安富利 (AVT) 2011 Q3 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 third-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 third 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 exclude the revenue from the ProSys business, which was divested at the beginning of the March quarter of fiscal 2011.

Organic growth is also adjusted for the transfer of the existing embedded business from TS Americas to EM Americas, which occurred in the first quarter of fiscal 2011, which did not have an impact on Avnet -- an impact to Avnet on a consolidated basis, but did impact the groups by approximately $97 million in the third quarter of fiscal 2010. 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 employed, 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 financial and operating results of Avnet. Listed on this slide are several factors that could cause actual results to differ materially from those described in the forward-looking statements. More detailed information about these and other factors is set forth in Avnet's filings with the Securities and Exchange Commission.

In just a few moments Roy Vallee, Avnet's Chairman and CEO, will provide Avnet's third-quarter fiscal year 2011 highlights. Following Roy, Ray Sadowski, Chief Financial Officer of Avnet, will review Avnet's return on capital employed performance and provide fourth-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, and effective at the beginning of fiscal 2012, our Chief Executive 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 third-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. In our fiscal third quarter, the Avnet global team delivered another very strong performance, as sequential growth exceeded expectations at both operating groups. Pro forma revenue grew 16% over the year-ago quarter, marking the fifth consecutive quarter of double-digit growth and was flat sequentially as compared with the typical decline of 4% to 7%.

Sequential growth was better than seasonal for both operating groups, across all regions, with the exception of TS EMEA, where the sequential decline in sales was in line with normal seasonality. As a result of this strong organic growth and the significant positive impact of value creating acquisitions, reported revenue increased 40% over the year-ago quarter to $6.67 billion and declined only 1.4% from the seasonally strong December quarter, including the divestiture of ProSys.

Gross profit dollars increased 35% year over year, while gross profit margin declined 46 basis points, due primarily to the impact of acquisitions which had lower gross profit margin profiles than Avnet's legacy businesses. On a sequential basis, gross profit margin increased 36 basis points, due primarily to double-digit sequential growth with stronger gross margins at EM and the TS seasonal mix shift, as EM grew to 59% of total enterprise revenue in the March quarter, from 53% in the December quarter. Adjusted operating income grew 47% year over year, and adjusted operating income margin increased 18 basis points over the year-ago quarter to 3.9%, as the positive impact of double-digit organic growth and operating leverage was partially offset by the impact of lower margin acquisitions.

Although some of the acquired businesses have a lower margin profile, we fully expect to deliver returns commensurate with our targets over the next several quarters, as we realize synergies and apply our value-based management discipline. On a sequential basis, adjusted operating income and operating income margin were roughly flat, as a strong improvement at EM was offset by seasonality at TS and the divestiture of ProSys.

One of our most important efficiency metrics is SG&A expenses as a percentage of net gross profit dollars. In the March quarter, this ratio improved significantly by 272 basis points year over year and was up slightly from the December quarter due primarily to seasonality. On the bottom line, adjusted earnings per share on a diluted basis grew 45% from the year-ago quarter and, at $1.10, set a record for the fourth consecutive quarter.

This significant EPS growth is being driven by the combination of strong organic growth, coupled with continuous improvements in efficiencies and value-creating acquisitions. Despite the growth at our more capital-intensive EM business, enterprise working capital grew less than 1% after adjusting for acquisitions, divestitures, and the change in foreign-currency exchange rates. Sequentially, working capital velocity declined slightly, as expected, but remains well above pre-recession levels.

Return on capital employed of 14.9% was roughly flat with the year-ago quarter and has been within our range of 14% to 16% for 6 consecutive quarters. As we consistently operate within our return targets, we expect to accelerate the growth of economic profit dollars, which will drive EPS growth and total shareholder returns. Cash flow from operations was $188 million this quarter and $121 million for the trailing 12-month period. Our VBM discipline was a key factor in our ability to grow profitably during this timeframe and fund that growth with cash generated from operations.

Now, let's turn to the operating groups. Global demand for electronic components remained strong this quarter, as technology spending by consumers and businesses continued to lead the economic recovery. In the March quarter, EM exceeded expectations and grew revenue 10% sequentially, as compared with the typical seasonal increase of 4% to 7%, with all 3 regions contributing. Reported revenue grew 36% year over year to a record $3.93 billion, while pro forma revenue grew 18% from the year-ago quarter. This represents the fifth consecutive quarter that EM grew pro forma revenue double digits year over year; and, similar to the sequential growth, all 3 regions contributed to this impressive multi-quarter performance.

EM's book-to-bill ratio closed the quarter above 1, making this the eighth consecutive quarter that this ratio was at parity or better. Based on the first few weeks of April, it appears that demand in our served markets remained solid, although the impact of the Japan triple disaster is not yet clear. EM gross-profit dollars increased 12% sequentially and gross-profit margin was up 22 basis points, driven by a higher mix of business from the Western regions and continued margin improvements in the core components business. Gross-profit margin declined 10 basis points year over year, as the improvements in components were more than offset by the lower gross-profit margin embedded computing business acquired from Bell Micro and transferred from Tech Solutions at the beginning of the fiscal year.

During the recovery, we've often highlighted the excellent job EM did managing inventory in a period of rapidly growing demand and extended product lead times. The EM global team has done an equally impressive job on productivity and efficiency initiatives, which has resulted in a steady decline of SG&A expenses as a percent of net gross-profit dollars. In the March quarter, this critical metric dropped 351 basis points sequentially to the lowest level in over a decade. With double-digit sequential growth, gross-profit margin expansion and expense efficiencies, EM grew operating profit 2.2 times faster than revenue. Operating-income margin of 5.7% increased 57 basis points sequentially and 73 basis points year over year, due to a combination of geographic mix and operating leverage in our business model, and the solid execution of the EM global team.

Despite the strong sequential top-line growth, EM grew working capital of less than half the rate of revenue, which resulted in a two and-a-half day reduction in its cash cycle. Inventory declined sequentially by $22 million in reported dollars, and by $63 million in constant dollars, while inventory velocity improved half a turn. Working capital velocity declined slightly year over year. However, it remains comfortably above pre-recession levels. EM's continued strong growth in operating income and disciplined working capital management drove return on working capital up 170 basis points over the year-ago quarter and 380 basis points sequentially, remaining above our target of 30% for both the quarter and the fiscal year-to-date.

Now, let's turn our attention to Japan. Fortunately, none of our people were injured, but our heart felt condolences go out to those who were more directly impacted. We can all learn from the civility, resolve, and character of the Japanese people. While it is difficult to gauge the impact Japan could have on our June quarter results, we are working closely with our suppliers to ensure that our customers have the products they need to continue uninterrupted production or minimize the impact of any shortages.

Our backlog has increased a bit, as customers provide more visibility into their requirements, but we do not see evidence of double ordering. Overall, our bookings and billings continue to indicate a healthy demand environment for technology; and the global EM team is working diligently to grow our business, while delivering the highest level of customer service that our trading partners have come to depend on. Although we do not currently anticipate a meaningful impact to our June quarter, there are some potential risks, so we are providing a wider-than-normal range in our guidance.

Technology Solutions revenue also exceeded expectations, as both the Americas and Asia regions declined less than normal coming off the typically strong December quarter. Pro forma revenue declined 12% sequentially to $2.7 billion, as compared with a normal seasonal decline of 16% to 20%. Reported revenue grew 47% year over year, while pro forma revenue grew 12% in constant dollars, driven by 20% plus growth in Asia and North America. TS EMEA experienced a typical seasonal decline in March, and its year-over-year organic growth turned slightly negative. The multi-quarter technology refresh cycle continued this quarter, as year-over-year hardware sales continued to grow faster than software and services, led by industry standard servers and storage, which were both up over 50%.

We also saw strong demand for microprocessors and, at the end of the quarter, an uptick in demand for hard disc drives, as customers sought to secure product after the earthquake in Japan impacted parts of the HDD supply chain. Gross-profit margin at TS declined 78 basis points year over year, due primarily to the impact of acquisitions and higher sales of lower-margin products. We remain committed to achieving our return targets in all regions, as we continue to implement the planned integrations and apply our VBM discipline to the new operations. On a sequential basis, gross-profit margin was down 17 basis points. However, if you exclude the impact of the recently divested ProSys business, gross-profit margin was down only 6 basis points and due primarily to product mix.

TS operating income increased 15% over the prior-year quarter and operating-income margin declined 58 basis points to 2.1%, due primarily to the impact of acquisitions. Operating income and operating-income margin declined sequentially due primarily to the seasonal decline in revenue and, to a lesser extent, the impact of the divestiture of ProSys at the beginning of the March quarter. Although the seasonal decline in the March quarter had its typical effect on TS results, we continue to see progress at our recent M&A investments when compared with the September quarter. In Latin America, where we integrated 2 companies without an existing Avnet infrastructure, both gross and operating-income margins were up nicely from the September quarter, as we apply our value-based management discipline to pursue profitable growth opportunities in this high-growth region.

In Asia, where margins improved with the recent acquisition of itX, a leading value added distributor in Australia, we also experienced improvement in our existing business, as we slowed our rate of investment and began the process of improving margins in this high-growth region. In EMEA, we completed the Bell Micro IT conversions, and we expect to realize most of the remaining synergies in the June quarter, as planned.

ROWC declined over 1700 basis points sequentially, due primarily to the seasonal decline in revenue and a higher mix of lower-margin products. Although ROWC declined from the year-ago quarter, due primarily to acquisitions, TS is still achieving our target through the first 9 months of fiscal '11. TS began the year with several acquisitions that presented unique challenges, as integrations not only span multiple regions, but also involve multiple integrations within countries of a region. By relying on our documented and disciplined integration process, we completed these integrations on schedule and will exceed our synergy targets

In addition to the efficiency aspects of the integration process, we used our best people/best practices principle to build a strong team, utilizing the skills and talents of multiple organizations, and are focused on a wide range of top-line growth initiatives. As we enter the final quarter of fiscal 2011, TS is beginning to realize benefits from these investments, as we leverage our leadership position and global scale and scope to accelerate profitable growth in a significantly expanded served market.

Now, I would like to turn the commentary over to Ray Sadowski, to provide more color on our return on capital results. Ray?

Thank you, Roy, and hello, everyone.

This next slide details Avnet's return on capital employed performance and economic profit generation over the past 2 years. The blue bars represent economic profit dollars generated each quarter, as quantified on the left axis. The red line, which correlates to the right axis, depicts our quarterly return on capital performance over the same timeframe. We have also added a solid black line at 10% for our weighted average cost of capital, and the gray range is our target return on capital of 14% to 16%. As you may recall from our analyst day in December, we had targeted ROCE at 2.5% to 3% above our weighted average cost of capital since we introduced VBM in 2001. So our goal had been to generate a return of 12.5% to 13%.

In fiscal 2009, we were required to write down approximately $1.4 billion of goodwill as a result of the decline in our stock price, when the financial crisis depressed global equity markets. We still consider that capital employed in the business, so we raised our return on capital goal to 16% and targeted a range of 14% to 16%, knowing that we would continue to pursue value creating M&A that would meet or exceed our 12.5% hurdle rate. Hence, we have started this slide with fiscal 2010, as that was the first year that reflected the higher target range. As you can see on the slide, our return on capital employed improved in fiscal 2010, as a recovery in our served markets, combined with a leverage in our model, drove return on capital within our target range in the second and third fiscal quarters and above the range in the fourth quarter.

Economic profit swung from a slight negative in the first quarter of fiscal 2010 to consistent growth, as we ended the year with $149 million of economic profit. With these high returns and a continued focus on working capital velocity, we used only $30 million of cash from operations to fund our significant top-line growth of $3 billion in fiscal 2010. This allowed us to invest a significant portion of the $1.1 billion of cash that we generated during the downturn in fiscal 2009 into value-creating M&A that would facilitate additional economic-profit dollar growth going forward. Year-to-date in fiscal 2011, we have invested $691 million, net of cash acquired, in 7 acquisitions that will enhance our competitive position and afford new opportunities for growth.

During 2011, we continue to generate return on capital within our target range and grew economic-profit dollars year over year each quarter as we integrated the acquisitions and began to realize the synergy benefits. Through 9 months, we have generated economic profit of $179 million, which represents a significant increase over the comparable period a year ago. As you can see, this slide depicts our VBM strategy at a high level. That is, generate return to within our target range, grow the business and EP dollars, invest the cash flow from those consistent returns into value-creating M&A, which then accelerates the growth of business and EP dollars, thereby creating more shareholder value. While Avnet is made up of a number of value-added distribution businesses with different business models, meaning earns and turns goals, we expect the same return on capital employed across the portfolio.

As you know from the 2004 to 2007 recovery, our VBM philosophy had a dramatic impact on our financial performance, as we made steady progress toward our long-term goals. Now that we are consistently achieving our return goals, continued growth in our business will result in accelerated economic-profit growth. As Roy said earlier, it is difficult to gauge the impact of the Japan earthquake and tsunami on our June quarter. As a result, we have widened the range of expected sales for EM and, therefore, for Avnet's revenue and EPS for the June quarter.

As a result, we expect EM sales to be in the range of $3.85 billon to $4.25 billion and sales for TS to be between $2.75 billion and $3.05 billion. Therefore, Avnet's consolidated sales are forecasted to be between $6.6 billion and $7.3 billion. These numbers reflect normal seasonality at both TS and Electronics Marketing. Based upon that revenue forecast, we expect fourth-quarter fiscal year 2011 earnings to be in the range of $1.10 to $1.22 per share.

The above EPS guidance does not include any potential restructuring charges or any charges related to acquisitions and post-closing integrations and assumes an effective tax rate of 28% to 30%. In addition, the above guidance assumes the average euro-to-US dollar currency exchange rate for the fourth quarter of fiscal 2011 is 1.44 to 1. This compares with an average exchange rate of 1.27 to 1 in the prior-year fourth quarter and 1.37 to 1 in the third quarter of fiscal 2011.

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

(Operator Instructions). Amitabh Passi with UBS.

Roy , I was wondering if you could give us some sense of whether you're able to quantify if you saw any benefit or any sort of pull-in of orders in the first quarter from some of the disruptions in Japan and if you could also just give us a book-to-bill

Okay. Let me -- I'll take the first part and flip it over to Harley for the book-to-bill. Amitabh, as you might imagine, it's a little bit difficult to look at the bookings and the billings in the last couple of weeks of March and identify precisely what portion of that was attributable to Japan. However, to the best of our ability, we think it was on the order of about $50 million, five zero. So, it had a nice positive impact, but not a dramatic impact on the quarter. Harley?

Yes, hi, Amitabh. Our book-to-bill for the business in total was just over 1 for the quarter, with America being slightly above, Europe being slightly below, and Asia being a little bit more above.

Got it. And then just maybe a follow-up question on the TS segment. Roy, any incremental insight in terms of just the trends in EMEA? I think we've now seen, with the exception of one quarter, year-over-year growth rates low single digit, turned negative this quarter. I think one of your biggest competitor actually had positive growth in the March quarter. So just some thoughts in terms of what you think is happening in the market.

So, I guess a couple thoughts, Amitabh. One is that our geographic exposure in Europe as well as our product mix is a little bit different, so I'm not sure that we can compare them directly apples and apples. But the second point I would make is that during the month of February we did the IT integrations related to Bell. So Bell had two systems or two platforms in different parts of their business. We actually currently run with two platforms as well and so it was a relatively complex integration and I do believe that during the month of February, we probably had a negative impact on revenues, which is hard to quantify, which I think was taken care of by the month of March and we feel good going into this quarter with our service levels in Europe, but we could have had some self-inflicted negative impact on our revenues there.

Okay. Thanks. I'll jump in the queue.

Okay.

Scott Craig from Bank of America-Merrill Lynch.

Roy, can you update us on your thoughts for the target margins in the TS business, given what you've seen now in the first couple of quarters here with Bell Micro? And then secondly, I know this is bit of an unfair question because you do have differences with the businesses, but Arrow just or a big competitor of yours just announced earnings and the guidance for the June quarter was above normal in the components business and you guys are pointing to normal. So I'm wondering if there's anything within there that you can point to that would show the discrepancy between the two outlooks for your firms. Thanks.

All right. I'll take the first part and flip the second part over to Mr. Feldberg. But, Scott, let me sort of replay what we tried to communicate in December, because I don't believe anything has changed. We have specific targets for our TS business, North America, Latin America, EMEA, and Asia. And there are turns earns targets that get us to our LRPTs from a return on working capital perspective. Assuming that we achieve our targets for each of those units within the next couple to three years, two to three years, and then making an assumption around the growth rates, so we understand the relative mix, we end up within the range of our current guidance for TS on a long-term basis. And it is possible, maybe even probable that we would be closer to the low end of the range than the high end of the range, but we feel we can achieve that stated range based on achievement of our goals by region. So at this point in time we're not planning on changing our long-term targets and of course we'll certainly update that by next December and we would expect to see progress on a steady basis between now and then. Okay, Harley.

Handle the -- hi, Scott, this is Harley. Your question I believe was centered around some variance between our projected guidance and that of our largest competitor in the June quarter. And obviously I can't interpret the intent of their guidance. I can only tell you what we intended to project and that is that we see fairly seasonal guidance. We think it's fairly normal. But we wanted to add a degree of risk, a degree of risk reflective of the fact that there are a number of questions relative to the Japan situation that are not yet fully defined. So although based on what we know today we don't anticipate significant impact in the June quarter, we did want to highlight that there are a number of questions and risks take are still not completely defined.

And Scott, just one specific point. We have a roughly $600 million business in Japan. There's various ways that disaster in Japan is going to impact the tech supply chain. Right? There's consumption in Japan. There's export from Japan. And then there's the export of raw materials that go into manufacturing processes around the world. So it's kind of got three levels. We have a lot more exposure to the Japan consumption part via Harley's $600 million business there.

Okay. Thank you.

You're welcome.

Sherri Scribner with Deutsche Bank.

I wanted to get a sense of your views on the operating margin at this point. Clearly, the EM business is now above your long-term targets and you gave some detail just now about the TS business. But one of the questions I get from investors is how much more operating margin leverage is there for the business. So I wanted to get your sense of where you think that operating margin leverage is coming from and if there's additional operating margin leverage.

Okay. Hi, Sherri. Let's let Harley take the lead on that and maybe Rick or I will provide a little color. We'll see.

Hi, Sherri. So I would never make a comment that additional leverage and operating margin improvement is not possible. I would want to offer a data point that traditionally the March quarter is, in a normalized year I would say that March is our peak quarter and it's not unusual to see flat to slightly down on the margin in the June quarter. So at this point I'm not projecting significant additional growth. Really because we've got to see how the rest of the year plays out. But I can assure you, we continue to be very focused on finding additional profitable ways to continue to grow that margin.

And then, Sherri, it's Roy. If I could add another dimension. So let's zoom up for a minute to get away from seasonality and the impact of a March quarter versus a June, et cetera. Think of it this way. On the one hand, we have operating leverage in each of the regions that EM is doing business in. And so if we looked at EM America, EM EMEA or EM Asia and we looked at the performance over time, we should see ongoing improvements in the operating margin. On the other hand, there is a regional mix shift that's going on in parallel with that, whereby more and more of our revenue as a percentage of EM total is coming from the lower margin Asia region. And so the reason -- we know we've been at or above our range now for several quarters, but we're also trying to contemplate how the mix shift by region is going to impact that overall operating margin. So we've got operating leverage by region sort of offset by mix shift through the regions and we just need to watch that for a couple more quarters and of course as always we'll update our guidance range at our annual meeting in December.

Okay. That's helpful. Thank you. And then just following up on the TS business, it sounded like from your previous comment you don't expect us to be in that targeted range for a couple of years. Is that a reasonable assumption or should we expect to see you into that targeted three area range sooner than that? Thanks.

On a global basis, I would say two to three years.

Okay.

We have parts of the portfolio that are already there, Sherri, but these investments we've made in Latin America and Asia and then the ongoing scaling out of Europe, that's where it's going to take us two -- we think, anyway, two to three years to get to that operating range. But again, with progress along the way.

Okay. Great. Thank you.

You're welcome.

Craig Hettenbach with Goldman Sachs.

Roy, can you talk about just the inventory in the channel. It appears we've made our way through the inventory correction in the last couple quarters, just what you're seeing, say, from customers and how you're managing inventory in light of the environment.

Again, Harley, you want to take that?

Sure, Roy. Hi, Craig. As you saw, our inventory was -- our inventory movement in the quarter was fairly neutral and to the best of our knowledge today I think we'll see a similar reality in the June quarter. And that really should be interpreted as a reflection of our belief that the E times in general in the aggregate continue to remain stable, therefore, we adjust our pipelines and our available inventory according to that. With that said, I would obviously acknowledge, as we talked before on potential Japan effects, that there are aberrations to that reality. There are areas where we and everyone else in the supply chain are working very aggressively to ensure adequate supply to our customers' needs over the next couple quarters. So I guess to sum up, generally speaking, inventory seems about appropriate in the overall supply chain, but we are working on a number of areas specific to Japan that require some additional involvement.

And Craig, it's Roy. I'll just throw a little bit more color on that. So in the last eight quarters, EM's had a positive book-to-bill ratio. In the first five of those eight, the book-to-bill ratios were quite high and this is where all of us were curious about how this was going to play out from a tech supply chain perspective. But in the last three quarters, so we're talking about nine months of time now, EM's book-to-bill ratio has ranged from 1.0 to 1.02. And that is what we would describe as stable, normal, firm, sustainable. So the book-to-bill ratio seems to imply that the supply chain is in balance from an inventory perspective and that demand remains firm.

Got it. Thanks for the extra color there. And then Ray, if I can just follow-up one of the topics from the Analyst Day, just on capital allocation, any updates (inaudible) on how Avnet is approaching buybacks, dividends versus M&A?

Yes, hi, Craig. Pretty consistent with what we've discussed back in December, which is our view that the primary benefit from a shareholder value creation perspective is to utilize cash in value creating M&A and so we continue down that path until we get to a point where we're sitting with significant enough liquidity to allow us to do something different. But based upon where we are today, as well as the pipeline of potential M&A activity, we'll continue down our path of making the investments in value creating M&A and then go from there if that should change sometime in the future.

And Craig, it's Roy. It might be worth just emphasizing one thing Ray said, which is we don't have surplus liquidity at the moment based on our stated balance sheet strategy. But also, our M&A pipeline is quite robust. We have lots of opportunities, both groups, around the world. So, as Ray said, our belief is that value creating M&A is the best way to drive shareholder value creation and ultimately TSRs. So at the moment, no plans for buyback or dividend.

Thank you.

You're welcome.

William Stein with Credit Suisse.

Just trying to clarify an issue around Japan and potential pull-ins in hard disc drives. So, Roy, I think you mentioned you estimate about $50 million of bookings pull-in at the end of March owing to Japan, but then you also mentioned you thought hard disc drive was an area that was affected. Did I get that right? Is that actually part of the components business or is that -- I thought that was in the systems segment. Can you clarify that?

Yes, Will, hi, it's Rick. Let me jump in here. The HDD business is actually cross-region and cross-group for us, so I'll try to provide the color from an overall perspective. For the March quarter, we had some sense at the very end of the quarter there was a little bit of pull-in with the HDDs based on some of the notifications and news that was coming out of the key suppliers. And looking ahead into this quarter we do expect some tightness for May and June in particular, but not expecting any material revenue impact at least for this quarter.

So, but that's across both segments of the business?

Yes. Our HDD business is part of the embedded business for our EM business in North America and then from the Bell history we moved the other embedded businesses in Europe to TS and Latin America to TS.

So midpoint of guidance, does it contemplate anything -- any reversal of the pull-in there or does it contemplate no effect from Japan?

Will, I would say that's one of the reasons why the EM guidance. When you adjust for currency, it's closer to the low end of our typical range. And that's one of the things we considered in that guidance.

Okay. Great. And then one other just housekeeping question. I think you delivered lower taxes, part of the beat was driven by that in the quarter and you're guiding, I think, a couple percentage points lower on taxes at the midpoint. Does that guidance reflect a go-forward view beyond just the current quarter? And what's the -- what's driving the change, please?

Hi, Will, it's Ray. So, at the moment it really is looking at one quarter out and takes into account the level of profitability that we're having in some of our European legal entities. And it's very high level of profitability that is causing some of the benefits that we're having on our overall effective tax rate. As we go forward into fiscal year 2012, we'll have to see whether or not some of the structuring that we've done relative to taxes and things like that will allow that to continue or whether it may have a relatively minor impact. But at this stage the guidance really reflects what we think for the current quarter.

Great. Thank you.

Brian Alexander with Raymond James.

First, Roy, it's been great working with you last 10 years or so. I know you're not going far, but congratulations on the transition to Chairman and Rick on the CEO role.

Thanks, Brian.

Thank you, Brian.

Just on the TS profitability, margins 2.1% sounds like you're saying mostly due to the acquisition effect and mix, but if I just look at the profit dollars for that business, they were only up $7.5 million year-over-year. You had double-digit organic growth in the Americas and Asia. I realize Europe was down. But Bell's profitability alone in that business should have contributed, I think, more than $7 million in profits. Especially given you're well through the synergies. And I realize you've got some of Bell classified in EM, but I would think the TS profits for Bell should be above $7 million. Can you drill down on what's really going on from a TS profitability perspective this quarter and how much of the shortfall was driven by Bell versus the legacy business and did that IT integration create a lot of duplicate costs that you can quantify?

Want to jump in?

Brian, this is Phil. How you doing? Certainly expected this question from you based on the summary this morning. And it's obviously complex. There's a lot of moving parts to the equation and as Roy pointed out earlier, we've had multiple integrations going on in multiple regions around the world. And some of the other things that have happened through these acquisitions with Bell, itX and others, expanding us into Europe and expanding us into Latin America, is our overall portfolio is also changing. So we're into different margin model regions with different returns. So that all said, we're having more revenue coming in from outside North America, which is our highest return region today. So what we're really trying to do is balance the potential of the performance and continue working the emerging markets, our VBM and increase the drop-through returns.

We did have an issue this quarter with a supplier in North America that certainly didn't help some of the profitability and we're working through that, real-time, to continue to make the appropriate adjustments. We did have, as Roy pointed out, we had the integration completed in Europe this past quarter and it was a major integration. Our teams over in Europe did a nice job. Doesn't come out -- happen without some temporary, if you will, challenges, but we got through that. As we get into April and we're into April, we're well through that and moving forward. So we had, I'll say, a bit of a hiccup in Europe that maybe wasn't expected. So we have a lot of moving parts, but we are, as Roy pointed out to the question earlier, committed to the LRPTs. We're planning for that as we get into fiscal '12 and beyond. And where we need to, we'll make appropriate expense adjustments as well in regions where we need to get the returns moving at a greater rate.

So, if I'm hearing the comments correctly, it does seem like you've pushed out your margin goals in TS at least a little bit. I know it was uncertain before, but is any of that related to Bell not meeting your profitability objectives and just given that it's going to take a few years to get TS profitability back to your targeted range, what has to happen to get there? Is it mostly volume leverage in your existing business? Is it changing the portfolio composition or is it just fixing some underperforming units?

Hey, Brian, it's Roy. I guess my first comment is I think you might be over-reading the situation. My second comment is, we're not pushing out our timeline at all. And I would say this, if you -- you said most of these things, but let me say them back to you in a little bit different words. The profitability of Bell before we acquired it was weighted towards North America and North America is the part that got integrated with EM. Okay?

Yes.

The second point, as Phil just mentioned but I'm going to add a little bit more color, we did have a significant change with one very large supplier over this same period of time and 90% of our global revenue with that supplier was right here in North America. So this is the region that was most heavily impacted. The third point is just very tactical for this quarter, which is the strong HDD and microprocessor revenues that occurred in the March quarter. So there was a little bit of a mix shift and, as you know, that affects the gross margin, which then plays through to the op margin to an extent. So those are the things that are happening.

Now, in the context of so what needs to happen in order to get that business to our returns. At a high level it's just portfolio management, applying our value-based management disciplines, so if you circle the globe again, TS North America, it is appropriately monitoring and reacting to changes in our revenues and profits by vendor. In Latin America, it's applying VBM principles to ensure that we grow profitably, so cross-selling, adding franchises, et cetera. And then to your point, if we do ultimately identify revenues that do not and will not meet our return goals, we will de-select those revenues and some of that is already under way. Remember, as you go to Europe, the system integrations did not occur until February and the majority of our synergy cost savings were expected to come in the back half of this fiscal year.

So we still have those to benefit our European business and then once again we have cross-selling. And then lastly, in Asia, we have been investing heavily for organic growth and you've seen the growth rates there and we now see those organic growth rates beginning to slow and as they slow, we are beginning to decrease our rate of investment and increase our rate of profit harvesting. So there's a different story for each one of the geographic units, but the high level answer is we're applying our VBM discipline, we have goals for each of them and we will manage those businesses to our goals and we expect that over the next two to possibly three years we'll be well within our stated profit range for TS.

Okay. Thanks for all the detail.

Sure.

Matt Sheerin with Stifel Nicolaus.

So just a bigger picture question maybe for Roy and Harley. If you look at some of the EMS providers out there, the big guys like Flextronics, Benchmark, Stanmena, a lot of them missed revenue numbers for the March quarter, some guided a little bit better, some a little weak for June. I know that you don't play in all those markets, but they did specifically talk about weakness in communications infrastructure and that is a market that you play in, particularly with some of your semiconductor suppliers. What's your take on that market? Doesn't it sound like you're seeing any particular end market weakness, so do you have any perspective on that?

Sure. Hi, Matt, this is Harley. So for the March quarter, we had a, I wouldn't want to call it a soft EMS quarter. I would say it was less strong than our overall business and I believe the same will be true in the June quarter and I guess my view on that is it's really a customer base comparison comment. In other words, if the strongest driver to our March results were indeed the broad industrial base, the thousands, tens of thousands of customers all over the world, actually, I was going to say in the west, but it's actually all over the world now, if that indeed was the strongest driver to our above normal growth, that's not the strongest area for the global CMs. Although we had an okay quarter with them, clearly we saw some softening and we did see some behavior that I would categorize as strong management of their inventory supply chain prior to the Japan events. But again, I guess to sum up, it's really primarily a difference in the account base structure.

Okay. So you're also seeing softness going into June. They sound -- seem to sound like they're going to see a snapback. I'm not sure if you're seeing that in your order books yet.

We've seen a snapback. I'm not prepared to say if it's their order books improving or their reaction to the Japan issues. It's really not that clear to me. And I wasn't trying to suggest that that business is soft. It's really less strong than our overall business in March, which was particularly strong across a very wide breadth of accounts.

Okay. Great. And then let's go back to Bell Micro. It's going on a year now. I guess you did the integration or the acquisition last summer. What's left in terms of cost coming out in the next quarter or two? And one area that has been dragging down margins a bit is the disc drive business on the tech solutions side and I know going into it, Roy, you talked about the possibility of looking at that and if that business didn't meet your profitability or returns goals, you would look at maybe divesting that at some point. So what's your long-term take or commitment to disc drives now and what's your general reflection on the Bell Micro acquisition going on a year now?

So let me start at the end, Matt, which is we have met and exceeded all of our cost synergies. We are very pleased with the talent that we've picked up in the Bell acquisition and maybe I'll just point to one most notable, which is our regional President for TS in Europe is Graeme Watt, who was Bell's global distribution leader. But there are many other examples throughout the organization of strong talent. We've added some supplier relationships. We've added some customer relationships. And I think on balance, we feel very good about the Bell acquisition, the realization of synergies, and the impact on our EPS.

So broadly speaking, very good. As we drill down on the disc drives, I don't know if I've ever used this expression with you, but I have with several investors and it may sound a little bit cute when I say it, but the bottom line is that we are 100% confident that we are going to achieve our return goals throughout the entire Bell enterprise. What we don't know is how big the revenue stream is going to be. So we're working with our own people, as well as with the vendors, to make sure that we are exercising all of the levers possible to retain and grow as much revenue as we can that achieves our return goals. When we ultimately determine that a part of the revenue stream will not meet our return goals, we will de-select that revenue. So I think it's still a work in progress here and should play out, I would say we need several more quarters, I think, before it's actually going to be a done, settled out in terms of the revenue mix.

We also have, Roy, in the HDD space, we've got some rationalization going on in that space at the same time now.

Of the suppliers.

That's right. That creates some new dynamics in that opportunity as well.

That's fair. And the costs left to come out of the business?

Ray?

Hi, Matt. So it looks like at this stage we have our target overall of $60 million, which we will come in a little bit higher than that. Won't give you a number at this stage. And right now we're probably left to go that you'll see a benefit in future quarters is roughly $10 million, $12 million, $13 million on an annualized basis. So say between $10 million and $15 million on an annualized basis coming in over the next two quarters.

Okay. Great. Thanks.

You're welcome.

Jim Suva with Citigroup.

Thank you and congratulations to you and your team there at Avnet for the strong results and outlook and coming out of the recession stronger than before.

Thanks, Jim.

Looking at the big picture of the entire total tech supply chain, can you kind of help us better bridge the gap as both distributors, Arrow and Avnet, had very, very strong results and outlooks. Most OEMs, IBM and a whole list of others, had strong results, as well as a lot of the chip companies. But the gap is that we've seen the exact opposite from the EMS companies, whether it be Flextronics, Benchmark, Stamena and others, both the March quarter as well as the outlook were meaningfully below expectations. In your view, kind of what's causing that gap? Is it the OEMs kind of double ordered late last year when lead times were longer and now lead times are more normal or is there some signal that demand is starting to become more tempered or rush orders from Japan or what's really going on there? Can you help us reconcile as you guys are so critical in the entire tech supply chain.

So, Jim, Harley mentioned just a little bit ago that our EMS business was weaker than our total business. Even though it was up, it was up less than the others. And when you talk about the publicly traded EMS companies, as you know, if you look at their customer base, the 20 customers that represent more than 80% of the revenue, and you line them all up, it seems as though that the publicly traded EMS companies in aggregate are serving about 100 customers. Okay? We are serving more than 100,000 customers. And what we're seeing is we're selling a lot of products to a very broad base. For example, our best product category for the quarter, strongest category was analog. And analog is a kind of category where we sell a little bit to a lot of customers, lots and lots of transactions. So I don't know if there's an analogy here, but my understanding is that the Russell 2000 right now is outperforming the NASDAQ, the Dow and the S&P and distribution seems to be outperforming EMS. There might be a parallel there.

Great. Any sense about the double ordering, some people thought that maybe the -- you talked about equilibrium, but any thoughts about double ordering or are things back in the normalized state for run rates and lead times.

I think prior to the Japan disaster, so right up to the end of March or the middle of March, we would have said product lead times have now pretty well normalized, maybe just a slight extension, but really good enough to say everything was normalized. Our book-to-bill has been between 1 and 1.02 for the last three quarters in a row. It just feels like demand is firm, inventories are being very well managed and the supply chain is running well. Now, our view is Japan is going to have an impact, but it's probably going to be supplier specific and maybe even down to the SKU specific in certain cases, whether they do or don't use specific resins for example. But on a broad basis, we don't think that Japan's going to have a big impact. So we think it's kind of business as usual and our outlook for the June quarter is normal seasonality and it applies to all three of our EM regions. So things feel like they're well under control, Jim.

Thank you and congratulations again to you and your team there at Avnet.

Thank you.

Brendan Furlong with Miller Tabak.

Quick question on the, it's a clarification more than a question, on the wide spread of your revenue. The upper, call it the upper half of that, the midpoint of the range, is just purely the gating factor there is Japan?

The upper and the lower. The approach we took, Brendan, was to widen the range. What did we do, Ray, $50 million on each end? The lower would be attributable to unit shortages. The upper would be attributable to customers increasing inventories in the supply chain and possibly some ASP inflation. So one extreme scenario is there's a negative impact and the other extreme scenario there's a positive impact and we took the approach of just widening the range.

Okay. Following up on a question earlier on on the TS, your gross margin's down about 80 bps year-over-year, call it roughly around 9%. Are the gross margins going to stay around this level for a while? On a related question, people press you on the operating margin, when do we get operating margins back even to the high twos, never mind into the low threes.

First point is, we would expect improvement sequentially here in the June quarter. So baked into our guidance is the expectation that as some of these things roll out, the synergies Ray talked about, the IT integration being behind us, the improvements we've been making in the other regions, all of that in aggregate you should see a noticeable change in TS profits showing progress towards the range. Brendan, then the issue on margins really becomes an issue of mix. So if two years from now we have $2 billion HDD business that's generating more than 30% ROWC, that could have a more permanent effect on margin. If on the other hand we're unable to achieve our targets and we de-select some of that revenue, you could see a revision or a -- yes, revision back to our margins sort of pre-Bell. So product mix and then of course scale will be the two things that will drive the margins going forward.

I got you. And then I guess my last question would be maybe a parting gift from you, Roy, what do you think the semiconductor growth rate will be this year?

(laughter) 8.73%. (laughter) No, it's getting off to a really good start. And similar to what we just did with our range, I think there's some scenarios that say there's actually a draw down this year due to Japan, which might turn out to be a deferral into 2012. There's another scenario that says no, that's not it at all. The net impact's going to be more risk aversion throughout the supply chain and where people have spent the last 10 years talking only about how can I run my inventory more efficiently, they're now beginning to use the word risk and start thinking about what's the appropriate amount of inventory to carry. So, I'm going to say it's high single digits and above secular, which continues to indicate strong demand for technology in this recovery.

Excellent. Thanks a lot.

You're welcome. And as usual, Brendan, I could be wrong.

Shawn Harrison with Longbow Research.

With TS EMEA do you expect a return of organic year-over-year growth in the June quarter?

Good question for Phil. I don't know. That's a market issue. You know, --

June, year-over-year, quarter-over-quarter.

Organic.

Organic. I'd have to get back to -- at this point I believe the answer is yes, but I need to look at the more detail from an organic standpoint with all the changes in the mix.

We have no way of knowing that, Shawn, but I think the answer is yes. It should be a positive number even if it's only in the low single digits.

Okay. And then just two brief follow-ups. Interest expense expectation for the June quarter and then also free cash flow. Typically I know, I guess, the cash cycle declines a little bit or improves a little bit, I guess, sequentially, so free cash flow should improve from what you did this quarter. Is that expectation -- ?

Hi, Shawn. It's Ray. From an interest expense perspective, really not expecting any change from a sequential basis, it will be roughly the same, plus or minus a little bit. And from a cash flow perspective, right now our expectations, Harley mentioned earlier, relative to inventory being essentially flattish for the quarter, you couple that with anticipated profits, we would expect number one, certainly to be cash flow positive and if I would maybe guess at it, comparable to what we just did in the third quarter would be something that I think is a reasonable expectation, recognizing the fact that obviously with working capital movements, which are fairly significant on a day-to-day basis, it could come in a little less or a little more than that.

Shawn, just a reminder for everybody, we're sitting now with $3.8 billion in working capital and operating income of $0.25 billion per quarter. And so the only reason we don't actually try to forecast cash flow for you is because a little bit of change in working capital has a profound impact on cash flow. But I think --

On a temporary basis.

On a temporary basis, yes. That's the other reason why we also tend to talk about cash flow on a rolling four quarter basis, because it tends to smooth that stuff out. But I think barring surprises, we should have a nice positive cash flow for the quarter.

That's more than fair. Thanks so much for taking my questions.

Shawn, this is Phil. I'd just confirmed, we are looking at organic growth in the European marketplace in the US (inaudible) low to mid single digits. Okay.

Thanks a lot.

Based on the management forecast.

Based on the management forecast.

Right.

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

Thanks, everybody.

This concludes the teleconference. You may disconnect your lines. Thank you for your participation.