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

Welcome to the 2020 Stifel Cross Sector Insight Conference, virtual conference, and we're pleased to have Avnet, one of the largest semiconductor and component distributors globally. With us this afternoon and representing the company, we've got Bill Amelio, the CEO; Tom Liguori, CFO; Phil Gallagher, who's Global President; and then we also have Joe Burke, VP and Treasurer and IR. And Joe is going to go through the safe harbor statement, and then Bill and Phil will go through some slides. Joe?

Thanks, Matt. Good afternoon, everyone. As a public company, we're subject to the requirements of regulation FD prohibiting the selective disclosure of material nonpublic information. Today's discussion may include forward-looking statements that involve risks, uncertainties and assumptions that are difficult to predict, and actual results could differ materially. Several factors that could cause or contribute to such differences are described in detail in Avnet's most recent Form 10-Q, 10-K and subsequent filings with the SEC, and include the scope and duration of the COVID-19 outbreak, and its impact on global economic systems in the company's operations, employees, customers and supply chain. Any forward-looking statements are only as of this date of the conference call and Avnet undertakes no obligation to update or supply new information after this call. So with that, it's my pleasure to turn the presentation over to Avnet's CEO, Bill Amelio. Bill?

Thanks, Joe. And we're on Slide 3. And I want to thank everyone for your time and your interest in Avnet. Avnet plays a fundamental role in the supply chain. We supply electronic components over 140 different countries. We stock inventory and we ship components to our customers. And you think about us as a key linchpin between all the suppliers of semiconductor space as well as the interconnect passive and electromechanical space, and we provide that bridge to our customers. We do 2 fundamental things for them. We do supply chain, pipeline work for them, meaning that we take their forecast and ensure that all the parts they need, we're able to deliver them when they need them. Additionally, we work with customers in a demand creation model, where we work with them to pick the right technologies for them to be able to build their products and build them effectively at the lowest possible cost and with the appropriate level of the lead time associated with them. So we essentially are a one-stop shop for customers procurement staff. And we give customers' visibility of what's happening with their inventories and what their positions are with respect to their ability to ramp up their own production. We have a very resilient business model. It's a strong and healthy countercyclical balance sheet, which means that when we go into a down market, we buy less inventory and we collect receivables, so we generate a lot of cash. And we've seen that happen over the course of the last several quarters, given what's occurred with COVID-19. Additionally, when you think about the COVID-19 response, we provided life-saving medical solutions for whether it's ventilators, respirators, personal protection equipment, you name it, we were literally an important part of that. And we are an essential piece of the supply chain. So it was important for us to stay up and running, which we were able to effectively do across the world. We might have a few fits and starts at the beginning of when this first hit. But in general, we're running at full steam in all of our warehousing operations and our manufacturing outlet. And it is clear, we have a culture of diversity, inclusion and innovation in all that we do. If you could move to Slide 4, please. As we look at slide 4 -- okay I think we got -- there was something that technically happened there. Am I back online again?

Yes. Yes, you are, Bill. We can hear you now.

Okay, I don't know what occurred here, but anyways, we -- sorry about that. If you could turn to Slide 4. This gives you an idea of the scope of our operation. We are 15,000 employees strong. We have over 3,000 engineers across the world and 600 of them are software engineers, and I'll talk a moment -- a little later about where we're utilizing our software talent in order for us to get the higher-margin space. We also have an engineering community that's 2.2 million strong. And that engineering community allows us to do a couple of things. We're able to help customers in their research of their new products by cutting down the research because we can give them a qualified answer to their question. From a standpoint of a supplier, we're able to help them get feedback on our new product introductions as well as be able to help them with unique use cases that they may not have thought of themselves. We have over 2 million customers in the 140 countries I mentioned earlier and 1,400 suppliers on our line card, and we ship about 122 billion things a year. If we move to Slide 5, Phil is going to take over right now for a couple of slides. Phil?

Thanks, Bill, and thanks all for taking the time to spend your time with Avnet. Yes. Bill, what I want to do is just cover a couple of slides and the first one here is that I'd just say, we are, frankly, smack in the middle and the center of this technology supply chain. We talk often about our suppliers and our line card coverage, and we have a saying internally, and I've been here for 39 years, we like to have gaps and overlaps. So we want to have overlapping technology and make sure we don't have any gaps in what we're servicing our customers because, as Bill pointed out, we're selling solutions. The more we can sell to the customers, service the customer, the more value we are to them, the more stickiness, if you will, that we have inside those customers. And here, you can just see -- these are -- this data is accurate. As you can see, you got 10 out of 10 passives; 8 out of 10 discrete suppliers; 7 out of 10 analog; 10 out of 10 in microcontrollers; 6 out of 10 in that, that's application-specific products. You can see the footnote kind of some more like on the lines of ASICs and custom products. 6 out of the top 10 connector lines; 5 of 10 logic; 7 of 10 opto. And these are the key technology lines across the board. So I just want to put that out there to all the investors that we are rock-solid from a supplier and commodity coverage standpoint. Next slide. Okay. So here, just want to -- these are, again, some household names and CR supplier engagements. We are #1, okay, distributor for these suppliers in calendar year 2019. Broadcom, NXP, Nexperia, Infineon. We won the #1 distributor globally 2 years in a row. You could read the rest. But it's where do I want to point out where we also have exclusivity, okay? Broadcom, big chip supplier out there. Xilinx, really the envy of the industry as far as having Xilinx. There's not a supplier on this line card or our entire line card that doesn't want to try to piggyback around what Xilinx is doing out there in the industry. And we are -- they're really exclusive distributor. And then Marvell, okay? We're also exclusive globally with -- semi-exclusive with Renesas. Back to Xilinx, when you talk about demand creation, some of the things Bill touched on as well is, we do for Xilinx roughly about 50% of their design, what they call the reference design boards. Avnet actually designs the boards, manufactures the boards and sells the boards into the marketplace along with the Xilinx sales force. So again, we're winning with the winners. These relationships are rock-solid. And as I said, we're #1 with all of them in 2019. Next slide. Okay. So what I want to do is, at a high level, point out what our fiscal 2021 strategies are. And these are -- by the way, these weren't created for this session today, these are directly come out of our Board of Director meeting we just had 2 weeks ago. Need to drive demand creation, we'll continue to commit to demand creation. Why? For Texas on the BOM, so we had the opportunity, we get the registration and it comes in a higher-margin upwards of 500 to 700 basis points versus pure fulfillment. So it's a clear upstream value to our suppliers as well as to our customers. IP&E. This is interconnect passive electromechanical growth. We have roughly a $3 billion business in IP&E, and it runs, again, roughly 500 to 700 points higher in margins. So this is a real growth opportunity for us, a much more fragmented industry. There's a lot of smaller niche players in this space, but you'll continue to hear us talk more and more about IP&E growth, both organically and inorganically moving forward. Velocity fulfillment, we also call this Avnet United, kind of one of the -- in an unfortunate way, one of the silver linings, it's come out of the challenge that we've all been through here the last 3 or 4 months with the virus is supply chains. And if you all can relate to broken supply chains in your own personal lives, possibly, or the effect it could have if you didn't continue to run and operate in. We're now getting a little more opportunities from both our supplier side and our customers in Tier 1s and Tier 2s to say, "Hey, how can you help us with our supply chain services?" We get asked the question of manufacturing -- is supply manufacturing going to continue to move around the world? We're fine with that because we're in 140-plus countries, as it was pointed out earlier. And the fact is we can take a supply chain anywhere the customer supplier wants it to go. Customer and supplier engagement. This is our Net Promoter Score. It's our customer engagement as we sit today, it's at one of the all-time high. And in fact, the customers enjoy doing business with Avnet as we do with them, obviously. Drive joint selling. So we talked about Farnell. Farnell's a great opportunity for us. It truly differentiates Avnet in the marketplace. No one else has a catalog, a high service provider on the front end for the customer set tied to the -- someone like Avnet with the size and volume that we have in the marketplace. So we're going to continue to work Farnell as a separate front end. However, we'll continue to drive synergies on the back end, lead sharing -- lead share between Farnell to Avnet and joint selling to Avnet with Farnell. Okay. We're now taking Farnell into Avnet's largest customers and leveraging our position with those customers in a positive way to expose Farnell to some new opportunities that they may not have had before. So we're extremely excited and doubling down on our Farnell investment and beginning to see some real good progress there. IoT, nontraditional customer growth. So this is tying the core to IoT. And Bill probably talked about this a little bit more in our ecosystem, but bottom line is IoT is certainly something everyone is aware of what's happening. Sure, there's some IoT applications out there, but this is kind of the -- as we call it internally, kind of, demand creation on steroids. It's given us something new and frankly, unique, to talk to our customers about. I think a lot of people understand IoT and what they want to go do, they're not sure how to get it done. And we're really provide -- beginning to provide the help, both to our core customers, industrial, medical, as an example, and our suppliers. Suppliers all have chips on the edge and sensors and whatnot. The issue is, how do they really take it to the full value for the customer and take it all the way up to the cloud and drive analytics as well. And then working capital velocity. Near and dear to our heart, particularly now, with the challenges in the industry, we're protecting our balance sheet. We're increasing our velocity and going to continue to maximize our cash flow. So Bill, with that, I'll turn it back over to you.

Slide 8. Thank you very much, Phil. Phil touched upon a little bit about our ecosystem. And the idea of the ecosystem was us to build out a strategy that allows us to follow a customer throughout their product life cycle. From the time they have an idea of the back of an envelope to the time they go to pilot production, full-scale production, end-of-life and the follow-on services. And as Phil mentioned, Farnell was the anchor to our ecosystem or the real linchpin to what we're doing, that got us into early pilot production in small volumes, which where we weren't before. And as he mentioned, it's called a catalog distributor. So we're able today to provide all these various different services. We talked a little bit about how the communities help both suppliers and customers. We provide design services, where we're able to take an idea that may just be not even well thought out yet and help them turn it into a real product and a prototype. We do new product introductions and we have manufacturing support in all that we do. We provide supply chain services, where we take a customer's demand for, say, 13 weeks out to 26 weeks even a year and we were to pipeline that material, could be hundreds of parts, could be thousands of parts and ensure that they're able to ramp up their own production because we make sure that they have guaranteed source of supply. And we have a second to none logistics operation across the entire world. If we move to Page 9. Phil mentioned our IoT practice. And what we've built out over the course of the last several years through organic growth as well as acquisitions is the ability for us to take a customer from the device to the gateway, to the network, the cloud, the applications in the cloud, the insights that they can gain from the devices that they have out in the field. If you think about the IoT space, at the end of this year, 2020, there'll be 20 billion connected devices. At the end of 2025, there will be 50 billion devices. That shows you the potential growth rate here. And this is not an easy space. Otherwise, there'll be a lot of people that were able to already crack the code with respect to being able to do an end-to-end solution for a customer. Avnet can do that. The IoT practice that we built out allows us to do all the things necessary to be able to do a proof-of-value on the concept that the customer may have, for example, a predictive maintenance solution, an asset monitoring solution, a smart worker solution, a smart factory solution, all those things are the various different use cases that we are piloting as we speak today. And in some cases, we're now scaling those opportunities up. We also built a platform that will enable other systems integrators to leverage what we've done in our middleware, with our software support that I talked about earlier, with respect to the software engineers that we have in place. We built this platform, specifically to build out a marketplace where we're able to certify, plug-and-play all the devices from our suppliers. And by the summertime, we have over 1,000 devices, plug and playable. And then it allows application developers the right to the platform as well to take some of the applications we've already developed and augment them as well as create new and unique applications and, of course, enable systems integrators to use, build the applications and the devices in their own IoT practice to reduce their time to market, take out complexity and improve their cost. If we can move to Slide 10. And my final slide. Look, we've been around for 99 years, and we're still going strong. We've been able to adapt to wave after wave of technology change. And we did that by building on our core foundations, but yet being able to embrace the changes necessary in order for us to live in a new world. We sustained through decades of trusted partnership with so many different suppliers. We have partnership that span almost 100 years in some cases. And we supported all of our customers' business needs, no matter what those needs are, to all the various different times from where we were back founded in 1921 to where we are today. So with that, we'll open up to some Q&A. Thank you.

Okay, great. Thank you, Bill and Phil, for those slides in the overview. I did wanted to ask, obviously, questions you're probably getting just in terms of the overall demand environment. You did guide below seasonal without any specific guidance. But I do know that coming into the quarter, you and many of your suppliers had saw pretty strong backlog and then, of course, disruptions impacted things. But with production coming back in Europe and North America, what are the book-to-bill levels look like? Any color you could give us on the regions relative to your expectations going in?

Well, in the last earnings call, we had mentioned our book-to-bills were over 1. And we also talked about Asia was the first that, of course, to go through the pandemic and came out of this first. And we're seeing stabilization there and potential some growth but at a much lower base than we were previously. That's kind of what we have already reported out. And of course, you know that China, Taiwan and some of the major demand opportunities over there are running at full speed, while other countries still have -- some have had a backlash like Singapore, India and Japan, to name a few. But in general, the overall market there is stabilizing and moving forward. In EMEA, I would tell you, that's probably our most concerning spot, with automotive being a big piece of who we are there. And automotive, of course, started back up again and then shut down, and that will remain a concern, and we're hopeful that as the weeks go on, that will turn around, and we'll start to see some recovery in the European market. And then at the time of the earnings call, we had mentioned that the Americas was the next spot we were worried about as the pandemic moved into later stages in the Americas market. And the great news is that with the jobs report that came out on Friday, it looks like we're in a much better position, and we're hopeful that more businesses will open up their pocket books and start spending again, we'll start seeing some more robust demand coming out of the Americas market.

Are you still having a positive book-to-bills in all your regions? Or is that going negative in some?

We're about to -- place -- we've talked about previously.

So positive. Okay. That's certainly encouraging. And then also, one thing we haven't talked about was 1 of your big suppliers, TI, unwinding business, I guess, still by the end of the year. That TI number was a bit higher than some had expected in the March quarter, I think it was $400 million. Could you give us color on how that unwinds? And I know you've already put some plans in place to make up some of the lost profitability and top line. But could you just walk us through that?

Sure. I'll take a shot at that and then have Phil comment as well. Yes, you're right, last quarter, it was about $400 million, and we essentially gained a little bit of share. But our plans are to see that wind down from between that earnings call and the end of the year in a linear fashion. And although we feel that it might go a little bit longer than that. And that's kind of what the data would suggest today. Our plan to replace the gross profit specifically is the three-pronged attack. One is we have opportunities where there's pin-to-pin compatible, other components from other suppliers that we can suggest to our customers to go put on that product. Second thing is our ability to demand create on future designs and be able to migrate the customer from TI parts to somebody else's parts. And of course, the third thing would be, we call share shift. If you think about a given customer, they'd like to have a balance between their distributors. And when they see an unbalance occur because of some distortion, like this move from TI from one distributor to another distributor, they'll take supplier parts on the other distributor and move them back to us, and we call a share shift. And if you look at the relative pipeline of opportunities, I would say, demand creation and share shifts are about equal, and that the pin-to-pin is about 1/3 of the other 2. So that gives you a sense of where it'd be a -- it's coming from. Additionally, the opportunities that we're bringing in have a tendency to have a higher-margin since the the TI line was our lowest margin line. So we don't have to fill all the revenue back up again in order to up the gross profit or we just have to do a fraction of that. And we're well on our way to do that. And with that, I'll have Phil make a couple of comments as well. Phil?

No, you covered it well, Bill. Matt, very transparent on this one. And we're having regular meetings. I have one set next week by regional presidents, and this is tactical. We're fair, basically, you've gone -- we got it nailed down by at the global level, each region around the world, each country within the region and right on down to the city and the account manager and the account. So we know exactly what we need to go replace. It's a lot of work, a lot of effort, but we're very pleased to date with the pipeline that we're building in those 3 buckets that Bill talked about. I'll just make one other comment. The -- it's interesting in the March quarter, as we shared with you, Matt, we actually gained share in the West. In Europe and Americas, we actually gained share inside their channel. So I think that's a real testament to our sales team. I think it's a testament that our customers and what I mentioned on the call today that our Net Promoter Scores as high as they've been, customers like doing business with Avnet. They don't like being told where to go. So it's going to be interesting. We're modeling it in the second half. It will be coming out. And looking to replace it as it goes out.

Okay. Fair enough. And then one of the other -- obviously, your margins have been below your targets, and obviously, on lower volume. But the other reason is that the premier Farnell business, which was generating double-digit margins a couple of years ago, they've seen with the inventory correction in the downturn last year. And then now COVID margins are under 10%, and I know the long-term target is to get them back to double digits. And you've talked about some of the investments in inventory, as I know, they have a new distribution warehouse now. How is that looking in terms of how long do you think we can get through -- will it take to get back to those double-digit margins?

The way I look at it, Matt, is that we are well positioned for the next upside that will happen. When the upside happens, that's when we start to see the lead times expand. And when that occurs in the catalog space, specifically, the growth rates outpace the broadline space. And in the last upturn, we weren't as well prepared as we are today. We didn't have the new warehouse in place. We didn't have all the SKUs done. Our web speed wasn't where it needs to be. Well, we've made all those investments, and we are well positioned. So when the upside happens, that we're highly confident that we'll be able to get us back into double-digit operating margins again.

But what about in the sort of a normalized environment, let's say, a low growth environment, normalized lead times. I know there's 2 big competitors out there in Mouser and Digi-Key, with big market share. Those companies are also making investments. It does sound like that cross-selling opportunity you talked about, where Avnet cross-selling into the other part of their customers' supply chains, that's the opportunity. So just walk us through how you build share in a normal environment.

The normal environment, we still expect to be above 10%. When we're in the higher growth market, we'll be able to expand those up to more like 15%. That's kind of the range of reasonableness that we believe is possible as we start to get out of the current COVID environment.

Yes, Matt, this is Phil. If you look back 1 or 2 years ago, with that -- Tom help me on this, 4 quarters ago or so? 5 quarters? That we actually...

Yes, 4 quarters ago, we're at 12%.

Yes, at 12% exactly, okay? And we have the model with moderate growth, okay, not a huge recovery to get back -- that back into double digit as a normal. That's what we need to do. And the investments on the 5-point plan we've been talking about, our BMA, we are seeing results. The strength of Farnell, as you know, is in Europe. We've got specific plans to continue, juice and goose up Newark, to get them stronger across the board, in semiconductors in particular. And then at Asia, we're actually holding -- we actually doing pretty well in Asia relative to competition. So that's the plan. We know we can't just count on up markets. We get that. We've got to be able to do it through a cycle.

Yes. It looks like we just have a few minutes left. But one question that came out of what you were talking about, Phil, particularly in the -- and you too, Bill, about the fact that this COVID has really created lots of disruptions and really force customers to scramble across different geographies. And of course, you're very well positioned, as you said, in all regions. Do you think that this will lead to market share gains from distribution overall, particularly the enterprise EMS kind of business, which a lot of that is direct? And is there a value? And are they willing to pay you a margin for those services? Or is this more of just a short term thing?

I'll go first, Bill, if you want. First of all, those large EMS guys, as you know, Matt, I mean they may not talk about it all the time, but we're probably one of the #1 or #2 suppliers in all those guys. With the Jabil, Flex, [ Celesta, Good Plexus ]. It's a big segment for us, has been and continues to be. So they're actually pretty good part -- very good partners for us. What I was referring to is some of the large OEM suppliers coming to us. More and more were where they're having challenges with the supply channel, we can't name any, in particular, and then coming to us to help build out supply chain models. So some of them -- think of it, Matt, some of them could be asset light. So when the margins might be a little bit leaner, we can net it out and do it in an asset-light model, so it gives us good returns. And we call it kind of supply-chain-as-a-service. So we've -- our gentleman who runs that and his team in the Avnet Velocity, they're actually at capacity on building out models for some customers and proposals. So there's -- and again, there's some large OEM customers that are household names to everybody on this call, that are coming to us now because they need help with their supply chain around the world. Particularly as it starts to move and you get some of the -- as we're all, unfortunately, hearing about the different hotspots around the world where there's some challenges. So I think it's here to stay, right? I think it's an inflection point, it's positive, and I think it's good for us.

And you talked about the asset light. So in other words, that's a consignment model where you're not burdened with the working capital?

Basically, it's a little bit different than that. But there's some of that already, Matt. Yes, absolutely, inside the model. And there's just some other financial models that we're working on.

Yes.

Okay. We're down to the last few minutes. Any last comments, Bill?

Go ahead, Bill.

Yes. I would add to that. Look, the things that happened during this crisis, as it demonstrated the capabilities and the breadth of experience we have with the company to be able to deliver this value to customers. And what happened was they realized that how essential we were, and therefore, I think we're going to see some expanding opportunities as we move out of the COVID environment.

Okay, great. Listen, Bill and Phil and Tom, thanks so much for your time. And we look forward to talking to you soon. Thanks again.

Thanks, Matt.

Matt, thank you.

Bye.