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Edited Transcript of AVT earnings conference call or presentation 8-Aug-18 8:30pm GMT

Q4 2018 Avnet Inc Earnings Call

PHOENIX Aug 24, 2018 (Thomson StreetEvents) -- Edited Transcript of Avnet Inc earnings conference call or presentation Wednesday, August 8, 2018 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ina McGuinness

* Philip R. Gallagher

Avnet, Inc. - Member of Executive Board & President of Electronic Components

* Thomas Liguori

Avnet, Inc. - CFO & Member of Executive Board

* William Joseph Amelio

Avnet, Inc. - CEO, Member of Executive Board & Director

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Conference Call Participants

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* Jim Suva

Citigroup Inc, Research Division - Director

* Joseph Michael Quatrochi

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* Madison Suhr

Raymond James & Associates, Inc., Research Division - Research Analyst

* Mark Trevor Delaney

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Matthew John Sheerin

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst

* Paramveer Singh

BofA Merrill Lynch, Research Division - Associate

* Shawn Matthew Harrison

Longbow Research LLC - Senior Research Analyst

* Steven Bryant Fox

Cross Research LLC - MD

* William Stein

SunTrust Robinson Humphrey, Inc., Research Division - MD

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Presentation

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Operator [1]

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Greetings, and welcome to Avnet's Fourth Quarter and Fiscal Year 2018 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ina McGuinness. Please go ahead.

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Ina McGuinness, [2]

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Thank you, operator, and welcome to Avnet's fourth quarter fiscal 2018 business and financial update call.

As we provide the highlights for our fourth quarter and 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 for 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 we translate Avnet's non-U. S. dollar-based financial statements into U.S. dollar. When we refer to organic sales, we have adjusted the prior periods to include the impact of acquisition. 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 begin the presentation, let me remind you that today's remarks and presentations contain forward-looking statements, which are statements addressing future financial and operating results of Avnet. These -- 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 are set forth in Avnet's filings with the Securities and Exchange Commission.

Today's call will be led by Bill Amelio, Avnet's CEO; and Tom Liguori, Avnet's Chief Financial Officer. Also here today to participate in the Q&A session is Phil Gallagher, President, Electronic Components.

With that, let me turn the call over to Bill Amelio. Bill?

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [3]

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Thank you, Ina, and good afternoon, everyone. I'm very pleased to share our fiscal fourth quarter and full year results. It was not only a strong quarter but a promising ending to an important transformative year for Avnet.

Our fourth quarter results showed continued strong demand around the world with our Electronics Components group, delivering their strongest results of the year, growing nearly 6% sequentially and 10% year-over-year. Premier Farnell also had an outstanding quarter, growing 13% from a year ago. Q4 was our strongest adjusted operating income quarter in the last 5 quarters, which demonstrates that we not only are growing again but growing profitably. This is a sharp turnaround from where we were 1 year ago and is evidence of our significant transformation underway at Avnet.

Avnet's transformation is a result of us focusing efforts on 5 key strategic priorities. Let's take a look at how we're doing as a company on these 5 strategies.

The first is accelerating our Electronics Component business. We exited fiscal 2018 having replaced all of our revenue from supplier program changes that affected us a year ago. We made up the entire gap for both revenue and gross profit in just a few quarters. That rebound came about to a very focused attention to expanding our line card and finding innovative ways to support our customers through the transition, demonstrating our agility as an organization. Our customers have noticed, as demonstrated by the fact that our Net Promoter Score has rebounded back to previous high levels.

As a result, our Americas component business has significantly improved. This quarter, we saw the Americas region grow 5% sequentially with operating income that grew 19%. We further strengthened our America business by adding Tony Roybal as President of our Americas electronics group. Tony is a strong and seasoned executive, bringing over 25 years of semiconductor channel experience to Avnet and is ideally qualified to lead our Americas region to continued growth and profitability.

We continue to add suppliers at a meaningful pace. Just this past quarter, we added 3 new supplier lines to our Electronics Component business and 4 new supplier lines at Premier Farnell. The biggest addition was our recent announcement that Microsemi is once again a part of the Avnet line card. We have deep knowledge of their products and expect to see revenue from that line grow over the next several quarters. In addition, this quarter, Avnet remained in the Gartner Top 10 High-Tech Supply Chain list, another proof point of our outstanding execution and world-class capabilities. This recognition demonstrates Avnet's unique ability to consistently serve our customers and suppliers on their term anywhere in the world.

Our second key strategy is to scale the high-profit businesses of Premier Farnell, Avnet Integrated and IoT solutions.

Let me start with Premier Farnell. We added Premier Farnell in order to combine the capabilities of our small order quantities for customers in the development phase with Avnet's traditional volume-based capability as customers then ramp into production.

When we acquired Premier Farnell, they had exited their fiscal 2016 with negative 4.4% revenue growth and operating margins under 6%. Now the story is quite different. Exiting fiscal '18, Premier Farnell is growing at double-digit pace with operating income -- margins nearly 12%. The improvement trajectory of this business is far more than just cost synergy.

The benefit of being part of Avnet is paying off in better overall customer experience and in development and sharing of customer leads and inventory across Avnet and Premier Farnell.

Our Avnet Integrated business has spent most of the past year merging global operations from design to supply chain and manufacturing to establishing truly global business capability, serving the integration needs of customers around the world. The fruits of this effort are starting to pay off. In Q4, revenue of our Avnet Integrated business grew 7% from last year, with operating income growth of over 60% and operating income margin improvement of over 150 basis points from a year ago.

In our IoT area, our end-to-end solution pipeline is growing rapidly. In Q4, the number of new customers in our pipeline grew 59% sequentially, and the dollar value of that pipeline grew nearly 300%. These are solutions that combine hardware, software, security, cloud and analytics that leverage our ecosystem's capabilities.

Our third key strategy, to extend and deploy digital capabilities to drive growth and customer satisfaction and efficiency. I am pleased to report that our digital performance continued to grow at a rapid clip. Web-based sales more than doubled from a year ago and were up 18% sequentially. Digital transactions now represent 55% of Avnet's total transaction. This digital transformation lowers our cost to serve and provides truly unique omnichannel support capability, serving our customers on their terms.

We're also supporting our customers through artificial intelligence with a tool called Ask Avnet that operates across our entire ecosystem, helping customers find all the information they need to simply and effortlessly transact business with Avnet. Just this quarter, the number of Ask Avnet sessions across our ecosystem grew 200% with the vast majority of users rating their experience positively.

Avnet is leading the industry and offering AI tools that enhance the customer experience of our expanding customer base. Overall, our digital transformation efforts are by creating key strategic differentiators from transactional functions, such as inventory management, to how we price and quote our customers, to how we manage and qualify customer leads, to how we design solutions with our ecosystem assets so -- and so much more. We've already seen both top and bottom line improvements over the past year as a result of these initiatives, and this is just the beginning.

Our fourth key strategy is to leverage our ecosystem to expand customer opportunities. Let me start with a recent example of how our ecosystem is working to bring new customers and new revenue streams to Avnet. We recently signed a deal with a cryptocurrency customer to design and manufacture a hardware wallet for cryptocurrency storage. Up to this point, the company only dealt in the software space. They reached out to an important part of our ecosystem that specializes in manufacturing solution, Dragon Innovation, to provide consultation on developing and manufacturing our first hardware product.

After finding out about all of Avnet's capabilities, they chose to have Avnet to do design engineering and manufacturing rather than doing it themselves. Because of Avnet's expertise, the time-to-market will be much shorter with lower risk and at lower cost. This is just one example of a growing list of new customers being served across different parts of our ecosystem, providing multiple revenue stream at higher profit margins. A number of these cross-ecosystem opportunities is growing and will continue to feed both top and bottom line growth opportunities for Avnet.

I also want to highlight an important point about our engineering communities of Hackster and element14. We announced just this quarter that these communities have crossed over the 1 million registered member mark. This is a significant milestone. We now have 1 million engineers and innovators helping to reshape the R&D model of the future. They are creating an increasing pool of business opportunities for Avnet and its ecosystem.

The communities form an increasing valuable opportunity to our suppliers who are looking to engage engineers with their technology as well as for customers of all sizes looking to speed their time-to-market and lower their cost. Our highly respected communities have unlocked assets with several Fortune 1000 brands that are nontraditional but carry lucrative revenue opportunity.

And finally, our fifth key strategy is to drive performance and operational excellence with continuous improvement. Tom will cover many of the financial metrics, but I wanted to highlight just a few areas where our focus on operational excellence is paying off. We've reached our $120 million annual cost savings target, and we're using these savings to not only reduce our cost but also to fund important growth initiatives. We made significant progress in managing our operating expenses this past year.

Adjusted OpEx as a percent of revenue and as a percent of gross profit improved each and every quarter. Our adjusted operating margins overall increased 32 basis points from a year ago, and our adjusted operating income dollars reached $187 million this quarter, which is up $45 million from our first quarter.

We have lowered our net working capital days again this quarter by 7 days, and we'll continue to focus on managing that in a disciplined manner going forward. I'm pleased with the significant progress that we've made operationally, and we're set up to grow profits at a rate faster than revenue growth going forward.

So in summary, Q4 is a very solid quarter for Avnet and a solid ending to an important year. We're executing well and we're accelerating our Electronics Component business. Premier Farnell is adding meaningful to our profitability and our growth and our end-to-end solutions capability. Avnet Integrated and IoT are strong pipelines for revenue growth and at higher margins. Our ecosystem is truly unique and offers compelling value to our suppliers and our customers. Our digital transformation is delivering new and improved ways we serve our customers, and our relentless focus on operational excellence continues to improve our financial performance.

The momentum we have exiting our fiscal 2018 is real and it is why I'm so optimistic about Avnet's future and our ability to hit the financial targets we laid out in our recent Investor Day. Avnet is uniquely positioned to drive today's ideas into tomorrow's technology, providing full end-to-end solutions, including hardware, software, security, cloud and data analytics, all the way from idea to product and from product to market.

With that, I'd like to have Tom give you some more color on our financial performance. Tom?

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [4]

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Thank You, Bill. Good afternoon, everyone. Today, we march another quarter of solid progress.

Revenues in Q4 reached $5.1 billion, an increase of 10% year-over-year. Adjusted earnings per share increased 18% year-over-year to $0.99 per share. Net working capital days declined by 7 at 86 days, all of which resulted in $236 million of cash flow from operations, the highest level in 5 years.

Each of our segments performed well. Premier Farnell had another outstanding quarter. Revenues grew 13% year-over-year, and the team reached a record operating margin of 11.8%. Premier Farnell enjoys gross margins in the high 30% range and has a path to even higher operating margins by leveraging Avnet's global capabilities as it grows.

Within the Electronic Components segment, Avnet Integrated, another one of our higher-margin businesses, grew revenues 7% year-over-year. With the keen focus on streamlining cost, the Avnet Integrated team increased operating margins 150 basis points year-over-year. Americas continued to accelerate, growing revenues 5% sequentially and operating income by 19%.

Our EMEA team delivered 7% revenue growth year-over-year and continued to be our best performing region in Electronic Components in terms of operating margin. Lastly, our Asia team added franchises and customers and grew at a [torrid] 20% pace year-over-year. Just as important, they held margin steady and were able to improve working capital days while achieving this growth. As a testament to the quality of our business growth and management team, Asia contributed more than $100 million of operating cash flow this quarter while growing revenues 20%.

Going down the income statement. Gross profit percent declined 61 basis points sequentially due to a higher mix of Asia revenue. Asia, while fast growing and generating excellent cash flow, has a lower gross and operating margin percentage, which tends to lower our consolidated metrics.

Our management of operating expenses paid off this quarter. We held spending flat year-over-year while growing revenues 10%. As Bill said, we reached a $120 million annual cost savings target and reinvested the savings for growth and strategic initiatives. Our goal is to continue to maintain operating expenses relatively flat by streamlining cost and reallocating savings to our growth initiatives. Operating margins increased 32 basis points year-over-year and 4 basis points sequentially to 3.7%. Operating income dollars reached $187 million, up $45 million from Q1. Other expense of $8.2 million was largely foreign currency expense from a stronger dollar.

Our tax rate of 23.3% was as expected. Adjusted earnings per share of $0.99 beat the midpoint of guidance and is an increase of 18% year-over-year. Excluding the just mentioned foreign currency expense, earnings would have been $1.04.

Turning to the balance sheet and cash flow. Net working capital days improved sequentially from 93 to 86 days. Notably, cash flow from operations in the quarter was $236 million. We ended the year with $621 million of cash, a sequential increase of $191 million, and maintained our debt leverage at 2.2x.

We sold $78 million of Tech Data stock, which completes the sale of the remainder of the Tech Data equity we own. The proceeds generated were used to repurchase $117 million or 2.9 million shares of Avnet's stock. Approximately $272 million remains under the current share repurchase authorization.

This week marked the final settlement with Tech Data or the working capital and tax matters associated with the sale of our TS business. As part of the settlement, we received, in August, a cash payment of $120 million.

At our Investor Day in June, we laid out our road to value creation consisting of: first, scaling our higher-margin business, such as Premier Farnell, Avnet Integrated, demand creation and IoT; second, optimizing our cost structure and operating margins; and third, deploying capital to the highest returns, which includes our working capital reduction initiative, capital allocation plan and share repurchase program.

We added the scorecard to our earnings call on Slide #17 to discuss our quarterly progress in these important areas. Our higher-margin business has continued to grow and be accretive to earnings. To illustrate, in Q4, Premier Farnell and Avnet Integrated comprised just 16% of our total revenues though contributed 34% of total operating profits.

While revenues from these 2 businesses grew 10% year-over-year, we have not yet seen an uptick in this overall metric, measuring the percent of total revenues coming from higher-margin businesses due to Asia's high growth rate, which this quarter was 20% year-over-year.

We've made significant progress in managing operating expenses. OpEx as a percent of revenue and as a percent of gross profit improved in each quarter during 2018. We further streamlined our cost structure at the end of June, implementing an additional $37 million of reductions as we entered fiscal 2019. This is on top of the $120 million Bill already mentioned. Operating margin improved every quarter this year.

For working capital, we are ahead of schedule. This quarter, we had a 3-plus-day improvement in both our inventory days and payable days. We expect very good progress throughout 2019. We redeployed the funds freed up from working capital to repurchase shares, reducing share count by 6 million or about 5% of shares outstanding during fiscal 2018. Overall, we are 1 quarter into our 3-year target of achieving $7-plus adjusted earnings per share.

Our scorecard shows we are tracking well to our initiatives. We have tremendous runway available to optimize each of these metrics and create shareholder value.

Looking forward to Avnet's September quarter, we expect sales to be in the range of $4.8 billion to $5.2 billion. Based on this revenue forecast, we expect adjusted EPS to be in the range of $0.95 to $1.05. At midpoint, guidance represents year-over-year revenue growth of 7% and adjusted EPS growth of 32%.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Joe Quatrochi with Wells Fargo.

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Joseph Michael Quatrochi, Wells Fargo Securities, LLC, Research Division - Associate Analyst [2]

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A couple of questions from me. First, I was wondering if you could kind of -- I know in the press release, you said book-to-bill is comfortably above 1. I was wondering if you could give us a little bit more detail around that and then kind of the puts and takes of the demand environment.

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [3]

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Yes, book-to-bill is excellent across all regions. We're above 1.1 in every region and it continues at good strength, so nothing more to say about that. We're pretty excited about the prospects ahead.

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Joseph Michael Quatrochi, Wells Fargo Securities, LLC, Research Division - Associate Analyst [4]

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Okay, fair enough. And then just kind of on the working capital management side, I know that you're working to reduce that. But how do you balance, I guess, your inventory levels with the existing growth that you're seeing and the goal to bring that down?

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [5]

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Well, as you can imagine, we've got many SKUs across the world and we have an opportunity to be able to ensure that we optimize. Where we think that there's going to be additional demand, we can bring in product for that. But where there isn't, we want to move as fast as we possibly can. And we're balancing across the globe, and that's one of the changes that we've made over the course of last couple of years. We have an opportunity to be able to manage not only in a region but across regions where we have to.

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Operator [6]

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Our next question comes from the line of Shawn Harrison with Longbow Research.

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Shawn Matthew Harrison, Longbow Research LLC - Senior Research Analyst [7]

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My congrats on the progress in 2018 as well. The first question is maybe a bit for Tom here. You said you're ahead of schedule on the cash cycle improvement. I know the goal is less than 70 days. Would you expect a linear improvement in fiscal '19 toward that 70 days? Or since that you're running ahead of plan, could you get that cash cycle reduction more than 5 or 6 days as you move through 2019?

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [8]

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Well, we -- when we were at Investor Day, we told you at the end of '19, we'll be 83 days. So we're ahead of schedule to that. And I think we're feeling good right now that we'll beat our 2019 number. That said, we're down 14 days, I think, in 6 months, which is really tremendous progress by all of the teams. And you should expect, while we would hope to see sequential declines, we have to make it 14 days. There may be a few up, a few down. But overall, it's in a great direction and gives us a lot of confidence to get to 70 or below.

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Shawn Matthew Harrison, Longbow Research LLC - Senior Research Analyst [9]

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Okay. And then as my follow-up. The incremental $37 million of cost reductions you announced here on the call, how much of that will be reinvested in the business versus a net number kind of leading to a decline in operating expenses?

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [10]

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Yes. That was $37 million, company-wide, right. That wasn't related to any specific business -- company-wide. And the important thing to remember is our goal is, okay, as we grow, to hold operating expenses flat. So a good part of it will be reinvested in growth, which is the variable cost for distribution centers and commissions and things like that. We have a really good project going on. And in this current quarter, we're opening our new distribution center in Asia. That's a good example of reapplying some funds. And we're pretty confident by the second half of this year, we'll start to get some productivity improvements that you'll see in the financials from that.

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Operator [11]

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Our next question comes from the line of Matt Sheerin with Stifel.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [12]

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So a couple of questions. The first, just following up on the question on book-to-bill and demand, your guidance basically guiding relatively flattish quarter-in-quarter. But you've been -- and it looks more seasonal than anything. You've been running -- particularly if you take out, say, the market share losses, you've been running well above as your peers have seasonal for 3 or 4 quarters. So it looks like a return to seasonality. Is there anything we need to read into that -- read into that? Talk generally about lead times. Your inventory days were down. So it looks like there may be signs of stabilization in terms of supply. So could you just give us more color on the demand environment?

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [13]

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Well, lead times, for sure, they're still extended but they are stable. So they haven't gotten worse. That's for sure. And as far as our seasonality, we're in that range of the seasonality that we [committed] we'd have minus 2 to plus 2. So there's nothing more to read into that.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [14]

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Phil, do you have anything to add?

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Philip R. Gallagher, Avnet, Inc. - Member of Executive Board & President of Electronic Components [15]

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Yes, Matt. No, look, the book-to-bill is 1:1, give or take, plus or minus in each region. So we're really positive. Lead times, just expound on those, not a big change in the last quarter, Matt. I mean, we know there's definitely some constraints out there. We're managing through it. And going back to the last question, our inventory, we're constantly optimizing our inventory against our supply chain needs with the -- from our customers where we get good forecast. The demand environment is pretty good. I mean, the verticals, you have transportation/automotive continue to be strong. Industrial continue to be -- to look really positive. So no, I think we're Steady Eddie as we go into the next quarter as best we can see it.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [16]

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Okay. That's helpful. And then, Tom, you talked about OpEx staying sort of flattish. And if we apply that to the September model and back into your -- the gross margin looks like that's going to be down sequentially in that. Is that also just a function of seasonality in Asia typically up and you're growing faster, it looks like, in Asia than your -- in other markets? Is that basically the reason why gross margin should be down?

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [17]

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I don't think gross margins will be down. I don't -- I'm not exactly sure, Matt, how you got that number. One thing to keep in mind is, yes, this is seasonally -- when Asia has the peak revenues, okay. So as we get into January, February, Chinese New Year seasonality, that's the low point. That's where mix will help us, and we're feeling pretty good about our operating margins gets into 4% or above sometime in the second half of the year.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [18]

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Okay. But -- okay. So you expect margins particularly because you also talked about Premier Farnell and the Avnet Integrated also growing faster. And obviously, they have better margins. And I don't know if there's seasonality in those businesses as well.

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [19]

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Actually, Q1 is -- typically, they have lower seasonality. So if you look at our current quarter in the mix, what you saw in the results is fairly typical. Asia has a larger mix of the revenue.

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Operator [20]

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Our next question comes from the line of William Stein with SunTrust.

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William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [21]

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I'm wondering if you can give us an update on the ERP implementation. How far are we along? Maybe just remind us as to what's outstanding and what's the timing to complete this effort.

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [22]

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Yes. So we're great. Our Americas system has stabilized. And as I said on the last call, the strategy is that we'll be implementing the next phase of it in our Avnet Integrated business. And that will be happening as we speak, and that will be going live over the course of the next 18 months.

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William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [23]

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Okay. And then as a follow-up, if I can, any comments by end market in terms of the strength that you saw in the quarter and, in particular, any spots of weakness? We've heard from some semi and other component suppliers some mix things about automotive, in particular, more recently and wondering what you're seeing in that regard.

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Philip R. Gallagher, Avnet, Inc. - Member of Executive Board & President of Electronic Components [24]

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Yes. Will, it's Phil. Let me just expand a little bit from Matt's question. So our 2 largest and fastest-growing are -- and we call it really transportation versus just automotive because it's further extended beyond the automobile, right, with -- along with the EV and the grid and ADAS, I mean, across-the-board farming equipment, et cetera. It's all getting more electronics with [fuel] attached to it. So we're still seeing good demand there in all regions of the world. We play a little bit with the Tier 1s from fulfillment. But we're getting into Tier 2, Tier 3. It's really an expanding market right in our sweet spot. So that's actually going quite well for us. Industrial, if I combine with the applications of IoT expanding, it's actually expanding the industrial customer base really. It's again a longer tail, I should say, as well as nontraditional customers coming in. So they're not start-ups, but they're traditionally customers that don't have electronics in them, okay, but obviously want to start using some more applications on IoT. So actually, the industrial, always strong in Europe, continues to be strong in Europe, doing well here and in Asia. I just got back from Asia last week, and things look very positive. There -- of course, defense, aero, a bigger segment for us here in the Americas is looking to be very strong, and that's a sizable business for us here. So no -- I mean, again, I don't want to sound overly optimistic as we never know. But right now, things look pretty good in the different segments, which is why we think we're not seeing as much of the typical cyclicality either that we've seen in the past.

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Operator [25]

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Our next question comes from the line of Jim Suva with Citi.

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Jim Suva, Citigroup Inc, Research Division - Director [26]

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This is kind of more a bigger-picture question, but you can answer it however you want. In the past 12 to 24 months, the industry has changed a lot. Avnet lost some pretty big supplier contract, and Avnet won some very important supplier contracts. Can you help us understand right now -- is that state of the environment still pretty much in flux and with changes that are happening in the works? Have these calmed down? Are the suppliers looking for you to do more or less? There's just so many changes in the past couple of years. I just wanted to get a pulse on where we stand today because you won a lot. I'm wondering if there's a lot more left for you to win or things kind of have slowed down or just kind of a pulse on the industry from a supplier-distributor relationship.

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [27]

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I'd say it's more stable today than it was a couple of years ago. And I think I would foresee it being that way with respect to supply lines with the exception of some acquisitions occur in the supply space. That could then change some of rules of the game. But what we're seeing right now, we're seeing stability with all our top suppliers. We spend a lot of time with them. Between Phil and I, we visited over hundreds of our decision-makers out in the supply chain and we have regular ops reviews with them and make sure that they understand exactly what our commitments are, and we work diligently to ensure that we achieve those commitments.

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Philip R. Gallagher, Avnet, Inc. - Member of Executive Board & President of Electronic Components [28]

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Yes, Jim, I'll jump on that as well. For sure, you're right. The last couple of years, there's a lot of movement, okay, a lot of it caused by accelerated M&A and consolidation on the supplier side. It was accelerated but it wasn't new. If you go back 25, 30 years -- unfortunately, some of these have been around that long, these things happen. I mean, they just seem to happen. There's a lot in a short period of time, okay. So yins and yangs, back and forth. So you're absolutely right. But what -- to Bill's point, we don't sit in the supplier boardroom. So we don't know what they're absolutely thinking, when the next shoe may drop. But we feel very good, very -- never comfortable but confident, okay, where we sit with our supplier relationships right now and particularly with the -- bringing Microsemi back is a big win for us.

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Operator [29]

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Our next question comes from the line of Param Singh with Bank of America Merrill Lynch.

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Paramveer Singh, BofA Merrill Lynch, Research Division - Associate [30]

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So guys, it looks like you did phenomenal with Premier Farnell margins there. But we have heard from this channel that a lot of companies, like Premier and its competitors, are benefiting from some sort of shortage where people, instead of buying from traditional distributors because they are getting allocated, are buying small lots from companies like Premier and overpaying for it in some way. So do you feel that's part of the reason why you're getting such phenomenal margins in the Premier business? And are you saying that this 12%-ish margin is sustainable [at best]?

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [31]

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Okay. Short answer to your question, no. Now with respect to sustainability, our game plan is to get that number higher. That's what we want. We think there's some more room to grow operating margins in the Premier Farnell space, and we're going to do it. We demonstrated now. We've almost doubled the profitability in that business unit, and we went from one that was shrinking to one that was growing. So we're very comfortable with the position that we're in. We're really comfortable with our competitiveness, and this whole play with ecosystem plays extremely well at Premier Farnell. Lead sharing is really phenomenal between Premier Farnell and our core component business. So it's going better than we expected. So I'm very bullish on that acquisition and what it brought to Avnet.

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Paramveer Singh, BofA Merrill Lynch, Research Division - Associate [32]

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Have you guys quantified any metric on what lead generation from the Premier [bought] business is going into your core business and how that's benefiting you? Or is that...

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [33]

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No, I'll give you some color. We just started -- something that we weren't expecting to happen that's happened but exciting is the fact that we're registering designs from Premier Farnell early in the life cycle, and they get passed on to the core component business. And the amount that get approved are higher than any other leads that we have in the business. They're getting approved at a rate of 66%, which is pretty phenomenal. We're -- now we [applied] that in Europe, and we're already at 12 million that have been approved. And that's going to grow pretty substantially over the course of the next several quarters. So that's one example. I gave you an example in my remarks earlier about how the leads get moved around the ecosystem. I used Dragon as one example, but that happens not only in Dragon. It happens with Hackster. It happens with Premier Farnell. All of a sudden, we get a nontraditional company lead that we're able to capitalize on and bring it into the core and start ramping up production. And there's plenty of that that's going to happen. In future earnings calls, we'll flesh that out a bit more to give you an idea of exactly why that means so much for the company.

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Philip R. Gallagher, Avnet, Inc. - Member of Executive Board & President of Electronic Components [34]

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Yes. Param, this is Phil. The other direction of leads, if you aren't just from Premier to the Avnet core but also have the core back to Premier, what we're calling engineering and where a lot of our traditional customers are doing NPI, new product introduction, where we have leverage in -- like in scale, we're expanding the Premier Farnell into the core base. So it's really going back and forth both ways. The teams are really working really hand in hand out there in the field.

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Paramveer Singh, BofA Merrill Lynch, Research Division - Associate [35]

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Okay, great. And then really quickly, I have a follow-up. Based on the guidance, it looks like -- I'm just trying to figure out. It looks like that the core business margin might be flat to slightly down sequentially in your guide. Is that based on mix of region? Or is there something that I might be missing there?

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [36]

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Yes. That again would be higher mix of Asia business.

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Operator [37]

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Our next question comes from the line of Steven Fox with Cross Research.

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Steven Bryant Fox, Cross Research LLC - MD [38]

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First question, I was just curious on the positive cash flows for the quarter. How much would you say was a result of just your own internal improvements on working capital versus just natural improvements in growth, et cetera? And then I had a follow-up.

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [39]

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A good part of it, $140 million, $150 million-ish.

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Steven Bryant Fox, Cross Research LLC - MD [40]

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And so when we look at going forward proportionally on the days improvement you're talking about, is there any reason to think that you shouldn't annualize to something similar as we go through this fiscal year?

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [41]

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So I think what we've said before, Steve, which is true, every day, it's worth about $50 million. But what you see is, right, we're growing. So when we talked about Investor Day and getting to $7 a share, we're assuming that we're going to reduce working capital but it's -- roughly, I think, half will get reinvested for growth. So we have -- we had a really good cash flow quarter but are we going to have front row of $230 million? I don't think so. I hope so, but it's in the right direction.

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Steven Bryant Fox, Cross Research LLC - MD [42]

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Got it. And then just on the gross margins, I was wondering if we can get a little bit more detail on how much of the gross margin decline was directly due to the Asia mix and maybe what the -- how much of the positive offsets were related to the Americas profit improvement and the Avnet Integrated growth.

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [43]

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So the good news on this is just about all of it is due to mix. And if you look at the gross profit percentage by business, they're generally improving. So that's a good sign for us going forward.

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Operator [44]

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Our next question comes from the line of Mark Delaney with Goldman Sachs.

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Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [45]

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First question is a follow-up on the Asia region and [speak] for a little bit more color about why Avnet thinks that region in particular has been growing at such a strong rate and even faster than the other regions. And on the topic of Asia, especially for China, how are your customers thinking about potentially managing through some of the tariffs? And has that changed the demand patterns at all?

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [46]

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I'll take the tariff question first and then we'll go to the first question. The good news is it only represents a small portion. 1% of our overall line cards is impacted by the tariffs based upon our evaluation to date. That could obviously change if the rules change. Our Americas business will be most affected, and our expectation is that product price increases that come our way will be passed on to the customer. So that's kind of the overall game plan, what we see with tariffs.

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Philip R. Gallagher, Avnet, Inc. - Member of Executive Board & President of Electronic Components [47]

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Yes. I'll jump on it. Asia in general -- Greater China, we should say, is the fastest-growing part of the region. As I said to Matt, I was just there last week. It's just strong. I mean, right now, the demand is just good. And of course, this quarter, as Tom pointed out, a ramp-up quarter in Asia-Pac get ready for -- some of that's consumer-based and get ready for the holidays in December. But as I look at Asia today versus many years ago, many years ago, it's still a big part, but outsourced, right. A lot of it was outsourced from the U.S. -- predominantly U.S. and Europe as well in the Asia-Pac, starting in Southeast Asia, working itself to China and Vietnam, et cetera. So you still have that element that's there, okay, which is terrific. And we track well over 1,000, 1,000 OEMs that do design in other regions. In Asia, we have a great tracking system. So that continues to grow. What we really see is the organic growth now in China -- particularly China. I was there last week. The amount of the innovation, okay, that's going on in engineering and their own designs and own products, that's continuing to expand. So let me just summarize, of course, consumer is strong. We don't play as much in that, but we do still play in that. But it's the diversification of the markets. So automobile is a perfect example, on the ADAS there's all -- a ton going on in indigenous, Chinese-manufactured automobiles that we're playing in today that wasn't there many years ago. So I think that kind of sums it up.

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [48]

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So great strength in Taiwan, great strength in China, great strength in Southeast Asia. So we're hitting on all cylinders over in Asia at this sort of juncture. In the verticals that Phil mentioned, both industrial and transportation are doing extremely well.

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Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [49]

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That's helpful. And a follow-up on Microsemi, which was -- you mentioned a few times now on this call as a positive development. Can you give a sense how long that will take to fully ramp? And then should we think about coming that in at fulfillment margin and just given that -- I'd imagine you're maybe starting from scratch, [in particular since you] lost your prior design registrations.

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [50]

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Sure. That's exactly right on that. We expect to see revenues picking up in the back half of the year. So stay tuned. So that's a great pick-up for us, as Phil mentioned, and we're pretty excited about having the line back. We have great expertise. As you know, we had that line for a long time and we were, in fact, the best demand creator in that line for Microsemi. And we'll continue to be that way as we move forward.

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Operator [51]

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(Operator Instructions) Our next question comes from the line of William Stein with SunTrust.

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William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [52]

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First, a clarification. Bill, I think when you're asked about book-to-bill before, I -- the press release said above 1, and I think your comments -- I wasn't sure if you said 1.1 or 1:1...

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [53]

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1.1.

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William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [54]

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1.1. That's -- so that's where it was globally and -- okay. So that...

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [55]

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I said it was greater than that in every region.

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William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [56]

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Greater than 1.1 in every -- okay.

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [57]

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Yes.

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William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [58]

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Okay. That's great. And one more if I can. I apologize if this was asked already, but we've -- we all know that there have been shortages and extended lead times, in particular, in capacitors but also discretes. Is that influencing the bookings? Has that extended it at all? I know the last time we asked, it sounded like this is a problem that's being managed reasonably well and customers weren't in line-down situations. But if you could provide any update on that, it would be helpful.

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Philip R. Gallagher, Avnet, Inc. - Member of Executive Board & President of Electronic Components [59]

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Yes. Will, it's Phil. First, on the booking, we track as best we can the bookings and make we're sanitizing and cleansing the bookings as they come in. So we keep as accurate as possible we can our backlog and our book-to-bill. So we do watch for what you talked about very closely. And so do our suppliers -- as do they. As far as -- yes, some of the caps that you're talking about, MLCC, some discretes, yes, it's tight out there. And we're all expediting and we're all doing all we can to keep our customers' lines moving forward. There are some challenges for sure, but it's not a -- I wouldn't call it a significant impact or a threat to future revenues at this point in time.

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [60]

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And I'd [usually] quote to the cancellation rates and expedite rates across the world, and they're pretty stable. So there's no shocking news with respect to that, and you can see that jump up one way or the other. We're starting to see big issues with our customers.

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Operator [61]

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Our next question comes from the line of Shawn Harrison with Longbow Research.

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Shawn Matthew Harrison, Longbow Research LLC - Senior Research Analyst [62]

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First, if I may, a clarification. Tom, did you say that you're expecting the EBIT margin to be north of 4% in the back half of fiscal '19?

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [63]

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Yes.

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Shawn Matthew Harrison, Longbow Research LLC - Senior Research Analyst [64]

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Okay. That's a nice positive.

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [65]

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Operating income to be exact.

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [66]

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Yes, we said operating margin.

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [67]

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Operating margin.

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Shawn Matthew Harrison, Longbow Research LLC - Senior Research Analyst [68]

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Operating margin in excess of 4% in the back half of '19.

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [69]

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So that's -- go ahead.

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Shawn Matthew Harrison, Longbow Research LLC - Senior Research Analyst [70]

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I'm sorry.

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [71]

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So part of that is mix related, right, because when we get to second half, we're going to have a lower percentage of Asia, greater percentages of the other businesses on top of just the continued transformation efforts we have every quarter.

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Shawn Matthew Harrison, Longbow Research LLC - Senior Research Analyst [72]

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Okay. And then 2 clarifications, additional details. What is the expected CapEx number for fiscal '19? And then also, should we expect kind of the ongoing dynamic has been that Tech Data proceeds have been used to buy back stock? Is that what we should expect for the latest level of proceeds?

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [73]

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The CapEx is about $150 million for 2019. And in general, we're going to stick to the capital allocation plan, which is about 50% to share repurchase over the long term.

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Operator [74]

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Our next question comes from the line of Adam Tindle with Raymond James.

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Madison Suhr, Raymond James & Associates, Inc., Research Division - Research Analyst [75]

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This is actually Madison on for Adam. I know gross margins were impacted in the quarter by the mix of the Asia region. Could you guys just give us an update on how some of the other aspects are trending from a gross margin standpoint, whether it's Avnet Integrated or demand creation?

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [76]

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Yes. Generally, the decline in gross profit is because of mix, which is because of Asia. The good news is if you look at the gross profit percentage in each individual business, they are generally increasing quarter-over-quarter.

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Madison Suhr, Raymond James & Associates, Inc., Research Division - Research Analyst [77]

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Okay. And then I know in the press release, you mentioned that online sales doubled year-over-year. Can you just give us an update on what that run rate is?

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [78]

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Digital sales.

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [79]

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Oh, digital sales. Digital sales are up 18% and we are -- we had an absolutely great quarter, and we look forward to having a great year coming up. So essentially, if you look at our core business, we actually doubled digital sales year-over-year. So that's really great, and we have Premier Farnell and all of our electronic transactions that we do -- almost 50% of what we do now is handled digitally. It's about...

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Thomas Liguori, Avnet, Inc. - CFO & Member of Executive Board [80]

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Yes, roughly $1 billion.

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [81]

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Roughly $1 billion, Adam (sic) [Madison].

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Madison Suhr, Raymond James & Associates, Inc., Research Division - Research Analyst [82]

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Okay. Roughly $1 billion, you said?

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William Joseph Amelio, Avnet, Inc. - CEO, Member of Executive Board & Director [83]

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Yes.

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Operator [84]

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Ladies and gentlemen, we have reached the end of our question-and-answer session. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.