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

Good morning, everyone. Thanks for joining Citi's Virtual Tech Conference today. My name is Tim Yang, and I cover tech distributor sector at Citi. I also support, senior analyst, Jim Suva, on tech supply chain coverage. For this session, we are pleased to have Avnet Interim CEO, Phil Gallagher; CFO, Tom Liguori; and VP of Treasurer and Investor Relations, Joe Burke, joining us to share their insights about Avnet and the industry. As a background information, Avnet is the third-largest semiconductor distributor globally with sales in America, EMEA and Asia. A few housekeeping items from Citi research side. There are disclosures associated with this for you to review. All clients subject to MiFID II are reminded they need to have research agreement in place and contact Citi salesperson if you have any questions. [Operator Instructions] Before we dive into questions, I will hand over to Joe Burke for safe harbor statement, and then Phil will give a quick overview of Avnet. Joe?

Yes. Thanks, Tim, and hello, everyone. Today's discussion may include some 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 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 the date of this investor call, and Avnet undertakes no obligation to update or supply new information after this call. And with, that I'm please to hand it over to Phil Gallagher, Avnet's interim CEO. Phil?

Yes, thanks, Joe, and good morning and nice to -- morning for everybody. So hope everyone had a nice holiday, a 3-day weekend. I already got messages, some people wish they had 3 more days. But you have to wait a little while for that. So I just have a few slides. I want to really thank everybody for their time today, and we'll get into what's on you minds with regards to Q&A. Tom, he wanted the first slide that Joe was showing. In the background was our new Leeds facility in the U.K., supporting Farnell. That's an operation that's up and running slowly. We're ramping it up, and hopefully, we'll be full-bore production in the December time frame. Tom?

Phil, I'm having some difficulties moving this. So I would just proceed without the slides.

Okay. So I only had 3 slides really. And one was as I just shared with you -- maybe 4, was the supply chain facility -- there you go, Tom, was the supply chain facility, in the background, you can see there in Leeds. Yes, it's probably about 30% up and running at this point in time. And hopefully, by December, we've had a little bit of a delay due to the COVID virus and then just now managing the warehouse management system, getting that up and running. That will support all Europe and parts of America with our Newark business. So it's really a pivotal move for us in leveraging our size and scale for Farnell, which will be our most profitable business. Just for those that don't know, we don't want them to make an assumption. Avnet is a global technology-enabled distributor. We're in the center of the technology supply chain, between $18 billion and $20 billion in revenue. And for the most part, 100% in chips: semiconductors, interconnect products, passives, and then you see on a PC board, you see all those chips, that's basically us. We're thrilled we're going to be celebrating in 2021 our 100th year anniversary as a publicly held company -- I'm sorry, as a company, with over 50 years publicly held. Was founded by the Avnet brothers in New York City, Radio Row, and grew from there. I've been with Avnet 38, going on 39 years. So good or bad, almost 40% of the time that Avnet's been around, I've been here, all right? And seeing the company go through thick and thin, good and bad, up cycles, down cycles, and of course, 2020, a year like no other that we're also managing through, we feel pretty successfully as we get to the light at the end of the tunnel. We'd like to say we're in the design change, supply chain. So we do everything from health and start-up companies in product design, all the way through supply chain. Anywhere a customer wants to go in the world, we can service them. We're in over 140 countries right now, and that's a pretty dynamic number, particularly as we have a lot of supply chains, particularly with the COVID situation, the China situation, customers want adaptability, flexibility, resiliency in the supply chain. I think one of the silver linings has been that they've come to us. We've increased our customer count. We've increased opportunities with customers we weren't doing business with before, whether it be TAM, direct business to distribution or just large OEMs that we're doing -- dealing direct that wanted to deal through Avnet. So we stock and we ship inventory components. We probably add value or do something to a chip 35% to 40% of the time before we ship it, whether it be special handling, date lock code, PROM programming, connector assembly, customer-specific instructions, rarely -- a very small portion of our business is just time-placed utility when we're not doing something for it. Another big piece of what we do is the supply chain management. So we do -- about 50% of our business or so is where we're taking in an MRP. Or for those not familiar with the term, we're taking in a customer's forecast. We don't have hard backlog. We're taking in their feed. And it gives us visibility to their production for the future. That feed inside of 30 days is probably about 35% to 40% accurate. Beyond that, I don't say it in the disrespectful way, they don't have visibility much beyond, which is, again, an opportunity for Avnet, and we take all these feeds, thousands of them, frankly. And that's how we manipulate, if you will, or average out the supply chain needs that we then funnel back to our suppliers. Our average cancellation rate is in the 20%, 25% range. And that's the -- I like to call as the shock absorber for the industry and the value that we bring. As far as our customer base, extremely diverse. We have tens of thousands of customers, if you add in Farnell with hundreds of thousands of customers. And we are in the industrial space. Fast and growing, increasing in the automotive-size transportation space. We play in the medical space, which has obviously been very hot for us lately with the COVID. It's a relatively small piece of our total business, but it's been very busy. We have defense. Defense has been very busy and getting busier. And we do deal within the consumer space as well. People don't think of that, but we're actually playing in many of the consumer items that you either wear on your wrist or have in your hand. And we do value-add for them as well. And then, of course, telecom has always been big. Networking communications, you name the big guys out there, we're doing business with them up to, including one of the largest 5G guys that's in the business. Okay. Tom? Getting asked a lot, love this slide, I can't take credit for it. But during my first week, somebody said, what are you going to change? What are going to dramatically move? And I think it's just a -- it's a gauge. It's a balancing act. It's -- we're going to turn the knob a little bit up in some areas, a little bit down in others. We are not, by any stretch, throwing away our strategy. I got asked that at the first week, are we changing everything? The answer's no. It's more of a balancing act. We have our -- first and foremost is to recover in this downturn, and we're watching that closely. I'm sure there'll be some questions on it. You guys have some good handles on that as well, and we'll share with you what we're seeing. I want to streamline the organization. I want to simplify the organization. I want to flatten the organization. Want to really focus on -- this may sound boring, but focus on our foundation of what we are, okay? Get the foundation strong, get Farnell strong and then build upon that foundation with things like IoT and Avnet Integrated and other strategies that can go further differentiate us. Right now, we need to get rock solid on the balance sheet, which we're focused on, rock solid and hitting our expectations to the analyst on the earnings. And from there, we will continue to expand and yes, down the road, M&A. Right now, we're focused on the balance sheet. Bringing up M&A to Tom and he pulls out and wants to shoot me. So we just kind of -- we absolutely need to settle down a focus on our fundamentals, and the team is excited about that. Our team -- actually, they're really excited about that. And this business is -- I oversimplify it because I'm a simple person, is seriously about our suppliers, our customers and our employees, okay? And we do not have the old heart-and-brain argument. What's more important, our suppliers or customers? And the obvious answer is, well, customers. But in distribution, as the customer is on the call, I would have this conversation, we have to have rock-solid supplier relationships because without those, we can't service our customers. We don't have a business without our suppliers. Likewise, suppliers don't need us if we don't have a strong customer base, right? So it's really a heart-and-brain debate that we have constantly, but we need rock-solid supplier partnerships, not vendors, that would beat them up, that we align with our suppliers. Got to go drive value. And what do suppliers went from us? They want demand creation, increased customer base and revenue, okay? What customers want from us? They want complete solutions, which is what we bring. And in the middle of that, it's our employees. And a lot of the automation in digital and e-commerce and EDI and everything else going on out there, business is still done through people that they like and they trust, and our employees are clearly the glue to our success between our suppliers and our customers. So Tom, that's really about it. I just kept it pretty fundamental, pretty basic at time. We're sure we got a lot of questions, but thrilled to be here today. Thank you for the time. Thanks for your interest in Avnet, all those on the phone. And I think I'm turning it back to Tim, I think.

Yes. Yes. That's a great overview.

Great. Thank you very much.

Yes. So macro environment has been very uncertain this year. Phil and Tom, maybe can you just talk about the demand trends in the near term, maybe 6 to 12 months? And how this changed as we enter into 2020 and as the pandemic spread globally?

You want me to take that, Tom?

Please. Thanks, Phil.

Yes. And Tim, that was the demand trend, you said, right? The -- so you look at the lead times and what's happening out there.

Yes. Sure.

It's really dynamic right now. It's a great question. We're studying this very closely as we speak. I'm afraid to use the word optimistic because you got to be careful with that. But right now, if I look at it today versus 3, 4 months ago, versus March, we are a bit more optimistic about the future. Again, I wasn't really optimistic, but I'm not calling a bull rush here, by any stretch of the imagination. In March, we all saw what we thought was that turbo, we're double ordering, double bookings, things along those lines. There was a bit of a panic in the market to get materials, particularly around medical. That seems to have settled down. Our book-to-bills right now in Asia and in Europe are positive, not dramatic, healthy. I want to say positive in a healthy way. Europe is still probably the softest from a standpoint of book-to-bill, which is expected. We're still in the summer months in Europe, just literally coming out of that here in the September -- early September. We'll see -- I think September is going to be a really interesting month for Europe to see how things go. But if you look at Asia, as we sit right now, we're feeling pretty good about Asia, good China. The automotive seems to be showing some life, which is really good news. And our teams at forecast feel pretty -- I'm sorry, in Asia, feel pretty optimistic on the recent forecast. Asia still, like I said -- Europe is still, like I said, the softest. However, there is some of the signs of life in Germany and central, not only in automotive but in industrial. Again, we'll see how it goes in September. And America is kind of holding its own. America has been kind of steady as she goes. Not too far up, not too far down. It's just kind of hanging in there. So we're cautiously optimistic as we get through the September quarter and look at the December quarter, tough again in the March quarter. So it's tough to go, I know 6 to 12 months, I love that, given that we're 6 to 12 months out. But it just isn't a normal cycle. It's just not. We do see some lead times gone out. We do see some substrates trying to get filled up, so that's public knowledge. So we'll just see how things go. But right now, we're feeling a heck a lot better today in September than I did back in April, May.

Got it. It sounds like demand trends are improving in the near term. How do you think the pandemic has changed the -- has shaped the underlying drivers for the growth outlook for your end markets in the medium term, basically like 2 to 3 years? Do you think that changed at all? Or it's pretty much similar compared to pre-pandemic?

It probably depends on the industry you're in. As I said earlier, the silver lining for us is we are seeing customers -- I don't want to name customers, we got to be so careful, that have come to us that previous had not come to us because they want to be secure supply chain globally, they wanted a backup supply chain because they realized how supply chain -- how critical they are. If you do have a supply chain that goes south, that's a big problem. We all found out from a consumer standpoint, right? I don't want to get into who had toilet paper and who didn't. But supply chain broke all of a sudden, you couldn't get essentials. So it's the same thing in manufacturing. I'd say the -- I think industrial, defense, automotive will start to come back is -- our leader in Europe constantly says, people will not start walking. They will buy cars. Sooner or later, they will buy cars. Airlines, travel, hotels, I think it's a whole different ballgame. But again, I'm not an expert in that. So I think we'll have to see how that goes, right? I think for distribution, electronics distribution, I think it's further solidified our spot in the center of technology supply chain from design to manufacturing.

Phil, I would add, and first of all, I just want to say to everyone, we're thrilled to have Phil leading us. We're thrilled to have Phil focusing our distribution capabilities, our growth. And let me just start by that, but...

Thanks, Tom.

I think it's really important what we're seeing, which is, yes, customers and suppliers, everybody is concerned about having diversified supply chains and having sustainable supply chains, and what the last -- well, now 4, 5, going on, 6 months has taught us is that suppliers are increasingly relying on us to be able to tell them, what are the demand signals out there in the market because we may have half their revenues going through us and touching thousands, tens of thousands or more of their customers. And same with customers. Customers are very concerned about supply chains. They're very concerned about delivery routes, but they're concerned just about supply. And they view Avnet as a source of trusted supply. And we've been on many conferences, and we're always talking about what's under our control, right? We're managing what's under our control. It's really nice to see something that's outside of our control, moving in the right direction, which should give us some good backwinds over the next 2 to 3 years, Tim.

Got it. So how has the company actually changed your business practices to enable more efficient operations? I think Phil and Tom, you guys mentioned this pandemic and the suppliers relying more on you guys to reach out to customers, and the customers rely on you guys for the supply chain. So I guess, how has your company actually changed the business practice with this uncertain macro situation?

Yes. Let me jump in. I think Joe can jump in on this one as well from a treasury standpoint. Now he's managed his job, it's -- or you too, Tim. It's affected everybody. I think what I do get concerned about, starting with the concern, I think everybody says they're busy and productive or productive. I think sometimes, a lot of times, we're more busy than we are productive. If you know what I mean. We're on calls. We're doing things like, okay, is that really busy or are we being productive? And I think there's a difference there. So I'm challenging the team on that. Make sure we're productive, okay? Doing the right things. At the same time, make sure you're doing the right things to give yourself some balance. I know this sounds soft, but we found ourselves in front of these great Teams calls or Zoom calls, whatever, 12, 14 hours a day. And then that, I can tell you, is not healthy. Go for a walk, get out, it may be too hot where you are right now, go for a walk. But get out, go mix it up a little bit because it's not healthy, right? So I think what it has done, I think it really has forced, or accelerated is a better word, the digitization of the future and how we do things. I know on the -- good news, bad news, a very high, frequent flyer and get all the perks you can go with American Airlines. And that's good news and bad. The good news is you have the [indiscernible] you're traveling every week somewhere. And I got to say this has been kind of nice to be able to not do that. And use tools such as we're using today that have very effective calls with, as Tom knows, at least 10 CEOs in the last week that I never would have done before. I would have been traveling, trying to get to them -- of our top suppliers, by the way, I mean, household names to you. So I think that's been a real positive. So if you use it right, I think it's really good. I don't think it's 100% full time this way. I do still think you need to get to meet with people to shake hands and say hello and share what we normally do from a social standpoint. So I think just over time, there'll be diminishing returns there. But as far as how we work smarter and more efficiently, more effectively, I think it's -- we've learned a lot of what we can do without having to get on a plane or a limousine or car service or what have you. I mean Tom, Joe?

Tim, I would add that while we've always had a focus on backlog, managing inventory, I'd say the -- actually, the daily contact with suppliers and customers is better than ever, and it was always good in the past. And even, Phil, I think you'd be the first to say within our company, when we look at each of the regions and we look at the distribution centers, well, we ensure that there's multiple paths. There's -- I don't want to say redundancies, but there's definitely a backup because it's very, very important for us to be adaptable to events as they come every day. So other than that, we continue to move to -- we have our service centers up and running in Serbia, Guad and India, where we're outsourcing many functions. And those were paused for 2 to 3 months. While we were in, as Phil said, pandemic, people didn't have connectivity. But we're really happy to say that the teams have managed well through that really, really well, and we seem to be functioning extremely well as a company during this.

Have you guys thought about reducing the office footprint or maybe the warehouse for current, like just adjust for that because of this pandemic or it's not quite like a near-term priority for you guys?

Yes. Well, not the distribution center, right, because we still -- we're supplying inventories. So not there. But yes, clearly, the office, we've already made actually several changes in offices that have 20 people or less. Hey, it's working great, working from home, okay. So we don't need full-time offices. So you're seeing some of that. Phil is in our office. We're officially working from home, but many of us have been in our office. It's all set up for when we return. But what is clear that, yes, longer term, in our larger facilities, we'll probably need less space. And those are going to take quarters but more likely years, right, to evolve. But in the meantime, as leases come up, yes, definitely, we're definitely reevaluating them, and there's a handful that have changed already.

Yes. I would just say, Tom, it's a great question, Tim. Yes, we actually reduced some office space, some of the -- as Tom says, some of the remote office space where we have few people. We might have been doing subleasing of spaces and things on those lines. Yes, you don't need it anymore. I mean we love to have offices, but offices don't sell anything for you, okay? They take up overhead if you don't need it, and we can put that money towards our customers and suppliers.

Got it. That's probably the part of your cost savings, but we can dive into that later. Phil, as the interim CEO of Avnet, what are the immediate goals for you and the company to achieve in the near term? It's amazing that you actually have worked in Avnet for 40 years, roughly 40 years. That's amazing achievement.

You're telling me. But 39, don't jump the gun on that.

Oh, sorry.

I was teasing you. Yes, 39 years, out of Drexel University here in Philadelphia. It's probably -- well, it's a good question. I get -- it's probably the #1 question I get asked. And we're still refining this as we go. It's a work in process. Tom and Joe have been amazingly helpful; and Ken Arnold in the HR; and Mike McCoy in General Counsel; Ken Jacobson, our Corporate Controller, we're going to continue to evaluate the organization. Structure should follow strategy. So we're looking hard at this strategy. And as we adjust this strategy, we're going to adjust the structure. The focus has to be on growth again. Yes, market share does matter, operating improvement in -- operating income dollar improvement, return on working capital. And so growth, OI, return on working capital, our top strategic initiatives. And the question is, how do we do that? Well, we've got to get back to some of the basics. And I must say we walked away from the basics. But being a technology distributor is something to be proud of, okay? And I think we're really, really good at it. We've been good at it, as you just pointed out, we're going on 40 years. So we need to nail that down, that between our foundation of the core, what we call the core, and Farnell. On top of that, we already made the announcements that we're going to continue to drive IoT. IoT, I believe, the corporation believes, is closer to the business than not. So we moved IoT from a transitionary standpoint over the next 30 days, right into one of the BUs in the regions, okay? It's -- IoT is an extension of demand creation of what we do. Avnet Integrated, we moved that closer to the core, still evaluating it, but Avnet Integrated where you sell boards, customers make boards, they buy boards, they integrate boards in one set of the solution. So those are just some of the fundamentals at the highest level, but it's really just about simplifying, of understanding the roles, flattening the organization, porting the R&A, responsible authority -- responsibility and authority into the regions, okay, where the decisions are made closest to the customer and closest to the supplier and then relentless focus on the execution and accountability. There's not a lot of black magic. I mean that's what we need to do. And we can do it, have done it, and we'll do it again.

Sure. Yes. Definitely. The foundations of the business, it's very important for you guys. And on TI transition, it seems like there's acceleration of the disengagement in September quarter. If customers still need TI products, does that mean that they will still need to go to your competitors to get those TI products? Or how can you maybe just maintain those customer relationships with this acceleration of the TI transition? Hello?

Looks like Phil might have froze there, Tim. Tom, do you want to take it?

Sure. Thanks, Joe. So yes, the TI revenues will transition out by the end of December. We were -- this last quarter, $324 million of revenue. Coming up in September, we'll be in the 100s, right? And then below $100 million for December. But the good news is that will no longer be a headwind. That will be behind us. In the meantime, hey, we've had 9 months going on a year of working to replace it. On an annual basis, TI was $1.6 billion to $1.8 billion of revenue, but it was at very low margin because it was fulfillment. It was just bring it in, ship it out. And our goal is not to replace $1.8 billion of revenue. Our goal is to replace the gross profit dollars. So that's more like $900 million of revenue to $1 billion. And that comes from socket replacement, share shift, just working with our customers and longer term, the demand creation of that. The good news is, when you look at like where do we have orders going into the future for? We're just a hair under 20% on the way of replacing that. So I think originally, we said it's about a 24-month process. And happy to say we're pretty much on track to that, Tim. And I'm going to be really happy after the end of December, we'll probably have these questions exed off any of our investor conferences because it will be gone. It will be more about all of a growth phase going up.

Got it. In terms of that 20%, are those customers are new customers or they're basically like similar customers, the same customer base that was with TI products?

No, it's pretty much the same customers. I mean there may be a few new ones, but it's really focusing on our existing customers and supplying the other analog products that we have, continuing things like in Americas to grow our share. It's a lot of hard work. Phil and his team, he has gone down to the branch level with what they've had historically for TI, what we need to make up by account plans, and people across the world are working furiously. And the good news is we're starting to see the traction there.