Avnet, Inc.
Q3 2007 Earnings Call Transcript

Published: 27 Apr 2007

[Operator:]

Our presentation will now begin. I would now like to turn the floor over to Vince Keenan, Avnet's Vice President and Director of Investor Relations.

[Vince Keenan:]

Good afternoon, and welcome to Avnet's Third Quarter Fiscal 2007 Corporate 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 events. In addition to disclosing financial results that are determined in accordance with generally accepted accounting principles or GAAP, the company also discloses non-GAAP results of operations that exclude certain items. Reconciliations of the company's analysis of results to GAAP can be found on the Form 8-K filed with the SEC today and several of the slides in this presentation and on Avnet's investor relations website. Concurrent with the acquisition of Access Distribution and reflecting recent industry trends, the company has reviewed its method of recording revenue related to the sales of supplier service contracts and determined that such sales will now be classified on a net revenue basis rather than on a gross basis. While the change will reduce Technology Solutions sales and cost of sales, it will have no impact on operating income, net income, cash flow, or the balance sheet, thereby positively impacting margins. As we provide the highlights for our third quarter fiscal year 2007, please note that we have excluded certain items from the prior period in the accompanying slides in order to facilitate comparison with current periods. These items include restructuring, integration, and other charges resulting primarily from the Access and Memec acquisitions and the gain on the sale of businesses. Additionally, in the pro forma results, prior periods are adjusted to include Access Distribution, exclude divested businesses and reflect the revenue change from gross to net with sale of supplier service contracts. 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 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 third fiscal year 2007 highlights. Following Roy, Ray Sadowski, Chief Financial Officer of Avnet, will review the company's financial performance during the quarter. At the conclusion of Ray's remarks, Roy will wrap up with additional comments and fourth quarter guidance, after which a Q&A will follow. Also here today to take any questions you may have related to Avnet's business operations is Rick Hamada, Avnet's Chief Operating Officer; and our new President of Technology Solutions, John Paget. Harley Feldberg, President of Electronics Marketing, will not be joining us today due to a death in his family. With that, let me introduce Mr. Roy Vallee to discuss Avnet's third quarter fiscal year 2007 business highlights.

[Roy Vallee:]

Thank you, Vince, and hello, everyone. Thank you all for taking the time to be with us and for your interest in Avnet. The third quarter of fiscal 2007 was a quarter of excellent operational execution, despite a sluggish sales environment. While total revenue was slightly below expectations, both operating groups delivered solid earnings improvements, which resulted in record third quarter net income and earnings per share. At Electronics Marketing, our highly diversified revenue base, spanning a wide range of products and end markets, once again allowed us to weather slower sales at large contract manufacturers and achieved significant sequential and year-over-year improvement in both gross profit and operating income margins. At Technology Solutions, severe weakness in our microprocessor business drove revenue below the low end of our expectations. Despite this unexpected weakness on the top line, the addition of Access Distribution and continued expense efficiencies increased TS's income margin , excluding the beneficial impact of the change to net revenue, resulting in TS's 15th consecutive quarter of year-over-year improvement in operating income dollars and margin. The strong earnings performance at both operating groups combined to drive Avnet's operating income margin up 43 basis points sequentially to 4.6%, with roughly half of the improvement resulting from the change related to the sales of supplier service contracts. With EM at 5.8% and TS at 4.2% or 3.7% excluding the effect of the change to net revenue, the March quarter is the first time that operating income margin at both operating groups and the Enterprise level have been within the range of our long-term goals. While on the subject of long-term goals, we also made significant progress on another important goal -- return on capital employed. Maintaining a double-digit ROCE is vital to Shareholder value creation at Avnet. In the third quarter of fiscal 2007, strong growth in earnings and further improvements in working capital velocity at EM drove Avnet's ROCE up to 11.3%, an increase of 145 basis points over the year-ago quarter, excluding last year's restructuring and other charges that Vince mentioned earlier. As a result of this performance, our rolling four-quarter ROCE improved to 10.7%, steadily progressing toward our goal of 12.5 to 13%. While we still have more work to do, we are pleased with the impact our focus on profitable growth and operational efficiency has had on our profits and returns even as top line growth has slowed. Finally, our strong earnings and disciplined working capital management allowed us to generate a significant amount of cash flow. In the March quarter, cash flow before cash used for acquisitions was $251 million. When you combine this with the December quarter, we generated $486 million of cash in the past six months, essentially financing the acquisition of Access with the cash generated since the transaction was announced. Our emphasis on value-based management has resulted in a business model that is generating positive cash flow through the business cycles, creating strategic flexibility to enhance shareholder returns. At Electronics Marketing, the March quarter represented a continuation of the trends we experienced in the December quarter. Even though revenue was near the low end of expectations, EM's highly diversified revenue base and focus on profitable growth drove gross profit margin up 68 basis points year-over-year and 36 basis points sequentially. As a result of the continuing focus on expense efficiencies, EM has consistently expanded operating income margins even though year-over-year growth in their end markets has slowed. In the March quarter, EM grew operating income margin 77 basis points over the year-ago quarter to 5.8%. This is the fifth quarter in a row that EM has delivered operating income margin over 5%, and the first time that EM has been within our 5.7 to 6.2% target range for operating income margin. While the gross margin expansion that is attributable to customer and regional mix may slow or even reverse a bit in the future, we expect operating income margin expansion to continue, driven by operating leverage as the large EMS customers and communications end markets eventually return to growth. For EM, the highlights didn't end at the income statement this quarter, as further improvements in working capital metrics drove velocity to a record 4.8 times. The combination of higher sequential sales and flat inventory at EM resulted in inventory turns of over 6 while days sales outstanding decreased in all three regions. This record working capital velocity combined with higher operating income margin drove a 387 basis point improvement year-over-year and a 548 basis point improvement sequentially in return on working capital. In the March quarter, EM EMEA achieved ROWC above our 30% goal for the first time. With both the Americas and EMEA regions realizing returns on working capital above 30%, we now have well over 70% of EM's global revenues generating ROWC above our hurdle rate. In the third quarter of fiscal 2007, EM revenue of $2.44 billion was up 4.7% sequentially and roughly flat with the year-ago quarter. Similar to the December quarter, revenue came in around the low end of expectations as a result of lower purchases from our large EMS customers due primarily to muted demand in the communications infrastructure end markets. The Americas region grew revenue 2.6% sequentially and was down 5.9% when compared with the third quarter of fiscal 2006. Asia, which met our expectations as a result of strong March sales following the Chinese New Year, was down 7.5% sequentially and 1.1% year-over-year. The EMEA region, which has less exposure to large EMS customers, grew revenue 17.9% sequentially and 12.8% year-over-year after adjusting for divestitures in the year-ago quarter. Excluding the impact of foreign currency translation and divestitures, the EMEA region grew 15.9% sequentially and 3.4% year-over-year. We are encouraged by the fact that our EM global book-to-bill ratio is back in positive territory after strengthening each of the past two quarters. For our global EMS customers, the book-to-bill trend is also improving across all regions, but it is still unclear to what extent their customer demand is picking up. For EM globally, we expect all three regions to experience typical seasonality in the quarter. Before I get started with the TS highlights, I'd like to introduce our new Global President of Technology Solutions, John Paget. John brings to Avnet a deep understanding of the technology industry and a wealth of IT supply chain experience from the supplier, VAR, and distributor perspectives. His skills and leadership experience will benefit Technology Solutions as the IT distribution industry continues to evolve, grow, and focus more on solutions. We are very optimistic that with John at the helm, TS will expand on its industry-leading position and continue to produce exciting results. Technology Solutions has been investing in award-winning systems and integrated solutions to accelerate the success of our trading partners and the acquisition of Access Distribution built on that strategy by integrating the leading value-added distributor of Sun Microsystems. In addition to adding roughly $2 billion of annual revenue, Access Distribution meaningfully expands TS's customer and supplier bases. The integration is proceeding very well and we expect to be essentially complete by the end of June of 2007. Our estimate of cost synergies continues to be at least $15 million. We are increasingly optimistic that one plus one will equal more than two from a revenue perspective over the coming quarters. Although it has only been three months, based on the support of the VAR community, suppliers and employees, we expect this acquisition will be one of the most successful investments to date for Technology Solutions and a solid contributor to Avnet Shareholder value creation. Finally, while the top line was challenged by the significant weakness in microprocessors, the bottom line for TS was a story of consistent improvement in financial performance. In the March quarter, Tech Solutions' operating income margin improved 93 basis points over the third quarter of 2006 to 4.2%, with approximately half of the improvement coming from the change to net revenue. This represents the 15th consecutive quarter of year-over-year improvement in both operating income dollars and margin, either including or excluding the results of Access in this first quarter as a part of Avnet. In the March quarter, Technology Solutions sales of $1.46 billion were up 25% as compared with the year-ago quarter on a reported basis and roughly flat on a pro forma basis. At a regional level, Asia grew revenue 1.8%, while the Americas and EMEA regions were down 0.6% and 1.3% respectively on a pro forma basis. Microprocessor sales were down 37% sequentially and 49% year-over-year. Our Avnet Partner Solutions business, which is focused on selling Enterprise computing products, was up 2.8% on a pro forma basis as compared with the third quarter of fiscal 2006 with growth across all three regions. As we look forward to the June quarter, we expect our sequential growth to diverge from our typical historic trends. In microprocessors, which are typically down in the June quarter, we expect sales to be roughly flat sequentially coming off the very weak March quarter. At APS, we expect sales to be up significantly due to the fact that our new second-largest supplier, Sun Microsystems, has its fiscal year end. And now I'd like to turn the commentary over to Ray Sadowski, Avnet's Chief Financial Officer. Ray?

[Ray Sadowski:]

Thank you, Roy. Hello, everyone. Let's begin with an overview of our operating results for the third quarter fiscal 2007. This slide shows a year-over-year comparison with a dollar and percent change in the highlighted columns on the right. Please note that we have included reconciliation to GAAP net income at the bottom of the slide to account for the restructuring and other charges in the prior year third quarter. As already has been mentioned, the March 2007 quarter has been adjusted to reflect the change in the method of recording revenue related to the sales of supplier services contracts, while the March 2006 quarter remains as reported. In connection with our acquisition of Access Distribution, we review the method of recording sales of supplier service contracts and determine that based upon recent changes by Access and others in the industry, such sales will now be classified on a net revenue basis rather than on a gross basis. Although this change reduces reported sales and cost of sales, it has no impact on gross profit operating income or net income dollars, but does have a positive impact on margins. In addition, the change has no impact on the balance sheet or statement of cash flows. In the March quarter, reported sales of $3.9 billion were 8% higher than in the year-ago quarter. Revenue would have been $4.09 billion in the current quarter had sales of supplier service contracts been recorded on a gross basis. Gross profit of $534.8 million was up $61.4 million as compared with the third quarter fiscal 2006. Our gross profit margin improved 60 basis points year-over-year to 13.7% in the third quarter fiscal 2007. Year-over-year gross margin was impacted by a number of factors, including business mix and the impact of the change related to sales of supplier service contracts. EM's gross profit margin increased 68 basis points year-over-year and 36 basis points sequentially. At TS, gross margin increased 112 basis points year-over-year, primarily due to the change related to the sales of supplier service contracts. Excluding the impact of the change related to the sales of supplier service contracts, Enterprise level gross profit margin was unchanged year-over-year as a result of the addition of Access into the business mix -- which, similar to other businesses in TS, has a lower gross margin than those in Electronics Marketing. Including Access, TS revenue grew to 37% of Enterprise revenue from 32% of the total a year ago. Operating expenses of $353.7 million were up $19.1 million or 5.7% year-over-year excluding restructuring and integration charges in both the current and prior year third quarters, due primarily to the addition of Access Development. Both groups are continuing to benefit from our ongoing operational excellence initiatives as shown by our significant improvement in expense as a percentage of gross profit dollars and in operating income margins. Operating income of $181.1 million was up 30.4% as compared with the third quarter of fiscal 2006, excluding certain charges from both the current and prior-year quarters. Operating income margin improved 80 basis points to 4.6%, benefited in part approximately 21 basis points by the change in the services revenue treatment. Below the operating income line, year-over-year interest expense declined 21% due to lower debt and a lower effective interest rate as a result of our cash flow generation and refinancing activities. Taxes increased $16 million due primarily to the increase in pretax income. The effective tax rate, excluding certain charges for the third quarter fiscal 2007, was 33.1%. We currently estimate that our effective tax rate will be between 32% and 35% for the fourth quarter of fiscal 2007. Net income excluding certain charges in the prior-year quarter increased $34.2 million or 45.5% to $109.4 million, driving diluted earnings per share to a record $0.73 in the March quarter as compared with $0.51 per share in the year-ago quarter. GAAP net income increased $34 million or $0.22 per diluted share as compared with GAAP net income of $71.2 million or $0.48 per diluted share in the prior year third quarter. Earnings per share was impacted by a slight increase in diluted shares outstanding from 148.1 million in the December quarter to 150 million shares in the March quarter. This next slide looks at the key productivity metric of expense dollars to gross profit dollars over the past 15 quarters. The bars represent the individual quarters while the trend line depicts the performance over a trailing 12-month period at the end each quarter. On a trailing 12-month basis, our ratio of expense to gross profit dollars, excluding restructuring and other charges, declined from 74.8% at the end of last year's March quarter to 67.6% in the current quarter, improving significantly over the last five quarters. A 727 basis point improvement since last year is further proof of the leverage we have built into our business model at both operating groups. At Electronics Marketing, the expense to gross profit ratio improved 353 basis points while at Technology Solutions, the ratio improved 513 basis points on a year-over-year basis. We expect our continued focus on profitable growth and operational excellence to drive continuing improvements in efficiency as we steadily progress towards achieving our long-term financial goals. Similar to the last slide, we are providing both quarterly and a trailing 12-month trend line, which portrays operating income margin over the past 15 quarters. A trailing 12-month operating income margin improved from 3.2% in the third quarter of fiscal 2006 to 4.3% in the third quarter fiscal 2007, benefiting slightly by roughly 5 basis points by the change in the net revenue treatment. In the March quarter, operating income margin of 4.6% improved 80 basis points year-over-year, benefited in part approximately 21 basis points due to the change related to the sales of supplier service contracts with both operating groups contributing to the improvement. At Electronics Marketing, operating income margin of 5.8% improved 77 basis points, and at TS, operating income margin of 4.2% improved 93 basis points as compared with a year-ago quarter, with roughly half of the TS improvement coming from the change in services revenue treatment. On this graph, we have shown return on capital employed, which is a key metric in our value-based management philosophy that we introduced six years ago. As is evident on this slide, during the last 15 quarters we have made significant progress toward achieving our stated target of 12.5 to 13%. From 3.2% at the end of September of 2003, our trailing 12-month return on capital employed has increased by a factor of more than three, to 10.7% in the current March quarter. While Memec had a lot to do with last year's improvement, the multiyear trend is all about our focus on profitable growth, operational excellence and returns at both operating groups across all regions. On a year-over-year basis, return on capital employed increased 145 basis points to 11.3%. As depicted on this next slide, pro forma free cash flow -- that is, free cash flow generation before taking into account the cash used for acquisitions -- reached nearly $600 million for the trailing 12 months. During the last components downcycle in 2004, we generated over $400 million pro forma free cash flow on a trailing 12-month basis. However, the combination of higher margins and faster asset velocity have changed the cash generation characteristics of our business model. With this strong cash flow generation during the December and March quarters, we're able to, in essence, pay for the Access acquisition with cash flow generated since we announced the acquisition. During the quarter we completed a debt offering of $300 million aggregate principal amount of 5.875 notes due in 2014. We used the net proceeds to repay borrowings under our short-term facilities that were used to fund the Access acquisition. Based upon current interest and anticipated cash flow, we expect interest expense to be roughly $19 million to $20 million in the fourth quarter. Including the impact of the recent financing activities, we have continued our trend of maintaining what we believe to be investment grade credit statistics. On a trailing 12-month basis, at the end of the March quarter, debt to EBITDA was 1.8 and EBITDA coverage was 8.5. The strengthening of our balance sheet, along with favorable credit markets, has allowed us to execute several debt transactions that have lengthened our debt maturities while lowering our effective borrowing rate. The end result is we now have a greater flexibility to fund growth and create additional Shareholder returns. Now let me turn it back over to Roy, who will provide our outlook and guidance for the June quarter. Roy?

[Roy Vallee:]

Thank you, Ray. Looking forward to Avnet's fourth quarter of fiscal 2007, we expect sales at EM to be in the range of $2.42 billion to $2.52 billion, and sales for TS to be in the range of $1.68 billion to $1.78 billion. Therefore, Avnet's consolidated sales should be in the range of $4.1 billion to $4.3 billion for fourth quarter of fiscal year 2007 and earnings should be in the range of $0.73 to $0.77 per share, including approximately $0.02 per share relating to the expensing of stock-based compensation. The above EPS guidance does not include the amortization of intangibles and additional integration charges related to the acquisition of Access, as these amounts have not yet been determined. So with that, let's open up the lines for Q&A. Operator?

[Operator:]

(Operator Instructions) Our first question is from Jim Suva with Citigroup. Please state your question.

[Jim Suva:]

Thank you very much and congratulations. Can you talk about now that April is pretty much behind us for the most part, some of the demand trends that you see as they've been progressing? I know you mentioned about MPUs, how it's looking to be stronger -- and any commentary about how this quarter is likely to progress from a linearity perspective?

[Roy Vallee:]

Well, Jim, this is Roy. How are you? So, of course, we would have taken into account what we know about April, which for us, closes tomorrow based on our 4-4-5 calendar. So that is baked into our forecast at this point. That includes commentary about the microprocessors, et cetera. In terms of linearity, we're going to experience a little bit different linearity this year than we have in the past, driven predominantly by that Sun fiscal year end. We have yet to go through one of these, but according to our friends at Access, there's a lot of activity at the very end of the quarter, similar to what we typically experience, say, with IBM at the end of the December quarter. So there will be a big swing for us in June, and even more specifically, even down to the last week of June. With that, let me just ask Rick or John if they'd like to add anything.

[Rick Hamada:]

No - Good morning, Jim, it's Rick. I would reinforce speaking from early on the EM side, again -- very normal seasonality outlook for the component business. John, any comment?

[John Paget:]

I would say that's the same, but certainly echo the Sun -- or the Access impact will be significant in that last couple of weeks.

[Jim Suva:]

Great. Thank you. My one quick follow-up question is now that you're basically standing on all your goals -- and by the way, congratulations on all that. Do you reach a point where you want to deliver on those for a couple quarters in a row, or do you want to come back and revisit those and potentially bring it higher? How should we look at that?

[Roy Vallee:]

So, Jim, we will update our target ranges, of course at our annual Analyst Day, most likely in December in New York City. And I would tell you that of course mix of business does have an impact on where the operating margins go, both within the groups and at the Enterprise level. But the way we run the business, it would be our expectations that over time, those margins should continue to move north even if they are moving north at a slower pace than they have in the past.

[Jim Suva:]

Great. Thank you. And congratulations once again.

[Roy Vallee:]

Thank you.

[Operator:]

The next question is from Matt Sheerin with Thomas Weisel Partners. Please state your question.

[Matt Sheerin:]

Yes, thanks. Hi, Roy. Question on the computing business -- and in your guidance, looks like June is going to be up a lot because of the Sun business. So would that imply that we're going to see sort of a see-saw effect where September, which is normally up low to mid-single digits for you -- would that be down and December up and then March down again? Just help us with the seasonality there.

[Ray Sadowski:]

I think what you're going to see, Matt, is normal seasonality in everything with except -- as you're used to seeing from an Avnet standpoint, with the addition of Sun into our marketplace, you'll start to see a little bit different pattern certainly with the high June. And they also have a relatively high December from a normal seasonality standpoint.

[Roy Vallee:]

And, Matt, just from my perspective, normal seasonality is hard to peg. But I would say that typically, when you say up low single digits, were you talking about TS in specific? That's right, sequentially.

[Ray Sadowski:]

Yes. So typically, that is true and that's led predominantly by the microprocessor business. The Enterprise computing business is typically all I would say more or less flat in those quarters. And so, yes, you're right. The spike that we get into the June quarter, we do have to give that back in the September quarter and then it turns out that the Sun business also has a pretty strong December quarter, just not quite as high of an amplitude as the June quarter.

[Matt Sheerin:]

Okay, great. That's helpful. And then on the gross margin for the March quarter, which was obviously very strong, even not counting the change in revenue recognition -- could you tell us how much of that was related to AMD? If you had seen AMD before the processor business come in line with your expectations, what would have the impact have been?

[Roy Vallee:]

That's probably the one number we didn't calculate.

[Matt Sheerin:]

Would you say like 10 to 20 basis points, give or take?

[Roy Vallee:]

I would say based on its relative size, Matt, I doubt if it could be more than 10. It's probably going to be less than 10 basis points at the Enterprise level.

[Matt Sheerin:]

Okay. And looking ahead obviously, you talked about seasonality in the electronics business, so that would imply you're up flattish or maybe down a little bit. Asia snapping back and then North America kind of flattish. Does that make sense? Flattish to up a little bit?

[Rick Hamada:]

Yes, Matt, it's Rick. It's actually I think Europe flattening out a little bit and America strengthening a bit with Asia leading the strength there.

[Matt Sheerin:]

Okay. So the gross margin, how would that shake out, then?

[Ray Sadowski:]

It's most likely going to be down for EM for the June quarter.

[Matt Sheerin:]

Okay.

[Ray Sadowski:]

On a sequential basis.

[Matt Sheerin:]

Okay. Just one last quick question if I can throw it in. The inventory in the March quarter, you said it was flat for EM quarter to quarter?

[Ray Sadowski:]

Yes, that's correct.

[Roy Vallee:]

It was actually flat quarter to quarter in reported dollars. If you back out the currency impact, inventory was down roughly $40 million.

[Matt Sheerin:]

What's your position, Roy, on inventory overall here, given the way the cycle is playing out?

[Roy Vallee:]

I continue to believe, Matt, that the global inventory correction cycle, which started pretty much in the summer quarter, has now played out. We feel like our inventories are in very good shape and I think our expectation for inventories would be that the current level of terms would be not significantly changed on a quarter on quarter basis. So inventory should move pretty much in concert with revenues.

[Matt Sheerin:]

Okay. Thanks a lot.

[Roy Vallee:]

You're welcome.

[Operator:]

The next question is from Brian Alexander with Raymond James. Please state your question.

[Brian Alexander:]

Thanks a lot. Good afternoon. Roy -- struggling a little bit to understand how you're going to keep expanding operating margins in EM over the next several quarters in light of the gross margin tailwind that you've been getting due to customer mix, et cetera, and the potential for Asia to grow as a percentage of the mix going forward. So it seems like there's some potential headwinds at the operating margin line. So I guess are you implying that there's that much operating leverage in the large customer base to offset those headwinds? Maybe it will help us understand how much growth you have to see for that statement to hold true, that operating margins in EM are going to continue to expand on a year over year basis.

[Roy Vallee:]

So, the answer is yes. Brian, when you look at the operating margins that are being produced by EM today, they obviously include all of the fixed overhead in the EM business. When our sales to these large EMS companies rise, the contribution margin, or the variable margin, is going to be a significant portion of the gross margin on those sales. And since we're talking about 5.8% operating, and a double digit gross margin even in those accounts, we are comfortable that as our sales return or rise in those accounts, we should be able to continue to expand the operating margin. Now, on a longer-term basis as Asia becomes a bigger and bigger portion of the total, that works in the other direction, of course. And as you know, we're managing each of the regions to our return on capital targets. So although the gross margin may come down, you should still see strong returns and strong cash flow.

[Brian Alexander:]

Okay. Just a follow up to that. Roughly how much lower are the margins in the large customer base relative to your small and medium-size customer base?

[Roy Vallee:]

Oh, roughly two-thirds of the gross margin.

[Brian Alexander:]

Okay. And then, my final question -- by the way, welcome, John, to the call.

[John Paget:]

Thank you very much, Brian.

[Brian Alexander:]

For TS, you're guiding up close to 20% sequentially and I understand your comments about microprocessors and also Access benefiting from Sun's fiscal year-end. I'm trying to parse these out. TS has grown at most 5% sequentially. You've also got an acquisition I think in Asia-Pacific, which allowed a couple points of growth. Maybe just help us understand what the Access contribution will be to the TS growth in the June quarter versus how much sequential growth you're expecting in the legacy business?

[John Paget:]

Certainly Brian. With the close that the year-end Sun business the majority of all of our growth will come from Access in that quarter. The rest of it will be relatively in the same sequence that you've seen it in the past.

[Brian Alexander:]

What was Access in the March quarter in terms of total revenue?

[Roy Vallee:]

Brian, this is Roy. Let me jump in on that one. And maybe clarify something and then also attempt to answer your question. So, I think most of you know that Access was about 80% Sun microsystems, and we are very committed to maintaining that Sun vertical business unit, if you will. That business unit will be based in Colorado. However, there are the other 20% of the Access business over the next couple of quarters will get commingled with the other business development emerging activities that are already in place at Technology Solutions. And so speaking about Access on a quarter by quarter by quarter basis will become irrelevant over the next couple of quarters. Now, all that said, the performance that we had on the March quarter was below our expectations and I would say from a revenue point of view, in the middle single digit range below our expectations.

[Brian Alexander:]

What were your expectations?

[Roy Vallee:]

Well, remember we talked about a $2 billion run rate and roughly $0.5 billion of sales.

[Ray Sadowski:]

And that was all gross revenue.

[Roy Vallee:]

And that's in the gross revenue format. Thanks, Ray.

[Brian Alexander:]

Thanks a lot, guys.

[Roy Vallee:]

You're welcome. By the way, Brian -- while the revenues were, I would describe as slightly below our expectations, the profits generated were actually above our expectations. And that's part of what lifted the Tech Solutions' overall performance.

[Brian Alexander:]

Did it add roughly $0.03, $0.04 to EPS in the quarter?

[Roy Vallee:]

That's real close. I would say in the $0.04 range.

[Brian Alexander:]

Thanks a lot, guys.

[Roy Vallee:]

You're welcome.

[Operator:]

The next question is from Thomas Dinges with J.P. Morgan. Please state your question.

[Thomas Dinges:]

Hi, good morning, guys. Roy -- wanted to just go back to the one area you were talking about with some of the weakness that you saw in Asia and you characterized a lot of it as related to the EMS companies and obviously we've seen some of the results from a number of those guys, and you do have some major supply chain engagements with some of your large semi suppliers there. Can you talk about the health of the rest of the business there looked like? Meaning, are you still seeing pretty strong growth over there, or was there something else going on over there that's been impacting that business a little bit and I've got a quick follow-up question after that.

[Roy Vallee:]

Yes. It's a very good question, Tom. Let me throw a few comments and I'll ask Rick if he'd like to add. If I look at our business in America, the weakness at the large EMS customers is a disproportionate share of the weakness. In other words, the remainder of the -- let's call it SMB component customers are actually reasonably healthy. When you go to Asia, the performance of our business outside of those large EMS customers is very similar to our performance inside of those large EMS customers. So I think what that speaks to is some other kind of slowdown in the overall component purchasing in Asia. It could speak to consumer demand, it could speak to ASPs on certain consumer devices. But our exposure to the non-EMS customers has also been weak in Asia. We did see strength coming out of Chinese New Year. We are expecting sequential growth. However, when you reflect back to year on year, we'll actually need some sequential growth just to get to a flat year on year revenue number for Asia-Pac. Rick, you want to add anything?

[Rick Hamada:]

No. You got it covered. Book to bill was roughly 1 to 1 in the region which was the strongest performance of the last three quarters.

[Thomas Dinges:]

Okay, great. A lot of discussion obviously about Access and the relationship with Sun. But obviously you've had a longstanding relationship with one of the other very large hardware vendors who had talked a bit about some weakness at their particular quarter. And then you've got another vendor in there that has obviously been a share gainer over the past couple of quarters based on the data that's available. Can you talk about what the other parts of the business were like in this particular quarter? And as you're looking forward, you're expecting the big bounce obviously with Sun from the seasonality standpoint. What else are you seeing out there from a pricing or overall volume standpoint? Just any color there would be great.

[Roy Vallee:]

Tom, okay. I'll lead again and ask John if he'd like to tag in. I think the simple answer is, we were slightly disappointed with our revenues at TS, even excluding the microprocessor situation. I say slightly because what we saw was sequential declines in the range of normal seasonality, but year on year gains that were below the sort of mid to high single digit number that we would expect coming out of that market. So, we did in fact see some of that same weakness that you heard from the other major hardware suppliers. As we look at our forecast for the current quarter, there is some -- rebounding I guess if you would call it, Matt used the term snapback. I don't think I'd use snapback as the term, but we are expecting some better revenue results in the current quarter as compared to what we got in the March quarter. John?

[John Paget:]

And I would add to that as we move more deeply into solutions distribution and the emerging businesses, we're seeing those take a greater or have a greater impact on our revenue growth as well.

[Thomas Dinges:]

Okay, thank you.

[Roy Vallee:]

You're welcome.

[Operator:]

The next question is from Steven Fox with Merrill Lynch. Please state your question.

[Steven Fox:]

Hi, good afternoon. Could you talk a little bit more about inventories on the Electronics Marketing side? You said the turns were above 6 times. I wasn't clear if that was an improvement or decline from the prior quarter year ago?

[Roy Vallee:]

So I'll just give you the data and then again, Rick, if you want to add anything. But sequentially, Brian, that was an improvement of 35 basis points or so. Compared to a year ago, it's down slightly, down about 25 basis points.

[Steven Fox:]

Okay. And then, looking at the components business, I know we spent a lot of time talking about mix. But if we forgot about mix for a second and just looked at the regions apples to apples, from the current margin levels you're at -- where is the most potential to improve margins and roughly by how much?

[Roy Vallee:]

Are we talking gross or operating?

[Steven Fox:]

Operating is fine.

[Roy Vallee:]

So, I think this question was touched on earlier. And again I'll flip it to Rick if you'd like to add. In both America and in EMEA now, we are performing to our hurdle rate of 30% ROWC or greater. And so while we would expect continuous improvement in the margin driven by operating leverage, we're now shifting our focus a bit in those regions to growth and investing in increasing the top line now that we're getting our hurdle rate on the returns. In Asia, however, we are still below our hurdle rate. Its both a very competitive market but also a very exciting growth market. And so we're constantly trying to balance between getting to our hurdle rates within a reasonable time frame, but at the same time investing appropriately to participate in the growth opportunity in the region. So, if you look out over the next few quarters, operating margin expansion should occur in Asia more so than Europe and America. But we would expect Europe and America to drift a little bit north from here just based on operating leverage.

[Steven Fox:]

So the fastest growing region has most leverage coming up?

[Roy Vallee:]

I believe that's correct.

[Steven Fox:]

Okay, great. Thank you very much.

[Operator:]

The next question is from Bernie Mahon with Morgan Stanley. Please state your question.

[Bernie Mahon:]

Good morning.

[Roy Vallee:]

Hi, Bernie.

[Bernie Mahon:]

Question for you -- on the guidance for EM, I guess I'm a little confused because you're guiding for normal seasonality, but then, Roy, you just talked about how Asia Pacific weaker than normal, and in North America, you still have the large EMS guys working inventory down. Is that all made up for because Europe is so strong? Or how do you kind of reconcile that to normalcy now in the June quarter or EM?

[Rick Hamada:]

Sure. Bernie, it's Rick. Good afternoon. Just to add some color on the overall book-to-bills, the large EMS customer segment for us, it was a positive book-to-bill and more positive than the regions in aggregate. And as I referred to earlier, for Asia, roughly 1 to 1 now -- that was best book-to-bill performance fiscal year to date. So that positive book-to-bill in that customer segment, as well as the region probably give us that outlook.

[Roy Vallee:]

And Bernie, so let me just repeat what we think would be normal seasonality for Avnet's business in the June quarter, Europe would be actually down slightly. America would typically be up slightly. And then Asia would typically be up sort of low to mid single digits on a sequential basis. And the book-to-bill that Rick just talked about coming through the March quarter, as well as the information we've gotten on April to date, would indicate that that's roughly what's in store.

[Bernie Mahon:]

Okay. That's helpful. And then, Ray, maybe just on the gross margins for the June quarter for the overall business, historically, it's kind of flattish to up some. But now you have Access in the model. Plus you have the new way you recognize revenue for the service contracts. What should we expect on a sequential basis? Would it be down 30 or 40 basis points or not quite that much?

[Ray Sadowski:]

You're at the gross margin level?

[Bernie Mahon:]

Yes, for the overall company.

[Ray Sadowski:]

If you're going gross margin -- so sequentially there is no impact of the change in services revenue since we've done it the June and March quarter. So you really, year-over-year, it's a different story. But sequentially you're comparing apples to apples. So therefore, the margin will be driven by the mix of business and based upon the strength in the Sun quarter relative to the total business, we would expect margins to go down. The number you gave is I think a little bit on the high side. But you're probably, I would say, in the 50, 60 basis point range potentially -- again, depending on mix overall.

[Bernie Mahon:]

Okay, that's helpful. Thanks a lot.

[Roy Vallee:]

Bernie, if it helps, take a look at our prior December quarters and kind of what you've seen in terms of gross margins and operating margins and then just keep in mind we've got two things going on in the June quarter. We've got the TS revenue growing as a percent of the total driven by the Sun year-end. And then we also have the Asia region growing faster than Europe and America in the EM business. So all of those will put pressure on the gross margin line. But of course all that's baked into the earnings forecast that we've provided.

[Bernie Mahon:]

Okay. That's very helpful. Thanks, Roy.

[Roy Vallee:]

You're welcome.

[Operator:]

The next question is from Kevin Sarsany with Next Generation Research. Please state your question.

[Kevin Sarsany:]

Hi, guys.

[Roy Vallee:]

Hi, Kevin.

[Kevin Sarsany:]

On Technology Solutions, I don't know if you mentioned it -- what was the health excluding the AMD business for your legacy VARs?

[Roy Vallee:]

Kevin, we did talk about that. It was okay, not what we would have liked. Positive year-over-year growth, but in the lower single digits instead of the higher single digits. So it was a little weaker than we would have liked.

[Kevin Sarsany:]

And is there any reason? I mean --

[Roy Vallee:]

Yes, corporations aren't spending on CapEx like we'd like them to.

[Kevin Sarsany:]

Okay. All right. And looking at the next quarter, it looks like you're guiding the 20% sequential increase. I'm just wondering, what would you frame what the potential margin impact historically in your December quarter you grow sequentially 20% to 30% in margins sequentially are up 80 to 100 basis points? Could you kind of frame that?

[Roy Vallee:]

Well, I think very similar to the last question. It's going to be a similar effect for you, not quite as strong. Typically in the December quarter, TS grows in aggregate 25, 30%. We're talking about 20. So it's going to be just very, very similar, Kevin, but not quite as strong as the December change.

[Kevin Sarsany:]

You also have microprocessors coming back. So that will mute it a little bit.

[Roy Vallee:]

I think they're going to be more or less flat, better than a typical seasonal down but more or less flat sequential.

[Kevin Sarsany:]

For microprocessor?

[Roy Vallee:]

In the June quarter, yes.

[Kevin Sarsany:]

Okay. And just looking at EM and -- looks like you're troughing but margins are expanding sequentially, which is unusual obviously. You've done a lot of work internally. But is there anything you could point to in the industry -- more rational ASPs being steady that allowed to you do this that also, in future downturns, will kind of provide this nice backdrop? And I guess obviously on the reverse when things do grow, you may not see that big help?

[Roy Vallee:]

Okay. So again, I'll take a crack and ask Rick if he wants to chime in. As you maybe would imagine, I'm going to tell you that the majority of what we've been able to do in this cycle compared to prior cycles, I would attribute to the work of our team as opposed to structural changes in the industry. As you know, we've been on this value-based management campaign. We've been very focused on issues like making sure we're generating the right kind of revenue streams. We call it profitable growth. And then also making sure we apply a range of operational excellence initiatives to drive productivity and efficiency into our business. And I really think that what's happening in our numbers is those activities permeating throughout the organization, and if you maybe pardon the euphemism, but getting 11,700 employees all growing in the same direction or pulling on the rope in the same direction. Now, with all that said, I do think there are some structural changes as we talked at the analysts' meeting in December. And the one I'll point to in specific is that with more semiconductors being fabricated by foundries, there is less fixed asset owned by the semiconductor companies. That creates a lesser incentive to lower price when business falls. So their utilization rates of their own factories are higher than the utilization rates of the foundries and that creates -- it eliminates a motive to drop ASP. Obviously with higher ASPs, we've got a better financial model and more of an opportunity to apply the operating leverage that we built into the company.

[Kevin Sarsany:]

Okay. Thank you.

[Roy Vallee:]

You're welcome.

[Operator:]

The next question is from Carter Shoop with Deutsche Bank. Please state your question.

[Carter Shoop:]

Hey, guys, great quarter.

[Roy Vallee:]

Thanks, Carter. Wanted to talk a little bit about Europe. Obviously EM had a great quarter there, based on your sequential growth rates and your two largest competitors there -- looks like you guys took some shares. So congratulations there. My question focuses around the sustainability of the strength we've seen in Europe, particularly on the component side. We've seen that growth really outstrip the other regions quite dramatically and obviously outstrip the global European GDP over there. How sustainable do you think this growth is, and what gives you confidence in that?

[Rick Hamada:]

Hey, Carter, it's Rick. Good afternoon. First of all, Europe has been the strongest the last two out of the three quarters. Still looks positive book-to-bill through the March quarter. And they also have the least exposure to the large EMS business that we've talked about in a couple different points here today. So we feel good about the overall environment out there. We still have opportunity to grow, particularly in our IP&E business. And all that factors into an optimistic outlook for that particular region for us on the EM side.

[Carter Shoop:]

Okay. I guess fair enough. And then, with Access, can you remind us again what the margin structure is going to look like there? And how much that margin structure fluctuates on a seasonal basis?

[Roy Vallee:]

Well, Carter, I think what we said is the gross margins are a little bit lower than our TS overall gross margins. The operating income margins had been running within the range of our TS operating income margins. And then, of course, what's happening is we're moving up the TS margins. But in conjunction with that, we have the synergy cost savings, which will impact effectively the margins coming out of Access. So, long story short at the operating level, Access is sort of consistent with the overall margin model of TS. Okay? And seasonality --

[John Paget:]

Margins.

[Roy Vallee:]

I don't know.

[John Paget:]

It has to do with mix.

[Roy Vallee:]

Yes. So you may see a slightly higher June and December, slightly lower March and September, but the operating margins are relatively stable.

[Carter Shoop:]

Okay, great. Thanks a lot.

[Roy Vallee:]

You're welcome.

[Operator:]

Thank you. The next question is from Harry Blount with Lehman Brothers, please state your question.

[Harry Blount:]

Hi, guys. Just one question if I might. And this focuses on the microprocessor business. Is the ROCE numbers on the lower level of activity here still within targets? Or maybe asking the question a different way, I think you guys made a decision a while back to exit the majority of one supplier's business because it didn't meet minimum hurdles. Is that still the case with the AMD business at this point?

[Rick Hamada:]

We're still meeting the hurdles, Harry, this is Rick. We're still there and not looking forward to having a more dramatic decision necessary in that space.

[Harry Blount:]

Okay. So nothing short-term that we need to really focus on here. But it's something that we sounds like we need to keep an eye on?

[Rick Hamada:]

We certainly will be.

[Roy Vallee:]

But the message Harry, is revenues were very disappointing. But the profitability on those revenues was okay.

[Harry Blount:]

Got it. Great. Thanks.

[Roy Vallee:]

Nice job on CNBC this morning.

[Operator:]

There are no further comments in queue. I'd like to turn the call back to management for closing comments.

[Vince Keenan:]

As we conclude today's quarterly analyst call, we will now scroll through the slide mentioned at the beginning of our webcast that contains 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 presentation, including the GAAP financial reconciliations, can be Accessed in downloadable PDF format at our website. We would like to thank you for your participation in our quarterly update today. If you have any questions or feedback regarding the material presented today, please contact the Avnet Investor Relations Department by phone or e-mail. Thank you.

[Roy Vallee:]

Thanks, everybody.

[Operator:]

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