安富利 (AVT) 2011 Q1 法說會逐字稿

Greetings. And welcome to Avnet's first quarter fiscal 2011 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Vince Keenan, Avnet's Vice President of Investor Relations. Thank you. You may begin.

Good afternoon, and welcome to Avnet's first quarter fiscal year 2011 financial update. If you're listening by telephone today, and have not accessed the slides that accompany this presentation, please go to our Web site at www.IR.Avnet .com, and click on the icon announcing today's event. As we provide the highlights for our first quarter fiscal 2011, please note that in the accompanying presentation and slides, we have excluded restructuring, integration, and other charges from both the current and prior year period, and the gain related to negative goodwill from an acquisition during the current quarter.

When discussing pro forma sales or organic growth, reported revenue is adjusted for one, the impact of acquisitions by adding Avnet's prior periods to include the sales of businesses acquired as if the asset additions had occurred at the beginning of fiscal 2010, two, the impact of the extra week of sales in the prior year first quarter, due to the 52, 53-week fiscal year, and three, the impact of the transfer of the existing embedded business from TS America's to EM Americas, which occur in the first quarter of 2011. Which did not have an impact on a consolidated basis but did impact the groups by approximately $98 million. Sales taking into account the combination of these adjustments is preferred to as pro forma sales or organic sales.

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 financial statements into US dollars. And finally, when addressing working capital, return on capital, return on working capital and operating income drop through, the information is in our non-GAAP section of our presentation.

Before we get started with the presentation with Avnet's 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 of several facts are that could cause actual results to differ materially from those described in the forward-looking statements. More detailed information about these and other factors are set forth in Avnet's filings with the Securities and Exchange Commission.

In just a few moments, Roy Vallee, Avnet's Chairman and CEO, which provide Avnet's first quarter fiscal year 2011 highlights. Following Roy, Ray Sadowski, Chief Financial Officer of Avnet, will review the financial impact of recent acquisitions, and provide second 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 of Technology Solutions. With that, let me introduce Mr. Roy Vallee to discuss Avnet's first quarter fiscal 2011 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. We got to off to a strong start in the first quarter of fiscal 2011, as the fourth consecutive quarter of double digit year-over-year organic growth, plus the impact of three acquisitions we completed in July, combined to drive revenue well over $6 billion.

The technology markets that we serve continue to lead the overall economic recovery as pro forma revenue grew 26% year-over-year in delivered dollars, and over 29% in constant dollars, with both operating groups delivering double digit organic growth. Overall, reported revenue grew 42% year-over-year, due to the strong organic growth and the significantly positive impact of acquisitions. Gross profit dollars, which increased $223.4 million, year-over-year, or 45%, grew faster than revenue, as a result of continued gross profit margin expansion.

At EM, gross profit margin improved 22 basis points over the year-ago quarter and was down 69 basis points sequentially due primarily to the impact of the acquisitions which have historically had a lower gross profit margin profile than Avnet's. As a result of the strong growth and gross profit volume and improvements in productivity, operating income, excluding charges, grew 108% year-over-year, to [$222.5 million] (corrected by company after the call).

Operating income margin increased 114 basis points over the year-ago quarter, to 3.6%, and was down sequentially due primarily to the impact of acquisitions, and seasonal factors. A significant portion of our recently-acquired businesses have historically had a lower margin profile. However, they also tend to operate with higher working capital velocity. As we complete the integrations, we will realize additional expense synergies which we expect will improve operating income margin and deliver a return on capital of at least 12.5% on the acquired businesses.

On the bottom line, pro forma earnings per share grew 111% year-over-year to a record $0.93 per share. Similar to the way the acquisitions scaled up our income statement, they also had a significant impact on our balance sheet. Working capital grew $931 million sequentially, or 37%, to $3.46 billion. Of the total dollar increase, 61% was attributable to the acquisitions. 12% was due to the change in foreign currency exchange rates. While the remaining 27%, or $254 million was the increase added to support the organic growth. Despite this increase in absolute dollars, working capital velocity remained well above pre-recession levels.

Return on capital employed, or ROCE increased 501 basis points over the prior year quarter to 14.8%, even though we have not yet realized all of the expense synergies we have identified associated with the integrations that are under way. While the impact of Bell Micro, Power Technologies and Unidux are already evident in our financial statement, additional benefits should be realized in future quarters as we complete the integrations of those businesses and identify opportunities to accelerate profitable growth. By enhancing our competitive position in key technologies, expanding our presence in higher growth geographies, and increasing our global scale and scope advantages, these acquisitions position Avnet to continue outgrowing the markets we serve and create additional economic profits.

Now let's turn to the operating groups. The team at Electronics Marketing turned in another very strong performance this quarter, as all three regions translated double digit year-over-year sales growth into improved organic gross profit margins, operating income margins, and return on working capital. Revenue of $3.62 billion grew 49% year-over-year, while pro forma revenue grew 40%. With all regions growing greater than 30%.

Gross profit margin increased 27 basis points year-over-year, and approximately 70 basis points when you exclude the impact of acquisitions. This strong year-over-year improvement in organic gross profit margin was consistent across all three regions and as a result, EM's legacy gross profit margin is now substantially back to pre-recession levels in each region. As a result of the strong revenue growth, and gross profit margin improvement, operating income margin improved 197 basis points, to 5.3% year-over-year. This significant improvement is further evidence of the operating leverage in EM's business, as we continue to perform within our stated operating income margin range of 5% to 5.5%.

EM added working capital as a result of acquisitions, higher volume, strategic growth investments, and shorter product lead times, while working capital velocity improved 13% over the year-ago quarter to 6.2%, and remained at a record level. In the September quarter, EM inventory grew $464 million, or 32% sequentially.

However, excluding the impact of acquisitions, the transfer of inventory from TS related to the embedded business, and the impact of foreign currency, EM's inventory growth was roughly 15%. Despite this increase in absolute inventory, turns improved 6% over the year-ago quarter, to 7.1%, and all regions continue to operate with inventory velocity well above pre-recession levels. We remain pleased with our working capital productivity, and will continue to rapidly adjust to changes in end demand and/or product lead times.

The combination of improved operating income margin, and solid working capital velocity drove return on working capital up 1461 basis points, year-over-year, to above our stated enterprise target of 30%. All three regions were at or above their specific targets for the second consecutive quarter, and have been generating significant economic profits for the past three quarters.

While we are proud of this quarter's overall performance at EM, we still have opportunities to improve going forward. With our acquisition of Unidux in Japan, we added significant scale to our existing business, yet we are still a relatively small player in a very large market, where our returns are running below our stated long-term goal. The embedded business in EM Americas, which has grown substantially, is working to improve its margins and velocity and drive returns to our stated goal as well. While the expected deceleration in EM's bookings this quarter indicates that the inventory build cycle is ending, we are comfortable that the working capital investments we have made position us to more effectively service our current business levels and continue to grow profitably.

Similar to EM, Technology Solutions opened the new fiscal year with double digit year-over-year organic growth before the significantly beneficial impact of acquisitions. The technology refresh cycle that we first saw in the Americas region a year ago continued this quarter, as pro forma revenue at Tech Solutions grew 11% year-over-year in delivered dollars, and close to 14% in constant dollars. As in recent quarters, hardware grew faster than software and resold services, as businesses continue to upgrade legacy equipment in the data center to increase efficiency. In the September quarter, double digit year-over-year growth in storage, industry standard servers, networking, and microprocessors was was partially offset by a decline in proprietary servers. Including the impact of acquisitions, TS revenue of $2.56 billion grew 33% year-over-year in reported dollars.

Excluding the impact of acquisitions, TS gross profit margin improved year-over-year and was down sequentially in line with typical seasonality. On a reported basis, gross profit margin at TS declined 12 basis points year-over-year and 54 basis points sequentially, due primarily to the impact of acquisitions and product mix. Portions of the recently-acquired businesses have historically had a lower gross profit margin profile than TS, but generally operated with a lower expense structure and higher working capital velocity.

TS operating income grew 10% year-over-year to $57 million, and operating income margin of 2.2%, was down 47 basis points year-over-year, due primarily to the impact of acquisitions as we have not realized the majority of the expense synergies affecting the TS business. As we continue to complete the integrations, we will realize operating expense synergies that should result in improving margins. ROWC was down year-over-year primarily due to the impact of acquisitions, also.

Even though the acquisitions had a downward pull on TS returns this quarter, there are many opportunities across the portfolio to improve our results going forward. In the Americas region, where our North America business continues to generate returns well above our target levels, we have established a sizable footprint in the higher growth Latin America region with the acquisitions of Tallard and Bell. As we leverage our global partnerships and scale advantages, we intend to translate future growth into improved financial performance.

The TS EMEA region, which had been progressing on a multiquarter improvement plan, has grown by 50% with the addition of Bell, which should accelerate its progress toward our financial goals as the synergies there are realized. Finally in Asia, where we have been investing to support rapid organic revenue growth, we are now at the point where our scale allows us to steadily improve profitability.

While the investments we've made throughout TS had a negative impact on our results this quarter, we have ample opportunity to improve our financial performance over the next several quarters. And we remain fully committed to our return goals across the portfolio of businesses. Now, I would like to turn the commentary over to Ray Sadowski, to provide more color on how those acquisitions will impact our financial results. Ray?

Thank you, Roy. And hello, everyone. Before we go to the Bell integration update, I wanted to spend a few minutes reviewing our balance sheet and liquidity position, after the significant investments we made in the first quarter of fiscal 2011. The table on this slide details a change in liquidity and credit statistics that occurred in the first quarter of fiscal 2011.

During the quarter, we used $575 million of cash for acquisitions, and used $112 million of cash for operations, as a result of the growth in working capital. We funded these investments through a combination of cash on hand and additional drawings under our short term facilities. As a result, our available credit lines declined from $850 million to $790 million, as the funds drawn were somewhat offset by a $150 million increase in the borrowing capacity available under our accounts receivable securitization program.

As of the end of the quarter, our total liquidity, which is comprised of available credit lines and $662 million of available cash on hand, was $1.45 billion. This strong financial position allows us to continue to invest in the future organic growth of our business, as well as take advantage of any value creating M&A opportunities that may arise.

At the bottom of the table, you can see that our credit statistics remain well within investment grade criteria. Our trailing 12-month debt to EBITDA for leverage increased slightly from 1.7 to 2.0, while our coverage ratio improved from 12.1 to 12.6, as a result of our increase in operating income, and our ability to borrow at very attractive short-term interest rates. We expect both of these metrics to improve as we realize additional synergies going forward.

While we frequently cite the benefits of our value-based management culture when it comes to returns, the numbers I just reviewed highlight a less visible yet equally outcome of that discipline. By reacting quickly to changing market conditions and staying focused on working capital, we generated over $1.1 billion of cash from operations during the recent downturn in fiscal 2009. That strong cash generation allows us to fund double digit organic growth in our served markets, while also investing in value-creating M&A, that should add approximately $4 billion to our top line, and generate a return on capital of at least 12.5%. Our VBM culture was the foundation that allowed us to make these investments while maintaining our strong financial position and investment grade credit statistics.

The integration of Bell Micro is proceeding well through the September quarter. We have retained all key personnel, supplier franchises, and customers. As of the end of September, all customer facing organizations have essentially been integrated and are focused on meeting customer demand in a typically strong December quarter. In the Americas region, we have converted the Bell business to Avnet IT systems and are now beginning to realize additional expense synergies in the December quarter.

In EMEA, the integration covers more countries and local social practices impact timing. We plan to convert the Bell IT systems during the March quarter so that there is no risk of disruption of shipments in the very important month of December. We remain very comfortable with our overall operating synergy target of at least $60 million. As you can see on the percent complete line, we will make steady progress achieving the synergies throughout the year, and continue to expect that we will be virtually 100% complete at the end of the fiscal year.

The next slide on the slide provides the estimated cumulative energized synergies we estimate ill with be achieved at the end of each quarter based on the schedule and measures our progress toward the goal of at least $60 million in annualized operating expense savings by the end of fiscal 2011. The next line simply reflects the incremental change by quarter. The fourth line portrays the affect on operating synergies of operating in the September quarter and the estimate of operating expense savings impacting future quarters. The final line provides a cumulative tally of the synergies achieved on a year to date basis.

As you can see, we estimate that we have realized $6.3 million of operating expense synergies in the first quarter of this fiscal year, and currently expect to realize approximately $41.2 million of cumulative operating expense synergies savings in fiscal year 2011. Beginning in fiscal year 2012, we will have essentially completed the integration of Bell, and we will be realizing operating savings at the annual rate of at least $60 million.

Looking forward to Avnet's second quarter fiscal 2011, we expect TS sales to be in the range of $2.9 billion to $3.3 billion. And sales for EM to be between $3.4 billion and $3.7 billion. Therefore, Avnet's consolidated sales are forecasted to be between $6.3 billion and $7 billion. These numbers reflect the normal seasonality at TS, and slightly below normal seasonality at EM, when you adjust for M&A and currency.

Based upon net revenue forecast and the impact of expense synergies that I covered earlier, we expect second quarter fiscal year 2011 earnings to be in the range of $0.99 to $1.07 per share. The above EPS guidance does not include any potential restructuring charges or 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 second quarter of fiscal 2011 is $1.40 to EUR1. This compares to an average exchange rate of $1.48 to EUR1 in the prior year second quarter, and $1.29 to EUR1 in the prior sequential quarter.

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

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Our first question is from the line of Shawn Harrison with Longbow Research. Please go ahead with your question.

Hi, good afternoon. Maybe if we could just discuss kind of the less than seasonal trends you're seeing at EM. Unless I missed it, I didn't hear a book to bill ratio for EM. And maybe if you could discuss the linearity of orders you saw through the September quarter into the month of October.

Hi, Shawn. Let's let Harley take the lead on that and I will fill in any blanks if I see them.

Yes, hello, Shawn.

Hi.

The book to bill for EM for the September quarter ended at one to one. And the linearity would have been that we were positive in July and August and dipped down slightly in September.

Okay. I guess the function of it dipping down, is it more of in demand adjustment or is it more of a lead time adjustment, if you can parse it one way or the other?

Sure. It is not atypical, Shawn, for us to dip down in the five-week ending period of the quarter. Really due to accelerated shipments that occur based on how customers will time their receipt of products. So that is not particularly unusual or ominous at all, quite frankly.

Shawn, it is Roy by the way. The October book to bill through three weeks at EM is back up in positive territory.

Okay. So I guess the question is, what is leading to a slightly below seasonal EM then?

Shawn, I'm reluctant to say a bit of conservatism but what I would say is that with the -- with the lead times coming down from our suppliers, which we additionally saw in the quarter, I think we're being a little bit cautious. I'm being a little bit cautious, relative to how the quarter will evolve. December tends to be one of the harder quarters to handicap, because of the heavy amount of holidays that do occur in the quarter. So overall, our business feels quite solid. Our book to bill as you mentioned was at parity. So I think if anything, I would categorize our guidance as being slightly below normal seasonality.

And Shawn, it is Roy. Let me just -- I will throw some macro color on this. Our EM business, and for that matter, the component industry on a global basis, has been outgrowing its end markets as the tech supply chain has been increasing inventories across the supply chain. As the suppliers have ramped output, and supply is beginning to meet demand and product lead times are beginning to come down, the need to continue expanding those inventories in the supply chain is diminishing. So it would appear to me that the inventory accumulation phase of this cycle is coming to an end, and so the sales of components into the supply chain is going to weaken a bit, even if end demand remains solid and perhaps even continues to grow with the cyclical economic recovery. So we're just -- we're still expecting a good healthy environment, but not as robust to what we've seen over the past few quarters.

That's more than fair. And just on the lead times, where do you think lead times are at right now across the broad product portfolio you carry versus say normalized? Are we close to normal? Or are we still a little bit a ways away?

Hi, Shawn. It is Harley again. Again, with always the disclaimer that we're such a broad average of so many different things going on, relative to lead times, with some products still extended, some having come in, and so it is really a very broad averaging process, but I think if I wanted to oversimplify it and create some color, I would say that we have come down from where we were at the peak, from an extended period of time, but I do not believe in the aggregate we're back down at this point to where we were let's say in 2008. I think it is still extended. But clearly, the trend has been down from where we were a couple of quarters ago.

Okay. Thank you very much for all of the color.

You got it.

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

Thank you. Roy and Ray, I wanted to get your sense of end demand as we go into the December quarter. I think there has been a couple of cautious comments from some companies, certain segments that seem like maybe they're seeing some slowdown. It sounds like you're expecting a bit of -- I think correction is maybe too strong of a word, but a bit of a modest correction, as lead times start to get back to normal levels in the EM business. So I wanted to get your sense of what you think end demand actually is for components. And then on the TS side, what are you seeing in terms of servers, storage and networking demand?

Sherri, I will give you the macro view and any of our guys can jump in with anything they would like to add. I think the picture on end demand is actually quite good. As we look across our portfolio, so this is components and IT, around the world by region, we continue to see solid end demand. On the IT side, of course, we sell into data centers, operated by businesses, and we believe that business spending on capital equipment and information technology in specific remains pretty good. We don't see any weakness there.

And on the EM business, in terms of our end markets, it looks pretty solid, pretty much across the portfolio. If you drill down, or double click on that, there were a couple of pockets in the September quarter that demonstrated some weakness, specifically the PC endmarkets, and most notably netbooks, and also the large format LCD television markets. But we're already seeing signs of recovery in those markets coming into the December time frame.

So overall, end demand looks pretty good. The only concern we have relative to EM is this notion that supply is beginning to catch demand, and therefore, inventory accumulation or expansion is starting to come to an end.

Hi, Sherri, this is Harley. I think one additional slant on that I would add is if you read, as we all do, assume, most of the results coming out of our key suppliers, without pointing to anyone in particular, the general feeling I've had is that they have seen some adjustment in their customer backlog and reschedule it and possibly some of their largest customers. And we obviously track that religiously as well. And we've seen nothing so far, this far even into October, that suggests any significant change to that pattern. So without a lot of churn in our backlog, and our cancellation and reschedule, we read that from our vantage point to predict a pretty solid demand flow.

Okay. That's helpful. And then just switching gears a little bit, your cash balance has had a decent hit from the acquisitions you've done. Clearly, you articulated your ability to borrow if you need to. I guess I'm trying to get a sense of what is your appetite for additional acquisitions at this point when you're looking at digesting Bell over the next couple of quarters, and you have a couple of other acquisitions you're digesting, and what do you have on tap and is there anything -- what is your expectation for acquisitions?

So this is Roy. Sherri, the way I would describe that, Avnet's overall profitable growth agenda starts with a robust list of organic activities by group and by region and that continues to be our number one priority. Driving organic growth, which tends to be the most profitable kind of growth. However, we also feel that we have a capability or a competency in the category of value creating M&A and we certainly intend to continue with that strategy as well.

If you look at the limiters, I would say, Ray may kick me under the table, but because of the financial criteria we put on our acquisitions, we probably are never going to have a problem funding them. I don't think that capital is a limiting factor. However, a more limiting factor is where we are busy doing integration work by group and by region, it is our preference not to do multiple M&A at the same place at the same time. Okay?

So that doesn't mean we absolutely positively won't, but our bias would be to steer M&A by group and by region so that we have plenty of bandwidth to deal with effective integration to make sure we're executing against our plans. Okay? So look for us to continue doing M&A. We feel we're fully funded for that. And what we will take into consideration is our organizational capacity to effectively digest them.

Thank you. The next question is from Matt Sheerin with Stifel Nicolaus. Please go ahead with your question.

Yes, thanks. Hi, Roy, and everyone. I wanted to get back to the whole question of the cycle, what you're seeing. It looks like based on what you've done in past December quarters that you're pretty much in line with seasonality. Not really much below.

One thing, Roy, that having covered the company for a long time, typically in these cycles when there is some sort of a slowdown, whether it be an inventory correction, demand or orders, distribution tends to see it first, but now you've got a bunch of suppliers being a little bit more cautious, seeing bookings slow down. And while Avnet and Arrow seem to be seeing things better than normal or at least normal now, why do you think that is? Is it because you've got more industrial exposure, more exposure to Europe, which had been lagging the cycle? Or are you more tied to the IP need type of products that are still extended in terms of lead times? Why do you think that is?

So Matt, I'm going to make a couple of points. One is on a reported basis, our EM guidance is absolutely in line with normal seasonality. Just remember that we owned Unidux for two months out of three last quarter.

Okay.

So there is a little bit of carry-over in our forecast. And on top of that, the sequential change in currency is providing a little bit of a lift to the forecast. So if you normalized for both of those, you would see that we're at the low end of normal seasonality, or maybe just slightly below that. Okay?

Okay.

All right. Now, second point. I think you hit on the two things I would say. In terms of the difference between what our suppliers are seeing and what we're seeing, you're absolutely right. We have more exposure to industrial, and I would even broaden that to say business spending, as opposed to consumer. And I think as you look around, where there is some weakness, like in the net book category, and the LCD category, it tends to be in the consumer end markets, as opposed to the business end markets. So that would explain a little bit of the relative strength of distribution and Avnet in specific, versus the overall industry.

The other thing I would throw at you, and there is no way to quantify this, but I will just make the point. I believe that the electronic supply chain has gone through structural changes, that is making it increasingly more efficient. And that efficiency probably shortens whatever lag time there was from the total market to the distribution market, and maybe even the regions themselves. From Asia to America to Europe. I think a more efficient supply chain means that things are acting more in concert with each other, or tighter correlation to each other.

Got you. Okay. That is helpful. And then turning to the computing business, and specifically, Bell Micro and the storage exposure there, I know that the disk drive market has been relatively volatile over the last couple of quarters, has that been a head wind at all for you and what sur long term strategy in the disk drive market?

So Matt, the way we've integrated Bell, we have disk drive business at both EM and TS. I'm going to ask Rick, who manages both of those, to make some comments.

Good afternoon, Matt. I would tell you that based on our expectations, per the integration from Bell, that's where the majority of this had come from, all of the quarterly results we saw for our HDTV business was very much in line with those expectations. And again, we will continue to work on the overall long-term profitability of those revenue streams as part of our VBM management. But for purposes of the September quarter, we're learning as we go, getting reengaged in a major way, and everything was in line with what we expected.

Hey, Matt, it is Roy. I would just add one thing. Remember, we've talked about micro processors for years and years and similar to HDD, our end markets are the PC integrator, and the white box makers, not the global brand markets. So very frequently, our business is not in direct sync with the overall market. We're serving those integrators and those white box makers on a more localized basis. And as Rick said, we actually met all of our expectations on HDD, and for that matter, on microprocessors as well in the summer quarter.

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

Yes, thank you. Ray, post the integration of the acquisitions, and looking out a bit in time, from a capital allocation standpoint, would you consider a dividend or buyback, or how are you guys thinking about that?

Hi, Craig. It is Ray. I think at this stage, we're still looking at, as I think Roy mentioned in response to an earlier question, opportunities to grow the business both from an organic perspective and some value-creating M&A. And based upon where we stand today, we think that is the right deployment of cash. Because we are not in an excess cash position at this particular point in time. Obviously, it is something that we continuously look at and if we get to a situation where our liquidity is excessive from what we think we need or from what we think is anticipated to occur over the near to midterm, we will take a look at dividends and/or buyback, whatever we think is appropriate. But based on where we are right now, our focus is still on the organic growth side of things, and the value creating M&A.

Okay. And Harley, can you just talk about pricing trends and components in the September quarter? And outlook there in the December quarter?

Sure. Hi, Craig. I assume what you're referring to is ASP movement. We have not seen any appreciable change in the September quarter. And in my opinion, I'm not expecting anything of substance, looking forward to December. And presuming the next question is why, as I said earlier, although we are addressing the realities of declining lead times, from many of our suppliers, we don't see it coming back down to where it was previously in the near term. So we believe that is primarily why we are just not seeing or feeling any high degree of pricing pressure at this point in time.

And Craig, it is Roy. I will add a little historical perspective. If you zoom up for a minute, when these cycles in the components industry, can be either supply-driven, or demand driven. When they're demand driven, as in the tech bubble, and the great recession, it is common to see ASP erosion, because there's excess capacity, and excess inventories. But when they're just cyclical in the context of inventory expansion and contraction, but product lead times, and utilization rates at the factories are normal, we tend to not see ASP erosion. And that's our expectation of the current cycle.

Thank you. The next question is from Brian Alexander with Raymond James. Please go ahead with your question.

Yes, Roy, you explained the inventory increase and I think you said it was up 15% if you back up currency and acquisitions but your outlook for EM next quarter I think at the midpoint is down about 5% for sales if I back out currency and acquisitions. Why would you be adding 15% to inventory? I am just looking for more color there.

Sure. Well, I guess I will take the first pass, since you threw it at me, but I will certainly throw it to Harley for any thoughts. Remember, Brian, that for several quarters in a row, we were unable to get the amount of product that we wanted to support our customers' needs.

And remember that when we have demand that we can't fill from our inventory, it puts a lot of extra stress into our system. There is extra quoting that goes on. There is extra expediting. We're cross-docking in the warehouses. We're doing premium shipments.

And so there is a level of inventory that we need to actually be able to function in the way we would like to function. Providing the right service levels, at the right level of productivity and efficiency. So simply put, we needed more inventory that we could not get our hands on, and for a variety of reasons, we were able to increase the inventory in the September quarter.

I am going to make one more comment, which I think may be sort of what you're trying to get at and that is aside from the fact that we had higher volumes an we needed more inventory for that, we did want more inventory that we couldn't get, but we didn't forecast, we would get as much in, in the September quarter, as we did. The product lead times came down. We wanted the product. But we ended up getting a little more than we thought we would, so inventory built more than that, more than we would have expected. However, we're still well above our pre-recession levels of velocity, and we are frankly very comfortable with the level of inventory we're operating with, and the velocity of that inventory and working capital in total. Harley, you want to add anything?

Yes, I think Roy, I kind of will slide off your comments there, around inventory coming in through the quarter at an accelerated rate. Not inventory we weren't expecting. But at an accelerated rate. I think Brian, I don't want this to sound like an excuse but in a business where we're working with hundreds of thousands of customers and hundreds of thousands of SKUs, in an ideal world, for every part number that a supplier moved from 12 weeks to eight weeks, we would automatically adjust our backlog in our pipeline from 12 weeks to eight weeks. And the reality is, there is a lot of art, there is a lot of science, there is a lot of experience in there.

So I think I would just reiterate what Roy said. As the quarter develops, our receipt of inventory coming in was a lot quicker than we really had anticipated in the beginning. I want to clarify though this is not inventory we're not trying to get rid of or unhappy to have, but the timing was a bit quicker than we would have expected, so we will adjust to that through the quarter. And we will flatten it out. And that really is the main reason.

Hey, Brian, I will add two more comments. Things that have not jet come up. Some of the inventory build, which I don't think I mentioned earlier, was actually strategic in the sense that there is a couple of parts of our EM business where we're looking to gain market share, specifically what I would describe loosely as e-commerce, and IP&E. And in both of those areas we placed orders with the intent to increase inventory to drive additional profitable growth. The other comment I would make is that, as Harley just pointed out, it is very hard for us to be precise in our prognosticating of inventory. Our current expectation is that in the December quarter, inventory is going to be roughly flat, somewhere in that ballpark, since we did accumulate inventory in the September quarter, we don't think we're going to need to accumulate much in the December quarter.

That's helpful. And just a question on the operating margin, implied in your December outlook, should we be thinking at the segment level that EM is going to come in a little bit below 5% and TS can get back to 3% or a little bit above 3%? Is that how you look at your guidance.

No. This is Ray, Brian. How are you? We don't think the EM guidance would suggest being below 5%. Based upon what we know now. And TS again would be in line with what you just mentioned.

Above 3%.

Above 3%, yes.

So Brian, I don't know if you saw this, I know there is a lot of data to digest, but we will have what, Ray, $6 million or $7 million of equity comp in the corporate piece in the December quarter so you may not have picked that up in your model yet.

Okay. And then just on process, any update there?

Rick, you want to take that?

Hi, Brian. Yes, we are continuing with our process for divestiture. We have some interested parties. Multiple interested parties still participating at this point. And we are still on a track to have this concluded by the end of the calendar year.

Thank you. The next question is from Steven Fox with CLSA. Please go ahead with your question.

Hi, good afternoon. I just wanted to look at Brian's question in a little bit different way on the TS margins. So off of the 2.2% margins that you reported with the acquisitions, you said it was diluted by the acquisitions, so does that mean that the natural margins for a quarter like that would be the 2.2% plus the synergies you expect? Or is there something else that we should also factor in?

Steve, it is Roy. I will take the first pass and open it up for Phil. If you look at the TS business, and exclude the acquisitions as well as the transfer from TS, we would have delivered about 2.5% operating margin. On a go-forward basis, of course the synergies are going to impact the margins coming from the M&A, and then I just want to remind you that independent of the M&A, we have these investments we have been making such as TS Asia, and of course, we have been on a multi-quarter plan to improve profitability in Europe. So all of those are factors in the mix for the current quarter. But all of those create opportunities for expansion going forward. So Phil, you want to add anything?

Yes, Roy, just a little bit more color on it. Actually, and you're right on, it is about 60% of the lower year on year decline, or roughly 28 to 30 basis points were attributable directly to the Bell and Tallard businesses being acquired and integrated. As we obtain the full synergies, as Roy pointed out, we will certainly get that margin back up to where the ranges plan to be from a VBM standpoint but just one other comment. So we are around 2.5%, okay, if we excluded that, and that takes into consideration the investment model that we have been making in the Asia-Pacific region.

That's very helpful. And just one quick follow-up on the quarter just completed, did you say that roadway, the September quarter from an EM standpoint was typical seasonality, or how would you describe the trends there? Because you're talking about normal seasonality, but what kind of a base are we talking of?

It was better than normal.

Okay. And as we think going back into the next few quarters that is not really repeatable? That is more of a function of the psyche that is in the past?

Yes, precisely. I think with four quarters or with five quarters, I think we had five quarters in a row of EM above normal seasonality, and what we see in the December quarter, Steve, is low end of normal, or slightly below, and we're not forecasting the March quarter yet. However, if history repeats itself, I wouldn't be surprised if we got another quarter of low end of seasonality or maybe just slightly below that. And then my suspicion is by June or perhaps September quarters, EM is probably heading back to normal seasonality.

Thank you. The next question is from William Stein with Credit Suisse. Please go ahead with your question.

Thanks. Roy, I'm wondering if you could talk a little built about the stronger and weaker end markets and the component business in the quarter, and then also by EMS versus OEM as well?

All right. I will tell you. What I will take the first one and give Harley the second one. So Will, just kind of a reminder, our EM business is very broad-based. We have a large number of suppliers serving a very large number of customers, and as a result of that, we don't tend to think about our business in the context of end markets. We think of it as more geographic.

And quite honestly, we had very strong results from all of our geographic businesses last quarter. Perhaps Europe was a little bit stronger than the others. Asia probably right about in the middle. And America maybe just slightly weaker. But all three of the regions performed very, very well. IT to industrial to medical and even into defense, and then on the consumer side, terrific growth through our Asia operation, to a wide range of consumer products. The only end markets that we were able to identify weakness in the September quarter was PC and LCD TV. Harley?

And I think your second question, Will, Was around EMS. and I think what i would say, playing off of Roy's description of better than seasonality, made with the strongest growth, the strongest -- the most above season, normal seasonality being in Europe, I would shade EMS slightly below that. And I would say probably pretty normal seasonality for our EMS business. Not quite as exciting as the total, really for the reasons that Roy suggested because the strongest propellant to our above seasonal performance really would be the broad industrial base. Which isn't typically where our EMS business lies.

Thank you. The next question comes from Ananda Baruah with Brean and Murray. Please go ahead with your questions.

Thanks, guys, for taking the questions. Hey, Roy, you may have just indirectly answered this, but just wondering when lead times do kind of move back towards normal, do you expect to be able to sort of navigate this, the smooth process, or the smooth wear will have any sort of head wind impact or head wind potential to revenues or margins?

Ananda, I think we, as long as we don't end up with excess stored inventories throughout the supply chain or excess capacity at the supply level, barring those things, we should be able to maintain fairly stable average selling prices. And as a result of that, operating margins should actually tend to continue trending up as long as we're seeing growth in absolute terms. So at this point, I would say we intend to navigate this cycle without any noticeable disruptions to our financials. But we do need to stay tuned and see if excess inventories or excess capacities develop. At the moment, we don't see that. Nor do we anticipate it.

Thank you. The next question is from Brendan Furlong with Miller Tabak. Please go ahead with your question.

Thank you. Good afternoon, everybody. Question for you. Now with the acquisitions, Bell Micro, et cetera, can you take a stab what you think in normal seasonality on a quarterly basis is on a go-forward basis?

Well, I could let Vince answer that but I know what is he going to say. We've got -- Brendan, we've got an annual analyst day coming up in December, and we will do our best to update everybody with what we think is the new version of normal seasonality. But we don't have that prepared for this call.

Okay. I will wait until then. The second question I have is on the EM side. With the EP acquisition of Bell Micro and what have you, is will a geographic impact on gross margins on the geographic basis? Does the US take more of a hit than Asia for example, Europe take less? Or how should I think about that?

Hi, Brendan. This is Harley. Today, the Bell Micro business for EM is almost exclusively isolated to America. So that is the area where we would see a change in our aggregate gross margin. As you would guess, we manage them independently, to sure that we don't allow any deterioration in our core is we've seen nice progress there, specifically in America. So it is only in that region today where there would be a change to our overall gross margin.

And Brendan, it is Roy. I will just go ahead and add, our EMA gross margins are sort of in the mid teens, from a legacy perspective, and our embedded business now with Bell is in the double digit range. HDDs, on a stand alone basis, tend to run below that.

The embedded systems where we're doing solutions for customers actually tend to run more like the components, the traditional components margins, mid teens or a little bit better. So it is -- that's the way those two are stacking up. Think about the embedded at right at double digits with the legacy business at mid teens or slightly better. And what is going to happen going forward, for EMA, will be a function of the mix now between those two businesses.

Thank you. The next question comes from Amitabh Passi with UBS. Please go ahead with your question.

Thank you. Roy, you talked about wanting to build some inventory on a more strategic basis. One of your largest competitors is basically pursuing a similar strategies. And I suspect there are others in the supply chain doing same. At the end of the day isn't this basically a zero sum game and we will basically see some pain down the road?

Harley you want to take it.

Sure. I would reiterate at the chance of being corrected here that I think Roy's description had the strategic portion of our inventory increase at the end of the list. In other words, if you're going to quantify how much, behind really the M&A related currency impact, and the shortening of lead times, the fourth piece would be strategic. So from our perspective, it is an element of it, but I wouldn't want to color it as the biggest part of the increase.

Roy mentioned very briefly our web-based business. We internally call it Avnet Express. And to give you an example on that. Even though today it is a smaller part of our business, it is a type of business that requires a much broader inventory coverage, which will have a lower velocity than our core business, but it has significantly higher margins. So again, today, it is a small part but that is one area for example where we did invest proactively as we roll that program out globally over the next couple of quarters.

And Amitabh, it is Ray. I will just add to that. So the other category that we invested in was IP & E. And similar to e-commerce, it tends to be a large number of SKU's but not particularly high volumes per SKU. So the kind of investing we've been making is to drive higher margin profitable growth and not the kind of units per SKU that would cause us to want to influence pricing as a result of that investment.

Got it. One other question, and perhaps Roy, this is a bit hypothetical but would still love to get your take. Year over year growth rates tend to decelerate, do you think we could enter into the territory of negative year-over-year growth trends? I know previous cycle, we've kind of seen the semiconductor market kind of trough at the sort of flattish year-over-year trends, but his cycle, we've also seen tremendous expansion in growth rates on the upside. And I'm wondering as we kind of decelerate could we actually see negative year-over-year growth trends?

So you kind of covered it. In the tech bubble and in the great recession, we did get to negative year-over-year comps, especially if you look at it on a quarter to quarter basis. However, in between there, we saw periods of accelerating and decelerating year-over-year growth rates. But as an industry did not experience any negative quarters measured in terms of year-over-year. It is our expectation that that is the kind of cycle that we're in here. Okay? And I think the real answer to your question, will we get to negative growth or not, I think it is going to turn out to be a function of the strength and continuation of the cyclical economic recovery. As long as we do not slide into a double dip and see a demand drop, I'm optimistic that we won't have to get to negative year-over-year comps to work our way through this inventory cycle.

Great. And then just final question, I don't know if you said this, where are lead times today and if you can update us on cancellation rates, and perhaps what proportion of your backlog is in excess of 90 days?

Sure. Our lead times are, in the aggregate, so on average, there he have come down from their peak, but we still see them overall, with exceptions in both direction, as extended from where they were prior. So come down, but not all the way down. And the other question was cancellations and reschedules. Really have seen no dramatic alteration on the past previous quarter's ratio. And you no he what percentage of your backlog is over 90 days? That was part of the question. You don't have that?

I don't have that in front of me. I can get that before we close. Yes.

So as Harley said, there is a lot of different SKUs in the inventory, or product lead time category. But I guess think of it this way. If normal is eight weeks, and we got to 16, we're in the 12-week range today. So we're kind of -- we're working our way back on average, but not all the way back to normal yet. My personal perspective is, end of this calendar year, maybe beginning our first quarter of next year, we will be closer to that eight-week level.

Thank you. The next question comes from Jim Suva with Citi. Please go ahead with your question.

Thank you, and congratulations, gentlemen, to great results and the outlook. And when we look at your integrating several acquisitions, whether it is Bell, Unidux, Tallard and such like that, can you let us know if those were fully integrated today, either in aggregate or maybe one by one, what would have been kind of the EPS power for this quarter? Does it like add an additional $0.05 for this quarter or $0.10? I'm trying to see what the earnings power would have been with those integrated into your acquisitions?

Yes, so Jim, it is Roy. I think when you roll it all together, obviously there is a lot of moving parts here, but we think the overall accretion is between $0.40 and $0.50 on an annualized basis with all of the synergies in. If you look at what we got, you take the synergy number of $6 million-ish, add to that the operating income of those operations, and ray, what would you say we got this quarter?

$0.05?

It is in the $0.05 range.

$0.05, $0.06. Maybe $0.05 to $0.07, Jim, this quarter. So the potential is -- maybe the right way to think about it is, the potential is about 10 to 12 annualized, and we got about half of that in this quarter.

Great. So when we add that up, does that mean that you now on status quo, the company's earnings power is 425?

Well, we don't forecast that, so I'm not sure how to answer the question of earnings power. But if you made assumptions that revenue and the other dimensions of the income statement would stay relatively stable or maintain the current trajectory and then get the synergies out, we're at $0.93, add another $0.05 or so, you start getting up over $4 a share. And, by the way, Jim, as from your model, typically the first quarter is not 25% of the full year.

That's true. Okay. I was just comparing it to consensus and it just looks like that there is material room for upside and again, congratulations to you and your team for great results.

Thank you very much. And look, I think the big difference between run rate and consensus, I believe, is prognostication is about the inventory cycle, for the most part. I think most of us believe double dip is not on the horizon for macro economics. So the issue is really specific to EM, and we will have to see how this thing plays out.

Thank you. There are no further questions in queue. I would like to turn the call back to Vince Keenan for closing remarks.

Thank you for participating in our earnings call today. As we conclude, we will scroll through the non-GAAP to GAAP reconciliation of results presented during our presentation along with the further description of certain charges that are excluded from our non-GAAP results. This entire slide presentation, including the GAAP financial reconciliation and the access and downloadable PDF format at our Web site, in the quarterly results section. Thank you.

Thanks, everybody.

This concludes today's teleconference. You may disconnect your lines. Thank you for your participation.