安富利 (AVT) 2005 Q4 法說會逐字稿

I would like to turn the floor over to Vince Keenan, Avnet's Vice President and Director of Investor Relations.

Good afternoon and welcome to Avnet's fourth quarter and fiscal 2005 year-end corporate update.

If you are listening by telephone today and have not accessed the slides that accompany this presentation, please go to our Web site, www.ir.avnet.com and click on the icon announcing today's events.

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

Before we get started with the presentation from Avnet management, I would like to review Avnet's Safe Harbor statement.

This presentation contains certain forward-looking statements which are statements addressing future financial and operating results of Avnet. Listed on this slide are several factors that could cause actual results to differ materially from those described in the forward-looking statements. More detailed information about these and other factors are set forth in Avnet's filings with the Securities and Exchange Commission.

In just a few moments, Roy Vallee, Avnet's Chairman and CEO, will provide Avnet's fourth quarter and fiscal year 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 about the Memec integration after which a Q&A will be conducted.

Also here today to take any questions you may have related to Avnet's business operations are our two operating group presidents, 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 fourth quarter and fiscal year 2005 business highlights.

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

Looking back at the recently completed fiscal year, we're pleased with our overall performance given the mid-cycle inventory correction that impacted our Electronics Marketing group. As you may recall, the year got off to a slow start last September when a components inventory correction in Asia spread to other regions and precipitated two quarters of negative sequential growth at EM.

However, as a result of new levels of discipline in inventory and capacity management the supply chain reacted quickly and made this a relatively short correction for the electronic components industry. By the second half of our fiscal year, sequential quarterly growth resumed and our focus on asset velocity allowed us to close the June quarter with the highest inventory turns in the history of the Electronics Marketing.

At Technology Solutions we had a record year as our focus on adding value along with strength in the small and medium-sized business segment combined to drive double-digit year-over-year revenue growth. For fiscal year 2005, TS grew revenue by 10.5% and more importantly grew operating income almost five times faster than revenue.

Contributing to this performance was our Avnet computing components unit where strength of microprocessor sales delivered solid revenue growth for the year. Perhaps the most significant contributor to TS record profit performance, excuse me, record profit performance was our enterprise computing unit in Europe which swung to a profit for the year.

Overall, Technology Solutions improved its operating income margin for the year by 80 basis points to 3.1% in fiscal 2005, and it generated shareholder value for the fiscal year by delivering a return on capital in excess of 13%. These results demonstrate that our value-based management initiatives continue to have a positive impact on our profitability and return on capital.

Avnet, Inc.'s revenue which grew across all three regions in both operating groups was $11.1 billion for fiscal 2005, an increase of over $800 million, or 8% over the prior year. From an operating leverage perspective, our operating income drop through, or the percent of incremental gross profit dollars that drops through to the operating income line, was over 70% in both operating groups.

As a result of this focus on profitable growth, our pro forma operating income grew $63 million, or 25% from fiscal year 2004.

Excluding certain charges related to restructuring and debt extinguishment in fiscal 2004, pro forma EPS increased 34% in fiscal 2005. GAAP EPS more than doubled to $1.39 in fiscal 2005 when compared to EPS of $0.60 in fiscal 2004.

We're very pleased with the fact that revenue grew in every region in both operating groups and we grew pro forma earnings per share more than four times faster than revenue.

In addition to our earnings growth, another highlight of the fiscal year was our asset velocity. With EM setting a record for inventory turns in the fourth quarter, we were able to reduce our cash cycle by 14 days versus the year-ago fourth quarter and close out the fiscal year with record working capital velocity.

On an annual basis our working capital consisting of trade receivables plus inventory less accounts payable decreased 13% and our working capital as a percent of fourth quarter annualized revenue was a record low 14.9% at the end of June. In addition to the record working capital velocity, we achieved our highest levels of revenue, operating income, and return on capital in the past four years.

Also, due to earnings and record working capital velocity, we generated $426 million of free cash flow for the year. With the integration of Memec, we are confident we will continue to drive significant improvement in our key financial metrics and increase shareholder value.

As you can see on this next slide, we've added Memec to the EM quarterly revenue history in this chart to give you an idea of what our electronic components revenue would have been if Memec was a part of Avnet. Excluding Memec, EM revenue of 1.62 billion for the fourth quarter of fiscal '05 grew 1.5% sequentially in delivered U.S. dollars, and was up 3.1% if you exclude the translation impact of changes in foreign currency exchange rates.

Sequential quarterly sales growth at EM was led by the Americas region where revenue grew 6.2% followed by Asia at 3% where we achieved record quarterly sales.

EM EMEA, which has been impacted by softening demand, experienced a sequential revenue decline of 4% in delivered U.S. dollars but was actually flat on a constant dollar basis. Year-over-year EM revenue was up slightly from the year-ago quarter.

As I mentioned earlier, the mid-cycle inventory correction had a negative impact earlier in the year and revenue levels have returned to where they were before the slowdown. Although the Memec acquisition did not close until after our fiscal year-end and therefore Memec revenue was not consolidated in our June quarter, I would point out that Memec revenue was up 7.2% sequentially and down 1.9 versus the year-ago quarter.

As I will discuss in more detail later, Memec sales for the April 1st through July 4, 2005 quarter were positively impacted by shipments that otherwise would have fallen into our first quarter of fiscal 2006.

Moving to Technology Solutions.

Sales for the fourth quarter of fiscal '05 were $1.2 billion, an increase of 16.4% on a year-over-year basis in delivered U.S. dollars, and up 15.3% in constant dollars. This increase represents the third consecutive quarter where TS revenue grew double digits on a year-over-year basis.

Revenue in the Americas was up 19.5% year-over-year on the strength of servers and software.

In EMEA reported revenue was up 2.8% year-over-year and was down 1.4% if you exclude the translation impact of changes in foreign currency exchange rates. Asia revenue grew 56% year-over-year due to a significant increase in the sales of microprocessors.

On a sequential basis, TS revenue in the fourth quarter of '05 grew 3.7% in delivered U.S. dollars and 4.7% in constant dollars. At a regional level the Americas was up 12.7% sequentially while Asia and EMEA were down 17 and 13.2% respectively.

Microprocessor sales were down sequentially in all three regions in the seasonally soft June quarter although the decline was more than offset by strong sales in our enterprise computing divisions in the Americas and EMEA. We are very pleased with Technology Solutions' performance and expect that SMB spending on IT and our focus on solutions will continue to drive profitable growth over the next several quarters.

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

Thank you, Roy, and hello, everyone.

Let's begin with an overview of our operating results for the fourth quarter of fiscal 2005. This first slide shows a year-over-year comparison with the dollar or percent change in the highlighted columns to the right.

Starting with the top line, revenue in the June quarter of $2.83 billion increased 6.9% as compared with the prior year quarter.

Gross profit of 370.9 million was up $2.9 million as compared with the fourth quarter of fiscal 2004. Gross profit as a percentage of sales was 13.1%, down 79 basis points from the year-ago quarter primarily due to the lingering impact of the electronics components mid-cycle inventory correction.

In reported dollars, operating expenses of 285.2 million were up $3 million year-over-year. However, in constant dollars expenses declined $2.2 million.

Operating income of 85.7 million remained essentially flat as compared with the year-ago quarter. Operating income margin of 3.03% was down slightly over the year-ago quarter primarily due to the strong performance EM posted in the year-ago quarter.

Below the operating income line there was a $1.6 million increase in interest expense to $22 million, due primarily to rising short-term interest rates, and a $1.3 million increase in other income on a year-over-year basis, due primarily to interest income on higher cash balances and foreign exchange gains.

The fourth quarter tax provision was positively impacted by the final mix of profits for the year by country with varying statutory tax rates. The positive impact of the tax rate catch up on net income for the fourth quarter was approximately $0.02 per share.

The resulting effective tax rate in the fourth quarter of fiscal '05 was 27.3% as compared with 25.9% effective tax rate in the fourth quarter of fiscal 2004. All in all, this resulted in net income of 47.3 million, or $0.39 per share as compared with net income of 48.7 million, or $0.40 per share in the year-ago quarter.

We expected that our effective income tax rate will increase in fiscal 2006 as the majority of Memec's profits and the synergy benefits to be realized in the integration are in higher tax rate jurisdictions. The Q1 2006 fiscal guidance that Roy will provide later assumes a 33% effective tax rate. This of course is subject to change as we move throughout the year.

This next slide highlights the sequential change in our results for the fourth quarter of fiscal 2005.

Revenue of 2.83 billion was up sequentially by 2.4% in delivered U.S. dollars, and 3.8% in constant dollars from the March quarter. Gross profit increased 6.4 million to 370.9 million, and gross profit margin of 3.1% was down slightly as compared with the March quarter.

Operating expenses of 285.2 million were down 800,000 sequentially. At an operating group level TS expenses were up in support of strong sales in our enterprise computing business while EM expenses were down 3.6% due to further operating efficiencies in EMEA and the Americas.

Sequentially, operating income increased $7.2 million, or 9.2% while operating income as a percent of sales increased 18 basis points to 3.03%.

Interest expense moved up sequentially due to rising short-term interest rates. Net income of 47.3 million was up 6.2 million, or 14.8% from the March quarter, and earnings per share came in at $0.39 per share.

This next slide looks at some of the productivity metrics that we use to monitor our business.

As you can see in the graph on the left our expense to sales ratio decreased sequentially by 28 basis points to 10.1%. This improvement is due primarily to some further operating efficiencies at EM during the June quarter.

On a year-over-year basis, our expense of sales ratio declined 58 basis points with both operating groups contributing to this improvement.

As the graph on the right shows, this quarter our ratio of expense to gross profit dollars declined 157 basis points sequentially versus the March quarter. This improvement was driven by both EM and TS as we continued to stay focused on operational efficiencies and drive profitable revenue growth.

On a year-over-year basis, expense to gross profit remained flat as the year-over-year reduction in operating expenses as a percentage of sales was offset by lower gross profit margins in the current year due to the impacts of the previously discussed electronics components mid-cycle correction. For fiscal 2006, with the integration of Memec, we will continue to drive operational efficiencies to lower our cost structure which should have a meaningful impact on our key financial metrics.

This next slide portrays operating income margin performance and working capital velocity, two core metrics of our value-based management initiative. As you can see on the left operating income margin of 3.03% improved 18 basis points when compared with the third quarter of fiscal 2005.

In the June quarter Electronics Marketing's operating income margin of 4.03% was 18 basis points better than the prior sequential quarter, but down 65 basis points as compared with the year-ago quarter, which was the last quarter before the electronic components mid-cycle correction impacted all three regions.

Technology Solutions quarterly operating margin of 3.11% was the highest for a June quarter in four years. This performance was 38 basis points higher than the prior sequential quarter and 75 basis points higher than the year-ago quarter.

The chart on the right depicts working capital velocity, another key performance metric in our return equation.

Consolidated working capital velocity reached 6.4 in the June quarter, up strongly from 5.7 in the March quarter and 5.4 in the year-ago quarter. At EM strong inventory management resulted in record inventory turns of 5.2, contributing to a near six-day sequential reduction in its cash cycle.

TS had another good performance in working capital velocity with a 29% sequential and a 44% year-over-year improvement, representing the 15th straight quarter in which TS has improved its year-over-year performance in this key financial metric.

As you can see on this graph, our return on working capital improved significantly by 299 basis points sequentially to 19.3%, due to a combination of higher operating income margins and higher working capital velocity. This is our best performance in the past four years and is further evidence of how effective our VBM initiatives have been at driving returns.

On a year-over-year basis, return of working capital improved 186 basis points primarily due to higher working capital velocity. We remain focused on profitable growth and operating efficiencies to drive this number higher as we believe this metric is critical to shareholder value creation.

We closed out this fiscal year with another strong quarter of cash generation driven primarily by earnings and working capital reductions. We generated 51.1 million of free cash flow during the quarter bringing the total free cash flow generated for the year to 425.7 million.

As a result of this performance we ended the quarter with 638 million of cash and cash equivalents and net debt of 607 million, the lowest net debt has been since the fourth quarter of fiscal 1999.

Concurrent with the close of the Memec acquisition on July 5th, we used approximately 333 million of cash on hand to pay the cash portion of the purchase price, transaction-related expenses, and nearly all of the outstanding debt of Memec, thus immediately beginning to realize net interest expense synergies of at least $10 million annually.

Our debt-to-capital ratio at the end of our fiscal year was 37.2%. Adjusted for the acquisition of Memec on a pro forma basis our debt-to-capital ratio improved to approximately 33.6% as of July 5, 2005.

The next slide portrays our pro forma capital structure after closing the Memec acquisition and simultaneously paying off a majority of Memec's outstanding debt.

As of the close of the transaction on July 5th, Memec had approximately $52 million of cash and 292 million of debt on their balance sheet. After using approximately 343 million of cash to pay for the cash portion of the acquisition price the retirement of nearly all of Memec's outstanding debt, including accrued interest and other transaction-related costs, we started the new fiscal year with 347 million of cash on our balance sheet.

Our book equity increased by $418 million due to the 24 million new shares we issued as part of the purchase price. When combined with our post transaction debt of 1.27 billion we have reduced our debt-to-capital ratio from 37.2% to 33.6%.

The ability to improve many balance sheet and credit statistics while closing a transaction of this magnitude is a result of having adequate cash on hand. Although we often mention how our VBM initiatives drive better financial performance, the 426 million of free cash flow generated in fiscal 2005 are our focus on working capital paid an added dividend this year.

In addition to the cash outlay completed for the acquisition of Memec as I just described, we expect to use cash during the first quarter of fiscal '06. That takes into account a $54 million accelerated contribution to our pension plan in the U.S. that we made in July 2005, our expectation that working capital will be roughly flat to the June quarter, including Memec, and takes into account some cash outlays for severance and other Memec integration-related costs.

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

Thanks, Ray.

Before we move on to guidance, I'd like to review the status of the Memec integration and then Ray's going to provide an update on the recording and timing of the financial impacts.

Although we closed the Memec acquisition just over a month ago on July 5th, the important task of planning for this day began more than three months ago when the transaction was announced on April 26th. Project teams from both companies immediately went to work evaluating what was the right strategy and structure for EM in each region of the world.

Their work was driven by two primary objectives. The first objective was to ensure a seamless transition for our customers by shortening the transition period as much as possible. With a global integration of two multi-billion dollar businesses we wanted to quickly stabilize the organization and maintain EM's focus on customers and suppliers.

Our second priority was to reposition the organization to accelerate the achievement of our long-term financial goals. By adhering to our long-standing integration principle of retaining the best people and the best practices, we are also strengthening the talent level of our organization and improving our value proposition to our combined customer base.

In addition to their internally focused analysis, some of the teams also spent considerable time talking to customers and suppliers to understand which structure would best preserve the demand creation capabilities of Memec and optimize Avnet's value to the industry. As a result of this business combination, Avnet will achieve the industry's best balance between design and supply chain revenues, along with a much more efficient cost structure that will drive higher returns to shareholders.

Now let's take a quick look at the status of the integration.

As you may have seen in press releases, we have established an Avnet Memec specialty business in each region to focus on demand creation for particular suppliers. These specialty business units have their own dedicated sales and technical organizations but will leverage EM's common resources such as IT, logistics and value-added services.

This structure allows us to focus on additional market opportunities by minimizing supplier conflicts. When combined with our existing structure, Electronics Marketing will offer an outstanding line card complemented by the industry's best balance of world-class design and supply chain services in every region of the world now including Japan.

Initial reaction from customers has been very favorable. They see real positives to reducing their vendor base and gaining access to the resources of the combined business.

By shifting a higher percent of their purchases to Avnet's supply chain services, customers can also lower the cost of managing their supply chain while at the same time reducing inventory levels and risks. We are optimistic that the combination of a broader line card and enhanced services will increase our overall share of our customers' business.

Turning to our suppliers, we have experienced a similar positive reaction. As suppliers consider the benefits of having the largest sales force in the industry, selling their products at every major electronic components market, we've had several suppliers expand the relationship to include new geographies and become global in scope.

By retaining the majority of Memec's customer facing personnel with their strong engineering focus and technical expertise, we've been able to retain their unique demand creation capabilities. We remain committed to being the most efficient channel to market and continue to believe that revenue losses as a result of the integration will be offset by cross-selling opportunities as we work our way through the integration process.

Turning to things we have more control over, we're moving quickly on personnel decisions throughout the organization. Guided by our practice of retaining the best people, we have announced the EM leadership team in all regions and I am pleased to welcome eight new members to the senior executive team who joined us from Memec.

At the regional level, timing varies a bit as expected due to regulatory requirements and the scope of the integration. In the Americas region, we are well on our way to completion.

Over the last weekend in July, we integrated the IT systems in America and physically relocated Memec's inventory from their distribution center in Reno, California to our Chandler, Arizona facility. Throughout July in the Americas, we trained the former Memec salespeople on Avnet systems, and by the first week of August the former Memec team was in their new Avnet sales office working with their new colleagues on new systems with inventory shipping from Avnet's value added logistic service center in Chandler, Arizona.

The majority of personnel notifications in the Americas have been made and the process of assigning accounts is now complete.

In Europe our progress will begin by the labor regulations in individual countries. With that said, early in July we transferred Memec's inventory into our [Poin] facility in Germany.

Where applicable, teams are meeting with workers counsels to develop restructuring plans and we expect to move quickly once those plans are approved. We expect to have Memec's systems transferred to Avnet's IT platform during the second quarter of fiscal 2006, and expect the bulk of the restructuring will occur in the second and third quarters of '06.

In Asia, where we have less restructuring to do, we've also identified the leadership team and are busy assigning accounts and training customer facing personnel to sell an expanded portfolio of products and services. Similar to Europe, we will convert IT systems during our second fiscal quarter and we expect a majority of personnel moves to be completed by the end of the calendar year.

In summary, the Memec integration schedule is right on track and proceeding smoothly. The majority of the integration should be done in the first three quarters of this fiscal year and should essentially be complete by the end of March 2006.

We expect the integration to be 100% complete by the end of fiscal '06 and estimate we will realize operating expense savings of at least $120 million per year and net interest expense savings of at least $10 million a year. By the first quarter of fiscal '07, five quarters from now, we expect the full benefits of the $130 million in annual synergies to be included in our financial results.

With that, let me turn the commentary back over to Ray to provide some additional details on the timing of the financial impacts relating to the integration.

Thank you, Roy.

With only five weeks of being a combined business, I'm going to preface my synergy update with a few qualifications. Although we are 100% confident in the minimum 130 million of cost synergies, the exact timing of those synergies is a bit more difficult to estimate.

With a global integration of two multi-billion dollar businesses, there are too many moving parts to be precise with the timing of the financial impact at this stage. What we've done on this slide is to provide some detail on our expected progress and how that could impact our income statement for fiscal 2006.

Not shown on this slide is the $10 million of annualized net interest expense savings that we began to realize with the payoff at closing of nearly all of Memec's outstanding debt.

To start, let's take a look at where the synergies will come from. Roughly 60% of the synergies are people-related and will be realized through the fiscal year as we reduce census.

Another 20% is tied to the elimination of redundant sales offices and distribution centers and incorporates both leased and owned facilities. The final 20% is primarily driven by the elimination of depreciation on owned IT-related assets and termination of IT-related maintenance and other contracts that will no longer be used in the combined business, along with some other miscellaneous expenses related to general administrative functions that will be eliminated on an ongoing basis.

As for timing, the quick start in the Americas region will contribute to allow us to achieve 35% of our synergy goal at the end of September 2005. By the end of the second quarter and third fiscal quarters, we expect to complete another 25% and 35%, 30%, excuse me, of the integration respectively as both EMEA and Asia will ramp up the implementing of their plans.

As Roy mentioned earlier, labor regulations in various countries add another variable that could change these percentages somewhat. However, we do expect to have achieved approximately 90% of the annualized synergies by the end of the March 2006 quarter.

The remaining 10% of the integration will take place in the fourth quarter and we will be 100% complete at the end of the fiscal year.

The next line on this slide provides an estimate of the quarterly synergies that we expect to have achieved by the end of each quarter based on the integration schedule, and measures our progress towards our goal of $30 million in quarterly operating expense savings by the end of fiscal 2006. The third line on the slide portrays a specific amount of incremental synergies we expect to achieve in each quarter.

Although these two lines quantify our progress, the reported operating expense savings impacting each quarter's P&L will be lower due to the fact that the restructuring actions will take place throughout the quarter and we won't realize 100% of those savings until the next quarter.

The next line represents our best estimate of the reported operating expense savings impacting each quarter's P&L.

The final line provides a cumulative tally of the annualized synergies achieved on a year-to-date basis. As you can see, we currently expect to realize approximately $71 million of cumulative operating expense savings in our fiscal year 2006 P&L.

I would also point out that the synergies are therefore back-end loaded with 52 million, or over 70% of the annual impact occurring in the second half of the fiscal year. Beginning in fiscal 2007, we'll have completed the integration of Memec and will be realizing operating expense savings at the annual rate of at least $120 million, or $30 million per quarter.

Also, it is important to note once again that we have already achieved the full net interest expense synergy of approximately $10 million annually through the paydown of certain of Memec's debt on the July 5th close date.

We remain committed to the long-term business model presented in New York at our annual analyst day in December. Many of you will recall that our goal was to achieve return on capital employed of 12.5% within three to five years.

We believe the benefits of the Memec acquisition should allow us to accelerate reaching that goal so that it can be obtained within a two to three-year period. In addition to the Memec integration activity, we will continue to manage our business by group by region to achieve these goals.

Now let me turn it back over to Roy who will provide our outlook and guidance and some additional closing comments. Roy.

Okay. Thanks, Ray.

Now for our guidance. Looking forward to Avnet's first quarter of fiscal '06, it's a particularly difficult quarter to forecast due to moving parts in EM with the integration of Memec.

We expect revenues for Electronics Marketing, including Memec, to be in the range of 2.11 to 2.16 billion. And we anticipate sales for Technology Solutions to be in the range of 1.09 to 1.14 billion.

Therefore, Avnet's consolidated sales should be in the range of 3.2 to $3.3 billion in the first quarter of fiscal '06.

EM's sales guidance is negatively impacted by approximately $40 million due to factors related to the Memec acquisition. First due to the timing of the closing of the acquisition, one day of Memec shipments in July were included in Memec's preclose results of operations and are therefore excluded from Avnet's first quarter 2006 results.

More importantly, due to the merging of warehouse operations in Europe immediately following the close, it was necessary to expedite certain shipments originally scheduled for early July into June in order to ensure meeting commitments to customers. These projections also take into account that the September quarter is typically a slower seasonal quarter as we complete the summer months.

Based on the anticipated sales, we now expect earnings to be in the range of $0.30 to $0.35 per share. The net income guidance does not include the charges associated with the Memec integration, the expensing of stock-based compensation, or the amortization of intangibles associated with the acquisition of Memec, but it does assume the 33% effective tax rate that Ray mentioned earlier.

Please note that we're not providing annual guidance, which we normally do not do, and which with all the activity surrounding the integration of Memec would prove to be very challenging anyway. However, we feel reasonably good about the markets we serve now that the inventory correction and the electronic components industry appears to be complete.

The Memec acquisition is going very well and incoming orders for the first five weeks of this quarter are encouraging.

And with that, let's open the lines up for Q&A. Megan?

Thank you, sir. [OPERATOR INSTRUCTIONS] Our first question is coming from Brian Alexander of Raymond James.

Thanks. Good afternoon. Roy, just to pick up on that last comment you made about encouraging order trends. Just trying to get a sense for your overall guidance in EM if we were to exclude Memec sequentially. I'm coming up with about flat sequentially, and I'm just trying to reconcile that with your comments that order trends are encouraging.

Brian, that's correct. Normally for the summer we would expect EM to be flat to down maybe a couple of percent.

If we try to factor this anomaly related to the timing of the Memec close and to move the warehouse, it turns out that EM revenues will be flat to maybe down 1%. So at this point, you know, we see things as being normal to maybe slightly ahead of normal in terms of market conditions for Electronics Marketing.

And if I were just to better understand your earnings guidance for September, if I just look at your operating margins using the midpoint of your revenue and earnings guidance, it looks like you're implying about 2.9% operating margin which is actually down sequentially from June despite the fact that your mix is shifting heavily toward the Electronics Marketing group. So just help us understand why the operating margin declined sequentially, how much of that is an actual decline in your traditional EM business versus TS or maybe just walk us through that.

Yeah, Brian, hi, it's Ray. I think the margin, the operating margin you suggested is reasonably close. And I think you have to look at the factor of, the revenue that Roy mentioned, the commentary we put in our press release relative to the $40 million because that is incremental gross profit dollars or would have been incremental gross profit dollars which has a reasonably significant impact on operating income. So that's probably the primary factor that's going to impact that.

So should we expect TS operating margins to be roughly flat sequentially or how should we think about the individual segments?

If you look at, if you combine all the segments I guess you would expect to see, with the sales decline sequentially at TS, you will see some operating margin decline.

Okay. Then just last question. You mentioned earlier the drop through being 70%, I think that's, your long-term goal is to be 70 to 80, how confident are you that you can keep the drop through above 70 for the entire fiscal year '06?

A couple comments relative to the 70. It depends upon the business unit. I think our expectations with Technology Solutions is not that high because they're already performing from a return on capital perspective above our target levels. So the 70 to 80% first refers more to Electronics Marketing until we get up to that level and I think we are very confident we will achieve those on an ongoing basis.

You'll certainly have situations where any particular quarter we may not hit those numbers but I think as you look and obviously some of the, when some of the synergy impacts are reflected in our financial statements will certainly impact those numbers to some extent, but from an overall perspective until EM achieves its overall return on capital goals, we would expect to be able to achieve a 70 to 80% drop through on a reasonably consistent basis.

Okay. Great. Thanks.

Our next question is coming from Carter Shoop of Deutsche Bank.

Thanks. I wanted to better understand some of the charges that you're going to be taking in the current quarter in regards to Memec and how much of that's going to be flowing through the P&L. For example, moving the inventory around, training employees. Is that going to be considered a one-time charge or is that going to be flow through the P&L?

I guess, hi, Carter, it's Ray. I guess a couple things. The bulk of the charges that we have will not flow through the P&L, they will be goodwill-related charges and they will relate to severance, lease commitments, being the two biggest items by far, and then some asset write-offs as I think I mentioned in my commentary, as we bring over some of the Memec IT things as an example, you know, a lot of the equipment and stuff we already have in place. So there will be a, where we have our own IT systems as an example so you'll see a fair amount of write-offs of IT-related equipment.

So with the severance, IT-related equipment, as well as the facilities which for the most part we will be vacating Memec facilities as opposed to Avnet facilities, the bulk of those charges will go through the P&L. Having said that, there certainly will, sorry, will go through goodwill, excuse me. Having said that, there certainly will be some charges going through the income statement.

At this point, don't have a handle on how much that's going to be but I think in the scheme of things through the year, it's not going to be a huge amount of money but there certainly will be some and as soon as we're at a point of being able to get a little bit more precise relative to how those are going to be split out between goodwill and impacting our financial statements we'll let you know, but again, I think the vast majority is certainly going to go through and impact goodwill.

Great. Maybe as a follow-up. Just based on initial calculations here, it looks like the profitability level at Memec is going to be a little bit below what I was expecting especially given the fact that your Americas region's going to have two months of systems being integrated work force reductions, etc. Can you talk a little bit about where Memec's operating margin was in the June quarter, where you're expecting it to be in the September quarter? And that would be relative to the pro forma 2.8% operating margin that you guys posted for 2004 for Memec there.

Okay. Well, I can answer the first part of the question but not the second part of the question because Memec really as a stand-alone entity will not exist going into our first quarter. Although we will have, as Roy described in his commentary, we have set up some specialty business units from a sales perspective. They will not be fully loaded, burdened P&Ls. So Memec as a stand-alone business entity for the most part will not exist.

In terms of Memec's, hopefully I have it here, Memec's operating income margin, oh, they're in the roughly 2.8% range thereabouts for the June quarter. But again, keep in mind that, and I don't want to be too precise with the number because there's a lot of items that, as Memec being a non-public company, there are a lot of unusual items that flow through their P&L and we can debate for ever what's non-recurring or special or normal, all that kind of stuff so just a rough order of magnitude would get you to about a 2.8% or thereabouts, operating income margin for their fourth quarter.

Great. Thank you.

Our next question is coming from Bernie Mahon of Morgan Stanley.

Hi, good afternoon.

Hi, Bernie.

Roy, I had a question for you just in regards to your last comment on encouraging order trends. Could you talk a little bit about that by geography? I mean it seems like right now we're in a pretty slow period for Europe, North America I would think is pretty back-end loaded quarter also and could you just talk about what you're seeing in Asia? I guess I would expect some pickup in activity there just kind of given the back-to-school build.

Yeah, Bernie, I've got Harley here so why don't we ask him to cover that question?

Thank you. Hi, Bernie.

A little regional color. In Europe, to start with, where you started, we're seeing incoming orders actually at a very encouraging level based on what our normal expectation would be based on normal seasonality. So the incoming order levels, at least through the first five weeks of the summer quarter, have stayed stronger than we really anticipated.

In the Americas, I think it's fair to accurately describe it as a fairly flattish line. We're seeing pretty consistent order levels with what we saw in the previous quarter.

And yes, I think your assumption in Asia is accurate. We are expecting some growth and we are seeing some very encouraging incoming order behavior out of Asia.

Okay. And then just maybe as it relates to end-markets, particularly in Europe. Where are you seeing that incremental strength and also the other regions if you have that?

It's really across the board, Bernie. It's, our again, our base coverage is so broad that there's no single end segment that really is uniquely outstanding at this point relative to its behavior.

All right. Thanks a lot.

I would add one last comment, Bernie, and I guess it's a bit of an editorial. Currently with the inventory levels behaving as they have all through the channel, it's really impacting customer behavior across the board through all segments. That's really the biggest driver from my perspective.

What are you saying, that customers are building inventory just because their inventories are low?

No, I'm saying that customers, end demand appears to be holding up nicely and their inventory they're holding is very low.

Okay. That's better. Thanks.

Our next question is coming from Matt Sheerin of Thomas Weisel Partners.

Thanks. Hi, Ray and Roy. Just a question on gross margin. I know that you've talked about Memec's gross margin being, I think last year around 17% so if you could help us sort of get to a blended number. Doing the numbers I get to around 13.7 or 13.8 for September, is that right?

Just for Electronics Marketing?

No. Just for the whole Company, just blended for the Company.

The whole Company, probably be slightly less than that.

Okay. And I know you gave lots of numbers about costs coming out and some you know, some you don't, but could you give us a ballpark of the op ex as a percentage in the September quarter then? And what your goals are? I mean I know getting to a specific number's difficult but what are your kind of longer term goals on SG&A as a percent and then operating margin?

Well, I guess the way we'd look at expense, our long-term goal is probably more tied to gross profit dollars.

Okay.

And it's in the, let's say the 65% range as a target number. Expectations for Q1 overall of expense to sales will be a little bit higher than the June quarter. And again, a big factor is a comment I made earlier in response to Brian's question and that is when you look at the $40 million of sales that just are not in the Q1 numbers, and most of the expenses being in there that will have the impact of driving up the expense to sales ratio. So more likely you're looking at, I've got a rough ballpark figure at this point in time, maybe 10.5%, maybe a little bit less than that.

Okay. Great. And then on the, on semiconductors and components, there's no commentary on pricing and we're hearing kind of mixed things but generally things seem to be relatively stable. Any comments there?

Harley?

Yeah, hi, Matt. Pricing is clearly stable. We manage and track ASP as does everyone else and there really has not been any significant movement in either direction through the June closed quarter. But clearly we continue to see strong pressure on pricing, more so than ASPs.

Meaning our margin.

Margin. Margin.

Your margin, okay.

Margin pressure as opposed to pricing pressure.

Okay. And just lastly on Tech Solutions your guidance implies a little bit more than sequential decline that you saw last year, if you could just comment on that. It looks like it'll be down in the mid-single digits sequentially.

Rick, why don't you take that one?

Yeah, good morning, Matt. Yes, absolutely, the issue there is more I think on a great June quarter. We grew sequentially from Q3, which if you remember last quarter when we had the call, we were projecting breaking the pattern where Q4 was down sequentially from Q3, set out a guidance of one to five up and we were up about I think it's 3.7 in delivered dollars sequentially.

So we broke that particular pattern and with the 16% year-on-year growth it's higher than the lower double-digit say 10, 11% growth that we've usually been seeing. So we're looking at that sequential growth now for Q1 at, I think it's 7.7.

And if we hit the midpoint of that guidance by the way, Matt, nine months of calendar '05 to nine months of calendar '04 we would be at 11.7, somewhere around 12%, you know, nine month to nine month growth, keeping ahead of that double-digit. So more of a statement around a great June quarter than it is foreseeing some disappointment in September.

Okay. Thank you.

Matt, this is Roy. I just, I would add that we don't see any particular weakness by geography, by business unit for TS in the summer. The forecast is just a rollup from the field taking into account the July actuals.

And I would say to the extent that we move towards the high end or low end of that forecast, a lot of the story will be told around microprocessor sales for the September quarter. They're normally strong in this quarter and typically strong in the September months. So that'll be Rick's wild card this quarter.

Okay. And Roy that's mostly AMD, right?

Predominantly. We still have some intel in Europe and Asia but it's heavily weighted towards AMD for us.

Okay. Thanks.

You bet.

As a reminder to participants, if you would like to ask a question, you may do so by pressing star one on your telephone keypad. Our next question is coming from Scott Craig of Banc of America.

Good afternoon, everybody.

Hi, Scott.

Roy, can you help us on the people cost savings. Can you take us through again how many people you expect to let go overall compared to the 2400 people that Memec originally had?

And then can you also discuss the tax? Is there opportunities to get the tax rate a little bit lower, particularly as Asia's probably going to be your fastest growing market over the next few years? Thanks.

Yeah. Scott, let me do the people part. I'll give Ray the tax part.

We have been avoiding talking about headcounts really just due to sensitivity for all the people involved. But if you look at the numbers in aggregate, you can see that, you know, we're talking about removing something like 40% of the Memec total SG&A.

Bear in mind some of that is real estate, IT, things that Ray mentioned. So the personnel impact won't be quite that large but it'll be in that ballpark as a percentage of the Memec staff. Ray on the taxes.

Yes, Scott, on the taxes, I think if you look at the Memec, two things are impacting the overall tax rate. One is, if you just think about how tax rates are calculated in general, we have, as most businesses do, have some permanent items that are in there. Those are dollar-based benefits, so to speak.

So as your profits increase, those fixed tax dollar benefits that you get have a lesser and lesser impact, or a greater and greater impact on your overall effective tax rate. So your profit's going to go up and that will have a bias towards moving your tax rates higher unless those profits are in lower tax rate jurisdictions. Which brings us to Memec and your question related to Asia.

If you look at Memec overall and where its profits were around the world, it was predominantly in the Americas and in the Americas we have a 39.5% tax rate. If you look at their largest operation it was also in the Americas because that's where their corporate headquarters were and that's where there, for the bulk of, I shouldn't say the bulk, therefore a significant amount of the synergy savings and therefore benefits to profits will also come in the Americas and again that's at a 39.5% tax rate.

So even with Asia being our fastest growing region at a significantly lower tax rate let's say depending upon the country, 16, 17, and 18%, it's still not going to be enough to bring that tax rate down. So we believe that right now could it go higher than 33%? It's possible. I don't think it's going to go much lower. I don't think we're going to see 30% tax rated that we've seen in the past, which again, were driven to some extent by lower levels of profitability. So as profits start to move up the tax rate's going to move up as well.

And then, Scot, just to be clear back on the people for one moment. We talked about numbers relating to the Memec staff but of course we are adhering to our principle of best people in the integration and focused on retaining the majority of the Memec customer facing personnel. So some of the reductions will be coming from existing Avnet people as well.

Roy, can you remind me how much of the employees were customer interfacing?

I believe the last time I looked at that data it was 1800 of Memec's 22 --

We've got to characterize customer facing. That's a broad category. If you're talking about feet on street, it was not --

Right.

In the sales operations. Right.

I don't know how the exact numbers. So 1800 is not, certainly not salespeople which I think --

It includes back office support and the sales managers.

So I certainly don't have, I don't know if you guys have, we can get back to you on the question but how many direct customer facing personnel, it's certainly not that high of a number. And we can get back to you with the specific number after the call.

Okay. Thanks.

You're welcome.

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

A couple questions. First of all, Roy, you mentioned a couple times that operating cost savings would be at least $120 million. What is it that you see as further opportunities? I'm sure you don't want to call too many things out, but in general, what else is beyond what you've already targeted?

Well, Steve, you were there, I think, in New York when we presented our long-term business model.

Yes.

I think most of the folks on the call are aware that Technology Solutions is already operating at that model. Electronics Marketing is not yet producing the return on capital and return on working capital that we feel is necessary for a long-term healthy business. And so our primary focus right now is on integrating Memec and ensuring a smooth and rapid transition.

But our goal doesn't stop there. Our goal is to drive EM by region to achieve our long-term financial model. And that's where additional actions could be identified and will be taken, Steve.

Okay. And then secondly, if you look at the specialty business units you set up, you mentioned some margin pressures, but when you look at those business units specifically, is there any reason to think that they won't be as profitable as say Memec was in the past? Is there anything that's changed in the dynamics now from the consolidation?

No. I can't give you anything that's changed.

Okay. And then, lastly, for those of us who need to choose to include option expenses in our numbers, would there be a significant change from what has been published in the 10-Qs, Ray.

No, I don't think so. I think in the 10-Qs you're talking roughly $0.02 per quarter.

Yep.

At this point I don't see anything that's going to significantly change that number.

Thank you.

Steve, starting last year, we began moving away from the use of options, not totally but reducing the use of options. And you'll see that --

Right.

As we roll through the next year and two.

We'll be putting in a different long-term compensation plans which will have different elements, significantly less stock options as Roy mentioned, so that'll have different accounting treatment but overall I think the ballpark number for right now is roughly $0.02 per share.

Thank you very much.

Our next question is coming from Kevin Sarsany of Foresight Research.

Hi, guys. I have a question you mentioned and I actually wasn't sure if I should bring this up, but you mentioned it about the Memec cost savings some relate to Avnet. How much of the, is the figure you're giving out there the total Avnet and Memec cost savings?

The cost savings or the cost to achieve the savings?

The cost savings from personnel facilities. Because you mentioned --

The $120 million includes everything, yes.

Okay. So that includes anything you're doing with Avnet?

At the moment, yes. But as Roy mentioned just a second ago, you know, as we go through the fiscal year and look at EM's ability to achieve our long-term goals, you know, other things are possible.

Okay. And on the Avnet changes or personnel reductions that you're doing, is it focused in a certain region or is it just region by region?

No. It's really just focused on the integration in general. It's really, it's, at this particular point in time, it is tied to the smooth integration of Memec into the Avnet organization and just going back to what Roy mentioned earlier, best people versus best practices.

Kevin, one color I could put on that is in America and in EMEA, we and they had the biggest operations and as Ray said earlier that's also where their corporate office was. So there are a substantial amount of synergies coming out of the West, per se.

In Asia PAC there are some synergies but it's predominantly being viewed as a growth market so we'll consolidate management, some facilities, some IT, but there won't be significant synergies there and then in Japan essentially nothing. It's not impacted other than we'd like to continue to add resources and grow our position in that large market.

Okay. And a follow-up on Asia is I think on the last call you were talking about Asian EM margins being about half of Americas and EMEA with Memec. Do you see those increasing?

Actually, Memec's gross margins in Asia are higher than Avnet's. There's a higher concentration of this design-win type revenue. So yes, our gross margins in Asia could move higher as a result of Memec.

How about operating margins?

Operating margins should move higher if nothing else as a result of the integration. We will have a lower overhead cost structure in Asia.

And also, Kevin, even though we're starting with lower margins overall, operating leverage does exist there as well. So as they grow as a region, we would expect operating margin to expand.

Okay. Thank you.

You're welcome.

Our next question is coming from Amit Daryanani of RBC Capital Markets.

Thanks. Could you give us a split in the TS segment between hardware and software?

Rick.

Yeah. I've got that. On a global basis, hardware 72, software 18 and services 10%.

All right. And then, you know, you just made a comment that end demand is holding relatively well and OEM inventory levels are rather low. I'm just wondering given that scenario would you expect to see some improvement in ASPs and lead times potentially stretching a little over the next few quarters?

Yeah. Amit, this is Roy. My answer to that would be, you know, seasonally for the industry, the business gets better here in the back half of the year predominantly related to consumer and IT spending. It is, I think the probability is good that lead times will be longer as opposed to shorter as we go through the end of the calendar year and typically ASP would follow the lead time.

So as long as there is capacity to support demand, ASPs will remain a bit under pressure as that capacity gets more highly utilized, and manufacturers can start tuning for profitability, you'll see some ASP elevation as well.

But my sense is that I would expect pricing to remain stable to maybe slightly improved over the balance of the year with lead times stretching somewhat and the wild card being capacity utilization rates as we go out of the year.

Fair enough. And then, what was the book to bill for you guys for the June quarter?

For the corporation or for EM?

You know, if you could give me both and if possible even by region.

It turns out they're essentially the same. The book to bill, Harley, for EM was right about parity for the quarter.

Yeah.

For the quarter.

Q4.

One to one. And TS. Amit, is almost always a one-to-one book to bill.

All right. And no real shift between different geographies either?

In the book to bill in the June quarter, Europe was slightly weaker. Not significantly but slightly. Asia was slightly stronger.

As we look at the beginning of this quarter, I think Harley already commented, the book to bill is actually quite strong but I wouldn't take five weeks, you know, out of context. We're just getting off to a very encouraging start this quarter.

All right. Thanks a lot, guys.

You're welcome.

Our next question is a follow-up question from Brian Alexander of Raymond James.

Yeah. Just wanted to ask a couple follow-ups. I want to go back to the synergies. I'm just trying to understand better I think you're looking for about a third of the savings in the September quarter, yet you alluded to the fact that the Americas is where most of the heavy lifting will take place because that's where most of the overlap is with Memec, and I think you're pretty much complete, at least that's what I read into your comments earlier, with the Americas integration, so just trying to understand why we wouldn't see more synergies in the September quarter if you've already made a lot of progress in the Americas?

Well, the main reason being two things. One, a lot of the actions are taking place, you know, they're almost done now or essentially done so you're midway through the quarter so you're not getting a full benefit for the quarter.

So it's not as though they're happening day one. They're happening during the quarter, midway through the quarter, so right now we're looking at, if you look at the, on the slide that we presented where there's $6 million of synergies, the bulk of that is in the U.S. It's almost all of it. And by the time we get done, does the number turn out to be slightly higher? That's a possibility.

So the percent complete that you provide, that's by the end of the quarter, or is that --

Yes. Right. So what you're looking at by the end of the quarter, 35% of 120 million is 10.5 million. And what we're saying is the impact during the quarter, because of when things happened.

Yeah.

Is 6 million bucks.

Got it. And then, just to go back to the assumption about no revenue attrition. Is that an assumption you would make in each region, or are you assuming you might have some loss in the Americas, for example, but then you'd have more cross-selling opportunities in Asia?

I'm looking at Harley here. I think it's by region, Brian.

You know, Brian, the reason why we feel it like, this is Harley. As Roy said, five weeks of data you need to be a little careful.

But part of our enthusiasm about the incoming booking levels is really based on the fact that relative to our supplier retention strategies, we really achieved almost everything we were looking to pursue there. Therefore, the levels really aren't disparaging very much by region, they're consistent with what we saw before. The supplier lineup and the customer lineup has remained so far pretty consistent.

And where, the last question just on Europe to follow-up. I guess were you surprised to see Europe flat sequentially and I guess so far looking pretty strong in this quarter? If you go back over the last few years I think Europe's been down about 2% to 8% in the June quarter sequentially in local currency, and this year you're able to hold it flat, so I'm just trying to understand if that's, you know, a stronger market than you might have expected or if you're just taking more share now?

It, there's two different comments here Brian. I think one is that Europe was looking for a while like the weakest region of the world. There were a little late coming to this mid-cycle correction and it felt like they would be late coming out. But we were pleased with the flat revenue in constant dollars for the June quarter and we're even more pleased with the bookings starting this quarter.

Relative to the market, you know, based on some other data we've seen it would appear that we're growing a little faster than the market in that region.

Great. Thank you very much.

You're welcome.

Our next question is coming from Craig Hettenbach of Wachovia Securities.

Yes. Thank you. Going back to the topic of lead times, could you discuss through the June quarter and first five weeks of this quarter, have you seen any change yet in the lead times?

Relative to semiconductors, if that's what you're asking, there has not been material change, although we have seen some isolated situations primarily in Asia of some parts tightening up a bit. But I would be remiss if I called it a change in the market. But we have seen some indicators specifically in Asia of some tightening.

Overall, to the Company now, do you guys quote a level of lead times that you are seeing in the market?

It would be a gigantic average of a thousand different [bar] types and multiple hundreds of different suppliers. So not a statistic we value very much.

Understood. Okay. Lastly then, just on the inventory front, you know, days of inventory at a historically low level and we are approaching a stronger seasonal period. Do you guys expect to increase inventory going into that build or how do you view inventory into next quarter?

If the question's specific to components, you'll recall when Ray did his comments earlier, he mentioned working capital and inventory specifically fairly flat, which is really reflective of the, I would ask you to think of that in the context of the sequential decline that we are, seasonal sequential decline we are looking at. So we are thinking that we need to be careful and we're watching the inventory levels very carefully through the quarter driven by our interest in what's happening in the incoming order levels.

Okay.

And also just keep in mind that when we're talking about inventory, you've got to be with the compares in that obviously Avnet's inventory's going to go up because we now have the Memec inventory as well, so what Harley's referring to and what I referred to earlier flat working capital, it obviously assumes the addition of the Memec working capital.

Understood. Thank you.

Our final question is coming from Jason Gursky of JP Morgan.

Hi, guys. Just a quick follow-up on the headcount. I know you don't want to talk about forward going numbers but if you could just give us a sense of what the headcount of the combined companies was on July 5th and where you stand today?

It was about 12,000.

Well, on July 5th -- wait a minute, Jason.

Yeah, July 5th and where we are today.

It was about 12,000 at announcement. I don't think we have that data in front of us, so we'll have to get back to you.

Just don't have it.

Okay. And then on a year-over-year decline in revenues from Memec, can you just add a little bit of detail about where that year-over-year decline came from and how their quarter kind of shaped up against what their plan was for the June quarter?

Well the, if you look at their decline, it was one, and going by memory, 1.7%. You know, our business was just the right side of positive year-on-year. We think we gained a little bit of share. I think their decline was relatively consistent with the marketplace year-on-year.

Jason, again, it's historical data that we don't have going back an additional year relative to the color. My guesstimate would be that you're looking at a variance in customer base focus between Avnet and Memec. If you think about their products and the types of industry those products service, I would guess that slight variance is a result of that.

And then the way that their quarter kind of shaped up according to what your expectations were?

The revenue for the quarter was a little stronger than we would have anticipated going in and part of that is attributable to these things we talked about, Jason. There were some revenues that were captured from the first day of July as part of the Memec quarter.

Right.

And there are some revenues where, in preparation for moving the warehouse in Europe, we had them ship into early July to support customers and minimize any impact during the transition. So they were stronger than we would have anticipated.

But backing those out it was pretty much in line.

Pretty much, uh-huh.

By the way, their book to bill was, I think it was just below parity, but pretty close to parity as well.

Okay. And then finally, Ray, what's your assumption on foreign currency, particularly the euro when you're making guidance for this coming quarter?

Our typical guidance just whatever it was on the day we give guidance. So --

Okay.

We don't try to guess what's going to happen so as we rolled up guidance just early this week, whatever the euro was is what we use.

Okay. Great. Thanks, guys.

Gentlemen, there are no further questions at this time. Do you have any closing comments?

Yes. As we conclude today's quarterly analyst call, we'll quickly scroll through the slides mentioned at the beginning of our webcast that contains 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 format at our Web site, www.ir.avnet.com.

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

Thanks, everybody.

Thank you, ladies and gentlemen for your participation in today's teleconference. You may now disconnect your lines at this time and have a wonderful day.