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

Good morning. We're day 3 of the conference. Good to see everyone here this morning. I'm Melissa Fairbanks. I'm an analyst with the IT supply chain and semiconductors teams. We are thrilled to host the team from Avnet this morning. Today, we've got CEO, Phil Gallagher; CFO, Tom Liguori; and Joe Burke from Treasury and Investor Relations. I think to start, Joe is going to read a brief safe harbor statement. And then we'll go through a quick presentation and open it up for Q&A.

Okay. Thanks, Melissa. Hello, everyone. As a reminder, 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. 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, Melissa. I'll get it back to you.

All right. And I think Phil has a few slides to go through. I believe the slides are available on the website. For those of you listening at home or in your virtual office.

Great. Do you want me to just jump right in there?

Yes, go ahead.

Melissa, thank you very much. And I want to thank everybody for the interest in Avnet today. So appreciate you being here, whether it's live in person or on audio. Just a few slides I'm going to cover today, and then we want to get into the Q&A and really what's on your mind. I've been in the role about 15 months now permanent, a few months -- I was interim for a few months. And then with Avnet, minus 1 year roughly 40 years, started in 1982. We've been around for roughly 100 years. So with that, let me just jump right in. We've only got 3 slides to give you some color about Avnet and some of our performance highlights. One of the themes when I came in was kind of back to basics, focus on execution, operations, drive growth, market share, seal up, if you will, or further strengthen our supplier relationships as we sit between our suppliers and our customers on a global basis. And I think we've done that. And I guess, I have the clicker. Okay. So let me -- there's Joe's statement. Good job, Joe. Okay. So you can see the numbers. We just kind of kept at high level. And we have strong revenue performance, roughly 26% year-on-year growth in the past quarter. We've had 6 consecutive quarters of operating margin improvement and beating the guidance and consensus. And we really continue to invest in our core capabilities. We'll talk a little bit more about Farnell in a minute as far as our e-com digital portfolio, if you will, and the go-to-market strategy there. And we remain committed to shareholder return. And in the past quarter we actually raised the dividend up roughly 24% year-on-year, which we think is really important. It is a show of confidence in our own performance, our execution and our future performance. Okay. So next slide, it really just talks about the 2 operating groups. We have 2 groups. I'm sure we'll get into some Q&A around this as well. We got the Electronic Components group, which is what we call basically the core, we're doing from design chain, from supply chain and basically everything in between, you can see the growth in the core business sequentially and year-on-year, and our margin improvement, and we're not done here, but we've had done with our margin improvement yet. We'll talk more about that, but we've had steady improvement on the margin side of the equation. And then Farnell. Farnell is a business that we kind of call it speed and convenience. It's our online business, our online catalog, really broad depth of SKUs or part numbers on a global basis, roughly 70%, 7-0, actually 72% of their business transacts online, a true e-commerce from room to tomb, and it's a little bit over 50% of the revenues. And the 50% is exciting, frankly, I get even more excited about the 72% because that talks about efficiency, productivity, and that's going to be more and more of the wave of the future with e-commerce and buying things online, and we're well positioned with Farnell and you'll hear us talk about Farnell a lot and we were doubling down on it for now. We'll doubling down, why? Well, it's 8% of our revenues and 25% of our profits. So we can get that to 16%, you can do -- you can kind of do your own math. But we're doubling down organically and looking at acquisition as well. And the last slide is really our road map, okay? We have seen in the last 15 months or so with what's going on in the supply chain. We're kind of becoming that orchestrator of supply chain services. It's -- it's been a positive from an Avnet standpoint is more and more companies on the customer side as well as the supplier side are seeing the value that we bring to the supply chain. So I have to say people take supply chains for granted until they can't get what they need. And then everybody goes back and start looking at what happened in the supply chain. And we're being pulled into, like I said, customers and suppliers that maybe weren't thinking of us prior, okay? And again, we have -- on the core side, roughly 60,000 to 100,000 customers. And then Farnell catalog side, we have well over 1 million customers. So just a continued opportunity there. We'll talk about our continued operating margin improvement of 4% to 4.5%. We see line of sight to that, maybe even a little ahead of time. And again, Tom will touch on that. And then the other -- we've been very transparent. The other big opportunity for us is the continued improvement in our Americas performance. Over the years, EMEA, Europe has been steady as she goes. Asia continued to do well. We had a hiccup or 2 many years ago or 4, 5 years ago in the Americas, but we are making progress, not only in the top line, in the Americas, but on the bottom line and operating margin performance. And we have more runway to go there. We're probably about 60% to 70% of where we think we need to be and where we need to go. And again, we have line of sight to that. So we're going to continue to invest organically, continue to invest inorganically to continue to drive growth and profitability and returns for Avnet and for our shareholders. So brief? brief enough?

Brief enough.

Okay, so let me just thank you again for being here.

Sure. So I think semiconductors are obviously a topic that we're all hearing about in places that you probably never expected to hear about them before. It's probably important to talk about supply and demand dynamics that you're experiencing now.

Just a quick -- just get this out of the way to begin with. Many investors have asked about exposure to Ukraine or Russia. Have you experienced any disruption as a result of the recent events?

First of all our thoughts and prayers go out to that whole situation. We hope that it improves sooner than later. That said, roughly 1% of our revenues are tied into Russia and Ukraine. We have around 75 employees between Ukraine and Russia, the bulk of that in Russia. Good news is we're in contact with all of them and everybody is okay. We don't know, and Tom -- what's the other effects? I mean that -- I'm not -- I don't have a halo over my head to call that. We haven't seen it yet. The demand still in -- across Europe, Americas and Asia is extremely good. But it's early days, and we'll just have to adjust and adapt to the things we can control and the things we can, and we're just going to make adjustment.

Kind of seems like we've been doing a lot of that over the past few years, moving from one region to another and addressing.

If you're not adapting, you're done.

Exactly. Exactly.

That's how we've hung around for 100 years.

Exactly. So maybe review what you're seeing in current supply. You obviously have very strong relationships with your suppliers, probably even strengthening throughout this. Are there any hotspots or areas in particular that are still tight? Or is it just kind of stabilized at a difficult...

I think more the latter. I don't think as -- again, there's always going to be pockets that are maybe improving a little bit and other areas that might be even getting a little bit worse. But as a general statement, things are still pretty tight. And it's not -- most interesting is it's not discriminating, if you will, against any one vertical. And that's part of the issue, but it's also part of the opportunity, right? Because demand is up and demand is up -- I always compare to '99, 2000 for those that have been around the market -- semiconductor market took a hit there. It was so top heavy to remember Y2K, PC, data center, telecom, networking, I mean, that was a big, big part. There was other applications. That was -- and when that went the whole industry went and it went hard. I was running the Americas at the time, and it was very painful. This one -- I hate to say the development, it will jinx, it feels a little bit different because of the pervasiveness of electronics, we're talking about to tell the audience is that the applications from consumer to industrial, of course, automotive and then the EV and then the grid-free electronic vehicle, battery management in general in the industrial space I mean whether you're a drill manufacturer or jack hammer whatever, they're all battery. Everything is going to battery, which is electronics. Then you got the medical, of course, defense and aero. So just -- I mean, an LED smart -- smart LED light bulb has 20 chips in it, right? And we talked to somebody this morning, they can't get their La-Z-Boy because there are electronics inside the La-Z-Boy. That wasn't happening in '99 and 2000. So it feels different, things are still tight. I think they're going to be into 2022 and we're not bold to predict that. But it feels like certainly through March and in June, feels pretty tight.

We've heard some commentary from some of your supplier partners just over the past couple of weeks that their time line, their horizon is lengthening.

So I'm glad you mentioned it. So I just don't -- maybe its wisdom or whatever -- but you talked about -- I know a lot of the network here, so I won't mention anyone. They're much more bold. Hey, they're sold out through 2022 into 2023, particularly in the high-end controllers and some of those -- that space. I just say, "hey, look, things are tight, we'll manage it as we go." But our backlog, because of lead times being out, so our book-to-bills are still really strong. And what's happened is the bookings and the backlog is going up further because you've got to continue to adjust for the lead times. But yes, I know which suppliers you're talking about. I don't hope them because we don't do that, but it looks pretty tight through the year.

All right. How has this -- the tight supply impacted your revenue? Your growth expectations, either in the near term or kind of longer term?

Well, if you look back several quarters, you can just share the charts that are available, obviously, that we've had terrific growth still, which is kind of the irony of this whole situation, right, even though a lot of our customers didn't, so might be inhibitive but I don't have a pretty good performance as our suppliers. So there's chips getting out there. I mean people are getting chips, is not enough for the total demand. As I said, we were up 25.6% quarter-on-quarter or year-on-year in this past quarter. And our inventory, actually grew a little bit. And by the way, we think that's a good thing. Some analysts, not you but some analysts are like, "Oh, my god your inventory grew well," but we're a distributor, we want to have inventory. So I complimented in the last earnings call, our asset teams have said thanks. They did it -- I mean publicly, they did a great job because it's good inventory, there is difference been good inventory and bad inventory. And in June, when we grew inventory, we exceeded our revenues in September. September quarter, we grew inventory. We blew out October, and we're feeling good about our current guidance. So again, hard to call what's going to happen in the next 3 quarters. But we feel pretty good about our inventory. We like to have more. Tom, what's our days now of inventory? What do we want?

It's 62 and we'd like to have 65 to 70. So more to come.

This is a little bit of a tangent, but do you manage the inventories between the core and Farnell businesses differently?

For sure. Now do we also share, yes, the answer is yes. We try to do more of that seamlessly. But yes, the core -- so on the core side of the business, in the core, again, that's the component side. That's what we're doing in design. We have well over 1,000 field application engineers. We do design, impact design with them for our suppliers through manufacturing anywhere in the world, 140 countries around the world is what we ship into. So we build a lot more supply chain management there. And what's that mean? We're taking in thousands of MRPs with forecast from customers either via EDI, API, fax, we'll take it any way they want to send it to us, then we aggregate that and then go upstream, as I like to say to our suppliers and give them the demand that we see over the next x number of months and quarters and it's thousands, Melissa. So we get a good view across tens of thousands of customers, a good view of what the demand is and then we manage that accordingly. We might have consignments, in plant stores, so whatever those engagements are, and that's about 55% of our business. So in general, we're going to have a more narrow SKU count in the core, right, but a really deep inventory. On Farrell, Farnell, they have a much broader SKU count and a more narrow inventory. Why? Because they're dealing a lot with MRO, so engineering, new products introduction. So engineers within the customers that they want their kits. They want to get everything from one stop shop, it's speed and convenience, so you've got to have a much broader SKU count. So that's how we manage that much differently. But both sides of the operating groups, their measure of returns. So we can have less turns -- inventory turns in Farrell because the margin is a lot higher, okay? And his return on working capital is phenomenal actually. So we're trying to get into to add more as much inventory as we can add. And on the core side, we still manage it by return on working capital. So all the executives are paid on returns. So you still got to manage it appropriately. But different models for sure.

Sure. So that kind of leads me into my next question. Do you think the current situation or what is your view will this current situation permanently change the way on the customer side distribution is used?

We think it further -- we already know the value we bring. I have to say we're in the center of technology supply chain. We're dealing with amazing technology for the suppliers and amazing applications into our customers. We have seen more customers that maybe weren't utilizing us prior for whatever reason, it might have been Tier 1, maybe there's more on the direct side even out of Detroit, some customers now coming in to Phoenix to visit with us on their supply chains. So we're seeing more opportunities than we've seen before. I do believe it's going to be permanent. I kidded one of those companies, I was kidding with one of them, saying, is thing going to be like a convenient and leisure thing. And they are like, no, we have to permanently change because we're all reading about that, right? A $0.50 chip or $2 a chip is holding up a $150,000 car or a $0.5 million dump truck, right, that's got all the automation. And so I think there is a permanent change. And what we want to be as I had on that slide, we want to be that orchestrator. So I think customers -- so many customers have -- and we support it, have outsourced so much that they've lost visibility and the transparency to where their products are coming from, where they're being built. So inserting us into that, still using the outsourcing, we help orchestrate and give them the dashboards and the visibility so they can see what's really going on with their supply chain. So we believe a large piece of it will be permanent.

Excellent. So obviously, we've seen inflationary pricing up and down for supply chain. For the most part, historically, you've been able to pass along a lot of those price increases. Maybe Tom, this could be a chance for you to talk about how is the current environment affecting your margins, your returns, profit dollars? And how you're planning for the future?

No, that's a really vital point and important to understand investing in Avnet. So prices are clearly benefiting us more on the Farnell side, core is more we pass along price increases. We have scores of suppliers that have increased prices, and they've done it 2 or 3x. One of the questions we always get is what happens when the market turns. Well, a couple of things, and I'll talk about it in a second. If you talk to the suppliers, prices are more a market reset. And I kind of and I think Phil does. We have a lot of -- put a lot of credence in that for this reason. If you look at today, there's fewer suppliers, it's more proprietary technology, the devices are used in more and more products. They play a bigger role in the product with kind of activity. So if I'm an MTPA supplier with proprietary technology, I can probably hold my prices better than the past. But one of the questions I think the -- if you look at our valuation, and I am going to quote Melissa's report, right, you have us at -- Melissa has us at $5.70 EPS for this year and $6.50 for next year, and we're all in on that. Yet our share price is $40. We're trading at historically low multiples. Today, we're about 7x P/E. Historically, we're 9 to 12, so you can do the math. So I respect the concern on what happens when the market changes. So let's just address that head on. First of all, if the market turns, we're not sure prices will go down, but let's say they do. We have 2 businesses. We have components. We have Farnell. Components today, our operating margins are 3.7%, 3.5%. If you go back pre pandemic, you're going to see for 2 or 3 years, it's been 3.5%, 3.6% consistently, okay? So there are certain dynamics that happen in our core business, returns on capital that earn that type of margin, and we don't really see that changing. We actually see it increasing because we're at 3.5% margin. And we have always talked about Americas is progressing. They're about 2/3 where they need to be as they continue to make progress on growing their revenues and improving margins. That's going to help that core. I think a lot of investors are concerned about Farnell. We're very open. We want to be transparent about this. Farnell margins today are about 13.5%. 350 basis points of that is pricing, okay? They benefit from pricing. This is e-commerce, you go on, we're changing prices every day. What we've said, but we really -- I don't think people fully appreciate it, but there's a number of cost pressures that come with today's market as well, namely our freight cost, right? Everybody knows freight costs are astronomically high. And we brought on a new distribution center, and you could say it's perfect timing or you can say it was kind of rough timing. It's perfect timing because we needed the capacity to make the revenue, but it's been difficult to bring it out because of -- they grew 35%, Farnell grew 35%. So there's some inefficiencies. So there's about 150 basis points of cost that shall the market return to normal will benefit Farnell, okay? So through the cycle, we think of Farnell is like 10% to 12%. I know I'm giving you a lot of math. I think this is on investors' mind, is really, really important. So then the question is, well, okay, Phil just said we're going to get to 4% and 4.5% operating margins. And when we say that, we mean in the near term, 3 months, 6 months, it's very tangible. It's right there. And over a midterm of maybe 2, 3, 4 years, we can get to 4.5%, 5%. So near term, it is about continued performance in Farnell. We've invested a couple of hundred million dollars over the last couple of years with e-commerce systems, inventory breadth and that is paying off. We always give you the stats, Melissa. So that's part of it. It's getting Americas to continue their progression on the margin cycle. When you look at our business 3 to 4 years down the road, the first part is about growing our higher value, add businesses faster than the core. And we're doing that today. Farnell grew 35%. This quarter, the core grew 25%. Most of the times, you'd be ecstatic about 25%, right? But Farnell outgrew it. They did the same thing the quarter before that. We're making investments. We want to grow Farnell faster than business today, did you say the stats today Phil? Revenues are 8% of total operating income from Farnell's quarter. We can see that plus a couple of the other -- we have an embedded business that's like chip on a board and think of it our embedded business has Farnell 3 or 4 years ago, we're investing in it. If we can get our -- our plan is to get our higher-margin businesses, which are those that have operating margins of 10% plus to be more like 30% to 40% of our profits. But this is our path forward. So I'm sure one of your questions is buybacks, just we're buying back and you may see more of that. And for all the reasons we just talked about, that's why we're buying back shares, we do think part of its market, we're not alone with these low multiples. But I think when you start peeling away the layers on some of the concerns, Phil and I feel pretty confident about it.

Excellent.

And the cash flow Tom?

And the cash flow. So we've had a meeting earlier this morning, and the discussion was, what if it turns and this is like 2008. So okay, we see today as demand is very strong and demand in autos is very strong. These are short-term issues. It's more a shortage issue. But cash flow is like, okay, what would happen if geopolitical events or others turn the market? We have a countercyclical balance sheet, meaning that when the market slows, we collect all our receivables, we slow the inventory purchases. During the pandemic, we had a slowdown, we generated $1 billion of cash, okay? So our plan, Phil and I, and we worked with the board on this, if that happened again, we're in a great -- we're in a much better position to be opportunistic, Meaning if you compare us, our balance sheet today versus 4 years ago, and I thought 4 years ago, it was fine. We have $500 million less debt. We have a more structural change in our margin structure because of the investments we made, we think we can hold margins better. But if the economy turned, we would generate a lot of cash. And this time around, we'd be very opportunistic. So what does that mean? I mean it'd be much more buybacks. And potentially, Phil mentioned M&A. We'd love to do some smaller tuck-in to grow our Farnell business. And you can appreciate today these are smaller. So nobody get worried about large transformative acquisitions. But the companies are highly valued today. And in a downturn, they would be much less. So that's our doing more to doomsday and we don't see it, but have confidence that's the benefit of owning Avnet shares that we can perform through the cycle differently. In an up cycle, we're going to expand margins. In a down cycle, we can generate cash. And today, we can do -- we could really use that to our advantage.

For sure. We've got 5 minutes left. I can open it up for questions. I can't believe how quickly these sessions go. Anybody? Okay.

You mentioned your management team is compensated on returns. Can you elaborate on that and what the targets are?

Yes. So I'll go first. So the management team going out to regional presidents. First of all, when the sales go up, everybody's paid an incentive on gross profit or net profit. Okay. So no one's paid on revenue. everyone's compensated on margin of some sort. And the variable piece of their income is somewhere roughly 40%, 50%. so everybody's got skin in the game. Further up you go, it's OI% and return on working capital, okay? So -- and we have targets to get return on capital employed over 10%, and it equates to a return on working capital number around 20%, which is really your OI inventory payable receivable. Then of course, there's a long-term incentive and stock and equity.

Just a question. You mentioned your goal for inventory turns kind of 65 to 70 inventory days, 65, 70. Has that changed over the last couple of years given all the disruption in the world? Or are you thinking just kind of getting back to the inventory efficiency that you had pre '17 or '18?

It's kind of comfortable circle. For those that have been investors of Avnet, 3, 4 years ago, we went on a working capital of streamlining it, really get it tight, and that led to a lot of the cash flow generation. I think today, we view -- so inventory is almost like capital allocation, right? I mean it's a benefit to have inventory. And today, we have 62 days' worth of inventory. And we'd like to get that to 65 to 70 days.

But we may not be able to.

Well, that's problem right.

We're trying and then when it gets here, then we get some analysts say, hey, well, you got too much inventory, it's okay, we need that. So it's just impossible. Yes, we're not afraid to go invest in the inventory. We would -- as I said earlier, we have great confidence in our assets and products. We have a call, Tom and I have a call with the rest of the exec team every other week globally with all material folks around the world because we're watching that like a hawk.

And Phil is my boss, but - to Phil's credit, but really to the team's credit. If you think about people that are in our space like larger EMS companies, many have felt the -- they're hurt of shortages, right? You've seen people preannounce or something happens in Malaysia or Micron, we haven't had a blip, right? And I don't want to jinx myself, but the reason we haven't had a blip is because there is a constant focus on execution discipline, supply chain. Phil leads a meeting every 2 weeks where we have the presidents, and we're dealing with, how do you know the orders are right? And we have a lot of data analytics. And if somebody is ordering more than we think they should, well, then it's a critical impact and these are why we've been able to operate fairly well in a period of shortages.

For sure. Have you had any discussions on the customer side with just looking ahead once you're able to finally get inventories once supply finally eases? Are there any conversations yet with the customers about maybe working with you to hold extra levels of inventory just to kind of failproof their operation?

Yes. And I think particularly in some of those larger Tier 1s, they get penny-wise and dollar-foolish, right, to JIT that was in vogue. Yes. Yes, absolutely. Yes. These are -- you don't want to get sloppy, right? And you don't go back to just in case either, right? So it's got to be kind of just right. And that's where we call it our Avnet United velocity team, Dave Polson, who will be at an Analyst Day, we have upcoming. He manages those large engagements. And his team is almost at capacity in reengineering those supply chains. So -- and a lot of it is about the customer getting the visibility. That's why this orchestration piece is so key. They a lot of times don't know what they have. So take a large OEM customer might have outsourced to which we -- by the way, we totally support our EMS partners. There's one in town here not too far away, is a really great partner, but a lot of customers have outsourced so much they just lost visibility. So there might be enough inventory, but XYZ company has too much, so this one doesn't have enough, and they may not be sharing amongst each other, so we can help orchestrate that in the dashboards we're building to give that customer visibility and they get the right products to the appropriate outsourced manufacturer.

And creating more value for your customers, which is always a good thing. I can't believe it, but we're out of time. We do have a breakout session downstairs. We can continue the conversation there. Thanks very much, guys.

Thank you.

Thanks, Melissa.