安富利 (AVT) 2008 Q1 法說會逐字稿

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

Good afternoon, and welcome to Avnet's first quarter fiscal 2008 corporate update. If you're listening by telephone today and have not access to slides that accompany this presentation please go to our web site, 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 principles or GAAP, the company also discloses non-GAAP result of operations that exclude certain items. Reconciliations of the company's analysis the results can be found on 8-K filed with the SEC today and several of the slides in this presentation and Avnet's investor relations web site.

As mentioned on the last call in connection with Access Distribution and reflecting recent industry trends, the company started recording sales of supplier contracts on a net revenue basis rather than on a gross basis effective in the third quarter of fiscal 2007. While the change reduced cost of sales in the second half of fiscal '07 and first quarter of fiscal 2008, it has no impact on operating income, net income, cash flow or the balance sheet. There by positively impacting margins. As we provide the highlights for our first quarter fiscal 2008, please note that we have excluded debt extinguishment cost in the prior period in the accompanying slides in order to facilitate comparison with current periods. Additionally in discussing pro forma sales prior periods are adjusted to include acquisitions as well as reflect the revenue change from gross to net for the sale of supplier service contracts.

Before we get started with the presentation from Avnet management, I would like to review the Avnet's Safe Harbor statement. This presentation contains certain forward-looking statements, which are statements addressing future financial 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 forth in Avnet's filings with the Securities & Exchange Commission. In just a few moments Roy Vallee, Avnet's Chairman and CEO will provide the first quarter 2008 highlights. Following Roy, Ray Sadowsky, 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 provide second quarter fiscal 2008 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, Harley Feldberg, President of Avnet's Electronics Marketing and John Paget, President of Technology Solutions. With that leet me introduce Mr. Roy Vallee to discuss Avnet's the first quarter 2008 business highlights.

Thank you, Vince. Hello, everyone. Thank you all for taking the time to be with us today and for your interest in Avnet. The September quarter was another example of how our broad revenue base and focus on return on capital continue to the positive momentum in our financial performance. Even though we experience some weakness in the Americas, better than expected growth in Asia and our [VBM] culture allowed us to meet our targets for revenue and operating income. On top of that, realized another $0.02 per share as a result of a lower tax rate and higher other income than expected.

Starting with the Enterprise highlights for the first quarter of fiscal 2008, let's begin with the bottom line where net income of $105.5 million grew 31% year over year, excluding debt extinguishment cost that negatively impacted the prior year's first quarter or two and a half times faster than revenue. Earnings per diluted share reached a first quarter record of $0.69, up 25% over the prior year. Again, excluding the debt extinguishment cost in the prior year quarter. GAAP earnings per share increased $0.25 or 57% as compared with the first quarter of fiscal 2007. This performance was driven by a combination of strong execution of our value-based management initiatives by our global team, bolstered by value creating acquisitions. Our VBM initiatives continue to have a positive impact on our key financial metrics despite modest organic growth. With an acquisition strategy that creates shareholder value, we were able to augment our organic growth activities and deliver another quarter where EPS grew significantly faster than revenue year over year. With our core operations continuously improving, and more acquisition revenue to be added in the current quarter, we are optimistic that we can continue to grow faster than our end markets and consistently grow profits faster than revenue.

While it is relatively easy to find acquisitions that are EPS accretive, we look to ROCE, and shareholder value creation, as the real measure of our M&A success. In the current quarter ROCE improved 68 basis points over the first fiscal quarter of 2007 and at 11.5% our trailing 12 month ROCE was up for the 8th quarter sequentially. This is further evidence our disciplined approach to acquisitions is generating incremental shareholder value. Finally our acquisition strategy enhances organic growth by entering Avnet into new, higher growth market segments, broadening our portfolio of products and expanding into new geographies. In the first quarter of fiscal 2008, we saw those benefits as we were able to deliver 12.3% year over year top line growth globally even though our serve markets grew in the low single digits. By expanding our already broad revenue base to include more end market segments and geographies we continue to reduce our market to any one market segment and increase our ability to grow faster an more consistently than the markets we serve.

In the first quarter of fiscal 2008, electronics marketing continued to deliver solid results in an environment characterized by modest growth globally and slightly improving conditions in the electronics supply chain. In the top line EM's highly diversified revenue base generated sales slightly above our expectations as better than expected growth in Asia and a weaker U.S. dollar offset negative growth in the Americas. While sales in the lower margin Asia region increased to 30% of total EM as compared with 28% in the year ago quarter, EM's gross margin improved 20 basis points year over year with contributions from all three regions. And its operating income margin improved year over year for the eighth consecutive quarter. Another EM highlight in the December 2007 quarter was asset velocity. With the mix shift to Asia, which has a higher working capital velocity business model and year over year improvement in both the Americas and EMEA, EM set a record for working capital velocity of nearly five times. As a result of this performance, our cash cycle declined 6.9% as compared with a year ago quarter or close to six days. EM inventory grew sequentially by 7% in constant dollars, which was a bit more than we expected. However, inventory turns held flat sequentially and were up year over year. The combination of continued improvement in operating income and record asset velocity led to a 239 basis point improvement and return on working capital year over year. We believe that these results validate how our broad revenue base and value-based management culture work together to deliver consistent financial improvements in a challenging organic growth environment.

Finally, the list of electronics marketing highlights for this quarter would not be complete without mentioning the excellent performance of our Asia team. Our disciplined approach to profitable growth with a higher asset velocity business model in Asia translated a 9.5% year over year top lying growth into a 48 basis point improvement and operating income margin, and as 673 basis point improvement in return on working capital. On the balance sheet, EMA shows significantly improved inventory turns and working capital velocity, which together with the significant improvement in operating income margin drove it's ROWC to just shy of our long-term target for that region. Record quarterly sales and profits in Asia were a factor in EM's year over year improvement and operating profit margin globally. EM is on track to meet or exceed our ROCE goals in all three regions in the near-term future. In the September 2007 quarter, EM revenue reflected the seasonally slower summer as both EMEA and Americas were down sequentially but the Asia region experienced strong sequential growth driven primarily by digital end consumer markets. Year over year revenue grew 2.3% globally and was essentially flat after adjusting for the impact in the change for foreign currency exchange region. The Americas region, weaker than expected, declined 4.2% sequentially and was down 4.8% when compared with the first quarter of fiscal 2007. Despite market weakness, this region continues to deliver ROWC above our target level by actively managing its P&L and balance sheet. In Asia, where demand was better than expected, revenue grew 10% sequentially and 9.5% year over year with high growth rates in the sales of interconnect, passive and electromechanical components and flash memory. In the EMEA region reported revenue was down sequentially and up 4.6% year over year in delivered dollars but down 2.7% in constant dollars. Excluding the impact of foreign currency translation and acquisitions the EMEA region declined 2.8% sequentially and 3.4% year over year.

Last quarter, we stated we were encouraged by the activity at our large EMS customers where sequential growth appeared to indicate that the excess inventory at these customers, which significantly impacted our organic top line growth in fiscal 2007, may be improving. In the current quarter, EM sales to our large EMS customers were down slightly driven by our decision to exit a particular revenue stream related to a single large end customer with insufficient profitability. Excluding that one engagement, our sales to large EMS customers were roughly flat and we expect similar results in the December quarter. Our global book to bill ratio finished just slightly below one to one for the September quarter with regional variations that are consistent with prior years reflective of relatively stable and manageable product lead times.

Turning to the highlights at Technology Solutions we have to start at the top line where growth from acquisitions drove revenue up 32.5% as compared with the first quarter of fiscal 2007. While I've already talked about some of the benefits of broadening our revenue base through acquisitions, another significant benefit is the impact that additional scale can have on our financial performance. At GS, the 32.5% year over year revenue growth in the September 2007 quarter resulted in a 40.2% growth in gross profit and 50.1% growth in operating income. While this multiplier affect can vary based on the amount of revenue and cost synergies for each acquisition, it remains our strategy to consistently grow profits faster than revenue. As a proof point, this is the 17th consecutive quarter that tech solutions has increased both operating income dollars and operating income margin year over year. While the Access and Azure acquisitions are positively impacting TS America and Asia today, we have more exciting acquisitions that will significantly enhance our competitive position in EMEA. In October we completed the Enterprise Infrastructure division of Magiris, the acquired business, which has annual revenues of approximately $500 million, is a value added distributor of IBM, HP Enterprise computing products in seven European countries and Dubai. The addition of 140 skilled employees and 1300 value added resaler customers presents substantial opportunities for cross selling and materially expands Technology Solutions role in the European IT distribution channel. With this acquisition, we have become the largest value added distributor of Enterprise computing products in EMEA, with industry leading system intergrationg, marketing, financial and technical value added services.

While the Magiris acquisition solidifies our leadership position in Enterprise IT products our recently announced acquisition of IT Solutions division of ACAL PLC will significantly expand our product line by adding complimentary products in high growth segments including storage area networking or SAN, wired and wireless networking and security, and document management. ACAL IT Solutions markets portfolio from leading suppliers including, Brocade, Cisco, Emulex, Juniper, and QLogic. Its headway technology group, which specializes in the design of document imaging solutions will provide TS EMEA an access to an exciting new market segment. In addition, ACAL IT Solutions brings a suite of services that will enhance our ability to deliver service and solutions that meet the increasing complex requirements of the combined customer base. We expect this transaction to be completed later this quarter and to be accretive to calendar 2008 EPS by $0.03 to $0.04 per share. With these acquisitions, technology solutions is projected to produce roughly $2.5 billion of revenue in the region during calendar 2008. In addition TS EMEA now possesses unique scale and scope advantages that should further advance Avnet's value proposition and accelerate organic growth.

In the September quarter, Technology Solution sales of $1.61 billion were up 32.5% year over year on a reported basis and up 2.6% on a pro forma basis adjusted for acquisitions and the impact of the change in the method of recording sales of supplier service contracts. Revenue was a bit below expectations as a result of the slower growth in the Americas region. The region's pro forma sales declined 5.1% year over year as demand for some proprietary servers and microprocessors were weaker than expected, even though we experienced strong double digit growth and industry standard servers, storage, services, and software. In contrast, 31.6% pro forma growth in Asia was driven by our Enterprise IT products business, which was up over 45% as compared with a year ago quarter. The Azure acquisition, which closed in the June 2007 quarter, is becoming a promising platform for growth in the region as we are adding new suppliers which expand our abilities. The EMEA region pro forma grew 20.1% year over year in reported dollars and 11% in constant dollars. While our Enterprise IT products business lead the region with a growth of 24%, we also achieved double digit growth in our units that sell displays and PC components. Now I'd like to turn the commentary over to Ray Sadowsky, Avnet's Chief Financial Officer. Ray?

Thank you, Roy. Hello, everyone. Let's begin with a review of our operating results for the first quarter fiscal 2008 as compared with the prior year quarter. Please note that we have included a reconciliation to GAAP net income at the bottom of the slide to account for debt extinguishment cost in the first quarter of fiscal 2007. As previously mentioned beginning the March quarter of fiscal 2007 our method of recording revenue related to sales of supplier service contracts has been adjusted to record those contracts on a net basis rather than on a gross basis. On this slide, Q1 of fiscal 2008 reflects that new method while the first quarter fiscal 2007 remains as reported. In the September of 2007 quarter, sales of $4.1 billion were up 12.3% in reported dollars and 9.8% in constant dollars as compared with a year ago quarter. Organic revenue growth, adjusted for the change in our method of recording revenue related to the sales supply or service contracts and the impact of acquisitions was up 2.3% over the year ago quarter and was essentially flat when adjusted to exclude the change in foreign currency exchange rates. Clearly our M&A activity is allowing us to deliver double digit top lying growth in a slower industry growth environment. Gross profit of $526.5 million was up $58.1 million or 12.4% as compared with the first quarter 2007 due primarily to the impact of acquisitions and year over year weakening of the U.S. dollar against the Euro. While year over year gross profit margin up 20 basis points at EM, and 53 basis points at TS, the Avnet gross profit margin was essentially flat due to regional shift to Asia in EM, that Roy mentioned earlier, the business mix shift at Technology Solutions as it grew to be a larger percentage of consolidated revenue and impact of the change in method of recording sales of supply or service contracts.

Remember Technology Solutions has lower markets than electronics marketing, also significantly higher working capital velocity and returns on capital. Propelled by the acquisition of Access, TS grew to 39% of consolidated results up from 33% in a year ago quarter. Operating expenses of $361.3 million were up $37.9 million or 11.7% year over year. Primarily due to the addition of access distribution at the calendar year 2007, an increase in stock-based compensation and the year over year weakening of the U.S. dollar against the Euro. My productivity prospective gross profit and operating income per employee up 3.6% and 5% respectively as compared with last year's first quarter. As we continue to grow through acquisitions, productivity metrics such as these provide another measure of how effective we are in integrating businesses and realizing our synergy targets. Operating income of $165.2 million increased $20.2 million or 14% as compared with the prior year quarter.

Operating income margin improved 6 basis points year over year to 4% as a negative impacts of the business mix shift to TS and the regional shift to Asia at EM were offset by the positive impact of the change in net revenue accounting for sales or service contracts at TS. The operating income line, year over year interest expense declined $3.7 million or 16.7% due to lower debt and lower effective interest rate as a result of our cash flow generation and refinancing activities. Other income increased $3.7 million over a year ago quarter due to higher interest income, foreign currency gains this year as compared with a loss last year and higher income from our equity interest in a non-consolidated business. Taxes increased $2.8 million, due primarily to significantly higher pretax income offset somewhat by a lower effective tax rate. The effective tax rate in the September 2007 quarter was near the low end of the 31 to 34% guidance range that we previously provided due primarily to relatively higher than expected profits internationally where tax rates are generally lower than in the U.S., which was our weakest region. As more of our profits come from Asia and EMEA we'll see tax rates trend down from the historical levels. As a result we now estimate our effective tax rate will be between 31 and 33% for fiscal year 2008. Net income excluding costs related to the early retirement of debt in the prior year quarter increased $24.8 million or 30.8% to $105.5 million driving diluted earnings per share up 25.5% to $0.69 per share for the September 2007 quarter as compared with $0.55 per share in the year ago quarter. GAAP net income increased $41.4 million or $0.25 per diluted share as compared with net income and earnings per share of $64.1 million and $0.44 in the prior year quarter.

This next slide looks at the key productivity metric of expense dollars to gross profit dollars over the last four years. The bars represent the individual quarters while the trend line depicts a trailing 12 month period at the end of each quarter. On a trailing 12 month basis our ratio of expense to gross profit dollars declined 373 basis points to 70.2% at the end of last year's September quarter the 66.5% in the current quarter. The operating group level, electronics market improved it's year over year rolling four quarter expense to GP dollar ratio by 262 basis points while Technology Solutions improved its ratio by 403 basis points. The September 2007 quarter, the ratio of operating expense to gross profit dollars increased 42 basis points year over year. But due primarily to seasonality was up on a sequential basis from 64.5% in the June quarter to 68.6% in the current quarter. While the seasonally slower September quarter usually results in a sequential increase in this metric, as you can see in the bars on the graph, the sequential increase in the current September quarter is more pronounced then in previous years. This is due primarily to the impact of the Access acquisition with a June quarter as positively impacted by its largest supplier Sun Microsystems fiscal year end. We continue to increase our focus in resources on operational excellence initiatives and expect to maintain our trend of year over year improvement in this important metric although the rate this improvement could slow as we get closer to our long-term financial model.

Similar to the last slide, we are providing both quarterly and a trailing 12-month trend line which portrays operating income margin over the last four years. The trailing 12-month operating income margin improved from 3.85% in the first quarter of fiscal 2007 to 4.38% in the 4th quarter benefited by approximately 16 basis points due to the change to net revenue treatment on sales or supply service contracts. As we look at the September 2007 quarter on a stand alone basis, operating income margin of 4% improved 6 basis points year over year. As I mentioned earlier, the year over year change was driven by the negative impacts of a business mix shift to more TS sales and regional mix shift to more Asia sales of EM, offset by the positive impact to change of net revenue accounting for the sales of supply or service contract at TS. At EM operating income margin of a 5.2% improved 7 basis point and TS operating income margin of 3.64% improved 42 basis points as compared with a year ago quarter aided by the change in accounting for the sales of supply or service contracts.

On this graph we have shown a return on capital employee, which is a key metric on our value-based philosophy we introduced more than six years ago. In the September 2007 quarter, return on capital to employee improved 68 basis points to 10.6% as compared with 10% in the first quarter of fiscal 2007. Even though business and geographic mix changes have impacted many P&L and balance sheet metrics return on capital has continued to improve year over year because we manage each business unit to our state of return on Capital Markets or higher. On a trailing 12-month basis return on capital employee continued the multi year trend of year over year improvement as it increased 164 basis points to 11. 5% in the September quarter. This represents the eighth consecutive quarter that our rolling four-quarter return on capital employee has made steady progress toward achieving our stated progress of 12.5 to 13%. I would add that over the past four quarters we have delivered the steady improvement even though organic growth slowed and we have continued investing in value creating M&A. While broad revenue basis helped to offset some of the marked weakness, our focus on profitable growth, operational excellence and working capital velocity have had a meaningful impact on this important metric. Going forward the combination of value creating acquisitions and a disciplined focus on returns should continue to broaden our revenue base and contribute to our scale and scope advantages further enhancing our organic results.

As depicted on this next slide, pro forma free cash flow, that is free cash flow generation before taking into account the cash used for acquisitions was $749 million for the trailing 12 months. In the September 2007 quarter, we consumed $34 million of free cash flow before cash used for acquisitions due to an increase in working capital and more specifically a decrease in accounts payable driven primarily by timing. At 6.3 times, our working capital velocity continues to remain strong and our net days declined over two days as compared with the first quarter of fiscal 2007. We expect a return to positive cash flow before cash use for acquisitions in the December quarter. With this significant cash flow generation, we have been able to pursue our acquisition strategy while continuing to improve our credit statistics. For a trailing 12 month basis by the end of September 2007 quarter, debt to EBITDA was 1.6 and EBITDA coverage was 10.7. During the September 2007 quarter, we negotiate a new five-year credit facility with a group of banks has include 18 lenders. The new facility not only offers better terms and conditions in the facility it supersedes but also extends those terms for an additional two years. There was significant demand for participation in the facility and the strong sponsorship demonstrates the competence by the financial community in Avnet strategy and solid financial condition. Now, let me turn it back over to Roy to provide our outlook in guidance for the September quarter. Roy.

Thank you, ray. Looking forward to Avnet's second quarter of 2008 we expect normal seasonality at both operating groups with sales at EM to be in the range of $2.4 to $2.5 billion and sales for TS to be between $2.05 and $2.15 billion. Therefore Avnet's consolidated sales should be in the range of $4.45 to $4.65 billion for the second quarter of fiscal 2008. Management expects second quarter fiscal '08 earnings to be in the range of $0.83 to $0.87 per share up 24 to 30% as compared with last year's second quarter. The above EPS guidance does not include the amortization of intangibles or integration charges related to the acquisitions that have closed or will closed or will close here in the December quarter. So with that, let's open up the lines for Q&A. Darcy?

Ladies and gentlemen we'll now conduct the question-and-answer question. (OPERATOR INSTRUCTIONS). Thank you. Our first question will be coming from Jim Suva of CitiGroup.

Great. Thank you very much. Can you guys talk a little bit about the competitive environment, increased competitions and such as one of your largest competitors the other day announced they have seeing increased competition, increased pricing. Can you talk about that landscape that you're seeing?

Yes, hi, Jim. It's Roy. I think that was related predominantly to the components business, right?

Yes.

Okay. So Harley, why don't you take that one.

Sure, Roy. Thanks. Hi, Jim. I'm not sure I could categorize the quarter as reflecting increased competitive precious. Obviously we're in a very competitive environment and have been for sometime, but nothing we saw really jumped out at us and said we were in a heightened increased competitive environment. As a matter of fact, we were encouraged by the fact we were able to raise our gross margins year on year and actually every major region.

Okay. As a quick follow-up, when we look at SG&A, how should we kind of be looking at that. It went up a little bit this quarter. Is that due to year end, some adjustments to salaries, annual type increases? And what should we look forward to December going forward.

Jim, first of all, yes, we do, in fact, handle our merit pay, annual increases here in the first quarter of of the fiscal year. That's part of the equation. I think M&A is another part of the equation. I think what you should look for going forward is continued improvements at the expenses as a percent of overall gross margin. As Ray pointed out in his comments, where that metric improved year on year, it it move in the wrong direction sequentially, which is actually typical for us from a seasonal point of view. The expectations would be that we would move back in the right direction again here in the December quarter and on through the next couple of quarters.

Okay. Thank you.

You're welcome.

Our next question will come from Matt Sheerin with Thomas Weisel Partners.

Yes, thanks. Just want to get back to your comment about the competitive environment and components. You talked about EMS being a little bit weaker, U.S. being a little bit weaker. Roy and Harley could you just give us your views about where you think we are in the cycle and sort of looking out a couple of quarters as much as you can? I know visibility is limited. Where do you think we're headed in terms of this semi-conductor cycle?

So, Matt, this is Roy. I'll take the macro and see if Harley would like to add anything here. From our perspective, that the last semi-conductor I'll say so-called downturn concluded in the March quarter where we had year on year growth rates for the quarter of about zero. We have been improving since then and we are forecasting in the December result to improve again. But the interesting thing, Matt, is that, depending how you think about it, that's two or three quarters into the global cycle improvement and we're talking about a mid single digit growth year on year. So I think that either this cycle is going to be longer than the last couple, meaning it will stretch out well into calendar 2008, or, you know, the growth rates overall are just lower than what pretty much all of us in the industry are expecting. So this is -- we're in a gradually recovering environment but it's the slowest rate of improvement that I've seen in an industry upcycle.

Matt, if I could, in addition to what Roy said, you comment specifically on EMS. One of the things I've been observing with EMS is that it's actually becoming less valuable for me to look at our global EMS business in the aggregate. Because there clearly are some that are doing far better than others. When you net all that together, as Roy said in his opening remarks, minus a customer that we chose to exit, our business is pretty flat there. It's really pretty flat. With that said, some are doing quite well, others are doing less well. We think that's probably going to continue in a pretty steady state in the foreseeable future.

Okay. Are there other big customers where you may not get certain returns or margin metrics that you also may walk away from some business?

Hey, Matt, this is Roy again. Across both of our groups, this is something that we've been doing, I guess in a manner of speaking you could say that it's connected to our overall value based management initiative in the sense that we really look not only at the profitability of the customer but all the way down to return on capital by customer including return on capital by vendor. So I think that the answer to your question is this is something we've been doing for an extended period of time. There was one particular account that, just came to a head this last quarter. There's not a lot of additional accounts to deal with. We're well down that road.

Okay. And then my last question has to do with inventories. You talked about inventories being up maybe a little bit more than you liked. Just talk about your strategy here on inventory. I know you've talked in the past about maybe opportunistically building, sounds like you think we're at the bottom of a cycle. What should we be looking for going forward here.

So again, I think -- let me qualify the question by saying that typically when we talk about inventory, it's components related.

Yes.

It's EM related. Harley, why don't you take that one. Where do you see your inventory going in the next quarter or two?

Matt, indeed you are correct. We're always interested in making opportunistic buys that we think can improve either our profitability or market share. So we will continue to do that as we said in the opening remarks, the inventory came in a bit higher than we would have liked, so we will adjust that in the December quarter. But I do want to reiterate we want to continue to use inventory as a strategy to grow our business.

And Matt, I would ask you to continue to look at, in fact all of you, please look at velocity as opposed to inventory dollars. Because obviously as the business grows in places like Asia it will need more inventory to fuel that growth. Bur our consistent focus is on improving the velocity, or the productivity in that inventory investment.

Which indeed, Roy, was the case in every region around Europe.

Thanks a lot.

You're welcome.

Thank you. Our next question will come from Brian Alexander of Raymond James.

Good afternoon. Just a follow-up on the margin question from earlier. Your operating margins, Roy, in the EM business were down I think about 60 basis points sequentially. Your overall gross margins on a consolidated base were down I think 15 sequentially. On higher EM mix. Favorable mix shift but gross margins down. So if I look within EM, my guess is that you're operating margins were down sequentially in probably all of your geographies. I guess I'm trying to tie those two together. You already answered the question about competitive pressures not intensifying during the quarter. So I'm just wondering why the 60 basis points sequential decline in EM operating margins. What caused that? Was it gross margin related? If not, what was it?

Brian, if you recall, or just look back at your notes, we had a particularly profitable quarter in the June quarter in Europe. And in fact, it's actually become somewhat of a Seasonal pattern for us. But last June was particularly strong, and so we've commented on that last quarter. If you look at EM's gross margin globally, it was down sequential. However, it was essentially flat in both America and in Asia whereas it was down in Europe, which was fully expected. So what we saw was very much what we thought was going to happen. Maybe the one exception is that our revenue in the Americas region was lighter than we thought and our revenue in the Asia region was greater than we thought, so there was a little more distortion to the margins driven by mix than what we had anticipated.

Okay. So you're not seeing anything, obviously you mentioned from a competitive standpoint, you're not seeing anything from a supplier or customer standpoint that is causing any variance from your expectations in terms of overall gross and operating margins within the components business?

Not at all, no.

And just a follow-up question, on the revenue guidance for the December quarter in TS, if I just try to look at apples to apples excluding some of the acquisitions that are coming into the fold here, it looks likes you're guiding up maybe 20% sequentially for revenue for TS, which I think historically you've done closer to 30. I'm not sure if you've seen a change in the demand environment or you're just being conservative or if my numbers are off.

As usual, your numbers are not off. There's a few maybe anomalies relative to our past seasonality. I'll let John speak to that.

Hey, Brian, how are you doing? Let's talk about a few things that might be just a little bit different than you're used to seeing in the fourth quarter for TS. I think there are about four of them that we've ought to talk about. First and foremost, this is not Sun's year end, so we have the Sun phenomena with the year end being in June. So you'll see a little bit different cycle there. Secondly we have Magiris in our revenue guidance at about $150 million. But more importantly we have a little bit of a timing situation. So normally you would expect to see us do roughly in the past about $200 million on the last day of December. We don't know exactly how much that is. But our last day of the year actually falls one day sooner than the last day for most of our vendors or the majority of our vendors. So we have roughly a little bit of flow that's going to flow into our third quarter versus in our second quarter. And also I'd like you to remember that this is first time you'll see December where we have the gross to net phenomena going on as well. The way I calculate it, it's about 30% sequential increase and roughly 34% year over year growth.

Okay. Thank you very much.

You got it.

Our next question will come from Thomas Dinges at JPMorgan.

Hi, John just to follow up on that last question but in a kind of more high level picture and Roy you're probably ongoing to comment on this as well, you guys in the emphasis on small mid-tier Enterprise touching a lot of different verticals, I was hoping you could just comment right now about kind of the way that the overall customer base is feeling going into the fourth quarter. Obviously we've heard at least so far on a vendor call or two about some hesitation at the end of September and maybe a little bit of trepidation as you move into December. I know based on where your guidance is, what you guys are thinking numbers wise. I'm wondering more qualitatively what the customer basis is feeling like right now and then I have a follow-up.

Okay, Tom why don't we let John, take the lead on that one. I may provide some color. We'll see.

Sure, Tom. I have spent a good part of the last 30 days out in the field, in fact all over the world. Interfacing with the [vars] and really trying to understand where they are from that perspective. What I'm getting back from our customer community is, in fact, they are seeing their quote in activity on an increase in this month. The little bit of rollover from September. But generally speaking, it looks like we're going to have a very basic seasonality cycle for this quarter, would not anticipate having a great deal of difficulty here.

Tom, it's right. We have been probing our customers regarding the credit crunch and impact on financial institution end customers. And the feedback we're getting is that that is not a factor for them and the pipelines are actually quite active. As John said, this feels like we're going into a very normal seasonal December quarter.

Okay. Then a quick one for Ray on the payables, you mentioned it was just purely timing. Obviously with the inventory being up, I may have answered my own question here. Is it fair to say maybe you guys pre-positioned some inventory in sort of the July-August period, which obviously creates the invoice and then as it didn't ship, you had your payment come due and you're not translating that off the inventory line?

There may be some of that, but I think if you look at the magnitude of the difference, inventory from a cash perspective, I don't know the number right off the top of my head was $40 million for the quarter. And yet you're looking at payables of a couple hundred million dollars. There's no doubt some of what you mentioned, Tom. It's more just timing of when invoices come due this quarter versus last quarter. So the way we like to look at it is more on a rolling four quarter basis. That's the reason we highlight rolling four quarters, only because if you look at the level of our overall working capital as I may have mentioned on prior calls, one day's worth of business is $175 million. So it's a whole host of items in this particular quarter driven mainly by payables in just the win periods cut off this quarter versus the prior quarter. Over the long-term it will smooth itself out. That's why again we try to emphasize more cash flow generation on a rolling four quarter basis.

Okay that helps, thank you.

Hey, Tom. It's Roy, too. Our expectations for the current quarter are no material changes in working capital overall. It's likely that EM will come down a bit. TS will move up a bit. In aggregate we don't think there will be substantial change in working capital. We should resume positive cash flow in the December quarter.

Okay. Thanks.

Sure.

Our next question will come from Steven Fox of Merrill Lynch.

Hi, good afternoon.

Hi, Steve.

Hi. Question on Asia first of all. Looks like it's coming up toward the same scale as Europe. You've highlighted the growth in the past being driven by the consumer mainly, but also talked about eventually looking like your typical distribution makeup. Where do you think it is -- what's going to be driving it over next year? Will you be able to see more industrial customers come into the mix or basically be driven by consumer end markets?

Well, let's see. Steve, I want to say that today our business in Asia is a little more than half indigenous customers and a little less than half multinational EMS companies. Okay?

Okay.

The indigenous customers for the most part are in the digital consumer business. Now as the markets grow, there will be more indigenous infrastructure kinds of customers, most notably, for example, in telecom. And we're starting to see that sort of industrial Cap Ex kind of manufacturing emerge in Asia. It's still a relatively small part of our total. In addition to that, you've got this international EMS business, which is predominantly end equipment that becomes corporate CapEx, heavy calms and high end IT related. So now as you try to project, you really have to project a couple of things. One is what happens to consumer spending versus corporate spending out over the next year or two? And I'm in the camp that says corporate spending should start to accelerate relative to consumer spending. It's very difficult to say. So I think if you put it all together, you look at our Asia business, I think our mix in Asia is likely to look a lot like it looks today over the next one to two years. I don't think the change in the nature of the indigenous account base will take place very rapidly.

Roy, if I could add one additional point to that -- hi, Steven.

Hi.

I think one other thing that's going to be interesting to watch is we're seeing the expansion today of the second-third tier EMS community in Asia. And that said, I would look at differently than I would look at the global EMS. So as we mentioned earlier, global EMS for us is flattish, I'd say. Pretty stable. But that other tier that I mentioned is growing significantly. The growth is difficult to bucketize, because it is indeed, EMS but it's coming from a different tier of customer some of which are indigenous to Asia and Japan, others which are indigenous to the west. It's important, I think, in our future analyze to consider the evolution of that third customer bucket as well.

That's very helpful.

Hey, Steve, it's Roy. Let me answer one more way. Thinking about it from a business model perspective. First of all, because of the indigenous growth in the local GDPs there, and because of the concept of global manufacturing, I think it is quite predictable that the growth rates in Asia for components will continue to exceed the global growth rates. So they will be the faster growing region. As we look at our business model, our expectations are that gross margins are going to be relatively stable, as we mentioned on the call they were up slightly year on year and essentially flat sequentially. We think that the gross margins will be relatively stable and similar to the balance of our model, expenses become scalable as we grow our business in that region. We're now on our way to $3 billion of top line. And as that number continues to grow, expenses as a percent of sales or GP should fall and Op margin should expand. That coupled with maybe a little more improvement in asset velocity and we're at our targeted return on capital.

That's helpful, sounds like an important trend to watch in the next year or two.

Yes.

Just lastly, real quick question for Ray on SG&A I might have missed this, relative to the dollars of SG&A you just had in end Q1, what are you targeting for Q2 roughly?

I'm sorry say that question again.

The dollars of SG&A spent, it was like $361 million in Q1, how is that going to look in Q2 more specifically? What kind of spend in dollars.

It will trend up a little bit. I would say right now under $10 million just due to significant growth in business that you'll see sequentially.

Okay. Thank you.

Steve, just a little bit of color, some of those corporate expenses including stock-based compensation will be down sequential. And then of course we'll have higher revenues and therefore some costs associated with that and then M&A.

Excellent. Thanks.

You're welcome.

Thank you. Our next question will come from Harry Blount with Lehman brothers.

Hi, guys coming back to the visibility, this is probably more on the component side, you guys have touched on it a couple of different ways. I want to press on it a one more times given the guidance we've seen from some of the individual players. I think you said in the prepared remarks that the book to bill ratio was a little less than one on a global basis. If you look at that plus some of your other indicators like lead times and cancellation rates, where are you guys getting the visibility and comfort that this will be normal seasonality that you won't see the slowdown?

Well, I'll give you one data point that may or may not answer your question and that is -- this is Harley from the components perspective. Every one of our reigns finished the September quarter with a better book to bill, more positive book to bill than a September quarter a year ago. That's one of the elements we look at when we think about our forecast going into December.

Harry, the cancellation rates at least here in America actually went down for some reason in the quarter. They have been very, very stable, so I think it's not a story. Product lead times are pretty stable which is why the book to bill is hanging out right around one in a very, very tight range. Of course we looked at bottom's up and top down forecast. If the question is are we 100% confident in the forecast, I'd say no. Visibility is still pretty limited. But we think that we should be somewhere between flat and down, you know, 3 or 4% sequential.

Okay. Then also related to your comments about APEC hitting the ROCE targets, historically you guys have started freeing up additional dollars for investment when regions hit their ROCE targets. Can you maybe comment a little bit bit on that as to when those dollars will be freed up and how you expect to deploy them.

Turns out, Harry, I think we've commented on this before, I'm not sure if it's been on a conference call or not, we have in Asia, we've been allowing our 50% drop through approach, even though they have not been at the return hurdle rate because of the high rate of growth there and concern over missing from a positional point of view in the marketplace. So we don't see much change in the way we're managing the operating leverage in our components business in Asia despite the fact that it's now approaching our ROCE target.

Okay. Last question was we heard from your competitor that they did not see the normal pick up in the month of September from Europe on the component side of the equation. I was wondering if you had the same experience over in that area, looking for more linearity within the past quarter.

When we look at the quarter in total and September as part of the quarter, our performance in Europe was really pretty consistent with what we had projected and pretty consistent with normal seasonality, and we see pretty much the same going into the third quarter.

Okay, thanks.

You're welcome.

Our next question will come from Jeff Walkenhorst of Banc of America Securities.

Hi, good afternoon.

Hi, Jeff.

Hey, guys. I'm wondering, you talk about in your release you talk about organic revenue growth of 2.3% year on year. To get a better feel of how the acquisitions performed for Avnet, there is any way you can give us in organic growth rate for operating income. Ray mentioned it was 14% year on year including on an overall basis. What would that be if you backed out the acquisitions?

Jeff, I don't -- I think if we could calculate it, we'd be happy to share it. But what happens is, as you know, we're integrating all of these acquisitions and the ability to track, you know, what's happening with the expenses and operating income on a current year basis and to separate the acquisition impact from our organic activity I think is close to impossible.

Right. Fair enough. Maybe another way to look at it. Do you think based on -- I mean I'm sure you have some way to separate at least the top line, if you look at the top line, has the performance of the acquisitions been in line with your expectations or has it been a little bit below?

I think we're pretty happy overall. I would share with you in the last 12 months, the biggest acquisition has been the Access deal, and I would say we've been -- we're slightly under our expectations from a revenue point of view. But we're slightly over our expectations for profitability point of view. And then in aggregate, I would say we're very pleased with our contributions from the M&A activity. No negative surprises.

To follow up on that point -- actually this gets back to what John was talking about earlier on the seasonality. You're confident you're going to see some positive seasonality in the fourth quarter but what happens given the Magiris addition, what happens in the March quarter white kind of sequential design might we model, equivalent to 20, 30% that maybe we've seen historically or has that changed?

There might, and I want to underline that word might be an anomaly this year, Jeff. I would say start with normal. One of the points that John made was December 31, this year, falls on a Monday. Our business, the way our calendar operates, we close on Saturday. So to the extent that there is revenue generated on Monday, that will be part of our Q3 as opposed to part of our Q2, and we have taken that into consideration in the forecast that we have provided. Other than that, I'd start with normal seasonality and then depending on how much business gets done on that Monday, that could actually have a beneficial impact to Q3 of this fiscal year.

Okay, thanks. One last question on the acquisition front given that this has been critical to your overall growth and organic growth is more or less flattish, both September and as well for December quarter, how is the pipeline looking for you, more competitive? What's pricing like?

Our pipeline continues to be active we still have -- it's not much change from last quarter. We have opportunities in both operating groups. We have opportunities in all three regions. There are more, as you might imagine, there's more opportunities to do smaller transactions. There are much fewer opportunities to do larger transactions. So overall I continue to be optimistic that we will continue to be able to conduct and announce and integrate acquisitions over the course of the fiscal year.

Very good. Good luck, guys. Thanks.

Thank you.

Next question will come from Carter Shoop with Deutsche Bank.

Couple of questions, start off with Harley. When we talk about the overall environment for EM, can you maybe categorize a couple of subsegments within that market, were there any particular markets or submarkets performing better or worse than expectations that really jumped out of you.

Are you referring to end markets or regions?

More on the end market side, kind of product categories, capacitors, connectors, analog semi, particularly better or worse than expected. Some comments like that would be helpful.

Sure. Overall a pretty predictable quarter from a semi-conductor perspective, nothing just out at me that was dramatic. We saw some enhanced flash opportunities in Asia, as you would guess, with the holiday buildup. But that was pretty predictable. Analog continued to be quite strong for us in the quarter. The one area that really spiked for us and was a very positive experience is we did see double digit growth in IP&E. That was a very pleasant surprise. No doubt that contributed to our gross margin performance.

Is that a sequential or year over year comment?

Both.

Okay.

Excuse me. Double digit, year on year, high single digit sequential.

Great. One more for you, Harley, here. In regards to the inventory, is there a way to break out what the inventory build was for EM versus TS on a sequential basis?

Yes. For EM, the inventory build was approximately 90 million.

Great. Thank you. For John, can we talk a little bit about how the two-tier distribution model might have a little bit different end market exposure relative to your customer base? So when we think about the slowdown we've seen on Wall Street and how that's impacted some companies like IBM or Sun, can you talk about how maybe you guys are less exposed to that, if you guys are?

I think because we have a broad portfolio, we're significant in Sun, HP, IBM, storage and so forth, there's certainly an opportunity for us to feel less spiky, if you would, depending on how the vendors participate. And certainly because there's different year ends for each one of those manufacturers as well. I think that spikiness is certainly mitigated for the most part.

Okay. I guess when we think about the end markets that you guys are servicing, I think a lot of people talk about the financial markets being roughly a fifth to a quarter of the actual demand for your customers. Now, do you guys have a little bit less exposure to the financial services based on your model, how you're servicing more the middle tier and lower tier customers in regards to size?

I think that's absolutely correct. We certainly see a less of an impact there. Much of that financial community we're talking about is served on a direct basis versus a distribution basis as well.

Helpful. Ray, you might have mentioned this already, why other income is up so much and what the outlook is for the next quarter?

Other income was up year over year three primary reasons. One, interest income. So keep in mind we've been generating a significant amount of cash. So interest income has moved up and will continue to move up as we continue to generate cash. Other than to the extent we may use some for M&A activity. We also had a relatively nominal currency gain this quarter that goes below the line, but it compares to a more significant loss a year ago. Then we have an investment. You may recall we sold the business about a year and a half ago. We maintained an equity interest in that business. So part of the income from that investment is in there as well. I would say as we go forward into Q2, we'd expect that number to be roughly the same as what it was in Q1. I don't see anything dramatically different at this point in time. Currency is always something that's difficult to forecast and based upon the size of our activities, it moving up or down is expected to some extent. But overall I'd say our numbers should be relatively flat on a sequential basis.

Okay, great. Last question. In regards to the acquisition pipeline and your outlook for making acquisitions over the next two years, I think we've historically talked a little bit about consolidating European IT hydromarket and selectively trying to find interesting opportunities in the Asian IT hardware market. Is that still top two priorities for or are we opening up the spiget and looking for other opportunities outside these two markets.

You know Carter, this is Roy. Those two both remain high priorities for us. I also think when you start thinking about the next two years, there will be some opportunities to consolidate the EM market in Asia. Remember we have this toe hold in Japan. It's our expectation we'll be able to conduct some additional transactions there. And then as I mentioned earlier, you know, smaller deals like the two IP&E we've announced in Europe, we'll continue to do that as well. TS we've got opportunities in what I would describe as high growth emerging market segments that we're also looking at. Those tend to be smaller as well. So there's actually by group, by region an acquisition profile that we look for.

Thank you.

You're welcome. Ladies and gentlemen, I know we're running late but we have one more question we're going to try to squeeze in.

That question will be coming, a follow-up by Matt Sheerin

Actually the question was asked and answered regarding the other income. Thanks a lot.

Okay. You got it Matt.

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 results presenting 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 the GAAP financial reconciliations can be accessed in downloadable PDF format at our web site. We would like to thank you for our participation in our quarterly update today. If you have any questions or feedback regarding the materials presented, please contact the Avnet investor relations department by phone or e-mail. Thank you.

Thanks, everybody.

Ladies and gentlemen, thank you very much for your participation in today's audio conference. That will conclude it for today. You may disconnect your lines. Have a good day.