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Edited Transcript of AVT presentation 7-Mar-17 8:25pm GMT

Avnet Inc at Raymond James Institutional Investors Conference

Orlando Apr 10, 2018 (Thomson StreetEvents) -- Edited Transcript of Avnet Inc presentation Tuesday, March 7, 2017 at 8:25:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bill Amelio

Avnet, Inc. - CEO

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Conference Call Participants

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* Adam Tindle

Raymond James - Analyst

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Presentation

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Adam Tindle, Raymond James - Analyst [1]

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All right, so we'll go ahead and get started here. I'm Adam Tindle, covering IT supply chain at Raymond James with Brian Alexander. We're very pleased to have Bill Amelio, the CEO of Avnet.

For those of you who may know Avnet from years past, the story has changed pretty significantly over the past 6 to 12 months; and coincidentally, that happens to be the time where Bill was brought on as full-time CEO. So I'll let him tell the story, and we'll save five to ten minutes for questions.

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Bill Amelio, Avnet, Inc. - CEO [2]

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Thanks, Adam. Welcome, everybody.

The obligatory Safe Harbor Statement. I'm sure you read it and memorized it, so I won't go over it. Let me tell you a little bit about the Company.

So those of you who aren't familiar with the story, we're headquartered in Phoenix, Arizona. We were founded almost 100 years ago, and we've had a major transformation in the Company in the course of the last 7 months. In fact, I'd say that we've introduced more change in the last 7 months than we've seen in the last 20 years

And -- starting with the fact that one of the areas where we've had the most concern about our business model is with our TS business, which we just concluded a sale. We announced the sale in September, and it got concluded on February 27. And critical of that is that we got a significant amount of proceeds, and we will be redeploying those proceeds to pay down debt. And we authorized $500 million of share repurchase, which gives us a $625-million share-repurchase bucket that we have to be able to go to share buy-back. So that's a part of the story that we're on today.

We've been recognized with lots of different achievements over the years, and the Company has been around a long time. And the two major things that we do for our customers is, one, we provide design-chain services, which allow us to design in solutions that customers essentially put our suppliers' technology on their product, and we get a preferential margin associated with that when we do that.

The second thing is, we do supply-chain services, which essentially is -- we not only just ship product, we also do special terms with customers. We provide a single point of contact. So, as opposed to a customer worrying about hundreds or thousands of part numbers, we will handle that all for them, and they only have a one-stop shop to come to us with respect to being able to supply electronic components to them.

If you look at the addressable market, it's growing. However, I will say that if you look at this projection over the last several years behind us, they always got essentially reassessed downward, unfortunately. But this past year was the first year where we saw the downward motion not so much.

So we actually had about a 3% growth in the market last year in 2016. So this projection going forward looks a little bit more realistic. We're seeing a lot more optimism in the market. Our book-to-bill rates are up now, and that's a very good sign. We're starting to see areas where the lead times are actually getting extended. That's another good sign that the market is tightening up. And we're seeing some good demand out there.

The two sectors that are really important for us happen to be two higher-growth sectors, and that's in industrial and automotive. There's a lot of IoT content in that. Today, we ship about $300 million of IoT devices, and that is essentially [growing], which is a key growth factor for us.

And what's interesting about that part of the market, which I'll talk about in a few more moments, is the fact that that's not only getting done by large, well-known companies. It's also getting done by this new movement that's out there called the maker movement. Which means, you could be in your garage, you could be in your dorm room, you could be anywhere, and you have an opportunity to be able to design an IoT device. And I'll talk some more about that whole movement in a moment.

If you take a look at where we fit in the supply chain, we're essentially right between our suppliers and customers. We have 600-plus customers on our line card. There's some key marquee names that are on our line card. We have 110,000 customers; and broken between the OEMs, ODMs, and EMS, are the major categories of our customers.

I mentioned this idea of design chain. And why that's so important for us is because we do get preferential margin. Whenever we win a socket for a supplier and we start shipping product against that customer, we'll get anywhere from a 10-plus-point margin differential, versus just supply chain. So that's why that's important to us.

One of the key capabilities of the Company is, we can design anywhere and then build anywhere. So for example, there's a lot of designs that happen in the European market, as well as the Americans market that eventually gets fulfilled over in the Asia market. And we track those designs very thoroughly and make sure that we get our preferential margin no matter where they get built. And that's one of the key, I'll say, value drivers of the Company to make that we do that efficiently and effectively.

Now let me talk about a major acquisition that we did. So we divested the TS business. That allowed us to have some additional room for us to take a major investment in Premier Farnell, which is a category company.

So if you think about our business space, and you think about our competitors, I'd put it in four different quadrants. There are broad line distributors, like ourselves and our nearest competitor. There are category companies, like Premier Farnell and Mauser and DigiKey, to name a few. There are niche companies that tend to be [IPD] companies, and then the brokers. So that's kind of the circle of competitors that we have.

Premier Farnell adds an interesting element to our arsenal. Essentially, what they do extremely well is low-volume production, with lots of skews, very thin when it comes to the inventory level, but lots of different skews and the ability to deliver within 24 hours, so very great capability to do low-volume distribution.

Avnet for our history has always tried to backward-integrate and do this. But the problem that we always ran into is that our sales force when they're calling on customers always had the viewpoint that -- well, if I'm going to get the volume sooner or later, I'll give away the front end, small-volume stuff and use that as a loss leader.

That is not the business model we'd like them to be in. So one of the only ways that we could get into the position where those low volumes can be captured with higher gross margin is with the opportunity to buy a Premier Farnell.

Additionally, Premier Farnell has over 450,000 [engineering] community, called Element14. And why that's important is because they're designing the future. That IoT discussion I had a little earlier is exactly what some of these engineers are doing in their spare time. They're coming up with some real creative solutions that weren't there previously.

So what we have the opportunity to do now is to take a product from the idea stage through pilot production, volume production, end-of-life, in a seamless fashion.

So historically what you'd see happen is, when Premier Farnell got to a volume situation, they'd have to go out to competitive bid because they didn't have the capability to support it from a volume point of view.

Now we will seamlessly take those leads over to Avnet, but it will appear to the customer that they're still getting fulfilled by Premier Farnell. So we'll be able to hold a margin that's higher for a longer period of time, which gives us the ability to be able to drop more to the bottom line.

So our three key objectives with respect to digital -- because one of the other main elements that Premier Farnell brought to us is the fact that we were able to up our game dramatically in digital presence.

We were doing roughly about $100 million of business on the web with Avnet's mother company. When we added Premier Farnell, that added about another $500 million of capability, and a terrific website that has great capability.

On top of that, over the last 18 months, we developed some significantly good tools with respect to improving time to market on the design point of view for our customers with Avnet, which now we're able to port over to Premier Farnell and even make that site more robust.

Secondly, what we want to do is, be able to have the tools necessary to have customers go from the beginning of a design all the way to completing their design, all online without being touched by a field application engineer. That's highly effective from the point of view of giving us a low-cost-to-serve model.

And finally, we want to build this unique, end-to-end model. We can take a maker who has just got an idea, help them create a product, help them then take that product and create a company, go from creating a company to ramping into pilot production and eventually into full-scale production.

So another way to look at that is -- in this linear model that says -- we bought another company called Hackster.io. If you haven't looked that one up online, it's very fascinating. Because what you'll see there is lots of different product types. A lot of them are IoT-type devices, but very creative.

So these are people that go to the site that have an idea, not necessarily engineers, but entrepreneurs, and they want to create a product. And Hackster's sight gives them to tools necessary to actually create the product. And simultaneously, they get help on that site because there's 200,000 users there to actually give them feedback on their product. If they hit the mark on this, you need to work on this, you need to develop that. And they eventually create the product.

Once they create their product, we've developed this website called MakerSource, which you can view as kind of the Angie's List of creating companies.

So you can go to that site and say, look, I don't know where to begin to start a company, but I need a sales force. So it can tell you, here's how you get salespeople to help. I need to get some legal support. Here's some opportunities for you to go talk to somebody with legal support. And we get that site funded by all those different people that want to participate in becoming part of this movement of getting these makers to become full-scale companies.

So once we create company [we have an opportunity then] we point them to Premier Farnell as their supply chain of choice so they can do their product production early volumes with Premier Farnell. And as they grow that volume, we seamlessly move them over to Avnet, where we have now an opportunity to be able to service them through volume production all the way through end-of-life.

So that's the new ecosystem that we developed with this full concept of saying, when you're earlier in your life, we want to be able to cast a wide net, capture literally millions of customers in a very low cost-to-serve model, as they migrate through this progression of their life cycle.

What occurs is, eventually we're able to put a field application engineer on the account because it's gotten large enough and we want to optimize their product line from a cost standpoint and a lead-time standpoint to give them the best possible chance to be successful in the marketplace.

So if you look at our financial performance in the past quarter, we grew our core 4% year over year in constant currency, and that's excluding the acquisition of Premier Farnell, as well as a strategic decision that we made almost a year ago now to exit out of some high-volume, low-margin business in Asia.

Premier Farnell did, in fact, exceed our expectations with respect to sales, and they helped us expand our margins, so two good things that demonstrate that the acquisition is already off to a great start.

From an overall sales point of view, we're at $4.2 billion, which [was in] growth in constant currency of 3.4%. Operating income was up 7.9% for the year, and we were ahead on our guidance by $0.03 to $0.77 a share.

So if you look at our margin walk, taking into account the sale of TS, the acquisition of Premier Farnell, and then synergies from PF -- as we reported in the last quarter, we were actually at 13.7%. So our gross margins are already hitting on our expectations.

From an operating-income point of view, because we haven't yet completed all the synergies, we ended at about 3.7%. So we're well on our way to achieving what we expect to achieve with these two acquisitions, as well as the synergies associated with Premier Farnell.

Speaking of synergies, our synergies are -- revenue is 3X that of the cost. And at this juncture, we already have covered our revenue synergies with projects, so we're just about covered on our costs. So we've made great progress since we bought the property on October 17.

So an earnings-per-share point of view -- if you look at this walk -- I'll break it into three buckets. One is the strategic transactions, which are selling TS. Of course, that was dilutive. And then adding back Premier Farnell, which was accretive. And then the cost reductions we've done over the course of the next couple years, which include Premier Farnell synergies, as well as Avnet Advantage, which was a program we started a few years ago to take costs out of the Company.

And then our strategic reallocation of capital one (inaudible) debt payback. So some of the proceeds that we got from the Technology Solutions sale will go to buying down our debt. That was about -- a little over $1.5 billion. We've also, as I said, authorized $500 million more for share buy-back, which will be included in that last column, there. So that gives you a sense of where we think the earnings per share will be going over time.

From a capital-allocation-priority point of view, of course organic growth is number-one important for us, to be able to grow that top line. We think this new ecosystem [mall] that we created has some great opportunity for us to be able to accelerate our growth as we move forward, because we'll have an opportunity to capture more of those makers earlier in our life cycle and shepherd them through the process of growth.

And what we've learned over the years is the fact that if you capture a customer early in the life cycle, you essentially have that customer for life, because they really are loyal to you because of all the help that you give them early in their life.

Secondly would be, of course, the strategic value-added acquisitions. And as we think about the competition -- I kind of told you the four quadrants of the competition that are kind of in the center, like this. But the disruption to a business model usually doesn't happen by the competitors, themselves. It happens somewhere outside the sphere of your competitors.

And we've categorized various different areas where we see opportunities for us to either partner with firms that could help this ecosystem become more robust or, in fact, do some acquisitions. And that's where we've developed our pipeline of possibilities for acquisition -- pipeline going forward.

We have a disciplined share-repurchase process. Historically, we've used book value as kind of this feeling for where we purchased our stock. And when it goes below book value, we start buying more and more and more. So the lower our book value, the more you buy.

As we move forward, we've done some work with respect to what we believe is share price values from our standpoint, using some discounted cash flow analysis based on our projections of where we think the business is going, as well as some market tests that have been done. So that number is now a bit higher, and that gives us an opportunity to buy more stock as we think our stock is undervalued. And you'll see us out in the marketplace. In fact, over the last several weeks, we have been in the market buying back some of our shares.

And finally, we've increased our dividend this past quarter 5.9% to $0.18 a share, and you'll see us continuing to focus on these areas with respect to our capital allocation.

So to kind of sum up before we go on to questions -- look, we're a global leader in value-added component distribution. We believe the combination with Premier Farnell gives us an unmatched model that's first-mover from the standpoint of us being able to capture these makers early in their life cycle and drive them through their entire life cycle.

We have a nice addressable market of over $300 billion and growing. We have a revenue stream from a broad base of customers, and we're in various different, diverse market segments. I noted a couple that are growing -- automotive and industrial. And we have an improved business model with some strong cash flow generation. In fact, in down cycles, this business generates lots of cash. And we have a disciplined leadership team, and we have industry experience to be able to drive some of these key new strategies that we have in place.

With that, let me open up to thoughts and questions on your mind.

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Questions and Answers

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Adam Tindle, Raymond James - Analyst [1]

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All right. Thanks, Bill. Maybe I'll just start on Premier Farnell. One of the pushbacks we get from investors is, it was obviously publicly traded. We can see the results, and it was viewed more as kind of a troubled asset. You've owned this since October. Maybe talk about the top-line and margin issues that they were experiencing historically, and then tie this into recent performance that you highlighted here in the last quarter.

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Bill Amelio, Avnet, Inc. - CEO [2]

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So doing the due diligence at Premier Farnell, we had noted the trends that Adam said -- that they were wise enough to get on board -- Alvarez & Marsal would help them put together a get-well plan and work through a lot of the issues that they had and put them on a right trajectory.

The reason they got in some issues is because they had five key management changes, CEO changes in the course of the last several years, that caused a lot of disruption to the company.

The good news is that get-well plan has worked extremely well. This past quarter, they had great results. They overachieved what we expected on top line and margins. And as we look forward, their projections are looking really solid, as well.

So we're really happy with the asset. And as I pointed out, we've already all but got all the synergies lined up with respect to projects that we believe we're going to get accomplished. We've been on record to say half the synergies will come in at the end of the calendar year and the rest of them in the following year.

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Adam Tindle, Raymond James - Analyst [3]

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Okay. And please feel free to raise your hand if you have questions.

Keeping on that subject, as you talked through the strategic direction in shepherding customers through the various stages, I think pilot build is the hole that your competitor has. Talk about the importance of this and the challenges to not having that capability.

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Bill Amelio, Avnet, Inc. - CEO [4]

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As I pointed out, the Premier Farnell model is -- their gross margins are in the mid-30s. So they've done a super job of being able to capture more value with small volume. And neither ourselves or our nearest competitor, with our current business model, were able to get higher margins, simply because our sales teams tend to want to give it away because they're more interested in the volume production.

By having this capability now, we'll always put early production in -- or early [part] distribution into Premier Farnell, so we'll capture that margin.

And then what happens is, as that customer starts to ramp up, we will keep that customer as part of Premier Farnell for some period of time, so we'll feather down the margin. And we have an opportunity to instead of going into a competitive situation where it immediately drops in gross margin, we will hold that margin longer, which gives us the capability to get more to the bottom line.

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Adam Tindle, Raymond James - Analyst [5]

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Okay. And I think in the last quarter, you saw revenue growth was 4% in constant currency [ex the] Asia exit. Is this type of a growth profile sustainable based on the existing business that you have today? Is that how we as investors should think about the long-term growth profile of Avnet?

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Bill Amelio, Avnet, Inc. - CEO [6]

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There will always be quarter perturbations, and as you noted, there's [been an announcement] with some supplier consolidations, and so we'll have a quarter, or so, in front of us where we'll see some that come off the top line. And that will have an impact in a quarter, or so. Then we'll get ourselves back on that same growth trajectory again.

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Adam Tindle, Raymond James - Analyst [7]

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Okay. And maybe on that subject of the walk that you just showed us on EPS, does that include the recent supplier losses, and does it also include the strategic transformation that you have been working on since September?

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Bill Amelio, Avnet, Inc. - CEO [8]

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So I didn't include either one of them, so let me talk about the strategic transformation, because I think that's important, because that's a very big number eventually.

So in the May analyst meeting, I plan to present the details associated with our transformation project and essentially talk about how much of it is going to be used to offset some of the supplier consolidation and margin erosion we have from the suppliers doing what they do, as well as how much we think it's going to be accretive to the bottom line.

So what is the transformation program? Well, back in September, we started a program that was an eight-week program to do due diligence on the Company. And we looked at it through the lenses as if we were a private equity firm and determined where the value drivers were inside the Company. And we came up with some really ambitious targets, which as I said, I'll share with you what those targets are in the May meeting.

Then the next eight weeks was to do a bottom-up plan to come up with projects from our teams to be able to deliver on those particular [values]. And when we added those projects up, we ended up having actually an overachievement of what we expected to get. So we have over 450 projects with several hundred colleagues across the Company working on these key transformation projects.

So as an example, there's projects that work on, how do we get the most efficient pricing across the world? So we're picking up best practices that we have in one part of the Company and migrating them quickly to another part of the Company.

How can we share inventory more effectively? How do we have one commodity manager that does procurement, versus five that we have today that are talking to suppliers? How can we more effectively manage our inventory by doing a center-of-gravity analysis that says we ought to have our inventory in a certain spot and hub and spoke it to all the other areas so we're able to overall reduce the level of inventory? So that's just a few of the 450 projects that we've got running that's going [out to] transformation.

So that will be a net-plus. And I should point out, with the losses of a couple suppliers that we talked about, there are net-minuses that we will then see what the balance point is over the course of the next couple months.

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Adam Tindle, Raymond James - Analyst [9]

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You expect the balance to be positive?

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Bill Amelio, Avnet, Inc. - CEO [10]

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We expect the balance still to be positive.

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Adam Tindle, Raymond James - Analyst [11]

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Okay, all right.

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Bill Amelio, Avnet, Inc. - CEO [12]

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But not necessarily in any one quarter. That's the problem. We'll have some [monthly distance in] quarters.

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Adam Tindle, Raymond James - Analyst [13]

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Understood. Maybe on supplier consolidation -- because this is kind of an investor debate, in the recent supplier losses. Talk about your view of these as isolated incidents or the start of a trend, something more wrong with the components business.

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Bill Amelio, Avnet, Inc. - CEO [14]

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Well, let's take the biggest one for us, which is not a loss, but it's kind of a change in the industry, and that's Texas Instruments.

They made a decision to do all the demand creation themselves, and they'll use the channel for fulfillment. So we haven't lost any revenue with them, but our margin profile is dramatically different.

And they made that decision because they had a catalyst of buying National Semiconductor, lots more salespeople, and decided that they had the capability to service a lot more accounts direct. And they believe with their broad portfolio of products that they can use their digital platform to go after the tail of customers and be able to effectively manage that.

Our viewpoint is, that may not end up being a lasting strategy, because if you're an engineer or a designer and you want best-in-class technology across the entire industry, most likely you're not going to go to any one supplier's website; you're going to go to somebody who's agnostic.

Furthermore, some of the accounts they took early from us were only in design registration when they took those accounts direct. So therefore, they're starting to see growth off of those accounts off the back of both of the distributors, who they took those demand creations from.

So we have a different view with our friends at Texas Instruments that we'd like them to come back, and we will welcome them back at any time into the fold to do demand creation. But we've moved their resources to other suppliers who are highly interested in using those resources to do demand creation for them.

A second example would be ADI, where they made a decision that said -- look, we plan to take more accounts direct. There's going to be less gross-profit margin available for the industry. And we plan to take a margin cut when we decide to consolidate it with one particular supplier -- or, distributor.

Linear Tech was a pending acquisition that's going to be completed very shortly. That happened to be 100% into our competitor. So from a risk-profile point of view, it made a lot more sense if they're going to consolidate [what] distributor would you consolidate [in], which was the one that would give you the least amount of risk. Because their volume was split 50-50 between ourselves and our nearest competitor, and Linear Tech was 100% with our competitor. Therefore, it made sense from their standpoint to take more accounts direct and take that business all into one supplier, or one distributor who would have the least amount of risk.

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Unidentified Audience Member [15]

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(Inaudible ? microphone inaccessible)

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Bill Amelio, Avnet, Inc. - CEO [16]

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Well, if you look at them, they actually have done reasonably well right now. But the problem is, you can't sort out the distortion with the fact that the reason they're doing well is on the backs of distributors who they took the design registrations from.

So we had a bunch of design registrations that hadn't started shipping yet. So they took those accounts from us. Now those accounts are shipping, so it essentially gives them an inflated view of the progress.

So once that sorts out, we will know better. Because as we speak, both ourselves and our nearest competitor are doing exactly the same thing. We're using the rest of our line card on [rev] designs that they have, and we're taking sockets away. We're tracking exactly how many we've taken away, and it's not an insignificant amount. So we're convinced that as time goes on, they're going to start to see that this may not be the right strategy and they'll be rethinking coming back and talking to distribution.

One of the other things I'd note is the following. If you think about where we sit in the space, if you [paredo] all customers [you say] the largest customers here and then go down to the tail over here -- there's a line that's always there that says the supplier will take the biggest accounts always direct; and that line kind of moves depending upon the growth in the industry.

If the growth in the industry is robust, that line gets very close to the axis because they only can service so many accounts with the resources they have. Because those accounts start to grow, and they start demanding more attention because they're growing. And therefore, they need distribution to handle the tail of the distribution.

And what I believe right now is that the pendulum has swung way this way and is starting to swing back now, because we're starting to see growth come in. And that's evidenced with our book-to-bill ratio is up, and some lead time on certain components is starting to tighten. Yes, sir?

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Unidentified Audience Member [17]

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(Inaudible ? microphone inaccessible)

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Bill Amelio, Avnet, Inc. - CEO [18]

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Let me hit lead times first. So it's spotty on certain components. So it's not across the board, unfortunately. We'd like to see it across the board.

On Qualcomm and NXP, we've got a terrific with NXP. We've been in contact with them throughout this discussion. They have indicated to us that they are locked and loaded with us. So we don't see any issue there.

Now, I have a session with NXP at the end of this month, where we'll reiterate our plans with them and talk through any particular strategy changes they want to have in mind. But at this juncture, we're totally locked with them.

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Adam Tindle, Raymond James - Analyst [19]

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Maybe in terms of the share repurchases -- I think you alluded to the more aggressive pace here recently. So you've got $675 million in authorization, which is about 10% of your market cap, maybe even a little bit more. How quickly do you intend on going through this? And then once we get past this initial tranche, would you view more to come?

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Bill Amelio, Avnet, Inc. - CEO [20]

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Well, I think we have a ways to go before we talk about more to come. Because $625 million is a lot, and we have a disciplined process that we're using. And the further we're away from where we think the target price is, the more we'll buy. But as we start approaching that, of course we'll slow down.

So at this juncture, we're out there buying, and you'll be able to see on a daily basis, and you'll get a kind of a sense of what that model looks like. Because as the price changes, you'll see us fluctuate how we purchase shares.

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Adam Tindle, Raymond James - Analyst [21]

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And on cash generation, I think you guided pro forma cash generation to about 55% or 65% of net income. Are there opportunities to improve this, or do you believe this is just the structural level?

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Bill Amelio, Avnet, Inc. - CEO [22]

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We definitely think there's opportunity to move that up. We want to just sort out and let it settle in with the Premier Farnell acquisition. Once we get a couple months behind us, I think we'll come out with different projections that are higher, associated with cash generation.

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Unidentified Audience Member [23]

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(Inaudible ? microphone inaccessible)

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Bill Amelio, Avnet, Inc. - CEO [24]

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It's split between the rating agencies. One is comfortable. One is not as comfortable. So two and a half does a little bit better than three, and that's kind of where we're positioning ourselves right now.

And with respect to cash on the balance sheet, we comfortably could run with $400 million to $450 million of capital to take care of our fluctuating working-capital needs.

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Unidentified Audience Member [25]

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(Inaudible ? microphone inaccessible)

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Bill Amelio, Avnet, Inc. - CEO [26]

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It's [growth].

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Adam Tindle, Raymond James - Analyst [27]

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All right. I think we'll leave it there. Thank you so much, Bill.

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Bill Amelio, Avnet, Inc. - CEO [28]

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Thank you.