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

I think we're good to go. First meeting back from lunch. I am Melissa Fairbanks. I cover analog semis and IT supply chain companies here at Raymond James. And we are happy to welcome back the folks from Avnet. Today, we've got Phil Gallagher, the CEO; Ken Jacobson CFO; And then we've also, in the audience, got Joe Burke, he's hanging out VP of Treasury and IR. So I think we're just going to go straight into kind of the Q&A.

I think most of you are familiar with Avnet. That's the good thing about a tech conference, right? But Phil, I think it might be beneficial just to do like a quick review of your most recent quarter results, your expectations for the December quarter outlook.

Okay. And I'll let Ken jump in. So good afternoon, everybody, and thanks for being here and Melissa, thanks for the invite. So the September results, I'll let Ken touch on that a little bit. I'll just kind of give a little bit more of an outlook on what we're seeing right now without and kind of more of the same, unfortunately. So if you go and take a tour around the world real quick, the good news is Asia Pac. At least we called Asia Pacific bottom at in March quarter. And Prince Yun, our leader there. We've grown June over March. We've grown September over June. And September actually grew year-on-year across Asia Pac, which is a really good sign because typically, as I said in the earnings call, typically, not anything is typical anymore. The ups and downs of the markets typically start and stop in Asia Pac. So we think that's a good sign, and we'll see some sequential growth in December in Asia Pac as well, which is also pretty typical, but we had a really strong September, so we're glad to see that. Europe is really the softest spot right now and probably no surprise. But particularly in our space, our largest verticals are industrial and transportation and the other 2 that we get hit pretty hard in Europe, and we don't see that really changing a whole lot as we get through the quarter. As a matter of fact, as you get into later December with European shutdowns was not actually more than likely to stay about where we're seeing it now. The Americas is somewhere in between. Okay. here is kind of bouncing along the bottom. Of course, unfortunately, with what's going on in the world, defense aero is a very strong vertical for us. It's about 20% of our business in the Americas, and that's actually holding up really well. So that's kind of a tour. So it's decent in Asia, actually positive. Europe continues to be soft. And we think that through the quarter, hoping to see that turn in the March quarter and then the Americas, like I said, somewhere in between. Do you want to make any...

Yes. From an overall results standpoint, about $5.6 billion in revenue, but with the return to growth in Asia and the softness in Europe, there was a pretty significant mix shift to our Asia business, which overall, it was good because of the signs of Asia getting back growing, but it runs at a lower gross margin than Europe. So we had a little bit of a pressure on the operating margin, even though revenues were flat. We did generate cash. I know we'll talk about inventory. Inventory was flat when you take a foreign currency out of the equation, but we bought back about 100 million of shares in the quarter as well at pretty attractive prices.

Okay. Have those end market dynamics, you reported in late October. Now here we are middle of December, has there been any kind of change from what you were seeing at the end of October?

Not really. It's about the same. I touched on the verticals. Industrial still soft. And as Ken said, there's just some inventory issues out there as you guys all know. Transportation still soft. Consumer we're doing actually okay in defense and aero, as I said, is doing fine, aren't going to continue to grow. But there's no real signal changes...

Great. One question I get quite a bit is how some of the trends are -- the broader trends are definitely in line with what we've seen from some of your suppliers, also some of your end customers. But then if we compare, there are certain areas where you've kind of been outperforming, maybe in APAC that's one to highlight. Does your line card or your specific supplier exposure have anything to do with that?

Yes. I think we've got a pretty hot hand right now from a line card standpoint. We don't like to get into any -- I start mentioning I missed one for some CEO, you mentioned this. But you know our line. we're very confident with the supplier relationships we have now as well because that's another question we constantly get supplier lineup. I think in Asia Pac, yes, I know you referred to, we are definitely outgrowing the market. We have a great team there. I know that sounds -- but we have a very senior executive team there led by Prince Young. We also have a strong position in Taiwan. So Taiwan we're very strong. So as Taiwan picks up, we tend to outgrow the market a bit. And we're not overexposed to China. So China is somewhere plus or minus 10% of our total business as a company. So something happens in China, although we're seeing China, actually, China is actually flattening out and starting to see a little bit of modest growth in China as well, which is good news. But again, if it goes up or down, it doesn't swing us that much. But there's no -- other than that, there's no special vertical we have or anything like that. We're not overexposed in any one region really. And then within like AI, artificial intelligence, you have to bring that up at least once, right? We don't have a lot of exposure to -- so it's not like we have an AI solution. And we're selling into that market. We're getting some benefit, but it's not really what's swinging it.

I also had to just start, I think we're holding up overall just because of the diversification, not only the supplier line but also the vertical markets. So we don't have any supplier line more than 10% of our business, but pretty diversified in terms of end markets as well. So -- there was some up, some down, but it's overall holding up and the lack of concentration there is, I think, a good thing.

Great. I think one other thing that I get asked about quite a bit and your suppliers get asked just about every quarter. What are you seeing in terms of pricing? We do have excess inventory in the channel -- we'll talk about inventories in a minute, but the pricing environment as lead times have come in, demand has kind of normalized?

So far, and we get those questions in the one-on-one. So far, particularly in the higher-end technology products. Prices will hold up okay. We're not seeing the ASP degradation we've typically seen in the past. As a matter of fact, without naming names, a few suppliers probably start raising prices again, high-end stuff. Commodities, standard products, multisource products, that always goes up and down. And there, that doesn't hurt us that much when we just buy better. So you buy smarter, sell smarter. So that doesn't really have a big effect on the margins overall, I would say, pretty stable right now.

Great. Great. That, of course, leads us into inventories. I think this has been one of the biggest hot topics over the past couple of years now. So in the past, Phil, I've stolen this phrase that you used that you act as kind of the shock absorber for the industry. So we've had kind of an unusual trajectory of this cycle. It hasn't exactly been a normal cycle that maybe we're starting to see a little bit more normalized behavior. But has this changed the way you and your suppliers are approaching managing the supply and the inventory and that shock absorber dynamic?

Yes. So just for the folks haven't heard me use that before. It's kind of the role we play. We're the middle guy, we play bank, okay? In many cases for our suppliers and or for our customers. So we're as much a financial services companies anything. And our backlog, our inventory adjust roughly 20%, 25% per day. Between cancellations, pushouts, pull-ins. So when you got $5-plus billion inventory, that's a lot of sway happening inside the logistics centers, if you will. I would say -- look, we got into this situation as an industry on with Avnet, I should know for 42 years. So we've seen a few cycles. This one is definitely a little choppier than we thought and going a little bit longer than we thought. And there's been some just, let's just say, interesting behaviors in going through those tight times with the NCNRs, the take-or-pays, I think we kind of caused some of this as an industry with the inventory excess that's out there. Suppliers are working with us really well right now, I would say, across the board. Where they need help, we help them. So there's a lot more give and take. I should note the inventory is good inventory. So inventory distribution is not a bad thing. It starts -- it's not wine, so you don't want to too long. But it's not -- the inventory -- the quality of the inventory is really good right now. And as I said on the earnings call, and it's not -- I think it's important for people to realize it's not all inventory is up. I mean in the IP interconnect, passive, electromechanical, discrete, our inventory is fine. It really is concentrated. -- you pre it out, it really concentrated in a few technologies and a handful of... I think we're just remain focused on adjusting inventory where it's -- we have excess or too much. We continue to work with customers. We continue to drive that. And there's some cash to unlock there, but we feel pretty good about our progress, and we want to be really focused on the medium and long term and not be so shortsighted on the inventory that we miss have on some opportunities. So we're being -- trying to be very balanced with our inventory reductions, although be clear, it's a priority for us to continue to drive it down.

Yes. I was just going to say, so Ken mentioned the customers. So we'll work with our customers. Customers have the financial challenges, and we've been really fortunate. Our AR has been very healthy. So we've not had many write-offs at all from a bad debt standpoint, but we're going to work with those customers. There's no sense in jamming them with inventory, if they can't afford it, can't pay for they're just going to close a problem on the receivable side. So we're doing -- everyone is -- I wish it was easy just to hit a button. And so everyone is kind of a one-off conversation, but quality inventory is good. We do expect to bring inventory down, and we do expect to generate cash.

Yes. So moving on from inventories from one hot topic to another. I think the theme of this conference this year is probably all around tariffs. So maybe just the threat of tariffs at this point. What's the potential impact on either your business, your suppliers? What are your current thoughts about what's going on? And how are your suppliers approaching you potentially working through this?

Yes, it's a common question we get actually, we got it 3, 6 months ago, right, before the elections. And my first response is we manage the business to go drive the business and do the right things every day, and we'll adjust and adapt where we need to adjust and adapt. So the tariffs don't really overly -- I don't -- that's not one of the things keep me up at night. We have a process to handle it. We definitely pass it on. suppliers know we can handle it. And as it gets defined and whether Mexico, Canada, China, whatever, we'll just adjust and manage it. We have free trade zones down in free trade zone down in Chandler, Arizona. So we put those in place, and we'll see where that all ends up. So we can't overengineer or be overly concerned so you actually know what's going on. Now we are talking to customers. Customers are talking to us. We get this question from many of you, are they going to take it early, maybe so they can avoid the tariff -- we're not overselling that. If the customers want to take it, fine, that's great. But we also don't want a mortgage by March quarter. So we don't have many takers on that though. Now it's early December. So we'll see how the rest of the month is.

Now I think we have the playbook. It was painful the last time to develop it, so -- but it's now ready to go, so I hope it will be easier this time around. But we don't anticipate a significant impact.

Okay. It has been something that you've had to negotiate in the past. And that's kind of one thing that I tend to point out to investors is that you're kind of good at responding to changes in the environment.

A lot of our suppliers have dual sourcing. So and so you basically take the China produced goods and you sports it on Europe and the Asian markets, and you try to get as much as you can of China content in the U.S., and that's the biggest way to avoid it in the first place to route your sourcing the right way.

Yes, that's a lot more dialogue upfront about that. it's XYZ supplier, and they make widget A in Europe, and they make the same widget in China. He ship the stuff from Europe to us. versus the stuff in China. And so those dialogues are all happening as well.

Interesting. Okay. Great. So maybe getting back to kind of the near-term performance metrics. Farnell, has been a very opportunistic business for you and serves as a really nice funnel for the broader components business, but you have had some challenges there recently. If you could just give us an update on the progress there, that would be great.

Yes. So first, let me just be very clear. I was very transparent on the earnings call, we really disappointed in the Farnell drop so that's one, and we need to go resolve that, and we will. We've made a handful of executive changes already. We've had -- we're restrategizing the whole position with Farnell. The opportunistic part that you alluded to any tight market conditions a couple of years ago, nontraditional customers kind of swoop down and gave them additional volume over and above what they typically would get at good margins. So it kind of was -- the tide was high and everything looks great. And then when things came back down, negative drop-through was as good as the positive drop-through. One time Farnell, it was 6% of our revenues and over 20% of our operating income. So it means a lot to us. Now it's basically at the bottom. So we restructured a new leader in, Rebeca Obregon. You can imagine there's -- and she's restructured the organization. About a year ago, we announced some cost measures reductions, which we've done, between $40 million and $60 million. We didn't know the market was going to continue to go down like it did. So we're doing more, unfortunately. And they also over not over country. Their largest region in Europe. So it's kind of a double invested for that getting hit the market down. But the concentration in Europe is higher. And then we're calling it a power of one, okay? So what we're doing is the previous leadership kind of had a moat around Farnell. It kinds of isolated and no, no, it should be closer to the Avnet core. Not going to integrate it, okay? But what Farnell brings to Avnet is that e-commerce digital front end, okay, and a long tail of customers, new product introductions and whatnot. And what Avnet brings to Farnell, but some of the other catalog guys don't have or high service guys don't have is Avnet's customer base and supplier base that they can get access to. So there's a bunch of cost measures, then there's a bunch of growth initiatives as well. And we think we have the road map to get it back to at least double-digit operating margins. The expectation is just get better, okay? So if you're 1%, which is terrible, get it to 3%, then get it to 5%. And that's all -- we see that as a tailwind for us as we get into calendar 2025. So anything you want to add to that?

The gross margin in part, gross margin in that business are very attractive relative to our average gross margin. The gross margins are stable there, just unfortunately, a bad mix with the sales decline. It's even worse on the mix side of things. So we expect the recovery of more on the board, semiconductors and IPD products as the growth comes back, and so the margin should loose up as well.

And actually, we're making investments there, too. So we made the structure changes. So Rebeca Obregon is leading that now. And then I went -- just announced and we press released that I hired a Chief Digital Officer, okay, Dave Youngblood. And he came from 2 of our suppliers we don't have, okay, one in Texas, one in Boston. And he built out [ .coms ]. The guy is super talented, brought him in about 6 weeks ago, and his primary charter is to go focus on Farnell digital customer experience.

Excellent. So before we get into maybe some more longer-term opportunities for the company, I just want to pause and see if anyone had any questions?

Well, I haven't studied the business, but just a lot of your suppliers have consolidated over the years. what's going on with distribution in terms of consolidation opportunities as obviously the large competitors? It's still very frank...

Well, I get in the IP&E space, interconnect past mechanical much more fragmented. There's still a lot of smaller regional in Europe for example, by country type of distributors in the IPD space. On the -- and that's an opportunity. There is an opportunity there. A lot of them are private. Actually, almost all of the private actually that are IP&E. On the semi side, you got us -- you mentioned the guys in Denver, and you got a couple of Taiwanese guys. And you got the Berkshire group, right? I mean to that, the tail, [ Brian ], really, really drops off. So there's not -- I think the industry has been consolidated for the most part. Maybe there's another move or 2. I mean the one Taiwanese guy just bought the guys in Canada, right? So that came together. But I don't see a whole lot more on the active side on the semi side. But definitely in the IP&E, there could be some opportunity.

Okay. Great. Anyone else? Okay. We'll move on. So this is one of my favorite topics. I always have to bring this up whenever we see each other. So I was able to tour one of the Arizona facilities. I saw the programming business in operation. So talk about what kind of opportunities does that business drive the revenue and the margin profile for that business? And if you're happy to give us an exact number, I'll build it into my model.

So we're talking about just for quick education. So we sell chips, as everybody knows, a lot of chips need to be programmed for software, right? You've got the hardware and then the software gets loaded on to the chip that gets into your weather phone or whatever the application. We do that programming, okay? So in Chandler, Arizona, in Singapore, Hong Kong, Europe, we have -- our programming centers are all tied together because you might do a prototype in Boston or New York, I should say, it could be in production in China. You got to go through that certification and that approval. So our programming business is a great business for us. It's sticky, so once you have it, it's sticky. And the margin is another 5% to 10% margin depending on the device. But the other value-added stuff that you talked about before, most we need to continue to drive value equals benefit minus cost, right? So anything we can do more to the chips or to the products before they go out from a services standpoint or a value standpoint really matters. So when you got the demand creation, where we do 32% of our business where we have FAEs actually doing designs for our customers on behalf of our suppliers. We have the embedded business we've talked about our new brand called Tria, that's roughly an $800 million business, give or take, where we have our own boards. We're actually designing and manufacturing boards for the end customer, okay, which is really great. Then of course, we've got our supply chain as a service we've talked about before. So we're trying to hit and then IP&E, the question just asked, IP&E, why is that important for us? Well, it's $3 billion, $3.5 billion of business for us a year, although we're known as a semi house, it's about 400 bps more margin. So you get higher margins in the IP&E space than you do in the semis as a general statement.

So all of these value-added services, some of the programming, the embedded, all of that, how does that help differentiate you from the competition? You touched on some of the domestic competition. Taiwan, obviously known for doing very high volumes. Is this a differentiation for you?

Well, we believe it is. I think back to a couple of questions ago, just on Farnell. Farnell is one of the bigger differentiators we have. So that's why we need to get that right because that gives us that reach into the customer base, and they've got 1 million-plus customers. They define a customer as an engineer. And as Farnell sells progress, they sell a Xilinx FPGA development kit. Well, that sales leader then goes hits and assigned a cat and that goes directly to the account manager on the core side. okay. So that's differentiated. So we're getting reach into the market that otherwise within the quarter, we wouldn't touch on those customers. You mentioned programming services. Supply chain as a service is a big differentiator. And that actually reports to directly into [ Ken ] -- because when we talk about these large supply chain deals, if you will, their finance models as much as they are distribution models, okay? So these are financial services models for the customer. It's actually supply chain as a service where we're very light on working capital, and we just build out -- effectively gross profit dollars. We believe design services, as I mentioned, is a big differentiator for us. I said we got 2,000 FAEs. We actually build our own boards. And that's -- you get higher margin, and it's super sticky.

May I just say our global scale, combined with those capabilities allows us to solve any customer problem statement they have, whether they're a small customer, they go to Farnell and global OEM that wants to use our supply chain services. So we feel we're well positioned and kind of can fit any need they have, and that's unique relative to a lot of our competition might be really concentrated in China or Taiwan, for example, we do have a global reach, which does give us an advantage.

That's a good point. As designs happen in one region, manufacturing goes oftentimes to another region. We have a call it a business migration team that does nothing to track designs anywhere to go in the world. And then we get the other side of the question, well, what if customers decide to move out of China or we call that the China plus one. Is that a risk to us? Not really. We just moved the supply can into where they want to go. So they want to go to Vietnam, South Korea, back to Guadalajara back to the U.S. We just ship and lift the supply chain. So that's -- it's a differentiated value we actually bring to the end customer. But very little risk.

Great. Maybe is there anything that you've been doing with automation more recently that could help also give you some sort of competitive advantages or maybe attract some new business or any other future area that you're investing in now?

Well, I'd say the big one is digital. And of course, artificial intelligence and some proof of concepts. We've got some case studies going on. The amount of information that we have being at the center of technology like we are -- and you've got suppliers on one end, customers on the other. We take in 50% of our business is done via supply chain. So we're taking in thousands of MRPs from customers, whether it be EDI, APIs, et cetera. So the data we have is really rich. And then what we're trying to do is figure out how to best leverage that data for a better value proposition back to the customers and upstream to the suppliers. That would be probably the biggest thing we have going right now. And that's part of the Chief Digital Officer, bringing him in I just wanted to be sure that Avnet, I call it up periscope. So we're looking ahead out into the marketplace, somebody is dedicated full time to making sure we've got the right digital solutions for our customers and suppliers because we got to get more efficient, right? And we got to get more productive. We can't be growing 15%, 20% a year and hire an x number of people. And then when things turn down, you end up reducing the workforce. We got to find a way to grow without adding that percentage of SG&A as well to drive efficiency and productivity.

Okay. Great. So you touched on this or you mentioned it just a little bit ago about some of the competition, the consolidation that happened with a Taiwanese player, took out someone in Canada. I do get asked quite a bit, this is -- it was kind of an unusual transaction, really broadened their scope in terms of the end markets or the regions that they touched. So does this change the landscape in the Americas at all? Have you seen any kind of change in competitive environment?

Not really. I mean, look, you talked about WT in future. And there are good competitors. We compete with WT in Asia. We compete with Future in the rest of the world. We have not seen any major shifts in the competitive landscape. We still compete with future. We still compete with WT. Will there be in the future? We'll see. No pun intended. But I think that was a play for WT to diversify their portfolio and get more into the West instead of just concentrated in Asia.

Okay. Interesting.

They're good competitors.

Good. Good. And I think we have just overall seen a much more rational competitive environment over the past several years in general. There was a worry that we were going to get kind of a shock to it. But Ken, I want to give you a chance to talk. We do have to talk about capital allocation. You guys have been doing a lot of buybacks recently. It was nice to see positive cash flow last quarter. Maybe talk about some of your expectations for the cash flow through the downturn. This does seem to be a little bit of an extended downturn than what we're normally used to. But your expectations in the near term, how you're going to prioritize the use of that cash?

Yes. So we've generated over $800 million of cash over the last 4 quarters. And I think we're right now focused on a combination of share buybacks. Our shares continue to trade at or below book value. So we think that's a really good attractive price as well as pay down some debt. Our interest expense is significant over the past couple of years relative to what it was. And so there's still a lot of opportunity there to pay down some debt, be balanced in our approach. Our target is 5% of our outstanding share count being taken out this fiscal year and kind of then keep that as a kind of trend. And then we have a pretty healthy dividend increased just this past September. And so -- and some CapEx just to invest in the digital tools and warehouses and some other things. So all of those are kind of balanced, but none of them are overweighted in one particular area, and we feel pretty good about having excess cash flow capacity here over the next 12 months to be able to take advantage of all of those.

Okay. Great. You did touch on the interest expense is a little higher. You have been doing a really good job bringing down inventories the past few quarters. I would expect that to continue, barring any further shocks to the end market in general. But in terms of what we normally see ahead of an up cycle, when we do start to see that inflection point in demand return to growth kind of more broadly, and I think Europe is going to be a key there. Is there a risk that all of a sudden, we won't have brought down the inventories far enough? Or does that actually provide you with an advantage to respond to changes in demand?

Yes. I guess how I'd characterize it is we've got some excess inventory in certain pockets. We need to make investments in other pockets. And so as the market recovers and we return to growth, right, we're going to be investing in inventory, but we think there's enough inventory in totality, right? We got to repurpose some of the inventory dollars, but I would think if we return to growth here in the next couple of quarters before we have the time to rightsize the inventory, then we would be able to grow without adding or using a lot of cash to invest in the working capital, which has been normally our approach. We invest cash in inventory and accounts receivable as the business grows. And I think we've got sufficient inventory to avoid that in this kind of alternative scenario where the growth comes back, let's say, snaps back in March or something like that.

Great. Great. Yes, feel free to put an exact date on...

Yes, we're done with that.

That's the number one question.

We're done with that.

We just have a couple of minutes left, but are there any questions from the audience? [ Suni? ]

Yes. You talk about embedded business and your demand creation. I'm just curious as you think about AI longer term, and a lot of talk about AI at the Edge...

For IoT.

Yes. Do you see an opportunity to invest more... [Technical Difficulty]

Yes. No, it's a really good question. The answer is yes, there's definitely going to be an opportunity on the Edge on how fast that happens and translates even with the next-generation laptops, iPhones, all the things that are going to be hit with the AI. We have a company called Softweb we acquired years ago. They got 600 software engineers because a lot of the issue when you get on to the edge is security, right? They are experts in building software security on the Edge. And that's where we're actually working with -- again, I want to mention this, you can guess who the top controller suppliers are we have in our line card some are Europe, some are Japanese, Japan, some are here. We're actually working with them already on these IoT Edge opportunities to embed the software into their chips. So they're actually working with us as much more as they're working direct. So it is a real opportunity, and it's definitely going to come. Some of it is already here, obviously, but it's going to accelerate. And we think we're positioned well because a lot of it is going to be industrial automation, building automation, all those -- that's 37% of our business is industrial. the application is perfect.

Okay. Amazingly, I think we are out of time. But I just wanted to say thank you again, Ken and Phil and Joe. Always great to have you.

Thank you, Melissa. I just to make absolute comment. Just thanks again for your interest. Thanks for the questions. And I know there's a lot of uncertainty out there in the marketplace. And Ken answered it well from a financial standpoint. We're not bullish. We're not bearish. But we're excited to be where we are today. We're the center technology supply chain. Yes, there's a little bit of a correction going on. Maybe it's going a little bit longer than we thought. But our job is to be sure the company is positioned for the growth, okay? So we're not doing any major restructuring. We're not doing -- we're, of course, managing expenses well. We're managing the balance sheet well so that we could be positioned for the next 3 to 5 years, this industry is going to grow 5% to 7%. It's a huge opportunity for us, and we're positioned in the right spot. So I just want to focus on the execution and doing the right thing every time. Okay. So I do want to share that.

Excellent. Thank you very much, guys.

Thank you, Melissa.