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

Welcome back, everyone. This is Melissa Fairbanks IT supply chain and analog semiconductor analyst here at Raymond James. Right now, we've got Avnet joining us. We -- the team from Avnet. We've got CEO, Phil, CFO, Ken, and then also Joe Burke is joining us in the back of the room. So I think we'll just get it kicked off and welcome. Thanks for participating again. We always enjoy having you here. I think, unless you wanted to say some opening.

Thanks for having us. We really appreciate the invite. Appreciate you being here. I appreciate everyone's interest.

Maybe just a quick review of the September quarter results, December quarter outlook.

Sure. Well, we run fiscal year provided June. I think that's important to note. And had to throw in that we had a record-breaking June fiscal '23 on many fronts, including going north of $8 EPS from a few dollars on a couple of years ago. So building off that momentum, we're really, really thrilled. We closed out September quarter around $6.3 billion, which was ahead of guidance, okay? And down roughly 6.1% year-on-year. EMEA, just to give you a regional breakout. Europe was up 8.3% year-on-year. The Americas was up 6.5% year-on-year. And Asia was down about 16% year-on-year, which is typical for what we've seen in Asia and still we're able to grow some share. Earnings per share adjusted were $1.61, well exceeding guidance and consensus -- so overall, September hit our expectations. I'll let Ken comment here in a second. As far as December outlook, kind of gave that outlook in our last earnings call, not much to update at this point in time. Ken anything...

I had to try.

Yes, I know you. So -- we're sticking to it.

Sounds good.

I mean I would just say that gross margins are holding up pretty well. We have our operating expenses well under control, but the area that we have still some work to do is on the working capital side, the inventory side, in particular, higher than we'd like it to be. We think it's stable in terms of flattish or we think we have it under control, but it's going to take a few quarters to kind of get through the inventory and to lead that to cash flow generation, which we're disappointed in, but I think that's the priority by Phil and the team of getting through the inventory and making sure we generate the cash we should with those sales declines.

Okay. We'll definitely get into the cash return and capital allocation later. But I just want to dig in on some of the geographic trends, your year-over-year trends in EMEA have been relatively strong for a while. But you've had several straight quarters of year-on-year declines in Asia. In EMEA, it almost seems as though you're outperforming some of your suppliers. Is that just reflective of the easing supply you're able to actually ship more through? Or is there something else going on...

Yes, Europe has been amazing for us. I'd say at because we have a great team in Europe because it's a very experienced team, and it does matter -- leadership matters. And we've been very consistent -- in Europe, it's been our top-performing region now for many years, no different than this past year. And it's interesting, Melissa, when you go back a year or so ago, and that's less all that's going on in Europe between the wars and the energy crisis, and we're all aware of that. We frankly expected Europe to kind of soften up a little bit. And it didn't. We ended up June a year ago, with the record number in September. I just followed with 3 quarters in a row of record top line and bottom line performance in Europe, what's happening. It's just -- it's a very resilient market. We have gained share. So yes, to part of your question, Europe is just a very -- the industrial tail of customers in Europe, this is really, really long, even larger than the Americas. And of course, you got the automotive as well. But yes, just it's been very good for us. You mentioned Asia Pac, that's -- that's Asia Pac. And we're not over -- I mean, everybody -- we're not overweighted to China with Asia. I think that's important for the investors to know. I mean, China in total for Avnet Inc. is less than 10% of our business, right? So it affects us in Asia, it's 25% of Asia roughly, give or take. But we're not overweighted. We think -- and we gained share in Asia and that's, again, public information. And Prince Yun and Asia Pac, actually who's our leader again, another experience leader really feels we're bumping along the bottom in Asia. You're going to start seeing Asia start to come back a bit. Not overly bullish I'm not bullish or bearish on anything right now, but some good optimism that Asia Pac might be through the worst of it. And we had good success in Japan as well.

Great. Great. I think this will kind of lead into a discussion on pricing. It's been a little bit surprising even as the shortages have kind of eased. Pricing seems to be holding in fairly well. How much of that do you believe is structural. We've heard kind of from the supplier side of things that they expect us to be relatively permanent. But are you seeing any signs of customer interest in maybe returning to normalized pricing where we get a few percentage points of decline each year?

Well, the customers are always interested.

Yes, of course. I guess that -- it was not a...

We love our customers. yes, so we saw the pricing inflation in the last several years. And you're right, typically, and I've been with Avnet for -- well, it's 42 years now. And typically slightly start to the average selling prices that you see the deflationary effect. Now in standard products, multisource products, you're going to see that. Portfolios up and down. But in the product you're referring to the higher end, typically the higher end, we're not seeing much inflation, if at all. And the input costs are started coming down. labor, inflation, zinc, silver, gold, I mean, all the ingredients, if you will, to go in, they're not coming down. So if they're not coming down, I don't believe we're going to see the pricing deflation that we typically have seen in the past.

It seems like we've certainly gotten beyond any risk of a major price correction because we're now a few quarters into moderating demand, a little bit of a downturn and still haven't seen that collapse.

That's my sense. Again, look, I could be wrong. We will find out soon. We're just not getting that type of pressure. And actually, there's a few suppliers that are still talking about raising prices not like it was a couple of years ago, every day, there's 25 or 30 more suppliers raising prices. So I think it's, for the most part, is stabilized.

Okay. In Asia, there have been some reports that maybe a little bit more aggressive pricing in China in particular. Does your mix kind of help insulate you from that? Or are you seeing that?

I don't think we're seeing anything out of China -- that's unusual. I mean I think you got the indigenous Chinese are building up their capacity and their capabilities. So there's no question the Western suppliers, probably even more so the U.S.-based suppliers are feeling some of that concern. But I wouldn't say it's anything too out of the ordinary at this point in time. Okay. We'll see though, that's going to be very dynamic as things move on with China.

Sure. So maybe moving on to inventories. I don't know if Ken, you want to address that. So we did see the inventories well, this might be a go on for Phil too. We saw your inventories rise at the end of last quarter. That was an opportunistic investment. You had signaled it well ahead of the -- with the 3Q guide that this is what you had planned. Maybe discuss your expectations for your own inventory levels going forward, if the industry correction is expected to last through midyear '24 and don't worry, I'm not going to ask you when you think it lasts through. How does this impact your balance sheet management?

I mean, I'll start by saying what we try to do is isolate the broad businesses inventory, right, the EC businesses inventory, whichever one is concerns about or reading into it and the word we'd like to describe it as a stable or stabilizing -- what that means is a tighter to work it down a Part of that is our customers working it down so we can replenish Part of it is suppliers giving more flexibility, which they are doing in terms of the inputs of inventory coming in. So it's definitely higher than we like it to be. There's definitely cash kind of trapped on the balance sheet because of that, but we do feel good about -- we've got the right controls in place. We've got the team working on it. It's our #1 priority is getting inventory levels corrected, generating that cash that we should at this point in the cycle when the sales are down, typically, we'd have more free cash flow generation, but we think we have line of sight to it, just a matter of continuing to kind of stay the course and work through it. And we want to make sure we work through in a manner that we're ready to capitalize when the market returns to growth by being flexible, but also firm with customers in terms of what we need to do.

Yes, I'll just add to that, and. I think -- and we're fine with -- we said that publicly, too. We believe we're going to bunking the bottom in somewhere around mid-2024 start to see more relief and some further growth. This is really a complex one because it's part of the role we play in the supply chain, right? And we deal with 1 million customers, and you got all the household names that everyone in here would know then you got to do the long tail of customers to hope not know. And we've got to work with them. I mean we can jam them on the inventory, and then they're just not going to pay us. Order going to go out of business or what have you. So part of our job is to work with these customers. And that's just what we're doing. It's not -- there's no EDI button or e-commerce went to say just go take care of it's kind of a hand-to-hand combusting ground, you got to go call to customer negotiating right now, they're looking for more cash on the balance sheet and it's actually a good margin play for us but it's an ongoing battle.

Last week, you -- I thought you had an interesting comment at a different presentation that you said distributors act as a shock absorber for the industry. And I think that was just a really good characterization of -- in the past, that's definitely been the case, but the cycle has certainly been a little bit more unusual.

Yes, it has been. And I have used that word a lot because that is what we are. For our suppliers upstream, our customers downstream, we're that guide in the middle. In normal times, our backlog adjust 25% a day. In normal times, our inventory we just -- we're booking canceling, pushing out, pulling in roughly 25% -- that's a lot of backlog to be managed, but that's what we do. And we access a shock absorber and part bank. And we just need to get paid for the interest and we need to get a fair interest for that return. Yes. And I remind our suppliers that -- and for many of you out there why we are so valued with the suppliers. Well, we handle, I said, millions of customers, some are strong balance sheets, some aren't. Well, we're at the bank, our spires getting paid in 30, 40 days. Okay. Then we go and extend the credit beyond that. So the value proposition is reliable well, but that's what we've been since for 12 years.

I think...

I would just say one area we did talk about in our earnings call was we do see growth coming in Supply Chain as a service, which is where we kind of step in and help provide supply chain, logistics and storage and all kinds of forecasting for big OEMs that are -- have a direct relationship, you typical with the suppliers, and we're stepping in to help them get product where they need to be as kind of a service, but sometimes that comes with some working capital, a lot of times that working capital is kind of cash flow neutral. It doesn't necessarily drag on cash flow, but it might optically show an increase in inventory. So we're going to continue to kind of try to give some transparency on that particular opportunity, which we view as distinct and separate from, let's say, the rest of the business, the rest of the inventory, less risk on the inventory and some of those things, but it's definitely where we see opportunity for growth in terms of some of these long-term OEMs are really trying to redesign their supply chains, make a more resilient supply chain. What we like to use as an example is you have a $2 microcontroller, holding up $100,000 luxury vehicle, the automakers aren't going to let that happen again. And so therefore, they need to redesign their supply chains to make sure they have stock in the right place to be able to weather hurricanes, typhoons and those kind of things. And so we see some strategic builds there in terms of the supply chain services starting to grow a little bit of ramp, even though we've been working on them for the past years, they're starting to finally get some fruition there. All those there's still a long tail for those to really grow to be meaningful, but you start to see some of that come in this quarter or next.

And I assume a lot of that is margin accretive because you're creating more valuable -- value for your suppliers and your customers. Maybe now we can start talking about some other margin accretive opportunities. So I had the benefit of being able to tour one of your facilities in Arizona, and I got to see the programming business. I think this is something that you don't -- on earnings calls, certainly, you don't get a chance to talk about it very often. But it does kind of seem like an exciting opportunity, a little bit differentiated from your traditional fulfillment business.

Yes. So thanks for bringing that up. By the way, we welcome anybody to come to Chandler Arizona[indiscernible] so facilities. I mean I think a lot of the times there's a misperception -- we're just buy a bunch of big boxes, put them in a smaller boxes and how they go. And over 70% of every line item we ship around the world, we're doing something to it, value-add services of some sort. A big one is programming to your point, Melissa. So for us I don't know we sell chips as everyone knows, right? And many of those chips like controllers have memory on them and for software, okay? So the chip doesn't do a thing without the software, right? So we've been doing programming services for years now where we actually load the software in a chip and then ship it. Oftentimes, we'll relabel that chip as well, whatever the customer wants is what we do, that's fine. So we have programming centers, multiple in the U.S., in Guadalajara, Singapore, Hong Kong, and you can prototype, a customer can prototype than test a software in Boston. Okay, and have it shipped in production in Singapore or Taiwan, okay? So that's the kind of capabilities we have. And we're programming tens of millions of units a year, let alone -- it's hundreds of millions a year. And there are some household names that you all know and are using now or on your wrist or what have you, we're programming for many, many large OEMs and it's a great business. It's sticky, okay? It's value-added services, so you get additional margin. but it's a great business. I should bring it up.

Sure. Maybe some other opportunities. We hear a lot about demand creation, design services, maybe some upfront engineering opportunities.

Yes. So really good point. So let's start with demand creation and demand creation for those demos. We have roughly 2,000 EE field application engineers around the world. And we influence design. So we'll influence microcontroller designs, FPGA designs, power designs and more and more customers want solutions as well. And we do that on behalf of our suppliers or with our suppliers. And again, stickiness because once you have that design win, no matter where that ships around the world as things are moving around the world, we're protected on that. And on average, we get 400 basis points more margin, okay, when we have the design on the chip. So we get that from a supplier. And in total, it's between 30% and 33% of our total revenue is tied to a registration and demand creation. So that's really key and critical which is why we pretty much report on that almost every earnings call. If not, we certainly get a question. Tied to that is design services, and they got more and more customers now actually outsourcing their total design or pieces of their design. They got the core engineers working on this, and there's other projects that just aren't enough engineers out there, they'll outsource to an Avnet. We have our -- which we get you to Europe, our Avnet Embedded business, okay, we actually do full turnkey designs, including monitors for medical applications, the monitors you see going through airport security. You can see the security, the TSA look at them. We actually -- many of those customers, we manufacture those with that screen, okay, ship it as a turnkey product. So it's a turnkey design services. And then we also do reference designs. So we've been doing that for years. Many of the reference design you see sold out there one might be for a large FPGA company at Santa Clara or now Austin. We're doing a lot of those, okay? And we're not only designing them, but we're manufacturing them and then selling them online. And another big area that we've focused on is in IP&E, Interconnect, Passives & Electromechanical. It is big [indiscernible] billion business. Yes, we're known in semiconductors, we love semiconductors. But 85% of the Board, 85% is IP&E, Interconnect, Passives & Electromechanical products and under 15% of the value of the Board. But they, again, on average, are 400 basis points higher margin in IP&E. So we've got to make sure our teams we're going in and selling the FPGA with the controller and the power and the analog. You can't -- your phone won't work without capacitors. If you can't connect it, it's not going to charge. So every one of those applications has an opportunity for IP&E. So there's just a couple off the top of where we're in continue to diversify our portfolio.

So you've kind of laid out at your last analyst meeting, how all of these things kind of combine toward driving towards your margin target. So maybe this is now a good time to talk about margin targets, how far you're there? You've had a really good improvement in the Americas business in addition to growth in some of these other margin accretive areas. How much going forward is going to be driven by growth in some of these newer -- not newer, but value-added services versus just traditional cycle, traditional mix dynamics.

Yes, I think it's always tough to tell a couple of years out. But what I would say is I think there's enough higher-margin opportunities to offset where we have pressures on when we're talking about the gross margin level. Because, say, there's going to be competitive pressures you talked about just overall ASP, we believe they're going to be pretty stable. But hey, there's tough competition. We've got several competitors out there that want to win business from us. So there's always going to be some level of competition. And we've seen that over time, but we also have higher margin opportunities to kind of help offset that and kind of keep it stable. So clearly, we're trying to drive to an improved gross margin with some of these mix opportunities. But even if we kind of keep it stable which is part of it, we can still with modest growth, expand operating margin. You saw that over the past several years with decent high single digits on average growth and really able to expand the operating margin, expand the EPS. Phil talked about the model for us as a value-added distributor to scale. So the more scale we can get, the more business we can win, we can leverage that with our overall infrastructure, and we're continuing to invest in digital tools and capabilities that make us more efficient and make it so for every dollar of new sales growth, we get, we don't have to invest necessarily $0.20 of OpEx. We can get that more optimized. And we're making some long-term investments as well. One of our drags on cash has been our CapEx has been higher than normal. We're building a new warehouse in Europe that's going to set us up for the next 20 years. And allow us to continue to grow there, but we're getting out in front of that. So it's ready to go by the time the growth comes. So we're excited about some of those long-term investments because we do believe the future is bright. And with that modest single-digit type of sales growth, we can definitely create more leverage and get to $28 billion and $30 billion and so on. And we think we've got the right long card and the right partners do it with.

Yes, we're just at that facility in Bremberg, right?

Yes.

And it's the single largest investment Avnet, Inc. ever made in the company.

I understand it's got the most automation as well.

It's phenomenal. It's exciting I'm probably not going to be here in 25 years but that warehouse will be. So it gives us that growth for the future in Europe and beyond our because they ship out globally out there as well.

Sure. Is that facility addressing specific end market verticals? Or is it just all broad-based?

It's broad based. It's broad-based. It's -- we have Tangerine still in pulling was outside of Munich, and this is just added capacity. But it will have programming centers -- a lot of them.

Excellent. I hope to visit that one too. So is it -- Ken, maybe for you, is it safe to say -- well, actually, both of you, is it safe to say that the industry is just generally more rational in terms of behavior. Historically, we've always thought about it as just being extremely price competitive, extremely price aggressive. But you are seeing this kind of differentiation where different distributors are investing in different types of value-added services. Is that a way of maybe kind of insulating against just returning to this cutthroat pricing environment?

I think it's fair. I think our supplier partners are very aware of what excess inventory potentially does the pricing. And I think they're been very good at working with us to try to help curb the inflow coming in at the same time. If they build something that we ordered, right, they expect us to take it. So I think there's lots of dynamics between the supplier and the customer that we're going through, but I think we're working through it better than we did last time around, more enlightened more understanding the long-term implications. And I do think the silver lining for us is we've always been a leader in supply chain and supply chain capabilities. And what we're seeing now is not only customers wanting to engage us for that, but suppliers understanding that this is not what we do, right? We design technology, we build it. We don't want thousands of customers and have to ship at all these locations, let's let Avnet do what they do best. So we're seeing a lot of opportunities coming out of this. And suppliers are helping us with those opportunities because they know that's not their expertise. People are focusing on their core capabilities and which we continue to do, and we think there's a lot of growth and opportunities for more operating income dollars in the space we're in, and I think we're well positioned to capitalize on that.

Yes. Melissa, I think it's a great question. I haven't been asked that. I think it has and generally got a little bit more rational. I think there's always look, it's a competitive market, there's always going to be competition. And there's always going to be some disagreements. But I think there's much more alignment and understanding it, particularly through this last crunch. This was a tough one, right? And it was different than anything I've been through before because it was so broad-based and so fast that look I felt the customers for the most part were pretty rational as well. And you understand when they're not. They got lines down, they can't ship. I was Chief Expedite Officer for a while, right? I mean that's what we do. But we love our supplier. Our supplier partners have been terrific. We don't have any one. It's important for investors to know about 1 supplier or a customer or greater than 10%, 11% of our business. So we're not overweighted saving on the vertical side. But the suppliers, I would say there's always a few there -- here and there, but for the most part, been much more rational. They're not just ship the stuff into the channel. I mean, it's not happening. You're right, many moons ago, that was happening, and I feel there's much more alignment.

Yes. I think there . And I think it's been encouraging to see not only has that not happened but also, we're seeing your margin levels, your peers margin levels stay at least even though we've seen some compression, it's at least above.

Yes, it takes several quarters to burn it off, okay. In order to get -- have that -- see that thing start to come down and as Ken explained, some of the timing issues, the core, especially going to stabilize. [Audio Gap]

The customers demand especially in the industrial space and the transportation seems to be holding up pretty well, which is a little unique this time around than others, which was really focused on broad-based demand falling off. pockets, Phil mentioned China. We've seen consumers, some of those things are following up with some of the key markets that we serve that have the most potential for us in the future. are still holding up pretty well in terms of demand, although customers are challenged with...

Finally get to this more normalized kind of cyclical behavior. We get some of the working capital release. Maybe discuss balance between CapEx investment, buybacks, bringing down some of the revolving debt and reducing some of that interest expense.

Yes. I think the priority will continue to be investing in the business and investing for future growth, but we think that once this warehouse is done, gets back to a more normalized level, let's call it, between $100 million to $120 million a year. And then the cash flow we generate or the free cash flow we generate. Think about it as some the debt buy down. We want to keep our leverage in order. We want to get that interest expense down. It's definitely through the roof right now, but also we see our shares as a really great opportunity, trading at 10% plus below book value. So we want to continue to buy back. We were in the market here this past quarter. And when we get back to free cash flow generation, we'll be buying back shares, and we'll continue to give the dividend, and we've had a steadily growing dividend, and we think that's meaningful, so we'll continue to prioritize that. But that will be the stacking ranking order, and we think there will be cash flow to invest in all those priorities.

Okay. Just about a minute left. Any closing remarks?

Yes. Well, thanks for the time. I appreciate the time. I appreciate all the investors and analysts here today. Look, I mean, as I said, it's going to be a bumpy road for the next several quarters, 2, 3 whatever that number is. But boy is our future bright, no pun intended with LEDs and everything. And we just walk around the city here, right? But it really is the applications for technology. I mean it's just everywhere, right? And that wasn't the case in 2000, 2001 when we had a tough adjustment in the market for those that might have been around or the financial crisis '08, '09, this just feels totally different. . And that's what I think everybody struggled with it's -- the mixed signals are so different this time with so many different markets and applications. I think it's where it's getting tougher for people to call it. Right? So -- but no, we're positioned well. We're very excited about the future. We've got a great team. We're just going to continue to focus on our execution.

All right. Great. Thanks very much, guys.