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

Good morning, everyone. I'm Melissa Fairbanks, the analog semiconductor and IT supply chain analyst here at Raymond James. We are thrilled to welcome the team from Avnet this morning. We've got CEO, Phil Gallagher.

Thank you.

CFO, Ken Jacobson.

Hello, everyone.

And in the audience here, we've got VP of Treasury, Joe Burke. So I think we'll just do a quick intro. Maybe if you can describe for people what Avnet does and...

Sure. Thanks, Melissa, and thank you for being here today. And those that are listening, again, I'm Phil Gallagher, I'm the CEO for Avnet. I've been in the role since November 2021 officially. Interim, August 2021. I've been with the company going on 40 years. So I started in 1982. Some of you probably weren't even around yet. So Avnet, we're -- as I'd say, we're in the center of technology supply chain. Avnet is roughly $25 billion in revenues. We ship into 140 countries around the world and manage supply chains anywhere they may go, okay? And we have some of the top-tier suppliers in the world. We're very proud of our line card. So I had to say that we have our suppliers that we manage upstream. We develop our value proposition down to 1 million-plus customers globally, and we do everything from demand creation. We have 2,000 engineers on staff, 600 of those are software. Software has become a bigger and bigger part of the equation for design solutions, particularly around IoT. And then we call it from demand creation to supply chain anywhere in the world. So excited to be here today. We've been around for 101 years. We started to -- Avnet is a family name. It has nothing to do with av.net or anything like that. We started in 1921 post World War 1, with military surplus right here up in the New York City on Radio Row, with transistors and whatnot starting post World War 1, connectors and then developed obviously, the business from there, Avnet listed on the NASDAQ. Again, thanks for being here.

Thanks very much. So obviously, you guys are right in the middle of the supply chain crisis that we've kind of been experiencing for the past few years.

have you heard of that?

Just a little bit, yes, when it's on the nightly news, semiconductors, that's pretty unique. So maybe could you review what you're seeing right now in terms of supply chain dynamics? Or are there still some hotspots? Any signs of easing?

Yes. So well, there is some signs of easing. We'll work backwards there. There's no question. It's -- there's some signs of easing, and in some cases, it has eased, okay? But again, I have been around for a few decades. This has been one of the most interesting cycles. And I think the -- first of all, I think the average person out there that didn't know what a semiconductor was now knows what a semiconductor is because they can get their TV their car, their sofa, you name it right on down the line because it all has technology, which is very exciting. And also supply chains, which is why I started off talking about the -- our core foundations, we manage supply chains. So it's been in a way of silver lining for us as a lot of customers lost track of their supply chains with all the outsourcing and going from the West to the East and in the Far East and then back to the West, that's been a great opportunity for us. As far as the -- like the kind of the underlying demand and probably, you have to go midrange a little bit, Melissa, because there's so many mixed signals right now out there. Everything -- all the lead times are coming in. Well, that's not the case, okay? Some lead times are coming in for some technologies. Others, they're not. So there's still -- this golden screw effect that's going on, there's a long pull in attempt, where you still can't get some, whether it be high-end controllers, FPGAs, some power products, battery management. Anything around batteries is still pretty tight. So as we look at this market, it's foggy, okay? There are still today, I'll say, pretty strong underlying demand in, I'll call it, transportation. We call it transportation versus just automotive because all the applications of technology from the car, trucks, golf carts, e-bikes, you name it, all is truck full of semiconductors, and that underlying demand is still pretty good. Even if the units demand come down, the content is going up so high. And then you got the industrial. Industrial is a -- I'd argue that's where we started between the industrial and defense. That is a long tail of customers. And right now, anything around energy, power management, building automation, that business has still got a good pull from a demand standpoint. And then, of course, defense, aero. Good news or bad, unfortunately, that's going to continue to grow. Yes, as we talked about in our December earnings in January or really February, yes, we saw AsiaPac start to wobble a little bit after some phenomenal performance. We hope that we still gained share. And some of that was what was going on with COVID in China, just some consumer PC, that's starting to soften a little bit or we saw that softening. Balance of Asia actually is still looking pretty good. And then as we talked about in the West, both in Europe and Americas, particularly, Europe in the December quarter had a record breaking -- all-time record-breaking billing number for us in Europe, which is kind of contrary to what you would think with what all is going on in Europe that we would see that. But again, that's had industrial and automotive transportation segment so strong. So yes, some softening in some places. The core still sees pretty good pull in demand, but midterm and beyond, I mean the proliferation of electronics and semiconductor and capacitors and connectors, it's just going to be up into the right.

Absolutely. So do you think the past few years has permanently changed the way distributors are used or changed the way that your customers order or plan or hold inventory?

Yes, I do think it's permanent. Now first of all, being here all the time, of course, I have a biased view. I know the value. We know the value that we bring to the marketplace in managing supply chains. And well over 50% of our business is where we're managing supply chains. We're taking in ERPs or MRPs, EDI feeds, APIs, heck we'll still take a fax if you want to sent it to us and help customers manage those supply chains around the world. And I think what happened is, as we kicked off with, not only was there a semiconductor shortage, but supply chains broke down, right? Whether -- and it all kind of hit at once, right, with post-COVID, Suez Canal, freezes in Austin, fires in Japan. And everybody looked at and say -- I was getting calls from customers that maybe weren't dealing with us before, really large household OEMs that you would all recognize say, hey, we need help in our supply chain. So we actually have continued to invest in that, bringing in supply chain architects under our Velocity, we called our Avnet United, Velocity team and then investing more in digital tools. Digital is key there. But I do think there's some stickiness, and I do think the markets are going to continue to see the value that we really bring to the market. Because again, customers are now also moving things around. I mean they need to -- they want to shift and lift from China to Vietnam to South Korea to back to Guadalajara, hey, no problem, that's what we do. People said, you're concerned if there's a shift? No. We're in all those countries, and we can help them set it up.

Excellent.

In terms of the inventory, though, Melissa, I would say, our big customers have now moved from just-in-time inventory to just-in-case. And so the resiliency of the supply chain, a lot of that is assurance of supply. So we do see perhaps shift and opportunity for us as OEMs want to make sure they've got enough components, especially the critical components, but they never get caught in this environment. Again, and the example uses a $2 chip was holding up a $70,000 luxury vehicle, right? You can't let that happen again. If you're an auto OEM and so there's opportunity into the future about strategic inventory holes and things of that nature that we see on the horizon as soon as the environment kind of normalizes and you have available components.

Last comment on that is the stickiness is what these -- just for the audience, when you go in and redesign and rearchitect someone's supply chain, you're not doing that 30, 60 days. And it's a concerted effort on both ends. There's a lot of challenges to that. Some of them take up -- or the one I'm thinking about, it's going 18 months. It's still not done yet because they've got a lot of change on the customer side as much as we do. So there [indiscernible] you're integrated. So yes, it is long term.

Great. So that concept of value kind of leads me into my next question about the competitive dynamics. So I recently got to take a tour of one of their distribution centers out in Arizona. I was pretty much -- I was impressed with the level of automation that they've got going on there. Where are some of the areas that you think Avnet has a competitive advantage? Maybe automation is one of those geographic footprint, line cards?

Well, first of all, thanks for coming in to see us. You've been in before, but not in the logistics center, and I'd offer that invite to any investor or potential investor or analyst because you have this perception of what we do. We buy a lot, and we break it in smaller volume and we ship it in. It's a lot more than that. Probably, 70-plus percent of everything we ship out of any one of our distribution centers, we're doing something to that part either tape and reeling it, customizing the part number, label, programming it, kitting it, something along those lines. So we're very excited and proud of -- and that's our McKamie facility. We call this one -- we moved the channel in Arizona in 1987, I believe. Some of the other differentiators -- we think that is a differentiator in our quality and on-time delivery out of logistics centers. And sticking with that, one of the big values we bring you saw it, it was our programming centers. People are like, look, programming centers. What do you -- well, a lot of the chips have software on them, right? And the OEM -- the customer has custom software might go into whatever the RAM might be or the controller. Well, we can qualify that. Let's say it's here in Florida, the customers say, "Hey, I need to change my software on this chip." We can qualify it here and have it in production in Singapore. So our programming centers are all connected on a global basis, and that's a big, big deal for some of the large OEMs that we do business because they're constantly changing the software. We need to verify it when we get into production, it can be the same day. So that's one, working from the logistics center. As I said earlier, we're shipping in 140-plus different countries. So that in and of itself is scale and size and flexibility and resiliency and adaptability and a lot of others cannot offer. We've been making tremendous investments in digital. I mean we have to drive more productivity and efficiency, and customers want to get connected digitally. So in the supply chain side of the equation, for example, we built out what we call control tower. Our suppliers like it as much as our customers because it gives everybody visibility and transparency in where the parts are, which in this past 2.5 years was a big deal because people don't know they're shipping the parts in, where are they going? Are they getting to the end customer demand. So digital, in general. We continue to talk about demand creation. I mean demand creation is 32%, 32% of our business. This is where we have our 2,000-plus engineers, 600 software enhanced -- actually doing design, working with our suppliers to get the products designed in to the end customer. Suppliers are leaning in on that. We give them the scale and the reach that they just don't get on their own. IP&E, it's Interconnect, Passives & Electromechanical. We have about a $4 billion business globally in Interconnect, Passives & Electromechanical. We're doubling down on that. And then the other big differentiator is Farnell, okay? Farnell, it's another division inside of Avnet. We operate, I call it, the front end different. So speed and convenience. Engine is -- their big customer base is engineering, new product introduction. They want to buy their kit of parts, and they want it tomorrow or 2 days guaranteed, and they'll pay extra for that. No different than us stopping the way home and get it -- fill up the tank and go on to convenience store and get one coke instead of going to a grocery store to buy a case of coke. You only want one, you're going to pay a little bit more for it. It goes into convenience. So that's a big part of their business. Their margins are 2x ours. And they also have, in Farnell, what we call maintenance repair MRO, which is a great business. It's a little outside the semi and components, but it's everything around an engineering workstation. And then we have lines like National Instruments that sell through Farnell so really diversification model there, and we're very excited about it.

Good. So that kind of leads me into your path. You've set a target for a 5% to 8% revenue CAGR. That's certainly above what we traditionally think of as kind of a growth CAGR for analog semis. And then operating margin above 5% consistently. Can you discuss the path to that? I think Farnell is clearly a piece of that. The value-add, the demand creation is certainly a piece of that.

Yes. So let me -- I'll touch on the revenue and I'll let Ken touch on the operating leverage and margin opportunity that we've been on a good progression here in the last couple of years. Maybe if you just look at the secular trends that we talked about a little bit earlier around growth, and we don't have the exact banger here exactly what the market is going to grow. But if you just look at the proliferation of electronics, again, we look at the share that we have today and the share gains we made, and we think there's more to go. On top of the vertical growth and I'm going to be repetitive here, transportation, automotive. I mean, following the holidays, you see e-bikes everywhere. Every power tool, okay? It's not -- if it's gas powered today, it won't be in 3 years, okay? All that is battery, including jack hammers, by the way. A huge customer segment for us. The electric vehicle, right, was not just electric vehicle, so ecosystem around electric vehicles. So, you've got charging stations, batteries, again, falls right into -- and the more that business grows, the longer tail of customers comes into play for us. I mentioned defense, aero earlier, and that's going to continue to grow. Medical -- if you've been to the doctors, hopefully not, you can't walk in without seeing nothing but electronics. So that's a great -- again, a great segment for us. So yes -- and I talked a little bit about the consumer PC being down a little bit. What we're talking about market, that's kind of soft. It's not gone, by the way. Well, that's going to flip back, right? So yes, we're bullish on that, call it, 2, 3, 4, 5-year outlook. In 5G, I'm not an expert on all this, but that's in its infancy. The application of 5G, it's still has barely hit really, to be honest with you. So yes, I'm very excited about the market opportunity, our position in the market, our execution and the opportunity for growth.

I want to hit on the -- I think talked about the revenue growth, but I think from a just a pure gross margin perspective, we feel pretty good about a stable gross margin profile. And what that means really is some competitive pressure. There's always going to be customer and competitive pressures on our margins, but we've got a lot of high-margin opportunities. Farnell being the highest, but the IP&E business, the demand creation of more supply chain services, those are all higher gross margin type of sales that can help offset just normal competitive pressures that we've always dealt with. And then really the most important thing from our standpoint is, the last couple of years, we've demonstrated we've been able to grow our sales while still investing in our business, right? So we've controlled the OpEx, but what it really is, is taking pockets of inefficiencies in our OpEx and putting into those areas that add more efficiencies. So whether that's warehouse capacity, digital tool to help make our team more effective and really just frontline resources, sales, FAEs, things that are really going to help enable that growth. And that's kind of how we're focused on expense. We're not looking to take expense out, but we are looking to find pockets of inefficiency and reinvest it in the business, and really get that operating leverage by growing the topline without adding significant costs because we're getting more efficient in getting that productivity. And that's really the path, and we've got now to 4.5% this last quarter. And we see that growth potential there, especially in the markets that we serve well. So.

You can definitely see that in your margin profile over the past couple of years. It's been very impressive. So on pricing, this is kind of a subject that we talk about up and down the semi supply chain. So a significant kind of unprecedented price increases when supply was the tightest. As supply of some of the components is starting to ease, have you seen any change in pricing behavior? Has pricing started to normalize yet?

That's a really good question, and -- because you would think when you start to hear lead times coming down or product's more available, it becomes -- the average selling price becomes a bit more deflationary. We're not really seeing that right now. Now as a matter of fact, most -- in January even amongst all these run wings of lead times come in, we had 22 different suppliers raise prices again.

Wow.

All right. So now there's a little fatigue out there from the customers, as you can imagine. So that's still happening while you're talking about lead times coming. So it's kind of -- to answer your question, so certain technologies, they're not coming down, all right? Others, standard products, multisource products, the market always will adjust based on the competitiveness of the market. And my feeling -- who knows if I'm exactly right here, but my take is that on high -- where there's been major CapEx investment in some of the higher-end technology products, you can determine what the high-end controllers, FPGA, whatnot. I don't think we're going to see the traditional ASP deflation this time. And historically, good Moore's Law, the price come back down. I don't think in that portion of portfolio, we're going to see much deflation or ASP erosion we'll see if the market will determine that, but right now -- and in our case, and we talked about this on previous earnings calls, if we grew 21%, ASP inflation was maybe 7% or 25% or 30% of that. So the rest was more just unit inorganic growth. So it wasn't as big a number as a lot of people want to think it was.

There has some -- there has been some concern that the suppliers have actually been over earning through the pandemic, just kind of taking price where they could when demand was strong. How does that level of inflationary pricing -- I think there's probably some concern that you and some of your competitors have been over earning as well. But maybe if you can just touch on how that pricing impact your profitability, your returns, how it flows through the P&L would be helpful.

Yes. So I let you ask the suppliers about that overall. We love our suppliers. And an interesting part, there's every supplier kind of handles it a little bit different. And it's not every supplier across the board, all the technologies prices have raise. There might have been certain pieces of their technology or of their portfolio. So I can tell you how we handled it, where we got price increases. And this might be different versus 25, 30 years ago where we maybe would be -- and we could be criticized. Maybe weren't -- we could have been maybe more opportunistic in the marketplace and taking advantage of price increases, and really, we don't do that. About 20 -- roughly 20%, 25% of our business is what we call time-place utility cook, book, ship, bill. The balance is under contract of some sort. We're doing some value add for the customer. So it's a much longer term engagements. So -- and we've been very transparent. So where we got a price increase, let's say, it was like $0.10 or 10%, okay? We pass on try to quickly as we could pass on 10%. we didn't pass on 20%. We didn't take that allocated product selling into the gray market or somewhere to go make 40% margin. It's just not what we do. So where we might have gotten a benefit in resale and which I just talked about or in gross profit dollars, we didn't get a big lift. We got a question from one visitors earlier, why don't your margins go up? because we're not really gouging on margins. We've got the drop-through on the volume and our operating margin leverage, but that's how we handle it. So on the downside, there is reduction should impact our margin as much either, but we'll see. But that's how we hand it.

Excellent. We're quickly going through time here. I just want to open it up. Are there any questions in the audience? Eric?

Yes, I wanted to ask Phil on transport. So you hit on it a little bit that there was a big debate, if people talk a lot about auto units and [indiscernible] rebuilding what we need in the lots and everything and kind of [indiscernible] refill that and we'll go back to brokerage where we were. You had maybe the more overly bullish view of it that we have a whole eco system to build out. Maybe a little more color on that as you see it because we don't have that visibility.

Yes. So -- and maybe I'm overly bullish. I don't think I am. So one -- 10, 15 years ago, I'm talking about from an Avnet standpoint, we weren't playing much in that space. So to us, that's kind of like a new market for us anyway. Other than in Europe, Germany specifically, we had a division called EBV, -- they're still there. They've been doing a lot with the automotive for a long time. But we really -- we were doing some fulfillment in that space only for some of the large Tier 1s. Now with the -- again, with the technology change, not just in EV, but driver assistance, the mirrors and we go to entertainment systems around all of that, that tail is just growing. So it's become more of a served market for us that we weren't playing in as much. So that alone is why I'm a little bit more bullish on that space because it's kind of a new market for us. I mean here in the Americas alone, we got 400, 500-plus customers in that space that weren't there 5, 7, 10 years or were just start-ups, 5, 7, 10 years ago. So that's why I'm a little bit more bullish. And then, of course, the content particularly in electric vehicle way up. But even the content and combustion, the content is still going up. So although the units might come down, I still believe there's a tremendous opportunity for Avnet, not just from fulfillment. We're still doing that, and that's growing, by the way, because of the supply chain breakdowns. And what Ken talked about with everybody got a little too lean, I mean why are we so lean when there's -- at the time, there was effectively 0 interest. So I think they got 2c, which is bringing them back into our space and an opportunity. So that's why I feel good -- and keep in mind, umbrella that with transportation. We're in Florida, right? Golf carts like he mentioned in e-bikes, dump trucks, trains, they all are just chuck full of electronics and going to be even more as we move forward. And then you got the charging that ecosystem, charging stations. So I just think it's a tremendous opportunity for us.

And I would just add. We feel pretty good about no suppliers represents more than 10% of our business. No customer represents more than 5% of our business. I feel pretty well diversified there and not overly concentrated in one particular supplier partner, but we still have a great line card that covers all the technology needs of the Board.

Interested in your thoughts on the 3 years or more on the biggest semi conductors in the world to take a very different view of how they want to use distribution in a more direct. And how they have more exposure in industrial [indiscernible] hindsight, what do we learn from that very much a single example?

Yes. So I won't talk about them too much. We -- it's a great question. I'm glad you asked it because we get this a lot, not as much as we used to. I would just say that our -- the balance of our suppliers, which we have great relationships with, and I'm not going to start naming because I missed somebody and I'll get a call. But we're #1 or 2 of every one of them globally. And they're actually leaning more into the channel. They're leaning more into distribution for customer expansion, demand creation. We don't meet with any of these top suppliers, many of them are here. First thing we talk about is what's your registrations, what's your demand creation, what's your customer expansion, okay? Because we build out that scale. I can't comment on why they did what they want at one time they were one of the top distribution lines. But they went a different route. They also didn't do it overnight. It was decades in the build, and they made some huge acquisitions to give them that size and scale. I could just say that today, we have we -- our analog number today is larger than it was 3 years ago, 3.5 years ago in total. And the benefactors were these other lines, we've got a little piece from this one, a little piece from this. And we've grown share. It's pretty public right now, not just with our suppliers but inside our customers. So I think with suppliers and this, I would say, and supplier what the industry has failed to consider is the customer impact. customers like to have options. And customers don't like to be told, oh, you can't deal with it because we've been a benefactor of it, right? I mean so sometimes you win, sometimes you lose. They don't like to be told that, right? So we didn't change any of our team's comp plans. We say, "Hey, go get the business. And customers will then internally shift business because they don't like to have things out of balance. So can't come, we'll see how it plays out in the end. We're really confident, never overcomfortable, but we're confident in our execution and our supplier partnerships right now and that we have a point of opportunity for continued growth and don't see anything on the horizon to see another one of those happen.

And I would just add, we feel pretty good about no suppliers represents more than 10% of our business. No customer represents more than 5% of our business feel pretty well diversified there and not overly concentrated in one particular supplier partner, but we still have a great line card that covers all the technology needs of the Board.

Good question. Thanks for asking that.

We've got just a few minutes left. I want to be sure to touch on capital allocation. So you've been -- your cash generation -- yes, Ken. Your cash generation has been pretty consistently improving. What are the priorities for cash? Like how do you decide to balance between buybacks, dividends, other potential opportunities?

Yes. I mean in the recent quarters, we've been consuming a lot of cash because we have to invest in the business on the working capital. So our main priority is to make sure the business has what it needs to continue to grow into the future. So not only is that working capital, but also things like warehouse capacity, digital tools and IT systems to help make us more efficient. so we are continuing to want to invest in both near-term needs for working capital as well as long-term needs in terms of internal investments. Absent that, we have a consistent dividend that we've consistently grown over the years. So we're committed to that. I think buybacks are attractive to us because of the fact we feel our shares are undervalued. We're still trading below book value, even though the shares have held up over the past year. We still feel there's credit we're not getting there, and so buybacks are attractive. And I think maybe less priority would be M&A more tuck-in, adding certain markets or certain kind of product lines, but nothing of any magnitude there. So I think right now, the buybacks look more attractive than any M&A because of the fact that M&A is still expensive or at least the expectations are still expensive. And we -- our share's being undervalued. So that's kind of the pecking order.

Okay. How has the current environment impacted your long-term planning in terms of capacity or geographic distribution. We hear a lot about on-shoring, near-shoring. You already have a pretty extensive global footprint. But has this changed how you're looking at your longer-term planning?

We're always looking at the footprint, okay, logistics footprint. We're doing that as we speak, and that's also for reasons of risk, right, which regions might have more risk than others and where are we located. We want to make sure we can hedge that if we need to. It's probably more of an Asia statement on, Melissa. No, we're really comfortable with where we are. I mean, we are -- and you're right, you got customers come in from Asia back to Guad or Asia back to the U.S. or in Eastern Europe. We just go wherever they need to go. So agility is key. Resilience is key, and we have a dedicated team that works with the customers on these different transitions. So we think our footprint is great right now. As Ken mentioned, we're continuing to invest in Europe because we see tremendous growth there with some new -- a new mega setup there in Germany. And so we feel now, we feel very comfortable with where we are right now. We can move anywhere the customer needs us to go.

Excellent. Excellent. I think that does it for us today. We do have a breakout session downstairs.