安富利 (AVT) 2007 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 Vice President and Director of Investor Relations.

Good afternoon,and welcome to Avnet's second quarter fiscal 2007 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. In addition, to disclosing financial results that are determined in accordance with generally accepted accounting principals or GAAP, the Company also discloses non-GAAP results of operations that exclude certain items. Reconciliations of the company's analysis of results to GAAP can be found on the form 8-K filed with the SEC today and several of the slides of this presentation and on Avnet's investor relations website. As we provide the highlights for our second quarter fiscal year 2007, please note that we have excluded certain items from the prior period in the accompanying slides in order to facilitate comparison with current periods. These items include restructuring, integration and other charges resulting primarily from the Memec acquisition.

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 which 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 forth in Avnet's filing with the Securities and Exchange Commission.

In just a few minutes Roy Vallee, Avnet's Chairman and CEO will provide Avnet's second fiscal year 2007 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 and third quarter guidance 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, Avnet's Chief Operating Officer, who 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 second quarter fiscal year 2007 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. Well, electronic component industry growth slowed in the December quarter as a result of the relatively mild correction that started a couple of quarters ago. Avnet's highly diversified revenue base allowed us to continue progressing towards our long-term financial goals. By partnering with over 100,000 customers and 300 suppliers in 70 countries, we have limited exposure to any one end market, product type or geography. In the current quarter, within the Electronics Marketing group, continued strength in Europe helped offset some weakness in the Americas region.

At Technology Solutions, growing demand for storage systems and industry standard servers made up for a decline in proprietary servers and propelled TS to a 28% sequential growth. While inventory issues Mar GMS companies and sluggishness in a few high volume end markets continued to impact the results of some component suppliers, our broad exposure to smaller OEM, EMS and ODM customers resulted in EM expanding its year-over-year operating margin for the fifth quarter in a row. While our diversified revenue base drove profitability sales, our continued focus on gross margin, operational excellence and return on capital drove another strong quarter of improvement in our income and return metrics. In the December quarter, consolidated operating income grew eight times faster than revenue and operating income margin improve to 4.2%, up 81 basis points over the year ago quarter, excluding last year's restructuring and other charges that Vince mentioned earlier. Combined with lower interest expense, as a result of lower debt and lower interest rates, net income and earnings per share grew 40% as compared with the second quarter of fiscal 2006.

The leverage in our business model is evidence that our margin improvement and the impact of our value based management initiatives is apparent in our return metrics and cash flow generation. These earnings, combined with another strong working capital performance, including a inventory reduction at EM and seasonally higher sales at TS, drove return on capital employed up 155 basis points over the year ago quarter, to 11%. This is the best performance in over 10 years and validates that we are continuing to create shareholder value.

Turning to highlights on Electronics Marketing for the December quarter, let's start at the gross margin line. Even though revenue growth was below expectations, EM's focus on profitable top line growth and a large base of smaller customers drove gross profit margin up 40 basis points year-over-year and 37 basis points sequentially. Adjusting for the divestitures we made in Europe towards the end of fiscal 2006, all three regions contributed to this performance. As we continue to emphasize our demand creation capabilities and industry-leading supply chain services, EM has been able to grow market share profitably. While EM's end markets remain highly competitive, we believe the breadth and depth of our products and services, combined with our talented and energized workforce will continue to deliver value to our customers and suppliers that translates into higher returns for our shareholders.

Even though year-over-year growth slowed this summer, this quarter, EM continued to build leverage into its business model which created additional margin expansion. In the December quarter, EM grew operating income year-over-year, more than eight times faster than revenue to $119 million. Operating income margin of 5.1% was 104 basis points higher than the second quarter of fiscal 2006 and represents the fourth consecutive quarter that EM has produced operating income margin over 5%. In fact, for the trailing four quarters, operating margin at EM was 5.2%, which is 68 basis points better than all of fiscal 2006 and approaching our goal of 5.5% or greater. With the higher margin regions of the Americas and EMEA entering their typically strongest two quarters, the prospects for EM further expanding margins are high.

Switching gears to the balance sheet, Electronics Marketing reduced its working capital, defined as trade receivable plus inventory less payables by 5% as compared with the September quarter. Most of the decline was due to a $51 million reduction in inventory, or approximately $67 million in constant dollars. With this reduction, EM's working capital as a percentage of sales is now back down to where it was a year ago. This working capital velocity, combined with higher operating margins, drove a 349 basis point improvement year-over-year in return on working capital. As I mentioned earlier, we began to see the impact of a mild inventory correction beginning in the summer months. As a result we have been diligently working to adjust our inventory to current demand and lead times, while maintaining the high levels of service that our customers have come to expect from us. With this quarter's decline, we are comfortable with our inventory levels in all three regions going into the March quarter.

In the second quarter of fiscal 2007, EM revenue of $2.33 billion was up 3.4% year-over-year and down 4.2% sequentially. This performance, which was below our expectations, was negatively impacted primarily by a continued slowdown in purchases from our large EMS customers in the Americas region. Year-over-year, the Americas region was down 3.9% when compared with the second quarter of fiscal 2006. In contrast to the America's region, the EMEA region was better than expected for the third quarter in a row. Adjusted for the divestitures in fiscal 2006 and the impact of foreign currency exchange rates, the EMEA region grew 6.6% over the year ago quarter. Asia, which also saw a slowdown in sales to large EMS customers was up 7.5% year-over-year and down 2.3% sequentially.

As a result of strengthened bookings in the Americas and EMEA regions, EM exited Q2 with a book-to-bill ratio approaching one. While the EMEA region is expected to experience its typically strong March quarter, lingering issues at large EMS customers serving high-volume end markets particularly in the communications space could impact growth for both the Americas and Asia regions. At Technology Solutions, another strong December quarter from our Partner Solutions business, which is focused on enterprise computing products, drove a 28% sequential increase in revenue. On a year-over-year basis, Avnet Partner Solutions grew over 10%, with particular strength in the EMEA region. At a product level, the demand for storage solutions and industry standard servers continued to be the drivers of growth across our bar base.

While the top line growth is indicative of the value TS delivers to its customers and suppliers, the operating income growth is a direct result of the leverage we have built into our business model. In the December quarter, TS's operating income drop though, which is the change in operating income dollars divided by the change in gross profit dollars, was greater than 75% on both a sequential and year-over-year basis. Operating income margin of 4.1% increased 43 basis points over the year ago quarter, while sales and operating income dollars set new records. This represents the 14th consecutive quarter of year-over-year improvement in both operating income dollars and margin.

Finally, we can't close out a discussion of TS highlights without talking about the recently completed acquisition of Access distribution. With TS already exceeding our return on capital hurdle rate, the Access acquisition provides an excellent opportunity to accelerate our growth and shareholder value creation. In addition to adding approximately $2 billion of annual sales, access enhances the TS line card to include an industry-leading position with Sun Microsystems as well as complimentary suppliers in new high growth technologies including security, networking and voice-over-IP. With the addition of approximately 600 loyal customers, TS will have an expanded bar base that offers cross selling opportunities. TS will also gain several hundred talented employees with strong technical capabilities and a commitment to excellence. Access is projected to increase Technology Solutions sales by roughly 40%, while improving Avnet's return on total capital employed.

As you can see on this slide, in the December quarter technology solution sales were $1.56 billion, up 28.4% sequentially, driven by strong sales of enterprise computing products through Avnet Partner Solutions. Revenue, as reported in the second quarter of fiscal 2007, grew 3.7% year-over-year, and 7.3% when adjusted for the divestiture of our Enterprise Solutions business a year ago. Included in these growth rates was a decline in microprocessor sales that impacted all three regions. At a regional level, year-over-year growth was led by the EMEA region where revenue grew 17.5% on a reported basis and 7% in constant dollars. In the Americas region, revenue grew 23.1% sequentially and 3.5% year-over-year after adjusting for the sale of AES. The Asia region, which is heavily impacted by microprocessor sales, was sequentially flat on both a sequential and year-over-year basis. And now I would 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 second quarter of fiscal 2007. This slide shows a year-over-year comparison with a dollar and percent change in the highlighted columns on the right. Please note that we have included a reconciliation to GAAP net income at the bottom of the slide to account for the restructuring/other charges in the prior year second quarter.

In the December quarter, reported sales of $3.89 billion were 3.5% higher than in the year ago quarter. Gross profit of $493.9 million was up $24.5 million as compared with the second quarter of fiscal 2006, while gross profit margin improved 20 basis points year-over-year to 12.7% in the second quarter of fiscal 2007. In year-over-year improvement in gross profit margin was driven by EM whose gross profit margins increased 40 basis points year-over-year. Operating expenses of $330.1 million were down $11.4 million or 3.3% year-over-year excluding restructuring and integration charges in last year's second quarter due primarily to a full year of operating expense synergies for the Memec acquisition being realized in the current quarter. Operating expenses were also down at TS year-over-year, primarily due to the reduction related to the divestiture of AES in fiscal 2006.

In addition, both operating groups are continuing to benefit from ongoing operational excellence initiatives. A $341.5 million of expenses in the prior year second quarter shown here does not include $24.9 million of restructuring and other charges primarily related to the acquisition and integration of Memec. Operating income of $163.8 million was up 28% as compared with the second quarter of fiscal 2006, excluding certain charges from last year. And operating income margin improved 81 basis points to 4.2%. Below the operating income line, interest expense declined by 23% due do lower debt and a lower effective interest rate as a result of our refinancing activities. Taxes increased $12.8 million, due primarily to the increase in pretax income. The effective tax rate for the second quarter of fiscal 2007 was 33.4%, down from 34.2% in the prior year quarter, due primarily to the mix of profits in countries with different tax rates.

We currently estimate that our effective tax rate will continue to be between $0.33 and $0.35 for the remainder of fiscal year 2007. Net income, excluding certain charges in the prior year quarter, increased $28 million or 40%, to 99.1 million, driving diluted earnings per share to $0.67 in the December quarter, as compared with $0.48 in the quarter a year ago. Net income increased $49.5 million or $0.33 per share as compared with GAAP net income of $49.6 million or $0.34 per diluted share in the prior year second quarter. There were no charges excluded from GAAP for the second quarter of fiscal 2007. Earnings per share was impacted by a slight increase in diluted shares outstanding from 147.2 million for the September quarter, to 148.1 million shares for the December quarter.

This next slide looks at the key productivity metrics of expense to gross profit dollars over the past three plus years. The bars represent the individual quarters while the trend line depicts the performance over a trailing 12 month period at the end of each quarter. On a trailing 12 months basis, our ratio of expense to gross profit dollars declined from 76.9% at the end of last year's December quarter to 68.7% in the current quarter, improving significantly over the last five quarters. As you can see on this slide, the rate of improvement started to accelerate after the first quarter of 2006 as we began to realize the operating expense savings from the integration of Memec. The 813 basis point improvement since last year is further proof of the leverage we have built into our business model at both operating groups.

On a sequential basis for the individual quarter, the operating expense to gross profit ratio improved 222 basis points from the September to the December quarter, primarily due to improvement at TS with a seasonally strong December quarter. At electronics marketing, the expense to gross profit ratio improved 622 basis points from the year ago quarter, while at Technology Solutions the expense to gross profit ratio improved 495 basis points on a year-over-year basis. We expect our continued focus on profitable growth and operational excellence initiatives to drive continuing improvements and efficiency as we move towards achieving our long-term business model. Similar to the last slide, we are providing both actual and a trailing 12 month line which portrays income margin over the past 14 quarters. Once again, the very positive impact of the Memec integration and our focus on profitable growth is clearly visible as a trailing 12 month operating margin improved from 2.99% in the second quarter of fiscal 2006 to 4.06 in the second quarter of fiscal 2007. In addition, TS continues to make improvements in operating income margin with the trailing four quarters reaching 3.5%.

In the December quarter, operating income margin of 4.21% improved 81 basis points year-over-year with both operating groups contributing to this improvement. At EM, operating income margin of 5.1% improved 104 basis points and at Technology Solutions, operating income margin of 4.1% improved 43 basis points as compared with a year ago quarter. On this graph we have shown return on capital employed, which is a key metric at our value-based management initiatives that we introduced six years ago. As is evident on this slide, during the last three years we have made significant progress towards achieving our stated target of 12.5 to 13% return on capital. From 3.2% at the end of September 2003, our trailing 12 month return on capital employed has increased by more than a factor of 3 to 10.3% in the current December quarter. While Memec has had a lot to do with last year's improvement, The multi-year trend is all about our focus on profitable growth, operational excellence and improving asset velocity at both operating groups. On a year-over-year basis for the individual second quarter, return on capital employed increased 155 basis points to 11%.

During the quarter we generated $230 million of free cash flow and over the past 12 months, generated approximately $330 million while continuing to grow sales and profits. This performance is further evidence of the impact of our value based management initiatives have had on the cash generation characteristics of our business model and consequently the improvement in our balance sheet. On a trailing twelve-month basis, at the end of the December quarter, debt to EBITDA was 1.7 and EBITDA coverage was 7.6, evidencing our strong, and what we believe, our investment grade credit statistics. With this strong cash flow and significantly strengthened balance sheet, we were able to utilize available liquidity to close the Access acquisition in the beginning of the third quarter fiscal 2007 while maintaining investment grade credit statistics, thereby avoiding dilution to our current shareholders. The reduction in interest expense during the December quarter was a net effect of increased cash flow low, lower debt and the refinancing activities that took place over the past several quarters. Factoring in the cash and debt used to acquire Access, we expect interest expense to be roughly 85 to $95 million over the next four quarters. Now let me turn it 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 year 2007, management expects sales at EM to be the range of 2.43 to $2.53 billion, and sales for TS to be in the range of 1.67 to $1.77 billion. TS projected sales include roughly $500 million for Access. Therefore, Avnet's consolidated sales should be in the range of 4.1 to $4.3 billion for third quarter fiscal 2007 ending on March 31, and earnings should be in the range of $0.67 to $0.71 per share, including approximately $0.02 per share relating to the expensing of stock-based compensation. The above EPS guidance does not include integration charges or amortization of intangibles related to the acquisition of Access as those amounts have not yet been fully determined. With that, let's open up the lines for Q&A. Operator?

[OPERATOR INSTRUCTIONS] Thank you. Our first question is from Mr. Thomas Dinges of JPMorgan. Please proceed with your question.

Hi, good afternoon, guys. A couple of quick ones for you. Roy, can you talk a little bit about the microprocessor business because that was one thing holding back the growth a little bit in TS and especially in Asia and specifically the question is you're down to one vendor basically in that business. You used to have a couple. It's a pretty tough business out there as you saw from the vendors from AMD's results. What's kind of the long-term thought around having that line card in the mix there and then I have another quick follow-up for you.

Okay. So hi, Tom. Let me make some comments and I'll flip it to Rick also in case he wants to add anything. Rick by the way is off-site. So the history of our microprocessor business is one where we had a substantial relationship with both microprocessor suppliers. As we applied our economic filters that we developed coming through value based management, we were struggling to generate appropriate returns on our business with Intel, primarily. And this varies by the way in different parts of the world. As we applied those same filters to AMD, we were at least satisfied and sometimes more than satisfied with the results and as a natural consequence, we deselected business we thought was not profitable and we invested in business that we thought was profitable. And so we evolved into this bigger relationship with AMD.

I can tell you that we still do business with Intel in various parts of the world. There is I guess I would describe it as intermittent but continuous dialogue with them around changes that they've made in their programs and their channel strategies. So it is possible that our business with Intel and microprocessors would grow over the coming quarters. I would circle back to AMD and just say that it is fairly clear to me that the industry has accepted AMD as a permanent and viable supplier of microprocessors so that the environment right now is a little difficult based on a bit of a price war between those two. And then on top of that AMD had some product availability issues that affected revenues in the early part of the December quarter and probably ended up affecting revenues at least through the channel for the entire quarter. And I think that will -- Tom, that will work itself out as we get through the March quarter here so we're expecting a more normalized kind of quarter with AMD and my belief is that we'll have a business relationship, a substantial relationship with AMD for as far as my eyes can see. Rick you want to add anything to that?

I would just comment that as far as looking back the last few quarters, the June quarter was the one that probably caught s a little bit off guard as to what was going on. The new realities in that market space, what's going on, the growth rates, the outlook, et cetera, we're now making sure that we build that into our outlook and I think that came in for the December quarter, you can see that we built in that type of expectation as part of our overall plans and we've done so for the outlook for March quarter as well.

And then just qualitatively on the gross profit, obviously was a nice quarter but this was even in light of TS having a higher sales with the seasonal quarter here, Ray can you just walk through a couple of the levers, was there some mix shift where maybe some of the -- either electromechanicals or passes or something was a little bit stronger for you guys than you had anticipated, a little bit less on the fulfillment side maybe because some of the EMS guys were not pulling as much? I'm just trying to get a little more color on the rise in the margin this quarter.

Tom, it's Roy. I'll take that. So actually you sort of covered here with that last bullet. As you might imagine, we have gross profit enhancement strategies and activities that are going on literally throughout our operations all over the world continuously. So that's an ongoing activity. And I would say that, in addition to that there are competitive pressures that push us down as we're executing strategies to push ourselves up and we would hope that over time we're winning that battle. But when you see a margin shift like it does or did this quarter, in most cases that's a reflection of business mix. And what happens specifically in this quarter is the miss or the short fall in EM's revenues were predominantly from higher volume, lower margin customers and as a result of that, the margin on the business that that we did write popped up. And that's where our diversified account base really helped us.

Okay. Thank you.

It's predominantly mix.

Okay. Thanks.

You're welcome.

Thank you. Our next question comes from the line of Mr. Michael Walker with Credit Suisse. Please proceed with your question.

Thanks. Couple questions here. The first one is the guidance on EM, which is remarkably bullish, relative to a lot of the noise we've heard out of the semi world, looks like you're guiding up 6% sequentially. Wondering if you could help explain why there's such a disconnect between the lower guidance coming out of semis for the March quarter, and the relatively strong guidance you're providing for the March quarter.

Okay. We'll ask Harley to take a shot at that. I may add a thing or two at the end.

Hello, Mike, how are you. I think the way I would think about that is number one, typically this is our strongest quarter of the year with our European business and in addition to that, they continue to be our strongest region over the last couple quarters. So we're very bullish on that continued strength. Most of the reports that I have read coming from our suppliers had been from suppliers who have a very different regional mix than we do. I know one of our guys announced this morning and I believe he said that his revenue split something leans towards 70% in Asia.

So we don't have that same dependence on the realities of that particular market as do most of our suppliers. So the biggest issue really is the regional mix. I think I would add one additional comment, that although the overall market has slowed down somewhat, we've been working very hard on multiple growth strategies inside of the larger $300-plus billion market and you actually mentioned one or two. We saw a very good growth in the December quarter in our IP business, interconnect pass and electromechanical and we also are seeing good results from our expansion efforts in what I would call small to medium customers. So those two factors showed good growth and we believe we'll continue to show good growth into the March quarter.

And Mike, I'll add a couple things. Our guidance for EM is up about 6% at the midpoint and our perspective over the last few years is that average or normal, if there is such a thing, is closer to 8%. And so from our point of view, we're actually guiding below normal and as you break it down by region, we're actually thinking EMEA is going to be absolutely fine. We had a positive book-to-bill in the December quarter, we're off to a good start this quarter. So we're thinking their seasonality actually is normal and where we're down is in America and Asia and when you roll it all up you come up with sort of a 6% midpoint as opposed to maybe what would normally be an 8%. And the other thing I'd like to point out is that this does not mean that our sales per day are up by 6% sequential. The reality is that a significant portion of that growth, which is why it's Avnet normal seasonality, is the number of working days in the March quarter versus the December quarter. So some of that growth is just number of days as opposed to higher sales per day.

Okay. That's helpful. Second question's around inventories. Obviously inventory's were down nicely and down on a days basis overall. If you look at EM specifically where most of the inventory concerns have been, it look like your inventories I think you said were down about $51 million on a days basis but your revenues were down $100 million, which suggest that inventories on a day's business may have actually increased on a component basis in December and most of that inventory decrease was on the TS side. Could you tell me if that's correct and give any more color around trend of inventories on the components side.

So let me do the numbers. I'll ask Harley to comment more qualitatively. In terms of inventory days, the way we calculate it, EM actually went from 62 to 64 days, so you are correct, the inventory did not fall as fast as the revenue fell for that quarter. So that's a valid point. However, in terms of dollars, TS inventories actually were up slightly in dollars. EM was down in delivered dollars and down even bigger in constant dollars and essentially we're back where we were a year ago with regards to EM inventory productivity, if you will. And are therefore pretty comfortable with our levels of stock. Harley?

Roy, I think the only thing I would add to that is that it is conceivable that we could have taken inventory down even further in the December quarter, but we are cautious on that when we think about the anticipated growth in the back half of our fiscal year. So we think our inventories are in excellent shape and will fuel the revenue growth we're looking for.

So with the revenues up 6% on EM is it fair to assume that inventory days on the EM side could be down in March?

Absolutely.

Thank you very much.

You're welcome.

Thank you. Our next question comes from the line of Mr. Bernie Mahon with Morgan Stanley. Please proceed with your question.

Hi, good afternoon. Question for you on the TS business. Margins there were up 40 basis points year-over-year. Did that have anything to do with a mix shift or is that just the leverage in the model? And then also what should we expect for margins in TS going into the March quarter as we integrate the Access acquisition?

Okay. Rick, do you have enough data with you to take that or would you like me to take the first pass.

I'll offer some, Roy and you can follow up.

Okay.

Part of the contribution on the boost for TS was due to a strong performance out of the EMEA region, both from an overall growth perspective as well as a profitability improvement perspective. So I think that that was a big contributor to it overall. On the outlook going forward, still are the recently reinforced sort of long range op margin goals that we talked about in New York in mid December of the 3.2, to 3.7. We do not see the integration of the Access business putting that range at risk or changing the game for us there.

Okay. But do you thing in the March quarter it would probably be at the lower end of that, just given kind of normal seasonality of the 3.2 to 3.7?

Yes, I would say mid to lower threes is probably the right range.

Okay that's helpful. Thanks a lot.

Bernie, just to follow on. So TS's gross margin year on year for all practical purposes was about flat. And the interesting thing there is that the divestiture that we made if you recall in TS was an end user business or a single tier business, and it actually had higher gross margin than our two tier business. So this is a good job by the TS team. But the operating margin expansion really all came from expense leverage.

That makes sense. Thanks.

You got it.

Thank you. Our next question comes from Jim Suva with Citigroup.

Can you talk about with the integration of Access, kind of what we should expect for SG&A kind of a run rate basis as well as for the March quarter, what amount of EPS contribution do you see coming from that?

Okay. So Ray, you want to take the SG&A question?

Sure. If you look at -- without getting into specifics concerning Access' full financial statement, as Rick just pointed out, overall their operating margin is pretty close to what TS's historical average has been. So we don't see that changing a little bit. So this certainly will have an impact of increasing expense dollars but should not have any big impact overall to some of what our ratios are, especially initially until we have an opportunity to take the synergies out of the business which should be completed by the end of the June quarter. From an earnings per share perspective, we've indicated in the past that During calendar 2007 we're looking at accretion of roughly $0.20 and a way to look at that is about again ballpark type number, a few pennies in the first quarter, it will move up to more than that, maybe twice that in the June quarter, because that is Access' strongest from a seasonal perspective, the strongest quarter of the year and then through the balance of the year, you'll get the remainder of the $0.20, roughly evenly, maybe a little bit less in Q3 and a little more in Q4 but not dramatically so.

As a quick follow-up to that so if SG&A was 330 this quarter, are you thinking that it I kind of goes up to 350 range or 380 range or where would it go from March.

Figure about 350 to 360.

Great. Thank you very much and congratulations.

Thank you very much.

Thank you. Our next question comes from Brian Alexander with Raymond James. Please proceed with your question.

Thank you, good afternoon.

Hi, Brian.

I guess just a clarification on the question that was asked earlier about TS margins and obviously you guys showed a lot of operating leverage and sounds like a lot of that came from Europe. I was wondering were there any non recurring/one time rebate programs that might have led to that profit performance or was that just blocking and tackling?

Rick, you can talk about just blocking and tackling.

I would reinforce that.

Nothing unusual, Brian.

Great. And then if I kind of back into your margin target for the March quarter based on top line and bottom line earnings guidance, it does appear that you're looking for continued margin expansion in both segments but I want to just touch on EM. The last time we had a slowdown of this magnitude where top line growth slowed to the low single digits, which it looks like you're projecting you had operating margin contraction in EM and now you're looking for continued margin contraction in EM and now you're looking for continued expansion. Maybe just touch on what's different from a few years ago versus today and why are you confident you can continue to grow margins even if revenue growth slows to low single digits. Thanks.

Yes. Brian, so first of all your observation is right on. In the last cycle, our peak quarterly revenue growth was 28% and our trough was flat. Okay? In this cycle, our peak quarterly revenue growth was about 17% and we think that was somewhat flatter by if you remember some revenue anomalies at the first quarter of the Memec integration. We really thing that revenue peaked at about 14 to 15% up. Right now it would appear to us that we're not going to get as low as flat when you adjust for divestitures and look at a pro forma revenue comparison. All that said, it's going to get close. It's going to be low single digits and the difference between these forecasts and what happened in the previous cycle is that for a variety of reasons, our gross margin is up and holding, whereas in that cycle you might recall we talked about some fairly significant gross margin decline and that obviously hit us on the operating income line until we could react with SG&A responses.

In terms of the mild correction that you're referring to, should we are you seeing that spread to other customer segments?

Again, I'll take a shot at it. Harley, you can add. So the inventory correction really has at least a couple of dimensions to it or heads on it, if you will. So one would be an imbalance of supply and demand or better said, forecast versus actual demand. So in the case of the EMS companies, as you well know, they receive forecasts from their users. They stage material to that forecast and if it turns out for any reason that the forecast was inaccurate, they can end up with an imbalance of inventory that then those be corrected. And I think -- so that's a general issue and the specific icon for this current last couple of quarters is calm infrastructure with maybe a little extra bias on wireless. So that seems to be the supply demand problem.

But more broadly, if you think back, product lead times, as they extend, members of the supply chain regardless of whether they're small, medium or large, EMS, ODM or OEM, distributors or EMS, we all have to respond in one way or another to those elongating lead times. So through March a year ago, lead times were extending. We exited the March quarter with many products in the 12, 14 week area and then we had some back end assembly and test issues in semiconductors that were extending lead times out to 18, 20, 22 weeks. And then what happened was all that began to mitigate in the June quarter and mitigated some more in the September quarter. So product lead times have come down to where what Harley, six, eight, ten.

Right.

Sort of the fat part of the bell curve on product lead times.

Right.

And so the whole supply chain has been able to contract that. So there's really both pieces going on here. And our belief is that the bulk of the supply chain is in the same condition we are, which is exiting the December quarter with inventories about right and then there are a few anomalies left, large end markets where there's still some kind of a supply demand imbalance and those are still working through.

I think the only thing I would add, Roy, is in addition to the particular focus on those segments you mentioned, underlying that for multiple quarters now is a behavior change with the vast majority of our customers, whereby they are much more aggressively managing their inventory peaks and valleys to a point that managing supply into the general base of customers has really gotten much more rational. You marry that with the lead time stability and we believe that we can continue to show velocity gain, even while adapting to that particular spike in that one segment you mentioned.

One last comment. Our book-to-bill ratios in components were positive through the June quarter. They went negative in the summer quarter and our book-to-bill ratios have been improving since about the middle of last quarter. So it seems as though that's the time frame in which most of our customers got their inventories in line with their true demand.

Thank you very much.

You're welcome.

Thank you. Our next question the line of Matt Sheerin with Thomas Weisel. Please proceed with your question.

Yes, thank you. Just to expand basically ask that gross margin question another way concerning the March quarter. It makes absolute sense that you're going to see an improvement given continued weakness in your big EMS customers in Asia. But in theory, Roy, should we expect gross margin then to come down in the June quarter and September as EMS and Asia comes back?

I think that's a fair assumption. There's actually two things that will happen, Matt. One is, if we now start adding purchases from larger customers on top of our current base, that would tend to pull gross margin down. Not necessarily operating, by the way, but gross. The other factor is we get a different regional mix in the summer. So in the March quarter and to an extent the June quarter we have strength in America and Europe and those are our higher margin regions. In the summer, usually you're starting to see the up, particularly in Asia at a fair amount of weakness in Europe. So you'll get a regional mix change as well.

Okay. Makes sense. And then maybe Harley can talk a little bit more about the passives and connectors electromechanical space. If you look at the suppliers, they seem to be doing a lot better than their semi conductor counterparts. Do you have any specific reasons why that is?

Matt, having come out of that space for a good portion of my previous career at Avnet, I can tell you that the good and the bad of that business is generally speaking the swings have always been less than semiconductor, both up and down. And I think what we're seeing there is if you looked at their pattern over a multi-year period, they're acting pretty consistently with where they have over the last number of years. So I don't find their reported data as compared to the semi guys to be that unusual. I think the only thing I would add is that they are doing an excellent job of expanding their footprint in some of the largest consumer products and selling more, selling more components, more complex differentiated components which have higher ASPs. So those would be my two points.

Okay. Great and then just my last question, on expected free cash flow going forward, with inventory, sounds like inventories are going to be kind of flattish, give or take, no reason to really build them or take them down at this point. So should we expect you to generate cash in this sort of low growth environment?

Hi Matt, it's Ray. I think as you go forward, one thing to always keep in mind, which I just need to do is, we have working capital that's now going to approach with Access about $2.7 billion. So a day's worth of activity meaning receivables, payables, net of inventory, used to be $150 million. Probably going to be $170 million per day. So it's always very difficult to predict what's going to happen in any one given quarter, just because of the size of the working capital. But as we go out to the balance of the year, we think we will be in a positive cash flow perspective. Don't think it will be as high as what we just experienced in the second quarter so it will moderate some. I don't think it turns negative so it does stay in a mild positive direction through the balance of the fiscal year.

Okay.

Matt, for us, we're starting to watch closely the of rolling four quarter cash flow generation because we think it sort of takes into account that volatility Ray's talking about and we don't see that number moving much at all. It was 330 million over the last four quarters and provided there's no significant downturn in business or significant upturn in business, that number should be roughly our go forward number.

Okay. Great. Thanks.

Thank you. Our next question comes from the line of Steven Fox with Merrill Lynch. Please proceed with your question.

Hi, good afternoon.

Hi, Steve.

Couple quickies. First of all, on the Access deal, if you're doing about $500 million this quarter, where do you think it would be on a peak quarter in June in terms of revenues?

So I'd say typical quarterly advance would be 20 to 30% sequential March to June in that business, Brian.

Okay. And then in terms of inventories, Roy, did I hear you right that you you thing you can bring down your component inventories this quarter?

No, you didn't hear me say that.

Nor I.

We think our inventory levels, Steve, are about right. Bear in mind, there is a sales increase going on so Harley was asked if he thought the velocity would improve and the answer is yes. In other words, we don't see inventory going up as fast as sales but we see it somewhere between flat and up slightly.

And then in terms of sales per day, are you implying that your sales per day in March versus December is going to look similar, down, up?

It's going to be up but it's much h much less than 6%. If we get sales per day up 2 or 3% we get 6% overall.

Okay. Great. Thank you.

You're welcome.

Thank you. Our next question comes from the line of Kevin Sarsany with Next Generation Research.

I don't know if I missed this I might have been humming the Super Bowl shuffle but can you talk about pricing?

Sure. Harley, you want to talk about ASPs a bit?

Sure, hi, Kevin. ASPs have remained -- I would actually categorize them as more stable in the December quarter than prior. Which I do find a little odd, quite frankly, because it was a challenging quarter in some ways from the top line but we see a good, stable environment continuing forward. Very little change in any way.

So with lead times coming in and pricing folding up, does that imply something on the demand side?

Kevin, what's happened is lead times have come in but they've kind of stabilized in that six or eight and in some cases still 10 week lead times. And capacity utilization rates have come down from the peak in the March quarter, but still up in the high 80s and in some cases in the low 90s. And so as a result of that, our suppliers are not particularly anxious to move ASPs down aggressively, nor are we. So I think what it implies is that we're in a relatively stable environment with a mild correction under way and at this point it's not a situation where our supply base is feeling like their overcapitalized with capacity right now and therefore they've got a lower ASP.

From a thousand feet, you've been talking about the new rational cycle and it appears that you guys lowering your inventory days over the last four quarters were kind of preparing for this. What worries you about the new rational cycle in the supply chain or somebody doing something that kind of ruins your theory?

Two things would worry me, one on the demand side and one on the supply side. So global economic conditions, if you think about how big the technology industry is now and the share of GDP that it possesses, more or less end demand is going to be heavily driven by overall economic strength. And right now global economic growth is looking pretty good with obviously some question marks regarding the growth here in America. The one thing on the supply side, if you follow the semi industry for a while, you remember that Japan was very disruptive when they had free money to build factories, Korea was disruptive when the federal government decided to essentially subsidize the semiconductor industry. A similar thing happened in Taiwan but in a different kind of business model and the thing that hasn't happened yet and I just am sort of hoping it doesn't happen and that is that the federal government of China does not get too aggressive in subsidizing semiconductor companies in China. If that happens you get irrational oversupply. So far, that has not happened and that's why we're in this I guess Camelot environment.

Okay, thank you.

By the way, for the audience, Kevin is in Chicago. Humming the Super Bowl shuffle.

Our next question is from the line of Harry Blount with Lehman Brothers. Please proceed with your question.

Thank you. Good morning, good afternoon, depending on where you guys are at. Couple questions, just to coming back to the guidance side of the equation. Not to put too much of a fine tooth comb on this, but the guidance as we look at it, the midpoint assumes basically that there is no improvement in the buying patterns of the tier one EMS. Is that correct?

Somewhere between none and very little.

Okay. And also related to that, what how did you guys take into account the fact that the Chinese new year's a bit later than normal this year in terms of setting the guidance?

Hi, Harry. This is Harley. I'll respond on that one since Roy and I had that conversation earlier today. We calculated as part of our valuation for guidance historically speaking a typical quarter for us in Asia is flat to moderate growth. So we think it's going to be similar to that, maybe towards the lower end of that range. But we have calculated as part of our projection.

Okay. And then back on the TS side of the equation, if I have done the malt had right on the impact from access, it looks like the guidance for stand-alone TS is down sequentially somewhere between 19 and 25%. It strikes me that that is probably a bit worse than normal seasonality for the stand-alone. Maybe could we talk about that a bit more?

It's actually pretty normal.

Okay.

Last year was down 22%.

Okay. So you're basically assuming a normal environment then?

That's correct.

Great. Thanks.

You're welcome.

Our next question comes from Scott Craig with Banc of America Securities. Please proceed with your question.

Good afternoon. You guys have been pretty consistently beating margins every quarter and the last couple quarters you've been beating them in a big way. First question on the December quarter, where was the biggest surprise for you guys on the margin side of things and then secondly, if I look to the guidance in the March quarter, where could surprise from the margin side of things come from?

So what happened for us this quarter, obviously we beat our own expectations on EPS by a pretty good margin. What happened is we got benefit relative to our own expectations in gross margin, in expense margin, in interest expense and in tax rate. So the answer to your question, Scott, regarding the operating margin is it was a combination of higher GP than we expected, coupled with better than expected productivity gains coming out of our operational excellence initiatives. So the combination of those two things created a lot of leverage on the operating income line. If you go forward, we're assuming that the gains that we've garnered we don't give up. We are not planning on any material changes in terms of operating leverage. And so I guess if we got a surprise, it would probably be in the gross margin area again, but I think we've got the guidance as dialed in as well as we can based on what what we know today.

And then when you look in the EM business and margins geographically, what sort of trends do you see as we work out in the next couple of quarters?

Well, as you know, EM has improved dramatically, but we're running -- trailing four quarters at 5.2% operating and we're looking for at least 5.5% operating. So what you can look for across all three regions is continued margin expansion as we manage that drop-through figure, we reinvest less than 50% of the dollar growth and we expand the margin quarter by quarter, barring a revenue or a gross profit dollar decline. So I think you should look for expansion coming from all three regions. I'm looking at Harley as I'm saying that. We'll get expansion from all three regions over the next couple of quarters. That would be our expectation.

Okay. Thanks.

You're welcome.

Thank you. Our final question comes from the line of Michael Walter with Credit Suisse. Please proceed with your question.

Thanks. Sorry to come up with a follow-up if that's all right. Just on the Europe, I guess I've been hearing a lot in the last two to three quarters about Europe being strong and that obviously the mix of Europe business is good for margins. So on this margin point my concern is just that when Europe starts to weaken again as I think it probably will, and if Asia becomes a higher part of the mix going forward is that going to start to reverse some of the margin progress over the last several quarters.

Mike, it will certainly impact gross margin and then depending upon volume, it may or may not have a negative impact on operating margin. we still get a lot of operating leverage on the incremental gross profit dollar growth. Okay? So it will -- it should, I should say, impact gross margin, it may or may not impact operating, depending on volume.

In December you talked about long-term two to three year I think you said operating margin target, 4.3 to 4.7, but by the June quarter my model anyway, you're already within that range. So the question is what do you change those targets, are they going higher? Do you have the time frame wrong?

A couple of comments. One is I believe we were trying to say more like two years than three years in December. Because we've been talking about these long-term targets for a couple of years now. So the date's coming in. The second thing is, this was brought up earlier on the call, the access business will pull Avnet's enterprise operating margins down. Now, we managed to return on capital so we'll still have a positive impact on cash flows for example and ROCE, but that will actually pull our margins down a little bit. So we think that range is appropriate at this point in time and of course we'll be happy to readjust it upwards if we prove ourselves wrong.

Okay. Thanks.

You're welcome.

Thank you. Ladies and gentlemen, at this time, there are no further questions. Gentlemen, do you have any closing remarks?

Yes. 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 along with a further description of certain charges that exclude from our non-GAAP results. This entire slide presentation including the GAAP financial reconciliations can be accessed and downloadable PDF format at 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 today, please contact the Avnet Investor Relations department by phone or e-mail. Thank you.

Thanks everybody.

Thank you. Ladies and gentlemen, this concludes the teleconference. You may disconnect your lines at this time.