安富利 (AVT) 2010 Q4 法說會逐字稿

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

Good afternoon and welcome to Avnet's fourth quarter fiscal year 2010 financial update. If you're 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 fourth quarter fiscal 2010, please note that in the accompanying presentation and slides, we have excluded the gain on the sale of assets, impairment charges and 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. And finally, when addressing working capital, return on capital, return on working capital, and operating income dropthrough, the definitions are included in the non-GAAP section of our presentation.

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 fourth quarter and fiscal year 2010 highlights. Following Roy, Ray Sadowski, Chief Financial Officer of Avnet, will review the financial impact of recent acquisitions and provide the first quarter fiscal 2011 guidance. At the conclusion of Ray's remarks, the Q&A will follow. Also here today to take any questions you may have related to Avnet's Business Operations are Rick Hamada, Avnet's President and Chief Operating Officer; Harley Feldberg, President of Electronics Marketing; and Phil Gallagher, President, Technology Solutions.

With that, let me introduce Mr. Roy Vallee to discuss Avnet's fourth quarter and fiscal 2010 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. Fiscal 2010 was a year of contrast as the dramatic decline that impacted our served markets in fiscal 2009 reversed course and turned into an unprecedented V-shaped recovery. Strong global demand drove quarterly revenue to a record $5.2 billion as year-over-year growth rates accelerated for the third consecutive quarter at both operating groups. In the fourth quarter of fiscal 2010, revenue increased 38.5% year-over-year in reported dollars and 40.5% when you exclude the impact of foreign currency. Gross profit margin, which was up year-over-year for the first time in seven quarters, improved 14 basis points sequentially and 63 basis points over the year ago quarter. Both operating groups improved gross profit margin sequentially and year-over-year, with the EMEA region delivering the strongest performance. As a result of strong revenue growth, gross margin expansion, and solid productivity gains, operating income grew four times faster than revenue year-over-year, and operating income margin of 4.2% increased 190 basis points over the year ago quarter. The operating leverage in our model delivered consistently through the year as operating income margin increased sequentially all four quarters. We ended the year with record quarterly EPS of $0.92, up 188% over the fourth quarter of fiscal 2009.

Turning to the balance sheet, working capital was roughly flat with the March quarter while sales grew nearly 10% sequentially. As a result, our working capital closed the quarter at a record low 12.1% of sales. While the V-shaped recovery and diligent management has had a favorable impact on working capital velocity during fiscal 2010, I would like to highlight that we also continue to invest for growth. At TS, over 55% of the increase in working capital dollars during the fiscal year was to support our growth in Asia, where we're expanding our footprint in high growth markets. At EM, inventory accounted for 96% of the annual increase in net working capital and was up 33% in constant dollars as we continued to invest to support profitable growth. Our value based management discipline has never been more evident as the Avnet team around the world delivered five consecutive quarters of higher return on capital employed, starting from a low of 7.4% in the third quarter of fiscal 2009 to a record 18.3% in the June quarter just ended. The combination of higher income and returns drove cash flow from operations to $124 million in the quarter. While it has been nearly impossible to accurately forecast the market, we remain steadfastly focused on profitable growth and economic profits, hence shareholder value, independent of market conditions.

Now let's turn to the operating groups. At Electronics Marketing, the recovery continued to gain momentum as year-over-year growth rates accelerated and all three regions delivered a fourth consecutive quarter of above normal seasonal growth. Revenue of $3.12 billion grew 47% year-over-year and 50% excluding the impact of changes in foreign currency exchange rates. The recovery which started in Asia has become global in scope as both Asia and EMEA grew over 50% year-over-year while the Americas region was up 40%. This consistency carried through to sequential growth, which was 11.2% in constant dollars, with all three regions growing over 10% from a relatively strong March quarter. The electronics components industry is now shipping record units. Lead times continue to be extended, but are improving slightly, and EM's book-to-bill ratio remained well over 1.1 to 1 for the June quarter.

Continued strength in the western regions resulted in a third consecutive quarter of sequential increases in gross profit margin and the first positive year-over-year comparison in seven quarters. Gross profit margin was up 27 basis points sequentially and 70 basis points year-over-year, despite ongoing rapid growth in Asia, with the EMEA region up by over 100 basis points sequentially. Strong revenue growth, gross profit margin improvement, and meaningful productivity gains drove EM's operating income margin up 287 basis points year-over-year to 5.6%, a level last realized two years ago in the fourth quarter of fiscal 2008. This significant improvement is further evidence of the operating leverage in EM's business, as all three regions were up both sequentially and year-over-year, and EM's operating income margin was above our stated target range of 5% to 5.5%.

Working capital velocity at EM set another record for the fifth quarter in a row, with the Americas and EMEA regions driving the improvement. Inventory turns of 7.6 also represented another record as EM grew inventory 6% sequentially in reported dollars and 9% in constant dollars. We remain very pleased with our working capital velocity and quality around the globe. With operating income margin above the high end of our target range and record working capital velocity, return on working capital also set a record this quarter and exceeded our stated global target of 30%. All three regions are above our stated goals and have been generating economic profits for the past two quarters. While the timing of the recovery was different by region, our response was not, as the entire EM team reacted quickly to changing market conditions and translated strong sequential growth into higher margins, returns -- and most significantly, economic profit generation.

The technology refresh cycle that has driven better than normal seasonal growth at TS this fiscal year continued into the fourth quarter as pro forma revenue at Technology Solutions grew 10% sequentially and 25% year-over-year. The EMEA region, which has experienced a prolonged downturn, surged into positive territory this quarter as pro forma revenue grew 20% year-over-year and 8% sequentially in constant dollars. In the Americas region, revenue grew 19% sequentially and the year-over-year growth rate accelerated from 14% in the March quarter to 27% in the June quarter. While networking, storage, and servers grew approximately 30% year-over-year, sequential growth was driven by server sales, which increased 30% from the March quarter on the strength of proprietary servers. With EMEA returning to positive growth, it appears that corporations around the world are investing in projects that refresh legacy technology and deliver increased efficiency in the data center.

TS operating income grew 51% year-over-year to $62 million due to our strong growth in the western regions. The EMEA region delivered significant improvement in profitability as operating income margin was up over 100 basis points both sequentially and year-over-year, making real progress towards our target. Globally, TS ROWC increased 844 basis points over the year ago quarter and remained above our stated goal of 30% for all four quarters of fiscal 2010. As we begin fiscal 2011, we look forward to a multitude of profitable growth opportunities that should continue to drive technology solutions top line and add to our scale and scope advantages. In the Americas, the Bell and Tallard acquisitions should add roughly $750 million of revenue in Latin America and provide significant exposure to these higher growth markets. The EMEA region, which is coming off an impressive quarter of profitable growth, will increase sales by more than 50% with the acquisition of Bell, and the combination of these two businesses will strengthen our competitive position in several important European markets and accelerate progress toward our stated financial goals. In Asia, we continue to grow as a result of the investments we've made in both organic initiatives and value creating M&A and expect to gradually improve profitability throughout the new fiscal year.

The next slide lays out Avnet's quarterly revenues and year-over-year growth rates for the past several years. Instead of spending time on the full fiscal year financials, we thought it would be helpful to review how the cycle evolved, its impact on Avnet's revenue, and how we performed on key financial metrics. As you can see, through fiscal 2008, we had been growing revenues in the low double digits. We finished fiscal 2008 at $18 billion, having grown 15% for the full year. As the slide clearly illustrates, fiscal 2009 brought a significant decline in revenue as demand dropped dramatically. Our year-over-year growth rate bottomed in the fourth quarter of 2009 at minus 20% and we closed that year around $16 billion in sales. Growth rates turned up in the first quarter of fiscal 2010 as end demand improved and participants began to realize inventory in the technology supply chain was at unsustainably low levels. Our year-over-year growth rate accelerated throughout the fiscal year, culminating with 38.5% growth in the June quarter just ended. The V-shaped recovery that the chart so clearly illustrates drove our revenue to over $19 billion in fiscal 2010, over $1 billion ahead of fiscal 2008's previous record level.

Now let's take a look at where that revenue came from. While our revenue is back above pre-recession levels, the geographic makeup of that revenue has changed significantly. Prior to the recession, the percent of Avnet's revenue from the lower margin yet higher velocity Asia region was increasing about 1% per year. During the recession, that rate of change accelerated, as Asia was less impacted by the downturn and began its recovery before the western regions. As you can see in the pie charts on the slide, Asia increased from 19% of our revenue in the fourth quarter of fiscal 2008 to 23% by the fourth quarter of fiscal 2009. In fiscal 2010, Asia increased another 3% as the western regions recovered later in the year and we continued to increase our investment in TS Asia. At our Analyst Day last December, we revised our stated business model to reflect this geographic mix shift. While our return goals did not change, our model now reflects lower operating margins and higher working capital velocity to adjust for these mix shifts.

On the next slide, we'll review how Avnet performed through the cycle on key financial metrics that we utilize to manage our business. Our operational management processes focus on return on working capital, which we define as earns times turns or operating income margin times working capital velocity. Prior to the recession, our operating margin had been above or within our stated range of 4% to 4.5% as depicted in the blue shaded area on the graph. As revenue declined in fiscal 2009, our operating margin dropped from the mid fours to a low of 2.3% in the fourth quarter last year. As a result of the significant decline in revenue, we initiated a series of actions that reduced our operating expenses by $225 million on an annual basis in addition to cost synergies related to acquisitions. As revenue growth resumed in fiscal 2010, the leverage in our model delivered, and operating income margin climbed steadily throughout the year. Gross profit dropthrough, which we define as the percent of incremental gross profit dollars that drops through to the operating income line, was over 70% at both operating groups in fiscal 2010, and operating income margin of 4.2% in the fourth quarter was back within our target range despite the accelerated regional mix shift to Asia.

Now, let's take a look at working capital velocity, which is depicted by the red line, and the revised target range of 6.7 to 7.5 turns is within the red shaded area. Working capital velocity, which had been running in the 5.5 to 6.5 range prior to the recession, declined modestly in fiscal 2009 as we reacted quickly to reduce both accounts receivable and inventory. Due primarily to reductions in working capital, we generated $1.1 billion of cash from operations in fiscal 2009. Once growth returned, working capital velocity climbed quickly to new records and above our stated target as a result of the accelerated mix shift to Asia, strong sequential growth, and continued great work by our team around the world. The dramatically improved working capital efficiency allowed us to use only $30 million of cash for operations during fiscal 2010, while revenue grew nearly $3 billion or 18%.

At the top of the next slide, we've added a table that shows ROWC by quarter. Prior to the recession, we were approaching our stated target of 30% ROWC. As operating income margin declined, ROWC dropped correspondingly into the midteens throughout fiscal 2009. As growth resumed, we achieved steady improvement through all four quarters of fiscal 2010 and finished the year at a record 33% in the June quarter. I believe this one chart sums up the impact that our value based management discipline has on the global operations of our business. Even though the recession stressed our model, the Avnet team reacted quickly, and when growth returned delivered higher margins, higher working capital velocity, and record returns. Equally important, the improvement in working capital efficiency allowed us to essentially self-fund rapid growth, which allowed us to invest the majority of fiscal 2009's $1.1 billion of cash from operations into value creating M&A. We did just that as we recently completed three acquisitions that will expand and diversify our revenue base, increase our global scale and scope advantages, add roughly $3.8 billion to our top line, and provide additional opportunities to grow shareholder value as we complete the integrations and realize synergies.

Now I'd like to turn the commentary over to Ray Sadowski, our Chief Financial Officer, to provide more color on how these acquisitions will impact our financial results. Ray?

Thank you, Roy and hello, everyone. In the month of July, we completed three acquisitions -- Bell Microproducts with operations in the Americas and EMEA, Tallard Technologies in Latin America, and Unidux in Japan. Since Bell with $3 billion of revenue is the largest of the three by far, we'll provide some detail on the integration of Bell into Avnet's operating groups and the timing of synergies. We closed the Bell transaction on July, 6 after which we retired its high interest rate debt and launched a tender offer to retire its convertible notes. Concurrent with the closing, we began moving forward with our integration plans and have designed a new operating structure. We strengthened our leadership team with the appointment of Graeme Watt to lead our TS EMEA business. Graham is a proven distribution veteran with significant experience building winning teems in the European IT marketplace. As we have developed more detailed plans post-close, we now expect synergies to be $60 million per year, at the high end of our initial range of $50 million to $60 million.

Offsetting a portion of these synergies will be the non-cash amortization of intangibles related primarily to the value of customer relationships, which we currently estimate will be approximately $9 million per year. Bell's North American embedded business will be integrated into EM's Americas region along with select portions of the TS embedded business. The Latin America business of Bell along with the operations of Tallard will be integrated into TS Americas. When the integration is complete, TS Americas will have over $800 million of revenue with a presence throughout the higher growth Latin America region. Finally, as Roy mentioned earlier, the integration of Bell's European business into TS EMEA will strengthen our competitive position and improve our performance as we drive towards our long term financial targets.

Now let's take a look at how our operating group revenue will break out as we begin the new fiscal year. The next slide provides a pro forma view of Avnet's fourth quarter fiscal 2010 revenue as if the acquisitions were already included in our results. The left hand column is simply our results from the recently completed June quarter by group and region. The next column reflects where the June quarter revenue from the three acquired companies as well as the transfer of a portion of the TS embedded business will be consolidated based on our new structure. The column on the right simply adds the first two columns and provides a view of Avnet's pro forma revenue for the June quarter by group and region. While this column is a starting point for Avnet's quarterly results as if we owned the three companies, I would caution that any previous range of typical seasonality may not apply to these numbers. In addition, keep in mind that we acquired Unidux at the beginning of August, so we will only get two-thirds of the sales benefit in the September quarter versus the three months included on the slide. With the addition of three new companies and the realignment of some of the embedded businesses, the blend of countries and products have changed within both operating groups. Therefore, our previously provided seasonality assumptions will be updated once we have more experience with the new structure.

Now we'll provide additional detail on timing of synergies and what the expected impact will be by quarter for fiscal 2011. I do want to caution that although we are comfortable with the $60 million of operating expense synergies, the exact timing of those synergies is a bit more difficult to determine at this point. Not shown on this slide is the roughly $13 million of annualized pre-tax interest savings that we began to realize immediately upon the close of the acquisition with the payoff of nearly all of Bell's high interest rate debt. As you can see on the percent complete line, we will make steady progress achieving the synergies throughout the year and expect that we will be virtually 100% complete by the end of the fiscal year.

The next slide on the slide provides the estimated cumulative annualized synergies that will be achieved the end of each quarter based on the integration schedule and measures our progress toward our goal of $60 million in annual operating expense savings by the end of fiscal 2011. The next line simply reflects the incremental change by quarter.

The fourth slide portrays the effect on operating expense synergies in the September quarter and an estimate of the reported operating expense savings impacting future quarters, and the final line provides a cumulative tally of the annualized synergies achieved on a year-to-date basis. As you can see, we estimate that we will realize $6.3 million of operating expense synergies in the first quarter of this fiscal year and currently expect to realize approximately $40.4 million of cumulative operating expense synergies in our fiscal year 2011 P&L. Beginning in fiscal 2012, we'll have essentially completed the integration of Bell and be realizing operating expense savings at the annual rate of $60 million.

Looking forward to Avnet's first fiscal quarter of 2011, we expect TS sales to be in the range of $2.25 billion to $2.55 billion and sales for EM are expected to be in the range of $3.35 billion to $3.65 billion. Therefore, Avnet's consolidated sales are forecasted to be between $5.6 billion and $6.2 billion. These numbers reflect normal seasonality of our Technology Solutions business and slightly better than normal seasonality in Electronics Marketing. While our gross profit margin typically declines 20 to 30 basis points sequentially in the September quarter, this year the decline will be greater as a result of the acquired businesses. The acquired companies are concentrated in computer products, which, similar to our TS business, have a lower margin and higher asset velocity than overall at Avnet. Therefore, we expect gross profit margins to be between 11.5% and 12% in the September quarter.

Another item that is impacting profitability in September is an increase in operating expenses in our core business. As we mentioned on our last quarter's call, our operating expenses will increase as a result of reinstating pension benefits in the US, merit increases that were not awarded last year, and the typical increase we have for stock based compensation in the September quarter. As a reminder, our stock based compensation spikes in the September quarter as we have to recognize full vesting for our retirement eligible employees, and that will go back down for the remaining three quarters of the year. As a result of the above items, operating income margin should be in the range of 3.3% to 3.5%. However, it should improve as we realize additional savings throughout the remainder of the year. In the September quarter, we expect interest expense to be between $20 million and $22 million and the tax rate to be between 30% and 32%.

Based upon that revenue forecast and the impact of the items I just covered, we expect first quarter fiscal 2011 earnings to be in the range of $0.76 to $0.84 per share. The above EPS guidance does not include any potential restructuring charges and any charges related to acquisitions and post-closing integrations. In addition, the above guidance assumes the average Euro to US dollar currency exchange rate for the first quarter of fiscal 2011 is $1.30 to EUR1. This compares with an average exchange rate of $1.43 to EUR1 in the prior year first quarter and $1.27 to EUR1 in the prior sequential quarter.

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

(Operator Instructions). Our first question is from the line of Brendan Furlong with Miller Tabak.

Afternoon. Thank you very much, guys. Could you -- I guess running through the Bell Micro acquisition, and I guess the other acquisitions that are hitting in this quarter, just run us through what you expect potential -- other things being equal, seasonality on a go forward basis, ignoring whatever might be going on in the markets right now? What do you think seasonality is on a go forward basis?

Yes, Brendan, this is Roy. There's two factors there, right? One would be what they have experienced historically and the other one would be what is the experience going to be now that it's part of Avnet, including our philosophy of running the Company as well as the impact of any vendor or customer changes that we might bring. So it's a little bit difficult for us to comment on that at this time. However, with all that said, I think if you look at the pieces, Bell had a enterprise computing piece that serves the data centers much like Avnet. We would expect that that seasonality would be pretty similar to RTS, which would be down 5% to 10% sequential in the summer quarter, and then Bell had a significant HDD business, which is more connected to the PC supply chain. Typically I believe that would be up sequentially in the September quarter, maybe something in the middle single digits, and Latin America -- I have to say we have almost no experience. I don't think we know what typical is there for the September quarter. And then lastly, Unidux over in Japan, I think that a normal seasonal quarter there for the summer would be something like flat to up a couple of percent.

Okay, and breaking out -- I don't know if you want to go on the Bell Micro, all things being equal again, the gross margin and operating margin profile when everything gets integrated?

Yes, I think that the composite of the Bell business, as it comes into Avnet Inc, and as Ray articulated, there are parts going to EM and parts going to TS. But when you bring it all in, the gross margin would be right around double digits, somewhere in the low double digit range blending the OEM piece, the enterprise computing and the HDD, and the operating margins -- depending upon the mix of business as we roll forward, I would say between 3% and 5% and probably around 4%.

Our next question is from the line of Steven Fox with CLSA. Please go ahead.

Thanks, a couple questions. First of all, I want to make sure I'm clear. On the embedded computing piece that was pre-existing with Avnet, did you say how much of that was shifting over between segments?

It was embedded in the numbers, Steve, that we gave you on the slide. And the figure, if you want to break down just what went from TS over to EM, it was about $80 million to $85 million a quarter.

Okay, and that brings -- so how big is the embedded computing business now in aggregate from a quarterly run rate?

For the Corporation?

Yes, with the Bell acquisition.

So let's first do a little definition. We're thinking about PC components -- so HDDs, processors, memory modules -- coupled with flat-panels, boards, drives, and then also systems that we might integrate for OEMs, and it's well over $1 billion business now for us globally.

Our next question is from the line of Brian Alexander with Raymond James. Please go ahead.

Thanks. First a clarification, Roy. I think you said you expected the Bell gross margins to be low double digits and I think historically they were in the 7.5% to 8.5% range. And if you still intend to exit the single tier businesses, which I assume were higher gross margin than Bell's corporate average, I'm just wondering -- how do you get their business to low double digits?

Brian, it's going to be a function of the mix, but it's our intent to grow the embedded systems piece, including full system integration. And those margins are typically midteens or higher, so it could dip into the high single digits. It depends on how much we grow the HDD business and PC components as opposed to the systems.

Okay, that's helpful and then in terms of thinking about how their business affects the operating margin profile at the segment level, because I think you said at the corporate level you hope to get them to 4%, but are there any major -- it sounds like the piece of Bell affecting EM is higher margin than the piece affecting TS, so I'm just wondering if you can comment of the EBIT split if you will between EM and TS and how it affects the segment margins?

Yes, we're doing a fair amount of speculating at this point. Let me just say this. My expectation is that the former Bell business in North America and the Bell business in EMEA should be roughly the same and in that 4% range. The part that's a bit unique by our standards is the Latin America piece, which is all going into TS, and that's currently been running around 1% operating margin. And we need to get our arms around that and work with it, but safe to say it's not going to run 4% anytime soon. So therefore, the EM piece may run 4% ish, whereas the TS piece might be blended more like 3.5% until we figure out Latin America.

Our next question is from Sherri Scribner with Deutsche Bank. Please go ahead.

Hi, thank you. I was hoping, Roy, you could just run through some of the numbers that you've talked about early on. I think you said $750 million in revenue on the Lat Am side and then Europe is somewhere around 50% up year-over-year. Can you just run through that again? Because I missed some of that.

Okay, I think the best way to do that is on that Slide 14, knowing there's a lot of moving parts this quarter -- what we have tried to do is take Bell plus Tallard plus Unidux and share with everybody the January quarter revenue split by group and by region. So we're all still left with therefore what does that mean for the September quarter, and we're obviously doing our best efforts to give you the accurate forecast by group, but I think the information you're looking for is all in there.

Okay, and in terms of the inventory this quarter, inventory was only up about 4%, which is clearly in stark contrast to what we saw from Arrow. It sounds like the components business inventory was up about 6%. Is there any reason that your inventory was only up slightly? And what are your expectations for inventory as we move into September? Clearly you have a lot of acquisitions. It seems like inventory would be up substantially as we move into September, but wanted to get your thoughts.

Well, I'll let Harley speak to the EM inventory and then I'll circle back and add any comments.

Yes, good morning, Sherri.

Hi.

Relative to the EM inventory, to give you maybe a clear sequential compare, as you said our inventory in June was up at a rate lower than our sales, and we see no reason today why the September results on that core business would really be any different. If I was going to bias. I'd say they'd probably a little bit less than they were, meaning inventory could be up a little bit more than we saw in the June quarter really as a result of the continuing change in lead times from our suppliers. But I don't see anything that would dramatically impact the ratio of inventory to sales going into the September quarter.

Okay, and Sherri, it looks like -- again, we haven't managed these businesses for the quarter, but it looks like in absolute terms, inventory might be up about $400 million. But most of that is included in the acquisition capital, the acquisition side of the equation. So we'll be looking as usual at the velocity and the returns in managing the inventory accordingly. And I think just to reiterate what Harley said, you could look for inventory to rise roughly in line with sales and with product lead times coming in just a little bit, maybe slightly higher.

Our next question is from the line of Jim Suva with Citi. Please go ahead.

Thank you, Roy, Ray, and Vince. This is actually [Samuel Mann] from Citi for Jim Suva. Phil, you might be the best one for this question. In recent years when Avnet exceeded the $2 billion a quarter mark in technology solutions, respective operating margins were well above 3%. I know you're investing in Asia, but could you provide some color on why margins were light and maybe a timeline on Asia?

Yes, I think you pretty much hit it already, but let me just recap for you. Our Americas operation is performing very well -- well in excess of our return on working capital goals and operating margins up in that 4% range. Our European business, as we've been communicating on previous calls, has been running below our targets. And up until the June quarter, we had not had the benefit of any meaningful growth in revenue there. And then starting in the June quarter, we did receive a nice growth in revenue. And as a result, operating margin expanded quite a bit, but remains below our targets. So let's consider Europe more of a work in progress. And then keep in mind that the Bell acquisition increases our volume there by 50%. So we're going to accelerate the rate of progress towards our targets, barring any other extraneous factors coming in to change that. And then lastly, shifting over to Asia, we have built what is now looking like about $1 billion business there. We've built it both through M&A but also through some significant organic investments, most notably in China and perhaps India, and we are profitable there but only slightly profitable. And as we achieve scale and that business begins to mature a little bit, we intend to harvest more profits, and we would expect profitability to be rising there as we move through the fiscal year. So the reason why the margin isn't what it used to be is because we've got investments we're making in Europe and in Asia that will provide us with future growth opportunities and income opportunities correspondingly.

That's helpful, thank you. And congratulations on the quarter.

Thank you.

Thank you. Our next question is from the line of Craig Hettenbach with Goldman Sachs. Please go ahead.

Yes, thank you. Roy, can you talk about how order trends were in the components business through the June quarter and up until August here? And then also just as it relates to supply constraints and lead times, how that changed up into the present?

Yes, sure, Craig. I'm going to ask Harley to take that one as well.

Hi, Craig. I assume when you mean order trends you mean incoming booking levels?

Yes, that's right.

So through the end of the June quarter, all of our regions remained above one to one, so we saw continued strength. And I believe your question was and what are we seeing so far this quarter, and I assume the backstory to that is our lead times coming down such that we're seeing any significant impact to the incoming order rate. And I'd answer that by saying that we've seen some impact, but through as much of the quarter as we experienced so far, which is only really five weeks, it really has not been very significant. There's been some adjustment with some of our customers changing the back end of their on order schedule with us due to perception and lead times are coming down, but overall it really has not been appreciable and at least at this point in the quarter we still remain over one to one. 1.1 to one.

And if I could follow-up, Rick, on the TS side of the business, strong growth across servers and storage in the quarter. Just what are you hearing these days from customers in terms of the pace of the tech refresh and how they're thinking about the back half of the year?

Okay, let's have Phil Gallagher take that one.

Good morning or good afternoon. It's Phil Gallagher. Actually, we did see very strong growth in the high end server business, outpacing everything else within the technology portfolio. And speaking of realtime with our key supplier partners and our VARS, at recent conferences we've had, there's optimism throughout the balance of the year with the funnels. As Harley just talked about backlog and incoming orders on the component side, it's different on the TS, you deal more on a one to one ratio. You don't have as much hard backlog visibility, but the funnels look positive and we're optimistic that we'll continue. But we'll just track it as we go and do the best we possibly can.

Our next question is from the line of Matt Sheerin with Stifel Nicolaus. Please go ahead.

Hi. This is [Param] Singh on for Matt Sheerin. Hello?

Hi. Go right ahead.

So firstly, you discussed gross margins decline due to new mix. But can you talk about expectations for gross margin within the EM segment going forward? And do you expect it to improve on better pricing and mix?

Okay, Harley would you like to take a shot at that?

Yes, sure, good morning. As we discussed in the past, our gross margins are really -- our ability to raise gross margins are derived from two areas. One is the relative health of our western regions, which as you know drives a higher gross margin. So as we said earlier in the opening remarks they were particularly strong, seasonally strong in the June quarter. So that helped. Point being that as that continues, we have the opportunity to continue to drive strong gross margin performance. The other is really connected to availability of product and lead times, and I believe as we also said in the beginning, that continues to be extended. Early stable, we've seen some indications of some reduction from some suppliers, but overall on the aggregate they remain extended. So we believe that we'll be able to continue to drive the type of gross margin that you saw from us in the June quarter, presuming those two indicators that I mentioned stay consistent throughout the quarter.

Right. That's fair enough, but you've been above seasonal for a year now, and looking out to the December quarter do you expect it's going to be more seasonal, meaning down in Europe and North America, or is it too early to tell?

Yes, again this is Harley again. I wouldn't venture to guess on the December quarter at this point. We'll know more as this quarter shapes up as we get deeper into the holiday build season in Asia.

Our next question is from the line of Ananda Baruah with Brean Murray. Please go ahead.

Thanks guys. Thanks for taking the question and congrats on a strong quarter. Roy? Just want to get your thoughts, I guess, if you could maybe just run through for us the areas where you think you guys may continue to be most acquisitive over the next four to six quarters by segment and by geography? And then you told us over the last, I don't know, four to six quarters that you plan on being more acquisitive as things stabilize. But could you give us a sense if -- I guess the opportunity set has been about what you've expected, greater than you've expected as you move through the year here? Thanks.

Okay, well, look, what I would tell you -- M&A is a difficult thing to forecast. We have a number of opportunities in our pipeline, so to speak. The reason it's difficult to forecast is that you don't have a deal until the end when you actually have a deal, so it's hard to actually provide forecasts. What I would say, Ananda, is that in the short-term, because we're busy in North America and Europe with integration activities, we would prefer to focus more on the Asia region. We have a general preference there anyway based on the expected growth rates over the next several years there. So we want to get more of our assets deployed in Asia in general. So I would say short-term, a little higher focus on Asia. Longer term we'll just continue to use the three filters that we've been using, which is culture, strategy, and economics, and we will most likely be making acquisitions that affect both groups in all regions.

In terms of how the pipeline looks, relative to expectation, I would guess I would say it's about as expected. I think that valuation expectations are fairly realistic, with the possible exception of Asia where they still tend to be a bit inflated, and we've already talked about our cash flow production being the driver of resource for us. But in general, the credit markets and equity markets are reasonably open as well and I think that creates a conducive M&A environment. So I would look for us and others to continue doing M&A for the next several quarters.

Okay, thanks a lot. And I guess the companies that -- I guess the opportunity set, is there any particular region that you see the companies being, I don't know, more conducive from sort of returns thresholds perspective and margin thresholds perspective so as to getting stuff done? I would say that that's relatively common across the regions. As you know, the margin structure changes, and therefore, the way we get to our return targets changes. But the ability to achieve our return targets is largely similar. Again, I think with the little exception of the EM business in Asia, where expectations are a bit high.

Our next question is from the line of Shawn Harrison with Longbow Research. Please go ahead.

Hi. Just a clarification first. In terms of the synergies related to the acquisitions, what is the breakout between EM and TS? Should it be split the way the revenues are split or is it going to be more weighted toward TS?

I think -- Shawn, it's Ray Sadowski. I think the biggest weighting of the synergy is going to be towards corporate. So it's hard -- if we take the Bell business and we map it into our organizational structure, when you have a large public Company like Bell, typically a significant amount of the synergies come from the corporate office type arrangement, meaning no Board of Directors, reducing audit fees, and all that kind of stuff. So if you look at the overall synergy number of $60 million, just poetic rough number, very very high level rough, 40% of it's probably corporate and the balance is split between EM and TS, and I would say the split between EM and TS is maybe slightly weighted. I don't have the numbers in front of me but I'd say slightly weighted a little bit more towards EM, but not dramatically so.

And the reason for that is essentially the integration, the way we're integrating the Company, the synergies only fall into three areas essentially. Europe with TS, the Americas with EM, and then corporate, and a very rough split is one-third/one-third/one-third. But I think it's probably a little bit more 40% corporate and then the other two not quite evenly split as I said, maybe a little bit higher percentage to EM, but again not dramatically so.

Okay, and then as just a follow-up on the operating expense increase this quarter related to stock based comp and merit based pay, how much of the stock based comp increase will decline into the December quarter? Was it -- I think last quarter you said you thought it would be $5 million to $10 million. Is it still in that range or maybe more than that?

So just to give you a rough number, in the fourth quarter just past, we recorded about $4 million. In this quarter, I don't have a precise number yet. We haven't made the grant yet and stock prices haven't settled in yet. But you're roughly going up by $10 million to $11 million and then it's going to go right back down to the $5 million range by the time you get to the December quarter.

Okay, and then just sneaking in one last quick question for Phil. Is there any momentum in the back half of the year in terms of gross margins from a recovery in your mid range server business?

Yes, good afternoon. It's tough to answer that at this point as we're moving forward. I think we've actually seen some stabilization in the mid range server business from a margin standpoint to work with the suppliers on that. We've seen a mix shift, which has been good to the higher range servers, which has certainly helped a bit. But it's really tough to predict based on the visibility that we have going through the balance of the quarter and in the December quarter.

And Shawn, it's Roy. Just to add to something to what Phil said, this is maybe a little bit subtle. But as the hardware refresh has driven hardware volume, it has also negatively impacted our services revenue stream because there are -- we're not selling maintenance contracts on the older hardware that used to exist. And our services revenue stream, although it's relatively small in revenue terms, it has a bigger margin content. So we've got on one hand the higher end servers having a positive impact on margin, but the loss of services revenues having a negative impact on margin.

Our next question is from the line of William Stein with Credit Suisse. Please go ahead.

Thanks. Hi, guys.

Hi, Will.

Wondering if you can give us any comments on the process and the -- what was called other products in the Bell Micro business? Are you planning on divesting all or pieces of that? And I'd also love to get an update on the Oracle Sun business and relationship.

Okay, Will, let me make one comment and I'll flip it to Rick for process and over to Phil for the Oracle Sun. And that is simply on the product portfolio side of Bell, we've given you today where those businesses are going to be integrated. As you might imagine, we're in active dialogue with those suppliers, with those customers, working with the Bell team integrating them. They're teaching us about some of the new product categories, we're teaching them about our financial metrics and financial discipline. And so at this point, unless you guys can correct me, I can't think of any significant product line or product category that we're planning on moving away from. We're all in at this point and just running the business accordingly.

Right.

So nothing there, Will, but now process, Rick has been managing that process and he will give you an update.

Sure, hi, Will. Rick Hamada here. Outside of the three major regions of Bell's distribution business, there really were two other brands that may be of note. One is known as Roark Data, which we are integrating into our TSA business, and the other was the process and there might have been the brand of Total Tech you have heard as well. Bell was in the midst of integrating those businesses into a singular VAR business now under the brand of Process, and we are in process with a financial advisor on looking at the opportunity to divest that business. We would like to bring that to a conclusion between now and the end of the calendar year, and we'll keep you posted on future calls exactly what's going on there.

Will, it's safe to say there's a significant amount of interest, a large number of NDAs have been received, and we're just trying to manage the process -- and as Rick said get to a close by the end of the calendar.

Sorry to interrupt, but that revenue is in the guidance for September? There's no disc ops that we should expect to see?

That's correct. It's about a roughly $100 million revenue stream per quarter, and that's in there. And since we don't yet know what the outcome of the divestiture process is going to be, we don't know what the offers are going to be, we decided just to keep it inside the regular operations.

Okay.

And Phil, on the Oracle?

Yes, on the Oracle Sun situation, thanks for the question. Certainly it's a work in process. We're still working through with Oracle and navigating their new quote unquote channel strategy. Ironically we did see some growth this past quarter with the Oracle Sun, but not at the levels that was typical in previous years in the history that we've had with Sun in particular. So it's certainly impacting more in the Americas for sure, but at the same time, we do see continued opportunity abroad specifically in Europe and Asia for value distribution in the Avnet, and we're certainly working with the Oracle team on that expansion. So still some risk certainly in the Americas, but we're working through that and we see some opportunity in the other regions of the world.

And Will, it's Roy. One thing just to add. Although we didn't see the classic year-end surge like we have seen previously under the Sun regime, we did see performance in our Oracle business comparable to our other major brands. So we had a reasonable quarter with them and maybe this is the new normal under Oracle's ownership of the Sun business.

Our next question is from the line of Amitabh Passi with UBS. Please go ahead.

Hi, thank you. Just a quick question. Does the integration of Bell change the corporate margin, the corporate operating margin goals you laid out at your Analyst day last year?

At the enterprise level?

Correct.

We need -- I'd like to defer that to December, but let me just say this, Amitabh. I think if they do, it's by a small amount. It's 10 to 20 basis points sort of thing, but probably not much.

Okay, perfect. And then just a second question. There seems to be increasing concern within the PC supply chain. Wondering if you can just comment on your hard disk drive business, what are you seeing there, and what do you anticipate for the September quarter?

I think first of all, again, this is relatively new for us. So we're not exactly old pros at it. And from our perspective, the PC supply chain typically has a weak seasonal quarter in June, and everybody talks about the September quarter being up sequential. But the reality is, it's usually not in July. It starts in August and runs through November typically. So in other words, we're at the first half of August here, and from our perspective it's a little too early to call what's happening in that supply chain. So I think -- not trying to avoid the question, trying to be straightforward, we don't yet have a good read on what's going on there.

Our next question is from the line of Brian Alexander with Raymond James. Please go ahead.

Just a few follow-ups. I wanted to go back to the guidance for EM revenue, Roy. If I back out the acquisitions, are you suggesting it's roughly flat sequentially? And I guess what does that imply by region in terms of seasonality? What are you expecting for sequential growth relative to normal seasonality in each of the regions? And I have a couple follow-ups.

Brian, I'll ask Harley to give the regional color, but the way we built the forecast, if you exclude the impact of all of the acquisitions, we actually see EM -- or if I could use an expression like core or our legacy EM business pre-acquisitions, we're up 2% to 3% sequential, and then with the acquisitions, it's flattish. And then by region, Harley? How would you color it?

Sure, hi, Brian. I would say Americas looks at this point to be somewhere around flattish. I think Europe will continue to be above seasonality, up a couple points, and Asia is probably -- again as Roy said relative to the PC supply chain, it is clearly backloaded going into September. So my best view today is probably high single digits.

Okay, and when you said flattish for Americas, you were excluding Bell from that?

Yes.

Yes, and Brian, I would say normal seasonal here would be minus 1% to 2%

As with Europe.

Right. And then to go back to the question about gross margins, I guess where are we in terms of that recovery, Roy? I know you said it's going to take many quarters, but do you expect to recoup most if not all of the gross margin erosion in EM by region? It looks like Europe had a very strong performance this quarter. Maybe talk about the Americas -- where you are relative to where you've been in the past. And related to that, if lead times contract, which it sounds like they've begun to, and if they revert back to more normalized levels over the next few quarters, would you expect gross margin in EM by region to come down or would you expect it to remain stable? I'm just trying to understand the relationship there.

Yes, all right, I'll take the lead and Harley obviously can jump in. So Brian, as we look around the globe, our gross margins for all practical purposes are back in Asia to the pre-recession levels, and we're well past halfway in the western regions, with Europe recovering at least thus far more so than our Americas region. So everybody is more than halfway back, the western regions are not quite all the way, and Asia for all practical purposes is back. The way I would think about the go forward here is that as long as we don't have a double dip macroeconomic scenario and a demand drop, I don't see lead times getting any better than where they were pre-recession. So let's call that six to eight weeks or a normalized environment, and in a normalized environment I would think we would continue to inch our way back towards the pre-recession levels of gross margin and they should not fall back.

Thank you.

If I could add a little bit to that, Brian. In preparing for the call today I thought a lot about how to respond to the lead time questions. And it's a very challenging environment we find ourselves in, because you're seeing a lot of notice in the press about various things that infer lead times reducing or inventory up a little bit. But what's [placeable] about our current environment, there are also a number of areas that have not improved at all, some of them actually in the lowest technology products that we represent. So we're entering an environment where there will be multiple data points in both directions, which will call for very very disciplined and diligent supply chain management for all of us. To add on to what Roy said relative to gross margin, the one piece I didn't refer to earlier when the question came up on the call around gross margin -- quite candidly because it sounds a bit like a sales pitch, I think it's better served for our December time together -- is we are not riding the lead time wave as the principal determining factor in what happens to our gross margin. We have a lot of great stories I look forward to sharing to you around our Avnet Express business and our Design Chain business and our [IP] business, all of which are focused around driving higher gross margins in the aggregate and our performance overall, regardless of upturn and downturn. So I look forward to sharing it with you, but I think we've got some real exciting stories to tell you that I think will allow us to overperform our peer group in that critical area.

Thank you. We have no further questions at this time. Let's turn the floor back over to Management for any closing comments.

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 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.