imply that we're coming off of a bottom here, ever so gradually.

So if I was to look at a graph, you know, orders that you have on your suppliers and the orders that your customers have on you, that spread has gotten back to a comfortable level?

That's correct.

Yes,.

That's the good way to think about it.

One other additional comment on the connector question. We are seeing strength in our mill interconnect business which, of course, is driven by the defense aerospace vertical and those connectors are typically not in stock. Those connectors are place in order, bill to order type inventory which is driving our purchases up.

Then one final question. The ems company seem to be a little more active and ems and maybe going a little bit beyond ems. If you look at the type of arrangements that you had with your customers, 18 months ago, and what you're seeing today, have there been any major changes in the way you do business with them or what they demand of you in terms of how you service them, how you inventory for them? And how you respond to their order patterns?

Well, Mark, I'm going to give you a relatively brief answer only because we're over the time limit.

Right.

But let me say this. We have always had agreements with our supply-chain customers that hold them accountable for any liability inventory.

Right.

So that part's not new. What is new will be our attention to the administration of making sure that there are active agreements in place for all liability product that we buy buy, and I can tell you that there is more attention on inventory throughout the entire supply chain. I think that cost of capital's gone up, access to capital has gone down. Importance of return on capital has gone up and all of that means that inventory in the supply chain is going to be treated as a much more precious resource going forward than it was in the last sort of boom cycle where there just was access to an awful lot of capital that was very competitive. All of that I think bodes well for the franchise distribution model where we are the only participants in the supply chain that is actually supposed to have inventory that is uncommitted.

Right.

Okay?

Right.

So I guess some of this still a bit too early to declare victory but I am quite optimistic that there's an opportunity for distribution to gain share in the next up cycle and, of course, we're looking forward to having that opportunity to gain share within distribution.

Terrific, thank you very much.

Thank you. And everyone, I know we're late so let me thank you all for your interest in Avnet and we look forward to talk talking with you last quarter.

For those of you who submitted e-mail questions, thank you, we will get Back to you by e-mail within 24 hours and at any time you can send any questions to investor relation at Avnet. Take care, everybody.

Thank you for your participation. This conclude's today's conference.