安富利 (AVT) 2009 Q1 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 of Investor Relations.

Good afternoon, and welcome to Avnet's first quarter fiscal 2009 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. As we provide the highlights for our first quarter fiscal 2009, please note that we have excluded restructuring, integration and, other items from the current year period in the accompanying presentation and slides. Additionally, in discussing pro forma sales or organic growth, prior periods are adjusted to include acquisitions. One additional item that I need to mention before we get started, in respect of our recent offer to acquire Abacus Group PLC, we need to remind you that Abacus is a publicly listed company. As such, Abacus Group PLC and Avnet's offer for Abacus Group PLC are regulated by the UK takeover code. Under the code, we are required to have a representative of our financial advisors, Banc of America Securities, present for the duration of this call. Further, we are not permitted under the code to disclose any new material information or comment on the offer over and above the information contained in our offer announcement published on October 10, 2008.

Before we get started with the presentation from Avnet management, I would like to review Avnet's Safe Harbor Statement. This presentation contains certain forward-looking statements which are statements addressing future financial and operating results of Avnet. Listed on this slide are several factors that could cause actual results to differ materially from those described in the forward-looking statements. More detailed information about these and other factors is set forth in Avnet's filings with the Securities and Exchange Commission. In just a few moments, Roy Vallee, Avnet's Chairman and CEO, will provide Avnet's first quarter fiscal 2009 highlights. Following Roy, Ray Sadowski -- Chief Financial Officer of Avnet -- will review the company's financial performance during the quarter and provide second quarter fiscal 2009 guidance, after which Q&A will follow. Also here today to take any questions you may have related to Avnet's business relations are Rick Hamada, Avnet's Chief Operating Officer; Harley Feldberg, President of Electronics Marketing; and John Paget, President of Technology Solutions. With that, let me introduce Mr. Roy Vallee to discuss Avnet's first quarter fiscal 2009 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. The first quarter of fiscal 2009 started off where fiscal 2008 ended. Top line performance continued a multiquarter trend of muted organic growth rates as sluggish demand in several end markets persisted. Revenue of $4.49 billion in the September quarter finished below expectations due to lower than expected sales in our Technology Solutions group. On a reported basis, revenue grew 9.7% year-over-year and 7% adjusted to exclude the impact of changes in foreign currency exchange rates. Revenue was up 0.9% on a pro forma basis when you adjust for the impact of acquisitions.

Gross profit margin improved 15 basis points over the year-ago quarter to 13%. This performance is a reflection of the excellent job the Avnet team around the world is doing by staying focused on profitable revenue, despite the challenging market conditions. Our previously announced cost reduction initiatives are on target, but lower than expected revenue this quarter had a negative effect on our operating income margin. Excluding restructuring, integration and other items, operating income in the first quarter of fiscal 2009 was roughly flat compared to the year-ago quarter, with operating income margin declining year-over-year and on the bottom line, diluted earnings per share declining $0.02 to $0.67.

We believe our team is executing well globally, but the macro environment is having a negative impact on our sales. Given the turmoil in the capital markets and the well-publicized decline in several economic indicators, it appears that organic growth may not improve in the near term. As a result, we are taking additional actions in order to continue managing our business to our stated long-term financial goals. In addition to the cost reductions that we announced in April and August, we are now targeting further cost reductions of $50 million on an annualized basis, which we expect will be fully implemented by the end of the March 2009 quarter. While it is difficult to gauge what our revenue will be over the next few quarters, these actions reflect our ability and commitment to respond to changing market conditions, while continuing to provide superior value to our trading partners. We will continue to closely monitor the vital signs across our diversified global portfolio of businesses and manage the things that are within our control.

While the cost actions we are taking are intended to protect the margins on our income statement, our balance sheet is the strongest it has been in years. Our debt to total capital is 23%, and we have over $1.3 billion of available liquidity, including cash and committed credit lines. Since we are well positioned from a liquidity perspective, we can continue to invest in enhancing our competitive position, both organically and through value-creating M&A.

At the beginning of the first quarter of fiscal 2009, we completed three acquisitions -- HorizOn Technologies, Ontrack Solutions and Source Electronics. Each of these transactions adds to Avnet's global scale and scope. We also recently announced an offer to acquire Abacus Group PLC, a value-added distributor of electronic components and embedded computer components in Europe, which had sales of GBP287 million for its fiscal year ended September 2007. Abacus' strength in IP&E products support our stated strategy to grow in this segment and its broad customer base creates cross-selling opportunities for our electronics marketing business in the region.

Now let's turn to the operating groups. In the first quarter of fiscal 2009, electronics marketing revenue of $2.7 billion grew 8.4% over the first quarter of fiscal 2008 on a reported basis and 5.5% after adjusting for the change in foreign currency exchange rates. On a pro forma basis, EM revenue grew 3.9% over the year-ago quarter. The regional trends are little changed from fiscal 2008, with pro forma revenue in Asia growing in the high single digits, Americas in the low to mid single digits, and EMEA growth negative in local currency. Throughout this period of muted demand, the EM team has delivered solid results by focusing on profitable sales, controlling expenses and driving working capital efficiency. In the September quarter, gross profit margin was roughly flat and operating income grew 6.6% over the prior year quarter to $138.7 million. This represents the 11th consecutive quarter where electronics marketing's operating income margin has been above 5%, even though the lower margin Asia region has been growing as a percent of our total.

While each region is experiencing differing degrees of slower growth on the top line, they are all contributing to the steady performance on the bottom line. In the Americas region, operating income grew faster than revenue year-over-year and operating income margin was up 4 basis points. The EMEA region improved both quarterly gross profit margin and operating income margin year-over-year, despite a revenue decline in local currency. The EM team in EMEA has been gaining market share through this downturn, and once the acquisition of Abacus is complete, will be an even more formidable competitor, especially in IP&E products. The Asia region had the strongest performance this quarter, as they were able to combine top line year-over-year growth with an improvement in both margins and returns, with return on capital employed improving 88 basis points over the prior year quarter. While the forecast for component growth are coming down, our electronics marketing group is executing well and continues to stay focused on our long-term financial goals. Some of the necessary corrective actions being announced today pertain to our EM businesses in the Americas and the EMEA regions as we respond to the challenging environment.

For first quarter fiscal 2009, Technology Solution sales of $1.79 billion were below expectations due to lower than expected sales of proprietary servers and microprocessors, predominantly in the month of September. On a reported basis, revenue grew 11.5% year-over-year and 9.2% adjusted to exclude the impact of changes in foreign currency exchange rates. Revenue was down 3.3% on a pro forma basis, when you adjust for the impact of acquisitions. All three regions were below our expectations, with the EMEA pro forma growth rate well below the other two regions. At this time, the well publicized credit issues have not had a measurable direct impact on our accounts receivables. However, the challenging macro environment has negatively impacted sales.

While TS revenue was lower than expected, gross profit margin was up, over 50 basis points both sequentially and year-over-year. However, due to the negative organic sales growth, operating income and operating income margin declined year-over-year. Previously announced cost reduction activities at TS are on schedule and operating income margin in the September quarter was consistent with the recovery plan that we initiated in March. The cost reductions being announced today are focused on the business units that have been most impacted by the recent slower demand. Since the beginning of the calendar year, our TS operating group has been impacted by the macroeconomic conditions, more so than our electronics marketing components business.

In the first quarter of fiscal 2009, Technology Solutions completed two acquisitions that position the group for future growth. In India, the addition of Ontrack solutions provides a platform to build a value-added distribution business in one of the fastest growing emerging markets in the world. In EMEA, the integration of Horizon Technologies is well underway. We are excited about the future, as Horizon brings us a number of talented associates with experience in developing and selling solutions that the SMB segment is embracing. Similar to our approach in the Americas, we see real demand for solutions built around practices, including virtualization, security, and mobility. In line with that trend, we continue to see strong double-digit growth globally in both storage and networking, somewhat offsetting the decline in proprietary servers.

In summary, the first quarter of fiscal 2009 should be viewed as one of solid execution, despite macroeconomic headwinds that negatively impacted our financial results. At electronics marketing, the focus on profitable growth and expense management produced operating income margins consistent with fiscal 2008, even as Asia's growing as a percent of the global business. Working capital velocity continues at historically high levels and inventory is very well aligned with end demand. At tech solutions, the recovery plan that was initiated in March is on schedule and producing the forecasted savings. Due to further revenue weakness this quarter, we're taking additional corrective actions in both operating groups to preserve operating margins and return on working capital. The integrations of the recently completed acquisitions are on schedule and the teams are working to accelerate the achievement of our return hurdles. Our balance sheet is the strongest it's been in years and affords us the flexibility to pursue organic growth and value-creating M&A opportunities that strengthen our competitive position.

While it is difficult to predict how the capital markets' turmoil will impact our business in the coming quarters, we are prepared to continue taking corrective actions as needed in the short-term while strategically deploying our resources to fund growth and create shareholder value for the long-term. While we don't have any special insight into the future, at Avnet we do have substantial experience with cycles and we'll do what we have always done -- stay focused on our trading partners and manage the things that are within our control. We have outstanding long-term relationships, a countercyclical balance sheet, and the best team in the industry, with a value-based culture that not only allows us to weather the tough times, but to emerge as an even stronger company.

Looking forward, our end markets are a reflection of the dampened expectations for growth in the global economy. At electronics marketing, October is off to a slower start than usual. ASPs and lead times have held steady and inventory's been well managed throughout the supply chain. At tech solutions, end customers seem reluctant to spend money on discretionary projects with a longer payback as proprietary server sales have been most effective. On the other hand, capacity and efficiency requirements are still driving storage and networking growth and our solutions practices are delivering attractive growth rates as well.

While the drumbeat of negative financial news may magnify the perceived impact of these trends, I would remind you that this is not anything like 2001, when the technology industry had significant excesses to work through. From elevated average selling prices and inventories to excess capacity and IT spending, the period leading up to 2001 created an overhang that amplified that downturn and lengthened the subsequent recovery. In the current environment, I believe that the technology supply chain has been much more disciplined. Based on historical standards, ASPs are not inflated and inventory days are significantly lower, while IT and CapEx spending have been moderate. Given those observations, we expect that end demand will drive this cycle and track closer to the changes in global GDP. While the recovery might be slower than we would like, the depth of this downturn will be somewhat mitigated by the improvements that we've made in our business, as well as by the structural changes in the industry that have occurred throughout this decade.

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 start with a review of electronics marketing. In the first quarter of fiscal 2009, EM revenue of $2.7 billion was in line with expectations, up 8.4% year-over-year on a reported basis and up 5.5% adjusted to exclude the impact of change in foreign currency exchange rates. On a pro forma basis, EM revenue was up 3.9% after adjusting for the impact of acquisitions. The Americas region delivered its fourth consecutive quarter of year-over-year growth with sales up 4.6% on a reported basis and up 2.2% after adjusting for the impact of acquisitions. The EMEA region grew 6.2% over the prior year quarter. However, sales were down 2.1% after adjusting for the impact of changes in foreign currency exchange rates. On a pro forma basis, EMEA sales were up 2% year-over-year. Our Asia region grew sales 15.6% as compared with the first quarter of fiscal 2008 and 7.9% on a pro forma basis.

Electronics marketing continued to do a good job managing through the current macro environment. For the first quarter of fiscal 2009, EM's operating income margin was 5.13%, down only 10 basis points year-over-year due to regional mix. As we saw improved operating income margins in the Americas, EMEA, and Asia in local currency. In Asia, where we continued to grow profitably, we were able to translate 16% year-over-year revenue growth and a 33% basis point improvement in gross margin into a 16% basis point(Sic-see press release) improvement in operating income margin. EM's return on working capital was down as compared with the prior year quarter, due to the slightly lower operating income margins and working capital velocity. On a year over year basis, working capital velocity at EM declined 2%, but we were able to maintain our net days. Although inventory was up 1.6% sequentially to support our growth in Asia, EM consolidated inventory turns of 6.0 remain near record levels. With revenue projected to be down for the December quarter, we expect EM inventory to be flat or down slightly at the end of our fiscal second quarter.

For TS, in the September quarter they had sales of $1.79 billion, up 11.5% year-over-year on a reported basis, and 9.2% adjusted to exclude the impact of change in foreign currency exchange rates. Pro forma revenue, after adjusting for the impact of acquisitions, was down 3.3% with the EMEA region representing the biggest decline. At a regional level, revenues in the Americas was down slightly at 0.8%. In EMEA, revenue grew 44.8% over the prior year quarter in reported dollars and 37% if you exclude the impact of change in foreign currency exchange rates. On a pro forma basis, EMEA sales were down 7.1% year-over-year. The Asia region grew 3.9% as compared with the year-ago quarter and was down 4.6% on a pro forma basis.

Despite the lower than expected revenue, gross profit margins at TS improved 51 basis points sequentially, with both the Americas and EMEA realizing significant improvement. Operating income of $51.1 million was down 12.7% as compared with the prior year quarter, while operating income margin of 2.85% was down 79 basis points. In the September quarter, the Americas region delivered operating income margin within our target range and its return capital employed was above our 12.5% threshold. In EMEA, where the end markets have been the weakest, our integration of Horizon is proceeding as expected. That, together with the additional cost reductions underway, should have a beneficial impact on the December quarter results. However, given the further decline on the top line, we need to take further cost reduction actions in both the Americas and EMEA regions to ensure the recovery plan initiated in March continues to drive progress towards our long-term financial goals.

In the first quarter fiscal 2009 tech solutions' return on working capital declined significantly versus the year-ago quarter, primarily due to the impact that lower than expected revenue had on operating income margin. Working capital velocity was consistent with the prior year quarter, while net days were up by 1 day. TS inventory was down 2.5% and 0.5% sequentially in year-over-year respectively as inventory turns improved 9% as compared with the year-ago quarter.

Now let's look at the enterprise results for the first quarter of fiscal 2009 as compared with the prior year quarter. In the just-completed September quarter, Avnet sales of $4.49 billion were up 9.7% in reported dollars and 7% in constant dollars as compared with the year-ago quarter. Organic revenue growth was roughly 1% over the prior year quarter. Gross profit of $584.2 million was up $57.7 million, or 10.9%, as compared with the first quarter fiscal 2008, primarily due to the impact of acquisitions and the change in foreign currency exchange rates, while gross profit margin was up 15 basis points year-over-year. As this improvement in margin demonstrates, our teams have done a good job driving profitable growth and ensuring we get compensated for the value we deliver, despite the macroeconomic environment.

Operating expenses of $419.7 million were up by $58.4 million or 16.1% year-over-year, primarily due to the impact of acquisitions and the change in foreign currency exchange rates. As mentioned earlier, we are taking corrective actions by region and by function within the business units that are being negatively affected by this challenging environment in order to align our costs in working capital with the current realities of the markets we serve. To date, we have realized approximately $40 million in annualized cost savings related to the actions announced in April and August. We expect the balance of those initial actions, together with the additional actions' annualized cost reductions of approximately $50 million announced today, to be completed by the end of March 2009. Therefore, the full benefit of all these cost reduction efforts should be fully realized in our fourth quarter of fiscal 2009.

In addition to these cost reduction efforts, we will continue to manage the integration of acquisitions and fully expect to obtain the planned synergies that will help in improving our margins even further. As we have mentioned in the past, we would like to remind you that as a services company, roughly 70% of our expenses are variable in nature. This gives us the ability to expand and contract costs appropriately to closely align our expense structure and working capital investments with market conditions.

Excluding restructuring, integration and other charges, operating income of $164.5 million was essentially flat with the prior year quarter, while operating income margin declined 37 basis points year-over-year to 3.66%. Below the operating income line, year-over-year interest expense was down $1.7 million, due to lower average short-term debt outstanding and lower short-term interest rates. Other income was down $8.1 million year-over-year, due to foreign currency exchange losses, lower interest income, and the impact of no longer benefiting from our minority interest in the earnings of Calence LLC, as we sold our investment in April 2008.

The effective tax rate in September 2008 quarter of 30.8% was lower than our prior year tax rate, primarily due to the mix of business among various locations with different tax rate, but was in line with our continued guidance of 30.5% to 32.5% for fiscal year 2009. Excluding restructuring, integration, and other items in the current period, net income for the first quarter of 2008 decreased $3.8 million or 3.6% to $101.7 million, while diluted earnings per share declined by $0.02 to $0.67. GAAP net income decreased by $12.7 million to $92.8 million, or 12.1%.

During the quarter, we used $5.3 million of cash, but over the trailing 12 months, we generated $492 million of cash from operations. Historically, we have used cash for operations during the first quarter of each year, our seasonally slowest quarter, and then begin to generate cash as we progress through the fiscal year. Despite slower growth, we are able to maintain our working capital velocity and inventory turns as compared with the prior year quarter. At the enterprise level, our net days were flat year-over-year and we did not see any signs of deterioration on our receivable bad debts, despite the continued concerns in the credit markets. The significant cash flow generated over the trailing 12 months has allowed us to continue to invest in strategic opportunities that enhance our competitive position and create long-term shareholder value without impairing our credit statistics.

In the first quarter fiscal 2009, return on capital employed declined 150 basis points to 9.3% as compared with 10.8% in the first quarter of fiscal 2008, due primarily to lower income resulting from the lack of organic growth. However, on a trailing 12-month basis, return on capital employed was 10.9% above our assumed 10% cost of capital for the eighth consecutive quarter. Despite our slowed progress toward achieving some of our key financial goals, we continue to [maintain] our investment grade credit statistics, reflecting our strong financial position. On a trailing 12-month basis, debt to EBITDA was 1.5 and EBITDA coverage was 11.9. We exited the quarter with $387 million in cash and have $950 million of committed credit lines available. We feel that the corrective actions mentioned earlier should get us back on track, progressing toward our long-term financial goals. As many of you are aware, we have made significant progress in both margins and returns since launching our VBM initiative in 2001, and we are taking these necessary actions to assure that we maintain those hard earned improvements.

Looking forward to Avnet's second quarter of fiscal 2009, we expect less than normal seasonality at both EM and TS, and we are providing a wider range of forecasts due to the changing economic environment as well as a fiscal calendar mismatch with our suppliers. Our fiscal second quarter ends on December 27, four days earlier than many of our major suppliers, which will cause some sales to carry over into the March quarter. EM sales are anticipated to be in the range of $2.39 billion to $2.55 billion and sales for TS are expected to be between $1.95 billion and $2.19 billion. Therefore, Avnet's consolidated sales are forecasted to be between $4.34 billion and $4.74 billion for the second quarter of fiscal 2009. Based upon that level of sales, we expect second quarter fiscal year 2009 earnings to be in the range of $0.71 to $0.79 per share.

Second quarter guidance includes approximately $0.02 per share related to the expensing of stock-based compensation as compared with $0.05 and $0.02 respectively in the first quarter of fiscal 2009 and the second quarter of fiscal 2008. The above EPS guidance does not include anticipated restructuring and integration charges related to the cost reduction and integration of businesses noted earlier in this presentation. In addition, the second quarter guidance assumes that the average Euro to US dollar currency exchange rate for the second fiscal quarter is 1.3 to 1. This compares with an average exchange rate of 1.51 to 1 in the first quarter of fiscal 2009.

With that, let's open the line for Q&A. Operator?

Thank you. (OPERATOR INSTRUCTIONS) Our first question comes from the line of Carter Shoop with Deutsche Bank.

Hi, guys.

Hi, Carter.

Wanted to better understand what you're assuming for operating margins by division. If you look at each division and you assume a similar type of corporate expense in the December quarter, it looks like you would need to see about 100 basis points of margin expansion in TS, and you would see EM be roughly flat. Can you help me understand what you're expecting by division on the operating margin side? And also what type of restructuring benefits you will realize in the December quarter?

Carter, this is Roy. And the punchline is, you're pretty close. I think that of course -- look, we might as well get this out early on the call. We have given a very strong effort into the top line revenue guidance for the quarter and we could explain in detail how we came about it, but the punchline is that we really don't know what the revenues are going to be. This is unprecedented volatility for us, but given the revenue ranges that we talked about, at the midpoint, EM would probably be about 10 basis points down from the last quarter and TS would be up possibly at the low end of our long-term range, that 3.9% that we've been shooting for for the last couple of quarters. So I think your model is actually very much right on the money.

So what I don't understand is how we're going to see margins in EM hold pretty steady on a, about 8.5% decline in overall sales in EM sequentially. It's -- obviously we don't have many quarters where we can look back to say what happens when sales in EM go down 8%, but I've got to think that we're going to see more margin pressure than what you guys are anticipating. Is there any -- are there substantial benefits from restructuring that we need to know about here to get more comfortable with your estimates?

Well, again, I'll take the lead and then Harley can chime in. Couple of things. First of all, our gross margin has been holding actually quite nicely, and typically in the December quarter we get a little bit of a benefit from some calendar year end supplier rebates, mostly over in the European region. So that's baked into the gross margin. And then, yes, from a cost reduction point of view, there are some benefits there. There were some actions that were already taken in the September quarter that we should get full benefit of in the December quarter, and that's factored into the equation as well. When you roll it all together, if we get to the midpoint of the revenue guidance, we think in round numbers, we're going to be within about 10 basis points from an operating margin point of view at EM. Harley, do you want to add anything to that?

Yes. Hi, Carter. The only thing I would add would be that the variable that's driving the wider revenue range for us is primarily an uncertainty as to the strength of the revenue line in Asia. I'm sure you've read many of our suppliers make numerous comments about their uncertainty about the strength of the holiday buying season this year. Therefore, that's the biggest variable in our top line. If that comes in at the lower end of seasonality or the lower end of our range, that would have an impact actually of -- we see less detriment to the operating income margin with that portion of our revenue being down more than the others is the way I think about it. So there is an element of mix in there as well.

Okay. As a follow-up question, I would like to discuss the working capital velocity a little bit, particularly inventories. I was surprised by Ray's comment that you would expect inventory and EM to be flat to down versus down aggressively, given the overall sales decline in the December quarter. Obviously you'll be building a little bit for a seasonally strong March quarter, but March quarter will definitely be below where we were in the September quarter. Why can't we work that inventory lower and how should investors think about the overall velocity in a downturn here?

Okay. Carter, I think that it is probable that our inventory will come down. Again, similar to my mix comment before, if the bulk of the reduction is in Asia, then Asia has a higher inventory velocity. In other words, it requires less inventory per sales dollar. I think that impacts the amount that it would drop to a degree. Our model in the west requires more inventory per sales dollar, obviously generates more gross margin per sales dollar, so it's not an apples to apples drop. I wouldn't expect when our revenues in the east dropped that you would see the same or equal amount of inventory drop. So I think that's part of it. The other element I would say is it is not our philosophy to manage inventory down as a direct element of revenue reduction as much as to focus on our working capital metrics. So I think it is fair that we continue to work on driving the inventory ratios higher, but inventory's only one of the elements that we're focused on to do so.

And Carter, this is Roy. Let me add one thing. I think Ray's point was really meant in a constant currency context. We typically, from Q1 to Q2, don't make major changes because we know coming right behind Q2 is Q3, which is a strong seasonal quarter for electronics marketing. But I do think it is highly likely that by the time we finish the December quarter, driven by currency, you'll see a reduction in the dollar value of EM's inventory.

Okay, guys. Thanks for the time.

You're welcome.

Our next question comes from the line of Jim Suva with Citi.

Great, thanks very much. First, quick question, with your different change of year end, with four days versus the calendar, can you just walk us through quickly, do you just do like an allocation, a look back after the calendar year has closed both on sales and margins? And then it seems like you should have a pretty profitable jump onto the March quarter with four days of high computing going into that. Can you just walk us through how you worked through that calendar close?

Jim, what happens is our cutoff, Ray, is Saturday night at midnight or something.

Yes.

There's a very precise, SOX process-oriented cutoff. So anything that is eligible gets invoiced by that time and counts as a part of our fiscal Q2. We will then continue booking and shipping on behalf of our suppliers and in support of our customers through December 31. From an Avnet point of view, those revenues will fall into our March quarter. However, from the perspective of supplier credits, we provide a point of sale report and they will calculate our rebate based upon our sales within their fiscal period. So we keep running business as usual through the end of the calendar quarter and year and that data gets reported to the vendors and from their perspective, those shipments went out. From our perspective, they fell into the March quarter.

All right. So you get the rebate and the credit, then, of those four days in the March quarter, which gives you a little head start for March versus what's typical?

I actually think this is to be determined. We -- the way our calendar works, we run a 4/4/5. What that means is we have a perfect 52-week fiscal calendar every year, so there's a day that's carried over, and then you accumulate that for typically about four years and then there's a 53-week year. Next year in our first fiscal quarter, we will have a 14-week quarter and therefore a 53-week year and we won't have this issue to deal with. This year is the most severe, because it's the last year before the extra week gets captured and so there's this four days of carryover. I think our practice historically has been to book the rebates in the fiscal quarter that we receive the rebates, so to speak, but I guess we'll evaluate that given the facts of the situation.

Great. Then my follow-up question, the rebates as far as I believe you negotiate them quarterly, and if so, have those rebate levels been reset after the meaningful deterioration in the economy, and I'm talking like after September, are we talking the first couple of weeks of October? Were you able to renegotiate lower levels there, given things have really deteriorated in the first part of October versus, say, mid part of September?

Jim, this is John Paget. You're correct in those are generally renegotiated every quarter and they are consistent with the existing marketplace and the macroeconomic conditions, so we're pretty comfortable that we have attainable targets and that we'll be able to benefit from those rebates.

And, Jim, I'll just add two points. This is Roy. One, as we mentioned in the script, our gross margins at TS for the quarter were actually up about 50 basis points sequentially and year on year. And so I think that while it's only been a couple of quarters, we continue to believe that the anomalies that took place in the March quarter were anomalies that are behind us and we're back to normalized activity from a supplier rebate point of view. The other thing that I would point out is that the first three weeks of October in the tech solutions business, and especially in the Americas region which is over 60% of our sales, we're off to a pretty good start. So we're pleased with the way the quarter is getting started from an IT spending perspective. Now, the caveat I would give you is that that's also what happened in January, in April, and in July. And then the disappointments came in the third quarter. But-- I'm sorry, the third month of the quarter. But gross margin for the last two quarters has been absolutely normalized. We have not had any rebate issues. We're not expecting rebate issues in the December quarter, but of course I suppose if sales fell off a cliff at some point through the quarter, that could be an issue, but we have no indication of that based on the first three weeks of activity.

Great. Thank you very much.

You're welcome.

Our next question comes from the line of Steven Fox with Merrill Lynch.

Hi, good afternoon. First question revolves around your receivables. Can you just talk a little bit about history of having levels of bad debt during recessions, what other extra steps you're taking currently given that this looks like an incredibly tight credit environment to protect your receivables? And what what would you anticipate would be the level of bad debt during, say, the next 12 months?

Hi, Steve, it's Ray. Couple different things. Depending upon which region of the world, for the most part outside the US, we use insurance as a way of protecting ourselves up to a certain limit as it relates to receivables and then use other techniques as well. And so from an historical perspective, even if you go back to the 2001 timeframe and you recall all the issues back then, we really did not have significant AR write-offs. The other reason for that is we obviously have a professional team of credit people that work diligently, understand the customers, work with the customers on a day-to-day basis and we have managed very, very well those relationships so that, again, historically we have not seen any significant bad debts. I can't remember a time quite frankly where we wrote off sizable numbers. It just has not occurred. Now, we obviously do have write-offs on a quarter by quarter basis, but they are not significant. And what we've seen so far during, let's say the last six, 12 months is no significant change in that and so we're not anticipating that the level of bad debts is going to increase by any appreciable degree.

Ray, I was going to say, I'm going by memory here, which is dangerous, but based on my memory, I can't remember a receivable write-down being taken in a fiscal quarter in a public financial statement.

Right. The only one I remember is Enron, and that wasn't a lot of money, but we had a little bit of money in Enron, but we subsequently recovered some of that as well. So in connection with an acquisition.

Right, and so really absolutely [we] have not had significant issues.

How about from the opposite level where you have to walk away from some sales because you get nervous about the credit environment and some of the smaller customers you deal with? Is that a possibility?

That's something that's always evaluated because the risk is there. As you know, with our -- in the scheme of things, relatively low margins, every dollar of bad debt requires an awful lot of sales to make up that. We certainly are more cautious, but I can't tell you today that we have walked away from a significant amount of business. We may have spread things out a little bit from a timing perspective in terms of how and when we do business with a certain customer, but at this stage, we certainly tighten up a little bit on how much credit we extend, but we can do it more frequently and therefore collect more money more frequently in order to mitigate some of that risk.

Steve, it's Roy again. Let me throw a little color on that. If you think about the components business, where the majority of our customers are long-standing OEMs that we've done business with for many, many years, the credit lines don't actually tend to move around all that much. They are asset-based, justified credit lines. And so if the customer doesn't pay on time and we hit the credit line, our revenues don't actually decline. They just get capped at that run rate in a manner of speaking. There are scenarios, of course, that you could paint where revenues would decline, but generally speaking, it says that we cap the growth as opposed to shrink the existing revenue stream.

Okay.

In the IT space, though, you got a very different scenario and frequently when we're working through our VARs to try to capture a large piece of business with an end user, we have techniques whereby we will issue the credit based on the worthiness of the end user as opposed to the reseller partner and then we do a variety of things like utilize escrow accounts and lock boxes, and/or in some cases provide a receivables collection service ourselves where we do the collections with the end user and actually pay the VAR instead of the other way around. So we have mechanisms whereby we can use Avnet's balance sheet as a way to ensure that we optimize revenues for our partners.

Great. That's very helpful. Thank you.

You bet.

Our next question comes from the line of Brian Alexander with Raymond James.

Gentleman, I guess just a clarification back to the mismatching of one of your suppliers. Can you quantify how much that is impacting your below seasonal guidance? I think you're normally up 22% to 27%, so if we look at mid teens sequential growth, how much of that is based on the environment and how much of that was is based on the timing of that vendor?

Brian, we -- it's very difficult. As you can imagine, we're going to do everything in our power to get the orders in and the shipments out prior to our cutoff on Saturday night, but right now we have baked into the forecast a $100 million to $200 million carryforward into the March quarter.

Okay. Thank you. And then just, Roy, on pricing, the gross margin performance, if I look at your business versus your major competitor, is pretty startling. Your gross margins were up year on year. They were down almost 60 basis points. In the components business you were flat. They were down around 100. Computer business, you were up 50. So they talked a lot about the difficult pricing environment on their call and I haven't really heard that come through yours. So I'm just trying to reconcile why your performance and tone, particularly around margins and pricing, are so different than theirs, and it may be difficult for you to answer, but then tie into that your outlook for the components business for next quarter. I think the decline you're looking for sequentially is about 400 to 500 basis points less severe than theirs. So I guess what I'm looking for, is there anything structural or mix-driven that you think is explaining that or are there other explanations? Thanks.

Well, I think, Brian, there's a couple of things that we know because they are inside of our four walls. Then there's some things that we don't know for sure, but we suspect. So I think what I would say is that from an Avnet point of view, maybe the -- it's hard to say which one's more important. But one significant factor is the work that Harley and his team have done around the design chain and selling more of the higher ASP products through engineering, with registrations, which as you know bring higher gross margins. We have evidence that show that that is increasing as a percentage of our total revenue and in fact I think here in the Americas we had a record quarter in design win sales in the September quarter. So if that is something that we're doing to a greater degree than they are doing, of course they are doing the same thing, but to the extent that it's a greater degree, it's protecting our margins. The other thing I would say to you is that we are highly disciplined around the achievement of our long-term financial goals and more specifically around the creation of shareholder value, making sure that we're managing customer relationships and supplier relationships to our return on working capital hurdle rates. If we can't get to those hurdle rates, then we don't write the business. And so I guess in a word, you could call that discipline. So heavy design win activity in the component space, strong discipline in both operating groups. The other thing that I would tell you that we surmise is that our competitor has had or enjoyed some significant high volume, lower margin, but high velocity business coming out of the Asia region, and of course you got to look through the P&L and the balance sheet to get the full impact of all of that, but that might be also causing a disorganization in margins.

Okay, great. Maybe as a follow-up to your first point on design wins, as I recall, that used to be roughly 25% to 30% of your EM revenue and I know it differs by geography, and I'm not sure if you're willing to update that for competitive reasons, but if you are, just curious how that's changed, particularly since the Memec acquisition a few years ago -- what are those rates today? Thanks.

Hey, Brian. It's Harley.

Hi, Harley.

I'll respond so Roy doesn't. Our goal is 50% and we're making progress towards that goal. We're not at that level yet. The one other gross margin point I wanted to add to what Roy said is that we saw I think our fourth quarter in a row of IP&E sales at a rate higher than our semiconductor sales, and as you well know, that also has a contributing factor to gross margin.

Okay. Thanks.

Good point. You got it.

Our next question comes from the line of William Stein with Credit Suisse.

Thanks, guys. Frankly, I was a little bit surprised by the opening comments as to the characterization of the end markets. It sounds like you're characterizing the current environment as an ongoing slowing demand environment as opposed to one in which you saw a more sharp downturn, let's say in mid-September. Am I just missing that, or maybe you could clarify as to how you see the change in demand, let's say, from September and then the current month to date.

This is Roy. The -- from our perspective, as we look at our organic growth rates, so adjusting for M&A, what we have seen over the last few quarters is that continued slowing of the organic growth rate. It was about 4% in the June quarter and it fell to 1% in the September quarter. So that's a significant change, but it's a slowing of organic growth and it's still a positive number. From an October point of view, thinking about the December quarter, I've already mentioned the fact that the TS business is actually getting off to a reasonably good start and we mentioned in our script that our EM business is lower than we would like, but it's not dramatic. It's moderately lower than we've been running and what we would like to see at this point in time. So we are concerned about it. Is there a knee curve coming? It's possible, but I guess what I would say is if I pay attention to our numbers and not the media, which on occasion has been known to hype the news a little bit, we see a slowdown, but we don't see a dramatic change in the business environment yet.

So forgetting both what your sales are and have been recently and the media, if you look at your customers' order rates, you are either backlogged or they are forecast, whatever we want to call it -- you're saying there hasn't been a sharp or sudden change, say, in mid-September or to date relative to what we've seen in the recent history? Is that right?

That's -- I would say --

From a TS standpoint. I would say that we've seen some very sporadic kinds of movement, perhaps some more increased requests for leasing quotes. A little bit perhaps longer sales cycles, but our quote rates are up. As we check with our resellers and systems integrators, they are feeling comfortable that this quarter forecast that they have given us are well within reach. Again, we started strongly in other quarters as well, but they are feeling at least cautiously optimistic at this point around their ability to deliver their forecasts.

This is Harley. Additional color on the component side. We've finished Q1 right around a global book to bill of 1 for the September quarter. And to Roy's comments, a little color on Roy's comments, from a components perspective on October, our shipments through the early part of the quarter so far have actually been okay. They don't cause us a lot of concern. Keep in mind in a components business, our customer base, our product offering, the amount of SKUs we support are so broad that our backlog is pretty much rock solid on a quarterly basis. We don't tend to look at it on a month-to-month basis. So for quarterly basis, our backlog looks okay and our shipments through the first couple weeks are in line. The concern that causes us to think very cautiously on guidance is the area where we're not pleased with is on the bookings side. Typically going into this December quarter, you would expect to see bookings elevated in October and November leading us into the ultimate slowdown and in some cases shutdown in the holiday period in December. So the caution we see is less than buoyant bookings at this part based on typically what we would see this time of year.

And overall, level visibility today versus let's say what it's been in the last couple of quarters, has it fallen off significantly or is it really very different? I mean your competitor talked in a much more negative way historically.

We read that, Will, in the transcript. I think from our perspective, if you look back at things we've said over the last several quarters, we feel like visibility is very limited period. The IT business, we have these long project cycles, but once the orders are booked, they tend to go out the door pretty quickly. In the EM business, we've got a substantial amount of our revenues in supply chain engagements, so we're staging material, massaging forecast, managing backlogs. And then when the triggers come in, they tend to go out right away, too. So our book to bill ratio hangs in right around 1, and as a result of that, we have felt for many, many quarters that we don't have a lot of visibility. So we don't think our visibility has changed, but what I will tell you is that we feel more risk based upon what's happened in the financial markets and all the stuff that we're reading and hearing in the media. So we, we're taking a more conservative view from a forecast point of view because of that, but what we're seeing in our numbers is a relatively moderate or mild impact so far. So we're concerned, but I don't think it's a change in visibility. We're just more worried.

Okay. Thank you very much.

You're welcome.

Our next question comes from the line of Matt Sheerin with Thomas Weisel Partners.

Yes, thanks. A lot of the key questions have been asked, so I'll try to ask them in a different way. Regarding the component revenue guidance, which at the midpoint is around 8%, down 8% or 9%, in previous years you've been down and mid single digits -- some years more, some years less. This year you do have -- I'm assuming that the three fewer, or four fewer selling days, that also is true in your components business, correct?

Actually not, Matt.

Okay.

We think there could be a small factor there, but the way we do that business, the way it operates, we think that it's a very small impact.

Okay. And then also, AVX this morning I thought brought up a very interesting point, which is that they thought some of their larger customers would have longer periods of shutdown at the end of the year, which makes sense. Now, in your supply chain engagement type of business, your larger volume business, are you assuming the same thing's going to happen? Has that been factored into your forecast?

This is Harley. I do think we will see some of that. It is somewhat industry-specific, and again, because we're so broad, there's not a giant hit. Automotive, for example, I've heard some of that coming out of Europe, that there's a potential for some of that to occur at the end of the year. And as I said earlier, the big wild card I think for us overall is consumer and how strong the holiday buying season will be and that factor will clearly drive the strength of the close of the quarter. One other comment that I wanted to mention relative to our guidance is also keep in mind, as I think Ray or Roy said early on, that our guidance is based on a fairly dramatic reduction in the Euro quarter on quarter.

Just a reminder, the September quarter in Avnet's financials was reported based on a $1.51 per Euro and the forecast we're providing today is based on a $1.30.

Thanks, Roy. That's a good point. That leads to my follow-up question on the expense line because just doing the math on your EPS guidance, sounds like gross margin could be up a little bit, but even to get to the mid or low point of your revenue guidance, you still have to get SG&A, it looks like down sequentially. So we'll be -- I know you've got cost cutting actions from earlier this year that will flow through, but are we to assume that the courtesy will work in your favor on the expense side in the December quarter?

Absolutely. The overwhelming majority of our expenses in Europe, if not all of them, are in local currency. And as you know, Matt, it's about a third of our company.

And what percentage of your revenue is in Euro versus dollars, because I know in some of your larger customers, it may be in dollars.

John?

Roughly 26% to 28% of TS is in Euros.

And then what about in, on the component side?

I'm not sure. I can get you close. I think it's slightly below 20% of EM total.

Okay. Great. And just lastly, Roy, on acquisitions, I know you're planning to continue to -- you talked about putting the free cash flow to work through acquisitions and you've got a big one coming online in the next couple quarters. In this environment, are you going to still continue to look and try to take advantage of opportunities or are things so uncertain now that you just want to conserve the cash, run the business and then wait a while?

Matt, it's a terrific question. It's one that we spent a lot of time thinking about and talking about. We'll be meeting with our board here in a couple of weeks and having more dialogue with them, but the current view is this. In the short-term, we are managing to protect margins, drive velocity and therefore protect return on working capital, and we are very concerned about liquidity, making the assumption that until the credit markets are actually open and functioning normally that what we have is what we've got. We are assuming that we need to operate with the liquidity we have on hand, okay? Given that, and taking a conservative view, we believe that we have some amount of capital that can be committed for strategic purposes and we think that the opportunity is -- I wouldn't call it unprecedented, but it's probably the rare opportunity right now to either acquire properties that could not previously be acquired or to get them at prices that could not previously be done. So we are in fact intending to continue making strategic investments -- by the way, both organically and M&A, but, yes, you could still look for us to do some level of M&A, depending upon our own cash flow and liquidity, as well as what happens in the credit markets here over the coming months.

Okay, great. Thanks.

You're welcome.

This will conclude the question and answer session. I would like to turn the call back to the management for concluding remarks.

Thank you for participating in our earnings call today. As we conclude, we will scroll through the non-GAAP to GAAP reconciliation of results presented during our presentation, along with a further description of certain charges that are excluded from our non-GAAP results. This entire slide presentation, including the GAAP financial reconciliations, can be accessed in downloadable PDF format at our website, www.IR.Avnet.com, under the Quarterly Results section. Thank you very much.

Thanks, everybody.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation.