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Executives

Vincent Keenan - Vice President of Investor Relations

Roy Vallee - Chairman of the Board and Chief Executive Officer

Raymond Sadowski - Chief Financial Officer

Rick Hamada - Chief Operating Officer

Harley Feldberg - President of Electronics Marketing

John Paget - President of Technologies Solutions

Analysts

William Stein - Credit Suisse

Ingrid Aja - Merrill Lynch

Brian Alexandra - Raymond James

Jim Suva - Citigroup

Carter Shoop - Deutsche Bank

Matt Sheerin - Thomas Weisel Partners

[Brandon Furlong] - [Marriot Tavec]

Sean Conner - FAS Advisors

Avnet Inc. (AVT) Q4 2008 Earnings Call August 6, 2008 2:00 PM ET

Operator

Please stand by our presentation will now begin. I would now like to turn the floor over to Vince Keenan, Avnet's Vice President of Investor Relations.

Vincent Keenan - Vice President of Investor Relations

Good afternoon and welcome to Avnet's Fourth Quarter Fiscal Yearend 2008 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 Principals, 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 in the Form 8-K filed with the SEC today and with several of the slides in this presentation and on Avnet's Investor Relations website.

As we provide the highlights for our fourth quarter and fiscal yearend 2008, please note that we had excluded restructuring, integration and other items from both the current and prior year period in the accompanying presentation and slides. Additionally in discussing pro forma sales or organic growth prior periods are adjusted to include acquisition.

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 SEC.

In just a few moments, Roy Vallee, Avnet's Chairman and CEO, will provide Avnet's fourth quarter and fiscal yearend 2008 highlights. Following Roy, Ray Sadowski, Chief Financial Officer of Avnet will review the company’s financial performance during the quarter and provide first quarter fiscal 2009 guidance, after which a Q&A will follow.

Also here today to take any questions you may have with related to Avnet’s business operations is Rick Hamada, Avnet’s Chief Operating Officer, Harley Feldberg President of Electronics Marketing and John Paget, President of Technologies Solutions.

With that, let me introduce Mr. Roy Vallee to discuss Avnet’s fourth quarter and fiscal year 2008 business highlights.

Roy Vallee - Chairman of the Board and Chief Executive Officer

Thank you Vince and hello everyone, thank you all for taking the time to be with us and for your interest in Avnet. Fiscal year 2008 was more of a challenge than we anticipated when we initially established our plans and budgets in the June 2007 timeframe. But August, they have all publicized issues about housing, credit and all began to spread throughout the economy and we begin to experience slower growth in our end markets. While slower organic growth has had a negative impact on our progress toward our long-term financial goals. We remained focused on driving return on capital employed to 12.5 to 14%. As we have stated many times, our Valued Based Management or VBM discipline is embodied by this key metric, which when coupled with growth is a proxy for shareholder value creation.

Similar to the mix of data points we read about on the economy, the details of our results are also mixed and raises the question, is the glass half empty or half full. Now that we have closed the books on this fiscal year, we can see that we missed our sales budget, earnings per share finished below our plan, and operating profit margin was down year-over-year. Well, that sounds like a glass half empty kind of year.

Putting things in perspective, however, we believe we can also view fiscal year 2008 as a glass half full year. We delivered record sales and EPS for the fiscal year, increased working capital velocity and generated a significant amount of cash from operations. As a result of the performance of our entire global team, Avnet was able to increase return on capital employed by 7 basis points at the enterprise level and grow economic profit dollars despite the well publicized difficult environment. This was accomplished through a disciplined VBM approach to managing our operations and making value-creating acquisitions. That sounds like a glass half full kind of year.

In addition to the consistent focus on our growth and margins, VBM requires that we pay similar attention to the management of working capital. In fiscal 2008, this was especially important as the slowdown in organic growth and business mix shifts reduced our operating income margin. This meant that working capital velocity had to improve. Our team did an excellent job reacting real time to market conditions and as a result improved working capital velocity, reduced our cash cycle by two days and generated more than $450 million of cash from operations. This performance further strengthened our investment grade balance sheet thereby providing the financial flexibility for us to continue investing in value-creating M&A to supplement our growth and enhance our competitiveness.

In fiscal 2008, we completed seven acquisitions and early in fiscal 2009 we have added three more businesses to our portfolio that increase our geographic footprint, expand our line card, add to our global scale and scope competitive advantages and bring us many talented new employees. These acquisitions, which span both operating groups and all three geographic regions, had annualized revenue of approximately $1.5 billion prior to being acquired by Avnet. Including the contributions of acquisitions, we accelerated our revenue growth rate to 14.5% over fiscal 2007 and grew pro forma EPS to a record $3.18 per share.

While some of the benefits of our acquisition activity are apparent in our current financial results, additional contributions will be realized in the future as organic growth accelerates and we leverage the new levels of scale and scope globally. By investing in value-creating M&A when growth is slow especially in the less consolidation international markets, we are improving Avnet's competitive positions and solidifying our indispensable role in the global technology supply chain.

In the June quarter, Technology Solutions rebounded from the disappointing March quarter as double-digit growth in service, storage and software drove revenue up 8.3% sequentially. However, revenue was slightly below the low end of expectation primarily due to lower sales of microprocessors and memory products.

The rebate issues that negatively impacted gross margin in the March quarter were collected as gross profit margin for TS rose 43 basis points sequentially to the highest level in fiscal 2008. Higher gross profit margin combined with the initial benefits from cost reductions drove operating income up 49.5% sequentially while operating income margin improved 88 basis points. On the balance sheet, working capital velocity at TS improved 15% over the March quarter was contributed to a 352 basis points sequential improvement and return on capital employed.

In the June quarter, the Americas region delivered operating income margin at the high end of our target range and return on capital employed well above our 12.5% threshold. Even though technology solutions faced challenging market conditions in fiscal 2008, it was a year of growth and expansion as we made several international acquisitions.

In Europe, TS solidified its position as the leading value added IT distribution with the acquisitions of Magirus and Acal in the first half of 2008 and the recently completed Horizon in July. In addition to expanded geographies, these acquisitions added new product lines and services and high growth segments along with an expanded customer base thereby creating new cross-selling opportunities.

The acquisition of ChannelWorks expanded Technology Solutions product line in Australia while the recent acquisition of Ontrack in India provides a solid base upon which to grow in one of Asia's fastest growing IT markets. Benefited by acquisitions, Technology Solutions revenue grew 27.1% to $7.63 billion in fiscal year 2008. Our pro forma TS revenue grew 4.7%.

While the June quarter represented significant progress and growth and profitability, operating income margin was down 45 basis points for the full year due primarily to the impact of lower organic growth in certain product lines. We are not satisfied with this performance and we will continue taking actions to align our expense and working capital investments with market realities. For the second year in a row, our most consolidated region, the Americas, delivered operating income margin at the high end of our target range and exceeded our 12.5% return on capital employed threshold.

In EMEA, where a consolidation process is still playing out, we will begin integrating the recently completed Horizon acquisition this quarter. As organic growth returns and we realize the financial benefits of the cost reduction initiatives, we will continue to make progress in driving Technology Solutions to generate operating income margins within our long term goals.

In the June quarter, Tech Solutions sales of $1.95 billion were up 9.9% year-over-year on a reported basis and 5.6% adjusted to exclude the impact of changes in foreign currency exchange rates. Revenue was flat on a pro forma basis when you account for acquisitions. On a product level, servers continue to decline as a percent of total revenue as Tech Solutions executes on its strategy of investing in solutions practices and vertical markets in the high growth segments. In the fourth quarter of fiscal 2008, our storage solutions growth rate exceeded 50% year-over-year for the third consecutive quarter while sales of networking products doubled from the prior year quarter, both benefited by acquisitions.

At a regional level, EMEA grew revenue 43.1% over the prior year quarter in deliver dollars and 26.4% if you exclude the impact of changes in foreign currency exchange rates. On a pro forma basis, EMEA grew 4.2%. The Asia region grew 1.6% as compared with the year ago quarter and was down 11.3% on a pro forma basis due to relatively weak microprocessor and memory sales. However, gross profit dollars at TS Asia grew 24.8% year-over-year on a pro forma basis. Revenues in the Americas region was essentially flat as growth in storage and networking offset declines in servers.

Turning now to the results for Electronics Marketing, the fourth quarter of fiscal 2008 represents another solid performance by our team despite the somewhat challenging environment. Revenue of $2.73 billion was above our expectations due to better than expected sales in all three regions. Our team in EMEA has done an excellent job of working through this macro slowdown by focusing on profitable and growth and asset velocity. Although EM EMEA's operating profit margins are down from record levels in the fourth quarter of fiscal 2007, working capital velocity increased 8% year-over-year and return on capital employed improved 49 basis points.

In the EM Asia region, the team improved operating profit margin year-over-year for the fourth consecutive quarter. The Americas region grew faster than the market and continues to exceed our return on capital employee target.

In fiscal 2008 electronic marketing revenue of $10.33 billion grew 6.7% over fiscal 2007 in delivered dollars and 2.5 % in constant dollars. Pro forma growth after adjusting for acquisitions was 5%.

Gross profit margin was up 15 basis points while operating income margins was roughly flat as compared with the prior year. Record working capital velocity at EM for the year contributed to a nearly 3 day decline in this cash cycle and 117 basis point improvement in return on capital employee. While the EM Americas region continues to exceed our returnables with relatively flat return on capital employee year-over-year, return on capital employee improved for both the Asia the EMEA regions by 95 basis points and 99 basis points respectively.

In summary, our EM team around the world reacted rapidly to the challenges in the market and stayed focused on profitable growth and working capital management while continuing to invest in organic growth initiatives and value creating M&A. Our emphasis on value added offerings focused on the global electronics design and supply chains has allowed us to take share without sacrificing gross profit margin. Our flexibility and willingness the partner with both customers and suppliers continues to gain traction in the market and we believe that we are well positioned to capitalize on future market opportunities.

In fourth quarter fiscal 2008, EM revenue of 2.73 billion was up 10.8% year-over-year on a reported basis and up 7.3% pro forma after adjusting for acquisitions. The Americas region delivered a third consecutive quarter of year-over-year growth with sales up 2.4%. The Asia region grew 10.3% as compared with the fourth quarter of fiscal 2007 and 3.7% on a pro forma basis.

The EMEA region grew 20.8% over the prior year quarter and grew 5% after adjusting for the impact of changes in foreign currency exchange rates. On a pro forma basis EMEA was up 15.6%.

Now, I would like to turn the commentary over to Ray Sadowski, Avnet's Chief Financial Officer. Ray.

Raymond Sadowski - Chief Financial Officer

Thank you, Roy and hello everyone. Let's begin with a review of our operating results for the fourth quarter of fiscal 2008 as compared with the prior year quarter.

In the June 2008 quarter, Avnet sales of 4.68 billion were up 10.4% in reported dollars and up approximately 5.4% in constant dollars as compared with the year-ago quarter. Organic revenue growth was roughly 4.2% over the year-ago quarter.

Gross profit of 611.8 million was up 60.2 million, or 10.9% as compared with the fourth quarter of fiscal 2007, positively benefited by the impact of acquisitions and the year-over-year weakening of the US dollar against the Euro.

At the enterprise level consolidated gross profit margin for the quarter was up 6 basis points year-over-year. Electronics marketing gross profit margin was up 7 basis points year-over-year even though the relatively lower gross margin Asia business continues to grow faster than our Western regions.

Technology Solutions gross profit margin was essentially flat for the quarter year-over-year was up 43 basis points sequentially as supply only bench returns to normalized levels. Our continued focus on profitable growth and value added services has allowed us to maintain gross profit margins despite the head winds of the macroeconomic environment in a very competitive market place.

Operating expenses of 413.2 million were up 57.4 million, or 16.1% year-over-year, primarily due to the impact of acquisitions and the impact of fluctuations in foreign currency exchange rates.

The cost reduction initiatives that we announced in April for certain business units are essentially complete and we expected benefits to be realized -- full benefits to be realized in the September quarter. We were able to reduce roughly 18 million in annualized operating costs during the June quarter. However, these were masked from our important results by the addition of operating costs from recent acquisitions as well as the impacted changes in foreign currency exchange rates.

In response to continued weakness in portions of our portfolio, we have identified additional corrective actions that will be initiated in the September quarter of approximately $15 million on an annualized basis with the full benefits expected in the March quarter. In addition to these restructuring, we continue to manage the integrations of our acquisitions and expect to obtain the synergies planned. Excluding restructuring, integration and other charges, operating income of 198.7 million increased 2.9 million or 1.5% as compared with the prior year quarter. Operating income margin declined 37 basis points year-over-year to 4.25%.

Taxes on income before restructuring, integration and other items decreased 3.5 million year-over-year primarily due to the mix of business. The effective tax rate in the June 2008 quarter was 157 basis points lower sequentially as the effective rate for the year came in at 30.6% resulting in a 28.9% effective tax rate for the fourth quarter of fiscal 2008.

This year-end true-up ended roughly $0.02 per share to our quarterly earnings relative to our earlier projection. We had a similar true-up of $0.02 per share in last year's fourth quarter as well. We currently estimate that our effective tax rate will be between 30.5 and 32.5% for the fiscal year 2009.

Excluding restructuring, integration and other items, net income for the fourth quarter of fiscal 2008 increased $4.3 million or 3.5% to $128.2 million, increasing diluted earnings per share to $0.85, up 4.9% as compared with $0.81 per share in a year ago quarter.

GAAP net income increased 19.4 million to $144.1 million or $0.95 per diluted share as compared with net income and earnings per diluted share of 124.7 million and $0.81 respectively in the prior year quarter. Included in the GAAP earnings per share is a non-operating gain of approximately 42 million from the sale of our interest in Calence LLC on April 1, 2008.

On a trailing 12 month basis, our ratio of expense to gross profit dollars increased 108 basis points from 66.5% at the end of last year’s June quarter to 67.6% in the current quarter. At the operating group level, Electronics Marketing increased its year-over-year rolling four quarter expense to gross profit ratio by 41 basis points while Technology Solutions increased its ratio by 421 basis points.

For the fourth quarter of fiscal 2008, the ratio of operating expense to gross profit dollars increased 302 basis points year-over-year with deterioration coming from both operating groups due to the lack of organic growth and the benefits from a previously stated restructuring activities not being fully realized in the June quarter. We expect the restructuring actions along with the synergy benefits of integration from the integration of acquired businesses to improve this ratio in upcoming quarters.

Our trailing 12 month operating income margin was down 20 basis points year-over-year to 4.2%. As we look at the fourth quarter of fiscal 2008 on a standalone basis, operating income margin of 4.25% decreased 37 basis points over the prior year. For Electronics Marketing, operating income margin was down 18 basis points to 5.6% while Technology Solutions operating margin of 3.2% was down 70 basis points as compared with a year ago quarter. The decline in year-over-year was due to slower organic growth and higher sales in the lower margin Asia business. At TS, we bounced back from our third quarter gross margin decline and expect to substantially recover the operating margin decline by the end of the calendar year. Again, as we mentioned earlier, we will continue to manage our portfolio of businesses to our long range financial model.

In the fourth quarter of fiscal 2008, total capital employed declined 114 basis points to 11.4% as compared to 12.5% in the fourth quarter of fiscal 2007. On a trailing 12 month basis, the total capital employed improved slightly by 7 basis points to 11.3% in the fourth quarter of fiscal 2008.

In and all, results were below expectations, we remain committed to our long range goal of 12.5 to 14% return on capital. Our disciplined approach to managing our business is helping us drive return on capital to huge levels and continue to grow shareholder value despite difficult market conditions and we are executing this while making smart acquisitions. Maintaining a strong balance sheet and substantial cash-flow generation provide us with the comfort that we can continue to invest in growth initiatives including value-creating M&A.

As depicted on this next slide, cash flow from operations was 454 million for fiscal 2008 and 257 million in the fourth quarter due to the combination of solid earnings and prudent working capital management. Despite the slower growth, we are able to increase inventory turns and working capital velocity for the fiscal year. As a result, on a sequential basis, cash generated from the reduction of inventory was $81 million during the quarter with reduction in inventories at both operating groups.

At the enterprise level, our net days were down 4 day sequentially and we continue to see no deterioration in our receivable bad debts despite the continued concerns in the credit markets. The significant cash flow generated during the fourth quarter and for the full fiscal year resulted in a continued strengthening of our balance sheet and credit statistics. On a trailing 12 month basis, debt to EBITDA was 1.5 and EBITDA coverage was 11.5. We exited the quarter with over 1.5 billion of liquidity including 640 million in cash, giving us a financial flexibility to capitalize on strategic opportunities.

Looking forward to Avnet’s first quarter of fiscal 2009, management expects normal seasonality at EM and TS with anticipated sales for EM to be in the range of 2.65 to 2.75 billion and sales for TS to be between 1.88 and 1.98 billion. Therefore, Avnet's consolidated sales are forecasted to be between 4.53 and 4.73 billion for the first quarter of fiscal 2009. As a result, we expect first quarter fiscal year 2009 earnings to be in the range of $0.70 to $0.74 per share. This EPS guidance does not include the amortization of tangibles or integration charges related to acquisitions and additional restructuring charges related to the actions that we have taken in the September quarter.

Before we open the line for questions, I would like to point out one item related to our December quarter, which is more of a reminder. As many of you know, December is typically the strongest quarter for our TS business, driven by the year end budget activities of many of our customers and by the fact that some of our key suppliers operate on a calendar year basis. Typically, a significant amount of the sales activity for that quarter occur in the latter part of December. In Avnet's current fiscal year, our December quarter end on December 27, four days before the end of the calendar year. As a result, some of the sales activity in calendar December will actually fall into our March quarterly results. Although we are not providing second quarter fiscal 2009 guidance at this time, we want you to be aware of this so that you can take it into account in your modelling. And as part of our usual practice on guidance, we will provide our December outlook on our September earnings conference call.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of William Stein with Credit Suisse. Please proceed with your questions.

William Stein

Thank you. So I am looking at the revenue growth guidance, on backing out what I think source Horizon and Ontrack will contribute and it looks like you are guiding towards the high end of normal seasonality for revenue growth of both segments, do you have that right and if so what’s driving that guidance level given the macro backdrop?

Roy Vallee

Hi Will, it's Roy. So I guess the first thing we ought to do is maybe backtrack and calibrate what is normal. So from an EM point of view, we think that anything from -1 to -4 sequential would be normal. Therefore, about -2.5 would be the normal midpoint. And we think that including M&A, we are guiding at about -1.5, so it's very close, perhaps just slightly better. As you know, we just came off the quarter where we exceeded the high end of our expectations for the quarter for EM. You have probably seen some of the SIA data lately indicating strength in the semiconductor market on a worldwide basis. We feel that we are gaining share in the component segment on a worldwide basis and so we are slightly ahead in that regard.

William Stein

Okay.

Roy Vallee

From a TS point of view, you are typically coming off of the June quarter, which is the Sun Micro fiscal year-end. We think midpoint would be down around 7% and including M&A we think were down roughly 7%. So perhaps the others, there is a rounding in there. 7.5 may be on the guidance we gave on Analyst Day versus 7% that we are guiding to.

William Stein

Okay, that's helpful. And then one more, I hope if we can get clarity on the rebate issue. Is there still -- I heard someone said that that issue is fixed and now behind us, but obviously margins are still quite a bit below the target range in that segment. Is there still something to be worked out in that segment in the current fiscal year, in fiscal '09 where we should see something from rebates cause margins to recover and return back into the targeted range?

Roy Vallee

Yeah, so -- again, this is Roy. Will we have full recovery at the gross margin line, so in fact our gross profit margin at TS for the quarter was the highest quarter we've had for the fiscal year and it was up just slightly from the fourth quarter of last year and that's where the rebate accounting would occur. So that bags the question therefore what's the problem with the operating relative to our long range model and our historical levels and the answer to that would be volume relative to where we last year and relative to our expectations. Keep in mind in both of our businesses, a significant amount of the top line growth that we are delivering right now, let's say in the last couple of quarters, is the result of M&A and currency and that kind of top line doesn't create the operating leverage that you would normally expect to see in our model. So the simple answer on TS, we need any combination of higher levels of organic revenue growth and/or lower cost as a percentage of revenue or gross profit volume and that’s how we are going to get our margins back.

William Stein

Do you think you are going to hit the target margin range in that segment in fiscal '09?

Roy Vallee

I think for the year, we are going to be very close. We certainly will and should for the December quarter, the seasonally strongest quarter of the year that should not be an issue. The question is can we do it for the whole year and I think it's going to be close to the low end of the guidance range.

William Stein

Thanks very much.

Roy Vallee

You are welcome.

Operator

Thank you. Next question comes from the line of Steven Fox with Merrill Lynch. Please proceed with your question.

Ingrid Aja

Hi. It's Ingrid Aja in for Steven. I thought if you can discuss more the -- a little bit more of what you were just talking about, the improvement in the TS margins and what limited that rebound or is it just volume and where do you think they can go by the December quarter?

Roy Vallee

John, do you want to take that?

John Paget

Let me see. So there was certainly a volume impact in this quarter as we were slightly below the low end of what we had anticipated. The gross margins were, as Roy stated, were the best we have seen this year. We are continuing to rollout and we will realize the full benefits of the actions we took from a cost standpoint in the September quarter and then many roll on into our quarter, which will be a December quarter. We expect and again the highest quarter that we have is our December, we would expect to be at that range for the December quarter.

Ingrid Aja

Okay, great. Thanks. And then maybe if you could -- what was organic growth rate for the quarter if you could back off those the currency effect and acquisitions?

Roy Vallee

Ingrid, at the enterprise level, it was essentially zero.

Ingrid Aja

Okay, zero. Do you have of TS and EM?

Roy Vallee

We do for EM it was slightly above zero and for TS it's slightly below zero.

Ingrid Aja

Okay. And then just…

Roy Vallee

I think clearly this goes back to my comment earlier. We are in a challenging environment for sure, however, what's happening is our team is doing a good job of managing operations effectively and as a result of that producing strong levels of cash flow. And then in addition to that we are using the cash flow to deal or to generate value creating acquisitions and those acquisitions are helping revenue and to an extent EPS, but more importantly strengthening our scale and scope and creating competitive advantage is going to benefit us for the long-term. So right now we are challenged with the lack of true organic growth and we are managing our way through that with the disciplined portfolio of management of approach and by reducing cost where appropriate and reducing working capital where appropriate.

Ingrid Aja

Okay, great. Well, I guess on the inventory levels that you have been able to achieve are at near top record turns, what kind of level of improvement do you think is left and which area, which business would you think that that mostly that is going to come from?

Raymond Sadowski

So the perspective that I have you know, first I have to give you the obligatory speech about, our goal is not have a zero inventory, in neither one of our businesses, right. This is part of the value preposition that we deliver at the global tech supply chain and it’s an important part of the value we deliver. So that’s not our goal. Our goal is to make sure that every dollar of working capital investment is productive and the same way that we think about every dollar of expense that’s invested in our business is productive, okay.

Ingrid Aja

Right.

Raymond Sadowski

So with that is you know, the backdrop. The reality is two things drive inventory, one, is increased volume and the second one is longer product lead times from our suppliers. Right now, you know, the unit volumes are relatively stable and the product lead times are relatively stable and in that environment, we can achieve higher and higher levels of inventory velocity. Well what would impact that going forward would be you know, if growth went negative we will actually generate more cash, if growth goes positive we would actually use some additional working capital and then the same is true for product lead times. If we get into a situation where product become more difficult to get and therefore we need more inventory to meet our service requirements with our customers then you will see our inventory begin to grow. Typically when that happens you know, revenue and gross profit volume is also rising and we are able to improve returns even though we might be increasing the working capital investments.

Ingrid Aja

Okay, great. Thank you.

Raymond Sadowski

Okay. Just to remind everyone on the call that the P&L in our business is cyclical and is impacted by revenues. The balance sheet is counter cyclical, we carry a large amount of working capital to finance the technology supply chain and when revenue declines we generate cash from the balance sheet and when revenues grows we use cash to invest back in. Okay, next question?

Operator

Thank you. Our next question comes from the line of Brian Alexandra from Raymond James. Please proceed with your questions.

Brian Alexandra

Thanks. Roy, how much of organic growth just to go back to the earlier comment about TS margins are going to be primarily driven by growth from there, so how much organic growth do you need to see to hit the target of TS margin target for FY '09. I am just trying to get a sense of how we would ramp to even 3.9% which is the low end of that range given that your gross margins have already recovered and we are still below the line of that range?

Roy Vallee

Yeah Brian, I think in the FY '09 plans we are thinking about something like a middle single digit organic growth rate baked in.

Brian Alexandra

Okay, so mixed single digit organic growth should get you upto the 3.9% for the full year?

Roy Vallee

Roughly.

Brian Alexandra

Okay. And remind me how much of the restructuring actions that you have already announced and the ones that you have announced today how much of those dollars have yet to hit TS?

Roy Vallee

Ray, can you take that.

Raymond Sadowski

Roughly incrementally we will say 4 million bucks on a quarterly basis, so 16 million on annualized basis.

Brian Alexandra

Okay. And then just switching over to EM, it looked to me that on an organic basis excluding currency you saw big year-over-year improvement, and I think you were roughly flat and your competitor was down closer to 10%. If you could just talk about, what drove the relative performance there, are there mix issue to explain it? Or is it just execution driven. And then I guess, the same question for Asia where it looks like you might have underperformed your major competitor? Thanks.

Raymond Sadowski

Brian, I think it’s a good opportunity to turn the call over to Harley.

Harley Feldberg

Yes, hi Brian. Obviously, I can't comment on how those numbers broke out. For us clearly we believe that we are performing quite well. We believe, we gain share in all regions actually. I will comment on Asia in a minute. And I think what we’re seeing is really terrific acceptance in the value based aspects of our offerings to both our customers and our suppliers. And, we really think its allowing us to grow ahead of the market and gain share. Specific to Asia, based on what major suppliers we track we really did not see any evidence of any share gain in our business in Asia.

Brian Alexander

I guess, I am looking at one competitor who reported I think 32% growth and you reported 4, are you suggesting that the 4% growth is above market?

Harley Feldberg

No, what I say Brian is that the core suppliers that we track, we were right in with their growth rates. There are other suppliers that maybe growing in an accelerated rate in that region both were [indigenous] supplier, but not on those that we are principally focused on.

Brian Alexander

Okay.

Roy Vallee

Okay. So Brian as you know, we’ve got very small exposure in memory as one example. Another example might be a product line like MediaTek where we don’t have the franchise and there is some exciting growth rates. But we track market share based upon, but we do have variety of ways, but one of the ways we do it is, we look at the products for which we are franchised and we accumulate a basket of revenues and our performance against that basket that our team is performing well in Asia. And one thing I will add is that our team is growing gross profit volume faster than sales volume in Asia as well.

Brian Alexander

Okay. And final one, on your guidance for TS, which I agree also looked to be a little bit better than seasonal, if I were to just look at on a year-over-year basis, it looks like you’re looking to improve growth there, if I pullout acquisitions, and if I pullout currency. Is that improvement in year-over-year growth primarily driven by a recovery and the issues you saw this quarter i. e. the CPUs and memory, or is that improvement coming from the core enterprise?

John Paget

Brian, I would say that recovery is coming across the business. So its not just in the microprocessor business.

Brian Alexander

Okay, thank you.

Roy Vallee

You are welcome.

Operator

Thank you. Our next question comes from the line of Jim Suva with Citigroup. Please proceed with your question.

Jim Suva

Great. Thank you very much. And can you please clarify two points. One is, we know this quarter we turned in better than expected and congratulations on that. You continually keep referencing the challenging environment and you’re guiding to normal. Can you help us connect that? And then the second connection is, when we look at the September guidance where revenue I think was better than everyone expected, it looks like there is a little bit of a disconnection there on the EPS outlook, which could have been a little bit better, is there something more on cost or shipping going on there or why the disconnect have not seen a couple of more pennies down to the EPS line?

Roy Vallee

Jim let me go backwards. As you might imagine we have sort of scrutinized these numbers. First point is if you look back in the history for Avnet, the first quarter is clearly our softest seasonal quarter, and there is a variety of factors that contribute to that, but it's on our softest seasonal quarter and typically we generate anywhere from 18 to 22% of our annual earnings in Q1. So this method is not actually out of line relative to our expectations. As far as what is driving it this year, I can point to two different issues, if you will. One, is that as I mention earlier, lot of the revenue that’s you are seeing now is coming from M&A and currency as oppose to organic growth. And so we are not giving the same kind of operating leverage that you would typically expect to get. Another way to say that is operating margin is down slightly year-on-year for the fourth quarter and we are expecting operating margin to be down slightly again for the first quarter. So that’s one set of issues. To get a little bit more tactical for you, Ray mentioned earlier that we have our equity compensation expenses and because there is variety of sort of archaic factors in terms of the accounting, but the net-net is that there is three $0.03 sequential increase in expenses due to our long-term incentive plan, it turns out to be a $0.01 change on a year-on-year bases. In addition to that this is the quarter that we implement on merit pay increases globally and there is about $0.03 sequential expense related to that. And then there is a third item, the tax true up that we had in the June quarter, if you look at the tax rate that we are assuming for the first quarter relative to what actually got booked in the June quarter, there is about $0.03 there Jim. So there is three specific items that round out to about $0.03 a piece and then on top of that you've got a different business mix. More sales coming from EM Asia, lower sells coming from EM Europe that’s part of what contributes to the every year this being our seasonally weakest quarter. So those are all the factors that are causing the EPS to be where it is on that revenue number.

Jim Suva

Great. And the challenging environment comments versus guiding to normal if you can connect that?

Roy Vallee

Right. The macro environment is difficult, but as Harley said we got a number of strategies in the EM business, John has got to set a growth strategy for TS around solutions practices in vertical markets and our team is performing well. We think that we are gaining share of our served markets around the world and we are doing that while maintaining or even slightly expanding our gross profit margin. So that’s part of the issue. And then I think the other thing is our mix of business in the IT space the SMB is a little bit stronger than the overall IP market and has been for the last few years. And in the EM business we have relatively low exposure to the consumer and we are seeing a fairly stable, although not robust, but stable environment in the business depending on CapEx. So all those things are going into our thinking and what we are experiencing.

Jim Suva

Great. And a quick clarification question when you mention December 27 to year end, what normally would you expect that quarter to be on historical, but since its so back end loaded. Can you help us adjust for historically looking back, if one were to close the books on December 27 what would be the normal?

Roy Vallee

We – I don’t know, If I have that in front of me, but I want to say its in the ballpark of 25 to 30% sequential growth for the TS business in the December quarter. And we expect that we are going to get typically seasonal growth at this point in time based on we know today. However, we don’t yet Jim have the handle on the impact of missing four days. If you look at last year, we were two days off from the calendar close and we had a small impact. And we talked about that openly at Analyst Day and then when we report the results. We are thinking that because there is four days this year is going to be little bit bigger impact, but we don’t really know yet how to quantify that. So we are going to do our best when we get to the guidance for that December quarter. But even then we are going have to give a range, because it’s going to be difficult to determine. What happens here is normally a lot of activity would take place in that four day period. Our team is going to work very hard to pull everything possible into our fiscal period and the question is going to be what customers can we not book and what orders can we not get out until the March quarter.

Jim Suva

Great, thank very much.

Raymond Sadowski

And by the way Jim, let me just wrap by saying, lets just to put it all in context, all we are talking about here is whether the revenue shows in the December quarter or the March quarter. If you look at revenue from October through March, it should be a non-issue.

Jim Suva

Great, thank you very much.

Raymond Sadowski

You are welcome.

Operator

Thank you. Our next question comes form line of Carter Shoop with Deutsche Bank. Please proceed with your question.

Carter Shoop

Good afternoon.

Roy Vallee

Hi Carter.

Carter Shoop

I wanted to ask two questions here. First, housekeeping question on stock option compensation. Thanks for pointing that out being a $0.03 drag quarter-over-quarter. Are we going to see a sequential benefit in the December quarter?

Raymond Sadowski

Yes, you will. So the $0.03 sequential increase essentially comes right back down again. I'm not sure if it's exactly $0.03, but it will come down, lets just say for conservative purposes $0.02. But yes, it will come down again. If you look at last year same pattern last year higher in Q1 and then coming down in Q2, 3 and 4.

Carter Shoop

Okay, great. One more housekeeping actually, the tax rate going up, I think you said 32 to 32.5%. Can you help me understand why that’s?

Raymond Sadowski

No, 30.5 to 32.5, right.

Carter Shoop

30.5 to 32.5, okay.

Raymond Sadowski

It is just going up marginally.

Carter Shoop

Got it. And then last question. When we look at the activity over the past two years do you think that’s a good way to think about the future acquisition activity for Avnet or do you think that we'll actually see deal activity above or below that type of a rate?

Raymond Sadowski

You know, Carter, it’s without -- hopefully without sounding like I'm avoiding your question, I really don't know how to answer it. We have a nice robust pipeline. I believe that the combination of the challenging environment as well as the lack of liquidity in the capital markets is bringing a lot of sellers forward. And as a result of that we have a nice pipeline at both EM and TS. We are working on deals, but I got to tell you, forecasting M&A is really, really difficult. So intuitively, I would think that the combination of our balance sheet and cash flow and our proven promise in M&A coupled with the fact that this kind of environment typically brings more deals forward. Your assumption might be a good assumption, but I just have to take the 5th on this one and tell you that I don't know how to forecast M&A.

Carter Shoop

That's fine. Thanks a lot.

Raymond Sadowski

You are welcome.

Operator

Thank you our next question comes from line of Matt Sheerin with Thomas Weisel Partners. Please proceed with your question.

Matthew Sheerin

Yes, thanks. Just one question, a follow-up to Jim concerning the computing revenue at the end of the quarter. So if these four days carried over to March, does that affect in any way how you account for when to pay the rebate dollars that is a big component of your gross margin in the fourth quarter?

Raymond Sadowski

That is an excellent question Matt. John, do you want to take it?

John Paget

Yeah Matt, it is not. Our rebate dollars are earned at the same calendar that the vendors earn.

Raymond Sadowski

So Matt we will continue – we do this every quarter by the way. So we know the answer to this question. Despite the fact that our fiscal period is closed, we will continue to transact business and report that business back to our vendor community and they will include that performance in their fiscal periods and our rebates are based on performance in their fiscal periods. The answer to your question is no impact.

Matthew Sheerin

Okay. And then just staying on gross margin, for the September quarter, you didn't give any specific gross margin guidance. And it's over the years some years is down, some years its up, but given that you have that Horizon acquisition kicking in on the computing side as you point out you are going to see relatively weakness in EM Europe which is higher gross margin and better sales in Asia. So what I assume gross margin would be flat to down sequentially?

Raymond Sadowski

Yeah. I think historically it tends to be down a little bit sequentially in the first quarter, and I think under normal conditions that would be the right assumption. Our current projections have it flat to down just slightly.

Matthew Sheerin

Okay. And getting back to the guidance and the visibility, it sounds like we are seeing a return to normal seasonal partners, but not everyone, there is a lot of your suppliers, a lot of other distributors are seeing continued weakness or not much visibility at all. You've had a few up and down quarters in terms of hitting revenue. So maybe you could talk hardly about the book to bill that you are seeing in different regions on a component side and what kind of confidence do you have in terms of visibility in both businesses?

Harley Feldberg

Sure. Relative to book to bill in the EM business by region, the way I would categorize the June quarter was we closed with slightly below one in the West, which for us would be both Europe and America, and subsequently slightly above one in the East in Asia. So overall it runs out to almost exactly one-to-one for the quarter with a slight variance between East and West.

Raymond Sadowski

And Matt as you know the components business with relatively short product lead times the need for the customers to book more than they are taking is really not there. And as a result book to bill tends to be very close to parity in times when product lead times are under control. In terms of visibility, well I'll tell you, that you just all have to do is play back the March quarter conference call. Through 11 out of 13 weeks in the quarter, we thought we were on track. And then the last two weeks we were very much surprised by the lack of volume. So I have to tell you that the challenge we have in this environment is visibility. Our management philosophy is really to stay on top of our operations on a, week-to-week, month-to-month basis and b, if I could use this term hyperreactive as oppose to predictive. So our modus operandi right now is to look at our portfolio, make adjustments where adjustments are needed, keep investing in the organic growth opportunities and we have them by group and by region, and then generate significant cash flow and use that cash flow for value-creating acquisitions. That’s the mode of operation that we are in right now.

Roy Vallee

If I could add on top of that Matt, when we think about the components business specifically and we think about the guidance going forward or the visibility as you said, two factors that we analyze very closely are those that sort of we see relative to excess inventory in the channel overall, which really looks quite manageable at this point overall, not just within our own business but overall and we read that as a good indicator. And secondly, we track unit volume. So though clearly there has been significant ASP pressure all through the supply chain. Unit volume has held up pretty good and coming into or closing out the June quarter, we were pretty much in line with where we would like to be.

Matthew Sheerin

Okay. And you haven't seen any abnormal spike in cancellations?

Raymond Sadowski

None whatsoever

Roy Vallee

Yeah Matt, historically cancellations would be a good indicator, but we are carrying relatively little backlog these days. There is so much in the supply chain category where we are staging the material based on forecast, but we are not actually booking until we get the notice. So I'm not sure that cancellations are as a good indicator as they used to be in the past.

Matthew Sheerin

It’s only after business is really good and then when you start to see cancellations that’s a sign of a slow down, right.

Roy Vallee

Yes, that’s a fair point.

Matthew Sheerin

Yeah, okay. Thanks a lot.

Roy Vallee

You are welcome.

Operator

Thank you. Our next question comes from the line of [Brandon Furlong] with [Marriot Tavec]. Please proceed with your question.

Brandon Furlong

Good afternoon, gentlemen. Just kind of a follow on question from several callers. The gross margin I have down slightly for the September quarter, which means SG&A as a percent of gross profit is we are getting a spike. Any kind of directional value that you can give us in December and March, as SG&A as a percent of growth profit or some such metric? Thanks

Roy Vallee

Sure. Brandon this is Roy. My suggestion would be if you just look at the historical patterns, you'll typically see a spike for us in the first quarter period, and then you'll see a nice drop in the December period. We have the revenue spike from tech solutions and then in the March quarter it tends to move back a little bit, but gross margin rises as a result of the mix shift. So, it’s actually -- my expectation this fiscal year would be that we would follow typically our normal pattern there. And if you would like some more insight, Vince can get with you after the call. I know you are relatively new to the story and building your database.

Brandon Furlong

Great, thank you very much.

Roy Vallee

You are welcome.

Operator

Thank you. Our next question comes from the line of Sean Conner with FAS Advisors. Please proceed with your question.

Sean Conner

Thanks guys. Just one quick follow up. On the Tech Solutions side of things, so I think you said your organic growth was roughly 0% if you include or exclude M&A on a constant currency basis. How do you think that compares to kind of just the overall industry? It seems like most of the other hardware companies excluding Sun actually are putting up pretty decent year-over-year growth. So can you maybe talk a little bit do you think you are still kind of maintaining share, are losing a little bit of share, is it because of your mix of products versus your peer group?

Roy Vallee

Sean, this is Roy. First of all, my meager reaction here is to get a little defensive, but let me explain why. We are giving you data that I don't think anybody else is giving. When we talk about organic growth and in constant currency, that's data that’s not typically talked about out there. So, for example, if you look at our TS delivered growth, it was up 9.9%. As we look at market share in the products that we are involved in and the mix of business that we have got, I think we feel very good about our share performance. John, do you want to make any comments about that?

John Paget

Certainly. We do track share growth certainly in the Americas. We've seen over the last three quarters a significant increase in our share especially in HP BCS as an example. You may take as much as 10 points of market share over the last quarter. So we feel pretty comfortable that we are continuing to gain share in the areas that we focus in.

Roy Vallee

Yeah and then Sean here the one other thing I'll point out, a lot of the hardware OEMs that are our suppliers have significantly higher exposure to emerging markets than we do so far.

Sean Conner

Okay.

Roy Vallee

Now you've seen us make moves. We've just announced a deal in India. We are moving into Eastern Europe in a reasonably strong way with our Tech Solutions business. So you are going to see us continue to make progress in that area, but we've been spending our time penetrating the larger more established markets and we are sort of now getting more focused on the emerging markets. So watch for that over the next few quarters as well.

Sean Conner

Okay. And just one follow up. Yesterday, Cisco talked about actually seeing kind of their business in US enterprise is that business is finally starting to pick up and at least stabilizing and order rates are picking up. Can you just may be talk about, give a little bit of color on the main regions, US on the hardware versus Asia versus Europe?

Roy Vallee

Well, I think we can support John's comments. We had a nice June quarter. We are off to a reasonably good start here in the summer quarter. Our Americas business is meeting and exceeding our financial targets. So we agree with all of his comments. As far as why? That is a tougher question. We speculated last quarter, the March quarter that IT budgets may have been reduced going into calendar '08 and then on top of that given the macro economic environment at the end of March, there were some decisions made to just hold on to cash and not use it for discretionary IT projects. It seems like because we had a normalized seasonal pattern in June that has loosened up a bit. But as I mentioned earlier, we are still down year on year. So I think that things are returning to a more normalized state in the US and our business is performing well within that environment.

John Paget

And in support of that Roy, we didn't see the push-out of any of the big deals that we saw say in the March quarter at the end of the June quarter and we closed most of those that pushed out.

Sean Conner

So the pipeline behaved normally?

Roy Vallee

Yeah right. Okay Sean.

Sean Conner

Thank you guys.

Roy Vallee

You are very welcome.

Operator

Thank you. At this time this concludes the question-and-answer session. I would like to turn the floor back over to management for any closing comments.

Vincent Keenan

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

Roy Vallee

Thanks everybody.

Operator

Thank you. Ladies and gentlemen, this concludes today's conference call. You may disconnect your lines at this time. Thank you for your participation.

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Source: Avnet Inc. Q4 2008 Earnings Call Transcript
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