安富利 (AVT) 2010 Q3 法說會逐字稿

I would like to turn the conference over to Vince Keenan, Avnet's Vice President of Investor Relations.

Good afternoon and welcome to Avnet's third quarter fiscal year 2010 financial 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 third quarter fiscal 2010, please note that in the accompanying presentation and slides, we have excluded some charges, a gain on the sale of assets, along with some offsetting one-time tax items from this current quarter, and impairment charges, restructuring, integration and other items from the prior year period. When discussing pro forma sales or organic growth, prior periods have been adjusted to include acquisitions. In addition, when we refer to the impact of foreign currency, we mean the impact due to the change in foreign currency exchange rates when translating Avnet's non-US dollar based financial statements into US dollars. Finally, when addressing working capital, return on capital, walk and turn on working capital and operating income drop throughs, the definitions are included in the non-GAAP section of our presentation.

Before we get started with the presentation by 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 slade 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 SEC.

In just a few moments, Roy Vallee, Avnet's Chairman and CEO, will provide Avnet's third quarter fiscal year 2010 highlights. Following Roy, Ray Sadowski, Chief Financial Officer of Avnet, will review the Company's financial performance during the quarter, and provide fourth quarter fiscal 2010 guidance. At the conclusion of Ray's remarks, the Q&A will follow. Since we have a large number of analysts who is cover the Company, I would ask thaw limit yourself to one question and if we have time at the end of the call, we will take any follow-up questions. Also here today to take any questions you may have related to Avnet's business operations are Rick Hamada, Avnet's Chief Operating Officer, Harley Feldberg, President of Electronics Marketing, and Phil Gallagher, President Technology Solutions. With that, let me introduce Mr. Mr. Roy Vallee to discuss the third quarter fiscal 2010 business highlights.

Thank you, Vince, and hello, everyone. Thank you for taking the time to be with us and for your interest in Avnet.

The third quarter of fiscal 2010 gained momentum month by month and sales exceeded our expectations at both operating groups for the third quarter in a row. And the technology markets we serve continue the multi-quarter trend of improving demand and year-over-year growth rates accelerated. Revenue of $4.76 billion increased 28.5% year-over-year, as compared with 13.2% growth in the December quarter. Along with this cyclical recovery, we improved gross profit margins sequentially at both operating groups. As a result of this strong revenue performance, gross margin expansion, and the operating leverage in our business model, operating income grew 3.4 times faster than revenue year-over-year and operating income margin of 3.7% increased 129 basis points over the year ago quarter. These results are being driven by our team around the world as operating income margin increased year-over-year at both operating groups across all three regions.

Turning to the balance sheet, we had another quarter of significant year-over-year improvement in asset velocity as working capital grew just 3% during a period when sales grew nearly 29%. As a reminder, the March quarter of fiscal 2009 was the trough quarter for both revenue and working capital velocity, which somewhat flattered the year-over-year comparisons this quarter. While the geographic shift to Asia has had a favorable effect on working capital velocity over the past few quarters, I would highlight for EM, both the Americas and EMEA regions delivered record working capital velocity. This keen focus on working capital productivity combined with the increase in operating income margin drove return on capital employed for the quarter to 15%, more than double from a year ago and in line with our long-term business model. Our performance this quarter demonstrates Avnet's capacity to generate economic profits and hence shareholder value as we continue to steadfastly focus on profitable growth.

While this quarter's performance is a reflection of the investments we made over the last few years, we also announced a major investment that we expect will have a significant impact on the future. On March 29th, we signed a definitive agreement to acquire Bell Microproducts for $7 per share in cash which equates to an equity value of approximately $252 million and a transaction value of approximately $594 million. With sales of $3 billion in calendar 2009, Bell is a leading value-added distributor of storage and computing technologies, offering a broad suite of value-added services, OEMs, VARs, system builders and end-users. This acquisition will strengthen our presence in several key markets in the Americas and Europe, while expanding our geographic footprint in Latin America.

Bell will double the size of our embedded systems business and add a variety of computer components, most notably hard disk drives to our product suite. Since we are very early in the integration planning process, there are no significant updates to the information we shared with you at the time of the announcement. The transaction which is subject to the approval of Bell's shareholders as well as customary regulatory approvals is expected to close in 60 to 90 days and our estimate of synergy cost savings remains between $50 million and $60 million. The investments should be immediately accretive to EPS excluding integration and deal costs, and we expect to meet our return on capital goal for acquisitions of at least 12.5% upon the completion of the integration. Now let's turn to the operating groups.

While Electronics Marketing typically has a seasonally strong March quarter based on strength in the western regions, the third quarter of fiscal 2010 was particularly strong, as all three regions grew above normal seasonality for the third quarter in a row. Revenue of $2.89 billion grew 14.7% sequentially in reported dollars and 17.3% in constant dollars. While the recovery in EMEA had been trailing the other regions, the pace of growth accelerated this quarter as revenue grew sequentially by 26.9% in reported dollars, and 35% in constant dollars. The Americas region delivered a strong quarter as well, with sequential revenue growth of 13.6%, while Asia grew close to 5% in a quarter that is normally down.

While some of the EM's revenue growth is related to inventory restocking by our customers, the combination of continued strong bookings in each region and lean inventories throughout the technology supply chain indicates that demand is strong for technology products in both the consumer and business end markets. Below EM's revenue line, a continued recovery in our served markets in the western regions, and an improved pricing environment, drove sequential improvement and gross profit margin for the second quarter in a row with all three regions once again contributing to the increase. The combination of higher sales and gross profit margin combined with continued diligent expense control drove operating income margin up sequentially for the third consecutive quarter, reaching 5% for the first time in six quarters. In the March quarter, EM grew operating income by 56% sequentially as all three regions increased operating income margin both sequentially and year-over-year.

Working capital velocity at EM set another record for the fourth quarter in a row, with the largest improvement coming from the EMEA region. Inventory was up less than 5% sequentially in constant dollars while sales rose significantly driving inventory turns to a record 7.4 times. Higher sequential operating income margin and record working capital velocity at EM combined to drive ROWC up dramatically both sequentially and year-over-year in line with our long-term business model. While the recovery in our served markets has fueled the improvement in EM's financial performance, we are not content to just ride the cyclical wave. We continue to invest in areas that will result in differentiated advantages in the marketplace and lead to continued profitable market share gains.

Throughout the downturn, we continued to build new logistics capabilities that will accommodate higher volumes and value-added activities, and we continue to expand and deliver services our customers value, like the recently completed Xvest series of technical seminars to enhance our demand creation purchase answer worldwide. While it is gratifying to achieve the low end of our long-term target for operating income margins this early in the up cycle we're making investments that should allow to us perform within our target range of 5 to 5.5% through the cycle.

In the third quarter of fiscal 2010 revenue in Technology Solutions also exceeded expectations resulting in a normal seasonal decline despite a very robust December quarter. TS revenue grew 17% year-over-year representing the second consecutive quarter of double-digit growth. In the Americas region year-over-year growth rates accelerated from 12% in the December quarter to 14% in the March quarter on the strength of storage and industry standards servers. In Asia, we continue to see the beneficial impact of our investments in organic growth and value creating M&A as reported revenue grew 88% year-over-year and 71%, excluding acquisitions.

Sales in the EMEA region have been relatively flat the past two quarters, indicating that the market there has stable stabilized but has not yet experienced growth. At the global recovery continues it appears that businesses are investing in project that is refresh legacy technology or add new capabilities to deliver increased efficiency and effectiveness in the data center. TS operating income grew 18% year-over-year to $50 million, as operating income margin improved in all three regions. ROWC increased significantly over the year ago quarter, and was above our 30% hurdle rate for the fourth consecutive quarter in line with our long-term model. Much of the improvement was driven by the Americas region, where our team has done an excellent job of translating improving demand into profitable growth and driving return on capital employed above our 14 to 16% goal, through the first three quarters of fiscal 2010.

While growth has returned in several of our served markets, we continue to invest in creating more profitable growth opportunities for the future. In the March quarter, we announced the acquisitions of PT Datamation in Indonesia and the HP business unit of Servo Data in the Czech Republic. Our push into emerging markets will be complemented by the acquisition of Bell with its presence in Latin America, which will further diversify our revenue stream while accelerating organic growth potential. Additionally, we continue to transfer our successful solutions path practices from the Americas to our international operations, where our partners are willing to invest in delivering solution that is accelerate their growth and ours as a result. As the recovery gains momentum, we are positioned to capitalize on profitable growth opportunities across more markets and technologies and translate that growth into incremental economic profits.

Now I would like to turn the comment over to Ray Sadowski, Chief Financial Officer. Ray.

Thank you, Roy, and hello, everyone. Let's look at the enterprise results for the third quarter fiscal year 2010 as compared with the prior year. For the March quarter, Avnet sales of $4.76 billion were up 29% in reported dollars and up 26% in constant dollars as compared with the year ago quarter. On a pro forma basis, revenue was up 28% over the prior year quarter. On a sequential basis sales of the March quarter declined approximately 2% due to the typical seasonal decline in Technical Solutions coming off its robust December quarter. Gross profit of $583 million was up 26% as compared with the third quarter of fiscal 2009, due to the increase in sales, as gross profit margin of 12.3% declined 25 basis points year-over-year.

This decline in gross profit margin is due to the combination of the continued geographic mix shift and lower gross profit margins at E M, primarily in the EMEA region. However, in concert with the cyclical recovery we continue to see sequential improvement in gross profit margins as EM's margins improved for the second consecutive quarter in all regions. As a result, consolidated gross profit margin was up 83 basis points sequentially due to the improvements at both operating groups.

Operating expenses, excluding charges in both quarters, were $408 million, up 9% year-over-year and up 5% after adjusting for foreign currency and expenses associated with companies acquired in the last four quarters. The 5% increase in pro forma operating expenses was primarily due to the incremental variable costs to support the strong year-over-year organic revenue growth of 25% adjusted for currency and acquisitions and demonstrating the significant leverage in our business model. Throughout the March quarter, we did begin to hire judiciously and many on our team worked overtime to support our much higher activity levels in order to maintain high customer service and quality levels. As recovery in our end markets continue, and we remain diligent at our cost management, two of the key productivity metrics we manage to manage our business operating expenses as a percentage of sales and percentage of gross profit, have been positively impacted year-over-year.

For the March quarter, we improved operating expenses as a percent of gross profit by more than 1,000 basis points year-over-year, while operating expenses as a percentage of sales improved 153 basis points. The operating leverage we have built into our model, coupled with the beneficial business mix this quarter allowed to us grow operating income 8% sequentially despite the slight decline in revenue. Operating income of $175 million excluding charges was up 98% as compared with the prior year quarter with electronics marketing leading the improvement.

Due to the combination of higher sales, firming gross profit margins at both EM and TS, and continued vigilant expense management, operating income margin at the enterprise level of 3.7% was up 31 basis points sequentially and 129 basis points year-over-year. This is the third consecutive quarter of sequential improvement in operating income margin and an indication of where clearly in a cyclical recovery phase. We expect to see additional improvements in operating income margin as we manage through this recovery and continue to work towards achieving our long-term business model. Interest expense for the quarter was $15 million, down $2 million over the prior year quarter due to the retirement of the $300 million convertible notes that were put to us in March of 2009.

The effective tax rate on income excluding charges was 28% in the current year third quarter, consistent with the prior year. The rate in the current quarter was lower than in prior quarters of this fixes year due primarily to significantly more income being generated from operations with lower effective tax rates. Our tax rate guidance for the June quarter is between 28 and 32%.

GAAP net income was $115 million or $0.75 per share for the third quarter fiscal 2010 including $7 million pretax of restructuring integration and other charges, a gain of $3 million pretax related to the prior sale of our equity investment in Kalas LLC, and a net tax benefit of $2 million related to prior period settlements and adjustments. Excluding these charges, net income was $116 million or $0.76 per share driving EPS up over 150% year-over-year and up 15% sequentially. Due to the robust increase in sales we used $63 million of cash for operations during the quarter while on a trailing twelve month basis we generated cash of $175 million. Our diligent working capital management globally resulted in significantly improved working capital velocity year-over-year for the fourth consecutive quarter.

Working capital increased only 3% year-over-year even though sales increased 29%, resulting in a two turns improvement in velocity with both operating groups contributing to this improvement. Net days at the enterprise level were down 15 days year-over-year, but were up four days sequentially due to the change in business mix as E M grew to represent 61% of total revenue as compared with 52% in the December quarter. Receivable days continue to be in a comfortable range, and we have not seen any significant deterioration in our receivable delinquencies. In the March quarter, return on working capital of 27% approached our 30% hurdle rate for the enterprise, as it improved more than 1,400 basis points year-over-year with significant improvements coming from both operating groups.

While this was a the fourth consecutive that TS was above our hurdle rate, this was the first quarter that E M reached our hurdle rate since we embraced value based management back in 2001. On a year-over-year basis, TS improved return on working capital by 669 basis points, while EM improved this important metric by more than 1,800 basis points. At the enterprise level, return on total capital deployed improved 756 basis points year-over-year to 15%, reaching the midpoint of our long-term business model. We improved our investment grade credit statistics with our debt to EBITDA at 1.6, and EBITDA coverage at 10.2 on a trailing twelve month basis. Cash on hand was $755 million as we exited the quarter, and when combined with availability under our credit facilities, we have approximately $1.5 billion in liquidity. Maintaining a healthy balance sheet with strong liquidity provides us with the financial flexibility to continue strategic investments that drive profitable growth.

While investing organically and continuing our value creating M&A activity, our goal is to expand Avnet's global scale and scope and continue to create long-term shareholder value. Looking forward to Avnet's fourth quarter fiscal 2010, we expect technology solution sales to be in the range of $1.85 billion to $2.15 billion and sales of electronics marketing are expected to be between $2.85 billion and $3.15 billion. Therefore, Avnet's consolidated sales are forecasted to be between $4.7 billion and $5.3 billion.

Based upon that revenue forecast, we expect fourth quarter fiscal year 2010 earnings to be in the range of $0.76 to $0.84 per share. The above EPS guidance does not include any potential restructuring and any charges related to acquisitions and post closing integrations. In addition, the above guidance assumes that the average euro to US dollar currency exchange rate of fiscal 2010 is 1.35 to 1 and this compares with an average exchange rate of 1.36 to 1 in the prior year fourth quarter and 1.38 to 1 in the prior sequential quarter. With that, let's open up the line for Q&A. Operator?

(Operator Instructions). Our first question comes from the line of Brian Alexander of Raymond James. Please proceed with your question.

Thanks. Nice quarter. How are you thinking about EM regionally in the June quarter in terms of sequential growth and what about EM growth beyond the June quarter, Roy? Sounds like you're pretty comfortable with customer inventory levels relative to forward demand so at this point would you expect the second half of the calendar year to grow in line with seasonal trends?

Hi, Brian. Thanks. Let me take the second part of the question first and I will flip it to Harley for the regional color. On a macro level it is clear that some of the volume in electronics marketing is a result of inventory restocking and the rest of it of course is the result of growth in absolute end demand. So far we have not seen any signs of any change in the environment. Our book-to-bill ratio quarter on quarter was essentially flat indicating that product lead times remain extended.

We know that our vendors are ramping output, and we know that our customers are beginning to accumulate inventories even though inventory turns are very healthy and in fact in many cases, setting records like ours are. Brian, I would expect in the second half of the year you could see product availability start to match the supply, but on the other hand, as you know, by the time we get to August we're in the seasonally strong period, where demand could actually or will actually ramp relative to where it is right now. Therefore, the answer to your question is I don't know, but at this point in time, I would advise our customers to assume product lead times will remain extended for the bulk of this calendar year, and the environment is not likely to change much until we get into the tail end of the fourth calendar quarter. Harley on the regional color.

Hi, Brian. Relative to regional color for the June quarter I believe was your question, at this point, up to and including what we have seen in April so far, our expectation is that all three regions will grow greater than what we would categorize as normal seasonality. We're seeing strength across the board in all three regions.

Just to follow up, Roy, you said the Bell deal would close in 60 to 90 days. Is that from today or the day you announce the deal?

That's from today. Our expectation is we'll get it done end of this quarter, early next quarter, and of course it is subject to regulatory approvals and the Bell shareholder approval.

Thank you very much.

You're welcome.

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

Thanks and hi, Roy and everyone. Just another question on the component side, Roy and Harley. A lot of the EMS, the very large EMS providers during earnings season have been talking about component shortages and in fact leaving revenue on the table because they can't get certain parts and talked about using distribution more than normal obviously to chase parts. Could you talk about the very large EMS customers as a percentage of your sale? Are you seeing more order flow from that constituency and do you expect that to continue going forward and then just as a follow-up there, talk about the pricing environment, not just ASPs from the suppliers, but in terms of your ability to prop up prices because everyone is chasing parts here.

Okay. Hi, Matt, this is Harley. Our revenues for the large EMS segment and I believe as you all know we segment that out into a separate group here at Avnet, grew right in line with what our overall business grew for the March quarter, so pretty much consistent with what we saw in our overall business. Clearly a lot of activity around looking for parts.

I think one of the reasons why you would have them highlight that challenge more than you would in our data is really the narrowness of their account base, so there is no question we have been involved with a number of them over the quarter, actually in the December quarter as well, on some pretty severe shortages, on some very large quantities of components, but that tends to be isolated at the largest accounts where obviously they do the bulk of their revenue, so although as Roy said earlier lead times are clearly extended, they appear to be if there is such a thing consistently extended or consistent with where we were previously, so I think they're going to feel much more the severity of those shortages than we would with our very broad account base.

Relative to pricing as I believe was mentioned in the script, we were thrilled that all of our regions were able to improve their gross margin for the March quarter, and clearly that is partially driven by the tighter availability of parts and extended lead times.

Okay. That's very helpful, Harley. Thanks. Just as a follow-up changing the subject a bit, looking at Europe given the financial crisis in Greece and then also given the deterioration of the euro, could you talk, Harley, about how you see that impacting your business over the next couple of quarters?

Yes, Matt. So as we mention in the script, from an IT end demand perspective, we see the region as stable but not growing, and yet on the other hand we had this very exciting growth rate in electronic components, so I think that leads you to a conclusion that says that exports coming out of the region are improving, and that would be corroborated by the declining value of the euro, making the European exports that much more competitive, so we believe that as long as the euro valuation sort of stays the way it is, exports are likely to be reasonable. Obviously somewhat depend end on global GDP, and therefore we have I would say an upbeat outlook for our electronics business, and then further when I look at the growth rates we're experiencing in IT, in America and compare them to essentially zero in Europe, it just seems to me that before this calendar year is over, we will see the resumption of some growth in IT spending in Europe as well.

Got it. Okay. Thanks a lot, Roy.

You're welcome.

Our next question comes from the line of Jim Suva of Citigroup. Please proceed with your question.

Thank you, everyone, and congratulations. My first question is regarding your outlook. When I run through typically I would expect to see a little bit of margin increase in the June quarter given the strength, but when I work through whether it is the midpoint of higher end of your guidance, it seems like maybe there is some more operating costs coming in or maybe some more salary merit increases coming in. How should we think about that, because it looks like if you take the higher end of your guidance, your EPS number would be extremely, extremely conservative, and the second question, as you think about that one a little bit, has to do with there was chatter about some of the PLD guys and I don't want to name customers, but one of your larger ones doing some more direct as opposed to channel distribution, and can you talk to us about how that's progressed and are you having to reallocate costs or resources associated with that to keep the cost structure in line or has that kind of been removed off the table given the rebound here?

Okay. Jim, let me take the first part and I will give Harley the second one. First of all, it is an excellent question. The answer simply put is mix, so let me drill down on that a little bit. On a sequential basis we're expecting our TS business to grow a little bit faster than EM, so you have a mix related factor there.

Then within EM, what typically happens every year in this June quarter, Europe is relatively weak while Asia is relatively strong, and so you look at an EM top line number and you're expecting a certain amount of operating leverage, but you've got to look at it by region, so the answer to your question is we're getting the leverage that we would expect, and we would hope for by group and by region, but it is the mix of the revenue that is creating these enterprise results that we're forecasting. I guess what I should say is it is the expected mix that is in the forecast that we're giving you. Okay? Harley, on the PLD.

Hi, Jim. The PLD story that I believe you're referencing is a fairly old story at this point that was a topic of a couple quarters ago. Honestly what I would say is what we said back then, and that is all of our suppliers do a certain amount of business direct and a certain amount through the channel, and that ratio is not a constant. It changes over time with all of them, and at the time there was some change and I can tell you that's really a past story and at this point we don't see any of that as part of the reality with that particular supplier you're alluding to. We had a terrific quarter together in March and we couldn't be more excited to about where we're going looking forward.

Maybe let me clarify that a little bit. I realize it is a little bit of a topic that a couple quarters ago was more relevant. I was just wondering has it progressed and run its course fully or is there still some changes going through the channel that could potentially impact you more forward-looking?

I think it is worked its way through. I think the reason why I answered the way I did, Jim, is it is not a constant. It changes with all suppliers over time, but that's not a topic of current conversation and wasn't at all in the last quarter.

That's all I needed for the answer. That's exactly what I was looking for. Thank you and congratulations to you and your team.

Thanks, Jim.

Our next question comes from the line of Craig Hettenbach of Goldman Sachs. Please proceed with your question.

Thank you. Roy, can you talk about the announced acquisition of WPG of Yosun and complications of competitive landscape in Asia and just consolidation expected in that region and the coming years?

Sure, Craig. First at the risk of stating the obvious, we watched the industry consolidate in North America and then consolidate in Europe and what we have been saying is that the industry is consolidating in Asia Pacific. This has been going on for a while. WPG has been one of the consolidators and of course we have been one as well. So my first comment is that consolidation at the industry level is good for all of the distributor participants. I think that that has proven itself in the western regions and I believe that it will prove itself in Asia Pac as well.

On the one hand, I would tell you that that we have the makings of a large and capable competitor within the Asia region. We had already viewed WPG as our, I guess most formidable competitor in that region, and obviously that continues. I would also tell you, though, that in the short-term there is always opportunities created with these mergers. There is the potential disruption factor, but more importantly, the concentration that happens at both the supplier and the customer level where the two companies may have overlapped and had significant revenue streams, so we have identified those concentration levels at least from a supplier point of view, and we are taking overt actions to capitalize on any short-term opportunities that may exist there.

Great. Thank you. If I can just follow up on the gross margin front, you talked about the changes of mix for the June quarter by business unit and geography. How about within EM just on a like for like basis within North America, within Europe, and APAC, how gross margin is trending?

Harley, do you want to take a shot at that?

Hi, Craig. I believe we will be able to increase our gross margin again in the June quarter.

Craig, we talked in the down cycle about I think we called it late cycle market pressures or in other words cyclical pressure different from the mix shift issue that you're highlighting, and as the cyclical recovery ensues, many of those pressures are now moving in the other direction, and so we have seen an improvement in EM's gross profit margin by region over the last couple of quarters, and I guess given that the overall environment remains healthy, our expectation is that trend would continue, and our objective is to regain most if not all of the gross margin that we had on a by region basis, and then that will leave us of course only with mix determining where gross margin actually goes.

Okay. Thank you.

You're welcome.

Our next question comes from the line of Ananda Baruah of Brean Murray.

Hey, guys, thanks for taking the question. Good to see the leverage working, too. Hey, Roy, just going back to the maybe sort of the M&A question bigger picture, you guys have been feels pretty vocal last I don't know three, four quarters about M&A opportunities out there as you come out of the downturn. You have always been pretty acquisitive, but I am getting the sense that maybe the opportunity coming out of downturn for nice accretive M&A, I don't know, feels like it might be a little bit stronger relative to how it was relative to the Avnet P&L as we were the last couple of years leading into the downturn. Is that a correct sort of way to think about it that there is opportunities out there that might more amply and they don't have to be bigger, could be the collective sum of many opportunities, much more beneficial to the Avnet P&L over the next few years?

Yes. Ananda, I think actually the answer to that question is yes for us and yes for industry even more broadly. I think we're seeing M&A heat up quite a bit, and I think there is two fundamental reasons. One is sort of economics. The capital markets were pretty well shut down for a while. You could almost think of that as creating penalty up demand in a normal M&A pipeline so deals were not getting done, and the capital markets for good credit companies are essentially wide open now, certainly the equity and the corporate debt markets are performing very, very well. So deals can get done.

I think the other factor here is that we are rapidly moving into a global economic environment, and therefore global scale and global scope is becoming increasingly important. So for many businesses, you need to make a fundamental choice. Are you going to operate at the global level, or are you going to find a partner that has the ability to help you get that done? So obviously we have chosen the path. We intend to be the premier company in value-added technology distribution. We have significant global scale and scope. We have financial strength. As a result, we're building and capitalizing on our M&A pipeline.

Thanks. Just a quick question, do you have any update on the impact from Oracle Sun, near term and intermediate and your thoughts there and anything different now?

Sure. We have been in close contact with them, and I will ask Phil to provide some color and then perhaps Rick or I might add something on top if there is anything to add.

Sure. We have been in regular contact with the Oracle Sun, the announcement they made a little while ago to align the channels a little differently from where Sun has been prior. We estimated that at a high level and they're still going through strategy adjustments somewhere in the range of maybe $100 million on a run rate basis across the world and where we may see a negative impact. At the same time, as we meet with Oracle Sun and their team, we see opportunities as well that may offset that.

We're further expanding in Europe, as you know, and we have had regular meetings with the Oracle team in Europe. We presently represent them in approximately 7 out of the 10 or 20 countries present in Europe, so as we further expand across Europe we see opportunity there as well. We're the only value channel, value distributor in Asia, and have presence of footprint across Asia and we're in the very beginnings of further expanding with them and want to expand with us in Asia, so overall, that's a high level overview. They're still working through some of the operational issues, and working through those with us. I guess the last comment I would make is last week they did announce which was positive we felt a global dedicated team and Oracle Sun dedicated team to Avnet to help us through this transition and to drive frankly growth through the value channel being evident, so we saw that as a real positive move last week from the Oracle team.

Thanks. That's helpful. I guess as a quick follow-up to that, are there any comments you can share with us that they've shared with you around their plans to consolidate partners from some particular level down to another particular level?

They continue to rationalize their channel as the numbers, Rick, off the top of my head I don't have this from the last quarter but go down from hundreds to --

Distributor level.

So they're in the process of doing that right now and I don't have all the specifics that data it in front of me, but that is their plan, and as they look in each country across Europe and the same in Asia, they might have 14 or 15 distributors today that are absolutely looking to narrow that down to 2 to 4 value guys.

Thanks a lot, guys.

You're welcome, Ananda.

Our next question comes from the line of Steven Fox of Calyon Securities. Please proceed with your question.

Good afternoon. Just two clarifications just on a follow-up to that sun question. When we look at the guidance for the June quarter, it seems to be pretty decent seasonality and so does that reflective of a normal Sun quarter under Oracle or not really and then secondly just, Roy, on your inventory turns being so high, what does that mean for how your stocking strategy for this quarter if your sellouts seems to be matching your sell-in at this point?

Steve, on the Sun piece itself, if we look at what happened in the March quarter, our Sun business performed roughly in line with the other server vendors that we do business with, and to be candid we're not 100% sure what to expect this quarter. We not only have the reality that it is now part of Oracle, and what sort of behavior Oracle will drive in terms of fiscal year end closes, but the Oracle fiscal year end is at the end of May, as opposed to the end of June. We have tried to factor that into our thinking. If you compare this seasonality to the last update we had given you, the investor community, it is actually below that seasonality but since then Sun is a smaller part of our total business and we have this new fiscal cut off, so we need to update you as a community at our next analyst day with our best efforts regarding seasonality.

I would just point out we feel like the guidance we're giving this quarter is more like the new reality and in fact we're guiding for accelerating year-on-year growth in our TS business. Our Sun business is operating sort of on a normalized basis in line pretty much with our other server suppliers, and then we're frankly going to learn more about how the seasonality works out with the Oracle cut off. With regard to inventory and our direction, I will ask Harley to comment.

Thank you. Hi, Steve. Our inventory turns were exciting for March, I think the way I tend to think about that is I think I used the term earlier, it is a bit of on odd thought but we're in an extended lead time equilibrium now and what I mean by that is we have adjusted as have most of our customers adjusted to longer lead times, but I think it is important to recognize that along with our record shipments and our suppliers announcing record shipments, they are shipping us obviously record numbers of units, so our inventory is I wouldn't want to set an expectation that as lead times come down or inventories going to about balloon because we just don't see it happening that way. Remember something about our continuing improvement in the velocity of our inventory is that a good portion of that is also a derivative of the regional mix that we have experienced over the last number of quarters with Asia playing a bigger part and naturally having a higher turns level on the inventory. So some of it is shortages, of course, but we are shipping quite a bit of product, and we're pretty comfortable with where we are, and we think we'll be in this range for a while.

So, Steve, I think the only thing I would add is for the June quarter as we look ahead, we would expect a modest increase in inventory and probably turns similar to the current level.

Thank you very much.

You're welcome.

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

Thanks. Roy, did I hear you say that book-to-bill was about flat in the quarter, seems a bit surprising to me and then I have a follow-up.

Yes. Let me qualify that. Thanks for the question. What we said was in the December quarter our book-to-bill was greater than 1.1. This is an EM commentary now. The TS book-to-bill tends to hang out around 1, but in the December quarter greater than 1.1, and I believe that was in all regions. What we're sailing about the March quarter is once again it is greater than 1.1 to 1 in all regions flat to the December quarter, not flat defined as 1 to 1.

I see. Is it fair to see it is well above 1.1, you don't need to be that specific, but of course correlating question is how concerned are you about double ordering and to what degree are sales being helped or driven by customers that you see once every bubble?

Yes. So the answer to the question is yes, it is well above 1.1 to 1 and again essentially the same as it was a quarter ago. Harley, do you want to take a shot at the double ordering question?

Sure. Obviously it is something we watch very, very carefully. It really relates to my last comment on comfort level with inventory levels and our velocity. One of the things that I find interesting because we went and ran the numbers because we're watching that closely, and as we suspected, we still don't see a significant any discernible difference in what you would call double ordering or questionable orders or buffer orders, whatever you wanted to call them, but clearly what has happened and expanded again in the March quarter is the length of orders that our customers are placing on us.

In March, for example, the over 90 day backlog increased in March year-on-year by about 25% compared to the under 90 day backlog, so what we are seeing are customers who are really focused on two things now, getting as much product as they can get to meet their upside shipping potential but also they have altered their behavior and are placing longer orders with us again, adapting to this equilibrium of extended lead times.

So, Will, this is Roy. The commentary I would put on this on top of Harley's facts are the people that I talked to are actually being more cautious than they are aggressive. I don't have a lot of concern about the classic double ordering but I do think we all need to realize that in the same way that the electronic components fell faster than the end market in the downturn, as inventories in the supply chain were depleted, it is now rising faster than the end markets that it serves as inventories in the supply chain are being replenished. When the supply chains are fully replenished, then that part of the ordering will diminish, and the question we will all be left with is what is happening with actual end demand and the rate of growth of that demand, and that's of course the $64 question.

Thanks very much.

You're welcome.

Our next question comes from the line of Shaun Harrison of Longbow Research. Please proceed with your question.

Two-part question. Looking into the next fiscal year will there be a step up in operating expenses maybe related to merit based payor just adding new personnel? I just want to make sure I don't get ahead of myself with my modeling, and then the other question is with EM given that the back half of the calendar year is typically one of the stronger periods for Asia, was the March quarter the potential peak for EBIT margins over the next two or three quarters?

Shaun, on the first question, there will be a step up in expense in the first quarter, so let me just cover the major items. Number one, we always have a step up in the equity based compensation. It relates to the accounting for retirement eligible equity grants, so that would be similar to prior years. The second thing I would tell you is that, yes, we have decided that we are going to have merit pay increases this year. We had been frozen for the last year, and on top of that the one thing that we did in the expense reduction phase that I would describe as temporary in nature was we had suspended the pension contribution for US based employees for a period of one year, and that also will be lifted as of July, the beginning of our new fiscal year, so we have those three things coming into play. Okay? With regards to the second part of the question, I will ask Harley to comment on how high are operating margins going to go?

Thank you, Roy. I think on the question was centered around March as the peak. What I would say without attempting to prognosticate beyond June, typically and if we are into a more typical environment, I am not sure I am ready to agree to that because clearly it hasn't been typical over the last six quarters, the higher operating margins achieved are in the March and June quarter. The only alteration I would make to your comment was you said March. I would say March and June. If we are in a more normalized environment, March and June typically would be higher margin than would be September and December. I would agree with that.

In other words, I would say the race is on for June relative to March, where we have operating leverage pushing margin higher and we have business mix by region pushing margin lower, and depending on how everything settles out, that will determine whether EM is higher or lower in that quarter, and typically, we would have these seasonally slower quarter ahead, but we'll have to see what the environment holds. On the first part of my question is there a dollar range that you would be willing to call out right now and then my follow-up question was just based upon some of the later cycle pressures you felt pushing down margins, as we come back here in the cycle? Where do you think you are in that in terms of getting those fully recovered?

So, Shaun, I think in the dollar question, dollar range question on operating margin for EM, we won't talk beyond the June quarter.

I meant operating expenses.

Sorry. We don't typically forecast that, right? They should be up sequentially along with the volume as well as some of the M&A that's in place, but probably not more than $10 million.

Hi, Shaun, it is Ray. We have a little work to do obviously to project out that far, but if you look back at the current year, fiscal 2010 the step up in the first quarter relative to the first item Roy mentioned which was equity compensation, that's a fairly significant number, so I am just looking for happened this year in Q1 versus Q2, Q3 and Q4, about a $10 million drop, so say fairly significant number in Q1, so that's consistent with prior periods so that's not new. If we factor in the inflation side of things as well as the pension, not sure, quite doubles that number, probably not that high, but I would say it is in that range, maybe another $5 million to $10 million of what my guess would be at this point in time.

Okay. Okay. Harley, where are we in terms of cyclical recovery of margin?

Of gross margin?

Yes.

My estimate, Shaun, would be we're about halfway there. I think we're about halfway back to where we were prior to the downturn, and we still feel comfortable that I would be hesitant to give you a predicted date, but we still feel very comfortable we will recover all of that by region.

Thank you very much for taking the time for my questions and congrats on the progress.

Thanks, Shaun. By the way, of course all of these comments exclude the impact of Bell, which could in fact have a substantial impact on our first quarter.

Our next question comes from the line of Amitabh Passi of UBS. Please proceed with your question.

Thank you. I just had a couple of questions on your use of cash. The first one was is it fair to assume working capital will likely still be use of cash in the third quarter and therefore you would be negative from a free cash flow perspective for the full fiscal year 2010?

I would say based upon it, it is right, based upon where we are right now and what we're looking at from a working capital perspective, I would expect again based on what we know right now we probably would use some cash in the fourth quarter, and maybe in a similar range I guess I will make a guesstimate at this time because so much happens as you know during the last few days of a quarter relative to cash flow and the working capital, but my estimate would be that we would use a similar amount of cash from operations, which would leave us negative for the fiscal year.

Following up on that, if I assume you use about $200 million of cash towards the Bell deal and the rest of the consideration funded by debt, it looks like by the end of June your net debt position could be around, I don't know, $900 million $950 million, and I just to want clarify, is that a level you're comfortable operating at or would you look to further reduce that and then what does that do in terms of your ability from the additional deals if any meaningful size? I suspect any further deals will be driven by excess cash you generate from operations?

Sure. If you look overall first of all our credit ratings are fairly strong credit ratings for our investment grade rating which is one of our prime strategies overall which is to maintain that. If you look at the capacity relative to additional borrowings, we don't see any issues at all relative to obtaining enough liquidity to fund obviously not only the Bell acquisition which we'll use initially our facilities we have already in place, but our ability to go to the market to raise additional capital in a variety of different financing forms we think is quite healthy, so even though we would expect to generate cash on an ongoing basis, again, if you look back at fiscal year 2010 and you now project it forward for the whole fiscal year, clearly with the significant growth in sales, the expectation would be that we would use some cash. Clearly not as much cash as we generated during the downturn, so we generated $1 billion let's say roughly last year we're certainly not going to use $1 billion this year, so in a much healthier environment from an overall cash flow perspective but our ability to adequately come up with cash that we need not an issue at all so the level of debt we would have the net debt position does not concern us, especially if you look at it from a credit statistic perspective and you factor in the increased profitability that will come with the Bell acquisition and other acquisitions we do we think that overall will not have any material impact on those credit statistics and therefore our ability to raise additional capital.

Okay. Appreciate it. Thank you.

Our next question comes from the line of Brendan Furlong of Miller Tabak. Please proceed with your question.

Good afternoon, everybody. Couple of quick questions. On the TS segment, wondering if you can give us color in the quarter on how servers versus software, storage, networking, played out in the quarter?

Yes. Phil, you have the breakdown in hardware and software services?

I sure do. How are you doing? This is Phil Gallagher.

Hey, Phil.

The hardware was approximately 69%, a little over that, software was in the 16% plus range and services was in 14%.

And in the hardware there was a predominant assuming storage is sounds like storage is stronger in servers in the quarter.

Yes, it was. We really haven't very strong performance in storage and then within the servers as we mentioned in the transcripts industry standard servers did lead the way there as well, but storage was really I would say the story.

Okay.

Brendan, storage was stronger than servers in total, but not stronger than ISS servers.

I got you. Understood. Quick one for Harley. Europe obviously extremely strong. Is there any color you can add there in terms of regionally was it northern Europe, Germany type of thing or industrial, auto, where was it coming from?

Hi, Brendan. Europe was pleasantly strong across all regions. Obviously the strongest would be those with the highest amount of their revenues derived from exports, but over all all of our regions, all of our speed boats were quite strong throughout the quarter.

Great. Thank you.

You're welcome.

Our next question comes from the line of Sherry Scribner of Deutsche Bank. Please proceed with your question.

Thanks. I quickly wanted to ask a question about your expectations for the operating margins going forward if I look at electronic manufacturing, electronic marketing margins hit the low end of your near term targeted range. I am wonder field goal that is sustainable going forward. I know you talked about mix maybe impacting that in the June quarter, but wanted to see the sustainability of keeping that 5% or higher number and then also your views on Technical Solutions, how that plays out at a corporate level over the next couple of quarters? Thanks.

Sherry, it is Roy. I guess the way I would answer that is the most likely scenario is that the EM operating margin will be around flat in the June quarter plus or minus depending on actual business conditions and mix. It is likely that it would be down seasonally for a couple of quarters, but again that could depend upon the strength of the recovery. Then it is likely that we'll test new highs in the March and June quarters one year from now. Certainly pushing up to the range, within the range of that 5 to 5.5% level.

From a TS point of view, the reality is we're achieving our long-term model from a return perspective, but we are below end margin based upon disparate performance by region, so the Americas region is performing very, very well in Europe as we mentioned earlier we actually improved operating income even though we have gotten no revenue growth out of the market yet, and so there we're looking for growth in the market coupled with the beneficial impact of the Bell acquisition to help improve those margins, and then finally in Asia as we have been describing, we're investing aggressively there for organic growth, and we're profitable but just barely profitable, and we're only beginning to harvest the profits there, so that's why you're seeing revenue growth for TS global with lower than what we would normally deliver in terms of operating leverage. I think the TS operating margin will be heading north as we integrate Bell, see growth from Europe, and harvest more profits from the Asia region.

Perfect. Thank you.

You're welcome.

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

Thanks. Good afternoon. Two questions here. First on the drop through on the gross margin drop through or gross profit drop through, Roy, how many more quarters do you think we can have that drop through number at such high levels above sort of 60% type of numbers and then secondly with regards to the services business within the TS segment, it looks like that's going to stall on a growth perspective flat year-over-year still. I would have thought there would be a focus on that, especially with the higher profitability so can you maybe give us some flavor as to what's going on from there? I know it is small but just curious. Thanks.

Sure. Scott, on the last part first, I think what's happening is we have attention in services. In fact, we just recently done some recruiting of executive talent in that category, but I think the IT demand is being driven heavily by the refresh cycles and therefore it is favoring hardware as opposed to both software and services, which are more project oriented. We think as the year goes on there is going to be more and more investments in application development and deployment and that will have a positive impact on services and software, but right now the demand is being more heavily driven by hardware refresh and as a result you're seeing that stalling as a percentage of the total. Okay? I am sorry, the first part of the question?

Just on the gross profit drop through.

Yes. Look, the answer gets a little bit clouded based upon both mix and the level of M&A activity. Our normal expectations are in the first year of a cyclical recovery on an organic basis we would typically get 85% plus drop through and that first year is going to expire in the June quarter because we started seeing the benefit last summer. Second year, we would still expect on an organic basis the drop through to be well above 60, 65%, so that would continue to be our expectations. We do have this one caveat regarding the pension that is going to skew that number a little bit, again depending upon how healthy the overall environment is and what the volumes are, so I think we're comfortable with drop throughs, let's say well above 60 from an organic basis and then variables based on mix and M&A activity.

Okay. Thank you.

You're welcome.

Gentlemen, there are no further questions at this time.

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 the 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 under the quarterly results section. Thank you.

Thanks, everybody.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.