安富利 (AVT) 2005 Q1 法說會逐字稿

Good afternoon. Welcome to Avnet first quarter fiscal 2005 corporate update. I'm Vince Keenan, Vice President and Director of Investor Relations for Avnet.

If you are listening by telephone today and have not accessed the slides that is accompany this presentation, please go to our website www.ir.Avnet.com and click on the icon announcing today's event. After registering, please click on the slides-only for telephone participants option that appears on your screen.

In addition to disclosing financial results that have been determined in accordance with Generally Accepted Accounting Principles, or GAAP, the company also discloses pro forma or non-GAAP results of operations that exclude certain items. Reconciliations of analysis of results to GAAP can be found on form 8-K filed with the SEC today, in several of the slides on this presentation, and on Avnet's Investor Relations website.

Before we get started with the presentation I would like to review Avnet Safe Harbor statement. This presentation contains certain forward-looking statements which are statements addressing future financial and operating results of Avnet. These results are based on management's current expectations. Actual results may vary materially from the expectations contained in the forward-looking statements. Listed on this slide are factors that could cause results to differ materially from those described in the forward-looking statement. More detailed information about these and other factors is set forth in Avnet filings with the Securities and Exchange Commission.

In just a few moments, Roy Vallee, Avnet's Chairman and CEO, will provide Avnet's first quarter fiscal 2005 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, after which Q&A will be conducted. Also here to take questions you may have related to Avnet business operations are Rick Hamada, President of Technology Solutions and Harley Feldberg, President of Electronics Marketing.

With that let me introduce Mr. Roy Vallee to discuss Avnet's first quarter fiscal year 2005 business highlights.

Thank you, Vince, and good afternoon, everyone. Thank you all for taking the time to be with us and for your interest in Avnet.

As we get into the numbers, I would like to remind everyone that the first quarter of fiscal year 2004 included an extra week due to our 53 week fiscal calendar last year. In the first quarter of fiscal year 2005 we continued to deliver solid year over year revenue growth while our focus on operational excellence drove significant improvement in earnings. Revenue of $2.6 billion was up 8% as compared to the prior year and up an estimated 16% on a per week basis. Electronics Marketing sales grew 15% year over year and 24% on a per week basis, driven by solid double digit growth across all three geographic regions. Technology Solution sales declined 1% year over year and grew 6% on a per week basis, with Asia growing rapidly due to strong microprocessor sales. This impressive performance is further evidence that our focus on delivering value to our customers is paying off across the enterprise.

On a sequential basis, Electronics Marketing revenue was down less than 3% while Technology Solutions revenue was flat. At the Avnet consolidated level, the less than 2% decline sequentially was at the mid-point of our guidance, taking into account that the normal seasonal slowdown was compounded by inventory corrections at some of our component customers. We are particularly pleased with the performance in EMEA, where both operating groups posted positive sequential revenue growth in what is typically a slow quarter due to summer holidays.

Turning now to operating income. We had another impressive year-over-over increase across both operating groups and all regions. Pro forma operating income increased $33 million or 80% over the year ago quarter. Year-over-over pro forma operating income margin improved 113 basis points to 2.8% driven by significant improvements in EMEA at both operating groups. Electronics Marketing, operating income growth of $25.5 million or 76% was three times the per week revenue growth rate, with EMEA operating income growth of 175% as compared with the year ago quarter. At Technology Solutions, we realize the full benefits of the applied computing and computer marketing combination from last year as operating income grew 50% over the prior year's first quarter. This performance drove TS operating income margin to an eleven quarter high of 2.6%.

Sequentially, operating income was down approximately 15% as a result of lower revenue at the higher margin Electronics Marketing group as well as lower gross margins. However, Technology Solutions had a strong operating performance as sequential operating income grew 12% and operating income margin grew 28 basis points on flat revenue. This sequential improvement was primarily driven by the EMEA region where our focus on quality revenue, coupled with the completion of our computer platform integration, contributed to a significant positive impact on operating income and a 304 basis point improvement on operating income margin.

Sales for the first quarter of fiscal year 2005 totalled $2.6 billion up 8% as compared with the prior year and up an estimated 16% when adjusted for the extra week in the prior year's first quarter. This represents the seventh consecutive quarter of year-over-over revenue growth at the enterprise level. Our Electronics Marketing team had a solid performance factoring in the challenges in the marketplace. The softness that we told you about at the end of the June quarter, continued through the September quarter as product lead times contracted and customers reduced their inventory levels. EMs book-to-bill fell below one in all three regions as customers reduced the backlog when concerns about supply drove some overheated bookings. Rather than an indicator of a longer term trend, we believe this is further evidence of how efficient the technology supply chain has become.

As you can see on this slide, EM revenue of $1.56 billion increased 15% as compared with sales of 1.36 billion in last year's first quarter. Year over year EM revenue grew 24% on a per week basis with all three regions posting double digit growth. This represents the fourth consecutive quarter that EM revenue grew double digits on a year over year basis. EM EMEA turned in another impressive performance as per week revenue grew 38% in delivered dollars and on a constant dollar basis grew 27%. Of particular note was the fact that double digit per week sales growth was consistent across all divisions and geographies in the EMEA region.

If we look at the trailing four quarters and compare them to the comparable prior year periods, our EMEA region has grown revenue 25% while increasing operating income by over 250%. This is further proof that our value-based initiatives are having an impact as we continue to grow share in the EMEA components market while delivering substantial improvements to the bottom line. On a sequential basis EM revenue declined 2.7% which was in the middle of our range of down 1-4%. Once again EMEA, continued its improving growth trend posting sequential growth of 1% in delivered dollars and flat revenue on a constant dollar basis during the typically weaker summer quarter. Throughout the quarter we saw some softness as customers reduced their inventories and backlogs in reaction to shorter lead times. These factors, coupled with inventory growth at suppliers, have led to a decrease in bookings while increasing short-term price pressure in the marketplace.

Moving to Technology Solutions. Sales of 1.04 billion in the September quarter were roughly flat with the June quarter and at the mid-point of our guidance. Revenue in the Americas was down 3% sequentially as strong growth and industry standard servings and microprocessors was offset by a decline in proprietary hardware products. Outside the Americas, both international regions grew sequentially on the strength of worldwide microprocessor demand. When you adjust for the extra week in the year ago quarter, year over year growth was 6% in delivered dollars and 4% in constant dollars. On a regional basis, year over year sales for both Asia and the Americas were up while EMEA was down slightly on a per week basis.

And now I'd like to turn the commentary over to Ray Sadowski, Avnet's Chief Financial Officer.

Thank you and good afternoon, everyone.

Let's begin with an overview of our operating results for the first quarter of fiscal 2005. This first slide shows a year over year comparison with dollar and percent changed in the highlighted columns on the right. As you can see in addition to the change columns we have included a reconciliation to GAAP net income at the bottom of the slide to account for the restructuring and other charges incurred in last year's first quarter. Starting with the top line, revenue September quarter increased 8% to 2.6 billion. Gross profit of 349.6 million was up 40.5 million or 13.1% over the first quarter of fiscal 2004. Gross profit as a percentage of sales increased to 13.4% from 12.8% in the year ago quarter.

Expenses of 276.5 million or 2.9% higher than last year. But if you exclude the impact of changes in foreign currency exchange rates, expenses were roughly flat. The combination of higher revenue, higher gross margin and expense controls resulted in a 32.6 million or 80.5% increase in operating income to $73.1 million. Operating income margin of 2.81% is our best September quarter performance in three years and represents a 113 basis point improvement over the year ago quarter. Below the operating income line, interest expense of 20.9 million was down 6.2 million from the year ago quarter, primarily due to lower average debt levels. All in all this resulted in net income of $36.3 million or 30 cents per share. This represents a 25.5 million or 236% improvement from the pro forma net income in the year ago quarter.

On a GAAP-basis our results of last year's first quarter included approximately $22 million of restructuring and other charges net of taxes. Taking this into account our GAAP net income improved 47.7 million or 39 the cents per share. In summary, year-over-year revenue growth of 8%, or 16% on a per week basis, produced a 233% growth in pro forma earnings per share.

The next slide highlights the sequential change in our results for first quarter fiscal 2005. Revenue of 2.6 billion was down 43 million, or 1.6%, from the June quarter due to lower revenue in our Electronics Marketing group. Gross profit declined $18.4 million or 5% to 349.6 million and gross profit margin dropped 47 basis points from 13.9% in the June quarter to 13.4% in the September quarter. This decline was due primarily to the drop in revenue at the higher margin EM group and short-term component pricing pressures.

Operating expenses of 276.5 million were down 5.7 million, or 2%, sequentially due primarily to the completion of cost reductions at TS EMEA and our continued focus on expense control. Sequentially operating income decreased 12.7 million or 15% while operating income as a percent of sales reached a three year high of 2.8% for a September quarter. At an operating group level, Technology Solutions operating income margin was up sequentially by 28 basis points to 2.6% while EM dropped 92 basis points to 3.8%. Net income of 36.3 million was down $12 million or 26% from the June quarter and earnings per share of 30 cents was at the low end of our range as lower EM revenue and increased price pressure in the components market had a negative impact for our profitability in the quarter. The combination of slightly higher than expected interest expense and effective tax rate negatively impacted earnings per share by roughly 1 cent.

Consolidated gross profit margin dropped 47 basis points from the June quarter to 13.4% in the current quarter. Most of the sequential decline was due to lower sales at EM and the increased short-term pricing pressures in the component markets mentioned earlier. In EM, both the Americas and EMEA, experienced lower gross profit margins in the September quarter. In the TS business, gross profit margin was down slightly. Although the EMEA region did report a meaningful improvement as they continue to focus on solutions which drive higher margins. On a year over year basis consolidated gross profit was up 61 basis points from 12.8% in the year ago quarter. Although both operating groups showed year over year gross margin improvement, the primary driver of the increase was Technology Solutions with their focus on value-added solutions selling resulted in higher margins in both the Americas and EMEA.

This next slide looks at some of the productivity metrics that we use to monitor our business. The graph on the left reflects operating expenses as a percentage of sales and the graph on the right reflects operating expenses as a percentage of gross profit dollars. As you can see, the decline in the expense to sales ratio has begun to level off as the business mixes stabilize at around 60% Electronics Marketing and 40% Technology Solutions. The business mix has an impact on this ratio since the Electronics Marketing business has a higher expense to revenue ratio just as it has a higher gross margin as compared with TS. In the current quarter, expense as a percent of sales declined slightly as our focus on expense control offset the revenue decline. As a graph on the right shows, our expense to gross profit increased 241 basis points this is quarter to 79.1%. The decrease in this performance was entirely due to the decline in gross profit at Electronics Marketing. We continue to be vigilant in controlling costs as our focus on operational excellence continues to identify opportunities for efficiencies that will contribute to improve profitability in the future. We expect to resume improving in this important metric in the December quarter.

Diluted earnings per share was 30 cents per share in the first quarter of fiscal 2005 representing a 21 cent per share or 233% improvement over pro forma EPS of 9 cents per share in last year's first quarter. On a GAAP basis, earnings improved 39 cents per share when compared to a loss of 9 cents per share in the first quarter of 2004. In the first fiscal quarter -- in the first quarter of fiscal 2005, earnings per share dropped 10 cents from the June quarter as a result of seasonal factors compounded by gross product margin pressure and EM.

The next slide portrays operating income margin performance and working capital velocity, two core metrics of our value-based management initiatives. The graph on the left, details operating income margin performance over the past two years. As I mentioned earlier the decline in operating margin from the June quarter is due to lower revenue and margin at Electronics Marketing. Operating income margin of 2.8% improved 113 basis point when compared to the first quarter fiscal 2004, represented a ninth consecutive quarter of year over year improvement in operating profit margins excluding impact of restructuring other charges. In the September quarter, Electronics Marketing operating margin improved 130 basis points to 3.8% when compared with prior year's first quarter. Technology Solutions' operating margin of 2.6% was 90 basis points better than a year ago quarter and 28 basis points higher than the sequential quarter.

The chart on the right depicts working capital velocity, another key performance metric in our return of equation. Over the last three quarters this metric has trended down, primarily as a result of the business mix issue referenced earlier and slower asset velocity at EM over the last two quarters. In the September quarter, working capital velocity declined over the June quarter due to a combination of a decline in revenue and a $72 million or 4% increase in working capital. The working capital increase was due to an $84 million increase in inventory, 59% of which occurred in the Technology Solutions operating group in support of the seasonally strong December quarter. At Electronics Marketing, inventory grew 3%, with little variation across the regions as an asset velocity has slowed somewhat from the recent levels as business has softened.

Consolidated inventory turns declined from 6.8 in the fourth quarter of fiscal 2004 to 6.3 in the current quarter. While the cash conversion cycle expanded by 5% sequentially to 75 days. Although we are not pleased with these results, we are comfortable with the quality of our inventory and expect to reduce it in the December quarter. We continue to focus on working capital velocity metrics and expect an improvement in the December quarter.

Starting with the new fiscal year we have decided to measure our operating groups on a pre-tax return basis. The change was more reflective of how we drive business. For the most part, we manage our income taxes at the corporate level so that our business unit leaders can focus on profitable operating growth. With this change we'll now focus on pre-tax return of working capital instead of no-tax return on working capital in measuring the performance of our business units. We will, of course, continue to measure returns on an after tax basis at the [ads and ink(ph)] level.

As you can see on this graph, the improvement that started during our restructuring phase has accelerated as sequential revenue growth coupled with profit and working capital velocity improvement returned in fiscal 2004. In the September quarter, year over year return of working capital improvement totalled 519 basis points representing the ninth consecutive quarter of year over year improvement. Sequentially, operating return on working capital decreased 298 basis points or 14.5% as a result of lower operating income and slower working capital velocity at Electronics Marketing. Although inventory adjustments at some of our customers caused a slight blip in sequential performance this quarter, we are confident that our value-based management initiatives will continue to drive longer term improvement in our returns and shareholder value creation.

Turning now to the balance sheet, in the September quarter we reduced debt by 34.1 million as we pay down credit facilities at some of our overseas subsidiaries. As a result, our debt to capital ratio now stands at 39.7% vs. over 50% just nine quarters ago. Interest expense of 20.9 million in the current quarter was up slightly on a sequential basis and should remain flat next quarter. During the September quarter we consumed approximately $7 million of cash from operations primarily due to the growth in inventory mentioned earlier. After subtracting the net of capital expenditures, cash used for a small acquisition in TS EMEA, and other items, our free cashflow for the quarter was a negative $11 million. We closed the quarter with $260 million cash on hand which, when combined with available credit lines on which we currently have no borrowings, provides almost a billion dollars of liquidity.

Now I'd like to turn the commentary back over to Roy. Roy.

Thanks, Ray.

Before we leave the numbers for the recently completed September quarter, I'd like to summarize a few key points. First, despite some challenges in the components market, we achieved double digit year over year growth on a per week basis. At Electronics Marketing we were able to mitigate the impact of inventory reductions at our customers and deliver another impressive quarter of year over year growth. Technology solutions was able to maintain revenue at June quarter levels despite what is typically a seasonally slow quarter.

Our EMEA region posted impressive gains in productivity and operating margins across both operating groups. Asia, despite the well-publicized issues surrounding indigenous customer weakness, was able to increase its operating income over the year ago quarter. Although the inventory correction had a sequential negative impact on our returns, we remain focused on velocity metrics and continue to manage working capital to market conditions. Throughout our business, our focus on delivering value to our customers and driving productivity improvements has resulted in profitable market share gains in new and expanding markets.

Before we move on to guidance I'd like to recap highlights at an operating group level. In Electronics Marketing we continue to expand our market share and profitability in key international markets. The EM EMEA region has continued its long streak of double digit year over year revenue growth while at the same time transforming itself from a challenged operation two years ago to one currently producing profitability comparable to the Americas. In EM Asia we have had 12 straight quarters of operating profitability while increasing our operating income margins in each of the past three years. We feel this is strong evidence that our focus on returns is having its desired effect, profitable growth.

Although we have made significant progress in operational efficiency we continue to drive productivity in all of our businesses. From revamping processes to making our IT infrastructure a competitive weapon we continuously strive to increase the value to our customers. EM's core strategies of design and supply chain services are having a meaningful impact on our business The investment we made in design with tracking has increased the percent of revenue we capture as manufacturing migrates to lower cost regions and more suppliers support the program. As business continues to globalize, more and more of our customers are turning to us to manage an increasingly complex supply chain. While these initiatives had a meaningful impact of our growth and profitability, we believe there is considerable leverage yet to be realized as we continue this process of increasing the value we deliver through our design and supply chain services.

In Technology Solutions, we continue to expand our geographic reach while expanding our line card(ph) In August, we completed our acquisition of DNS, the leading value-added distributor in Slovakia. This acquisition expands our foot print in Eastern Europe and allows us to provide solutions incorporating products from leading suppliers including IBM, HP, Cisco and Sun Micro. In September, we announced the new distribution agreement for Mexico that allows us to offer HP product solutions and services. Our 20 years of experience in the Mexico market, coupled with our long-term relationship with HP enables us to rapidly bring a winning combination to Value-Added Resellers, or VAR. The completion of our platform integration coupled with improved execution drove a significant increase in the EMEA region. Our focus on solution sellings that integrate software and services is allowing us to enhance the role of value-added distribution as migration to industry standard servers accelerates. We continue to invest in people, processes and systems that enhance our leadership role and drive growth and success for our customers. These initiatives position us to grow market share while continuing to expand our profit margins.

Now looking forward to Avnet second quarter of fiscal 2005, we continue to believe we are in a mid-cycle correction for the components business that should be completed within the next quarter or two and we expect Electronics Marketing revenues to be flat to down 3% sequentially. Meanwhile business spending on technology products continues to grow at a modest pace and we expect revenue growth for technology solutions to increase 20-25% sequentially due to normal seasonal strength. Therefore Avnet's consolidated sales should be in the range of 2.75 billion to 2.85 billion in the second quarter of fiscal 2005. Given this revenue outlook, we expect earning to increase sequentially and be in the range of 35 to 40 cents per share on a diluted basis, up significantly from GAAP income of 7 cents per share and pro forma income of 21 cents per share in the prior year December quarter. And with that, let's open up the lines for Q&A, Operator.

Ladies and gentlemen, at this time we will be conducting a question and answer session. [OPERATOR INSTRUCTIONS] I'll pause for a brief moment while we poll for questions. Our first question is coming from Brian Alexander with Raymond James.

Just a question on the guidance, Roy, for next quarter. When you look at the EM business, can you just talk a little bit about what you would expect to see geographically on a sequential basis?

Sure, Harley, why don't you take a shot at that.

Okay. Thank you, Brian. Thank you, Roy. By region for the December closing quarter we are expecting the Americas and EMEA to both be fairly flat to slightly down. We have a shot at sequential flat in both regions. And in Asia we are expecting some I would say flat to modest growth.

Brian, a little bit more strength in Asia on, of course, what is a smaller part of Harley's number.

Got it. And then just a little more color on the Technology Solutions business. I think you said 6% growth year over year adjusting for the week, and we've seen other enterprise-related distributors growing at 20-30%. Is there something different about your business mix relative to those other competitors? Do you think you might be losing share in key lines? Or how do you see that?

Great question, Rick, why don't you take that one.

Thanks, Roy. Good afternoon, Brian. Brian, in the segments we serve we feel we are competing well. We do have a different mix issue with some of the combined now from the applied computing, microprocessor, system builder, and OEM space. We remain focused on profitable growth and we are not, we do not believe there is any significant market share trend in the enterprise space we compete in that's moving in one direction or the other in any major way.

Brian, one thing that's note worthy, of course, the Sun Micro decision over the last four quarters to shift the preponderance of its revenue through distribution in North America. And that's benefited the Sun distributors, of course, has no impact on us.

Maybe I'll just finish on expanding on that last point. Are you seeing any enterprise distributors move in a similar fashion?

Again, Rick, what are you seeing today?

I would probably echo some comments that have been made in the marketplace already regarding Hewlett Packard looking to increase their channel share overall and IBM remains very committed. We feel good about that overall partnership. They made one minor change in their software strategy to move some de-tam to tam recently but we've worked through that and we are on to FY '05.

Thanks a lot.

Our next question is coming from Steven Fox of Merrill Lynch.

Hi, this is Vivian Cervantes calling in for Steve Fox. Just a quick question. You talked about sales per week on a year over year basis. Can you give us, I guess, an example of how this looks on a quarter over quarter basis.

Quarter over quarter, the fiscal periods were comparable. There were 13 weeks in each period so you can just take the sequential growth rate that is we quoted and those would be very straight forward.

So let's see, okay. If we were to take a look at -- I think I got you. And then moving on to Electronic Marketing. Operating income seemed to have suffered a little bit. Can you just characterize that between pricing and volume?

Yeah. Harley, can we identify how much of the operating income decline was revenue-related versus say gross margin?

As we stated earlier, Roy, our revenue decline was slightly less than 3% sequentially. And of that I would estimate two-thirds of our overall income decline was a derivative of margin pressure.

Right, and operating expenses for Electronics Marketing sequentially were essentially flat so that the decline in operating income was all in the gross margin category so you can certainly figure from there. You know how much of that was revenue and the balance margin erosion.

Got ya. Thanks.

Our next question is coming from Steven Savas of Goldman Sachs.

This is John Marshall for Steven. I had a quick question on inventory. I know that you said your customers were working down some inventories this quarter, especially in EM that affected you guys. I'm trying to get a handle on how quickly you guys are able to react to that reduction in inventory and you mentioned that you were going to be reducing inventories, probably in EM, in this quarter. Is that something that's likely to take a few quarters or something you may be able to address in one?

Okay. I think, John, I think that's one of the big topics of the day. Harley, take the first pass at that and then I'll fill in a little bit.

Sure, we believe we made a lot of progress in the recently completed quarter in bringing inventories in proper alignment with revenues. Many of the actions we took in the recent completed quarter will continue to show efficiency benefits in the just started quarter. So we think our velocity metrics will improve in calendar Q4 over calendar Q3 and looking forward past that, we believe that we can bring them back to close to record levels that we set last year.

So, John, I think, Harley gave you the direct answer to your question. We feel we've got our backlog in good position. We will have an inventory reduction this quarter. Then depending on what happens in revenue, we will get back to the velocity metrics in rough terms, that were record-setting last March quarter. The comment I'd like to insert here is just an observation that this mid-cycle correction that we believe is occurring, we cannot identify any firm examples of demand deterioration. There is growth in the IT industry. It seems as though business spending on CapEx is continuing to rise even if it is at a moderate pace. There does not seem to be any direct evidence of slowing in consumer spending. So given the lack of deterioration and demand and yet seeing weakness in bookings that is resulting in some weakness in billings. We believe this is about customers reducing their inventories and reacting to lower lead times. Product has accumulated with suppliers but to a much lesser extent with our customers and, therefore, we think from a cycle time perspective we're going to work our way through this over the next quarter or two and we should be back to normalized levels at inventories.

Thanks a lot.

Our next question is coming from Patrick Parr with UBS.

This is Lee Ann Soo(ph) for Pat. Can you give us more color on lead times and pricing trends -- by region and also by end market?

Can you repeat that one more time?

Can you give more color on pricing and lead times across different regions and markets?

Okay? Harley?

Sure. Are you inquiring looking back or looking forward?

Both.

Okay. For the quarter just completed we did see some pricing pressure across all three regions, actually. Currently, related to the second part of your question which is lead times, which continue to come down over the quarter. We do not anticipate significant change to lead times in the December closing quarter. We think they'll stay pretty flat to where they are today and pricing pressure will continue as well. Quite frankly until the inventory that Roy just referenced in the overall supply chain works its way through .

Okay, and has the pricing pressure been across all the different product lines? Or is it specific products?

It has really been quite frankly across all product lines. There are variances up or down, plus or minus, but in general I think a fair statement across all the product lines we support.

If I could ask one more follow-up question. What is your margin outlook going forward? Because if margins are lower in the Technology Solutions and Electronics Marketing, I would think margins that would be lower in December.

For the December quarter, it would be relatively normal for us to see an enterprise level decline in gross profit margin because there will be a big revenue mix shift over to Technology Solutions. And then in the March quarter it would be normal to reverse itself as Electronics Marketing regains as a percentage of Avnet total revenue. We actually believe that gross margins inside of the two operating groups should be relatively stable for the coming quarter and that change in gross profit margin for the enterprise will be largely connected to the revenue mix shift.

Thank you.

Our next question from Carter Shoop with Deutsche Banc.

Hi, guys. A couple questions, maybe just following up on the last one there with your expectations of gross margins being relatively stable in each division. I was curious how you plan on having gross margins stable particularly in the EM division, given the fact that pricing pressure continues and overall the higher margin geographies in America and Europe are set to decline.

I'll take that if that's okay. This is Harley. One thing to keep in mind when you think of EM and the component business is that you think back to what was occupying us in the early part of the calendar year, the landscape looked very different for us relative to where lead times appeared to be going and the behavior that many of our customers were involved with relative to expanding their pipelines and putting in more inventory. In support of that you saw, that many of us put in inventory and made a number of additive inventory purchases back in the early part of the calendar year, really designed to support lead time extension that appeared as well as growth we were enjoying. Much of that inventory purchased at those current market condition prices really has worked its way through our business. Much of it finishing up in shipping in the September closing quarter. When we look at the prices that we've been buying product from really throughout the quarter, pricing that will determine our margins going forward in this quarter as well as the one following it we see a much more advantageous position. So though we still see continued pricing pressure, we believe strongly that the deterioration we saw in the first quarter, our fiscal first quarter, will diminish for us specifically.

Okay. Great. That makes sense. To follow up there with regards to commodity pricing and your outlook for commodity pricing. If we were to see that pricing deteriorate meaningfully in the December or March quarter as a result of capacity coming online, would we expect you guys to reduce inventory levels further than initial plan - or your current plans right now?

I think as a general comment I suggest we will manage our inventories in concert with what our revenue performance is. So I would expect we will react really --

I guess what I'm getting at if you have your inventory for CM and all of a sudden if we're looking at pricing substantially deteriorating, would you guys reduce it given today's current lead times?

Carter, first of all, it's interesting hypothetical question, but our experience is that the kind of deterioration required to have a meaningful impact on inventory just doesn't happen, other than a complete industry collapse over a period of two or three quarters. If there is a additional pricing weakness in commodities, it's going to be in -- we'll measure this in mils, not even cents. Now to come back and answer that question more theorically, we manage in units, not in dollars. If the ASP dropped meaningfully? Sure. There would be a corresponding drop in inventory dollars.

I also would add an additional element, that it is also important to watch incoming booking levels as well, to determine our inventory purchasing behavior as well.

Great. One last question. On SG&A, I had a note here that you expecting that to increase by the $7 million sequentially, it was actually down $6 million which is 7% EPS impact. What happened there? Did we go halfway through the quarter and realized business was slowing down and we started to halt the payroll increases or to make restructuring or take initiative that is didn't come off the P&L? What happened there?

I think, Carter -- I think a number of different things. One, I was probably not as clear as I should have been on the last call relative to the $7 million. We did in fact have salary increases as were scheduled, but I shouldn't really have implied that because of that expense this would go up significantly because there are other items that would offset that. One of those, that we just briefly mentioned in the opening remarks, has to do with the benefits over in EMEA within our Technology Solutions group as the computer system came online. So you had that as a positive impact to reducing expenses.

In addition to that although not directly related to salaries and such, certainly related to compensation, from an incentive perspective, with a decline in gross profit margins within certain of our business units, specifically within the EM organization, that as well would have an impact of reducing expenses as it pays out less incentives. In addition to that we have other efficiencies as we continue to look at different areas of the business and try to find ways of operating the business on a more efficient basis. We continue to find ways to do so and have reduced expenses in certain areas.

Carter, just to give you a couple of numbers, this is Roy. If I look at last year just as an example and we think about the incentive compensation part of the equation that Ray was alluding to, as opposed to the salary part, in last year's September quarter we earned about 16% of the total annual operating income for the year. In the June quarter we earned about 33% so the variable compensation portion of our operating expenses certainly moves depending on which fiscal quarter we're talking about and Q1 would be the one lowest amount of variable compensation expense.

As you follow through on that and look at our December quarter with the expected increase in profitability due to strong December quarter TFs, we would expect expenses to go up, including expenses related to incentive compensation as well. As gross profit dollars and sales and profitability increase.

Great. Thanks a lot, guys.

We actually have a question that came in over at the web and then I think we may be through the questions unless anybody else has another one. Harley, I'm going to direct this to you. We've sort of touched on this already, in your guidance for Q2, what are your assumptions about unit growth and price declines for electronic components? and this is from Leonard Wilson of West Wind Capital.

Yeah, I think we did cover that earlier so let me restate that unit growth will be fairly flat to the recently completed quarter and as we said pricing pressure will continue, again, until more of the inventory overall on the supply chain works its way through.

With that, operator, any more questions?

No, sir. No further questions.

As we conclude today's quarterly analyst call we will quickly scroll through the slides mentioned at the beginning of our webcast that contain the non-GAAP to GAAP reconciliation of results presented during our presentation. This entire slide presentation including the GAAP financial reconciliations can be accessed in downloadable PDF form at our website www.ir.avnet.com.

We would like to thank you for your participation in our quarterly update today. If you have questions or feedback regarding the material presented today, please contact me at Avnet Investor Relations department by phone call or e-mail. Thank you.

Thanks, everyone.

This concludes today's teleconference call. You may disconnect at this time. Thank you for your participation.