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

Great. Yes. So I am Joe Quatrochi, the components distribution analyst at Wells Fargo. Happy to have Avnet's CEO, Phil Gallagher; CFO, Tom Liguori; and Treasurer, Joe Burke. I think Phil has a couple of slides he wants to touch on briefly. I'll turn it over to Joe for the safe harbor first.

Yes. Thank you, Joe, and good morning, good afternoon, 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 and 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 so with that, I'll turn things over to Phil Gallagher, Avnet's Chief Executive Officer. Phil?

Thanks, Joe Burke, and thanks, Joe Q. I appreciate the opportunity today. I'm not going to read through that slide. I just have a few opening comments that I wanted to make. First off, I hope everyone is staying safe and healthy in this crazy 2020 year that we're all experiencing. And I'm sure, like many, looking forward to a fresh start in 2021. I just want to share that I'm really humbled and thankful for the opportunity to lead Avnet as we prepare for -- to enter our 100-year century old anniversary in 2021. So it's an exciting time here at Avnet. And I've been here about 37 to 38 years of those 100, so 38%, almost 40% of the time as part of Avnet. But before starting the Q&A, I just wanted to prepare a few quick -- make a few quick comments about the path ahead for Avnet and why we think there's such a great opportunity and how excited we are. And hopefully, Tom and myself and Joe can answer any questions that you have. We're looking forward to building on the progress. We're not just starting last week as the announcement became official. We've been at it for the last several months, 115 days or so in restructuring, if you will, aligning our strategy and structure. And I've got great confidence, okay, in the future of this company and our ability to continue to create value for all of our stakeholders. We've got an incredible experienced management team, as I said, and that matters, okay? We really know distribution. Our regional leaders all have great tenure with the organization. We'll go through a little bit more of that when we get into the Q&A. I would like to say I'm really proud that we are in the center of the technology supply chain, right? We sit, I call, upstream suppliers to downstream customers and some of the highest technology suppliers in the world we've got on the line card, servicing some of the most highest technology customers in the world and taking in literally thousands of forecast on a daily, weekly, monthly basis from these customers on a global basis. It gives us great diversity. It gives us great outlook. It gives us great data and information for us to continue to remain vital, if you will, in that technology supply chain. So we're really, really proud of that. And as we got through this COVID, as we get through this COVID, I think it's become even -- if there is a silver lining, supply chains matter, okay? I think we all realize that now, whether it's consumer, industrial, semiconductor, what have you, supply chains matter, and we've been vital to many of our customers and suppliers in providing materials uninterrupted, okay, on a global basis in all countries of the world. And from all this, what's really key, and you'll hear more from Tom, our disciplined approach to working capital and our working capital allocation that's allowing us to maintain a very strong balance sheet, which positions us to deliver growth and profitability well into the future. Next slide. Thanks, [ Lindsay ]. So I just want to build -- as I said, we're building on momentum. So we're not starting today or starting Monday before Thanksgiving. I just want to highlight 4 areas for the investors on the call today. The top left is our design activity. Sometimes we talk about demand creation. Just somebody asked demand creation because we've been talking about it for years. But this is a really big deal for us and really differentiates us in the marketplace with our suppliers and our customers, allows us to get higher margin, a better stickiness -- stickiness because of the protection we get, [ first with the ] parts, when we do demand creation, okay, when we help influence designs on the chips into the board. And it's roughly 30%, give or take, of our business on a global basis. So it's really critical to our success. Last quarter, which is amazing, we actually had a record number of registrations, highest since fiscal '18, which is a bit of an oxymoron up here. How did you do that when people aren't traveling like they were? Well, similar to these conferences, some of the attendance is actually up because people were more accessible. So while the technical folks and our customers are now even more accessible than they were, allowing our FAEs to do design digitally versus maybe always face-to-face. You can see the revenues speaking for themselves. We had a really nice fiscal quarter, and we're going to continue to expect to deliver on our commitments, okay, to all our stakeholders, shareholders, suppliers, customers and our employees as we move forward. Tom will touch on the working capital. This is a Tom Liguori and Joe Burke's show here, the great progress we're making from a management team and driving working capital days, as you can see, to less than 80 days, getting into our longer-range target of mid-70 days. And then the cash and the debt position, and from a balance sheet standpoint, that's the lowest level we've had since 2010 of debt at $1.36 billion. And we got $483 million in cash and cash equivalents with another $1.5 billion in lines of credit. So we're solid. The foundation is solid. Now we want to use that to drive accelerated growth. Next slide, please. So as we said, it's really about our customers, suppliers and our employees, performance, growth, people. And we've not been sitting still. We've been doing some streamlining in the last couple of months. We've flattened the organization or put more back into the regions, building on our core distribution business, which is the bulk of Avnet's revenues and profits, while continuing to strategically invest in Farnell. We need that rock-solid foundation. It's really key and critical. And then we'll align the structure, okay, to match the strategy and the operations process to drive profitability, okay, and get the return on the capital metrics that I just talked about. Growth is going to be a key measurement and goal for the company this year. We must increase our market share; grow new revenue streams, which we'll talk about in Q&A with our customers and suppliers; and leverage a strong team, okay, I want to underline that, a strong team that we have with distribution experience on a global basis. So again, I just want to thank you for being with us today. I appreciate your time. And Joe, I'll turn it back over to you. Thank you.

That's perfect. It's a good overview. And I think Tom has a couple of comments he wanted to make before maybe we get into some of the questions.

Thank you, Joe. I think most of you know Phil very well. He's been with the company 30 years. You know he went to Berkshire Hathaway, [ representing ] strengthening their distribution business before returning. His background is sales, marketing, logistics. There's really no one better qualified to run Avnet today. But what I wanted to say, I think what you may not know is that, under Phil, there are some very significant changes underway within Avnet. And when the Board named Phil interim back in August, they gave him an awful lot of leeway to make change. And since that time, Phil touched on reducing the layers in the organization to get everybody closer to customers and suppliers. But there's also been a number of senior leader changes. Some people have left. And the people running Avnet today are long-term experienced distribution people that understand logistics, demand creation, the needs of customers and needs of suppliers. Many of you know that we were heavily investing in future initiatives, things that would pay off in 3 to 5 years, some uncertain, hey, many, many, many great ideas, but it was a very wide reach, and you could say perhaps overinvesting in that. And in a short period of time, Phil has evaluated that, reined it in, kept to what we think is key, things like IoT and moving that back into the core. But really, things -- we had made a number of equity investments and start-ups and all types of data projects and scaling that back for this reason, taking that money and putting it into our core distribution capabilities today. So like, as we speak, we're adding feet on the ground. I think Phil calls it boots on the ground, which is people in select geographies and verticals that can help us grow. There's a renewed focus on our Farnell Leeds distribution capabilities, things of that nature. Since August, we've had a number of senior leader calls. Yesterday, we had a town hall call with over 4,600 people live on the event. And what has resonated extremely well within Avnet is Phil's statement of priorities that we are here to grow our market share, regain our market share, grow our revenues and while we do that increase operating income and our returns on capital. So it may not be evident to you, but there are significant changes going on underway at Avnet today under Phil's leadership. So Joe, thanks for giving me a couple of minutes to just go through that.

Thanks, Tom.

Yes. That's perfect. And so maybe that's a good place to start. Phil, you've been the CEO for now officially for a week, but for several months, right? And so, clearly, the stock has been trading under tangible book value for a while now. So I guess maybe the first question is what do you think investors are missing or not fully appreciating from the Avnet story today.

Yes. It's a good question, Joe. Well, first, just as I said earlier, we've been around for about 100 years, starting next -- in January, it would be 100 years for us. And over that near century, we've traded below book before, okay, multiple times. And as we look back, every time, we've bounced back extremely strong significantly, okay? And that is what we expect to happen again. Look, we're in the middle of the technology supply chain. We've got great global scale. We're getting back to some of the fundamentals and basics. I know it sometimes doesn't excite people. It excites me because we've got to drive returns. We've got to drive growth. We've got to stop some of the, I'll call them, distractions that get to people -- charge -- moving forward and where does one need to go do. We need to further align, okay, and get closer with our supplier relationships. I mean our suppliers are our partners, okay? Sometimes we talk about suppliers as vendors. They're not vendors. In our world, they're partners, okay, and they're excited. I mean the message is resonating. Tom talked about a town hall. We had a supplier VIP event about 4 or 5 weeks ago. We had close to 400 supplier attendees on the event, okay, participate in the event. Again, usually, we get about 150, but due to the situation with COVID right now, we've got a lot higher attendance. So the confidence is there. We know what we need to do to focus on the execution. We know that's on us, and that's our commitment. But I'm extremely optimistic, okay, about the future of Avnet and it's 15,000-plus employees.

That's perfect. And so maybe just kind of diving a little deeper into that. Where have you kind of spent your first kind of several days being CEO? What have the conversations with your customers, suppliers been like? What type of feedback have you gotten from them?

Well, while remaining humble, the feedback has been positive from the suppliers and the customers. And I'm pretty close with a lot of the top CEOs that we deal with from a supplier standpoint, as well, customer standpoint. And I've been in contact with many of them in the last several months, as you can imagine. So I would spend -- probably the bulk of my time has been with the suppliers, okay, further strengthening the relationship and trust, okay, that they can have in Avnet. I don't think they lost the trust, but I think they were losing some of the confidence in some of the things that we were doing as we strayed a little bit. And they like the fact that we're in the middle of technology distribution. They like the fact that we're driving demand creation. They like the fact that we have a major focus on IP&E, Interconnect, Passives & Electromechanical. The Farnell story is a good one. It's not where we want it to be, but it's a good story, okay? And we're going to continue to drive the execution there. They like the fact that we're driving accelerated growth right now. We are growing share. We're back on offense. I think that's the message, and that's the message we want them to get and our customers to get. And I'll just make another comment. We measure our customer satisfaction, customer engagement in Net Promoter Score. It's a pretty, pretty popular survey, if you will. And our Net Promoter Scores are actually at an all-time high. So customers are enjoying engagement with Avnet. We're doing a good job for our customers, and we're doing a good job for our suppliers. And that's where I've just spend the bulk of my time. And the balance, as Tom point out, I just believe structure needs alignment with strategy, okay? Sometimes we run too fast with structure. What's the strategy and how we're going to drive the structure? So a lot of what we've been doing is around streamlining the organizations, flattening out the organization, aligning some of these businesses. I want to make it clear. IoT is still a strategy for us. Avnet integrated and embedded, still a major strategy for us. We just wanted to tie closer to the core, okay, take out some of the silos, if you will, and help drive a more natural selling motion, okay, from a sales synergy standpoint because a lot of that business is in the core already, and how can we leverage the thousands of account managers, inside sales, FAEs to go help us accelerate the growth there. But that's where I've been spending a lot of my time. And with you, guys.

Perfect. Well, that's perfect. And so last quarter, you guys talked about -- and maybe this is a question for Tom and Phil both. You talked about your focus for fiscal 2021 is improving revenue growth, generating better operating margins and ROIC. So maybe first, kind of talk about what are your revenue growth expectations. I guess what are the underpinning kind of, I guess, drivers of that as we look forward? And then how does that translate into better operating margins and ROIC?

Phil, you want me to take that?

Yes.

Sure. Okay. So really, the needle movers for us remain Americas and Farnell. Americas has done a great job over the last 8 to 9 quarters increasing the market share against our main competitor. But we still have a ways to go. What we haven't done as great a job on is our operating margin. And the team, I give them high credit. They've made a number of cost actions, cleaned up inventory. And I think we're really poised to now be able to leverage our growth as we go forward. Farnell, a lot has been said about Farnell. I think what everybody -- this is what I hear from The Street, that there's a belief that Farnell margins aren't going to get better, that it is more similar to core. That is nowhere near the truth. Farnell is just a totally different model, totally different customer. On the core side, we're dealing with the manufacturing side, procurement, high-volume distribution. Farnell, we're dealing with engineers, average order size of $350 or so; people that want to get any part they need on their desk tomorrow, and for that, they'll basically pay a gross margin of over 30%. So we're high believers in Farnell. I think we could have done a better job on setting the expectation pace of recovery. And we did that on our earnings call. We told you about 100 basis point improvement in Farnell margins per quarter. The third piece would be our OpEx. I think that's well understood by investors what we've done, what we're doing. We have a clear path to do that. So rather than talk about like expectations and endpoints, I think what you should expect to see from Avnet under Phil's leadership is that execution, execution every quarter. Now we're going to grow our margins quarter in, quarter out. Right now, we're in the 1%. We think in the near term, you'll see us, total company over 2%. I'm not talking about December but not that far thereafter. We've always operated at a 3% or above operating margin. Our industry has operated at that. That is clearly attainable, and we don't need herculean improvements to get there. What we need is to continue what we're doing in the core. And remember, core is 90% of our business. And our operating income improvement and our return on capital is really dependent on core. And Farnell, for the total company to get 2% or 3%, we have to be in the high single digits, 8% to 10% at Farnell. But that's where we're going. This is all about execution. This is quarter in, quarter out. What we'd like to be able to say to you 4 quarters from now is that we've just completed 4 quarters where we met our guidance or we exceeded our guidance in each one of those.

Tom, I'll just add on. I think it's a great question, Joe, and Tom touched on it well. The 2 biggest needle movers are Farnell, and we've got the game plan for that and the road map, waterfall charts right on down the line to get that to where it needs to be; and the Americas, rebounding the Americas. we're back on our feet, and we're back on offense in the Americas in a big way, okay? Now we need to focus on the operating margin and the drop-through. So speaking to drop-through, okay, we are driving growth, okay, but not adding the expense. So we need to drive accelerated growth, and that will drive OI dollars, okay? We measure drop-through as a measure of net OE to net GP percent, okay? So we look at the expense and the GP percent we're getting -- or GP dollars we're getting back on that. So that's kind of the ROI model and how we're driving that. As far as comp plans, I think it's important that the investors know our comp plans, and we're looking to get paid on operating income, okay, operating income percent growth and RWC, return on working capital, which will drive ROCE, which is part of your question. That's -- the regional presidents around the world, my staff, that's what we're lined to.

That's perfect. And maybe I'll just -- I'll insert an e-mailed question that I received. Can you talk about just the nature and the magnitude of the changes that you're implementing now relative to maybe some of the cost-reduction plans that are underway? Or I think some of those are about completed.

Yes. We still have about $40 million left on our original $245 million plan. And it really comes down to 2 projects. In finance, we're outsourcing many of our transaction processing functions. To date, we've outsourced over 225. Each one of those is a savings of mid-$25,000 plus. So it's major, but we're only halfway done with that project. And so that's a large part of what remains. The other is our Leeds distribution facility. This is really important for Farnell. It's a modern facility with higher capacity and lower total cost, and we started ramping this just as the pandemic hit. And with work stoppages and all types of issues, it's just been a very difficult process. So the good news is, last week, we had very good metrics coming out of there, but it's not at scale. Here's the deal, right? We need to be able to scale that. Once we scale it, that's when we'll get our cost savings out of that. And I think we've been very public about that. It's about a $19 million cost savings. So a good chunk of money remains. And I think the key way to think about our OpEx is that once those are complete from here on out, we have really good internal processes, organizations and systems, and that's how we leverage our OpEx to get higher op margins as we grow. When Phil talks about drop-through, many of you use the term operating leverage, same thing.

Yes.

Yes. And I guess, when you talk about like flattening the organization, I guess, can you help us maybe understand is, do I dare say there's something with like an ERP system implementation that might help with that process? Or how do we think about what that means, I guess?

Yes. I'll take that one first, Tom. No, it's not. There's not a new ERP implementation happening, Joe. We've got the past one under our belt. That's operating well. Now we're just continuing. Any ERP, once you have it in, you just continue to improve it and make things better. So no, that's in, and that's working fine; and Europe, fine; Asia, fine on the system IT front. When I talk about flattening, it's kind of what I talked a little bit about with the IoT and Avnet Integrated embedded. They're just sitting under separate leaders, okay? Then you had the core in Farnell. And the whole thing was trying to -- the whole strategy is trying to get it closer to the core because that's the leverage point. That's the foundation. Yes, we had -- and nobody is saying wrong, by the way. Just you had different leaders. So we just, frankly, moved some of those leaders. some left, okay? And I moved the IoT and Avnet Integrated more into the core, okay, and flattened out the organization, put it under one of our top leaders in Europe by name of Mario Orlandi. Actually, IoT is probably accelerating in Europe faster than the U.S. anyway. And then we'll take a chance to go peel that back more and see what's the expectation. I think maybe the expectation is a little bit higher than maybe it should have been, okay? But the opportunity is there. It's just going to take a little bit longer. So that's just -- that's one example. Frankly, in corporate, I think we started to have too much corporate, okay? And if there's demand generation being done in Germany or Asia or in the U.S., I don't want that -- those resources in Phoenix. I want them closest to the regions where you have the P&Ls. We have a large global business, but a lot of the decisions are still made locally. I mean they're still -- in Germany, France, Italy, China, Taiwan, California to Philly, a lot of it is still local. Yes, when there's global leverage, finance, HR, IT, we're going to leverage that as much as we can. Global customers that we support, which are in the hundreds, okay, yes, we're going to continue to service them globally. But a lot of the resources are still managed and decisions made locally. That's just a couple of examples. Well, I'm not replacing myself. That's another one. So I flattened the organization out and didn't replace myself and then had all the regional -- which would be our BUs, right? That's kind of our business units as one -- yes, they are reporting directly to me. We took a layer out there. And we did the same thing in the Americas with Tony Roybal, removed the layer and has the regional presidents -- VPs working directly for him. So there are some examples. Hopefully, that helps.

Yes. That's really helpful. And then I guess maybe a question for Tom. When we think about those things, I mean where do those fit in on the cost-reduction efforts in terms of is that part of the program that's already in place? Or are those kind of part of the $75 million, I think, you announced that's supposed to be recognized in this quarter? Or how do we think about those, I guess?

Yes. I wish to think about it as those are freeing up money to get reinvested in the core distribution business. So when we talk about boots on the ground, adding people in key geographies and verticals, growing our market share, that's what's going on inside the company. And that's really very timely and much needed.

That's perfect. Maybe in a few minutes we have left, but let's switch a little bit to the demand side of things. Can you talk about what you've seen in terms of last -- kind of if we go back, things are improving a little bit. But obviously, there's been a few second waves of lockdowns in Europe, maybe to a lesser extent here domestically. Can you describe maybe what you're seeing from a demand perspective post those events?

Yes. So as we mentioned in the Q1 earnings, coming out of that quarter, we started to see parity in book-to-bill -- above parity, actually, in Asia, the Americas and even Europe coming out of September, okay, with July, August just a little bit slower with the holiday summer months. Coming out of September, we started to see positive book-to-bills in Europe as well. So we're still seeing positive trends, Joe. We're pulsing it very closely, obviously, because of the COVID breakout, to your point. But right now, it seems like a lot of the effects, similar to here, I guess, as we have more shutdowns here in the U.S. Well, that's more -- or not as much impacting manufacturing, okay, or on the industrial side, okay? So we're still feeling pretty positive about making the commitments and delivering on what the promises that we made to all of you, plus our employees, customers and suppliers. So Tom, I don't know if you want to add anything to that or...

No, I think that...

Well, let me add one more comment, Tom, one more comment. We obviously get -- I mentioned it in the opening. We get thousands of MRPs from our customers on a regular basis. We're managing the backlog, I just need to make that very clear, very closely. There are some lead time issues starting to happen in some of our high-end controllers, not across the board. And we're seeing pretty consistent, okay, MRP forecast from the customers and suppliers. And again, they don't have a great visibility either, but that's not new. They really never have, okay? But we're seeing that. Everything look -- the cancelation rates look about right. Book-to-bills look about right. So we're pretty positive as we sit right now. Sorry, Tom, I cut you off.

No. I think that was perfect, Phil.

Okay.

Great. And so one of the questions that I get a lot is, for Farnell, I think after this quarter, we'll be done with kind of the transition of one of your large customers moving more distribution internally. Talk us through the timing and what you're doing to replace that revenue stream or maybe, more important, the gross profit dollar contribution?

Yes. And you're talking about guys down the south of us, right, Texas.

Yes. Yes.

Well, the good news is we're in the last quarter. So we're rolling off in the December quarter, so we'll start to be able to get to some more normal compares, if you will. So that's the good news. We have a three-pronged approach, Joe, and team, that we're looking at. It starts at a global basis, then we take it down to region, by country, by city, all the way down to the account manager. And there's 3 things we're focused on there and looking to replace that business. One, pin-for-pin replacements. We're going to just take one socket out, put another one in. That's roughly 10% to 12% of the business. The other piece is demand creation, okay, and replacing those sockets. As the new generation comes up with new products with our customers, our technical teams are in there, there's a processor, a DSP from that company. we're going to go look to take that out and design it with one of our current suppliers. That's a little bit of a longer pole on a tent because it takes time, okay? And the design to production, you got to catch them on the new revision, the customer that is, and that's a -- so that's a 12- to 24-month process. Then the last one, third one is share shift. Customers are not enjoying being told where to go with their business. It's very disruptive to them. Their supply chains get disrupted. I just mentioned that 1,000 of customers we're doing MRP sharing with. They got to change things around. I think the fact that the customer stayed with us as long as they did, and we grew share in the December quarter and March quarter a year ago or in the past 6, 9 months, and we -- and the customers knew we were going to be losing that line because they like doing business with Avnet. So share shift, what that means is there's other product lines we have that maybe we're not doing the business with that customer. Maybe it's with another distributor or maybe it's direct, and they want to try to shift that over to Avnet to make us whole. So they are the 3 areas that we're focused on.

That's perfect. And unfortunately, I think we're out of time. So guys, I think, thanks a lot for joining us today.

Thanks for having us, Joe.

Joe, thank you, and everyone, have a safe holiday season. But thanks a lot, Joe.

Thank you. Happy holidays.

Thank you.