安富利 (AVT) 2006 Q2 法說會逐字稿

Our presentation will now begin. I would like to turn the floor over to Vince Keenan, Avnet's President and Director of Investor Relations. Thank you, Mr. Keenan, you may begin.

Good morning and welcome to Avnet's second quarter fiscal 2006 corporate update. If you are listening by telephone today and have not accessed the slides that accompany the presentation please go to our web site, 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 determined in accordance with Generally Accepted Accounting Principles, or GAAP, the Company also discloses non-GAAP results of operations that exclude certain items. Reconciliation of the company's analysis of results to GAAP can be found on Form 8K filed at the SEC today and several of the slides in this presentation and on Avnet's Investor Relations Website.

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

In just a few moments, Roy Vallee, Avnet's Chairman and CEO will provide Avnet's second quarter fiscal year 2006 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 the Q&A will follow. Also to take any questions related to 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 second fiscal year 2006 business highlights.

Hello, everyone. Thank you all for taking time to be with us and for your interest in Avnet. As I provide the highlights for our second quarter fiscal 2006, please note we have also excluded restructuring, other charges and integration costs resulting primarily from the Memec acquisition, as well as incremental stock based compensation expense from the accompanying slides in order to facilitate comparison with prior periods.

Q2 was a very good quarter for Avnet, as we begin to realize the potential of the Memec integration and experience meaningful revenue growth. Both electronics marketing and technology solutions had a strong December quarter, with EM exceeding the high end of expectations on both the top and bottom line while TS delivered record results. At the Avnet enterprise level, revenue grew 15% sequentially to a record $3.76 billion. Including the results of Memec in the year-ago quarter, revenue grew nearly 10% on a year over year basis. In addition to the strong revenue performance, both operating groups set many records this quarter for expense efficiency and working capital velocity metrics.

Gross profit dollars per employee set a new quarterly productivity record, while our operating expenses before certain charges, as a percentage of gross profit, improved by 726 basis points sequentially to 71.9%. As a result of the strong performance operating income, excluding restructuring and integration charges, increased approximately 50% sequentially to $132 million while operating income margin improved 81 basis points to 3.5% in the December quarter.

On the balance sheet, both EM and TS set records for inventory turns and working capital velocity which contributed to a nearly 10 day sequential decline in our cash cycle. The combination of strong growth and profitability and disciplined working capital management led to a significant improvement in our return metrics. Our return on working capital increased 790 basis points sequentially to 24.4% while our return on total capital employed grew 301 basis points to 9.6%. We are very pleased with the progress our global team made this quarter toward our long-term financial goals and these results provide further evidence of the leverage we have in our business model. We remain committed to our long-term goals of 30% return on working capital and 12.5% return on capitol employed, and expect the additional synergy yet to be realized for the Memec integration will drive our progress towards these goals.

Now, let's look at some of the operating group highlights. Before we get into the numbers for electronics marketing I would like to remind everyone that fiscal year 2006 financials include the results of Memec, which we acquired on July 5, 2005, within our and Electronics Marketing Group. Since the transaction was accounted for as a purchase, the periods prior to the beginning of fiscal 2006 do not include Memec's results, again, as of July 5, 2005.

EM had a breakout December quarter as stronger than expected revenue growth and solid execution on the Memec integration lead to significant improvements in profitability and returns. Most encouraging about this performance is the fact that all three regions contributed as strong seasonal demand in Asia was augmented by better than normal seasonality in the Americas and in EMEA. This global uplift lead to 6.9% sequential increase in revenue to $2.26 billion. Including the results of Memec in the second quarter of fiscal 2004, revenue grew 11.5% over the year-ago quarter with all three regions experiencing meaningful positive growth.

In addition to the top line growth, all three regions delivered significant improvement in profitability. In the second quarter of fiscal 2006, EM grew operating income sequentially, more than four times as fast as revenue. Operating income margin improved 75 basis points to 4.1%. All three regions improved operating margins greater than 50 basis points on both the sequential and year over year basis including Memec results in last year's second quarter. From an operating leverage perspective, EM's sequential operating income drop through, which is the change in operating income dollars divided by the change in gross profit dollars was greater than 100% in every region as a expenses declined in all regions despite the nearly 7% sequential revenue growth.

As a final highlight for EM, I would like to a close with some additional insight into the compelling strategic and financial rationale for the Memec acquisition. If we look at the America's region where the integration was substantially completed by the September quarter we have realized significant financial benefits with no apparent revenue erosion. In fact, the December quarter revenue growth rates for EM Americas, of 5% sequential and 11.1% pro forma year over year, suggest that one plus one equals at least two. When we closed out fiscal 2005 in June, the EM Americas region was halfway toward our goal of 30% return on working capital. After just two quarters as a combined business we have closed over 75% of that gap on a quarterly basis and have significant momentum going into are seasonally strong March quarter. When we announced the Memec acquisition in April 2005, we told you it would accelerate our progress towards our long-term financial goals but we did not anticipate the additional revenue growth that is now contributing to that progress.

As you can see on this next slide we have added Memec history to the EM quarterly revenue to give you an idea what our electronic component sales would have been if Memec had been a part of Avnet for all periods presented. In the second quarter of fiscal 2006, EM revenue grew 6.9% sequentially to $2.26 billion. Including the sales of Memec in the second quarter of fiscal '05, year over year revenue growth was 11.5% in delivered dollars and 14.9% in constant dollars.

On a regional basis Asia had the strongest performance driven primarily by strong seasonal demand for digital consumer products. Including Memec's sales in last year's December quarter EM revenue in Asia was up 26% year over year, and 15.4% sequentially.

While Asia had the highest growth rates, the Americas and EMEA regions also exceeded expectations for the December quarter. As we've said in the past, EM's December quarterly revenue in both regions is usually down seasonally. This year, both regions experienced meaningful revenue growth, signaling strength in the non-consumer segments of the technology supply chain. Including Memec revenue in December 2005 quarter on a pro-forma basis, the Americas grew 5% sequentially and 11.1% year over year. In EMEA, sales were 2.7% sequentially and 1.6% on a year-over-year basis including Memec in the prior year. If you exclude the impact of changes in foreign currency exchange rates, EMEA grew 5.5% sequentially and 10.8% year over year, similar to the Americas region.

As we enter EM's typically strong March quarter we are cautiously optimistic for calendar 2006. The combination of strength and demand and leading inventories across the supply chain suggest revenue should trend up. EM enters calendar year with the Memec integration nearing completion an exiting Q2 with positive book to bill ratios in all three regions.

Before reviewing the technology solutions results I would like to recap some transactions we announced the past quarter. In an effort to increase focus and strengthen our leadership position and enterprise computing distribution, we divested two relatively small businesses focused on selling direct to end users. In one transaction we agreed to combine Avnet enterprise solutions, a division that specializes in selling network lifecycle management solutions directly to end users with [Kaylands, Inc.] to form a new company, Kaylands, LLC . Avnet owns equity in the new company and will report results using the equity method starting in the third quarter of fiscal 2006.

We also announced an agreement to sell our U.S.-based HP Enterprise end user business to Logicalis Inc. Concurrent with that transaction Avnet Partner Solutions and Logicalis entered into an exclusive distribution agreement whereby Logicalis will procure all of its HP and IBM Enterprise computing products from Avnet. The total sales over the five-year contract period are expected to exceed $1 billion. The Logicalis closed in January and we expect the Kaylands transaction to close in early February. We do not expect these two portfolio adjustments to have a material impact on our Q3 operating results.

Moving on to the Q2 performance, the typically strong December quarter generated new records for revenue, income, and returns at Technology Solutions. In the second quarter of fiscal 2006, TS revenue grew 29.8 % sequentially to a record $1.5 billion. Year over year revenue growth was 6.9% in delivered dollars and 9.1% in constant dollars. The December quarter is the fifth consecutive quarter were TS has delivered strong year over year growth.

For calender year 2005, TS grew revenue 11% and operating income 22%, with our enterprise value added distribution business leading the way with more than 20% revenue growth. The team also delivered several noteworthy accomplishments in the areas of expense and working capital productivity metrics. The operating income drop through defined earlier was at least 70% on both a sequential and year over year basis. The combination of strong revenue growth and expense productivity drove operating income up $22.7 million sequentially and operating income margin improved 87 basis points to 3.7%.

In the December quarter Technology Solutions's string of new records did not stop with the income statement. On the balance sheet, both inventory turns and working capital velocity set records and the cash cycle declined seven days year over year. This significant improvement in working capital efficiency drove substantial improvements on TS's return metrics as both ROCE and ROWC increased well beyond our long-term targets. With TS generating economic profit, in all three regions during the quarter we continue to look for opportunities to expand this business.

As you can see on this slide, in the December quarter Technology Solution's sales were $1.5 billion, a sequential increase of 29.8% in delivered dollars and 30.6% in constant dollars. On a year over year basis revenue grew 6.9% in delivered dollars and 9.1% in constant dollars. Our value added enterprise computing business led this growth with its fifth straight quarter of double digit year over year growth on a global basis.

In the America's region, revenue grew 27.8% sequentially and 9.8% year over year on the strength of storage and software sales. Our focus on solutions selling continues to gain traction as software and service growth outpaces hardware growth by an increasing margin.

In EMEA, strong growth enterprise computing products drove sequential growth of 42.7% in delivered dollars and 46.2% in constant dollars. The corresponding year over year figures declined 2.4% in delivered dollars, but increased 5.2% in constant dollars. The year over year growth was somewhat tempered by declines in our non-enterprise computing distribution business.

In Asia, sales were off 3.1% sequentially. However, sales were up 31.6% on a year over year basis. In the March quarter, although we expect revenue for Technology Solutions to experience its typical seasonal decline we continue to expect IT spending in the small and medium-sized business segment to maintain its trend year over year growth.

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

Thank you Roy, and hello everyone. Let's begin with an overview of our operating results for the second quarter fiscal 2006. This first slide shows a year over year comparison with the dollars and percent change in the highlighted columns on the right. Please note that the prior year results shown here do not include results of Memec, which was acquired at the beginning of the current fiscal year. Also note we have included a reconciliation to GAAP net income at the bottom of the slide to account for the restructuring and other charges in incremental stock based compensation which occurred during the quarter.

In the December quarter sales of $3.76 billion were 30.4% higher than the year-ago quarter with a strong organic growth at both EM and TS, and the addition of Memec's results in the current quarter. Gross profit of $469.4 million, excluding restructuring of other charges, was up $95.5 million as compared with the second quarter of fiscal 2005, and gross profit as a percentage of sales declined 48 basis points to 12.5% year over year. Most of the gross profit decline was due to the Electronics Marketing Group for both a regional mix shift to higher sales in Asia and competitive pressures negatively impacted margins. In the second quarter of fiscal 2006 Asia revenue grew to represent 27% of total EM revenue as compared to 22% in the year-ago quarter. As we explained before the Asia region has a different business model characterized by lower margins but lower expenses and higher asset velocity as compared with the EM in the Americas and in EMEA.

Expenses of $337 million excluding restructuring other charges were up $47 million or 16.4% year over year due to the inclusion of Memec's expenses in the current quarter. If you adjust the year ago quarter to include Memec expenses, expenses for the quarter declined significantly. The December quarter's expenses have been positively impacted by additional synergy resulting from the integration of Memec.

The Memec integration is proceeding well and we're on track for the synergy cost-saving amounts and timing we shared last quarter. Actions to remove an excess of $100 million of annualized operating expense synergies were completed by the end of the second quarter and we continue to expect to achieve the full $150 million annualized synergy target by the end of this fiscal year. The $337 million of expenses in the second quarter of fiscal 2006 shown here exclude $28.9 million of restructuring and integration costs and incremental equity compensation costs resulting from new accounting rules.

Operating income of $131.9 million, excluding certain charges, was up 57% as compared with the second quarter of fiscal 2005 while operating income margin improved 60 basis points to 3.5%. Below the operating income line there was a $1.8 million a year over year increase in interest expense to $23.1 million due primarily to rising short term interest rates. Other income increased $2.9 million primarily due to increased interest income, lower net foreign currency exchange losses this year versus the year-ago quarter and other items.

Taxes, excluding the tax related to certain charges discussed previously, increased $18.9 million due to a combination of higher pretax income and a higher effective tax rate. The tax rate increase from 31% in the second quarter of fiscal 2005 to 34.1% in the December quarter, primarily due to the geographic mix of profits after the incorporation of Memec's results into the Avnet consolidated tax calculation.

Net income including certain charges increased $30.1 million, or 69.2% to $73.6 million, driving earnings per share to $0.50 in the December quarter as compared with $0.36 per share in the year ago quarter. The current quarter per-share calculation was impacted by 21% increase in shares outstanding due primarily to the issuance of $24 million in connection with the acquisition of Memec. On a GAAP basis, our results for the second quarter of fiscal 2006 included $36.4 million pretax and $24 million after-tax of charges related to the restructuring integration costs and incremental stock based compensation. Taking these charges into account our GAAP net income was $49.6 million, or $0.34 per share.

This next slide highlights the sequential change in our results for the second quarter 2006. Revenue of $3.76 billion was up sequentially by 15%. Gross profit increased $46.2 million, or 10.9% sequentially, while gross profit margin declined 46 basis points to 12.5%. The sequential decline in gross profit margin was experienced in both operating groups. At Technology Solutions, higher percent of lower margin software revenue contributed to the decline. For Electronics Marketing, the regional shift to Asia impacting of the year-over-year comparison can also be seen in the sequential change as the percent of revenue from Asia increased more than 200 basis points from the September quarter to the December quarter. Operating expenses of $337 million, excluding certain charges, increased $2.3 million for the September quarter. At an operating group level expenses were down at EM as a result of the Memec synergies while TS expenses increased to support the 30% growth in revenue.

Operating income excluding certain charges increased by nearly 50% sequentially to $131.9 million, and operating income as a percent of sales increased 81 basis points to 3.5%. Taxes increased $15.6 million as a result of a 66% increase in pretax income and 112 basis point increase in our effective tax rate resulting from the increased level of profitability in higher tax rate jurisdictions. All in all, this resulted in net income of $73.6 million, or $0.50 per share, excluding the previously discussed charges, as compared with net income of $44.9 million or $0.31 per share in the December quarter. On a GAAP basis, including the charges previously discussed, net income was $49.6 million, or $0.34 per share as compared with net income of $24.9 million or $0.17 per share in the September 2005 quarter.

This next slide looks at some of the productivity metrics we used to monitor our business. As you can see on the graph on the left, our expense to sales ratio, excluding certain charges, improved substantially by 127 basis points sequentially to a record low of 9%. The improvement was driven by both operating groups as the focus on operational excellence, combined with the Memec cost synergies, to set significantly improve productivity metrics at the Avnet level. At Electronics Marketing, the expense of sales ratio declined 93 basis points sequentially and 248 basis points from the year-ago quarter. Technology Solutions, which realized a record low expense to sales ratio improved on this metric by 114 basis points sequentially and 26 basis points year over year.

As the graph on the right shows, this quarter our ratio of expenses to gross profit dollars, excluding certain charges, improved by 720 basis points sequentially versus the September quarter and 565 basis points year over year. Both the sequential and year-over-year improvement is due primarily to our focus on expense productivity and the reduction of operating expenses realized from the integration of Memec along with higher volume. This is another metric where we expect future synergy benefits will continue to drive meaningful improvement.

This next slide portrays operating income margin performance, one of our core metrics of our value based management initiative. Operating income margin of 3.5%, excluding certain charges, improved 81 basis points when compared with the first quarter of fiscal 2006 and improved 60 basis points on a year-over-year basis. At EM, operating income margin of 4.1% improved 74 basis points versus the prior sequential quarter and 85 basis points compared to the year-ago quarter.

Again, we are committed to achieving our long-term financial target 5.5 to 6.5% operating income margin at the EM level in the next two to threee years. In the second quarter, we made significant progress towards this target and as we further integrate Memec we expect to see continued improvement in operating margins.

Technology Solutions quarterly operating income margin of 3.7% was 87 basis points higher sequentially and up slightly as compared with the year-ago quarter. TS continues to operate above our long term targets for both return on working capital and returning capital employ.

This next slide portrays two key velocity metrics, working capital velocity and inventory turns. Consolidated working capital velocity of 7.0, was a record performance for Avnet. An improvement to 14% sequentially and 23% on a year over year basis with operating groups contributing to the sequential and year-over-year improvement.

At Electronics Marketing, inventory declined from the September quarter even though sales were almost 7% higher. As a result, inventory turns improved sequentially from 5.4 to a record 5.8. On a year-over-year basis working capital velocity at EM, improved 35% and its cash cycle declined by almost 33 days. On a sequential basis EM improved working capital velocity by 4% due to record inventory turns of 5.8 in the December quarter. With record inventory turns in the December quarter EM's year over year decline in Days of Inventory was the major contributor to the improvement in its working capital velocity. This is the fourth quarter in a row where EM has sequentially improved its inventory turns, and working capital velocity.

Technology Solutions also had a record-setting quarter for inventory turns in working capital velocity. In the December quarter, Technology Solutions inventory turns improved 23% as compared with a year ago quarter which contributed to a seven day reduction in its cash cycle over the same period. Technology solutions had a significant sequential improvement of 42% in working capital velocity as it was positively impacted by the seasonally strong revenue quarter. TS's Q2 fiscal 2006 working capital velocity was 46% better than the year-ago quarter and represents the 17th straight quarter in which TS has improved year over year performance in this important metric.

On this next graph we have shown both return of working capitol as well as return on capitol employed, two significant metrics that have become very important in how we drive our business since the adoption of our value based management initiative. During the last quarter we made significant strides towards reaching our long term targets for return on capital and return on working capital of 12.5%, and 30% respectively. The growth in operating income and record working capital velocity combined to drive return working capitol up 790 basis points sequentially to 24.4% with roughly the same improvement of the year over year basis. We expect return of working capitol to continue to improve from current levels as we maintain our focus on improving operating income margins and working capital velocity. On a year-over-year basis returning capital employed improved 199 basis points to 9.6% with both EM and TS contributing to this improvement. On a sequential basis, the improvement was even more significant at 301 basis points.

Let me turn back over to Roy, who will provide our outlook and guidance for the March quarter.

Thank you, Ray.

Looking forward to Avnet's third quarter fiscal 2006, we expect sales for Electronics Marketing to be in the range of $2.32 to $2.40 billion and anticipate sales for Technology Solutions to be in the range of $1. 2 to $1.25 billion. Therefore our consolidated sales should be in the range of of $3.52 to $3.65 billion for the third quarter of fiscal 2006.

We expect earnings to be in the range of $0.48 to $0.52 per share, excluding the expense associated with incremental stock based compensation amounting to approximately $0.02 per share. The earnings per share guidance also does not include the additional future charges associated with continuing restructuring and integration of Memec, which we expect we, the amounted to $0.02, and $0.04 per share. The amortization of intangibles associated with the acquisition of Memec and the net gain or loss associated with the divestitures of TS's end user businesses are also excluded from the earnings per share guidance.

With that, let's open up the lines for Q&A.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from the line of Steve Fox of Merrill Lynch. Please state your question.

Just looking at inventories, we are seeing other areas of supply channels, it looks like sales are growing on declining inventories. Have orders slowed to the point where inventories are catching up? How would you describe the inventory situation that this point?

Let me take a shot. I will ask Rick and Harley of they want to add anything. I think from our perspective, we look at TS, and EM in their segments of the supply chain a little bit differently. In TS, we're not particularly an inventory driven model and the fact is, our inventories do not fluctuate a lot there, but what's happening is ongoing progress on supply chain management with our suppliers is causing the model to become more inventory efficient and as we grow, software and services and other revenue streams that don't have inventory, it causes inventory velocity as a percentage -- expressed relative to total sales to continue to rise.

At Electronics Marketing, what is happening is more and more of our business is migrating to supply chain services kinds of contracts. And in those agreements we managed inventory strictly to customer forecast and demand and as long as product lead times are manageable and relatively stable, we are able to run those contracts very efficiently. As that continues to grow as a percentage of our total revenues we see the inventory turns continue to rise. With that, Rick or Harley, any additional comments?

Nothing to add from my end.

I will only add that in addition to the proliferation of supply chain engagements the regional shift that we experienced, the higher percentage of our business in Asia is also impacting and changing the historical terms model by which we manage the components business.

As a follow-up, if you look apples to apples at the component side of the business, whether by region or what have you, was there much change in your inventory turns during the quarter?

They improved sequentially, Steve, and essentially what happened is the inventories went up in the September quarter. We managed to back down a bit. Perhaps you could say this is part of the Memec integration as well, where we were able to digest all the Memec inventory and pipeline's operating from one monolithic supply but with revenues up and inventory dollars down we have improved inventory turns.

Quick financial question for Ray, could you talk a little bit about SG&A dollars for the current quarter, what is a reasonable range to expect?

I'm sorry, say that again?

SG&A dollar range for the current quarter.

For Q3? Rough range, probably going to be down, rough magnitude, $15, $20 million, you're in the $325 million rough range.

Thank you.

Our next question comes from the line of Matt Sheerin of Thomas Wiesel Partners. Please state your question.

Just want to talk a little bit about gross margin. You explained that Asia has had an impact, I know Xilinx has also had an impact on the Electronics Marketing. How do you see that shaking out? Has it bottomed here? Is there any mix issues in the March quarter as you should have higher sequential growth in Europe and the Americas versus Asia? To you see that picking up a little bit?

Harley, do you want to take that?

Hi, Matt. Looking forward to the March quarter, the current quarter, we believe at the aggregate level, margins will not be significantly different than what we experienced in December close. Multiple reasons why it could be complex, adding up all the regions, but specifically I would like to comment relative to your Xilinx note. We do believe the changes and adjustments we talked in some detail on our last call with all of view have completed, all distributor -- all suppliers are looking at their lineup, but overall and it has stabilized or bottomed out as you suggested.

In the quarter just ended, our gross margins for EM in America and Europe were essentially stable, our gross margin in Asia was down slightly but that was driven by some high-volume fulfillment business. So as we look at the March quarter, we think depending what happens to the mix of business by region, EM's margin should be fairly stable.

Can you give us an idea what the book to bill in each of your regions in EM was at the end of the quarter, it looks like from the sequential guidance you're giving, in line, a little bit lower sequential growth that you normally see in the March quarter which I know is normally pretty strong. Is that because the December quarter was so strong? And as part of that, could you comment on lead times in general for semiconductors and components?

Let me take a first shot, Harley, I'll flip it back over to you. The book to bills were positive, but I would describe them as modestly positive, all of the book to bills running below 105, somewhere in that range. That is factored into the guidance along with the reality that revenues in the March quarter were in fact very strong and -- in the December quarter, and there was some business there that will not repeat in the March quarter. So we see a reasonably good marketplace, we like the environment relative to inventory and capacity expansion, so we are cautiously optimistic, but the sequential changes maybe a little bit less than prior years where the December quarter was not so strong. Do you want to add to that, Harley, and take the lead time question?

I will just reiterate what Roy said. The quarter was particularly strong, obviously exceeded our expectations, and December in particular was incredibly strong. That does guide some of our guidance thinking forward to March as Roy suggested.

Relative to lead times, overall we have seen expansion in the quarter compared to what we discussed last time. I would say at the aggregate level, probably an additional two weeks when combined, all product categories, we continue to feel comfortable with our approach to managing pipelines. The area that expanded the most would be in the area we call standard products, where we did see some fairly extensive expansion in the quarter. We don't see significant reason for concern primarily based on the fact that our model is a broad line model whereby we carry multiple suppliers for each of those technologies. We monitor our pipelines very aggressively. We manage them based on our incoming revenues, so while we feel pretty good, I would be clear, we did see some expansion in December quarter.

Given that, do you see any need to build any buffer inventories here or are things pretty rational when you don't need to?

Overall we see them as rational.

Thank you.

A one additional comment, on those standard products, it appears the driver of lead time extension is packaging test as opposed to wafer foundry. Packaging test is largely labor driven, meaning the ability for the industry to expand is much greater than the need for a new fab. Couple that with perhaps a little bit of a seasonal slowdown in the global industry and we expect lead times to stay rational in the standard products area.

Thank you.

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

This is Jason Gursky stepping in for Tom. You talked briefly about the EM Group of the Americas and EMEA being a little bit better than seasonal in the December quarter. Can you talk about what happened in Asia this quarter? What the trends were in there and what the competitive environment looks like?

Harley, you want to take that?

Hi, Jason. We experienced a strong quarter in Asia as Roy suggested in our results earlier in the call, and that is driven by what you expect, a healthy consumption of digital consumer across multiple technologies, whether it be MP3, cellphone, digital camera, etc. Very strong performance, very competitive marketplace, as you suggest, one where many of us are driving growth but a very encouraging and strong close to the year.

But nothing above normal seasonality in Asia?

Not really.

I am not sure, we have been there since 1995, but I am not sure we really know yet what normal seasonality in Asia is. We had two years of 50% organic growth in Asia followed by a year of almost no growth and now, we appear to be back with Avnet plus Memec in our components business we are up 26% year on year for the December quarter. I am not sure we are prepared to state whether that is normal or not normal.

A follow-up, Roy, to your comments on capacity. Is it a one, two, three quarter deal before we see lead times begin to trend downward?

That is the $64 question. As you well know the semiconductor industry is driven by both supply and demand. I think the cycle we're in right now, inventories are being well managed and demand is being closely monitored and capacity expansion, product lead times and capacity expansion are both being well managed. All that said, I would say barring a sudden change in the growth rate of the industry, lead times should remain somewhat under control. There should be enough time for the industry to increase capacity to support these increased volumes.

Thank you.

One more thing, but Asia topic, I just want to also point out that I made the comment earlier that we have a good quarter in volume, hardly made the point that there is a lot of high volume consumer. As a result of that our gross margin in Asia went up as a percent of our total but it dropped a little bit sequentially, but all that said, we had a record quarter for operating income and operating income margin in Asia Pacific. We are very pleased with the results our team is turning in especially considering they delivered that while integrating Memec.

Thanks, guys.

Our next question comes from the line of Kevin Sarsany of Foresight Research. Please state your question.

Well done. Two questions. In your charges footnote you talk about, with the exception write-down of certain assets, took certain action with respect to existing EM in all three regions. Can you quantify that amount and what are you doing there and is this ongoing?

Are you talking in general for all the charges?

In your footnotes you mentioned excluding Memec.

There are a number of charges hitting the quarter. Most of it being integration related specifically to the Memec acquisition. In addition to that, there was some property that we are no longer utilizing as a result of other operating efficiency activities and some of that property we have written down in order to facilitate a quick sale. In the scheme of the numbers, relatively small. I don't have the exact dollars in front of me but the bulk of everything is clearly the restructuring and integration associated with Memec.

I was just wondering if you were downsizing or eliminating some existing prior to Memec operations to utilize the best of best practices.

That is ongoing but that is not really those kind of numbers. Keep in mind when you look at the Memec integration, based upon the size and complexity of integration, the line begins to blur in terms of what is a synergy expense versus operational improving expenses overall. It is virtually impossible to keep track of both of those because they are happening simultaneously all around the world.

My second question with regards to Xilinx. Part of your value is the services and value added services in the design wins and when they did the model change it was surprising to me, that is life, but then the Xilinx went ahead and raised guidance twice in the quarter and I assume the lead time on this, the process would point to you guys having you and Memec having produced that those wins. Can you comment on that either way? Am I reading too much into that? Any thoughts on that?

Just to be clear, what Xilinx did was they took a couple of hundred accounts and said they want to do the design work themselves. What they did with those accounts is they created a transition period where we were compensated for previous design work and then they created a demand fulfillment model because they do not intend to do any of that business direct. The number of customers they serve direct, really, has not changed.

Xilinx had a very good quarter. You might recall what they were a little bit short in the September quarter from their expectations. I suspect that some of what happened is revenue they anticipated in September came in the December quarter. Safe to say we had a very good Xilinx quarter as well. I guess I'd characterize our relationship with Xilinx as very good, the market share, our share of Xilinx business has fundamentally not changed.

As we talked on the last call in some detail, we encourage all of you not to look at that event as the beginning of some ongoing trend or process either inside of Xilinx or with our suppliers as a general community. It was a strategic decision they made that is not inconsistent with what our suppliers have been doing for 30 years. We adjusted to it by changing our model in many ways and as Roy said we're comfortable with our relationship with Xilinx. They're a terrific partner.

I was thinking the opposite, the fact that they had to guide up and exceeded their original expectations, I was thinking that was because of your work that you had done.

On behalf of EM I'll take the credit that you throw out. We appreciate that.

Alright, I'm done.

Our next question comes from the line of Scott Craig of Bank of America. Please state your question.

Can you go over cash flow and your expectations as we move forward here and then I have a follow-up as well.

If you look at the December quarter, the way we calculate free cash flow, we essentially used about $27 million of cash and a little bit more than that happened to be related to specific cash outflows related to the Memec integration, payment of severance and lease commitments, all of that kind of stuff. So essentially with the significant growth, basically flat from a cash generation perspective. As we go into Q3 our expectation is we will generate a little bit of cash as we start collecting -- as we mentioned earlier, December was a very, very strong month not only in EM, but also in TS had the typical year. So as we start collecting those receivables we expect to generate some amount of cash in the third quarter. The range is probably $25, $50 million expectations at this particular point in time. One of the things that is difficult to keep in mind, since our businesses, working capital is a so significant for the dollar perspective, just a few days difference from when we close our period has pretty big impacts on what our ultimate balance sheet looks like. and therefore what our ultimate cash flow looks like. That is roughly what we are thinking as we look into the third quarter.

You mentioned looking for opportunities to expand the TS business. Can you describe maybe where, either geographically or product wise you think you need to fill out and do you think you need to do that through acquisition as opposed to building organically?

You want to take a shot at that?

I will tell you that, hopefully consistent with the comments I have made in the past, out of our portfolio our enterprise distribution business, our technical distribution and high flex assembly we all believe have legs and extendibility geographically, and have been actively looking to see how we increase that footprint. There are opportunities in every region but I think the majority for us lie in Asia and Europe and we will continue on that path and as we have more firm announcements or set firmer expectations we will let you know, but basically the three major models that we are committed to in the portfolio we believe have some global reach and legs to them.

I would amplify what Rick said, product expansion, one thing for sure, we made some announcements on is software, we expect to grow our software business. We are always trying to expand the customer base, as in Logicalis, geographically we have parts of Europe and Asia that we're not yet present, we continue to add services to help our bars move more in the solution selling, including managed services to our AMT business. Relative -- specifically I didn't mean to send a signal that we have a deal pending, but we will pursue M&A to expand TS only where it fits our financial model and supports our return on capitol employed metrics. We will continue to look for M&A of that nature to fill out those geographic blank spots.

Our next question comes from the line of Bernie Mahon of Morgan Stanley. Please state your question.

Good morning. Just a question or kind of a follow-up for Harley, you said in response to an earlier question that the month of December came in really strong in EM. I was wondering if you could go into more detail as to maybe what was the driver behind that and did you see that strength continue into January?

Good morning. Really difficult to respond with detail on the elements or the components of the December increase. It was particularly strong especially from a year on year perspective. It felt like a typical month, whereby over the last couple years, we saw a significant drop-off in activity, both incoming orders and shipments going out the door in the latter half of December, specifically in Europe and America. We did not experience that this year. We had a very minimal drop-off due to the holidays. The strength continued all through the month. In actuality it was a full month as opposed to a holiday shortened month which is more typical.

As we continued into January, it has, we are off to a good start, I wouldn't say a great start, we're off to a good start but typically there is a bit of a breather in the beginning of the quarter, but we are continuing at an encouraging rate and it does go low for the March quarter.

That is great. Then Ray, a question for you. The restructuring charges that you take, you said for next quarter you expect the $0.02 to $0.04. How much more in absolute dollars of restructuring charges or integration charges do we have, and how many more quarters are we going to see that over?

It is roughly $4.5 to $9 million, and if you look to the current quarter numbers versus those, coming down, I think we'll have a little bit more in Q4, we might have a little more in Q4, but I would say that would be the end of it. Based upon our timetable all of the activities will be completed by the end of the fiscal year. We're not anticipating at this point any restructuring charges. If we go into Q4 I would expect at this time it will be below the $0.02 to $0.04 we just mentioned. It probably will be something, we are certainly working very hard to get all the actions taken as rapidly as possible but as we indicated to we will be 90% complete by the end of March and another 10% to go in the June quarter. Those charges will then become nominal as we get into that quarter.

Thank you.

Our next question comes from the line of Amit Daryanani of RBC Capital Markets. Please state your question.

Early in the call you spoke about lead time stretching out on some standard products of two weeks or so. Did you see a pretty good ASP uptick in those products as well? If so, could you quantify that?

We did not see any measurable ASP increase as a result of that expanded lead time.

So pretty much the entire 74 basis points uptick in operating margins was driven by higher than expected revenues and better cost savings?

That is reasonable.

One final thing. The stock based compensation, $4 million, that all flows through SG&A?

Yes.

Thank you.

You are welcome.

Our next question comes from the line of Carter Shoop of Deutsche Bank. Please state your question.

Great quarter. The only thing that stuck out from my perspective was the gross margin line. You talked a little bit about that but I was hoping to delve in there a little bit more. Is there a way we can look at gross margins on a sequential basis and try to understand the positive impacts from Asia and the mix shift between the positive developments at EM and how that was offset by the decline in Asia and what happened with Xilinx, what was the impact in the December quarter and how should we think about gross margins for the software division?

On a sequential basis, EM's gross margin in America and Europe, I would describe as stable, essentially flat. The gross margin in Asia, you know the revenue numbers. That has been disclosed. The gross margin decline in Asia sequentially, was on the order of, I want to say, 20 basis points. We can tie that back to specific large volume transactions, which probably won't repeat this quarter. That is why we think EM's gross margin is likely to be stable and even on a regional basis it could be stable this quarter.

Relative to Xilinx, we also saw that model change, stabilize in the quarter. Xilinx on a sequential basis was not a factor in our gross margin for this quarter. Any sequential change in gross margin. It looks like that is behind us as well.

Relative to software, typically what happens is there is this surge that takes place in the December quarter, there's a certain type of software business that we do in that quarter that is a heavy fulfillment, large volume, low margin, zero inventory, and in some cases we actually collect the receivable before we make the payable so it is a profitable business for return on capitol point of view. That will not carry into the March quarter.

Rick, is that a safe statement?

Yes, it is. It is also low-cost, low touch, the entire process is highly automated.

The software business that we are working to expand is more like taking applications into the mid-market space along with our Enterprise hardware. There we don't expect a material difference between those margins and the margins of our hardware. This fulfillment stuff we do every December quarter is what affected TS in the quarter that just ended.

Going out one quarter, I don't fully understand why we won't see gross margins increase more given all the positive tailwinds we're going to have here. Will we see the fulfillment business go down, Asia is going to decrease its percent of sales, the Americas and EMEA, in EM, your most profitable through divisions increasing. Is there something else there that we need to know about, given what Ray were talking about in regards to SG&A, it looks like ROCE maybe a 10 basis point improvement quarter over quarter in gross margins?

If all those things happen that you talked about we could see a positive trend quarterly in gross margin. But they all have to happen.

Help me understand North America and Europe, the EM division. Is that almost always up as a percentage of sales for EM as a result of Asia's seasonality?

Slightly. Our business in Asia also grows sequentially in the March quarter.

I was thinking it was going to be down.

We do participate some in that digital consumer space, but we also have a broader account base there including a lot of sales in the EMS companies who are supporting industrial products that get sold back into America and Europe, like communications gear. We are not down sequentially on a normal basis, in fact, now that I think about it, I don't think we have ever had a down March quarter from December in AsiaPac. Don't quote me on that, I am going by memory.

That is helpful. What about TS? How should we think about TS's gross margins relative to EMs?

In absolute terms?

Yes.

TS is just below double digit gross margins. Right around there.

That is a pretty major positive from the mix shift between EM and T S?

At the enterprise level. If you think about the September to December shift that should reverse itself in the December to March quarter.

If we look at gross margin trends, the industry has been under a lot of pressure the past several years, what is your outlook on the basis over the next six to 12 months for gross margins? Do you think environments as stable like it is pretty now, where the lead times are pretty stable, ASPs are pretty stable, can we maintain gross margins where they are now, or do you think we will see a continuation of this downward trend?

The point we have been trying to make over the past few quarters and I do understand the skepticism around this, but I would tell you that competitive pressure in the market is a factor on our gross margins, but it is far from the most important factor. For Avnet, the mix of business between our two groups, the mix of business between the regions within the group's, the mix of business within their regions like a heavy consumer fulfillment in Asia in the December quarter. Those are all factors that affect our gross margin greater than what is happening in the competitive environment. To the extent that lead times extend and prices firm and we are able to get more margin on transactional level, of course that would have a beneficial impact to our gross margin but that will be overshadowed by what happens with those other three mix factors which play a bigger role in the outcome of our GP.

Okay. Last question, Chinese New Year, any impact that you guys have seen? What kind of impact are you expecting from that?

Too early to tell. It is really beginning as we speak. We don't see any reason there will be anything abnormal. I think it will be fairly typical.

I would like to add a little color to what you and Roy were talking about a moment ago. It is a good opportunity to create expectations. It is a misperception to model the EM business globally as if our Asia business drops off a cliff in the March quarter. I don't mean to be so dramatic, but in reality, we do have a much broader customer base the most of our suppliers in that region. We see moderated growth rate compared to December, but we continue to grow that business. I think it is important to recognize that as compared to our suppliers and how they manage the sequential changes. Ours is more modest.

Thanks again. Good quarter.

We have time for one more question.

Our next question comes from Henry [Nha] of Lehman Brothers. Please state your question.

Congratulations on the nice quarter. A quick question in terms of the TS business, you touched on this a little bit before. Can you walk us through what the impact of the Logicalis and the HP business would imply to the TS business going forward?

Want to take a shot?

Good morning. From an overall perspective, with all of the moving parts, three things. It is the investment of the assets into the new Kaylands LLC, the divestiture of our HPs single tier to Logicalis, and then in addition retaining that, coming back and becoming a Logicalis distributor for their enterprise business going forward. There is no material impact at the revenue line as a result of all the combinations of those transactions. Our AES business was running just under $200 million a year type revenue number and as was stated in the Logicalis releases the incremental commitment back to Avnet, independent of the HP single tier that was divested to them is about the same overall revenue number.

Any difference in terms of profitability?

These the some of the moving parts we're working on this quarter. Theoretically we were achieving the end user types of margin selling it direct and now we've turned it into distributor revenue. There are some expenses associated with that business that will no longer incur, now that we are more pure distribution. We're working through those moving parts and as suggested in the outlook we do not expect any material impact on the bottom line. What it does exclusively at the gross margin level, we'll continue to work through and as we get clearer guidance we have to set some expectations there, but theoretically speaking, there could be some movement on the gross margin line because of that shift.

Thank you. Congratulations on the good quarter.

As we conclude today's quarterly analyst call we will now scroll through the slide mentioned at the beginning of our webcast that contains the non-GAAP to GAAP reconciliation of results presented during our presentation, along with a further description of certain charges that are excluded from our non-GAAP results. This entire slide presentation, including the GAAP financial reconciliations, can be accessed in downloadable .PDF format at our website. Thank you for your participation in our quarterly update today. If you have any questions or feedback regarding the material presented, please contact the Avnet Investor Relations Department by phone or e-mail.

Thanks, everybody.

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