Greetings, and welcome to the Avnet Third Quarter Fiscal 2019 Earnings Conference Call. At this time, all participants are in listen-only mode. All question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ina McGuinnes. Please go ahead.

Thank you, operator. Earlier this afternoon, Avnet released financial results for the fiscal third quarter of 2019. The release is available on the Investor Relations section of the Company's website. A copy of the slide presentation that will accompany today's remarks can be found via the link in the earnings release as well as on the IR section of Avnet's website. In addition, please note that we have recently made some changes to our branding, and we will now be referring to Avnet Premier Farnell business division as Farnell. Lastly, some of the information contained in the news release and on this conference call contain forward-looking statements that involve risks, uncertainties and assumptions that are difficult to predict. Such forward-looking statements are not a guarantee of performance, and the Company's actual results could differ materially from those contained in such statement. Several factors that could cause or contribute to such differences are described in detail in Avnet's most recent Form 10-K and 10-Q and subsequent filings with the SEC. These forward-looking statements speak only as of the date of this presentation, and the Company undertakes no obligation to publicly update any forward-looking statements or supply new information regarding the circumstances after the date of this presentation. Today's call will be led by Bill Amelio, Avnet's CEO; and Tom Liguori, Avnet's CFO. Also, Phil Gallagher, global president, electronic components joined us to participate in the Q&A session. And with that, let me turn the call over to Bill. Bill?

Thank you, Ina, and good afternoon, everyone. I'm pleased to report another solid strong quarter of execution for Avnet. Our ecosystem strategy is gaining momentum, driving deeper and more profitable customer engagements. As a result, we are well-positioned to capitalize on several important longer-term trends we believe will prove very positive for Avnet. We're working between the transition to a data-driven economy that is expanding Avnet's addressable markets with innovations in silicon, software and artificial intelligence, and 5G connectivity. Our customers are increasingly looking for full solution to take advantage of these trends. Avnet's end-to-end ecosystem provides a simpler, faster and more cost-effective route-to-market. Our solutions pipeline continue to grow as we expand our customer reach beyond traditional technology firms to improve nontraditional customers looking to harness the power of technology to improve their business efficiency and gain more insights about their customers. This change play right into Avnet's strength on our ecosystem and capabilities to guide our customers' ideas into reality. Turning to our performance in the third quarter. The market remains clearly mixed. We saw good performance in the western regions of Americas and EMEA and continued weakness in Asia. Revenue was down slightly from a year ago, due primarily to the decline in Asia. But when looking at revenue in constant currency, we grew slightly. More importantly, we increased adjusted operating income margin by 23 basis points year over year and increased adjusted earnings per share by 7%. We also generated strong positive cash flow, $269 million. In terms of vertical market performance, there was notable strength in defense and aerospace, and we continue to gain share in the segment. Other key vertical markets, such as industrial and automotive, slowed slightly, due mostly to the downturn in China, but are still performing relatively well in the western…

Thank you, Bill, and good afternoon, everyone. This quarter, we executed well in our efforts to control costs, expand operating margins and grow earnings per share. Let me take you through our highlights for the quarter on Slide 14. We delivered revenues of $4.7 billion, which was down sequentially or in line with our expectations. The constant-currency year-over-year revenues rose slightly 1.2%. Our transformation efforts continue to show positive results. Adjusted operating margin increased to 3.8% from 3.6% in the prior-year quarter. Adjusted earnings per share increased to $1.09, a 6.9% year-over-year increase. We had strong cash flow from operations this quarter of $269 million with working capital reductions contributing almost half of that. Our working capital dollars decreased -- days increased due to the lower revenues in Asia. Isolating Asia, net working capital days for all of our other businesses combined declined by six days sequentially. Our buyback program continues. Diluted share count in the third quarter was 109 million shares, 9% lower compared to the prior year. Our quarterly dividend payment of $0.20 is 5% higher than the prior-year quarter. Turning to business performance, starting with electronic components on Slide 15. The electronic components segment reported sales for the third quarter of $4.3 billion. The sequential and year-over-year decline is primarily due to the slowdown in Asia. Electronics components operating margin improved 15 basis points sequentially to 3.5%. Farnell revenues were essentially flat sequentially and down 1.5% year-over-year in constant currency. As Bill mentioned, uncertainties with Brexit impacted market demand and our revenues during the quarter. Despite the market headwinds, Farnell operating margins expanded to 12.4% in the quarter, 160 basis point improvement, both sequentially and year over year. By region, Asia revenues declined $419 million sequentially. And as Bill said earlier, the market is starting to show…

[Operator instructions] Our first question today is coming from Adam Tindle from Raymond James. Your line is now live.

I just wanted to start maybe on gross margins. I know the target from the analyst day showed a number of positives on the bridge that led to improvement throughout the year. Obviously, you had Asia soften pretty significantly, which should have helped mix. But it looks like guidance implies that gross margin is going to be down more than 50 basis points as fiscal '19 shapes up, so I'm just hoping that maybe you can revisit the assumptions on the bridge. What are kind of the main detractors that maybe weren't in that bridge? And how can we think about a sustainable level of gross margin?

Sure, Adam. So I recall, the bridge was at 13.6%. This quarter, we're at 13.3%. And you're right, it'll decline with the change in mix in Q4. So really when you look at that chart, you look at the bridge, no. 1 reason that's causing the change is mix. So this quarter, we'll have higher mix of Asia revenue and a lower mix of the western regions, which is really causing the change in our gross margin.

Okay. Maybe we can follow up. Because there was 100 basis points of risk adjustment in there as well. I didn't know if maybe there was something in that bucket that is materializing. But maybe I can touch on --

No. That's a really good question. So just to answer that, no. This is a change in mix.

And you mentioned you're just over a third of the way through the $245 million of cost savings. Can you give us a sense for timing in fiscal '20? Is it just kind of another third materializes then, and we should get that benefit to profit dollars dropping through as a result?

Yes. It's pretty linear over three years.

Okay. And maybe just one more piece of color on that. You had low-cost geographies and back-office integration of just about $100 million of savings between those two items, and they were, I think, $0 last quarter. So all on to come, can you maybe just talk about the logistics to those items and the timing to start those initiatives?

Yes. Those are -- okay. The third that we're through is the optimizing the cost structure. We're through some reductions we had made earlier in the year. So the low-cost geos, these are mostly in the back office. Those plans are pretty well in place. You'll start to see those materialize through fiscal year '20 and moving forward on, just as we've been doing every quarter.

Thank you. Our next question is coming from Shawn Harrison from Longbow Research. Your line is now live.

Good afternoon, everybody. I wanted to drill into Farnell and particularly the growth rate. I understand the Brexit dynamics and the single-board issues. But absent that, when do you think you'll have the inventory in place and the additional SKUs and everything else to really accelerate the growth rate? Because, to me, that should be a double-digit growth business, and obviously, you're pretty far away from where that business should be right now.

Sure, Shawn. I'll take that. This is Bill. Good to hear you. We're in the process of putting new warehousing space in place, and that's the construction's finished, and we will be in a process of ramping that up at the end of the year. It's going to take some time. We got to fit it out, of course, put the conveyors in, etc. That will allow us to expand pretty significantly. In the meantime, where we have productivity improvements, we are adding additional SKUs, and we'll continue to do that through the rest of the year. And as I pointed out, we have three other areas that we're focusing on as well. Web speed is important to us. Pricing and quoting is important to us and being able to add additional marketing spend to specifically target demand creation in areas where we think we have an opportunity. So with those things in place, we believe we can close the gap to the market in this particular space. But if you look at the overall market in this space, though, it is in fact starting to come down. It's double digit today, so I think it's come down pretty dramatically. And I think when you see the results all come in from specialty distributors, you'll see that they're down much slower than they were in previous quarters.

Okay. And I guess as a follow-up. The single-board computer dynamic, why does that resolve itself, for lack of a better phrase, in the second half of this calendar year?

There's a new refresh coming out. We've spent time looking at functionality that we believe is more robust than the release we just had that we're living through, and we will potentially have exhausted all that inventory of the previous version by the time we get to the September quarter.

Okay. And then as one brief follow-up, Tom. Where do you think you should be in terms of cash cycle exiting the calendar year, knowing there's some regional dynamics working against you?

Well, our cash should be above our net income. Is that what you're asking me?

No, I'm sorry, the days of your cash cycle.

Oh, days. Okay. So let me explain that because that is a little confusing. It's all in Asia. All of the other businesses combined, they came down six days. So Asia, this is timing of cash inflows and outflows when you have a decline in revenues. So in Asia, revenues came down $400 million. But when you look at the details of working capital in Asia, the receivables came down nicely, inventory came down. There's still more to do on both of those, but the offset was payable. So we ended up making a lot of payments for inventory that was purchased in Q2. You'll see that right in the balance sheet. Our payables in Asia were down $250 million. So that skews the total net working capital days. We may see that continue into Q4. I mean, I think it will come down from 91 into the high 80s. But that said, in this period, we are focused on generating cash out of working capital. And that's why we got to the $269 million cash flow from ops this quarter.

Yes. That is a very strong number. Great explanation. Thank you.

Thank you. Our next question today is coming from Joe Quatrochi from Wells Fargo. Your line is now live.

Great. Thanks for taking the question. I was wondering if we could kind of drill down the high-margin business, some of the puts and takes there. I think that business was down again year over year. And then if you even adjusted for Farnell, I think it was also down. So I was just kind of curious. So what's driving that?

Yes. Farnell is really everything that Bill just talked about. So specifically in the quarter, Brexit, you think between January and the end of March, we had daily reports of the hard Brexit, the soft Brexit. Is it March 29, April 10, April 12? It caused a lot of uncertainties. When you look at GDP and economic consensus out of the U.K., activity was down. In fact, even the Chamber of Commerce made a comment about it's the worst numbers in decades. And U.K. is 20% of Premier Farnell sales, so that affected it. That said, no, we need as much more we need to. We've been adding SKUs, but we're a third of the way there. That's probably a fair indicator.

So clearly, Premier Farnell is the leading driver of our high-margin businesses there. But right behind that, we have Avnet Integrated, which we're doing some more equipment that we pointed out in my remarks, where we are tuning up the Americas business to make sure we get growing those customers that are bigger customers and higher-margin opportunities for us. And we made a shift this past quarter to do that. You'll start to see that essentially give us some pop in the future quarters with respect to AIS. Demand creation is another area in our core business, core electronic components business. That is we're starting to see some real traction there and where registrations move up into the right, which takes some -- there's flag time there before that turns into revenue. But that won't, in fact, happen over time. And then,interconnect passives and electromechanicals has been a really -- that's a real bright spot for us, and we've seen that grow and a higher profitability than the average of the rest of the Company. So I think just some real positive areas that we can point to in that area and say, hey, just keep fleshing that space. And we're hopeful as Premier Farnell starts getting back to growth position, that will start changing that pretty quickly.

Okay. That's helpful. And then just on the inventory days, how should we think about inventory levels in Asia? And are they high today? And how long could it take to kind of work those down?

Asia inventory in terms of days is higher than normal, so that will start to normalize more in the fourth quarter, Joe.

Thank you. Our next question is coming from Matt Sheerin from Stifel. Your line is now live.

Yes. Just a couple of questions from me. One, could you provide any bookings trends, book-to-bill ratios by region and how it's looking now versus the end of the quarter?

Sure. Phil is going to take that one.

Thanks for the question. Yes. So right now, if you look at the components level globally, we're very close to 1:1, okay? The America's above 1:1, looking very good. Europe, just a little below 1:1. And Asia, below 1:1 but improving, which is why I made the comment that Bill made in the script, improving off from a book to bill, although the billings were down. But at least, we're starting to get some improvement from the last, let's say, couple of months to a quarter.

So a big reset in Asia. Obviously, when you move $400 million quarter to quarter, that's a big move. And now, we're starting to see at least stabilization at a lower level.

Yes. Got it. And just on gross margin. And you talked about some of the strengths. One, being the passives area. That's also an area where there were broad shortages in many areas. Now we're seeing really just a few large case-sized MLCs, ACs and couple of others. But in most cases, you talk to suppliers. Lead times have come in dramatically, so you would think that you might see some inventory correction of customers there. And as volumes do come back, whether it be in Asia and other regions, shouldn't we see a return to more normal pricing, meaning ASP pressure that you really haven't seen in the last couple of years? And would that impact margins?

Well, I look at it this way. First of all, the published lead times have not come down dramatically. They've definitely stabilized, and in some cases, come down. But in general, mostly, they're up. Actuals, as you pointed out, have come down, and we'll continue to track that. And I think a lot of the inventory correction that we see in Asia, there's a little bit potentially happening in Europe. Americas still seems to be pretty strong with respect to our bookings, so we're less concerned in the Americas of the inventory correction. And in general, ASPs didn't move much up on the upcycle. And I'm not that concerned that they're going to move that far down either. I mean, I think we're in pretty good shape.

Okay. And then on Avnet Integrated, you spoke about some of the issues there. Also at your analyst day, you talked about that being one of the sort of the rising stars, if you will, of that business, higher margin, higher growth potential. Now there seem to be some issue. So what -- could you just elaborate a little bit more on those issues and growth potential and margin potential there?

Well. No. I didn't say there's any issues in our interconnect passive and electromechanical --

No, Avnet Integrated, I'm talking about.

Oh, Avnet Integrated. Oh, Avnet -- what we did in Avnet Integrated. Specifically, I mean, let's divide it into three quadrants: the Europe, Middle East and Africa; Americas; and Asia. So Asia is growing like we expect, albeit from a very small base. Europe, Middle East and Africa is really doing well. But that said, we organized that operation a year and a half ago. We made some major changes there, and we're starting to see the fruits of that labor. We're really happy with that. In fact, we outstripped our capacity. We'll put more capacity in place over in Europe. So great story there. Americas, we essentially looked at our profile or pipeline, determined the best way for us to move forward in a high-margin way, and we're essentially exiting some contracts that I would say are smaller and less profitable for us, and focusing our attention on within our pipeline that's richer margin and there are larger opportunities, and that's happening as we speak. Additionally, we put on new capabilities that opens up more pipeline for us with a various configurate our opportunity. It allows us to get a lot more customers into the pipeline that have richer margin profile.

Thank you. Our next question today is coming from Steven Fox from Cross Research. Your line is now live.

Thanks. Good afternoon. First, again on the IP&E. You mentioned a high single-digit growth in that business. Can you just sort of dig into how you were able to outperform the overall company in that -- those markets? Was it adding line cards? Was it execution in certain markets, pricing, etc.? Can you give us some color there? Then I had a follow-up.

Pricing has been pretty stable across the board, and we've been able to get more supply in the last few quarters. That's been very helpful as well. But I would say it's pretty balanced across the world. We've seen great performance in every one of the region, so that's been pretty solid for us. And it's in all the end markets that we participate in. Industrial and automotive and mil/aero all have their own consumption of IP&E.

Yes. Steve, this is Phil. We have a big focus on this across the world. This tends to be a higher-margin business. In addition, we have a dedicated BU, business unit division, in Europe as well of Abacus, and they've had a tremendous growth in the European market. So it's really pretty much across the board.

Okay. That's helpful. And then in terms of the pipeline you talked about for IoT, nontraditional customers, the $600 million. When you start to build that type of backlog, how do you think about it in terms of actually turning into revenues, maybe upside versus downside things? How should we think about that actually contributing down the road?

We expect that that pipeline will convert 50% over three to five years. That's kind of our current production. And the way we think about it is this. It takes some time with respect to use cases. So the way the selling motion works is you work with a customer. You get a use case in place. You should prove out the proof of concept, and you show that the ROI is really there for the customer. Once that occurs, then we develop a playbook for the sales team to be able to replicate that across that industry as well as other industry. So if you take an example like predictive maintenance as an example, you throw out a use case for one customer and then demonstrate that works for others, and then you build a pipeline associated with that. That also takes the time to get that to convert from an opportunity in actual revenue. But we're previously working on many different proof of concepts than use cases, as we speak.

Thank you. Our next question is coming Tim Yang from Citi. Your line is now live.

Good afternoon. Thanks for taking my question. A quick follow-up on Farnell, how should we think about the timeline for the business to return to growth? And I have a follow-up.

Well, it's hard to predict the macroeconomic condition. But short of any other issues, in fact, if we get a break on Brexit and some help on China tariffs, that starts going our way toward the back end of the year. It starts to get back a growth posture in Premier Farnell, so we're really encouraged. And when we start layering in those investments, even in a no-growth environment, we should have an opportunity to be able to take share.

Got you. That's helpful. And then automotive and industrial end market, can you talk about your demand visibility compares to your quarter ago?

Sure. I'll have Phil handle that specifically.

Yes. Thanks, Tim. Well, in transportation for us, we classified transportation just beyond the automotive. It's in a range of 12% to 14% of our total business. We're actually seeing it's still pretty good. It's definitely down a bit from a year ago, no doubt, in all the regions but actually holding up pretty well relative to what we're reading out there, okay? As far as industrial, steady, I mean, again, particularly in the western regions. We see a bit of a hit in the Asia market in industrial, particularly in China. But in Europe, really long tail. The customers industrial space really fits right into our sweet spot as well as the Americas. And as we highlight in the script, we're seeing a really nice growth, high double digit in the defense and aerospace as well.

[Operator instructions] Our next question is coming from Mark Delaney from Goldman Sachs. Your line is now live.

Yes. Good afternoon. Thanks for taking the question. First, just a housekeeping-type question. Tom, you mentioned the $15 million gain from the real estate sale in your prepared remarks. I'm assuming that's what's behind the $9 million of other income that was part of the continuing earnings. But I just wanted to check where that may be in the P&L.

The $15 million is in restructure.

Okay. Got it. And then I wanted to also follow up on the OpEx outlook and some of the commentary there. At the analyst day, if I'm not mistaken, the growth from the Company kind of from the top line was in line with expectations. Quarterly OpEx could be $490 million or so. And if there was no growth in the business, quarterly SG&A would be running around $435 million or so. Is that still the right goalpost for us to be thinking about?

Yes, Mark. I think those are reasonable ranges. I think what you see in this quarter and what I expect you to see in Q4 are pretty sizable reductions year over year in our OpEx. So I think we're pretty much right on track with the OpEx compared to our investor day discussion.

Okay. And then I guess my final question just on gross margin. Percentage year over year was right around 13% for 4Q fiscal '18. Just trying to get a sense for what your expectations are for the June quarter for 4Q this year.

For the fourth quarter?

The upcoming quarter, just trying to -- gross margin percentage, kind of flat, up, down.

Gross margin will sequentially decline. The way to think about the midpoint of our guidance is if you take the midpoint of our revenues, the operating margins would be in the 3.6% range, and everything else is pretty constant. So the 3.8% in Q3 to the 3.6%, that's the mix change.

Our next question is coming from Adrienne Colby from Deutsche Bank. Your line is now live.

Hi. Thanks for taking my question. I wanted to ask about Farnell. You outlined a bunch of initiatives for improving efficiency, some of the quoting and marketing tools. I just wanted to check if -- are there any sort of higher-level integration efforts that are still under way? The rebranding obviously happened, but I don't know if there are any other assets that you acquired along with Farnell there's more rebranding or any other back-office integration that needs to happen at this point.

We have -- a couple of points. First of all, we are doing some more back-office integrations with respect to the various different functions because we took a light touch at the beginning of our journey with Premier -- with Farnell. And now, we are looking at areas where we think there's some additional efficiencies, and we're doing some more work in low-cost jurisdiction. We're doing some more work with what we can do, connecting electronic core -- electronic components core with what we're doing with Premier Farnell. So that's all going well for us. Regarding branding, branding is a journey. So the first journey was what you saw and what we announced right now. And as time goes on, what you'll see is it gets more tied into the Avnet business with respect to overall branding. But where we are now is a step in the journey.

And as a follow-up. In terms of the weakness you saw related to Brexit, were those order cancellations? Or should we think about that declining sales as deferrals? So do you expect it to come back when there is more clarity about Brexit?

When you think of the Farnell, think about it as somebody goes online or calls up a salesperson. If the material is there, they buy. So it doesn't tend to be more -- you're thinking more of what our core Avnet businesses versus the Farnell business. So Farnell, really if the supply is there, they buy. So what happens in the U.K., which represents 20% of the Farnell businesses, people just pause or are not buying at all.

Thank you. That does conclude our question-and-answer session. Ladies and gentlemen, that also does conclude our teleconference for today. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.