安富利 (AVT) 2006 Q4 法說會逐字稿

I would like to turn the floor over to Mr. Vince Keenan, Director of Investor Relations. Thank you, sir, you may begin.

Good afternoon and welcome to Avnet's fourth quarter and fiscal 2006 corporate update. If you are listening by telephone today and have not accessed the slides that accompany this presentation please go to our website, www.ir.avnet.com and click on the icon announcing today's event. After registering, please click on the slide only for telephone participants option that appears on your screen.

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 our Form 8-K filed with the SEC today several of the slides in this presentation and on Avnet's Investor Relations website. As we provide the highlights for our fourth quarter and fiscal year 2006, please note that we have excluded certain items from the accompanying slides in order to facilitate comparison with prior periods. These items include restructuring, integration, and other charges and the amortization of intangible assets resulting primarily from the Memec acquisition as well as incremental stock based compensation expense, the loss from the sale of some noncore business assets, and debt extinguishment costs. When addressing EMs result I would like to remind everyone that the fiscal year 2006 financials include the results of Memec and our electronics marketing group.

Since the acquisition of Memec was accounted for as a purchase the periods prior to the beginning of fiscal 2006 do not include the results of Memec which we acquired on July 5, 2005. However, for more informative comparisons on certain slides as indicated throughout this presentation, prior year data has been adjusted on a pro forma basis to include Memec results.

Before we get started with the presentation from Avnet management I would like to review Avnet's Safe Harbor statement. This presentation contains certain forward-looking statements which are statements addressing future financial and operating results of Avnet. Listed on this slide are several factors that could cause actual results to differ materially from those described in the forward-looking statements. More detailed information about these and other factors is set fort 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 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 with will wrap up with additional comments after which a Q&A will follow. Also here today to take any questions you may have related to Avnet's business operations is Rick Hamada, recently named Avnet's Chief Operating Officer, and is also acting President of TS; and Harley Feldberg, President of Electronics Marketing. With that, let me introduce Mr. Roy Vallee to discuss Avnet's fourth quarter and fiscal year 2006 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. When you look at the many highlights for fiscal 2006, there's one key event that stands out. The successful integration of Memec. When we first announced the Memec acquisition in April 2005, there was no question it was a great strategic move, but we did encounter some doubt regarding our financial projections. From revenue retention to expense synergies to global scope, the integration posed many challenges as we combined two large and complex operations across three regions of the world.

With four quarters as a combined company and the integration complete, we believe the numbers speak for themselves. In fiscal 2006, we grew revenue 28.8%, to a record $14.25 billion. If you include Memec sales in the prior year and adjust for the divestitures in the second half of the year, Avnet's pro forma revenue grew 7.6% and EM sales grew even faster.

Operating income, excluding the charges Vince mentioned earlier, increased 63% to $524 million operating income margin increased 78 basis points to 3.7%. While this is the fourth straight year of meaningful improvement, it is the first year that both operating groups realized improvement in all three regions. These absolute results speak for themselves. But the even better story is in the rate of change throughout the fiscal year.

Our year-over-year operating income margin dipped slightly in the September quarter last year, the first quarter of the Memec integration. Then it began to improve at an accelerating pace through the following three quarters as we realized the Memec synergies. In the December quarter, year-over-year operating income margin improved 60 basis points. That figure grew to 117 in the March quarter and we closed out the fiscal year with a 135 basis point improvement in the June quarter. At 4.4% operating income margin in the June quarter we are now approaching our long-term financial target of 4.5 to 5.5% for that important metric.

We also set post bubble highs this quarter for operating income dollars and margin, net income, earnings per share, return on working capital and return on total capital employed. Again, excluding the items Vince mentioned earlier. We are very pleased with our performance this past fiscal year and for the entire year -- for the quarter and for the entire year and feel the breadth of records spanning both the income statement and balance sheet further validate the success of the Memec acquisition and the capability of our company to create shareholder value.

Although we've already talked about the Memec integration being the highlight of the year, we must mention it again when it comes to Electronics Marketing's highlights. Around the world, the EM team did an excellent job integrating the regional organizations and realizing the synergy benefits while retaining customers and suppliers. EM revenue of 9.26 billion for the year was 48% higher than the prior fiscal year. If you include Memec revenue in the prior year and adjust for two small divestitures, annual pro forma revenue at EM grew 8.8%. While it is difficult to measure revenue retention, given the many variables we believe this performance indicates that one plus one indeed equal two.

And more important than the revenue growth rate, pro forma operating income demonstrated the operating leverage we have at EM as it grew more than five times faster than revenue to $419 million. While these results give an indication of overall performance we feel our productivity and efficiency metrics speak volumes about the EM organization. In the June quarter, we achieved post bubble records for sales and gross profit per employee, operating expense to sales and operating expense to gross profit ratios, operating income dollars and margin, return on working capital, and return on total capital employed. Again, this performance is indicative of the leverage we have in our model as we continue to leverage the scale and scope we have created.

Looking at the quarter, the number one high light for EM is the 49 basis points sequential improvement in operating income margin to 5.5%. With this performance, EM has achieved a low end of our long range financial target for this metric a full year ahead of schedule. Contributing to this performance was another sequential increase in gross profit margin with all three regions achieving meaningful improvement. In fact, EM delivered the highest gross margin since the acquisition of Memec. This increase in profitability, combined with another quarter of inventory turns greater than 6, resulted in a 179 basis points sequential improvement in return on working capital. The highest it has been in over five years. While we still have some work to do to achieve our 30% ROWC goal, it is gratifying to see that business units accounting for over half of EM's total revenue closed out the June quarter with ROWC at or above our long range goal.

In the June quarter we sold a business in the EMEA region that was focused on a variety of specialty products. We also exited a small programming business in France as we determined we could serve customers more efficiently with other facilities in the region. The two transactions had no material impact on pro forma operating income. As you can see on this next slide, we've added Memec history to the EM quarterly revenue to give you an idea of what our electronics component sales would have been if Memec had been a part of Avnet for all periods presented.

In the fourth quarter of fiscal 2006 EM revenue was flat sequentially on a reported basis and up 1.1% if you adjust for the divestitures mentioned earlier. While this performance was a bit below our expectations we would characterize it as normal from a seasonality perspective. We experienced a mild slow down in the month of June in both the Americas and Asia regions where a sequential quarterly growth was 0.8% and 1.6% respectively. EMEA revenue in the June quarter was down 2.1% sequentially on a reported basis, but you up 1.2% if you exclude the divestitures, slightly above our original expectations.

While sequential growth at EM in the June quarter experienced typical seasonality, year-over-year growth was double digits for the third quarter in a row. Year-over-year revenue grew 10.4% if you include Memec and the prior year quarter and 11.5% when you adjust for the two divestitures in the June quarter. The year-over-year growth rate was led by Asia where growth of 17.8% was very close to the fiscal year growth of 18.6%. The EMEA region grew 11.4% as compared with the year ago quarter and 14.7% when you adjust for the recent divestitures. The Americas region grew 5.3% as compared with the June quarter of fiscal '05.

We exited the fourth quarter with a positive book to bill in all three regions and expect typical seasonal patterns for the September quarter. Average selling prices continue to remain stable and lead times, while still extended in many areas, have started to come in on a few products as some of our suppliers have increased assembly and test capacity.

Turning to Technology Solutions. Our APS or Avnet partner solutions business which is focused on selling enterprise computing solutions to value added resellers grew fiscal year 2006 sales by nearly 10%. This is the third year in a row that APS grew double digits and gained market share with leading suppliers of hardware and software. Operating income margin improved 25 basis points over fiscal '05 to 3.3%, within our long range goal of 3 to 3.5%. In addition to meeting profitability goals, this is the second year in a row that TS has exceeded our return on capital employed target of 12.5%. With TS meeting all of its financial targets, we continue to look for ways to grow faster than the market through both organic and acquisition initiatives.

Moving on to the Q4 highlights for TS. Operating income margin increased 24 basis points sequentially to 3.5% at the high end of our target range. This is a record for a non-December quarter, December being when TS typically has its highest sales each year. It validates that our focus on value based management has created a business model that can deliver improved results even in a slow growth quarter. In fact, this is the 12th consecutive quarter that TS has grown year-over-year operating income dollars and margin. Not only is TS consistently performing within our operating income margin range, this is the fifth consecutive quarter that TS has exceeded our 12.5% ROWC goal.

During the quarter we also announced a significant addition to our line card. While we've had a relationship with StorageTech since 1999, there was a question mark as to how that relationship would evolve after Sun Microsystems purchased StorageTech in August 2005. After an extensive review of our capabilities, Sun has recently decided to expand our relationship and authorized Avnet to sell Sun storage products and AMD Opteron servers as well as its two and four way Spark servers software and services. This represents another strong addition to our focused line card and should be a source of additional growth going forward.

In the June quarter, Technology Solutions sales were 1.16 billion, flat sequentially and down 3.4% year-over-year. If you exclude the divestiture of our single tier business last quarter the pro forma revenue was up 1.3% sequentially, and up 1.9% year-over-year. The sequential growth rate was below expectations due to a greater than expected drop in sales of microprocessors. While visibility is always an issue in consumer oriented markets we do expect microprocessor sales to increase in the September quarter in line with normal seasonal patterns. Therefore, we made investment in inventory of microprocessors in support of the seasonally stronger sales in the September quarter.

At the regional level, pro forma sequential sales grew 7.3% in the Americas and were down 7% in EMEA, and 30% in Asia. While microprocessor sales negatively impacted sequential growth, we were pleased with our partner solutions business which grew double digits sequentially in all three regions. 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 fiscal 2006. This first slide shows a year-over-year comparison with a dollar in percent change in the highlighted columns on the right. Please note that the prior year results shown here do not include the results of Memec which was acquired at the beginning of fiscal 2006. Also note that we included a reconciliation for GAAP net income at the bottom of the slide to account for the restructuring and other charges, amortization of intangible assets, incremental stock based compensation, gains and losses of the sale of businesses and debt extinguishment costs recorded in the quarter.

In the June quarter sales of 3.61 billion were 28% higher than the year ago quarter due to the incremental sales related to the acquisition of Memec and solid organic growth at EM. Gross profit of $481.9 million, excluding certain charges was up 111 million as compared with the fourth quarter fiscal 2005 while gross profit margin improved 21 basis points year-over-year to 13.3% in the fourth quarter of fiscal 2006. Operating expenses of 323.6 million excluding restructuring and other charges were up 38.4 million or 13.5% year-over-year due to the acquisition of Memec. If you adjust the year-over-year quarter to include Memec, expenses declined significantly at both Avnet and EM even though EM's revenue grew double digits. The June quarter's expenses have been positively impacted by the operating expense synergies realized from the integration of Memec. The integration of Memec is now complete and all indications are it will be the most -- Avnet's most successful acquisition to date.

Actions to remove approximately 150 million of annualized operating expense synergies were completed in June as we wrapped up our fiscal year. Operating expenses were also down at Technology Solutions year-over-year primarily due to the reduction in operating expenses related to a divestiture discussed earlier and ongoing operational excellence initiatives. The 323.6 million of expenses in the fourth quarter of fiscal 2006 shown here exclude 26.8 million of restructuring integration costs, amortization intangibles associated with the acquisition of Memec, incremental stock based compensation costs resulting from the new accounting rules, and modification of our equity compensation plans related thereto, a loss in the sale of noncore business in Europe, and other items. Operating income of $158.3 million excluding those charges was up 85% as compared with the fourth quarter of fiscal 2005, and operating income margin improved 135 basis points to 4.4%. Below the operating income line there is a 2.5 million year-over-year increase in interest expense to $24.5 million, primarily due to rising short term interest rates.

Taxes, excluding taxes relating to certain charges previously discussed, increased $25.2 million due to a combination of higher pretax income and a higher effective tax rate in the current fiscal year. The tax rate increased from 27% in the fourth quarter fiscal 2005 to just over 32% in the current year, fourth quarter, due primarily to a change in geographic mix of profits following the acquisition of Memec. However, excluding the taxes related to certain charges noted above, our tax rate came in slightly lower than expected for the year. As a result, the four quarter earnings benefited by about $0.02 per share as compared with prior quarters during the year. Also note that our fourth quarter GAAP effective tax rate was negatively impacted by the loss on the sale of a small noncore EM business for which no tax benefit is available. We currently estimate that our effective tax rate will be between 33 and 35% in fiscal year 2007.

Net income excluding certain charges increased 43.7 million or 93% to $91 million, driving diluted earnings per share to $0.62 per share in the June quarter as compared with $0.39 per share in the year ago quarter. The current quarter earnings per share calculation was impacted by an increase in shares outstanding due primarily to the issuance of 24 million shares in connection with the acquisition of Memec. On a GAAP basis, our results for the fourth quarter fiscal 2006 included 37.7 million pretax and 32.2 million after tax of net expenses relate to the items previously mentioned. Taking these items into account, our GAAP net income was $58.8 million or $0.40 per diluted share as compared with net income of 47.3 million, or $0.39 per diluted share in the prior year fourth quarter.

This next slide highlights a sequential change in our fourth quarter fiscal 2006. Revenue of 3.61 billion was flat sequentially, as Roy addressed earlier. Gross profit increased $8.4 million or 2% sequentially, and gross profit margin improved 24 basis points to 13.3%. Sequential improvement in gross profit margin was delivered by both operating groups. Operating expenses of 323.6 million excluding certain charges decreased 4.5 million as compared with the March quarter. At the operating group level expenses were essentially flat at Technology Solutions while operating expenses at Electronics Marketing declined as a result of an additional -- as a result of additional Memec synergies being realized during the quarter and the sale of a noncore business at EM in Europe.

Operating income excluding certain charges increased 8.9% sequentially to 158.3 million and operating income margin increased 36 basis points to 4.4%. Taxes increased by $2.4 million due to the combined impact of the increase in pretax earning and the lower effective tax rate noted earlier. All in all this resulted in a net income of $91 million or $0.62 per diluted share as compared with 79.5 million or $0.54 per share in the March quarter excluding certain items in both periods. On a GAAP basis, net income was 58.8 million or $0.40 per diluted share as compared with 71.2 million or $0.48 per share in the March 2006 quarter, again including certain items in both periods.

This next slide looks at the key productivity and efficiency metrics that we use to monitor our business. As you can see in the graph on the left our expense to sales ratio, excluding certain charges previously discussed, decreased to 8.96% which is a record low. The expense to sale ratio was down 113 basis points year-over-year with both operating groups experiencing a significant improvement in productivity. In the June quarter we achieved an all time record for sales per employee and this is a 17th consecutive quarter of year-over-year improvement for this metric.

As the graph on the right shows this quarter our expense to gross profit dollars excluding certain charges improved by 215 basis points sequentially versus the March quarter and 974 basis points year-over-year. At 67.15%, our ratio of expense to gross profit dollars was a post bubble quarterly low for this important efficiency metric. Both the sequential and year-over-year improvements are driven by the reduction of operating expenses, realized from the integration of Memec and our continued focus on operational excellence, both of which contribute to the operating leverage in our model.

At Electronics Marketing the expense to gross profit ratio improved 272 basis points sequentially and by over 1,000 basis points from the year ago quarter. At Technology Solutions the expense to gross profit ratio improved 168 basis points sequentially and 401 basis points on a year-over-year basis. We expect our continued focus on productivity and operational excellence to drive meaningful improvement in efficiency as we drive toward our long-term business model.

This next slide portrays operating income margin performance, one of the core metrics of our value based management initiative. Operating income margin of 4.4% excluding certain charges improved 36 basis points sequentially and improved 135 basis points on a year-over-year basis. At EM operating income margin of 5.51% improved 49 basis points sequentially and 148 basis points as compared with the year ago quarter and represents a post bubble high at the low end of our long-term target range for this metric.

Technology Solutions quarterly operating income margin of 3.46% improved 35 basis points as compared with the year ago quarter and improved 24 basis points sequentially. TS continues to operate above our long range hurdle rate for operating income margin and continues to exceed our return on working capital and our return on total capital target as well. Due to the operating leverage in our model we expect continued improvement in operating income margin across the enterprise.

This slide portrays two key velocity metrics, working capital velocity and inventory turns. Consolidated working capital velocity of 6.1 represents a slight decline sequentially and year-over-year primarily due to the shortfall in expected sales. In the June quarter, Technology Solutions inventory turns declined as compared with the year ago quarter, due to an investment in inventory of microprocessors in support of the seasonally stronger sales in the September quarter that Roy mentioned earlier. Overall TS inventory grew $19 million sequentially.

At Electronics Marketing inventory was up slightly by $44 million from the March quarter, while inventory turns remained above 6, near our all time record high. On a year-over-year basis however, working capital at EM improved 10.1% and net days improved over eight days. With normal revenue seasonality in the September quarter, and an environment of stable to slightly lower lead times, we expect our inventory will be flat to down slightly in the September quarter.

On this graph we have shown both return on working capital as well as return on capital employed, two significant metrics that have become very important to Avnet in how we drive our business since the adoption of our value based management initiatives. During the last quarter we continued to make significant progress towards our stated targets of 12.5% for return on capital and 30% for return on working capital. The substantially improved financial performance at Electronics Marketing drove Avnet's return on working capital excluding certain charges up 165 basis points sequentially and 749 basis points year-over-year to 26.8%. On a year-over-year basis return on capital employed improved 251 basis points to 11.1% for the fourth quarter fiscal 2006 as improvements from both operating groups drove a significant impact at the consolidated level. On a sequential basis, the improvement was 82 basis points. With higher return on capitals employed we are enhancing our ability to generate positive cash flow on a continuous basis.

In the June quarter we generated 151.5 million of free cash flow. During the quarter we also repurchased 113.6 million of 9 and 3/4 notes due in February 15, of 2008. Primarily using cash on hand. With the majority of the cash payments related to the Memec integration behind us we elected to pay down this high interest debt and lower our interest expense in future quarters. At the end of the June quarter our net debt was 958 million and our debt to total capital was about 30.4%. Due to the hard work over the past few years, we have improved our credit statistics significantly and closed out the fiscal year with a post bubble high for interest coverage and a post bubble low for debt to EBITDA. Now let me turn it back over to Roy who will provide our outlook and guidance for the September quarter. Roy.

Thank you, Ray. So looking forward to Avnet's first quarter fiscal year, 2007, we expect normal seasonality of flat to slightly down revenue on our components business and slightly better than normal seasonality at Technology Solutions where seasonally stronger microprocessor sales are coming off an uncharacteristically soft June quarter. We expect sales for Electronics Marketing to be in the range of 2.32 to 2.42 billion anticipate sales for Technology Solutions to be in the range of 1.18 to 1.23 billion. Therefore, Avnet's consolidated sales should be in the range of 3.5 to 3.65 billion for first quarter fiscal '07.

In order to measure our performance on a comparable basis with fiscal 2005, during fiscal 2006, we excluded from our guidance and our analysis of results the amortization of intangibles related to the acquisition of Memec and the expenses related to stock based compensation as we adopted FASB 123R at the beginning of the fiscal year. Going forward, we will include these amounts in both our results and guidance. If we had included them in fiscal 2006, our diluted EPS would have been $0.59 in the June quarter and $1.87 for the full fiscal year. For the September quarter, we expect earnings to be in the range of $0.50 to $0.54 per diluted shares, including approximately $0.03 per share related to the expensing of stock based compensation.

We currently expect the impact of stock based compensation to be approximately $0.02 per share in each of the second through fourth quarters of fiscal '07, so the fiscal year impact should be roughly $0.09 per share. Also, keep in mind that as Ray mentioned earlier, the fourth quarter of fiscal 2006 was positively impacted by approximately $0.02 per share as our effective tax rate for the year came in slightly better than expected. This first quarter fiscal 2007 guidance assumes a more normalized effective tax rate of 33 to 35%, resulting in a sequential decline of $0.01 or $0.02 from the June quarter EPS due to taxes. Note that earnings per share in the September quarter are also negatively impacted by normal seasonal mix issues. At EM we expect to see higher sales in the lower margin Asia region and lower sales in EMEA and the Americas. And we expect TS sales to represent a higher share of total revenue. With that, let's open up the lines for Q&A.

[OPERATOR INSTRUCTIONS] Our first question is from Brian Alexander with Raymond James.

Thanks. Good afternoon. Roy, you talked about how the quarter ended softly in both North America and Asia yet you're expecting a normal seasonal pattern in EM in the September quarter. Just help us understand what gives you the confidence that we should return to normal seasonality as you exited the quarter on weakness.

Well, first of all, Brian, as we do every quarter, we have a bottoms up forecast. We have a top down analysis. We marry those two and decide what we believe our forecast should be. Secondly, as we mentioned on the call, we had a positive book to bill ratio on Electronics Marketing in the fourth quarter, that was at all three regions of the world. And on a global basis the book to bill was in the 1.05 range, so that gives us some confidence. And then as we mentioned, we saw a reasonably good quarter in our enterprise computing business and feel that we're going to get a seasonal bounce in microprocessors. So I think it's those factors in combination that cause us to be reasonably comfortable with this guidance.

Okay. Thanks.

You're welcome.

Our next question is from Bernie Mahon with Morgan Stanley.

A question for you on the inventory. I guess I'm still not sure why you built inventory on a sequential basis, when you're saying that lead times have come in some and you're just going into a seasonally slower quarter which I would think is pretty back end loaded at least in North America and Europe.

So Harley you want to -- first of all, Bernie, is it clear, the total inventory build was I want to say 63 million, of which we built inventory at Technology Solutions specifically around microprocessors. You'll notice by the way that although inventory rose total working capital did not, so all of the inventory build was done late in the quarter, predominantly in preparation for the first quarter. So with 19 million at TS, that leaves 44 million at EM and Harley, why don't you address the $44 million build at EM.

Sure, Roy. Thank you. Hello, Bernie. To add a little color to the inventory picture, as Roy mentioned we're up approximately 44 million sequentially. Of that 44 million, the vast majority, almost all of it was from one region, specifically from Europe. So overall, we're very satisfied and pleased with our management of the inventory asset through the quarter overall globally. Specifically going back to my comments on Europe, the inventory investment that we made was really a pre-meditated decision that we made around a business unit that's really showing very nice growth and we believe and we tend to view it specifically as part of our overall strategy relative to maximizing gross margins.

Okay. And then just to comment, just to clarify, when you said that on some parts lead times are coming in, when -- did you see that kind of through the quarter or was it at the end of the quarter when you saw some softness and also what products did you see lead times come in on? Is it more commodity or some of the ASICs or where is that?

Bernie, it really was throughout the quarter. We've seen as Roy I think mentioned in his earlier remarks, we've seen our suppliers adding back in capacity, really over the last couple quarters. So it is starting to pull in some of the lead times. But I would want to characterize that change that we described earlier as being fairly modest. I would not want you to take our comments to mean that we see any significant deceleration in overall aggregate lead times. It really is difficult to pinpoint by commodity, so much that I would say it's a more tempering than a pull back and overall when we compare lead times to historical precedent, they really continue to be extended from my perspective.

Okay. Thanks a lot.

You're welcome.

Our next question is from Steven Fox with Merrill Lynch.

A couple questions. First of all, Ray, the inventory write down for terminated lines, can you go into a little bit more detail on that?

Sure. None of that occurred during the quarter, all of that was done earlier in the year and it's simply for the most part is in connection with the acquisition of Memec, where as we looked at our overall portfolio of product lines we decided to cull some lines and as a result, needed to move some inventory and therefore took an inventory write down. But again, that occurred in primarily in the Americas and over in Europe. I'm not sure of the exact split and roughly I think that was about $9 million but that was all in the first half of the year, I believe. I'm not sure. I don't think we had any last quarter, but nothing in this quarter.

Okay. And then Roy, talking about the capacity, back end capacity coming on line, you've been sort of anticipating that for the last several months. Now that it's here, any thoughts on what it could mean to pricing? I know you're saying it's modest increases but how do you anticipate component pricing for the rest of the year?

Well, right now, on an aggregate basis, demand looks pretty firm to us and as Harley just mentioned, product lead times on average are still in that 8, 10, and 12 week range. What came in were some of the products that had gone out to 16, 18, and 20 weeks and they pulled back in a little bit. The second point, Steve, is that while the back end was causing some of that longer extension, the front end, or wafer fabs, is really a what drives product lead time and there we still see 90% utilization rates coming into the busiest part of the year for the industry, with the seasonality towards the end of the calendar. So I think as we look out over the next couple of quarters our expectation is that more or less, pricing and lead times are going to be fairly stable at their current levels.

Okay. And then lastly, on the TS business I know you're not giving guidance on December quarter but qualitatively how do you feel about typical seasonality playing out based on what your customers are talking about today?

Rick, you want to take a shot at that one?

Sure. Good afternoon, Steven. It is early but right now I believe we are comfortable with a typical December seasonality. It will be a significant double-digit sequential boost off Q1. But we'll know that better probably starting after Labor Day.

Thank you.

You're welcome.

Our next question is from Matt Sheerin with Thomas Weisel.

My first question, just want to get back to the demand picture that you talked about, Roy, and the slow down at the end of the quarter. Was that broad based or was it specific to certain products or customers and was it just a reaction to customers wanting to be more rational in managing their inventory or did you see any signs that their own demand was falling off?

So, Matt, we have been drilling down quite a bit, as you might imagine. We are struggling in both America and Asia to find patterns that would limit this to specific products or specific end market segments. So it feels more like a broad based sort of a change in momentum and let me just insert here and remind everyone on the call that we guided for greater than seasonal growth in the fourth quarter and what we actually got was seasonal. And the reason we guided for more was that we had come off of two very strong quarters of bookings, high book to bills, increasing customer backlogs and product lead times and so we thought that revenues in the June quarter were going to be better than seasonal and they turned out to be about average.

Okay.

Okay? And so I -- so my sense, this is a qualitative subjective comment, but my sense is that you're on point. This is the supply chain reacting sort of dynamically to changes in end market demand and product lead times and adjusting itself as it moves.

Okay. And then in the past, Roy, one of the leading indicators of a real slow down has been cancellations and order push backs. Have you seen any change in that area?

Harley?

Yes, hi, Matt. No, we monitor that religiously as you would suggest and we've seen no change that alarms us at all in any region.

Okay. And then -- but the book to bill is still above 1?

Well above 1.

And then on the inventory issue, so is Europe primarily a RoHS issue at this point with building inventory for customers or is it just general demand trends or both?

Matt, we were actually debating that topic earlier because it's obviously very important. It's extremely difficult to quantify with any degree of assurance. What I would say is no doubt some of it is. We continue to believe that it's a minimum amount driven by RoHS.

So Matt, if you think it through just a bit, the customers who are compliant or are required to be compliant, would certainly not want us to maintain an inventory, a special inventory for them. But customers who have exemptions conceivably could be placing scheduled orders to tie up noncompliant material before it's sold out or the prices have moved up too high. But we've been probing with our team over there and we can't find any significant amounts of that. There is -- we know there's some of it in the number but not significant. On the other hand, we are aware of some significant buys that were made by this business unit in Europe, that Harley's talking about and they were not related to RoHS. So we would say perhaps a small portion of that bill, 10% or 20%, something like that might be RoHS and the balance is not.

Okay. And just two quick last questions. You talked about normal seasonality in the computer business. Can you remind us seasonality in the December quarter and the components business. It's normally flat to down, right? Lower in Europe and the Americas because of days and seasonality and higher in Asia, is that correct?

That's exactly right.

And then on the Technology Solutions side you did not talk about weakness in IBM servers or proprietary servers which your competitors have talked about so can you give us some color there?

Rick, you want to pick that up?

Yes, Matt, how I would characterize where we're at on the proprietary server piece is that we -- the results are not inconsistent with the type of outlook that we are expecting, is it offering higher growth in some of the more exciting areas of storage, industry standard servers, software, and services, no, but the current trends are not outside of the expectations that we have at this time. In other words, I would not attribute and say a part of the reason that TS was short on the -- to the revenue projection for this quarter, I would not say that there was something new in the proprietary server space that contributed to that? I'm sorry, Matt.

Just an overall slow down, then?

Microprocessors.

It's mostly all processors then, okay.

Yes. So just a couple more comments. In the March quarter, we were a little bit disappointed with our sales and proprietary servers. They were below our expectations. In the June quarter we grew our enterprise computing business double digits sequentially in all three regions of the world and of course as Rick was just saying, that was led by industry standard servers and storage, along with software and services, but we met our expectations on proprietary servers in the June quarter. They were not below our expectations.

Okay. Great. Thanks a lot.

You're welcome.

Our next question is from Michael Walker with Credit Suisse.

Thanks. Do you expect then, inventories to be up in dollar terms sequentially in the first quarter?

Hi, Mike. We would expect -- if you assume for a minute that our revenue forecast is about right, and you assume that product lead times don't stretch, then our expectation is that inventory would be flat to down in the September quarter.

The microprocessor build is pretty much done with?

Yes, we'll sell those.

Okay. And I guess my second question is just to kind of understand the philosophy behind that microprocessor inventory build. I mean you had Intel and AMD both had tremendous inventory build of their own and I know that they have some of their own issues going on as well. It doesn't seem like we're blowing the doors off of the PC kind of supply chain and market demand type environment. So I guess I'm wondering why there seems to be a pretty big microprocessor inventory build going on throughout that entire PC food chain.

Well, I think on a macro level, you've got a battle going on with two giants and there's always a bit of synchronization around is the supply chain really synchronized with true demand. Do they have all the right chipsets to go with the right processors and so on and so forth. So we've all seen that in prior quarters. From an Avnet point of view, we have our projections for the quarter. We had opportunities to buy material at the very end of this quarter. Again, inventory build without a working capital build and we felt it was a very prudent investment that will enhance our Q1 results.

Okay. Thanks a lot.

You're welcome.

Our next question is from Thomas Dinges with JP Morgan.

Just one last one on the microprocessor side. How much of the shortfall this quarter was just simply related to the price war that is going on as opposed to some volume shortage? Obviously it was a pretty big deceleration especially in the Asia region there for TS that is pretty heavy on microprocessors.

Tom, two things. To put a number on it, our revenue sequentially in processors were down by $85 million. March quarter to June quarter. It is difficult to answer your question, however, because one would have to assume some price degradation as a normal course. So the question of how much was more than normal is difficult to ascertain. But clearly, units were down less than revenues were down.

Okay. And then more of a longer term modeling question here, you guys have obviously gone through a fair amount of cost cutting with the synergies from Memec and were able to realize some additional ones along the way. The OpEx dollars inclusive of option expense are now sitting at of a low point for the whole year despite the fact revenue has been growing. What is the expectation as you move forward here? We probably see a little bit of an uptick the next quarter just because it sounds like option expense is a little bit higher, which I'm assuming is sort of some annual vestings that take place in the first quarter of the year. But what's the expectation there? Do you think you've got another year with things that are in place to continue to get good leverage off of those dollars that you've got there in terms of actually driving those down or do we start to see those build up a little bit from here?

Hi, Tom, it's Ray Sadowski. I guess a couple of things. One, in connection with the options, you are you right, just a little bit -- $0.01 build just due to vesting that occurs during the fourth quarter. Concerning expenses on a go forward basis, as we've mentioned in our prepared remarks, the Memec integration is complete and all of the expense synergies that we had targeted initially and then even exceeded are for the most part done. Through the income statement we'll see a little bit more of that in the first quarter and I think on an ongoing basis, the way we run our business and I think we've talked about this a little bit in the past, it's not going to be necessarily driving expense dollars down in absolute dollars. It's more going do be a function of the growth of business and the investment in expenses that is necessary to support that growth.

So the way we'll model our expenses on a go forward basis, we have some business units that are currently at or exceeding our return on working capital targets and what we allow them to do is basically reinvest expense dollars in their business at a rate of 50% of the growth of GP dollars. For those businesses that are not yet at our return of working capital, where the amount they get to invest in expenses is less than that. The absolute dollar of expense will be a function of a business by business unit situation and overall growth from a profitability perspective specifically in gross profit dollars. But I'd say for the most part the expense reductions due to restructuring activities in connection with Memec for the most part are behind us and now it's increasing operating efficiency on a go forward basis that will be a big factor in determining what our actual expenses are on a go forward basis.

Okay. Thank you.

It's Roy, Tom, just, one more comment. Ray mentioned there's a little bit of spill over left on the Memec deal in the first quarter. I just want to offset to that is it's also our annual merit pay time frame so there will be some sort of offset to the Memec spill over in the form of merit pay increases.

Okay. That's helpful.

Our next question is from Scott Craig with Banc of America.

Thanks, good afternoon.

Hi, Scott.

Hi. Rick, on the Sun business that you guys have signed up there, can you take us through perhaps your goals longer terms, how big you think that business can get? And does the business come from other competitors or do you just think this is going to be a function of Sun's growth? And then my second question would be in the -- again, in the TS business, if I look out in the September quarter, how much of the increase in the September quarter is due to microprocessors? I guess another way of asking the question would be what are you assuming for the rest of the business as far as growth and how does that compare to normal? Thanks.

Sure, Scott. I'll start with the last one first. On MPUs, Roy mentioned the 85 million sequential decline. We would be looking for a sequential increase in the tens of millions and again with normal seasonality, perhaps a little boost because of the acute situation of the June quarter and then in the -- if you divide the TS into two worlds, and said microprocessors on one, and the rest of the business, the rest of the business is a more typical seasonality and getting ready to head into again the year-end of December quarter coming up. Going back to the first question on Sun, Scott, so we had a StorageTech relationship that was mentioned since '99 and our focus is driving a -- taking the entire storage portfolio here and I would absolutely acknowledge that our growth plans would include share gain but we're also trying to provide Sun with a new channel opportunity with a storage focused effort here that should also help them gain in the marketplace and grow the overall pie.

Okay. Thanks.

Our next question is from Carter Shoop with Deutsche Bank.

Hi, guys.

Hi, Carter.

You guys are about halfway through the quarter now and I was hoping we could talk a little bit about how you have seen the quarter progress so far. It sounds like the month of June was a little bit disappointing. Can you comment a little bit on how July trended relative to expectations a month ago or so?

Yes. It turns out it -- as you might assume, we're relying on that data as part of our forecast for the current quarter. We're forecasting the current quarter to be in line with normal seasonality, a little bit better over at TS. And so as you might imagine, what we've seen in the month of July and the first week of August is business very much in line with what our expectations would have been coming out of the June quarter. There are really no surprises either good or bad in the data we've seen in the first five weeks here.

Just so we're on the same page here, so we saw June take a step down and then kind of a continuation of that lower level of business in July?

Yes, again, let's be clear. A step down in terms of rate of growth, not necessarily in absolute terms. Remember, the June quarter revs were essentially in line with normal seasonality. What we're now seeing is normal seasonality coming off of that level.

Okay. And if we look at just a monthly level versus not the June quarter as a whole but the month of June, definitely it sound like it had a step down in regards to overall business trends. I'm just trying to better understand if that was more of an aberration where we've still go kind of a business trend slow down a little bit and then we're going off of that level or if things actually started to look a little bit healthier as you kind of entered into the September quarter?

Yes, I'm not sure we know the answer yet. I actually think Matt was pretty close to being on it from a subjective or sort of analysis perspective. It appears as though there was some slowing of purchasing. I would imagine as a result of either Sun's weakness in demand in certain segments or some reduction of inventories in the supply chain, but with that baked in, we still got normal seasonality. June Revs were not down on a per day basis. They were just not as high as we thought they were going to be and we see Q1 being pretty normal.

Okay. Fair enough. And then it sound like you've been hinting for a little while that you may be looking to do some acquisitions in TS down the road. Can you talk a little bit about the pipeline there for TS? Are there a handful of deals that appear to be accretive or are the valuations still a little bit too high right now to pull a trigger on some?

So obviously it's difficult to talk in specifics about M&A. But one thing that I'm very comfortable talking about and that's our commitment to ensuring that all M&A is value creating, consistent with all the work we've been doing with our existing operations. So we will maintain a very close eye on return on capital in any M&A activity and Carter if the prices are too high then those are deals that we just will elect not to do.

As far as strategy, as we've mentioned before, we'd like to fill out some geography in Europe. We're not yet pad European and we would like to increase our presence for TS in Asia Pac. Again, based on projected multi-year GDP growth rates there, we'd like to have more assets deployed in that region.

Okay. Thanks.

You're very welcome.

Our next question is from John Patrick Walsh with Wachovia Securities.

I was just wondering at this point now that you've done a good job integrating Memec and your credit profile is really strengthened, you're coming from a real strong financial position, as you look forward in terms of redeploying cash, what your potential thoughts are on that front particularly with regard to share buyback? Obviously your stock has been under a bit of pressure here over the past few months. Do you think we might see more buybacks as we head through this year?

Well, a couple things. One, -- thank you very much. We have obviously improved our credit statistics pretty significantly and on a go forward basis we believe we've created a business model that will allow us to generate free cash on a more continuous basis than what have been historical norms. I would say at this particular point in time we are focused at the moment on getting back our investment grade credit rating at one of the agencies and making sure we solidify our investment grade rating at the other one. Until that occurs, I don't think we're in a position of looking at buyback at this particular point in time. And secondarily, I think as we build cash on a go forward basis, we'll obviously do things to strengthen the balance sheet but as was mentioned earlier there are opportunities or potential opportunities to deploy that cash more effectively than buying back stock in order to grow the business from an M&A perspective.

So I would say that in the short term, unlikely to see any stock buyback. As we are committed to getting back to our ratings. Then on a longer term front as we do generate cash and solidify our overall credit position we will look at the most appropriate things to do with our cash and I would say the first thing we would look at is growing the business and that would mean in all likelihood some form of acquisition opportunities, but again, on a longer term basis, if appropriate, then we would address either a buyback or a dividend type situation. But that's certainly not in the near term.

Okay. Thank you very much.

Gentlemen, there are no further questions in queue at this time.

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

Thanks, everybody.

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