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

Well, good afternoon, everyone. This is Matt Sheerin. I'm the senior technology supply chain analyst at Stifel. And we're happy to have with us this afternoon whole management team from Avnet, one of the largest semiconductor and component suppliers in the world. We've got Phil Gallagher, CEO; Tom Liguori, CFO; and Joe Burke, who works in treasury and IR. Joe is going to start off with a safe harbor statement and then I will kick off with a fireside chat. I'll ask Phil to kind of give a quick introduction of the company, and then we'll get into questions. And if there are anyone that has questions, in the bottom of your box there should be a question area where you can punch the question in or you can e-mail me at [email protected]. Joe?

Yes. Thanks, Matt, and good afternoon, everyone. Just wanted to let you all know 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 filings with the SEC. And 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'll turn it back to you, Matt.

Okay. Great. Thanks, Joe. So Phil and Tom, welcome, and Joe as well. Appreciate you taking the time. Why don't we start, Phil, with sort of an overview of Avnet and how you see the company position. You took over as CEO last August. You've been with the company for many, many years. So maybe just give us some thoughts on how the company is positioned today maybe versus where it was last summer, how you're positioned going forward and then we can get into Q&A, talk about demand and other issues.

Thanks, Matt. That sounds great. Yes, been with Avnet for 39 years, and happy to acknowledge we'll be celebrating our 100-year anniversary this year. We were founded in 1921, not too far from where you are, Matt, on Radio Row in New York City. So just exciting to be -- to have this opportunity to lead the company in a special time. So, Matt, look, thanks a lot for hosting us. We really appreciate it. And I hope everyone listening today is healthy and doing well. And thanks for your interest in Avnet. And I'll be brief so we can get into to the live dialogue, Matt. But I would like to start out just by acknowledging the hard work from our team especially, and everyone on the call knows, particularly the situations over the past year. I'm really proud of the strides in a relatively short time we've made as an organization, particularly made such a complex operating environment that continues to be complex. We're not done yet. We've executed on the plan we outlined for ourselves. We're refocusing and simplifying our structure, committing to be a more nimble and efficient and empowered organization. And as demonstrated by last quarter's results, the work is paying off. In the third quarter, which is our March quarter fiscal, sales were up nearly $250 million sequentially. Revenue growth driven primarily by the strong sales in Asia, but we've also had better-than-expected results in both the Americas and continued incremental improvement in Europe, which is our overall best-performing region from a margin growth standpoint. Really pleased we saw higher-than-anticipated marketing -- operating margins of 6% at Farnell and expected to see continued improvement there, which we know is really important to all of our investors. We have a strong foundation, Matt, and remain confident we can deliver on all our recent commitments. Yes, there will be some challenges. But as we move forward and focus on growth, we'll continue to prioritize share growth, operating income performance and improving overall returns and return on capital. We will work hard to continue to earn the partner relationships, both suppliers and at sales stream and our customer relationships. I mean everything does, and we're thrilled to be part of their businesses, if you will. And driving new design solution, design chain still very critical, continue to be very critical as we move forward. And then last as we all saw in the last year, the acceleration to digitization of our business, continue to invest in the low-touch e-commerce, different self-serve design tools, self-serve supply chain tools for our customers and our suppliers, and that will be the focus as we move forward. So Matt, I'll stop there. We feel good about where we are right now. Plenty of work to do that we know, and that's what we'll be focused on.

Okay. Great. Thanks, Phil, for that introduction.

Let's start off with sort of questions you've been getting all day just in terms of the supply-demand imbalance that we've seen. The really strong demand drivers and continued issues with lead times. I know your book-to-bill is very high, so high that you really don't want to talk about it. Maybe not as meaningful because of all the ordering and the backlog that you're seeing. But could you update us relative to when you reported in late April, just about the book-to-bill, any other metrics that you have, bookings, backlog, order flow, et cetera?

Yes, Matt. So you -- I won't touch much on the guidance other than confirm we feel positive about the guidance we gave in the last earnings call. And again, I'll leave that at that. It's -- things are looking good there. Yes, it's an interesting market for sure, and one that's got some challenges to it. But you're right, the book-to-bills are above parity. So I'd like to say, in all regions, they continue to be strong. So it's -- we continue to see that book-to-bill carry from that March quarter as we enter into the month of June and our final quarter of our fiscal year, again, in all regions. So we pointed out in the last earnings call, Asia was coming out of it, out of the downturn and continue to be strong December and March quarter. Europe and Americas were in that recovering mode, okay, as we like to say. We're continuing to see that in a very positive light. So good news, good news there. What's different, I think, Matt, is it's changed since 3 or 4, 5 months ago, picked time-wise, the bulk of the conversations seem to center around the automotive and the transportation being the gap and where the concerns were and some shortages that we're all very well aware of. Today, it seems it spread outside of aerospace necessarily; industrial, medical, some consumer, I mean, just -- and we had redecorated the home and try to get an appliance, they're out on allocation, 9-month lead times. So it's just a spread, but much more diversified, and I think it speaks to the pervasiveness of the technology, right, electronics in the amount of end applications. So although it can be painful, okay, and yes, we're in expedite mode, it's a bit of a high-class problem, if you will, that the electronics industry is continuing to grow and show some real healthy signs. I think the key now, I use the word responsible, that we need all customers, suppliers, ourselves just continue to be responsible about what we really need, okay? And the demand out there, it feels real. The -- watching the cancellation rates, and they are pretty much holding steady. And again, we got a good [indiscernible]. The investors, we get a good look at it from the, I call it, the upstream and the downstream. And we're taking in thousands of MRPs and forecasts from customers on a daily, weekly, monthly basis. So we've got good visibility there. And of course, feed that into our suppliers upstream. We're at the center of technology supply chain. We feel good about that. Short term, there's going to be some challenges. Now that said, we're adding inventory, not to where we would want it to be. I mean there's still some constraints out there in quite a few different areas. I think that would be the other part of the story, not only the verticals that expanded from a capacity standpoint and demand, it's causing some additional challenges. I think the shortage of products was 4, 5 months ago, it seemed to be mostly focused on the high-end control orders, some memory and things on those lines. Now it's definitely a little bit more broad spread with the challenges of resins and plastics hitting the connect -- hitting some of our connector suppliers as well. So it's much more broadbrush. But again, that said, we still added 60,000 to 70,000 SKUs in Farnell. So we're adding inventory where we possibly can, the service-to-customer base out there as well as our supplier base. So that's an elevator speech here, Matt, on what we're seeing in the marketplace.

Yes. Yes. I know that a lot of your suppliers have talked about supply channel inventories being below normal, below optimal, and you've said the same thing. And I know that pretty much everything you get you're selling and pushing along. Are you getting a sense that the customers are adding inventory? Are they doing the same thing because they're consuming as soon as they get it because their own demand drivers are good, and they just don't have the buffer in place?

It's a great question. And I don't have -- I'd love to have the magic wand to see inside of all their WIP inventory, their finished goods inventory, their -- and backlog. I mean we don't see all that. We see their forecast, and as I said, we get quite a few of those in thousands. But as I'm talking to the customers, and I'm talking everyday, by the way, they are wanting to pull in. I mean so -- and not pull in, I'm not sensing to build inventory. They're pulling to build products. So I don't sense it, Matt. I'm sure some of it's happening out there, is it the book-to-bill or the orders, definitely something going on, but I don't feel it's that pervasive that it's just -- everybody just stockpiling inventory. I don't sense that, okay, not the many customers I'm talking to. I think -- and then we got the analytics around our supply chain and forecast management. We have an inventory call every other week with the global asset teams inside of Avnet. It doesn't feel that way at this point in time.

Okay. And I know that some of your book-to-bill incorporates bookings 2 or 3 quarters out. I know some customers are placing further out.

Yes.

Are you concerned about cancelations down the line? Or are there sort of agreements or contracts in place that, a, if you're going to place this, you've got to be obligated toward taking X amount or anything like that? Is it any different this time than last cycle?

First of all, good point you made, Matt. As lead times continue to go out, right, you're right, the MRPs and the customers tend to book out further. So that is part of the book-to-bill. So thanks actually for bringing that up. But we're seeing extended bookings, right, based on the lead times. As far as the cancellation rates, as I look at it right now, okay, when we look at the adjustments in our backlog, it's relatively normal. We'll not see an excessiveness there and normal for us to be -- I'll give a range, Matt, 15% to 25% of our backlog adjust constantly, push in and push outs, cancellations. And that's normal. And that's the value that we bring to the supply chain. We are kind of that buffer that helps manage for the suppliers and the customers through the cycle. So not seeing anything that would be eyebrow raising. As far as order is concerned, cancellation is always going to be there -- like, there's been a lot of suppliers enforcing NCNRs out there around, too. So the contracts we do have with the customers are a little lot firm contracts, okay, with the customers. Now they're all -- everything becomes a negotiation. So don't get me wrong, I understand that. But right now, we're not overly concerned with that.

Okay. Fair enough. And then I know we've seen ASP increases from a number of suppliers. And have you been able to pass that along? And do you see that -- I mean, we're in a rare inflationary period in this industry, that should be helping you, right, in not just top line, but do you see other benefits from that in terms of pass-through -- on that pass-through?

Yes. We feel confident we're passing the majority through. I'm not going to say we're passing everything through. There are some contracts that are tighter than others. And I remember they're probably north of 50 suppliers that have had some kind of price adjustments, and they're all a little bit different. How they're handling the ship and debit and the timing of the ship and debit and the new costs coming in. So really difficult to manage. But I will say that we're tracking it. We track it by supplier, by SKU, by customer. Kickout reports and exception reports to be sure that we are working to pass that through. And I would say most customers are really working with us. And we're not -- it isn't 25, 30 years ago. We're not gouging, we're not opportunistic out there in the marketplace, trying to raise prices just sort of for the short term. I mean that's not what we do, and that's not how we want to be seen as a partner to customers or suppliers. At the same time, we can't afford to be the one to absorb it all, okay? So being -- I think this is back to being responsible and transparent and trust to sharing that with the customers. And the suppliers have been helpful in documenting a lot of it. So that actually helps us and passes some of it through. So whether we see margin percent increase, well, we are seeing some of that. Last quarter, we saw some of that. But the -- but certainly, the ASP, okay, will increase a bit.

Okay. And then just on the supplier side, some semiconductor suppliers have said that they are working more closely with their direct customers to allocate more direct inventory there versus the channel. And I know in previous cycles, it's typically the other way around where put the excess inventory in the channel and you can go -- that's where you can get it if you're an allocation -- are you seeing that broadly? Or is that more of a one-off type of situation?

I think it's more of a one-off. We're not sitting in the boardrooms of all of our suppliers. And everything that they're doing is all their capacity. So I'd be lying if I said, oh, absolutely not happening or absolutely is happening. I'm sure there's cases where they're reallocating some things based on certain contracts they might have and they, frankly, the penalty costs that they might have in some of those contracts. So I'm sure some of that's happening. At the same time, most suppliers will tell you that their most profitable channel to market, okay, business is through distribution, okay? And on top of that, through the high service model, right, the high service level guys, right? So I would say that they're -- and again, as far as I'm talking, I would say they're trying to be as fair and objective as they possibly can. Because again, that's that long tail of customers that they really like that customer base. And they got to be careful that they're not overtly hurting a customer in the industrial segment or in the medical segment. Or -- so I would say if it's happening, it's isolated, but I don't believe it's happening across the board. I'm not hearing that from -- I'm not hearing that.

Okay. Okay. And just sticking on -- in terms of the supplier side, you had -- there have been some share shifts in the industry, obviously, with TI with their fulfillment model going basically to just 1 competitor, and you've lost some other lines over the years, but also added some key lines, and you have some exclusive relationships with some of the biggest semi-suppliers. I know since you've been CEO, one of your sort of mandates is to win some of that share back and certainly maintain those strong relationships with customers. So any update you can give us there in terms of that front?

Yes. Thanks. I've been spending an inordinate amount of time, appropriately so, by the way, with our suppliers. We don't have a business without our supplier partners, right? And a former CEO that you know well used to say what's more important, you harden your brain. In our world, is it a supplier or customer? The fact is it's -- you can't live without either one, right? So we've spent a lot of time firming up our current supplier relationships. I feel really, really good about that. And yes, several years ago, we took a couple of hits, Cypress, Microsemi, to name a couple, which we got both back. Infineon acquired Cypress, Microchip acquired Microsemi. So we got those couple back. And then we enjoy Xilinx and Broadcom and Marvell and Renesas is effectively other dominant or exclusive partners that are set. So we feel really good about where we are. We know we've got the one big one out there right now with Maxim. And I'm not sitting in the boardroom in Boston. Relationship with Maxim is extremely good with Tunç and Jon Imperato and Patrick Moore. They're very pleased with our performance. And as I tell our team, look, focus on what we can control and that's what we have, a relationship with Maxim. And we think we have a compelling opportunity to see that come through as a positive for us. But you -- control what I can control, and we'll go from there, but as far as the balance of the line card, we feel extremely good. And that's -- a lot of this isn't new. I mean -- and I think you've got to accelerate with some of the M&A on the supplier side. Go back 20, 25 years ago, as us and a couple of other guys doing a lot of the aggregation, and there's just been so much acceleration on M&A on the supplier side that it's caused some of these shifts, like I said, Renesas and IT, we ended up with that. Broadcom, we ended up with that. So Infineon acquired Cypress, and we got Cypress back. So I don't know how that's going to continue moving forward, I guess, as it will. But I think it affords us opportunity as much as it does risk.

Okay, fair enough. And then and you've talked about replacing some of the lost TI revenue with some share gains. And also, I know that certain customers where -- end customers you've actually gained share. Where are you in terms of closing that gap with that bridge?

Yes. So what we said is it was roughly $130 plus or minus million in gross profit that we wanted to replace, maybe a little bit less than that. We have 3 buckets, Matt, that we're tracking and continue to track. One is the pin-for-pin cross reference, that's effectively completed. That was about 7% -- 7% to 10% of the business because not a lot of it is pin-for-pin. The second bucket is the demand creation. That's the longer pull-in time, that's like a 12 -- more like an 18- to 24-month cycle. But we have a funnel that we're tracking by customer, by application, by project, where there's opportunities for us to replace TI with other brands that we have. Again, a longer pull-in time, that's the biggest bucket. Then the third one is share shift. Share shift meaning inside the customer. I think as suppliers go through these decisions to go with one or the other or one only, the customer gets affected by that. And they like to oftentimes balance the scales if they will. So what we try to attain with those is share shift, whether it's TAM to Avnet, other lines to Avnet, other -- whether it's [indiscernible], semiconductors with that share shift inside the customer, that's the third bucket. And we total it all up, somewhere around 53% of the business has been recaptured in other business, and we're tracking that in gross profit. And in Asia, for example, as we reported last quarter, without the guys in Texas, we grew 53% year-on-year in Asia and clearly gaining share without the guys in Texas. So -- and in Asia effectively -- and they had to [indiscernible] market the benefit. They're not naive, but they have effectively replaced the TI business, and we've had record numbers with and without TI in Asia Pac last 2 quarters.

Okay. And I want to spend some time on Premier Farnell. But before we do, just in terms of the core distribution business operating margins, which are in the low 2% range, not very long ago, you were well in excess of 4%. I know that you've set some targets a couple of years ago. I'm not sure how sale those are, but certainly -- or 3 years ago, but certainly, you have targets above where we are. So help us bridge that gap in terms of how you get there. Is it really on the top line? I know there's some cost-cutting, time, and other things that are going on.

Tom, do you want to take that first crack?

Sure. So total company, we're at 2.2% operating margins. And near term, which is now 4 quarters out, June of next calendar year, we expect to be at 3% to 3.5% net. And we had reset those targets 2 or 3 quarters ago. So on the core side, yes, definitely getting Americas back up to the same margin level as we have in Europe, but also demand creation, which is going on very well. And our digital strategy and digital on the core side means people can do self-service, right? They can go on, they can see their orders. It just makes us more cost efficient. On the Farnell side, they've done a really good job over the last 2 or 3 quarters, and we're at a 6% operating margin. Our refreshed target was to get to a 10% also by June of next year, and that is by continuing -- Farnell is a different model. Farnell has engineers coming on. If they can buy everything they need and get it on their desk in 2 days, it commands a higher gross margin, and that's what we're seeing. So with Farnell to get to 10% is continuing to add SKU selection in our inventory, continuing to improve the web buying experience on our website and some marketing spend. And one thing we didn't talk about last earnings, and what we'll be talking more about at this time is they had record revenues last quarter, and they are continuing to do well. So these are near-term targets to get to 3% to 3.5%. Matt, you bring a really good point. Why only 3% to 3.5%? Well, those are near-term targets. And we do believe that, especially Farnell, we had -- they were at 12%. That market allows a 15% or higher operating margin. So as they continue to progress. And on the core demand creation and digital, we can get over 3.5%. So I think the good news for Avnet is we have 3 or 4 quarters now of consecutive increases, and we've built some confidence with people on those targets, and there's more to come. Phil?

Yes. Thanks, Tom. And just to add to that, Matt, maybe reemphasize and should say. And you're right, Matt, that's why we confidently get there because we know where we were. We know we can get there because we've been there. And the biggest needle mover. We talked a lot about Farnell. We're very excited about where Farnell is. The biggest one is Americas. I mean Europe is running steady as she goes. It's our most profitable region. Asia, we're very pleased with our growth and returns in Asia Pac and continue trending in the right direction despite the loss of that wind down in Texas. And then the Americas is the biggest needle mover. We had the ERP issue, 4, 5 years ago, set us way back. That's behind us. And now as I say, you took the elevator down in margin. Now we've got to take the steps back up. And we have a plan -- a GAAP plan to get that operating margin back to where I used to run it. As you know, I know exactly where we can get to, and that is in process, and we're probably a little bit north of halfway there and moving in the right direction with the Americas leadership team and some of the changes we made here.

Okay. Okay. Great. That's helpful. And then on Premier Farnell, so maybe spend a couple of minutes just talking about that business model. How it's different than your traditional demand creation fulfillment model on the volume side, and so maybe the competitive landscape? And then also how you're using Premier Farnell to cross-sell and basically capture that engineer for the volume part of the business? And where you're actually getting complete from the design right through the fulfillment side?

Sure, Matt. Really excited about Farnell, and for investors, it's -- we'll get synergies, the full cost on back end, okay, HR, finance, some IT and whatnot. But on the front end, we see a distinct differentiated value proposition with Farnell. That's complimentary to what we do in the core business. Chris, who runs Farnell, sits on my staff with the regional presidents, and we go out. We have sales lead management [indiscernible] (00:26:51) with Farnell to Tom's point earlier, because a lot of early looks, new products introductions, the engineering communities, where they're selling, Xilinx FPGA design, evaluation kits, things along those lines. And then we feed that over to the core business for lead management. So that is happening on a regular basis now. We're actually joint calling customers together. That's accelerating, particularly in Europe right now because Farnell brings a differentiated value proposition that we think is unique to Avnet and Farnell, right? The other high service guys are, by the way, they're really, really good. So all complements to them, but they don't have FAEs, and they don't have account managers for the most part. And we bring that differentiated value prop as combined entities. So we're going to continue to manage them separately, make that very clear the operating models, margin models, the SKU expansion. The inventory models are different. However, there is opportunity for linkage between the 2. And not only Farnell giving leads to Avnet, but Avnet helping Farnell, where we have strong positions in large OEMs, large EMS, those companies will love to expand relationship with Avnet. So on the Avnet umbrella, we're able to carve out a portal that you will -- for Farnell to get an advantage, let's say, over some of the other high service models. And we've got some large customers that are actually pulling us in now and happy to make this part as a greater Avnet solution. So it's going well. And we've helped them expand their line card. I mean so they picked up Renesas and Micron and Xilinx, et cetera, over the past several years to just further fortify the position in the market.

Okay. And is Premier Farnell benefiting in any way from this component sort of situation where customers are actually -- instead of sort of small volumes actually trying to use Premier Farnell as a source to fill volume commitments, as we saw last cycle, or is that -- I mean, is that a benefit or you don't see that?

No. We're seeing some good lift in Farnell. Again, I won't give any guidance beyond what we did in the March quarter. But yes, it's -- they're definitely seeing. So it's hard to determine exactly how much, Matt, but I think it goes to your earlier question, suppliers still giving us inventory. They're not moving all that inventory outside. So Farnell clearly is getting some benefit. As I'm sure some of the other high service level guys are as well. As we saw same thing with MLCCs a few years ago, right? What we do is we try to manage that, that we don't want any 1 customer at the middle wipe out the inventory shared by other. My people, listen, we control that on the core side and the Farnell side to make sure that they don't get cleaned out of inventory for any 1 customer so we service the broader market.

Okay. Great. Well, actually a little bit out of time here. But just lastly, 1 thing we didn't touch on was just the capital allocation strategy. And I know, Tom, you're going to have some potential working capital challenges over the next few quarters as you try and obviously build inventory, help customers out. But also obviously trying to generate cash and pay down debt and perhaps resume the buyback. So could you update us there?

Yes. Basically, cash flows look good. That's why we just upped our dividend 5% a couple of weeks ago. We think that's a good steady return of capital. So far this quarter, we should be adding a little inventory. I mean still 3 weeks to go. We'll see how that goes. Buybacks are no longer on pause. That doesn't mean in any given quarter that we'll have them. But cash flows, we're confident over the next 2, 3 years and everything in the capital allocation is in play. You mentioned debt. We think the debt level dollar terms is right where it should be, Matt, and we don't anticipate paying down debt going forward. We think it's appropriate where it is.

Okay. Great. Any other last words, Phil?

Matt, first of all, again, thanks for the opportunity and to all the investors. I'll just close out where I started. We've been amply focused on the operationalizing of our business, continue to improve the operating income and the returns to the shareholders. Digital was something we're definitely doubling down. We spent a lot of time on Farnell today from an e-commerce standpoint and customer, self-serve demand creation. We didn't talk much about that today, absolutely still committed to the demand creation side of the equation. Still roughly 30% of our business is tied to a design win where we get, I don't know, between 300 and 500 basis points higher margin. And then as [indiscernible] continue to firm up our supplier relationships and our customer relationships. So we understand and respect how important they are to us. And without them, we don't have a business. So I want that message to be really clear. Thanks again for the opportunity.

Okay. Good enough. All right. Thanks, guys. Thanks, again. We'll talk to you soon.

See you, Matt. Take care. Thank you.