Avnet Inc

NASDAQ:AVT

Earnings Call Transcript 2018-Q3

[Operator]

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

[Vincent Keenan, Avnet, Inc.]

Good morning and welcome to Avnet's third quarter of fiscal year 2018 business and financial update.

As we provide the highlights for our third quarter fiscal year 2018, please note that in the accompanying remarks, we have excluded certain items including accelerated depreciation, intangible asset amortization expense, goodwill impairment, restructuring, integration and other items and certain discrete income tax adjustments from all periods covered in our non-GAAP results.

When we refer to constant currency or the impact of foreign currency, we mean the impact due to the change in foreign currency exchange rates when translating Avnet's non-U.S. dollar-based financial statements into U.S. dollars. When we refer to organic sales, we have adjusted the prior periods to include the impact of acquisitions. For additional information, refer to the non-GAAP financial information section of our earnings press release available on our website at www.ir.avnet.com.

Before we get started with the presentation from Avnet management, I would like to review Avnet's Safe Harbor statement. This call contains certain forward-looking statements which are statements addressing future financial and operating results of Avnet. There are several factors that could cause actual results to differ materially from those described in the forward-looking statements. More detailed information about these and other factors is set forth in Avnet's filings with the Securities and Exchange Commission.

In just a few moments, Bill Amelio, Avnet's CEO, will provide Avnet's third quarter fiscal year 2018 highlights. Following Bill, our Chief Financial Officer, Tom Liguori will review some additional financial highlights and provide fourth quarter fiscal 2018 guidance. Also here today to take any questions you may have related to Avnet's business operations is Phil Gallagher, President, Electronic Components.

With that, let me introduce Mr. Bill Amelio to discuss Avnet's third quarter fiscal 2018 business highlights.

[William J. Amelio, Avnet, Inc.]

Thank you, Vince and hello, everyone. Thank you for taking the time to be with us and your interest in Avnet.

We continued to make significant progress with our revenue and earnings momentum this quarter as both operating groups delivered above-seasonal growth in the March quarter. As a result, revenue of $4.8 billion grew in the high single digits year-over-year and adjusted operating margins expanded to 3.7%, the highest level in four quarters. Our transformation and cost reduction initiatives contributed to strong leverage as adjusted operating income grew three times faster than revenue sequentially and adjusted EPS increased 31% to $1.02.

Our Americas region at Electronic Components continued its turnaround with another quarter of sequential revenue growth and adjusted operating margin expansion. With our growth initiatives gaining traction and a strong book-to-bill across the regions, we expect to build on this performance and closeout fiscal 2018 with revenue and EPS above the original guidance we laid out one year ago.

Turning to the future, I'd like to provide an update on the four pillars of Avnet's business strategy that will drive shareholder value creation going forward. The first strategic pillar is our unique end-to-end ecosystem including our recent acquisitions: small order specialist Premier Farnell; design-focused Hackster.io; and manufacturing solutions provider Dragon Innovation.

Our communities composed of Hackster.io and element14 delivered another quarter of strong growth as memberships increased 12% sequentially and 48% year-over-year to nearly 1 million members. Online communities are becoming more important suppliers as they represent an engaged community that not only purchases more product, but provides an unbiased feedback and insight that can lead to an improved brand exposure, awareness and credibility.

For engineers, online communities provide more than just product and technical information, but a forum that they can collaborate, solve problems and ask questions. The design process has been democratized by the use of the Internet and communities.

We also continue to make progress realizing revenue synergies across our ecosystem. After significant efforts applying advanced analytics to match and segment our customer bases in all three regions, we're now seeing success to exposing the value propositions of our different businesses to meet customer needs.

We also use the output of this analysis to identify potential opportunities to register designs with our suppliers to further grow our core components business. So far, we found out that one of every two qualified leads from Premier Farnell becomes an approved design registration. This initial effort, which was tested in Europe, has already resulted in $5 million of approved design registrations from a pipeline that we believe will expand as we roll out these tools in other regions.

Although early in the process, we have been also seeing success from our enhanced digital functionality that allows customers to buy inventory from both Premier Farnell and Avnet on our trading websites. These represent just a few of the ways we're leveraging the combined customer base to drive higher-margin revenue growth as we add new features and products to our unique end-to-end ecosystem.

Our second pillar, the digitization of our business represents a multi-year effort to digitize more of our processes and utilize advanced analytics and tools to improve our business performance. Our end-to-end ecosystem is a proof point of the impact we're having as our annual run rate of digital revenue grew nearly 7% from the prior quarter to $850 million.

We also tested new tools and systems in the areas of CRM, lead generation, quoting, pricing and digital commerce that have demonstrated a positive impact on the trajectory of our revenue growth and margin expansion.

As we applied workarounds and software upgrades to the current system in the Americas region, we have seen a better than expected improvement in system performance as evidenced by our key performance indicators we track as well as feedback from customers and suppliers.

We're now able to shift our focus to a winning new business. Many of the digital tools we tested as part of the transformation have shown real promise to improve productivity, realize higher margins, accelerate revenue growth and improve the customer experience. As a result, we're focusing on systems that can accelerate growth and margin expansion globally while adding enhancements in the Americas system.

One of the areas in which we will increase investment on a global scale is CRM. We have tested a cloud-based CRM solution that provides new capabilities and reports including pipeline visibility, order characteristics, performance and other key data points by sales rep. We believe the deployment of this system globally will allow us to more efficiently track and share leads across our entire ecosystem to accelerate growth with our evolving customer base.

Other areas in which we will accelerate investment include quoting and pricing software. With our end-to-end ecosystem, we have more opportunities to win business, so it is critical that we provide our employees the tools and systems to quickly and efficiently produce more orders.

In summary, we are committed to globalizing our business processes and systems and we have modified our priorities to accelerate growth and financial performance.

Our third strategic pillar, our transformation initiative, goes beyond the introduction of new systems that I just talked about. It also focuses on leveraging the strength of Avnet by developing new go-to-market strategies focused on high-growth segments while deploying global processes that deliver best-in-class solutions.

One of the important growth strategies that our transformation initiative has focused on is the Internet of Things. At the Consumer Electronics Show, we introduced our IoTConnect platform, which utilizes the enterprise-grade Microsoft Azure hybrid cloud for data distribution and analysis. This quarter, we built on that relationship with Microsoft who chose Avnet as their first partner to distribute the new Azure Sphere solution.

This solution incorporates a highly secure Internet connected microcontroller that meets all seven properties of a highly secure device. By incorporating this product into their IoT solution, developers will ensure a safe and secure connected experience from the edge all the way up to the cloud.

When using Avnet's end-to-end ecosystem for system design combined with our expertise in manufacturing and supply chain services, customers will be able to deliver the highest standard of security when bringing their next generation of IoT solutions to market. Being selected by Microsoft for this important product launch is further evidence of the value suppliers can realize when they work across our entire ecosystem.

Another transformation initiative we have pursued is how we bring a deep and rich technical expertise to customers in a more streamlined and efficient manner. In the past year, we've globalized our management and alignment of FAE resources to focus on growth technologies and promote key suppliers in our AVAIL tool. Our AVAIL tool, which provides engineers block diagrams that address common engineering challenges, is continuing to expand the number of solutions and increasing the efficiency of our engineers.

Key performance indicators we track have been trending up. We have accelerated growth with many of those key suppliers as we captured two to three times more dollar content with each design. The value of our breadth and reach in the marketplace has been recognized by suppliers with several awards this quarter. We also added another 11 supplier franchises to our line card while expanding regional coverage with additional three.

Our focus on providing suppliers multiple paths to the market via our unique end-to-end ecosystem is gaining traction and translating into more growth opportunities in targeted markets including automotive and industrial.

The fourth pillar of our strategy is rightsizing the cost structure of Avnet. As we have told you on prior calls, we expect to realize $120 million of annual savings in fiscal 2018 by streamlining our structure and centralizing functions. We're expanding our fourth pillar to apply the same rigor and discipline to how we manage working capital. By sharing best practices and centralizing decision-making, we can improve our working capital velocity and free up cash in the process.

Finally, I'd like to invite everyone to our Investor Day on June 14 in New York City. Members of the Avnet leadership team will be providing more detail on our strategies and growth initiatives as well as demonstrations of customer success stories. We hope you can join us either in person or via the webcast and please reach out to our Investor Relations department, if you need additional details.

Now, I'd like to turn the commentary over to Tom who will provide more color on our financial performance. Tom?

[Thomas Liguori, Avnet, Inc.]

Thank you, Bill and hello everyone. A very positive quarter for us. Revenues grew 6.1% sequentially and 8% year-over-year. Adjusted operating margins expanded to 3.7%. While GAAP EPS was impacted by tax reform and an impairment charge, adjusted EPS was $1.02, a significant increase from last quarter's $0.78. We reduced net working capital seven days, generated $77 million of cash flow from operations and returned $93 million to shareholders. Let's review the details.

Year-over-year, revenue grew 8% and 2.4% in constant currency with both operating groups contributing. Excluding the impact of the previously announced supplier changes, revenue increased 7.3% year-over-year in constant currency. Sequentially, America continues to improve growing 5.5%. EMEA delivered another strong quarter growing 20% sequentially and 15% in constant currency. Asia declined 5% sequentially, 6% in constant currency, which is in line with normal seasonality and the impact of Chinese New Year.

Gross profit of $654 million increased $23.6 million compared to the prior-year quarter. Both Electronic Components and Premier Farnell contributed to the increase.

Selling, general and administrative expenses increased $21 million from the year-ago quarter primarily due to changes in foreign currency exchange rates. Excluding the currency movement, SG&A decreased $6.5 million from the year-ago quarter. Sequentially, SG&A increased $22 million. Of this amount, $10 million is due to currency movements and the remainder is due to volume-related expenses and a well-deserved bonus to non-executive employees.

We remain on track to our goal of $120 million of cost reductions in fiscal 2018 measured on a run rate basis. Year-to-date, we achieved 70% of the target with remainder expected in Q4.

As a result of these efforts, our adjusted operating expenses as a percentage of revenue have declined 32 basis points compared to a year-ago quarter. Now, we expect this downward trend to continue in fiscal 2019.

We recorded a goodwill impairment charge of $181 million in the third quarter. The goodwill was associated with the Americas region. As part of our planning process, we adjusted certain financial expectations for the Americas. As a result, we concluded the $181 million impairment charge was appropriate in the third quarter.

We are committed to our operating margin target of 4.5% to 5% and the impairment charge is not, in any manner, an indication of a change in our operating margin expectation.

Excluding the impairment charge and restructuring expense, adjusted operating income of $175 million increased $29 million or 20% from the December quarter. The third quarter adjusted operating margin of 3.7% was a 43 basis point improvement from 3.2% in the second quarter. Our Premier Farnell business continued to perform well expanding operating margins this quarter to 11.4%. Below the operating margin line, other income of $8.4 million includes favorable currency gains from the re-measurement of balance sheet items to U.S. dollars.

Our operating tax rate of 22.3% was 70 basis points better than the midpoint of our guidance range. Due to the recent tax reform legislation, we've recorded a tax charge of $230 million primarily related to the transition tax on foreign earnings.

On an adjusted basis, EPS was $1.02 in the third quarter, a substantial improvement from $0.78 last quarter and $0.88 a year ago. Of the $1.02 EPS, $0.07 per share were contributed by the favorable other income of $8.4 million and the lower tax rate. Excluding these two items, adjusted EPS was $0.95, the midpoint of our guidance range.

Turning to the balance sheet, we ended the quarter with $430 million of cash. We reduced our debt level this quarter by $141 million with the objective of lowering interest expense and improving our leverage ratio while maintaining availability in our lines of credit should the need arise.

Net working capital days decreased seven days to 93 in the March quarter primarily due to improved inventory management. Cash flow from operating activities was $77 million in the third quarter.

We sold $45 million of Tech Data stock which we acquired from the divestiture of the Technology Solutions business. We used these proceeds to repurchase $70 million or 1.7 million shares of our stock. We have $78 million of Tech Data stock remaining which will be sold in the fourth quarter. Entering the fourth quarter, we have approximately $390 million remaining under the current share repurchase authorization.

In summary, revenues increased 6% sequentially in the third quarter and adjusted EPS increased by 31%. Net working capital days declined by seven and we generated $77 million of cash from operations.

Looking forward to Avnet's June quarter, we expect sales to be in the range of $4.65 billion to $4.95 billion. Based on this revenue forecast, we expect adjusted diluted EPS to be in the range of $0.91 to $1.01 per share.

One last item, we are changing our stock listing to Nasdaq effective May 8. Our ticker symbol will continue to be AVT. Our Investor Day on June 14 will be at Nasdaq in Times Square, New York. Following our management presentations, we will have an aftermarket bell ringing followed by a reception. We look forward to seeing you all at the event.

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

[Operator]

Thank you. Our first question is with Jim Suva with Citigroup. Please proceed with your question.

[Jim Suva, Citigroup Global Markets, Inc.]

Thanks very much. Can you help us just a little bit, I figure out the gap between sales year-over-year were very, very impressive, but year-over-year, it looks like operating margins are down. To bridge that is that you need to do more restructuring, is it because of the sale of the TS business that you did and how should we think about why sales are growing year-over-year yet margins are down year-over-year?

[Thomas Liguori, Avnet, Inc.]

Sure, Jim. This is Tom. So, basically, on a year-over-year basis, we did have this supplier losses that affected margins and things of that nature. What we feel very good about is we're back to the 3.7% range. If you put that in relation to historical, I think before supplier losses, we're about 3.9%, so we're pretty much of the way back. That said, we have a lot of opportunity remaining for the margins. Target remains 4.5% to 5%, that's the Americas continuing to get better, that's expanding our revenues and margins of Premier Farnell. We're going to have a better revenue mix that's higher margin and continuing with these cost reduction efforts. So, hope that answers your question.

[Jim Suva, Citigroup Global Markets, Inc.]

Yes. And then a quick follow-up probably more for CFO type commentary, but on the tax reform that has happened, can you help understand about, I think Avnet took a charge for the new tax reform, so is there a future benefit that will see your tax rate go down or how should we think about the tax impact? Thank you.

[Thomas Liguori, Avnet, Inc.]

Yeah, no. That's a really good question and to be honest, we're working through that. But I think it's fair to say our guidance in the press release is 21% to 25%, so let's take the midpoint of 23%, we should be at or better as we go forward into the next fiscal year. That's one of the challenges, right? Tax rates around the world have come down and our job is to take advantage of that while being compliant and making sure we do this wisely. I'm looking at my General Counsel while I say that.

[Jim Suva, Citigroup Global Markets, Inc.]

Great. Thanks so much for the details.

[Thomas Liguori, Avnet, Inc.]

Thank you, Jim.

[Operator]

Our next question is with Param Singh with Bank of America Merrill Lynch. Please proceed with your question.

[Param Singh, Bank of America Merrill Lynch]

Guys, thank you for taking my question. So, when I look at your guide, implied guidance is for operating margin to be flat sequentially into the June quarter. Now, you have some more incremental margin benefit coming in from restructuring, Americas is improving. Why the flat margin guide? And how do we proceed to your 4.5% lower end of your target range from here? If you could quantify that a little bit, that'd be helpful and then I have a follow-up.

[William J. Amelio, Avnet, Inc.]

Yeah, okay. This is Bill. I'll start with the second part of the question and I'll have comment, the first part. As far as we're still guiding to 4.5% to 5% in the future and the way we get there, Tom mentioned a few things on the last question which was Americas recovering, Premier Farnell, I'll add a couple other things.

So, the digitization of our business is going extremely well. The more we look to the web, the lower cost to serve model that is both from a cost point of view as well as an improved margin point of view. We're digitizing elements of the process inside the company which makes us more efficient and more effective and allows us to get a better OpEx position. We're also continuing to transform the company with plenty of projects that will continue to work on that makes us more efficient in pricing, in the way we go to market, in the way we help qualify leads, in the way we essentially have the funnel of opportunities and how we manage that with new CRM tools. Tom?

[Thomas Liguori, Avnet, Inc.]

Yes. And Param, so we had a significant step-up, right, in performance this quarter, EPS and operating margin, and the midpoint of the guidance is similar revenues, some improvement in the cost leveraging. That said, we have a tremendous opportunity here, right, through EPS accretion and what has to happen is growth and growing more of the front-end of the ecosystem, the higher-margin business, continue to leverage the cost, and working on working capital, free up cash, and apply that to reinvesting in the business, M&A is available and more importantly, buybacks.

So every quarter, we want to focus on discussions of revenue, revenue mix, cost and our balance sheet. And by doing that and making progress every quarter in those areas, we're going to have a very good outcome on our operating margin and our EPS. That said, we want to be respectful that we need to help you and (24:35) quarter coming up similar revenues, slight improvement in the cost structure (24:43).

[Param Singh, Bank of America Merrill Lynch]

Okay. So, I guess as my follow-up, how much of your working capital is being negatively impacted by the ERP system in the Americas and when do you expect to kind of upgrade that system and what is the working capital level you think you can get the company to longer term?

[Thomas Liguori, Avnet, Inc.]

Yeah. So, I don't have a specific number. But, it's a sizeable impact on why the inventory increased. Part of it is also, it's hey, we had a really good implementation of an ERP system in Europe and we just want to be careful. There's been a build-up in inventory. That said, we all know that our working capital is historically at high levels. It's over 90 days even today. Historically, the company has been at 70 days or less. There's no one or two or three items that are going to get it back.

But the good news is this is fundamental. It's foundational. We have a team. They have action items. They're putting together the waterfall chart, the action items and timeframe. And we actually have a phrase internally, how do we get our working capital down one day at a time, because every day it's worth $45 million to $50 million. We get ten days, we get $500 million and that's our payout. So, I would say over two years, maybe over three years, historical levels in the 70-day range.

[Param Singh, Bank of America Merrill Lynch]

Okay. And just a clarification on the ERP system in the Americas. When do you expect to start working on that project and any timeline for that?

[William J. Amelio, Avnet, Inc.]

We're already in the midst of that and the game plan will be the following. We're going to implement our AIS business first, our Integrated Solutions business first and then follow up with the rest of the core. That helps de-risk the program significantly and in the meantime, we're already seeing inventory coming down as we see in the current system become more stable and allow us to be able to get more efficient.

[Param Singh, Bank of America Merrill Lynch]

Great. Thank you. I'll get back in the queue. Appreciate it.

[Operator]

Our next question is with Adrienne Colby with Deutsche Bank. Please proceed with your question.

[Adrienne Colby, Deutsche Bank Securities, Inc.]

Hi, thanks for taking my question. I was hoping you could talk a little bit more about the progression of your turnaround in the business in the Americas. Given the region is still seeing mid single-digit year-over-year declines, when are you expecting the region to return to growth on a year-over-year basis? And of the headwinds that you've highlighted in the past for the region, can you remind us where you've seen the most progress and where you still have work to do going forward?

[William J. Amelio, Avnet, Inc.]

Last time we were together, I talked about some of the key performance indicators that are associated with what we're watching in Americas and all improving, in fact, if you take a look at – pick anyone of the, ship and debit discrepancies, customer disputes, negative orders in the system, all have in terms of levels that we saw pre going live with the current system we have in place. So, that's when we say we'll become more stable, those metrics demonstrate that.

We've also seen anecdotally from our suppliers and from our customers both would say that we're going a lot better. We've won a lot of the awards this past quarter which is another indication that things are going in the right direction. I'd also point out that sequentially, we actually grew in the Americas, when you – as you've taken out, loss that were taken out, a good compare quarter-on-quarter and we're starting to see that robust growth happening again in the Americas. So, if you normalize and take the prior losses out year-over-year, we actually did grow.

[Thomas Liguori, Avnet, Inc.]

Next question.

[Operator]

Our next question is with Matt Sheerin with Stifel. Please proceed with your question.

[Matthew John Sheerin, Stifel, Nicolaus & Co., Inc.]

Yes. Thanks. First, I was hoping to get some more color on the demand environment you're seeing in various regions. It looked like you're trending at or above seasonal at least in a couple of regions. But, if you look at your guidance, looks like more of a return to seasonality. So, could you talk about that what you're seeing in terms of book-to-bill, lead times and those kind of metrics?

[William J. Amelio, Avnet, Inc.]

Yeah, sure. Book-to-bill is still solid, we're still over 1.1. That's great and we continue to see robust demand in all regions, lead times appear to be stabilized. There are some commodity that are, of course, still expanding but in general, it's a more stable environment and we still see pretty solid demand across the board. I'd like Phil talk about each individual region and give us some more color.

[Philip R. Gallagher, Avnet, Inc.]

Yeah. Hey, Matt. Thanks for the question and just a couple of comments. Bill mentioned book-to-bill. Each region is having a positive book-to-bill and we say that it's a healthy positive, Matt. It's not crazy, it's at very healthy 1.1 plus or minus range across the board.

Europe continues, I think it's at 19 or so quarters, we're doing extremely well in Europe organically, all divisions in Europe. Driven – Europe really with the automotive and the industrials extremely strong and we continue to play there and we feel gaining share. Asia/Pacific has been steady. You've mentioned seasonality. So, you're correct on that. Coming out of the March quarter, we actually take – we're pleased with the results even given the Chinese New Year and some of the drop-off you typically get coming out of the December quarter.

As we've discussed in the previous question, the Americas has been a little bit of a nemesis and we feel we're really starting to turn the corner, which is great with Bill's comments on some of the customer response, our Net Promoter Scores, our supplier feedback. We're feeling very confident that we're starting to get our traction back in the Americas and continue to see that moderate growth here at home as well which is really, really great. We've got all three regions hitting on all cylinders will be terrific.

Matt, you've mentioned lead times, Bill touched on it. I mean, memory is still really, really tight. Controllers, depending on which one, you're kind of anywhere in an 8 to 24-week timeframe, depending on the 8 bit, 16 bit, or 32 bit. And really the troubled area is still in the passives area. The caps and resisters are still pretty far out there. Nobody uses the A-word anymore, but controlled bookings, 50-week lead times in some cases, so that's been the lynchpin if you will in much of the supply chain issues, if there are any. Hope that helps, Matt.

[Matthew John Sheerin, Stifel, Nicolaus & Co., Inc.]

Yeah, absolutely. And just on the follow-up question, just following up the Param's question about why the operating margin is flat sequentially when you still have costs coming out, and I think the answer probably is that your gross margin I think would be down sequentially because of mix, I would think that Europe is flat to down after that very strong December quarter, and also the mix with Premier Farnell. Is that the way to look at it or is there other ways to look at it?

[William J. Amelio, Avnet, Inc.]

I'll make a quick comment and pass it on to Tom. A couple of things: one, we're going to have a richer mix of Asia in the next quarter as well as our expenses are more backend loaded in the quarter versus linear and that's two major reasons why we're getting the kind of guidance you've seen.

[Thomas Liguori, Avnet, Inc.]

Yeah. Thank you, Bill. And Matt, first, so it's a range, right? And I think it's fair to say that this quarter, the first quarter of our fiscal year which is September through December, we expect the metrics for operating margin and EPS and others to continue to improve.

[William J. Amelio, Avnet, Inc.]

I'll make one other comment too. Last April, when we gave out guidance, we gave our full year guidance and it's important to note that we met or exceeded every one of those guide points and at the end of the year now, leading the guidance that we put in place a year ago. I think that's an important accomplishment for the company, a demonstration that we've got momentum back again.

[Thomas Liguori, Avnet, Inc.]

And to follow up on Bill, if you take our fourth quarter guidance, this is again raising our total year. I mean it's somewhere we were last quarter.

[Matthew John Sheerin, Stifel, Nicolaus & Co., Inc.]

Yeah. Okay. Fair enough. Okay. Thanks a lot.

[Operator]

Our next question is with Adam Tindle with Raymond James Financial. Please proceed with your question.

[Adam Tindle, Raymond James & Associates, Inc.]

Okay. Thank you. First question for Bill or Tom. I know, obviously, margin improvement is a key focus in Americas, this is a primary opportunity. You've talked about the sequential improvement in sales and operating margin in this region. Is there any way you could help us understand the magnitude in which this region is below historical levels? I think historically America was once in like the 6% type operating margin, are we currently closer to half of that?

[Thomas Liguori, Avnet, Inc.]

We're significantly below. I give you one piece of information, quarter-to-quarter, we're about at 100 basis points improvement. This is like really good news. That said, there's a lot more we can do.

[William J. Amelio, Avnet, Inc.]

I'll have one more thing to your mix there. Premier Farnell continues to – we expand margins of Premier Farnell and we see that as a still possibility going forward to continue to be better there as well. So, that's helping the mix and then of course getting more efficient with all that we do with the transformation project, digitization, work in the ecosystem, we have an opportunity to be able to take out more costs.

[Adam Tindle, Raymond James & Associates, Inc.]

Okay. And Tom, I wanted to ask for more color on the impairment. I think, Premier Farnell is about 60% of updated goodwill and intangibles and which seem insulated based on strong results, but could you give us a sense of the risk of additional impairment to the other 40% of goodwill and intangibles because the market today would seem to indicate just about all the rest ex-Premier Farnell is going to be written down? Thanks.

[Thomas Liguori, Avnet, Inc.]

Yeah, that's a good question. So, first of all, this goodwill is associated with really two pre-2011 acquisitions, it is related to the Americas and it is related to changing the expectations that we're in as compared to a prior-year test. Let's say, I want you to know that the assumption that we'd use in the impairment is the same assumption which is a conservative assumption for Americas in our total company target of 4.5% to 5%, right? So, if we do better, we do even better on that range.

You have a really good point, Adam. This year end, we'll do other tests. We don't foresee any other material changes to goodwill and we anticipate favorable results from our year-end. And especially when you look at Premier Farnell, they continue to, as Bill's point, they continue to do better on revenue, they continue to do better on operating margins and they're performing very nicely.

[Adam Tindle, Raymond James & Associates, Inc.]

Okay. Thank you.

[Operator]

Our next question is with William Stein with SunTrust. Please proceed with your question.

[William Stein, SunTrust Robinson Humphrey, Inc.]

Great. Thank you for taking my question. It is a follow-up on the discussion earlier about the extended lead times what we think pretty clearly your allocations going on in passives. So, appreciate the color that you provided earlier, but can you tell us how that's affecting your business today, and how you expect it to affect you going forward? Oftentimes in these shortage situations, distributors are able to sort of out-earn from the margin side from this factor maybe that's not happening maybe it is. How do you expect that to progress going forward? Thank you.

[Philip R. Gallagher, Avnet, Inc.]

Yeah, this is Phil. Thanks for the question. Yeah, so I'll answer two parts of it that I think you're looking to get a response. One is ASP appreciation based on some cost increases, we're getting some of that. A lot of the contracts we have with customers inhibit us from raising prices. So, some of that we have to absorb in our, what I'll call our core business, our time-place utility business. Yes, we absolutely do raise prices in that part of the business, but it's not an across the board. So, it's kind of a yes and no answer. So, we are seeing some of it. We like to be able to do a little bit more, but we have some contractual obligations to our customers.

And the other part of the question that you're asking is that, so we can get some products as that hold up shipments in other areas of the business where we have supply chain engagements in particular. There's some of that, but it's really not material. It's relatively small, okay?

[William Stein, SunTrust Robinson Humphrey, Inc.]

And are the suppliers of the shortage materials adding enough capacity to enable you to grow through the rest of the year or are you concerned that you can sort of hit a wall on overall growth because of shortage in just a small number of parts?

[Philip R. Gallagher, Avnet, Inc.]

Yeah, I'd rather not comment on the suppliers' capacity. So, I mean, that's a – we have some insight into that, but not across the board. I think the more important part of the question is, we don't see product constraints as an inhibitor, okay, of us hitting our targets that we've laid out.

[William Stein, SunTrust Robinson Humphrey, Inc.]

Great. Thanks, guys.

[Philip R. Gallagher, Avnet, Inc.]

You got it.

[Operator]

Our next question is with Shawn Harrison with Longbow Research. Please proceed with your question.

[Shawn M. Harrison, Longbow Research LLC]

Hi, morning.

[Thomas Liguori, Avnet, Inc.]

Hi, Shawn.

[Shawn M. Harrison, Longbow Research LLC]

Hi. I want to play a little Devil's Advocate here. So, how would you get to the bottom end of the guidance range for the June quarter? I'm wondering like what could weaken, knowing that the book-to-bill is positive in all regions, you guys sound pretty upbeat, so I'm just trying to figure out what within the guidance could potentially weaken sequentially to take you down to the bottom end of that range?

[William J. Amelio, Avnet, Inc.]

Well, I made two points earlier. One is the mix shift to the Asia regions as well as back-end loading of our expense reductions that will come out towards the end of the quarter. So, we won't get the full run rate inside the quarter. That's two major reasons why. And I also pointed to the full year guidance again that we gave a year ago, we are substantially beating that. So, that's I think important also.

[Shawn M. Harrison, Longbow Research LLC]

Sorry, Bill. I meant solely on the sales front, because at $4.65 billion you'd be down a little bit sequentially, but it doesn't sound like anything in your bookings run rate suggests a deceleration from the third quarter into the fourth quarter, just solely sales.

[William J. Amelio, Avnet, Inc.]

Yeah, that's correct. We're not concerned with respect to big deceleration here and it's kind of what we're guiding at right now is that sales number. We hope to beat it.

[Shawn M. Harrison, Longbow Research LLC]

Okay. Tom, I was hoping if you could help me bridge on the OpEx line. I know you have $120 million of annualized savings that will be in there exiting the quarter, but what would be the inflation on any year-over-year basis that we're seeing? Because I'm trying to bucket, bracket the $30 million of OpEx savings that should be in there, but what will be offsetting that on a year-over-year basis potentially as we exit fiscal 2018?

[Thomas Liguori, Avnet, Inc.]

Yeah. Well, I mean, inflation is fair. I would view this more as – and this is why we talked about OpEx as a percent of revenue and the I think it was 32 basis point improvement. That's equal to roughly $60 million. So, a way to view these cost reductions are, these are initiatives that are reducing costs, okay. In some cases, it goes to the bottom line; in other cases it's reinvested.

I'll give you two examples and this is something I lived through this quarter. Our human resources department had an initiative to put more of the function online. When I started before I even had my first day, I went on to our HR system and I put in all my personal information, my tax information, my benefits. And they took a very manual and labor-intensive paper process, put it online and we saved couple of million dollars as a result globally. We took part of that and another thing I saw since I started, we reinvested, as Bill said, in the CRM system. So, it's taking costs and reallocating them from the non-strategic to the strategic areas with some drop into the bottom line.

The CRM investment is a very good example of moving things to the market-facing activities. We had a presentation from one of our, well from our Integrated Solutions group. They showed us the results. It was very positive, good visibility on pipeline and things of that nature. So, I would look at the cost initiatives as these are the cost initiatives part of which drop to the bottom line, part of which get reinvested. Over time though we should clearly see that as a percent of our revenue, we're getting good leverage out of these numbers, initiatives. Does that help?

[Shawn M. Harrison, Longbow Research LLC]

It does. Maybe if I could just a quick clarification, the 32 basis points you saw in the March quarter year-over-year, should that expand then as you enter into fiscal 2019, so that it's more than that because you'll have the remaining 30% of the synergies?

[Thomas Liguori, Avnet, Inc.]

Yeah.

[Shawn M. Harrison, Longbow Research LLC]

Okay.

[Thomas Liguori, Avnet, Inc.]

Without a doubt.

[Shawn M. Harrison, Longbow Research LLC]

Okay. Perfect. Thank you.

[Operator]

Our next question is with Mark Delaney with Goldman Sachs. Please proceed with your question.

[Mark Delaney, Goldman Sachs & Co. LLC]

Yes. Thanks very much for taking the question. First question is hoping you could help us think a bit more about the big picture in terms of the expense and spending thought process of the company. You're coming toward the end of that $120 million cost-cutting program and at the same time like making some investments into the digital and small batch efforts like Premier Farnell, Hackster.io, et cetera. So, you guys start thinking about expense levels into next year, are there other large cost-cutting programs you think you may want to put in place or maybe even want to increase investments more towards some of those growth areas? So, just any sort of sense of the run rate of expenses would be helpful.

[William J. Amelio, Avnet, Inc.]

Yeah, this is a continuous improvement process. We have a transformation project in place which you know about. We will continue to attack our cost structure and get it more efficient each and every day and that's one of the ways that we're going to help expand our margins to get to that 4.5% to 5%.

[Mark Delaney, Goldman Sachs & Co. LLC]

Okay. And for a follow-up question on margins. In the December quarter conference call, Bill, I think it was in your prepared remarks, you talked about doing a little bit better capturing some of the margin incentives that some of the suppliers have put in place for Avnet to try and go and achieve. Can you talk a little bit about what that incentive environment is like and how Avnet is doing and executing towards some those opportunities? Thanks.

[William J. Amelio, Avnet, Inc.]

I'm not clear on the question, could you repeat that? What do you mean?

[Mark Delaney, Goldman Sachs & Co. LLC]

You talked about expanding gross margins, I think, in the December quarter conference call and there were certain incentives that I think some of your suppliers had put in place and if Avnet achieved certain goals, I think, you got kind of bonus type payments.

[William J. Amelio, Avnet, Inc.]

Yeah, yeah.

[Mark Delaney, Goldman Sachs & Co. LLC]

If you could just talk about.

[William J. Amelio, Avnet, Inc.]

I got it. That was in regard to demand creation and our continually improving demand creation. If you look at our demand creation metrics, they are all up. Our registrations are up, our wins are up, and then across the board, we're doing significantly better which is, as you know, a higher margin opportunity for us. So, that's a lot of our – a lot of the suppliers on line card really appreciate that and reward us for that.

[Operator]

Our next question is with Steven Fox with Cross Research. Please proceed with your question.

[Steven Fox, Cross Research LLC]

Hi, good morning. I apologize if this was covered, I got cut off. But in terms of just the suppliers you're adding back to offset some of the losses you've had over the last year or so, can you give us a sense for where you are in that process, do you anticipate having to expand significantly further to cover what has happened in the last year-and-a-half or so and can you give us a sense for how would that help growth?

[William J. Amelio, Avnet, Inc.]

I'll give you a little color on now, we have Phil to give a little bit more detail. A couple of things, we're always evaluating overlaps and gaps. So, we had some gaps, obviously, when lost this key supply lines last year, but we more than made that backup again. So we have put in place the right technologies in the right places and we're really executing well against that and that's why I pointed out earlier the demand creation metrics are all going in the right direction, bodes well for us in the future.

[Philip R. Gallagher, Avnet, Inc.]

Yeah. Steve, this is Phil, how you're doing? I know I didn't cover this, it's a good question. So the losses were the losses, as Bill said, we're working to make those back up, okay, and registration design wins are pretty much at all-time highs right now which is really good news and a good leading indicator for us, as design win revenues roughly between 25% to 30% of our business. So, still a focus area, we got great progress with a lot of our suppliers.

The suppliers, and Bill mentioned the line card, we're always looking at the line card and these gaps and overlaps, as Bill talked about, we always want to have two or three technologies covered with our suppliers. Much of the suppliers we're adding now, we just don't want to add for the sake of having, that's not good for the suppliers, it's not good for us, but we're adding strategically around certain technology, particularly wireless, IoT areas such as that that should provide good growth for us in the future and that move the needle tomorrow while positioning for the future, okay?

[Steven Fox, Cross Research LLC]

Yeah, that's helpful. I appreciate that color. And then just on Premier Farnell, so what's the easiest way to think about sort of the margin expansion you've seen recently, is it just volume related, is there mix in there, or is it cost synergies, can you just sort of walk through just the Premier Farnell piece of the margins? Thanks.

[William J. Amelio, Avnet, Inc.]

To us, all of the above. We've added new supply lines into Premier Farnell, some of them are higher-margin supply lines which is great. We've also improved the cost structure, we continue to do that. System performance continues to get better, web speed continues to get better. All these things are adding into our ability to be able to capture more margin in the Premier Farnell space as well as the efficiency of us being able take on more cost.

[Philip R. Gallagher, Avnet, Inc.]

Steve, can I add to that, Bill? And overall, the revenue synergies between the core, we call the core which is the traditional EM, the component business and Premier Farnell, work really closely together with, as Bill pointed out, with the supplier community to help them add some lines they didn't have before as well as new product introductions and new leads coming from Premier into the core, okay, and then the core team work with Premier Farnell to get them into some of our larger customers where they may not have been playing. So, some really good revenue synergies there too which is resonating real positive to our customers as well as our suppliers. So, real tight linkage there for driving growth.

[Steven Fox, Cross Research LLC]

Thank you. Appreciate that color.

[Operator]

Our next question is with Lou Miscioscia with Pivotal Research Group. Please proceed with your question.

[Lou Miscioscia, Pivotal Research Group LLC]

Okay, great. Thanks, guys. So, first question is what do you consider to be normal seasonality going into the June quarter? Obviously, the prior numbers I have going back, I don't know, 10-plus years which suggest that you get some growth and, obviously, it looks like you're going to be flat at the midpoint, so just trying to understand that a bit.

[Thomas Liguori, Avnet, Inc.]

Yeah. Seasonality and we have to adjust out Technology Solutions, it's zero to slightly up, 0% to 3% to 4% normal range historically.

[Lou Miscioscia, Pivotal Research Group LLC]

Okay. Well, my numbers in 2005 to 2016 are up 2%, just Electronics Marketing. So, that does not include TS, not sure why, just your numbers. Okay, next question if I could, I guess, if anything going on with ZTE? I mean, did that affect any of it, some things have changed there?

[William J. Amelio, Avnet, Inc.]

We took some actions when the United States government had some actions against them several years ago and essentially anything going forward is de minimis in our results, they do not have any impact whatsoever on us.

[Lou Miscioscia, Pivotal Research Group LLC]

Okay, great. The stuff going on with your IT systems, I'm just curious as to – are we pretty much at a steady state IT spend and any visibility as to when that might actually see a material drop off, I mean, would it be six months, nine months, a couple of – maybe even 24, I'm not sure how much more you're going to have to continue to invest in consultants or just the systems in general as you work through some of these things?

[William J. Amelio, Avnet, Inc.]

In the Investor Day, I want to give you a nice roadmap of what we're going to do with respect to IT spend over time. We'll get more efficient as I pointed out with the current system that's in place now which is going to allow us to be able to shave out some costs going forward and that was one of the earlier questions about we're going to be doing some more things on taking our expense out of the company, the answer is yes.

[Lou Miscioscia, Pivotal Research Group LLC]

Okay. Last one, real quick, I guess, on the component side. It sounded from Phil that this wasn't going on, but just any double ordering or cancellations going on, given it seems things have been tight?

[Philip R. Gallagher, Avnet, Inc.]

Yeah. Look, yeah, this is Phil. We're really not seeing that. We watch it very closely, about 50% of our business is done on MRP sharing from the customers, so we have good visibility there. We're not seeing inflation, we watch out for inflation of quantities coming in from our customers in the MRP sharing, not seeing that. And the book-to-bills we think are healthy and what I mean by that, if they were 1.4 to 1, I think that'd be an issue, but they're now at 1.1 range which is pretty good.

We also track daily our cancellation rates as a percentage of bookings. We get pushings and pullouts all the time and – more than you would expect and they're right on average right now. So, we're not seeing anything – we would see it there first and we're not seeing it in any of the regions, okay, at this point in time. So, we think it's pretty healthy.

[Lou Miscioscia, Pivotal Research Group LLC]

Okay. Thank you all.

[Philip R. Gallagher, Avnet, Inc.]

Thank you.

[Operator]

Ladies and gentlemen, there are no further questions at this time. And I would like to turn the call back over to Vince Keenan for closing remarks.

[Vincent Keenan, Avnet, Inc.]

Thank you for participating in our earnings call today. Our third quarter fiscal 2018 earnings press release can be accessed in downloadable PDF format at our website, www.ir.avnet.com, under the Quarterly Results section. Thank you.

[Operator]

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