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

Good afternoon, everyone. Welcome to Oppenheimer's 27th Annual Technology Internet and Communications Conference. Very pleased to welcome our next presentation from Avnet. We have Ken Jacobson, the CFO; and Joe Burke, the VP of Treasury and Investor Relations. [Operator Instructions] So without any further delay, Joe, I'll turn it to you to begin. Thank you.

All right. Thank you, Charles, and good day, everyone. My name is Joe Burke, as Charles mentioned, and we're going to take you through some slides today. Some of those will be in intro to Avnet, but we'll also get further into current events and financials and whatnot. Before we do, just want to pause here at the safe harbor statement that you'll see on the screen. Some of the things that we'll be talking today contain forward-looking statements that contain, there are some risks, uncertainties and assumptions that are difficult to predict and these forward-looking statements that we have today are not the guarantee of performance, and for certain of the factors that could cause differences in the risks that you see and the statements that you see in the results, please refer to our Form 10-Q and 10-K on file on our website with the SEC and we will launch in. I would also mention that there will be a GAAP to non-GAAP reconciliation for some of the figures that we'll be mentioning in the presentation today. So let's start. Taking a look at Avnet, just as in general, Avnet is a leading global technology distributor and solutions company that supports customers at every stage of the product life cycle. From idea to design and from prototype to production. We have a unique position at the center of the technology supply chain that enables us to accelerate the design and supply stages of our customers so they can realize their revenue faster. We can help our customers navigate challenges anywhere around the world and help them get their products to market in complex markets. Some fun facts about Avnet. We were founded in 1921 in New York City. We've been in business for over 100 years. and we're headquartered today in Phoenix, Arizona, and we employ over 15,000 employees around the globe. Looking at us by the numbers, you can just see that we're supported by, again, the 15,000 employees, but 1,925 engineers around the world. We have well over 1 million customers served by Avnet and our operating group Farnell. And we are well positioned around the globe with a great global footprint of over 250 locations, administrative as well as operational locations around the world. And for fiscal year '24, you can see the revenues that we just closed and reported last week at $23.8 billion. Some of the key investment highlights that we'll be talking about today is about our position as a leader in the value-added components, distribution, supply chain with a growing digital footprint. We have a long history of working with market trends, ups and downs. But what we do have is we've been riding the electronic cycles up and down, as I mentioned, and we're very optimistic about the proliferation of electronics in the future. We have a great scale and scope to provide end-to-end offerings to our customers around the world with deep and diverse end markets. We have great supplier and customer relationships, we do not have any material concentration on our customer or supplier side. And one of the investment thesis is that's good to note is our countercyclical balance sheet and cash flow dynamics that as the market expands, we use our working capital or cash for our working capital expansion. And as the market contracts, we generate cash and allows that us to have a disciplined capital allocation with opportunities for significant shareholder return. So taking a look, we've been in this business for over 100 years, and during that for over a century, we've been adapting to the ever-changing technologies in the supply chain from what you see here, radio parts, switches, fasteners and today to where we provide end-to-end solution offerings to our customers we wouldn't be able to do this without building on a solid core of a foundation that's a deep rooted in supplier and customer relationships. And we've had the ability to adapt to wave after wave of change. And as we look forward, we're very optimistic about the future of technology from 1921 to present what holds the future and what gets us optimistic, we'll be talking about more in this presentation about the proliferation of electronics in almost everything we do throughout the supply chain and throughout the world. This slide here shows our global footprint. With our scale and scope today that's been built through organic growth, some M&A and just market share growth, we've been able to build a world-class leading footprint around the world, anchored by 10 primary distribution centers. As you can see where they are down at the lower left-hand side of this slide here. We have integration centers, 14 integration centers around the world where we're providing services such as integration of programming as well as software as well as hardware on boards. And on our device programming, we're loading up software on certain types of chips and sending them out to our customers. So if you take a look at this, we have great global reach to support our suppliers anywhere they want to go for market share as well as our customers and to be able to take them anywhere that they want to be around the world. So on this slide here, we're taking a look at the 4 pie chart that breaks us down in terms of the business region product and end markets. As you can see, on the left-hand side of the chart here, electronic components makes up roughly 93% of our business with Farnell and Electronic components is our high-value distributor. Farnell is a high-service distributor. We'll be talking a little bit more about that. From a regional perspective, you can take a look at our diversification. Again, the key here is we're well diversified. So Asia makes up roughly 40% as of our end of our fiscal year '24. EMEA, 35% in the Americas is 25%. From the product side, you can see that semiconductors makes up roughly 80% of our revenue IP&E or interconnect, passive and electromechanical makes up 16%. And then we have some other types of other products, computer products and things like that, test and measurement to make up the remainder. And again, another key investment highlight for Avnet is we have a very diverse end markets, and we're very pleased with the markets that we serve. You can take a look at industrial, consumer, transportation, defense. If I take a look at some of the, I'd say, industry analysts growth surveys for the CAGRs for the next few years, industrial, defense and transportation and automotive are some of the key fastest-growing CAGRs that are projected, and we're happy to be part of that. So if you take a look at Avnet, you know that we're well diversified, have a great global footprint and we can take our customers and suppliers anywhere they want around the world. One of the things that Avnet has is Farnell, as a broadline distributor, there's not many broadline distributors that have a Farnell, which is high service. So when you think about the core Avnet business where large customers are coming in, providing us with high volume. And we provide service, but it's just not a high service. A lot of this work is done through host-to-host connections, and we're taking material resource planning forecast into our ERP system and ordering from our suppliers in that fashion. That's the Avnet high-volume broadline business. Farnell is a high-service business, primarily dealing with smaller engineers and other hobbyists around the world. It's a high service business. We provide fast product, small quantities quickly to our customers overnight or same day. And for that, we command a higher margin. We believe the combination of Farnell and Avnet together is a winning combination. And it's an unmatched offerings by almost any other distributors, except for a couple. So we'll move on to the next slide, please. When you think about our line card, we're very proud of the line card that we have. Over 50 years of developing relationships with suppliers, you can take a look at how deep our line card is in terms of from micro controllers, passives, discretes, analogs, we have it all. There may be a few that we don't have, but we have some great supplier relationships that provide good offerings in terms of analog and from all across the board. So we have some very deep relationships. We're always looking to fill in gaps and overlaps in our line card and we believe that this line card is a winning combination for Avnet. One of the investment thesis is also is we have a very strong management team that's been in place for a while and has significant industry experience anchored by Phil Gallagher, a 40-year veteran in the industry at Avnet, in fact. So Phil has been our CEO for 4 years now. You can also take a look at some of the regional presidents and senior executives down below and just to show you that there's significant experience in our management, and it's a long tenured management and one of the things that's key for Avnet is we have good succession planning to help us move through any types of changes that might occur down the line. So one of the things we've put a lot of time in over the years is succession planning, and we're very proud of that. When we think about the market and where we're going from here, I've talked about the last 100 years, what makes us optimistic about the future. Even though the markets that we serve contracted in 2023 we believe that we'll cover in 2024, led by the semiconductor recovery. We believe based on industry sources that we tabulate there's going to be a 7% CAGR over the next 3 to 4 years. And with the IP&E, there should be a 5% CAGR, rolling all that up into the total market that we serve which excludes DRAM, flash, MPU, GPU, AI processors, that's going to expand roughly at a 6% CAGR. So that gives us optimism as to how we believe we're going to be growing over the future. So that's anchored by some of the business that we've put into serving AI data centers and things like that. So when you think about where we're leading AI will not only go into the data centers but to the edge, and we believe that we will be able to serve our customers as they build their products out to the edge. Some of the top end markets that you see here, wireless comm, data processing. But as we said before, as I just said, we'll be moving out to the edge on things that are smart homes, smart factories, et cetera. And again, if you take a look at where the market is today in terms of the supply chain, we believe that the semiconductor has normalized at this point. Lead times are generally stable. Pricing is generally in a normal range at this point and we believe this sets us up well that even though we're in a market correction or the final stages of a market correction now, we believe that we're well positioned to take advantage of the -- or to drive opportunities as the market recovers. So we'll next talk about some of the things that we're focused on to drive growth into the future. And if we take a look at our strategic priorities for growth, of course, it's anchored by great customer and supplier relationships. But some of the things that we're looking at that in terms of our partnerships and technical capabilities. I talked about our field application engineers. We have 1,900 to 2,000 field application engineers. These provide technical capabilities for our customers who do not have such. We have a world-class supply chain competencies, which we'll be getting into. We have a best-in-class customer experience. We're constantly engaged with our customers to evaluate how they're doing from their customer experience. And we have an unmatched product and services portfolio. Of course, that's anchored by great systems and technology offerings that we have constantly building on our digital capabilities, and it's all anchored by, again, 15,000 people in our field application engineers so this is the base for how we plan to grow into the future. And we'll just take a look now at some of the things that we've been talking about in terms of our profit and growth supporting capabilities and one is demand creation. So taking a look at how does demand creation work, this is a situation, as I mentioned, maybe our customers don't have the engineering capabilities. You have to remember that we deal with a long tail of customers who may not have engineers on staff. So what we do is we enter into a customer's sales process and we evaluate what do they need our account manager sees a need brings an FA in to engage with the customer and make perhaps we can help them identify a need and a design around what their next-generation product is. And if we are able to help them design a supplier chip into that product. We can register that and we can claim that registration. And for that, we get a higher margin. Typically, those margins could be anywhere from 400 basis points higher than typical fulfillment business. So again, one of the key value providers or value drivers for Avnet is having engineers on staff to help our customers build products faster with better capabilities depending upon what they want. If they want speed, we can help them with that parameter. If they want cost, we can help them with that. And so that helps us with ourselves. It also helps our suppliers grow their reach and their market share. Another area that we find attractive is interconnect, passive and electromechanical. That's where the majority of parts on a board today are IP&E, but the high-value ones and lower in numbers are the semis. So IP&E has basically lower price, lower prices, but it's higher saturation on a board. And we believe there's plenty of opportunities on the board and off for us to expand our IP&E business. Our IP&E business is roughly 16% today, as I mentioned on the prior pie chart slide, we're looking to expand that. Generally, it's a higher profit business. And although the inventory turns a little slower than our semis it's a higher returns, and it's as good or better return on capital. So we're always looking to grow this IP&E business to diversify our business model. Another area that we're improving is on our supply chain services. This is a very important offering for us. If we go back a few years when supply chains were running fine, everything was run and a cost of capital was low, everything was run just in time. But whether it was the COVID and lead times are going out on products, whether it was perhaps a problem in the Suez Canal or lines down due to a frost in Cresson, Texas. What our customers realized is the supply chain just-in-time practices of the past have to change to some extent. And so what we've done over the -- especially recently, and this business has always been a part of our business. It's just that it's expanded since the COVID times. For our customers, we help them to bring a little bit more continuity to their business. We help them ensure that there is supply and we make sure that we can provide them with inventory and payment terms. For our customers, that's a value providing service for our suppliers. We're able to give them better visibility of true demand, help them do better forecasting their revenues. And in some many cases, we have suppliers asking us to come into a customer and help them with their supply chain. When a customer comes to our supplier, our suppliers may say, that's not core to what we do. That's core to what Avnet does. Let me introduce you to the experts. And so today, we're very focused on providing the supply chain services to help our customers make sure that they have lines down are a thing of the past is another product and value order services that we provide. When you think about Avnet, where historically have sold IP&E and semiconductors. But increasingly, our customers want to shift from micro controllers to microprocessors and go from making a product to buying a product. It's all about getting from chip down to integrated solutions and helping our customers get to market faster. And therefore, we're adding value for our customers, partners and for Avnet. We reduced the development time and we recently announced our embedded group, the development of Tria, which is a focused business unit within our embedded group in this regard. And we're helping our suppliers also bring complex technology to the broader market for customers who don't have the time or capability to do the make themselves. We're helping them to buy. And again, this is a higher-margin business. This solution helps our customers with their production in the long run. And if you take a look at the -- some of the applications for our embedded solutions. You can just take a look at whether it's transportation or industry automation, smart factories, smart buildings, medical and professional consumer, we're finding out that these embedded products help our customers get to market faster. I'll turn it over to Ken now to take you through the financial update and to take you through the rest of the deck. Ken?

Thanks, Joe. As we mentioned, the overall market we serve in the semiconductor and IPD space is expected to grow over 6% over the next few years and really beyond that with the secular trends of the proliferation of electronics, but I really look at the last few years since Phil has taken over in our leadership team, we've had a 15% sales growth CAGR prior to the downturn from a revenue perspective. But more importantly, our businesses want to scale and as a global distributor. We can create meaningful operating leverage with that revenue growth. And so you can kind of see the growth within the overall operating income and operating income margin has expanded from 1.7% in fiscal '22 to 4.6% in fiscal '23, through that operating leverage, and we believe that business model holds true into the future. We have a global footprint that allows us to scale without adding a lot of operating costs. And so that future growth we expect from the broader market, we'll be able to continue to leverage and create operating margin and operating income dollar expansion. From an overall shareholder return perspective, we've been very consistent in terms of an increasing dividend over the past several years. This is about a 15% increase on average over this time frame with our next expected increase to come here in the September quarter, subject to our Board of Directors' approval. In addition to share count, we've been buying back shares. Our shares have continued to be undervalued by the market in our view and have traded consistently below book value, and we've taken advantage of that by returning 5% reduction in share count on average over the last several years. And if you go back even further than this, we've had a commitment to share buybacks. We believe that our shares continue to be a good use of our capital, and we want to be consistent in that approach. But over this whole time frame, we have returned a significant amount of cash to shareholders and we expect that trend to continue into the future. From an overall EPS standpoint, similar to operating income growth have been able to create operating leverage and with further buybacks we'd expect this trend to even continue further. Clearly, in the overall industry downturn here in FY '24, the market has been challenged, but we are starting to see signs of recovery we we'll talk about in a little bit. But from our overall standpoint, we have higher margin type of sales opportunities that kind of overall keep balance in terms of our sales growth, right? While some lower margin sales growth with some of these higher-margin opportunities that Joe talked about we believe we can keep the gross margin generally healthy and then control our expenses to be able to create further leverage on EPS as we move forward. From a capital allocation standpoint, we've invested $1.9 million, about $600 million of that has been through CapEx, including the construction of a new warehouse in EMEA that should fund our future growth for several years to come. That was about 30% of the overall capital allocation. But the remaining 70% has been returned to shareholders in terms of dividends and buybacks, you can kind of see those totals there. And we'd expect that kind of balance to continue that our CapEx needs are generally somewhere between $100 million and $125 million a year and after that, there's opportunity for dividends and buybacks and continuing to make sure our capital allocation priorities focus on return to shareholders. From a Q4 perspective, the last quarter we just reported on, we have experienced a market correction we're in a downturn right now and sales have decreased year-over-year across all regions. Although sequentially, we saw growth in Asia and our commentary was we were expecting the return to growth in Asia in either the September or December quarter, which we believe will then be followed by the Western regions shortly thereafter. From an end market, we're seeing strength in aero and defense, but some of the verticals that we focus on, including industrial and transportation have been down, although we're seeing pockets like in Asia, where those markets are beginning to recover. We've had pretty stable lead times over the past couple of quarters. Generally speaking, lead times are 12 weeks plus, but those have improved over the last several quarters to where they're back to a very predictable point. And our book-to-bill ratio, which is an important view of our healthy return to year-over-year growth. It's approaching parity in Asia, but it's still below one in both Europe and the Americas. Although we're seeing bookings increasing modestly, but at the same time, billings have gone down. So we're looking to balance that out that ratio. But again, hope to return to year-over-year growth in Asia. From an outlook perspective, the midpoint of our guidance assumes sales declining sequentially by about 2.6%. Again, that's a mix shift we have partially due to seasonality and partially due to the end demand we're seeing in different markets. So we'll have a growth in Asia sequentially, but we'll see further declines in Europe, in particular, which creates a little bit of pressure on gross margin for that mix. But generally speaking, we see positive momentum coming out of Asia with the West to follow and overall, these sales declines are becoming more muted than we had in prior quarters. Finally, I want to touch on our overall commitment to ESG. These are important to us as a company and to our employees, and we want to balance those out. Definitely, focused on environmental and doing what we can to be a good citizen here when it comes to social aspects in addition to some of our DE&I type of initiatives, we really want to be an inclusive workplace. And that's one of our core values. And we believe in strong governance, right? We believe in having the right checks and balances not only for our employees and our business units, but also for the management team and making sure we are committed to compliance and overall proper governance. So just to recap, our investment highlights. We are a global leader in the distribution space and are very well connected in the center of the technology supply chain. The overall industry we're in, with semiconductors and IP and just electronic components, the need for these components are increasing. The number of applications are increasing. So very good place to be in, in terms of our overall market outlook, and we're well positioned to capture that growth. We do provide overall solutions, right? We can provide products to any place anytime and have lots of different solutions that our customers need to help their supply chains and help get their products to market. We do have deep relationships. Many of our supplier relationships run over 50 years. Our line card is unmatched, as Joe talked about earlier. So we're very well positioned to be able to deliver the entire bill of materials that our customers need to build their products. We talked a little bit about the capital allocation priorities as well as our countercyclical balance sheet. We're poised to get back to a return to growth and to continue to make sure we're putting capital to use not only investing in our business for future growth, but also making sure we're taking advantage of the opportunity to buy back our shares and return cash to shareholders through our dividend program as well. And with that, Charles, we'll open it up to any Q&A. There may be.

Very good. Thank you, Ken. And Joe, we appreciate that. If you have any questions, you can submit those on the bottom of your screen. We did have a couple that did come in, although and Ken, I think you did touch on quite a bit of this at the end. I think they were submitted beforehand. But if you want to add anything. The question is surrounding signals that you look for in kind of calling the bottom in Europe or the Americas? And then when do you expect bookings in those geographies to start improving?

Yes. So I think key indicators would include a combination of our book-to-bill ratio, typically a book-to-bill close to one or at one would indicate a healthy return to growth. Part of that then is bookings, new bookings. So we do monitor booking trends, not only year-over-year but sequentially. And what we talked about is feel confident that we've kind of hit the bottom in Asia and on the road to recovery. We had sequential growth this last quarter. Part of that was seasonality coming off of the March quarter, which is typically seasonally softest due to the Lunar New Year, but we did return to sequential growth and we're very close to year-over-year growth. Hence, a book-to-bill would be over one and when you return to year-over-year growth. And I think looking at order cancellations, the overall health of the inventory, so other signs we're seeing as our inventory starts to improve, that was part of the constraint we were having with increasing bookings. We're still seeing overall challenges, I would say, in terms of the lead times are stable, but customers are reluctant to place orders any earlier than they absolutely have to. And so the visibility is a little bit lacking considering where the lead times are at. And so our supplier partners as well as ourselves are encouraging our customers to put in their bookings, so we have visibility to make sure we can satisfy product demand within lead times. And again, not everything is available overnight. And so although there is some elevated inventory levels on hand, that's not across all products in all product categories. So the visibility customers give us what their backlog help for us to inform the suppliers what to build, right? And so that's kind of the -- some of the concerns now is, yes, lead times are great, but they could extend out if we don't know the things to build. And so just continuing to encourage getting that visibility from customers so we can really get a handle on true demand but bookings and cancellations and things like that are definitely key indicators and the overall markets we serve. So typically, in these kind of market corrections. What we've seen in the past is Asia is the first one to start in the downturn and the first 1 to come out of it. And so we do think Asia recovery is necessary to get the rest of the world back on track, and there's positive signs we're seeing coming there.

Thanks, Ken. And then I think you guys mentioned chips used in AI will increase 27% over the next 3 years. Can you just talk a little bit more just your thoughts on AI and its impact for your business kind of across the board?

Yes. I think that was based on the market analytics that we get from industry sources that there's an expectation that they will increase to that extent. For us, we are seeing some involvement in particular, in Asia at this point, the build out of the data centers, but we're also mindful of the fact that as things start building out to the edge, there'll probably be similar products that we're selling that will help bolster that. So we're not seeing 27% at this point in time, but we're optimistic as that business increases. And just in general, Charles, as the market increases based on the CAGRs that we've given that we would expect that will be -- part of that will be AI related but we'll be in there supplying the parts to the build-out, whether it's in the data centers or to the edge to some extent. We're already seeing some of it and we expect that will continue to grow similar or more than what we've presented on the slide there in terms of the CAGR.

Very good. Those are the questions that we have received at this time, gentlemen. Joe and Ken, we really appreciate it. I just wanted to thank you and the Avnet team for participating at our conference. And thanks to everyone else for joining on the line. We appreciate it, and have a great day.

Okay. Thank you, everyone. Thanks, Charles. Have a great day.