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

Hello, everyone. It's so great to see you virtually. I'm Jim Suva, the Head of IT hardware and tech supply chain analyst here at Citigroup Investment Research. We're very pleased for this fireside chat to be with Avnet, stock ticker AVT. A couple of housekeeping items: No media and no press are allowed. If you're a media or press, please disconnect immediately. Any investor who may be subject to MiFID II, please ensure you have the research -- applicable research agreement in place. Also, there are disclosures associated with this on the Citigroup website, also our Velocity and the conference login. And we do want to note, if you go to Avnet's Investor Relations website online, they have safe harbor, risks and forward-looking statements, which you should especially pay attention to. I do want to mention that we're very pleased to have Avnet here today. We have Joe, Phil and Tom, all from their executive management team. As a reminder, Tom is Chief Financial Officer; Phil is Chief Executive Officer; and Joe is Head of VP, Treasury and Investor Relations. Likely, Phil and Tom will be doing the majority of the questions. [Operator Instructions] But thank you so much for joining us here today. And boy, I got to tell you, I've been doing this a long time, Phil, as have you. It seems like 2 or 3 years ago, there's a shortage of passive capacitors and resistors, or MLCCs. And then there was the Tantalum, the big bottleneck there. And then we have trade wars. Then a boat gets stuck in a canal sideways. Then we have COVID. It just seems like one thing after the other.

Can you talk about the supply chain situation and the semiconductor chips? Because you sit right in the middle of the ecosystem being a distributor.

Yes. Jim, first of all, thanks for having us, and thanks to your audience. We appreciate the opportunity to share some of the Avnet story and answer as many questions as we can in the time slot we have today. So thank you for that. Yes. Jim, in 4 decades that I've been around almost with Avnet, it's really amazing what's happening. You summarized it really well. It's like one issue after the other. And you're right, we sit in the center of the technology supply chain. So we're seeing views from, I call it, the upstream with the suppliers all the way through the hundreds of thousands to 1 million-plus customers that we see. So it's really a unique -- and this is just unique with all the things you just mentioned, right? 2, 3 years ago, it was really about MLCCs. 9 months ago, it seemed to be more around high-end controllers and automotive coming out of the rebound. And today, it's just very pervasive. I mean it's -- the verticals that we're servicing, you've got the automotive. And it's actually much broader than that, right? It's transportation, the industrial, the medical, defense, consumer. They all started to spike at the same time while you're coming out of the issue you just talked about, highlighted by COVID, where you had factories somewhat shut down or slowing down with an increased demand. So it's a pretty widespread, Jim. And at the same time, it's an opportunity, okay? I know it doesn't always feel that way. It is an opportunity for us to go review our supply chains. We have customers coming to us that maybe weren't coming to us prior, to help them build out supply chains. As I like to say, the -- sometimes people take supply chains for granted until they can't get what they need. Then they start to say, "What happened here?" What happened to the planning? What happened -- did lean go too far? JIT go too far? I'm sure it will be a question on inventory. Inventory is not always a bad thing if it's good inventory, right? So anyway, it's somewhat of an exciting time in our industry from that standpoint. It doesn't always feel that way. But for sure, it's causing us all to get better, okay, and to improve, all right? And that we'll continue to do that. But right now, the outlook is pretty positive through the calendar year, for sure. And as you know, many of the guests you've had on, the suppliers you talked to, are pretty bullish through '22 into '23.

So Phil, I hear you, but I got to turn it over to Tom as CFO. Your inventory went up by $400 million or rounded to $0.5 billion. So Tom, kind of what's going on there?

Yes. Sales have gone up substantially, Jim. And I think what you saw over the prior quarters was a decrease in inventory. I think, Jim, what's important to note, this is goods that we ordered. It came in. Our inventory is turning. It really brought our days inventory somewhat back to normal. We view it as positively. A lot of the $400 million, Jim, I think we did note that it was in Asia. And Asia continues to be strong. Seasonally, the September quarter is typically high for Asia. They're building electronic products really for later in the year with the holidays. And part of that was handsets. So it did go up. we wanted it to go up. We're a distributor. We saw it as a good sign, but I appreciate all the questions on it.

Are you at a point now where you're happy with your inventory, Tom? Or do you want to build some more? Or has it kind of been digesting through and -- as fast as you can kind of sell stuff that goes out the door?

Well, it's turning very rapidly. Demand is strong. If demand goes higher, we'd be very happy with some more inventory. We have long-term relationships with these suppliers. We're pleased that we can get inventory at times like this.

Yes. Jim, we see inventory as an asset. It's good inventory. It's fresh inventory. Just to put a number on it, Asia for us grew, what, net, up to 35%, close to 35% last quarter. And we're seeing continued growth this quarter. So we're very comfortable with where we are with the inventory situation at this point.

And I think can you talk about book-to-bill a little bit, where we're at? I think it's above 1. But I think -- to be fair, when there's not enough toilet paper on the shelves or not enough hand stuff, people buy a little bit more. So how should we think about book-to-bill of over 1 and potential for a double bookings occurring?

Yes. So I'll jump on that, and Tom, you can add some color. So yes, you're right, we've kind of stopped talking about book-to-bill, right, because it's well above 1. It's been above 1, well above for now 6, 7, going on 8 months or more. So we're going to discount that a little bit. As far as what we track -- what's happened with the bookings is as lead times go out, right, customers -- we're taking in, Jim, thousands of customers' forecast electronically on a daily, weekly, monthly basis. And we're managing that, that intake, if you will, in demand. Then we bounce that with our analytics, office supplier lead times. And then, of course, what inventory do we need to service the customers' demand. So it's going to be natural that you don't see an increase in book-to-bills, but the lead times are going out. So people are planning more. And we're telling the planner what we need. I met 2 customers yesterday. We need the visibility. So let's give us the visibility, then we can manage it from there. Sorry, so we're tracking that. And then we -- as far as double ordering and double booking, I mentioned this before. Typically, a double ordering, that's where a customer has placed an order with us and maybe 2 other guys for the same part, for the same supplier. The one who is about to catch more of that is going to be the supplier, right? They will identify that and see that more than we will. We catch inflated forecast, inflated bookings. We're doing business with Jim Suva, Inc., And you're ordering 50 pieces a month from us. We're doing that for years. And all of a sudden, you come in for, to your point, 500 pieces of toilet paper now, Jim. Well, okay, we flagged that with the analytics, go back to Jim Suva and say, "Do you really need this? Is this the real demand or not the real demand?" Because we all need to be -- I use the word responsible here. If we're all responsible, we'll get through this much better than not. So we'll catch that. And right now, as -- the book-to-bills are as high as they are. You talk to the customers. The demand really feels real and across all these different verticals. So it's a really unique situation for the industry, no doubt about it. But we're tracking that on a daily basis with [indiscernible] asset teams, our supply chain architecture on a regular basis, make sure we're validating that as much as we could possibly can.

Any comments on what's normal cancellation rates? And what are you seeing for cancellation rates? Because that could also be a bit of a yellow flag that could be raised.

Clearly, an indicator we watch and an early indicator. Our cancellation rates right now are normal. I mean I know this sounds crazy, but they're -- and just for the audience, we're like the shock absorber for the industry. It surprises people when you say, with the amount of pipelines we have in inventory, our cancellation rates, Jim, are normally in that 15% to 25% range, depending. So we're scheduling, rescheduling, canceling, reordering and excess -- that's normal, of course, business for us. And that's what we do for the industry. So we kind of work as kind of the financial buffer as well. So right now, we're watching that closely and have not seen anything abnormal in the cancellation area.

Well, that's quite higher cancellation rates than what I can digest. I'm hosting so many tech companies. I can't deal with any cancellations at all, let alone those 15%, 20% rates or whatever. Maybe over to Thomas, CFO. Can you talk about operating margins? The past few quarters, they've improved. Is that permanent? Or are you like over-earning because there's such a shortage?

Well, part of our margins are benefiting from pricing. So that's why we said, by the second half of the fiscal year, Jim, sustainable, durable margins of 3% to 3.5%, and let me explain that. That's mostly on the Farnell side. Our Farnell business -- and for anybody new to the story, it's selling online. It's predominantly to engineers and to entrepreneurs. If we have the part and we can get it to them in 2 days, we are in a pretty good price and gross margin. Well, they do benefit more than our core business on pricing. And you tend to see that through the cycle. So we came out with a 10% target for Farnell, which would be at mid-cycle. And we're reporting, Jim, last quarter, and we'll probably do the same this quarter, what are their margins as reported and what would it be without the benefit of pricing. So for instance, last quarter, I think they were at 8.3%. Well, 150 basis points of that was pricing. So what we're trying to do is get that 6.5% to 7% operating margin, leaving aside pricing up to 10%. The Farnell team is right on track with what they're doing. These are sustainable improvements with adding SKUs, adding marketing programs, pay-per-click, improving the response time. If you go on to the Farnell website, and any of you can do this, you'll see a pretty efficient and ease-of-buying experience. So Jim, a lot of work to make these sustainable. Yes, today, part of our margins are at pricing. But when we talk about sustainable, durable margins in the 3% to 3.5% or Farnell at 10%, that is through a cycle. Does that make sense?

It does. I would follow up by asking you, Tom, to get to that 10% operating margins at Farnell. Is that mix? Is that volumes? Is that you and Phil having your onboard recent hires ramp up? Or how do you get that 10%?

Yes. I mean there's a little mix. They added National Instruments, so there's some volume. But it's not a revenue-driven. It's more -- the more we -- we're only halfway through on adding the SKUs. That brings people to the site. And that's what you've been seeing. Their online web orders are at 51%, I think, year-over-year. But it's also the marketing programs and it's the buying experience, it's the e-commerce. We spent -- we're committing millions of dollars to improve our assistance in our e-commerce. And those are the types of improvements -- you improve it, you're not going to get customers today. It's more a longer term, but that's what we're doing. It's the same with SKUs, right? You have a SKU. Nobody is going to come on today for that, but it's a longer-term bringing people to the website. So they got a lot of traction. We feel really good about this, and that's how we get to 10%. And that's a target. Let's get there and then we'll talk where we go from there.

Let me add to that, Tom. I think a really, really good explanation. Jim, another answer to some of your questions, it's a little bit of everything, right? I mean so we've got the U.K. one facility, which we've talked about, the leads, which allowed us -- that's a major investment, a new logistics center. And we're not even getting all the efficiencies out of it yet, but it allowed us to close another logistics center. And this allowed us with the size and the automation to expand the SKUs. I remember well back when Farnell didn't have the investments, the resources, the IT infrastructure going back 6, 7 years ago, today they do. So it takes time. So things are starting to really build in the right direction. To Tom's point, the SKUs are coming out. We're invested in the e-comm, the website, the infrastructure to allow faster response online. And 51% of their revenues are coming through completely online and 70% of the line items -- 70% of the line items, over 50% of the revenues, and that tends to be higher margin. It's coming in online and going right out. So low touch. And we're managing costs. Chris and the Farnell team has done a really good job managing the cost. It's just a little bit of everything. So we're really bullish on Farnell right now.

So Phil, I think I've actually known you for close to 2 decades. Before, in your prior role at Avnet, then you went to coach football and now you're back at Avnet again. But while you took your coaching position for a little while, there's been some chip distribution relationships that kind of did some changing. Are there more of those in the works? Or how should we think about the landscape about their relationships amongst the chip -- just chip companies?

Yes. So well, this is not new. I mean, again, you're right. We've been around for multiple decades. And a lot of this has been accelerated with acquisitions and consolidation on the supplier side. With '80s, '90s, there was a lot of distribution, doing a lot of that. And it's accelerated in the last, what, 5 to 10 years on the supplier side. And there are some puts and takes here. I like to start off by saying, "Hey, we're really proud of like what we have." We've got some great near exclusive ratios from guys like Broadcom, Xilinx and Marvell. We don't typically mention suppliers. In this case, it's safe to do in this kind of COG is we're really proud of that. We don't talk about enough of what we do have versus where we might have fell short. Even some of the lines that we did lose in, what, 4, 5 years ago, we've gotten back, okay? The couple you're speaking to, I'll just put it on the table. You [indiscernible] ADI, Maxim with being the one right now. We have a phenomenal relationship with Maxim and Tunç and John and do a great job for them. We're roughly 80% of their channel business today and proud of that. We've been with them for a long, long time. So what we've asked our team to do is just focus on execution with Maxim, okay? Focus on the execution and deliver expanded customer base, demand creation and hit the revenue line. And ADI will make a decision they feel best suits their needs for channel alignment, okay? ADI is very close to divestment. We certainly respect that. Of course, we've had some dialogue, but that's as much as I can say. That's going to be in their core. We need to focus on our execution. The other one that's out there right now is -- and by the way, we'd be thrilled to have ADI, Maxim combined. And we think we have a great value proposition there. The other one that you're really referring to is probably AMD Xilinx, right? And both those lines, we've been together with for combined 60, 70 years. And we have a phenomenal relationship with Xilinx and Victor Peng and his whole team; of course, Lisa Su at AMD. So we feel very confident about that -- those relationships moving forward. And those are a couple that are out there right now. I always take an opportunity to thank our suppliers. We have great supplier relationships. Without them, we don't have a business. We know that. We're an extension of them. We continue to listen to them. Let's just say we had a couple of misses along the way in the last 5, 6 years. But we feel, for sure, we're back on track, on offense and doing the right things.

And how do you gain share in an industry that really has kind of 3 giant goliaths? I'm thinking about Avnet, Arrow and World Peace. World Peace, much less so in North America. But how does one gain share in the industry with 3 large goliath distributors?

Well, first of all, you got to focus on your customers, right? You've got to focus on your Net Promoter Scores and make sure you're operating to the level and standards that the customers expect you to. Then you need to make sure you're aligning with your suppliers. I always like to say we're an extension of our suppliers, right? And we don't -- we're [indiscernible] with our suppliers. We want to say, "Hey, what do you need us to go do in the marketplace? How would you incentivize and how do we gain a return on investment for that?" And what they're looking for is customer expansion, more demand creation and design identification, as I like to call it; of course, revenue growth. And then that's the what. Then how you do that? We think we have -- we just talked about Farnell. We have a really unique value proposition in the marketplace today that really no one else has. And it's high end with Farnell with a high-touch, high-service -- low-touch, high-service level with what we bring from the core. We're leveraging -- we're keeping it separate upfront on the front end because it's a different value proposition. But Farnell's 1 million-plus customers, we now have access to in the core, what we call, the core Avnet for distribution business, okay? We're also working with Farnell into our large customer OEM. So that's just one. That's a major opportunity for us. Demand creation, design identification, I think the key there, particularly in the last 18 months of what we've gone through, is how we further digitize that, right? What's the soft-serve tools? What are the digital tools we're going to bring to the market to help even take that to another level? Interesting comment, though. Even through the COVID, we're having record numbers of design, design registrations, design win revenue. It's really amazing. So that's another big area. And then supply chain services. I mean we have really unique capabilities there. As I said in the kickoff, we're seeing more opportunities through the disruption of the supply chain from suppliers and customers that may have not been using us for some of that. But now realizing, we need to leverage some of your global capabilities because supply chains are global. I mean you're dealing with the OEM, an original equipment manufacturer, in one region. You're shipping to -- could be up to 15 different, 20 different locations around the world. So that aggregation is real leverage that we bring. So I mean you can't continue to focus on everyone. You just got to focus on your own execution. And as you do that correctly, back to your football analysis, you will put points on the board and will continue to win in the marketplace. And we feel we are.

And Phil, for you, just to let you know, during this conference of 100 -- I'm sorry, 200 companies, they've all been talking about higher-value actions. Some hardware companies selling more security or services, some software companies doing more higher-end, value-added. What are some examples that Avnet is doing that investors can actually conceptualize and grasp about higher-value actions?

So some of it, I probably touched on already. I mean let's go back to Farnell. And Tom just spent a lot of time talking about the value that Farnell brings to the marketplace, the reach they have for our suppliers and customers who are willing to pay for that. So right, their getting Farnell into 8%, 9%, 10%, 11% operating margins is value to our shareholders. And it's adding value to our suppliers because of the reach that they bring on the digital side of the equation in e-commerce. I mean that's something we need to continue to double down on, we are. The digital tools are expanding. Suppliers want that too, by the way, and integrating supplier tools with our tools to give that customer the full view of the design to production and supply chain services. Again, the automation around -- and the digitization of supply chain services. I mean we don't mention customers' names, but we're doing all household names. And all your viewers and people in this conference would know who they are, okay? And we're continuing to drive upstream with those customers. And they're continuing to come to us for the services that we bring because -- whether it's inventory related, a fee-based service model that we're putting together or whatnot. So this has 3 or 4 things of what we're doing to go continue to drive value into the marketplace, synchronize the demand creation. That's -- we talk about demand creation and demand identification. That's -- roughly 30% of our business is where we're actually helping identify new design, help design into the customer's application and then drive the supply chain around it. And we get upwards of 300, 400, sometimes 500 basis points in incremental margin, okay, when we add value in the design area. So still something that's really critical moving forward. And most, if not all, suppliers still are looking for us to add value there.

And Phil, what do you mean when you say fee-for-service? What's the example that somebody not smart like me can actually understand? Is that hiring an engineer from your company to help me design my child-tracking device or something like that? Or what do you mean by fee-for-service?

Yes. It's a great analysis. Thanks, Jim. It's that, okay? So we actually have design engineers, okay, that we've acquired over the years, whether it be software or turnkey design. So we met with a customer yesterday that are kind of tapped out on their design engineers. They might be spending a lot of time on redesigning products to get other products in that they can get for their current manufacturing needs and demand needs. But we've got a third party, I would call it, that's Avnet owned, that we can go actually go in and do full turnkey designs for our customers. Now we will call that turnkey and a fee-based service. And of course, we help them with the design, we capture the chip revenue downstream, right? So that would just be one example. Some others are in the supply chain services, some really high-end Tier 1s. So maybe it's a different inventory model, okay? Maybe we're putting our supply chain architects and our program managers in play. And it's more -- it becomes a more fee-based model, less capital intensive. And of course, Tom with being the CFO and our Corporate Controller, Ken Jacobson, get involved in all those deals because they're very, very unique. They're typically with high-volume, Tier 1 customers and suppliers that want us to fill that gap for them. So it's really on both sides, from design, software and supply chain.

Well, Phil, I'll let you grab a drink of coffee or tea or something and switch it over to Tom and talk about capital allocation. Has anything changed, Tom, about capital allocation now versus, say, pre-COVID?

Yes. Pre-COVID, Jim, we were -- we really focused on buybacks and debt. I think if you go back 3 years, we probably had $650 million more debt. We had 20% more shares. And we're very happy with where we came through that. Well, we've spent a lot of time internally and with our finance committees. It's just like margins. What is a sustainable capital allocation program that provides our shareholders sustainable, steady returns of capital? And that's where we're at now. So we came out with the capital allocation program. It's about 50% returns to shareholder, 50% internal CapEx and M&A. And when I say sustainable, I mean through a cycle. Meaning if low market continues or we have a couple of corrections, what is the sustainable return of capital? So the good news is, hey, we just recently increased our dividend in 2 steps. So 14% since May, it returns about 2.5% yield at today's prices. We expect to see more on the dividend. And again, we view that dividend as sustainable through the cycle and more importantly that we can increase it every year through the cycle. Buybacks are clearly -- our belief is more on a sustainable price-type grid scenario. And on the other 50% of the CapEx is when we talk about how do you grow Avnet, it's continuing to modernize our distribution centers, keep our capacity in line with our revenue. So a lot of thought has gone into our capital allocation going forward. And I think the key thing is that you're going to start seeing this quarter-over-quarter return to shareholder and spending on CapEx.

Speaking of which, both you and Phil mentioned you wish you had more inventory. Permanently, and I'm talking outside of COVID and outside of this, is there a need for distribution to hold more inventory? Maybe talk with your customers or charge them for holding more inventory? Because stuff happens and it's probably going to happen again.

That's all part of what Phil was talking about. I'm not joking when I say when you think about capital allocation, well, part of it might be to inventory, right? There's nothing wrong with that. We're a distributor. What we target each of our regions on is what's our return on working capital. That's really what's important. Adding inventory to the extent that it provides a better solution to our customers, yes, we're more than happy to do that.

Jim, that's a really good point. And Tom has done a great job with the finance team and Joe and really driving return on working capital, days of inventory, working capital days. And it's always a tricky balance, what's too much, what's not enough. But yes, distribution -- inventory is not a bad thing. But what I think is going to be interesting, Jim, as we come out of this is what are these Tier 1s, Tier 2s? How are you going to think differently about JIT, about lean? Is having a bit of a buffer of inventory a good investment, okay, on their part? And having someone help them manage that, is that a good investment? Or things -- when things get back to normal, whenever that's going to be, whether it's 6 months, a year or 2 or 3, we don't -- nobody really knows exactly. Are they all going to just forget and go back to the way they did business? I'm of the mindset that customers I'm talking to, they said, right now, it's not getting easier here, short term. I can assure you that. They're talking about the future. So when I say supply chain architects, that's our Avnet United, Velocity team. They're getting pulled into more opportunities today than ever with some of these customers talking about exactly that, Jim. So we'll see. But we think it's going to be a positive for us.

Well, as we wrap it up, I want to ask you both the same questions. And we'll start with Tom first and then wrap it up by Phil. But what do you think investors do not fully appreciate or grasp? Tom?

I think the sustainability of the margin improvement. I think, underneath that question, Jim, is our share price. I struggle with the -- that we're posting revenue growth. We're expanding margins. We've got control on working capital, returning cash. I think the concern is that, well, to an investor, there's some market volatility. They see inventory go up and down. They start inferring, maybe that's a slowdown or maybe that's shortages or easing or that is going to affect pricing. And we don't see that. We see that this is a strong market and it's continuing. So I think they understand -- I think they want to see some maybe longer-term signals on stability in the market that will help with our messaging and what our share price is today. Phil?

It's a great answer, Tom. I would say the sustainability confidence over time -- I mean you do mention it, Jim. So I'll just -- I'm very transparent, very honest. These guys from facilities say, "Hey, we had a couple of misses, right?" We had a couple of hits and -- over the last 4, 5 years. I'm not going to deny that. So investors are going to say, "Okay. These guys -- is this company for real or not?" The answer is absolutely. I mean we posted, as Tom said, several 4 quarters or so on the positive. We've got our operational efficiencies down. The digital story is rock solid with Farnell growing lines. They're growing. The demand creation numbers are good -- or actually great. Our supply chain solutions, we're as busy as we've been. We've been building out these new models, which is really exciting. And I mean just really exciting. And the demand creation and the supplier relationships, I think that's the core. I mean really -- it really is -- we really have invested a lot of time the last -- well, over 100 years, by the way, that certainly reinvesting again here in the last several years to solidify those prior relationships. And we're excited about where we sit there. And then of course, as Tom already pointed out, the financial execution. So confidence, confidence over time, we become believers. And we think we're a really good value for the market right now.

I personally want to thank Avnet for sending their executive management team, both the CEO and CFO, and then Joe from Investor Relations for helping us out to put this together. And gentlemen, I really hope that next year, we're doing this in front of a live, large crowd like normally we have. But until then, this will suffice, and I sincerely thank you for your time.

Thank you, Jim. Thanks, all. Stay safe.

Thanks for having us. Thanks, everybody. Bye-bye.