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

Good afternoon, everyone. Before we get started, if you are a member of the press or media, please disconnect at this time. This is a restricted line. Any unauthorized party in this meeting or any unauthorized use of the information communicated in this meeting is subject to prosecution to the fullest extent of the law. Any unauthorized person, including the media that is on the line at this time, please disconnect. Please note, today's call is being recorded.

Great. So I'm Joe Quatrochi, the Component Distribution Analyst here at Wells Fargo. I'm happy to welcome Avnet's CEO, Phil Gallagher; CFO, Tom Liguori; as well as Joe Burke, Treasurer. So for anyone on the webcast, who'd like to ask a question, you can submit to the Ask a Question tab or you can e-mail me at [email protected], and I'll ask it for you. First, before we start with questions, I'm going to go to Joe Burke for the safe harbor. Joe?

Yes. Thank you, Joe. Hello, everyone. As a reminder, today's discussion may include forward-looking statements that include 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. 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. So thank you. And Joe, go ahead.

Perfect. So Phil, Tom, thanks for joining. Maybe first, just given the kind of environment that we're in, first, talk about the demand that you're seeing. Can you remind us what does Avnet's visibility look like today versus maybe what it has normally looked like in the past. What gives you confidence looking into 2022?

Yes, I'll go Joe, thanks for -- good to see you, and thanks for having us, and welcome all the investors and attendees. Hope everyone is doing well. So good -- great question. We don't give visibility out too far, Joe. But right now, for sure, the book-to-bills continue to be very strong. As we've said before, I believe it too strong probably. And a lot of that is due to the lead times continuing to extend or not coming in and the customers are planning further out. So we're getting that much more visibility, which is a good thing. So it's given -- we're getting a lot of to transparency there. We're taking in on the core side of the business, thousands of these forecasts on regular basis, and we're tracking them as best we can with the analytics for any inflated demand or things along those lines and then having dialogues with those customers. The demand, although the book-to-bills have been strong now for some time, the demand feels really good. And we feel -- we said this in the last earnings call, you had certainly through December in March, I don't like to get into 2022 or higher. But it looks like it's pretty firm, right? Despite the involvement I did with customers and suppliers and helped them with different shortages and demand that's out there so it definitely feels pretty good and pretty good and very diverse too, by the way, across all the verticals are pretty strong right now.

And maybe one of the things you talked about, you said maybe book-to-bill is a little bit too strong, I guess, talk about the things that maybe Avnet does to -- when you start to think about detecting double ordering? And maybe talk about how are those, I guess, your abilities or your processes to detect that improve maybe versus the last couple of cycles that we've seen in the industry?

Yes. Well we've got a more analytics today, and we're taking in a lot more customer forecast than we would have been in '08, '09, whatever that -- whatever cycle you want to articulate, certainly, much more than '99 and 2000 because the big crash. So what we do is we take in -- the double ordering, as I get asked that question a lot, helpful for us to detect, Joe, suppliers might detect that more than we would, but they would see that orders come in for similar customers, similar parts or multiple suppliers or distributors in this case. We look for the inflated book. So Joe Q is forecasting and been using 50 pieces a month forever. And all of a sudden, you can want 5,000 or 500 or what have you. We find that right away. We know exactly what the history of the party for that customer, what they've been through recent. And then we -- then you got to go back, it kicks out and you got to go back and make sure you are having a conversation with that customer. And that's where we have to be responsible. I think everybody is being more responsible. We'll navigate this, but there's a natural bias to try and go and trying pick up a few additional parts if we can, and our jobs is to trying to detect that and manage that. And that's what we're doing. But a lot of analytics now that we wouldn't have had years ago to capture these different kind of spikes, I'll call them.

Got it. Yes. And I mean, I guess, when you think about supply availability on your side, clearly, right, you're still kind of -- I think you've called it hand-to-mouth in terms of basically, any upside you could do in the quarter is more because of you get extra supply than you thought you could get, right? So I mean, how do you think about maybe even like demand destruction as you kind of move through 2022, is that something that maybe starts to -- you see that more? Or have you seen that at all at this point?

I'm sorry, Joe, demand, what?

Destruction in terms of your customer needing those components and going somewhere else or maybe they lose a deal because they just don't have the supply. I guess how do you think about that translating into kind of your backlog?

Yes. Yes. And we're working with them as much as we can. I mean there's definitely some shortages that are pretty severe and some long holes in the tent. So we're trying to navigate those with -- back with the suppliers and the customers. And that's a tough one. Because we definitely have some customers saying, hey, I can't get this part. I can't make my production needs in the March quarter or June quarter or current quarter, and we're just navigating those we best we can. I don't see any of this demand. That's why I thought you said demand creation. Demand is structured, I'm not so sure about that, frankly. -- that's a tough one to call. I would say the demand overall is going to look pretty good in the March and the June quarter. I don't see that tailing off as I see it right here today. And then we also watch, just to get the question on the, if I can't get this part then I don't need the rest of that volume and that of dynamic. We're not going to -- that might be what you're partly referring to -- we're looking at a little bit of that, but I'm hearing more about that than I'm actually seeing, and then we track very closely to receivables, right? So you have the inventory side, and you got the receivables side and customers can't make delivery, it's going to have issues with receivable. And right now, that's looking okay.

Okay. That's helpful. And one of the things that we've seen, obviously, is, pricing has been a nice tailwind for you guys in the industry, right? What gives you, I guess, confidence that pricing can maintain as we -- maybe supply starts to kind of catch up to demand next year? And I guess, how do you think about -- when I look at like the revenue growth that we've seen over the past 12 months or even just a couple of quarters? How do we think about that being driven by price increasing versus just shipping more component units, whatever you want to call it, over the last few quarters?

Yes. So pricing is interesting. It's obviously volatile right now, but it's not -- I guess, pretty best I want to just make a comment on front, but it's not everything, okay? So we're hearing about price increase, but still not the whole portfolio of all the SKUs or all the commodities, it's still a percentage of. So I think that's an important denote. And yes, it's given us a bit of inflation on the revenue side, but not as much as I think everybody is maybe talking about maybe it's a few percentage points here and there. Could you still have competitiveness in the balance of the market in the balance of the commodities and SKUs we're selling. The difference in this market, we'll see because typically, the supply-demand curves play out and the pricing could go down again. And I think the difference this time and we don't know, right, but is the amount of supplier consolidation, the proprietary nature of a lot of the products that are causing some of the issues, some price increases, I'm not sure if it's going to come down as it has in the past. And I think it might stick a little bit more this time. And there's been a lot of deflation in pricing over the 20-plus years in semis and components, in general. So we'll see. We are passing them on as fast as we get them. We're passing them on to the customers through our manual process. I mean every supplier handles it a little bit differently, but we are working to do that as quickly as we can when we get them.

That's helpful. Yes. I mean one of the things that we've kind of heard and I'd be curious on your thoughts is that the -- if you kind of go back from your suppliers, right? So a lot of the foundries have had to increase capacity for a lot of the trailing node -- trailing edge nodes where we haven't seen capacity added for several years. And they were producing on depreciate -- fully depreciated assets, where now they're bringing in new equipment, their cost structure is higher. So I guess, how do you think -- do you think that has a staying power in terms of the cost, the higher price that you get to pass to your customers? Do you think that is a piece of it? Or just curious of how you think about that, in the whole kind of grand scheme of pricing?

Yes. I would say if it's lagging technology, if that's you're referring to that, they're going to need to -- customers need to start looking at that. And some of it, it's more difficult than others, right? If it's a consumer type product that's not as big an issue because they're cycling through their -- the life cycles are much shorter. If it's medical or defense, there's going to be some challenges there. And we can play a role there and we do play a role there in working on supply chain services to these customers and EOLs and things along those lines. But yes, you've got older technologies, there's not as much investment going in. It's going to be a natural supply version where that pricing is going to continue to go up at be more painful for the end customer at the end of the day. A lot of the impact will be -- is what percentage of the total product is that get more component, right, maybe they can absorb or they can't. But we're working with them. we can get them into newer technologies with our command creation resources or FAEs. We're trying to move them to that next generation of supply. We had a conversation with industrial customers in last week as a matter of fact, we talked about that very issue on the life cycle of the different products and the technologies and where the investments are going, and they want to definitely try to move to the newer products, if they can.

Makes sense. And maybe just kind of one last thing on the pricing. I mean I think kind of ducktails into kind of the whole gamut in terms of where we're at in the cycle, I think in the last couple of quarters, some investors have been concerned about the price -- I'm sorry, the inventory increases that we've seen across the distributor channel. I guess how do you think about the dollar increase that we've seen in your inventory driven by just the sheer price increase of the components. And so just the average price of component that's in your inventory has increased relative to the prior quarter a year ago, versus the actual number of units of inventory increasing for you guys?

Yes. And that's a mix. Clearly, there's some price increase that have driven the inventory value as a matter of fact by the investors and analysts in the end of June quarter, we drove inventory up intentionally, and we committed to get it all out. We got most of it out in the September quarter. So we don't think inventory as a whole is a bad thing for distribution. But we -- and our days of inventory, we're very comfortable with where it is. But it's a mix, Joe. Again, not every part has gone up in price, okay? There are some in some memory, maybe some PLDs specific areas have definitely gone up. In other cases, they haven't gone up, okay? And so I would say it's a percentage. It's not the whole increase. And we're -- last quarter our inventory have been $40 million, $50 million. So we were actually -- our inventory is staying relatively flat and down in days. So we're comfortable where we are with the inventory.

Right. Okay. Yes. That's helpful. One of the things that you've kind of seen, I think, in the pandemic as well as just the supply shortage is just seeing new customers come to you that need increased hands-on help with supply chain management, things like that. So I guess how has that benefited your revenue growth? How do you think about those customers being sticky in terms of as things kind of normalize? Maybe they need less help, but are still sticking around to use those services. I guess, maybe talk about how to think about that as a percentage of revenue or what you can share and the growth you've seen there?

As far as the percentage of revenue, tough to give a number right now, percentage of opportunities in available market that's opened up for us is pretty significant, we believe. And what happened is I turned it -- people don't care about supply chains so they can't get what they need, right? Then all of sudden they say, hey, what happened here? And they go -- I think a lot has happened, right. And I think a lot of people taking their eye off the ball, okay, on the transparency in the supply chain and where all their components are as a further outsourced, which were, again, a big supporter of, but the further you get away from that end product the less visibility you have. So what's happened is, we've gotten a lot of opportunities in the last year plus, tough customers, that might have been dealing more direct or in the Tier 1 space. We might be piling them in Tier 2, Tier 3. Now they're actually coming in and saying, hey, we need some help here. And a lot of deferrals are also coming from the suppliers who are trying to service these customers in the more transparent, I'm calling the control tower kind of strategy, and so we can do the orchestration for that customer, where despite it may not be their core. So they've actually come to us to say, can you help us with some of these, X, Y, Z, Tier 1 customers that we typically have handled. And we're building out with our supply chain architects, these more customized solutions. So what's happening, if you think about it, Joe, if you go back years ago the outsource and then all of a sudden use an x number of EMS providers, which is great. But now when there's product shortages, you going to have a product that's being built by company A, that has excess inventory and company B doesn't have enough inventory and the end customers lost visibility there. So we can help drive some of that transparency and visibility to the end customer and the supplier for that matter and make it a smoother supply chain, overall. So it's significant. It's actually exciting.

So I mean, how do you think about, I guess, the stickiness of that post kind of things maybe loosening up from a supply perspective? Do you think those services, I guess, are integrated enough into their kind of day-to-day business that you can continue to kind of reap that benefit.

Yes. The answer is yes. And we were dealing with Tier 1s today, Tier 1 OEM customers, say, we've been managing the supply chains for years with them. And they're very sticky. So these engagements, we're talking about, they don't happen in a couple of weeks. We're actually in our consultants to work with the end customer. In some cases, it's we're working with the end customer, the EMS provider, the [indiscernible] and ourselves, all 4 of us getting together to say, okay, how do we manage this contract? How do we manage the supply chain. So these are obviously very sticky, to use your terminology, and very contractual in nature. And they have to be because you got to think longer term, this isn't where you just pick up and move go someplace else.

That's helpful. So maybe switch a little bit gears to the Farnell business. You've obviously seen pretty good growth over the last several quarters. So can you talk about what's driving that demand. Obviously, when there's a supply shortage, like you said earlier, right, people go to any source they can possibly get a component, how do you think about that relative to -- you guys obviously have been doing a good job at adding more product SKUs. You still got a little bit more to go from that perspective for your target exiting this fiscal year. But I guess, how do you think about just the demand that's more from the supply shortages versus maybe adding SKUs or just generally higher demand?

Yes. We really know what Tom talked on this when we talk about this on the last earnings as well, but very excited about where we're at with Farnell. We've been investing in Farnell for now several years, and it's really good to see the returns coming in. You're right. We invested in the SKUs, and we still have more to go there, which is good news. We've invested in a new logistics center and we call U.K. One. We've done a lot of work around SEO, search engine optimization, and our infrastructure. We've -- in the past 6 months plus, we've had over 8,000 customers, okay, to the customer counselor seeing more demand come into Farnell. Question is, how sticky will some of that be when new customers coming in? You're right, come in do they have shortages? Is it longer term or not. But right now, we feel very good about Farnell. We feel good about the long-term prospects for Farnell to hit to our long-term targets from an OI standpoint, that we actually publicized, we're actually a little bit ahead of the curve there. And we recognize we're getting some help from the market. And we're very public about that from a resales standpoint. I will probably get some help from the suppliers. They like to put product into the catalog values because they still want to -- the key for Farnell is not just the revenue and the operating margin we get, it's the customer expansion we get and get the visibility to the new products -- NPI, new product introductions, and engineering point, which would marry with the core. So it's a multipronged strategy and approach. Tom, any comment on that?

Yes. I think that was pretty complete. I guess what I would add, reduce our -- we are seeing proof points that the investments are paying off. So it's more than market. Last quarter, if you looked at SKUs that have been added in the last 2 years, Farnell contributed 15% of the revenues last quarter. So that's -- we felt very good about that. It says there is traction. We spend a lot of time and money on systems and e-commerce and the whole buying experience. And if you go on for now, you'll see some of that. This last quarter, I think the web orders were up to 53% of all orders. So we're getting traction. There's a lot more to go, a lot more to come, which is a positive. And to Phil's point, some of it is pricing, right? We've been very open about that. We look at for now being close to 11% operating margin this last quarter, 200 basis points of it is pricing related but there's just a slew of things that are getting traction. And so when we look forward, there's a lot of runway for Farnell to continue to expand operating margins above and beyond the pricing benefit.

And Joe, just to add that. Thanks, Tom. 53% of revenue, 71% of their transactions are on e-comm, 71%. So you're talking the lower cost to serve, which is very sustainable in the long term as well. So just wanted to throw that in.

Yes. And that kind of brings us my next question of that e-commerce portion of sales. I guess is there an upward limit as to where that could go over the next few years? Or is it kind of -- you continue to drive that as high as possible? And then how do we think about like the margin differential in terms of e-commerce versus non e-commerce on the Farnell side? Is that a kind of a tailwind for margins as well?

Well, I'd say -- I think there's plenty of room for both there. As I said, we had 71% of our line items that go through e-com, 50%, to almost about 50% to 53% of our revenue. So we're excited about that. And again, that is -- a lot of it about SKU acceleration, but it's also about making it easy to do business, how is your website, are you drawing a industry website. So I look at it a lot, it's e-commerce, but it's all about digital. And I think e-commerce and digital, okay, have been accelerated out based on what's happened in the last 2 years. And our future customers want to deal and interact with us differently. And our job is to be sort of we're adapting to where they're going. Our parts are going to where our customers [ going ], it's the whole digital experience. So, no, I think it's -- there's plenty of room for growth. And for now, we've invested in the infrastructure to allow for that growth. And keep in mind, some of that e-com, that's including -- we do a lot of MRO, which isn't as much online, right? So you test and measurement and things along those lines, but there is a little bit more of the selling. So it's not necessarily apples-to-apples to all components because that stuff is a little bit different and runs at a different margin -- good margin, maybe not as high as some of the components. But we're leveraging for now into the core. I guess that's the point. We have a lot of capabilities of Farnell that we can tap into the balance of the business.

Yes, that's a good -- and that's a good segue because that's one of the things I was kind of curious to get an update on is how to -- I think in the past, you guys have talked about sharing lead generation and things like that. I mean where are we in terms of that kind of transition or the investments that you're making to kind of facilitate that easier? Are we -- are those mostly done and now it's more just about executing. And I guess where do you see that kind of going over the next 12 months?

Yes. It's definitely accelerating, Joe, as we put Salesforce in around the world, Farnell has been on Salesforce, CRM for years ahead of the components business. So as we put the Americas up, we're getting Europe up, Asia up, that's SOL and that to be a more automated fee, if you will, and what happens is Farnell booked if -- Farnell is more likely doing business than [indiscernible] customer. We may not be doing business with recent Farnell customer because they're dealing with all the engineers [indiscernible] customers. So when we get -- when they sell something, and we force rank the lead around technology, things along those lines, it feeds to if it's an assigned account it goes directly to the core account manager or an inside salesperson, right, because it's assigned. If it's not, it goes to a central hub, and we do further lead qualifications. So that is in process, same process in all regions, the lead region in Americas and in Asia. And we've also got leads going the other way, right? So we have a lot of customer engagement. We're really the large -- we can bring Farnell in as part of that customer engagement and expand Farnell into that customer. So it's really going bidirectionally in both ways, which is exciting.

That's helpful. Maybe switch gears a little bit, let's kind of talk about the operating model. I think this past quarter, you guys have kind of maybe kind of provide us a little bit of an update and said, our target is to maintain at least 3% to 3.5% kind of through cycle EBIT for the total company. Talk about what's underpinning that. Your confidence in that. I think maybe a few quarters ago or maybe pre-pandemic, we were talking about component -- electronic components EBIT in the 4% to 4.5% range. Maybe what's changed there? Although maybe just let's just kind of talk through the new kind of component -- or I'm sorry, the operating targets.

Yes. So first of all, why you can come out with it. We want investors to be comfortable that if you invest in Avnet, through a cycle, we can deliver a 3% operating margin or above. The 3% to 3.5%, that's for the next 12 to 18 months. But whenever we're asked about, can it go to 4%, can it go to 4.5%? It sure can. And how does it do that, continued growth in Farnell, have Farnell grow faster than the core, have Farnell get into the teens in terms of operating margin. And on the core side, really, the opportunity is Americas. We've talked about very open about, we need to get the Americas operating margin back to where it was, and they're about halfway there. So the good news is they're halfway there, but the better news, there's more to come. So what's underpinning the 3% to 3.5%, we spend a lot of time with the businesses and having people be able to manage through the market. So there's a couple of things. Now obviously, the -- it's cost control, but it's more than that, right, because you need more of the cost control to manage through the cycle. It's kind of diversifying their product portfolio. Farnell is a really good example. And I don't think investors appreciate. Farnell is more than semi and IP&E product. Phil mentioned, MRO. They do a fair amount of test and measurement, right? Like, we just added National Instrument a couple of quarters ago. The more that we keep expanding that and we're expanding that base, that really helps you to be able to hold your margins through the cycle. Obviously, the underpinnings are things like demand creation and things of that nature. But that's really -- it's a major focus. We all know that if the market continues strong, we'll continue to grow our operating margins. Regardless, the hard part is managing it through the cycle. And I think we're making pretty good progress, Joe.

That's helpful. And your expectations for Farnell under that, maybe just kind of can we double-click on that? And then how do you think about the margin profile for the new SKUs that you're adding to your line card? I assume that you're in the -- I think it's -- over 200,000 -- 250,000 SKUs that you're targeting to add. How do you think about the margin profile of the added SKUs relative to maybe the existing line card prior to that?

Yes. So first of all, look, when we think of 3% to 3.5%, we think of Farnell at 10%, leaving aside pricing, right? So they still have a little bit to go. When we think of adding SKUs, we're adding SKUs to bring people to the Farnell website, okay? It's not -- we're not trying to add higher-margin SKUs or lift or our margin by that. And for those -- another thing that, and we really don't talk a lot about, but if any of the -- If any of you go on to the Farnell website, go on to the engineering community, there's 2 million engineers that are -- if you go into Element 14, which is "The Community," you can say, let's look at a power module. Let's look at a logic chip. And besides specs, it will give you all types of input from other engineers, you can ask questions. These are the types of things that draw people to Farnell and make them more resilient through the cycle, so to speak. So a lot of progress has been made and more to come on that, Joe.

Okay. That's helpful. Maybe in a few little time you have left. You guys recently kind of reintroduced your share repurchase authorization. Maybe talk about that, what kind of valuation metrics you look at when you think about share repo? And then maybe just kind of a last question for Phil or both of you for investors that maybe are looking at Avnet, how do you think about what's the thing you think investors are maybe missing or undervaluing the most viewing the Avnet story?

And so quickly on the buyback, the intent is at a minimum to offset any share creep from equity grants to employees. But you should expect that over 3 years, our intent would be to bring down the share count by some amount. So it's very important. The other part about our capital allocation is our dividend. We spend a lot of time -- increased our dividend 15%. We want to make a set of reliable, meaning that every year, we can increase it, we can do that in a good market and a bear market as well, Joe. Phil, why don't I pass it off to you for the final answer and any comments.

That's great. I think words come to mind on that, Joe, for the investors is stability, resiliency, perseverance and we celebrated our 100-year anniversary this year. So you don't do that without a lot of adaptability. I think that's what we bring to the market. In addition to that, the other thing for the investors is diversification. I mean we don't have any one supplier that's greater than 5% of our revenues, okay, with any one customer in the same boat. We're dealing with hundreds of thousands of customers, if you add Farnell, it's 1 million plus. I think we've got the end-to-end from design win, design chain through supply chain, and we're sitting right in the center of the technology supply chain and I know it's painful out there for a lot of customers getting products and some of the constraints. But it does speak to this industry, this industry the reason we're in this, obviously, part of it is COVID, but the part is the pervasiveness of the technology across all the different verticals whether it be industrial, industrial is still going to grow. Think about the applications with IoT in the industrial space. But the consumer, the automotive, transportation, industrial, factory automation, the pervasiveness is phenomenal. We're sitting right in the middle of it but additional opportunities that we talked about earlier, and the Tier 1 is now coming down and saying, we really appreciate the supply chain capabilities that Avnet brings to the marketplace. How can we leverage your expertise more, and we exist in 140 countries. So we're shipping product to 140 countries. So again, it adds to that diversification model. But yes, thanks for that question, Joe. Thanks for the time.

That's perfect. Unfortunately, we're out of time. So thanks, everyone, for joining us.

All right. Thanks, Joe. See you.

Thank you, Joe.

Thank you, everyone.