Avnet, Inc. (AVT) Earnings Call Transcript & Summary

Yes.

They made a cautious decision 4 years ago to get out of demand creation. And their concept was this, was that, look we're such a broad-based supplier that we look like a distributor with all the parts that we have, so why should we have anybody in between us and our customers. And we're building a robust digital site that any customer, the long-term customers can go to. And therefore, over time, we should be able to service everybody with either a pure salespeople or our digital site, and that should be the game plan. So I don't think there's anything that distribution could have done that would stop that thought process from happening. And our end objective is to get to that position. This is another intermediate step to get there. They took several years to get to this spot, and they accelerated with that announcement they made in November.

Tom, I think there might be some working capital implications of this change with TI because -- I could be wrong, but I think they have a lot of their inventory. So I imagine it's pretty working capital-light business for Avnet, at least relative to the other businesses. So any sort of implications for your target of getting to 70 days on working capital?

Yes. Most of the inventory was consigned, but there's a pretty substantial amount of receivables. So we've talked about this probably -- roughly a $300 million inflow as the sales go out. However, as we replace the sales with the steps that Bill talked about, that will go back into working capital. So independent of TI, we feel really good about the 70-day net working capital. And last year, we were at 96 days. Today, we're at 83, contributed to the cash flow. So it's not going to be overnight. It's not 1 or 2 silver bullet projects, a lot of hard work, that's where working capital is, teams day in, day out working at.

What did we return last year to our shareholders? How much in the last 12 months?

We returned $500 million. We generated $949 million of cash, it's like $9.40 a share compared to our share price quite significant. So in attaboy to the Avnet team and -- I really think that's the best part of the working capital reduction and the cash flow. Yes, it's a big dollar amount, but it really tells you about the person that works at Avnet, their skills, their dedication. And all of you know, you've worked in the industry, a working capital reduction, it's hard work, it's hard work. But they've done a good job, and it's part of our culture of get better every day.

And maybe we can continue along those lines with the conversation and use of capital this year or over the next few years. I think it's been pretty balanced and we've seen returning cash to shareholders and some tuck-in M&A, but what are the main objectives of revenue with that?

Yes. I think you're right. It's pretty balanced, continue to be balanced going forward. We spend -- about 20% of our cash flow is in CapEx. That's the distribution centers, modernizing them. A good example is in leads. We just opened the distribution center that's got more capacity at a lower total cost than what it replaces. We're putting in place a lot of SaaS-based tools, AI tools, CRM tools. So CapEx is clearly a priority. We have our dividend. We're going to continue to grow that 5% or so a year. This is something we're committed to. We did add, in the last 4, 5 months, debt, some debt reduction. And Mark, the reason for that is we're investment grade. And it's very important for us to continue to be investment grade. So when you're in a downturn, even if your debt is flat, downturn, your earnings are lower, so you got to bring down the debt. So I think we paid back about $350 million in the summer, another $140 million. There might be another $100 million, $200 million to go near future. But we're committed to the buyback program. It is based on a price grid. So the share price is down, we buy back more. So this week we're buying back more than we did a month ago. And as the share price recovers, we buy back less. And we're going to continue to do that. And I think you characterized it correctly, that's pretty balanced. In the M&A. So this last quarter, we did 2 acquisitions. And they're very indicative of what we're going to be doing going forward, which is Witekio was adding a capability that we didn't feel we had in-house. It was security for IoT. And then Phoenix is a distributor with a limited line cards, that in general, we will acquire distributors where they either bring a customer or market segment. We're not supporting or -- a supplier that we don't represent. And this is something we started before the TI transition. But what's very positive about it is, those acquisitions are going to contribute $160 million of revenue a year, so that in itself is 10% of the TI revenues. And so we have a couple more in the pipeline. So it's hard to tell or predict if you're going to get to the finish line with, but that's our capital allocation plan.

There's been uptick in announcements and news around the strategic changes in the broader distribution landscape. Phoenix made announcement that Tech Data [indiscernible] Avnet already did a lot of strategic actions, Bill, after you became CEO and made the divestiture of your hardware, software solutions business. But maybe any thoughts that you have on just some of this broader activity going on in the distribution space? Is it coincidental? Or is this indicative of something that's going on? And I know, Tom, you touched on this a little bit. There's maybe some things that Avnet is looking to do, but anything, Bill, from your perspective that you think would make sense for Avnet to be...

So you're correct. We took a lot of shareholder feedback historically and made a decision to spin out TS to Tech Data, as you know, and we bought Farnell instead which has been a great acquisition for us. And I think this -- what's happening in the industry today is demonstration that there is more value that the market -- that the private equity guys think that the market doesn't see yet. So I think that's what you're seeing occurring is that there is some value unlock there. And as we execute our strategy, we're hopeful the market notices that as well. And I keep working on you and your rate, need to somewhere along the way as we talk about that.

I was expecting that in some time. Maybe we could talk about some of the growth efforts that the company has? IoT has been one, there's has been some tuck-in M&A there. But maybe help us size how big is the IoT effort for Avnet at this point? And maybe just clarify to how exactly Avnet would define IoT?

Okay. So let me explain. We have a 5-point strategy that we've talked about a lot. The second element of -- the first element, of course, is the most important, which is amplify our core business to make sure we're doing all that we can to get that business humming all the time. So when the next upside comes, we're able to expand margins. So we're doing that. Second part is to grow some of the higher-margin businesses, which includes Farnell, Avnet Integrated, IP&E and IoT and nontraditional customers. So let me hone in on IoT and nontraditional customers for a minute. We announced in CES in Las Vegas a couple of things that were of importance. One is that we have a full end-to-end capability that we're able to do, the device, the gateway, the network, the cloud. As Tom pointed out, with now the acquisition of Witekio, firmware on a device to give us a higher level of security, which suppliers love because they've been doing work with Witekio for years, and that gets us tighter connected to our supply base. And when you think of IoT, you should think about it as demand creation on steroids. Because as we're able to get that launched, proof of concepts turn into rollouts, they drive a lot of components as well for our suppliers. From our standpoint, though, it gives us solution revenue, which comes in at a much higher margin profile, somewhere like 15% to 20% operating income, which is, as you know, a dramatic difference than sitting where we are today at 1.8%, trying to get 4%, 5% operating income. That's clearly a needle-mover. So the day that we are able to say this is an independent segment, meaning that we're able to say, look, the growth is pretty consistent, it's not lumpy, and it's growing every quarter, and it's giving the returns that I just described, and you can look at it on a regular basis, you'll get a different view of the company pretty quickly because you'll say, okay, now I see it, it's there, got it. But what are we doing? What kind of pipeline are we building? We're building cases typically around asset monitoring, predictive maintenance, smart worker, smart factory, smart city, all of the above, ADAS on cars as well. And we're focusing more on brownfield opportunities. So we highlighted one in the last earnings call, which was a smart metering company that essentially is replacing a lot of the meters here in the United States. And they essentially are using our platform, which was the second thing that we announced at CES, which was a platform that allows other systems integrators like ourselves to seamlessly connect their devices in the cloud with one click. And we're connected with, of course, Azure and Microsoft. And this has gotten a lot of fanfare already because we got a lot of SIs already signed up. So this will be in the 10s to the 100s when we're done, and it will allow them to be able to implement, for their customers, faster with less complexity at lower cost. And for us, it's been -- they're on our platform, so they're going to be doing some recurrent revenue associated with it. Simultaneously, we put in place about 30 different starter applications that any SI could use to start their claim to cut their time to market down and they can augment those applications and then post them themselves onto the website, and therefore, turn into an app store. So you can see over time, we have app developers who will be writing applications for IoT, similar to what you have on your phone. So as time goes on, we will be reporting out how the growth of that platform is, both from a business integrator's point of view as well as the devices that are on there, because we'll have a whole host of devices that will be plug and play and applications. So that could be a real growing platform for us. So we think we have essentially 2 paths that we're going down with IoT. One is these use cases that are giving some -- lots of traction in the areas I described as well as this platform that will get other SIs to be able to deploy their solutions and application developers who want to have their applications highlighted on the platform.

Yes. And just in terms of sizing revenue, if I understand correctly, it's still a little bit early because it's still lumpy.

Less than $100 million now, and it's still a bit lumpy. But this is something that, if we hit the inflection point, which we have on certain customers, let me give you an example. Typically, a proof-of-concept takes a while and it takes a little longer than we'd like them to. And certainly once you get one, all of a sudden, you get a lot more ideas from the customer and your lifetime value from that account goes up dramatically. So we're starting to see that occur. And as we hit this tipping point with a lot of these proof of concepts that we have out there, and they start turning into recurring revenue, we will be able to get this list as a reporting segment and start talking about a couple of hundred million dollars of revenue at 15 points of margin, it's now meaningful.

Yes. That makes a lot of sense. And Microsoft Azure has been a product line that the company has mentioned on multiple earnings calls, and so I think that's pretty exciting, and you mentioned it again is part of the IoT effort. When investors think about the Azure opportunity, is that entirely part of IoT or it's part of selling Azure separate from IoT?

It's part of the IoT effort.

Okay.

It's what we connect to for any of our IoT deployments. And if we use our platform -- when the SIs use our platform, they will be connecting into Azure.

Okay. Sticking with the theme of business opportunities that could help to expand margins. Demand creation is a traditional part of the distribution industry with much higher margins. I think in the past, you -- at the industry level, it's roughly 1/4 of distribution revenues typically tied to demand creation. Is that the right rough metric to think about for Avnet? And maybe talk a little bit about some of the tools that Avnet's rolled out to try and give a bit broader reach to your engineers so they can touch more people, and what that could potentially mean for your demand creation mix once...

So I think it would be helpful to start with what is demand creation. So demand creation is when a field application engineer that works with a customer and helps them design the solution. So they say, we have all these various technologies, and we literally have 3 to 4 to 5 suppliers put technology. We'll go to a customer and say, here's the best selection of various different components to do what you're trying to do. So we help them with the design. When we do that, it's called a registered part with the supplier. Once the supplier approves that, when we start shipping that, we get a preferential margin associated with that part. That's why demand creation is a higher margin opportunity for us than just fulfillment. So that's what it is. Now how do you make a field application engineer more productive? Well, if you're a really great field application engineer, you might be really good at maybe 1 or 2 technologies, but not 10. And what we've developed is a -- essentially a system that's called AVAIL, that allows us to put all the knowledge of every FAE into that. So when they're sitting down with our customer, they can use that system and that will be smooth and smart with every technology, so their content per design with a customer goes up dramatically when they use the tool. So that's one of the new digitization tools that are in place to help us get the percentage up. We're closer to 30% than we are 25%, and we have some of our reporting units like EBV, who's really the demand creator of the company. They're closer to 50%. And we're working diligently to understand those best practices and how we can apply those elsewhere. The Phoenix acquisition that we've done is another, what I'll call, limited line card acquisition that has very high demand creation percentages as well.

Another effort, and you alluded to this as part of the pillars of the company, but improving sales to smaller customers, and Farnell was particularly good at selling to small customers, get online tools. I think somebody is trying to broaden out the amount of products that are selling through Farnell and some thought sharing between the traditional business and Farnell. Maybe talk a little bit about that. And if you can kind of break down what percentage of the traditional Avnet is now to smaller customers? Any sort of metrics around the progress that you're making on that front?

So core Avnet had about 110,000 customers, and then we added almost 2 million with Farnell. So that gives you a sense of, we have larger customers in and Avnet, smaller customers in Farnell. And the concept was the following, is that as a customer is growing in Farnell, and we would notice if they were doing things that say they're getting close to production, like, for example, if somebody starts buying Xilinx chips, most likely that's going to production. Therefore, we try to make a call on them, if they can, an Avnet person calling you so we can seamlessly move that lead from Farnell over to Avnet. So that's one way we move leads. The other way that, I think, is just as interesting, maybe has even bigger potential, is now that we're incenting the core people to bring Farnell into their accounts. So we have a great foothold with a customer, but we never did any specialty catalog business with them. They're doing it with the other guys. We say, you probably didn't know we had Farnell, you should really use Farnell and they say, "Oh, yes, we should use Farnell." And we get potential share shift to be able -- on the front end of their new products to be able to have Farnell take over some of that demand. So we feel very encouraged about that.

On the Farnell business, the company mentioned a pickup in sales of the Raspberry Pi product. Maybe just talk about what that is? And how impactful that is for Farnell?

So there's only 2 real distributors of Raspberry Pi, us and another guy. And it's essentially a single-board computer that any hobbyist or somebody that wants to try out a new idea will use the Raspberry Pi platform to do that. We've actually used it and harden the design to actually create a really inexpensive gateway that's now gotten a lot of traction in our IoT brand. As 1 example, we've taken that and modified and turned it into a real product.

I just have other questions, I can keep going, but I do want to see if anybody in the audience would like to ask Avnet a question. Maybe sticking with the theme of business opportunities that could help expand margin Avnet integrated is one of those efforts. Describe what exactly Avnet Integrated is and the road map for that area?

So Avnet Integrated is essentially 3 businesses. One is a selling data center solutions to OEMs that they embed into their products. So that's a server storage, networking solution and software stack. One of the interesting things about that business is we created this new offering called Direct Connect. And with Direct Connect, what it does is it allows a software company who doesn't want to have the hardware drag their margins down, to have us essentially provide the hardware with their software as a utility on top of it that we sell to the customer. That gives them a unique approach so they can be valued as a pure-play software, but they need the hardware in order to be able to deliver a solution to the customer. So pretty interesting strategy that we have in place as well as the financials behind them with the customers. So it's working pretty well. Second leg of the business is a display business. Well, there's a lot of displays you see in a lots of industrial equipment that you wouldn't realize as Avnet. We're making those displays. And we've come up with a very creative process called simple connect. And what it does is it allows us to be able to quickly get a customer's idea and design for a display and be able to cut cycle times dramatically down to where they're able to have that new product get ramped up. So that's the second leg. The third leg is our embedded business. So we do embedded cards and boards. We have SMT lines in Germany, and you think, how could you actually have SMT lines affordable in Germany compared to what happens in China and Taiwan. Well, we've been able to automate the front end like no other. And I can tell you that most SMT lines around the world have disappeared because they weren't able to compete with China and Taiwan. This facility, where it takes 30 people over in Taiwan to do, we can do with 3. So we have a real interesting recipe that's successful, and that business is growing roughly over 10%, by 12% per year, and it's the highest margin business we've got in the company. So one game plan would be if we can find other opportunities for M&A in the U.S., as an example, that have capability but don't have this unique front end that we have, a whole copy and paste strategy, may make sense on an acquisition play to help grow the Avnet Integrated business to a more meaningful position in the company.

That's very interesting. That's helpful. There's -- maybe on Opex, Tom...

Sure.

As you had an OpEx reduction plan of $245 million. I think $190 million has been achieved so far. In terms of the incremental savings, should investors think about an absolute drop in OpEx dollars? Or is that just helping to fund other initiatives?

No. I think one thing that's very positive about our OpEx program is it's dropped to the bottom line. You can take our financials and look at OpEx year-over-year, quarter-over-quarter, and you'll see a pretty substantial reduction. So right, we're right about $190 million, we got $55 million more to go. We have very defined projects that are underway, as things like IT moving to managed services or outsourcing parts of finance. We just opened the distribution center that we talked about at a lower cost. And these are things that -- it's like the working capital program, right? We're going to slow down. We're going to control what we can, we're going to reduce our cost by $245 million. So reducing our working capital days, we're generating cash. We got our share count to just a hair below 100 million, which is really significant because it was 120 million shares just 2 years ago. So these are the types of things that, once we do get a recovery, they'll really help our bottom line performance.

I just want to make sure I understood everything you said there. So first of all, the company has done a great job getting its OpEx dollars down over the last couple of years. So I know there's a lot of hard work. Going forward, are you saying there could be a further absolute drop in OpEx dollars?

I think in the call, we talked about being in the $430 million range.

Right.

And that would reflect some level of recovery. We are investing in our e-commerce system. We continue to invest in our AI tools. One of our favorites, at least still in mind, is working capital, being able to look at our working capital and have some intelligence into things like payment patterns are changing or inventory opportunities exist. So there is some level of investment. But I think with a modest level of recovery in the $430 million is very reasonable per quarter.

Yes. Okay, that's helpful. Speaking of investments, and we're talking a little bit about CapEx and some of the working capital, the targets the company has. But as we think about how Avnet is managing its supply chain and its warehouses, are there things -- and you said AI is 1 of them, but are things like drones and robots that could potentially help with either efficiencies around working capital you maybe investing in.

No. That's really good point. So in the -- like the new distribution centers, they're very automated. And that's why the cost was substantially less than in the older warehouses. On AI, anybody that's been to our investor shows, I was taking my phone and show you that we have a tool where we can look at working capital by region, by day. To your problems of receivables, you can drill down and you can see the -- which customer it is. And we're supplementing that with now AI tools. So in December, we rolled out. It's too early to tell the results, but AI tool that will sit on top of what we develop. So to look at things like inventory for this customer, historically, when you bring in $100 of inventory, you use $90 of it the first month, you use $5 up in the second month and the remainder in months 3 and 4. Well, there's an opportunity for procurement people. And that's an example of the AI tool helping us to continue to accelerate bringing down the working capital days and generating cash. Does that make sense?

Yes. We're almost out of time. Maybe I'll sneak one last question in on tax rate. The company has a target to get to the high teens, if I'm not mistaken. What sort of time line should...

Yes. So we're at 21%. We think fiscal year '21, which would start in the September quarter, will be below 20% and very hard on that 5, 10 years ago, we were at 28% and has come down progressively every year. So a lot of good work by the tax team.

Great. We're out of time. Tom, Bill, thanks very much for being here.

Excellent. Thanks. Thanks, everyone.

Thanks, Mark. Thanks for having us.