安富利 (AVT) 2011 Q2 法說會逐字稿

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

Good afternoon and welcome to Avnet's Second Quarter Fiscal Year 2011 Financial Update. If you are listening by telephone today and have not accessed the slides that accompany this presentation, please go to our website, www.IR.Avnet.com and click on the icon announcing today's event. As we provide the highlights for our second 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 periods. When discussing pro forma sales or organic growth, reported revenue is adjusted for the impact of acquisitions by adjusting Avnet's prior periods to include the sales of businesses acquired as if the acquisitions had occurred at the beginning of fiscal 2010, as well as the impact of the transfer of existing embedded business from TS Americas to EM Americas which occurred in the first quarter of fiscal 2011 which did not have an impact to Avnet on a consolidated basis, but did impact the groups by approximately $93 million. Sales taking into account the combination of these adjustments is referred 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-based financial statements into US dollars.And finally, when addressing working capital, return on capital, return on working capital, and operating income drop through, 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 financials 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 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, will provide Avnet's second quarter fiscal year 2011 highlights. Following Roy, Ray Sadowski, Chief Financial Officer of Avnet, will review the financial impact of recent acquisitions and provide third quarter fiscal 2011 guidance. At the conclusion of Ray's remarks, a 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 second quarter fiscal 2011 business results.

Thank you, Vince, and hello, everyone. Thank you all for taking the time to be with us and for your interest in Avnet. The technology-driven economic recovery continued in the December quarter as we delivered a fourth consecutive quarter of double-digit year-over-year top line organic growth. Even though the rate of organic growth slowed as the comparisons got tougher, pro forma revenue was up 14% year-over-year in delivered dollars and 16% in constant dollars. Overall, reported revenue grew 40% year-over-year due to this strong organic growth and the significantly positive impact of acquisitions. Gross profit dollars also increased 40% year-over-year as gross profit margin was roughly flat. Ongoing margin improvements in our base businesses were offset by the impact of acquisitions which have historically had a lower gross profit margin profile than Avnet's.

On a sequential basis, gross profit margin declined 27 basis points, primarily due to the business mix shift caused by our Technology Solutions group's typically strong December quarter. Substantial year-over-year growth, combined with further improvements in productivity and efficiency, drove adjusted operating income up 58% over the year ago quarter as adjusted operating income margin increased 43 basis points to 3.8%. On a sequential basis, where growth was primarily organic, adjusted operating income grew 1.6 times faster than revenue and adjusted operating income margin expanded by 19 basis points, despite the seasonal shift in business mix. One of the most important metrics we've used over the years to measure Avnet's efficiency is SG&A expense as a percentage of gross profit dollars. In the December quarter, this ratio improved 243 basis points sequentially and 379 basis points year-over-year. At 66.8% for the December quarter, this metric is back to pre-recession levels, even as we continue to invest for profitable growth. As we benefit from scale and scope advantages and realize the remainder of the synergies from recent acquisitions, we expect to continue improving performance in this key operational metric.

On the bottom line, adjusted earnings per share on a diluted basis grew more than 1.5 times sales at 62% year-over-year to a record $1.07. Working capital grew $299 million sequentially, or 8.7%, to support the seasonally stronger sales at TS and double-digit organic growth at EM. Working capital velocity declined both sequentially and year-over-year, but is still running well above pre-recession levels. We remain very comfortable with the amount and quality of this investment. Return on capital employed, or ROCE, increased 61 basis points sequentially to 15.6% and has been within our target range of 14% to 16% for five consecutive quarters despite recent investments of $627 million in value creating acquisitions. This performance reflects our ability to manage Avnet's operations globally to insure that all investments ultimately meet our return thresholds. At our Analyst Day back in December, we showed you how Avnet emerged from the recession a much larger and stronger company, with multiple investments for profitable growth.

With technology markets forecasted to continue to lead this recovery, expanding operating margins and returns within our target range, Avnet is well-positioned to continue improving on our recent performance and continue to deliver increased shareholder value.

Now, let's turn to the operating groups. EM delivered another strong quarter to close out the calendar year. As the v-shaped recovery transitions to a more normalized growth rate, we continue to see strength in end customer demand and a technology supply chain returning to normal utilization rates, product lead times, and inventory velocity. Reported revenue of $3.56 billion grew 41% year-over-year while pro forma revenue was up 23%. This strength was consistent across all regions as all three delivered double-digit organic year-over-year growth for the fourth consecutive quarter. Sequential revenue growth was slightly below typical seasonality as expected, as the technology supply chain continues to adjust supply and inventories to end demand after several quarters of significant growth and extended component lead times.

It appears that end demand remains firm globally and inventories across the supply chain are being well managed as EM's bookings strengthened unexpectedly at the end of the quarter, driving a book-to-bill ratio of 1-to-1 for the full quarter. EM gross profit margin increased 22 basis points year-over-year and 10 basis points sequentially. The year-over-year increase was primarily driven by our EMEA and Asia regions where gross profit margin increased over 50 basis points. This improvement was offset partially by a decline in the Americas region where an increase in GP percent and our traditional components business was offset by the inclusion of the lower margin embedded business that was acquired from Bell Micro. EM's strong revenue performance, along with gross margin expansion and productivity improvements, resulted in a near doubling of operating income over the year ago quarter to $183 million. Operating income margin increased 150 basis points to 5.2% and while all three regions improved, the most significant increase was in EMEA. EM increased working capital during the quarter primarily due to a decrease in accounts payable, as well as a slight increase in inventory.

Working capital velocity declined both sequentially and year-over-year. However, at 5.3, velocity remains well above pre-recession levels and we expect it will improve sequentially. We are very comfortable with EM's inventory levels and our global team's ability to continue achieving appropriate returns on all invested capital. EM's strong growth in revenue and operating income drove return on working capital up 691 basis points over the year ago quarter to 27.5%. While ROWC was down sequentially due to the decline in revenue, EM's ROWC was up significantly year-over-year and through the first six months of fiscal 2011 is at our 30% target globally. In addition, EM operating margin is near the mid-point of our 5% to 5.5% target range. With EM operating within its target business model and a positive outlook for industry growth, we enter the seasonally strong March quarter well-positioned to grow profitably and generate increased economic profits.

Technology Solutions delivered its typically strong December quarter as revenue grew 25% sequentially to a record $3.2 billion. On a reported basis, TS grew 38% year-over-year and 41% in constant dollars. While year-over-year organic growth rates came back to single digits after four consecutive quarters of double-digit growth, the normal seasonal sequential growth indicates that businesses continue to invest in IT data center infrastructure. In the December quarter, year-over-year pro forma revenue grew roughly 7% in constant dollars. Excluding the impact of a major supplier that is transitioning its channel strategy, TS global revenue grew 9.5% year-over-year. The technology refresh cycle continued this quarter as our hardware sales grew faster than software and services for the fourth consecutive quarter. In the December quarter, industry standard servers grew 50% year-over-year, while storage grew 25%.

ISS represented 34% of our total server business. Our solutions path proprietary service offering continues to gain traction with suppliers and VARs alike, as we invest in additional high growth vertical end markets and technology practices. On a sequential basis, industry standard servers and software grew greater than 40%, while storage grew 30%. Gross profit margin at TS declined 28 basis points year-over-year and nine basis points sequentially, due primarily to the impact of acquisitions. Portions of the recently acquired businesses have historically had a lower gross margin profile than TS, and we remain confident in our ability to achieve our targeted returns as we continue to implement the planned integrations on schedule. TS operating income grew 3.4 times faster than revenue sequentially to $105 million and operating income margin increased 107 basis points to 3.3%.

Operating income margin was down 52 basis points year-over-year due primarily to the impact of acquisitions, as we have not yet realized most of the expense synergies affecting the TS business. Operating income drop through, which we define as the percent of incremental gross profit dollars that fall through to the operating income line, was 88% sequentially for TS. This leverage was typical for our December quarter with all three regions contributing. ROWC increased 1,586 basis points sequentially and was above our 30% target globally for both the second quarter and the first half of fiscal 2011. Although acquisitions had a downward pull on some of TS's year-over-year margin comparisons, we are now beginning to realize tangible benefits as we integrate them into our VBM culture and bring Avnet scale and scope advantages. In Latin America, revenue grew 35% sequentially, operating income margin was up 233 basis points, and return on working capital was above our 30% target for this typically strong quarter.

TS EMEA also had a solid quarter, as revenue grew close to 30% sequentially and operating income margin increased 179 basis points. While EMEA's ROWC was near our long-range target benefited by the seasonal revenue growth, we should continue to improve financial performance as we complete the Bell integration over the next two quarters and realize the majority of the expense synergies. In Asia, where we have been growing rapidly as a result of organic investments and M&A, operating income margin was up both sequentially and year-over-year. At the beginning of January, we completed our acquisition of ITX, a leading value-added distributer of IT systems and services in Australia which will significantly improve our competitive position in that country and expand our margins. As we enter calendar 2011, TS is well-positioned to continue growing faster than the market and improving its financial performance as we leverage our leadership position in mature markets and expand our presence in higher growth countries. Now, I'd like to turn the commentary over to Ray Sadowski to provide more color on our financial results. Ray?

Thank you, Roy and hello, everyone. The integration of Bell Micro is progressing well and we are already seeing benefits as we combine organizations and streamline processes. Effective January 4, we completed the sale of Prosys to Applied Computer Solutions. In Latin America, we consolidated the regional headquarters of Bell Micro and Tallard in Miami thereby improving communication between our new Latin America organizations and reducing a variety of overhead costs. The European system conversion that we spoke of last quarter is scheduled to occur over the coming weekend as originally planned and will be the catalyst for multiple other changes that could not take place until we're on one operating system. As mentioned on our last call, we converted the Bell business to Avnet's IT systems in North America at the beginning of October. As you can see from the table on this slide, we have not changed our synergy expectations or timing of the realization.

We remain very comfortable with our overall operating expense synergy target of at least $60 million and continue to expect the full benefit of synergies to be realized in the first quarter fiscal year 2012. Looking forward to Avnet's third quarter fiscal 2011, we expect TS sales to be in the range of $2.4 billion to $2.7 billion and sales for EM to be between $3.55 billion and $3.85 billion. Therefore, Avnet's consolidated sales are forecasted to be between $5.95 billion and $6.55 billion. These numbers reflect normal seasonality at both TS and EM. Based upon that revenue forecast, we expect third quarter fiscal year 2011 earnings to be in the range of $0.93 to $1.01 per share. The above EPS guidance does not include any potential restructuring charges or any charges related to acquisition and post-closing integration and assumes an effective tax rate of 29% to 31%.

In addition, the above guidance assumes that the average Euro to US dollar currency exchange rate for the third quarter of fiscal 2011 is $1.36 to EUR1. This compares with an average exchange rate of $1.38 to EUR1 in the prior year third quarter and $1.36 to EUR1 in the prior sequential quarter. With that, let's open the lines for Q & A. Operator?

Thank you. (Operator Instructions)Our first question comes from Steven Fox from CLSA.

Hi, good afternoon. Can you hear me okay?

Sure can, Steve.

Okay, good. So, just on the components business, the strengthening at the end of the quarter, the typical seasonality, and the return to normal lead times, can you, Roy, talk about how you see the year playing out? It seems like it's actually a better than normal start when we sit here in January. What would we be concerned about by region or by product segment? Is there anything else you could sort of add color around the components environment?

Okay, Steve. Yes, I'll take a shot and then see if Harley would like to do a follow-up. As we reflect on the bookings that strengthened in December, it seems to imply two things. One, overall global demand is strong. And by the way, the bookings were good really around the world, giving us a 1-to-1 book-to-bill ratio for the quarter, so it looks like demand is strong around the world. I think that implies both consumer and business type end markets. And, in addition, for customers to be ordering in December, it implies that inventories are well under control. So I think therefore, my knee jerk would be that 2011 would be roughly in line with normal secular growth rates. And I think, Steve, the variable wild card would be perhaps the rate of overall economic growth and what kind of macro environment we're looking at. Right now, demand looks very strong and inventories look under control and therefore, we're calling for a normal seasonal quarter here in March to get things started. Harley, anything you want to add?

Roy, I think I would only add that January started off in an encouraging way with shipments starting off strong which really, I think, supports what you just suggested relative to bookings at the end of December -- really followed through nicely.

And then just as a follow-up, can you just talk about working capital expectations under that scenario for the rest of -- just for the next couple quarters? Ray, do you see the Company being working capital or rather cash flow positive or how would you expect it to play out based on the guidance you just gave?

At this point, our expectation is, at least for the third quarter, we would expect that we would be cash flow positive.

Great. Thanks very much.

Thank you. Our next question comes from Scott Craig from Bank of America Merrill Lynch.

Yes. Thanks, good afternoon. Roy, or Ray, can you maybe talk a little bit about the gross margin drop through as you work through the rest of this fiscal year -- so for the next couple of quarters? And do you expect anything there one way or the other that would be somewhat different from what we've been seeing? Thanks.

Hello, Scott. It's Roy. I think that gross margin on a sequential basis should be up. It is normally up for us in a third quarter. We've got the strong TS calendar year-end affecting the December results. And then as TS reverts back to a normal Q1 and EM has a normally strong Q1, we should see an expansion of gross margin. And then I think I'd rather not try to get out and forecast Q4, but normally gross margin would be more or less flat from Q3 to Q4.

Right. And, Roy, sorry, how about from a drop through basis as well?

Well, so, I think the drop through is going to include some additional synergies coming through the Bell and now the ITX integration work. So, perhaps a little bit better than normal drop throughs over the next two quarters.

Okay, thank you.

You're welcome.

Thank you. Our next question comes from Shawn Harrison from Longbow Research.

Hi, good afternoon. Wanted to touch on TS. Good strength at the end of the year, maybe you could speak in terms of what you're looking for maybe over calendar 2011 and potentially how the synergies will build on the sales side from the three recent acquisitions at TS?

Yes, so Shawn it's Roy. I'll go ahead and take the first shot and again throw it to Phil for color or to Rick for that matter. Similar to EM, we had four quarters of double-digit growth at TS that ended the calendar year with a normal seasonal or sequential growth. And now we're in the land of tougher compares so the year-over-year rates have slowed, but on the other hand, it seems like normal seasonal growth going forward. Therefore, I think for 2011, the pundits are thinking middle single digits for overall IT growth. But interestingly, as we talked about in December, the large services portion of the overall IT market is growing slower than the hardware portion. And so I think our current belief is that hardware grows at 6%, maybe even pushing 7% in calendar 2011. Okay?

Okay.

And our objective, of course, is going to be to outperform whatever the market ends up doing. And our strategy for doing that would be our organic growth initiatives like SolutionsPath, but also the expansion of franchises into new geographies. And Phil, maybe you could just touch on a few of those. I think Oracle and HP and others have been expanding with us.

Yes, and I'll come back to that. Thanks, Roy. I'll come back and touch on the synergy part of the question as well. The remaining synergies, for the most part, within TS is over in Europe as we transition the systems as Ray talked about this quarter, as well as the facilities and the mesh that happened through pretty much the March and June quarter. And then the amount of synergies really come from value-based management as we integrate Latin America with the Bell Tower business in particular. And then of course, Europe, we continue to apply our VBM principles around suppliers and driving them, if you will, to the returns that we're looking for in those regions. And as we do that, we'll continue to increase -- to get back to the earlier question on drop throughs and improve our overall performance.

As far as opportunities go, we have more and more suppliers coming to us now than we have in some time, okay, wanting to expand with us globally. And as Roy talked about, I'm sure there's some questions later maybe about Oracle and whatnot, and there's certainly been some challenges there as we pretty much publicly stated. At the same time, there's opportunities for expansion with clients such as that as we expand across Asia Pacific, many suppliers wanting to expand with us, and not only Asia Pacific, but in greater parts of Europe as well. So I think Roy articulated well what we're seeing from a forecast, but we're pretty optimistic for 2011 at this point.

Okay. And then just maybe just a brief follow-up. It may be a two part question. Inventory levels, do you think you've peaked in terms of where you'd like to see your inventory at right now? And then, just to get clarification, it sounds as if customers are relatively happy with where their inventory levels are at so you're not facing any real de-stocking headwind out there?

So, Shawn, this is Roy. I'm going to assume that's an EM oriented question since inventory is rarely an issue relative to the TS. So Harley you want to put some color on where you think we're at in the inventory situation?

Sure, Roy. Hi, Shawn.

Hi.

Yes, I think your comment is accurate. I think, as Roy said in the opening script, we'd expect our velocity to accelerate in the March quarter and our forecast incorporates that. We were quite intrigued by the activity we saw at the end of December, because it really was quite actual, I guess for want of another term, in that we were expecting, as we suggested in our December meeting, that we would see a normal slowdown. But indeed, our customers behavior said to us that the supply chain overall is being managed very tightly and quite frankly, quite well from our perspective. As I mentioned earlier, we saw the shipments going right out in January, so we feel good about our inventory. I think it's about where it should be. And as our revenues increase, as we forecasted for March, we should show some velocity improvement as well.

Okay, thank you very much and congrats.

Thank you.

Thank you. Our next question comes from Craig Hettenbach from Goldman Sachs.

Yes, thank you. Harley, can you talk about just pricing trends, any volatility there as inventory is adjusted and any implications that has on margins?

Yes. Hi, Craig. It's interesting as we often talked about this on our calls. Our view on ASP pressure is really competitive pricing pressure and maybe the best proxy for that is our ability to raise gross margins. And I am excited we did raise our gross margins last quarter. We are forecasting they'll come up a bit again in March. And what that says to me is that there's an interesting balance there where the aggregate of all of our regional businesses suggest that there's long term pressure as our age of business outgrows our other regions. With that said, we're very focused, as we talked in detail in the December session, on a number of growth strategies designed to really offsetting that natural erosion. And we think the balance and the task we're holding ourselves to would be our ability to continue to show moderate increases going forward. And with the projections we see for the market for 2011, and obviously given an opinion on Q1, we think we'll be able to continue to find that balance and continue to modestly improve gross margins looking forward.

Great. Thank you. And if I could follow-up, Roy or Phil, just on the TS side. Roy, you mentioned the strength in hardware expected this year. Anything by category specifically within hardware that looks to be the most robust? And then also, any other comments around software and how that looks for this year?

Yes, so Phil you want to take that?

Yes, sure. In the hardware, we mentioned in the script that certainly, industry standard servers are still leading the way, which is positive. And at the same time sequentially, we still held our own even with some of the dip in one of our suppliers high end servers. We held our own sequentially in power overall. We're in high end servers overall. One thing, as we mentioned similar to the Analyst Day, storage is continuing to increase at an accelerated rate, not only quarter-to-quarter but year-on-year which is very exciting along with networking, very positive networking, and memory. So, across-the-board the hardware is looking very, very positive and we're comfortable with the mix there. Software, we had a good increase in software. It's about 17% of our mix right now in this past quarter and continue to have a focus on software and services as an increased mix to our total percentage of revenue.

And Craig, the software categories, security remains very hot, virtualization of course, and then also middleware and database software.

Got it. Thank you.

You're welcome.

Thank you. Our next question comes from Sherri Scribner from Deutsche Bank.

Hi, thank you. I wanted to talk a little bit about the operating margin, specifically in technology solutions and I guess also in electronics markets. If you look at the EM margins, you're really in that through your targeted range that you've talked about in the past and in technology solutions you're pretty close. I'm trying to get a sense of how soon do you think you reach those targeted margins and technology solutions? And as you become operating in those margins longer term, do you expect those margins will have some upside? And do you think you can increase that range?

So, Sherri, this is Roy. Let me take a whack at that one and again, any of the guys here may want to chime in. So, let me take EM first. As you said, we're operating in the range now and expectations are we'll expand margins sequentially due to the beneficial mix that takes place. We typically have a strong Europe quarter in March, pretty good Americas, and Asia is usually a little bit on the lighter side in the March quarter. So, EM is going to be pushing up closer towards the high end of that range. But these targets are meant to be three-year business planning targets. And as we look out, we see greater and greater percentage of EM's revenue coming from Asia, including Japan.

And so while we're going to be benefiting from operating leverage by region, and expanding margin on a region by region basis, we also have to take into account the rapid growth of the East for us and how that might grow as a percentage of our total and therefore bring down the global margin. So, what I would say to you is let us play that out for a few quarters. Of course, we'll get together not later than December and we'll give you an update on the EM range as we go forward. If you switch over to TS, we need to remember that the TS margin typically peaks every year here in the December quarter because of the revenue surge. And on a rolling four quarter basis, we're not actually close to the target range. And essentially, what needs to happen there, we need to keep up the good performance that we're getting from our North American business. It is already well within that range and in fact, perhaps over the top end of that range.

But as you know through M&A we've picked up a significant amount of business in Latin America and we need some time to develop that along with continuing in Europe and increasing the harvest rate in Asia. So, Latin America, Europe, and Asia all need to improve over time. And I think the expectation we would set is give us a two to three year period and we should have TS Global operating well within that target range of profitability.

Okay. So, with the improvements that you expect to come and the synergies with the Bell Micro acquisition that we should see completed by fiscal 1Q 2012 you still wouldn't expect to be in the target range for TS in fiscal 1Q 2012? You think it'll take a little longer?

What I would say to you right now is it would take a little bit longer. It does depend somewhat on how strong the revenue growth is. And candidly, Sherri, it also depends on whether or not we choose to de-select any low margin revenue which might change the top line. At the moment, we haven't identified any significant pockets of revenue that we do want to de-select. But we're really only two quarters in here on managing these acquired businesses and we're still teaching, delivering, and executing to our value-based management strategy.

Okay, great. Thank you.

You're welcome.

Thank you. Our next question comes from Brian Alexander from Raymond James.

Yes, Roy, to follow-up on the March guidance margins, sounds like we should be thinking EM's going to be around 5.3% or 5.4% with TS, somewhere in the high twos . I'm just trying to get a better sense for the segment margins. And related to that -- the overhead, how should we model that rate going forward? Because I think you had some comp expense spill over from September to December and I just want to be clear on what we should be thinking about March and

Yes, so Brian, this is Roy. I'll take the first shot. So, I think your assumptions are very accurate, as usual. EM should expand, I would say, between 10 and 30 basis points sequential. Of course, it does ultimately depend on the revenue growth and the mix of the revenue, but somewhere in that ballpark. And then TS -- remember we've divested the Prosys business effective as of the first day this quarter, so we've got this decline in revenue. Then we have ITX coming back in, and all in, we see TS performing in the mid-twos in the March quarter. And then at the corporate level, the sort of unusual December quarter expense associated with equity compensation will drop off, Ray, by what, $7 million or so?

Roughly $7 million. $6 million, $7 million sequentially we should see it drop off and then we'd expect to remain relatively flat until we get back to the first quarter of fiscal year 2012.

And that first quarter bump up Ray, again, is what, $8 million to $10 million, relative to June?

Relative to June, yes, I think that's about right.

Okay. And then, just a follow-up, just on M&A, you guys were pretty busy in calendar 2010. Your debt levels are higher than they've been in a while, but still pretty manageable. So, just talk about your appetite willingness to do M&A. And related to that, just an update on which acquisitions, other than Bell, are still being integrated.

So Brian, this is Roy. I feel very comfortable taking that one. And the answer is we still have a significant appetite for acquisition. I don't believe that M&A will be gated by our ability to finance. I think we're in very good shape from a leverage and coverage perspective. And of course, we don't buy things unless we can achieve our targeted returns. And therefore, obviously, we're acquiring even more EBITDA through the acquisition, so it won't be money. We do have a funnel. We've got our opportunity pipeline working. There's quite a bit of activity. And the one thing that we will allow to be a limiting factor, if you will, is to ensure that wherever we're acquiring we have the organizational bandwidth to do a proper job on the integrations.

So, that's really the only gating factor, so to speak. As far as what we're still integrating, you mentioned Bell of course, which is the big one. There's a back end relatively low level of integration of activity taking place in Japan. And now we have, with ITX, the integration of our businesses in Australia. Those are the activities underway.

Great. Thank you very much.

You're welcome.

Thank you. Our next question comes from Jim Suva from Citigroup.

Thank you and congratulations to you and your team on good results and coming out even stronger from the recession.

Thanks, Jim.

When we look at gross margins, company-wide gross margins, they were relatively flat year-over-year and I believe that's due to some integration headwinds there. Looking more forward-looking because we're all about forward-looking moving forward here, you talked about improvements to expect for the March quarter which is great. However, last March quarter, they went up materially quarter-over-quarter about 90 basis points. So can you help us better understand, when you say move forward into the March quarter, are you referring to on a year-over-year basis that they'll improve beyond last March? Or still below those levels? And when should we start to see year-over-year gross margin improvement?

So Jim, the comment that was made earlier was in reference to sequential margin improvement driven by the noticeable mix shift, as opposed to year-over-year . A couple of comments I would make to you is remember in the year-over-year compares, March a year ago we did not own Bell, Tallard, or Unidux. All three of which were acquisitions where their historical gross margins were running below that of Avnet. And so, that's where the integrations coming in have put a downward pressure on gross margin. And then as you pointed out, however, the improvements that we've made in our core businesses, our legacy businesses in the December quarter offset those impacts from the integrations and we were able to actually slightly improve gross margin year-on-year. And I think the other point you made was last March there was this significant improvement. What I want to remind you of is that last March, we had very strong growth from electronics marketing. We were entering this 30% growth era for electronic components, and so the typical mix shift that occurs was even more dramatic a year ago than we are currently projecting now. EM's been growing rapidly, so we're coming off a much higher base in December of 2010 than we had in December of

That makes sense. And then, just an accounting question. On the tax rate, it was 30% in September and 27% in December, moving around a little bit what should we model going forward?

At this stage, we look to the balance of the year, roughly 30%, we'd not expect it to be higher than 30%. So, we're assuming around 30%.

Ray, what was the adjusted December quarter tax rate?

If you look at it from a non-GAAP perspective, tax rate was, for the quarter in December was 30%. So, we're looking at that to be maintained.

Great, thank you and congratulations, gentlemen, to you and your team.

Thanks, Jim.

Thank you, our next question comes from Matt Sheerin from Stifel Nicolaus.

Yes, thank you. So, a couple of questions. One, on the electronics marketing, just want to go over the seasonality a little bit -- specifically on Europe. If you look at the midpoint of your guidance down, sorry -- up 4%, typically you're up in the low double-digits in Europe, up a little bit sequentially, mid-single digits in North America and flat to down in Asia. Is that how we should think about it? Because it just seems like that up 4% is just a little bit less than seasonality.

Harley?

Yes, hi, Matt. I think your regional estimates are right on target. I think they are essentially where we modeled it. And dependent on which way you round any one of those three numbers, you're between 4% and 5% sequentially, so it looked pretty seasonal to us.

Okay. Well, that's helpful. But -- so I guess my point on Europe is that we've seen probably four quarters of better than seasonal growth and then you had better than seasonality in Asia, in North America, but that slowed down. You saw a bit of a pause there as we saw this inventory and order adjustment with lower lead times, yet you haven't seemed to have seen that in Europe yet. So my question is, do you think we'll just get through the cycle without seeing it in Europe? Is something else happening there, or could we see a pause at some point because it's lagging?

Matt, obviously, I wouldn't dare to forecast out past one quarter at a time, but I would reinforce what was said earlier. And that was Europe closed December, not only very strong from a year-on-year shipping perspective, but also with our highest book-to-bill. So, we don't see any indicators so far that some type of adjustments is at least in the near to mid-term horizon.

And hello, Matt, it's Roy. One thing that is worth pointing out here, we believe that a significant amount of the strength that we're seeing in components in Europe ends up in equipment that's being exported back out of Europe. So, in a counterintuitive way, the sovereign debt issues that have put some pressure on the Euro currency actually have buoyed European exporters, most notably out of Germany, and that's where the strength from component sales is coming from.

Okay, that makes sense. And then on the computing side of things, you talked about the strength in industry standard servers. Could you talk about the competitive landscape? Because you've got some big guys like Ingram and Tech Data playing in that space? And then also talk about the margin profile of the industry standard servers versus the proprietary systems?

Sure. Phil, do you want to take a shot?

Well, yes. When you get into the standard servers, certainly the margin profile's different, Matt and a bit lower from the margin maybe but not from an operating standpoint. So, when we're playing the industry standard servers is that I would say more diverse market than maybe some of the traditional volume players like an Ingram and such would be playing. So, we're going to continue to only drive sales and accelerate sales in industry standard servers where we can get a fair return from a profitability standpoint. Some of the customers that we're starting to see some of the greatest growth in industry standard servers is actually in some of the embedded areas as well.

But we're doing more integration of industry standard servers into some -- let's call them appliances or end products that we end shipping for those OEM type or system integrator type customers. So, it's a more diverse customer set and we want to drive a higher complexity, for some of the industry standard servers as well so we can add more value around the total sale.

And hello, Matt, it's Roy. Just to add to that, a couple of things I want to point out. One is, we commented that industry standard servers represented 34% of our server revenues in the December quarter. So we are well aware that other distributors have set their sights on servers and other data center type products. And I certainly understand why they would do that. But our growth, the figures we threw out to you, the 50% year-on-year growth in ISS, the margin expansion that TS experienced sequentially, all of that is with a rising ISS business and ISS growing as a percent of our total servers.

The other thing I want to point out -- by the way, that does connect back to maybe one of Sherri's questions about the TS overall margin profile, so we're driving this business model while industry standard servers are rising as a percent of our total. The other thing I would just like to point out is that storage now, as a category, is bigger than our proprietary server overall category. And storage, of course, is a very rapid growing business and again, that's baked into the TS run rates that you've been looking at.

Okay, that's helpful. Thanks, Roy.

You're welcome.

Thank you. Our next question comes from Amitabh Passi from UBS Research.

Thank you. I just had a question on the cash flow profile. I think somebody asked earlier, I just wanted to dig a little deeper. One of the attractive aspects of your story is the M&A potential and we've now seen five of the last six quarters with negative free cash flow. And yet, when I look at the inherent potential of the business assuming operating margins get close to 4%, you should be generating close to $350 million, $400 million annually. So I just want to refine that as we look further beyond the next two quarters into fiscal 2012, can we start to expect the business model to normalize where you start to throw off some pretty decent levels of free cash flow?

So, Amitabh, this is Roy. The one answer is yes. The longer answer is -- I guess I would make two comments. One is, as you look at the cash flow that has taken place during this v-curve recovery, I would ask you to look back at the other edge of the v, and as you'll recall, we generated $1.1 billion during the downslope. And I believe we have used cash from Ops of maybe $250 million in the upslope, even though it's been multiple quarters. So, we still have net created enough cash to pay for all of the acquisitions that we've done this fiscal year.

The second thing I would say to you is that if we are correct about the EM and TS businesses reverting to more or less secular growth rates, then your model is absolutely correct and cash flow will be substantially positive. What would alter that would be if business grew slower, we'd actually generate more cash and if the business did continue to grow at a double-digit rate organically, that's the one thing that would cause cash flow to be not as positive as you're indicating.

Okay, got it. And then Roy, maybe as a follow-up, you talked about trends in Europe and your components business. Could you comment just on the technology solution side? Again the last six quarters, I think with the exception of one, we've seen some pretty lackluster trends. So maybe just what you're seeing broader-based in Europe and perhaps even some of the other geographies in tech solutions? And then just as a parting thought, Roy, I wanted to ask you if you'd consider even trying to present your gross margins on a geographic mix adjusted basis just so that we can get the -- isolate the impact of these geographic mix shifts that seem to be dragging down margins.

Well, let me do the second part first. We look at that internally and we use that not only to understand our business, but also to benchmark against competitors where we don't have gross profit by group by region. So, we mix adjust our revenues to theirs to try to do a competitive analysis. We haven't talked through the pros and cons of disclosing that information broadly, that, Amitabh, as you know, the risk we always create is, do we put outnumbers that actually make things more confusing as opposed to less confusing and we obviously would not want to go down that path. So let us take that under advisement.

Sure.

Okay. TS demand, let me just remind you a little bit, you kind of said this in your question. Whereas TS Global did experience four consecutive quarters of double-digit year-on-year growth, we only got that kind of growth in Europe for one quarter and that was in June, June of the 2010 calendar year. So, relative to the other regions and of course, Asia has been growing the fastest, America has been solid, and Europe has been the lagger for IT spending. So, think domestic consumption and perhaps influenced by sovereign debt and overall economic growth. All that said, in the December quarter, we got about 30% sequential growth in Europe and that is actually very typical, if anything, just sort of slightly on the high side of typical seasonality for Europe. So, demand there I would describe as firm, stable, but would not describe it as robust or growing at a rapid pace.

Okay, thanks.

Okay.

Thank you. Our next question comes from William Stein from Credit Suisse.

Thanks, guys. I might have missed this, but can you give us an update on lead times? I think you said normalizing or normalized. Is that process done? Have they bottomed out or is that still coming down?

Yes, Will, it's a great question so I'll turn it over to Harley for a great answer.

Thanks, Roy. Hi, Will.

Hello.

I would not classify lead times in the aggregate as all the way down. I forget what word you used. Clearly, they've continued to come in, but we continue to have the challenge. I was showing the team here some very current data as of this week at our team captures on lead times by supplier. It's not atypical, for example, for us to have a supplier that tells us their lead times are five to 18 weeks, something like that. And what that essentially says to us is that there are parts of our portfolio that indeed have come down to, if you call normal four to six, something like that, are in that range. On the other hand, there are elements of individual suppliers and there are suppliers specifically who still remain quite extended.

So, we continue to have that balance, that is one of our key value propositions of balancing four weeks, eight weeks, 12 weeks, 20 weeks into a consistent supply chain response to our customers. So, I would not call them all the way down. I would say they have continued to improve, but I don't see a situation of plentiful inventory and short lead times across the industry in the near horizon.

So, thank you for that, and given that, and I think you said earlier that you'd still expect inventory velocity in EM to improve throughout the year, it sounds like you're continuing, at least for now, to sell more than you're buying on the components side. Is that -- did I get that right?

That is typically our desire every day of the week. But I think, all joking aside, I think what I was saying earlier is that when you see sequential growth like we will in March and we believe the amount of inventory we have now, and as I've said many times in the past, the quality of our inventory, which is critical, is quite good, we're very happy with this state of our inventory, that when you see sequential growth like we will, you'll see improvements in our velocity.

So, Will, our expectation for the March quarter is that inventory will be more or less flat at EM, and yet, revenues will be up or mid-single digits so velocity will be up. And Will, just to put a little more color on this, I, just a few weeks ago, would have thought that, as the seasonal demand associated with the end of the calendar year dropped off, given the amount of investment that's gone into semi-CapEx throughout the year, we would have had the majority of SKUs back to a normal product lead time. And the reality is, as we've already talked on this call, our bookings picked up in December. We had a 1-to-1 book-to-bill for the quarter. We have a lot of SKUs that are still beyond normal lead time and I think that the explanation for that is that demand has simply been stronger than the component suppliers in aggregate have been willing or able to gear up for. So we still have a situation where on average lead times are more than normal and book-to-bills are positive and inventories are relatively lean because customers have not been able to accumulate them.

Yes, Roy, if I could, this is Harley again. I actually think it was Matt that asked the question earlier around our guidance. One of the variables in all of our guidance this quarter that we didn't speak much about is Asia, and it's a very difficult quarter to project for Asia. I'm sure you all follow a lot of the other announcements as we do as well. And obviously you've got a significant holiday in Asia that occurs this quarter, but it is possible if there is upside in the industry this quarter that Asia ends up being stronger than would be typical. It is possible. I mention that because if indeed that's the case, that'll further reinforce the comments we're making about inventory. It would take a drop off in Asia to really create excess in the supply chain, in my opinion.

That's all helpful, guys. I appreciate it. Just one other, if I can, on this side of the business also. When we look to your shipments and better bookings in the component business in December, is there any differential among the customer types, in particular, EMS versus your small and medium size OEM customers?

Yes, hi, Will, this is Harley again. Well, the good news is they both were positive and looked strong in the December quarter. We track, I think as you all know, we manage the largest global contract manufactures in a separate sales channel here, and so we have a very good feel for them. And our revenues to that channel were up nicely in the December quarter. And then I think as you also know, the base of our business, especially in Europe, is the broad industrial base, and that really looked quite positive as well. So both of those pieces looked encouraging as we exited December.

Great. Thanks, guys.

Thank you. Our next question comes from Brendan Furlong from Miller Tabak & Company.

Hi, good afternoon. Squeezing under the wire here. Just quick question on the gross margin. If I assumed geographic spread, the usual normal geographic spread in EM, and assumed that TS gross margins have bottomed in the December quarter, I get to roughly fiscal Q1 type of gross margins next quarter?

That should be close, Brendan.

Okay. And then, I guess a question for Harley, if he could give -- any sort of color you could give in terms of end markets, industrial, [coms], PC, et cetera?And what, you're saying some elevated lead times, if there's any particular parts of the market that are showing the elevated lead times versus vendors?

Yes, hi, Brendan how are you?

Hi.

I like that under the wire analogy with your last name, by the way. Not really. I think that the parts that are really rocketing now are very well known publicly, like the iPads, the iPhones and all of those. And we're not a particularly big player in that end of the market from an inventory management perspective, we do participate from a supply chain. So short of those, I'm not sure I could give you an end market. Auto continues to be strong in Europe, but short of that, it really is the very broad typical market.

I'll give you a quick data point before we run out of time here, that's kind of amazing to me, I was just looking at it a moment ago. In calendar 2010, we grew 25 suppliers over 25% year-on-year. So, for me that really is a data point used to reinforce just how broad our business is, all of those different technology suppliers, it was really across-the-board, and that is because of the breadth and the strength in many ways in the industrial market.

Excellent. Appreciate it, thank you.

You're welcome.

Thank you. We have time for one further question. Our last question is coming from Ananda Baruah from Brean Murray.

Hello, thanks a lot, guys. I appreciate it. Congrats on a solid quarter and solid guide. Roy, I was just wondering with -- on the TS side of things, and with the mix seemingly changing somewhat more towards storage, at least here in the intermediate term, how initiatives such as 3Par, which I know you guys are -- I believe you're selling it now, I know you're at least going through training, and even EMCs recent lower end push, which I believe you guys will participate in, how that might, over time, change what you're able to do? Enterprise, could it actually increase your potential to pull through more servers and softwares -- maybe you'll find yourselves really well positioned for virtualized environments and just the impacts there? Thanks.

Yes, Ananda, the way I would think about it, think of us as anything that's focused on the data center, we're going to be heavily involved in and if possible, leading. So, if you reflect on our history, the evolution was sort of servers, storage, software, and then networking and unified communications. And what's happening is, as storage becomes a bigger and bigger part of our total, and we all know what the secular growth rates are for the storage commodity, I think what it's doing is it's elevating TS's organic growth rate potential. The same could be said about ISS. As ISS increases as a percentage of our total server, that increases TS's organic growth rate potential.

So I think, from my perspective, meaning this stuff is going to play in data center buildouts. It's going to play in private cloud, it's going to play in public cloud and we're going to be involved in it if there's a data center involved. And I think the fundamental impact of storage is simply that it accelerates our organic growth potential.

Got it. Is there a, is it a reasonable assumption that since these were all higher margin types of data center sells and plays that over time, this could be something that you might have the potential to push the TS margin range up?

Well, the reality is our storage commodity, in aggregate, is not more profitable for us than our server commodity. It does have very attractive returns on working capital because a fair amount of this is actually drop shipped for us. So we do the demand generation, we do the technical support, but we don't actually do a lot of physical inventory. So we get nice returns, but it's not necessarily higher margin as we deal with these high end storage systems.

Got it. And just last thing for me, thanks, is as you go into newer markets, emerging markets, places like Latin America, how do you envision the TS mix evolving there over time? Lower end versus higher end types of stuff?

Yes, Phil you want to take it?

Well I can give you a quick snapshot. The question is we continue to expand in Asia Pacific, that's become a greater percentage of our total revenue and profitability. It's upwards of 12% to 13% and that's going to continue to increase as we just talked about earlier, ITX coming into Australia. Latin America is the other geographic expansion that's been the largest share in the last six months with the Tallard Bell. And so we articulated we've been actually very pleased with the performance of Latin America in a very short time. We need to continue to apply our VBM principles down there, but we have a nice mix today of enterprise, what I'll call traditional enterprise business, that we've had in North America come in from the Tallard side of the business that's operating very well in a short period of time.

And then we're still working through the Bell mix of that business and actually, in the short time, been pleased with that. But there certainly are some different lines that are maybe outside the typical enterprise product lines that we've had in the past, and they're the ones we're working with to see how they fit in, where they fit in and over time, what we do with them long term. But the mix in Latin America is still heavily towards the traditional enterprise.

Okay, fantastic. Appreciate it. Thanks a lot, guys. Congrats.

Thank you.

Thank you. I'd now like to turn the floor back over to Mr. Keenan 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 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 Quarterly Results section. Thank you.

Thanks, everybody.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.