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

All right. Everyone, it's so nice to be back up on stage, and I'm so pleased to welcome Avnet with us this afternoon. I'm joined by Phil Gallagher, CEO and Ken Jacobson, CFO, and we're going to have a very enlightening discussion, so hold on to your seats, guys. We're going to start off as an introduction and just take a few minutes for Phil and Ken to describe to us what Avnet is and what Avnet does.

Thank you, and welcome, everybody. I appreciate you being here online, and I appreciate your interest in Avnet. So I'll try to give you a little elevator speech here on what Avnet is. We're a one of the largest publicly held companies that a lot of people don't know anything about. We're a Fortune 180 company. We're listed on NASDAQ, obviously. Our corporate Phoenix, Arizona, but we were founded in New York post World War I in military surplus coming back from the war. So we've been around since 1921, roughly $24 billion to $25 billion in revenue globally. 45% to 50% of our business is done in Asia Pac. Europe is our second largest region, 30%, 35% and Americas is in the 20%, 25% range. We're in the semiconductor business. So 80% of our business is semiconductors. We're a distributor. So we manage supply chains from design chain to supply chain as we like to call it. So a lot of our top suppliers are here at this conference actually. And around 20% of our business is IP&E, we call interconnect, passive, electromechanical. We have roughly 250 product lines on our line card. We service customers in obviously, all geos and very diversified portfolio of verticals. Our largest vertical is industrial, roughly 30%, 35% of our business. The next would be transportation, let's call it, 12% to 15% of our business. In the Americas, defense and aerospace is about 20%, 25% of our business, and that will be a growth market here in Europe with all that's going on and it's been announced of recent. We have roughly 15,000 employees globally. We're in 43 countries around the world, and we ship into 145 countries globally. So that's kind of a little snapshot of who we are or what we are and what we do. But I'd like to just say that we're in the center of technology supply chain. We manage and work with all of our supplier partners to deliver from design to supply chain solutions down to our customers. And I guess I should mention that we have -- have that core roughly 100,000 customers in total, including individual customers, we have 450,000 to 500,000 customers around the world. It's a very diversified portfolio. I guess last comment. No one supplier is more than 10% of our revenue. It's very widespread, and no one customer is more than 4% of our revenue. And the customers we service are all pretty much household names that you would know anybody that has any kind of electronic components in it, semiconductors, connectors, capacitors, resistors, odds are we're selling and servicing those customers.

Impressive and global. Global. Great. So can you discuss areas where you believe that AVT has a competitive advantage of capabilities, geographic footprint, line cards, business units. There's historically been a view that competition and electronic component distribution is driven strictly by price. But can you both please describe why this isn't necessarily the case?

Yes, I'll start and turn it over to Ken for a couple of comments. Well, I know this is going to sound soft, but our people and our culture. I mean we have a very strong culture. The -- when you're in distribution, it is a people business. It's a relationship business. It's a business built on trust over long periods of time, and we've had a very stable executive team. I've actually been with the company for 43 years. I've been CEO for over 5. Ken, 13 years, I go right on down the line. Its culture is -- it does matter. It does make a difference. Our global footprint, as I just talked about, is absolutely a differentiator. We can help customers move their design chain or their supply chains anywhere in the world. So a lot of things we help design in might happen here in Europe or in the U.S. ends up being manufactured in Southeast Asia or China or wherever it might go, Guadalajara, et cetera. So our global footprint, our line card, you mentioned line card, we have some of the top lines in the world. I mentioned on semis here, Microchips here, Broadcom, AMD, I could go on NXP, Advanced Energy, who's also here, are all part of our line card. So our line card is an absolute differentiator. And then our diversification of portfolio, as I just talked about is we believe, a big differentiator for us as well. And lastly, I'll turn it over to Ken is the whole digital. We've invested a tremendous amount and continue to in digital future-proofing, if you will, our company because more and more engineers looking for design solutions, they're going to start online. The number roughly is about 68% engineers to they go online first to look for design solutions, then they'll go and contact our field application engineers, of which we have double lead engineers, 2,000 roughly around the world. Then we have a division that's based here in the U.K., actually at leads called Farnell. And that's our e-commerce front -- I'll call it our front end, and they're servicing customers for new products introduction. 72% of their business is done online of their line items and over 50% of their revenues. .

Not much left. But I think the other thing is the strength of our balance sheet, along with our size, ample capacity to support customers needs right, because part of what we do provide is working capital solutions and things like that as we talk about supporting our customers globally.

Great. That's very, very helpful, especially the touch on the culture, you can't discount how important that is. I agree with that. And we're perhaps at the end of a prolonged down cycle. And looking back and then looking ahead, first, what was different about this cycle? And then what's your strategic focus as a company as you emerge from it?

Yes. So as I said, I've been around for 4 decades or so, and I've seen a lot of cycles. And the one that always sticks in my mind for those who have been around for a couple of years is the '99, 2000, 2001, we had the Y2K, the perfect storm. The whole tech bubble exactly. And that was a precipitous drop. It just boom. It just kind of happened overnight, then it stayed flat for a while, then boom came back up. This one is different. And I think it's different for a lot of -- it's more global one. Our businesses are a lot more global than they were. You got the whole geopolitical situation around the world going on, which is continuing to add to some uncertainty, if nothing else. And inventory. So inventory became a real issue. Inventory is not a bad thing, but there's way too much of it out there for a whole myriad of reasons. But it just -- it has been prolonged and the recovery is like -- in the one-on-ones, I was just like, "Hey you calling the recovery." I'm not calling anything. There's no way. I've been wrong like 6 times in the last couple of years. But I am encouraged. I'm really, really encouraged about the bookings, the book-to-bills, the backlog increasing, our e-commerce activities going way up, the Farnell that I just talked about. I know the things we're focused on. I mean, coming out of this, look, you control the things you can. okay? And everyone wants to get fancy, dance, we got to focus on execution. We've got to -- I'll let Ken talk about asset management. We've got to focus on our asset management, focus on our inventory. Inventory for our suppliers that are here is not a bad thing. Now too much inventory for too long, it's not wine, okay? So you got to move it sooner or later, but it's not a bad thing. It's actually going to help set us up for what I think is an encouraging and optimistic view as we get into 2026. But it's about execution, okay? Focus on the execution. Now let you...

Yes. I'd say one of the things that did surprise us about this cycle is one of the strengths of our business model is the countercyclical balance sheet. As we grow, we tend to consume cash to invest in inventory and accounts receivable working capital. But as we go down in business, which we've had over the last 1.5 years, we typically generate a lot of cash, right, which we can do different things with buyback shares, reinvest in the business. And I think with the inventory situation as it is, the inventories trended a little higher than we normally would have expected. There's still some opportunity for our pockets of excess to unlock that cash. But I guess the good news is coming into what we would perceive it to be an upturn here coming. We're not calling it, but I think there's a lot of positive signs. We're well positioned, not only from a working capital standpoint, but also from a resources in terms of our technical capabilities or our engineers our sales force, right? We're well positioned there. So as we begin to recover, we're not going to have to invest a lot of expense into the model. So a lot of operating leverage should be created over the next couple of years.

And through this cycle, we've managed expenses well. Yes, where you got to reduce, you got to reduce, but we did a much more rightful shot go versus a broad just 10% out because we wanted to be positioned for the market recovery. But one area when you reduce expenses, you always got to make investments. But in our IT infrastructure, in our supply chain services we just talked about and talk about digital. I know we get the AI here, I'm sure in a minute, whether you like it or not, but the digital implementation of tools, okay, for -- by the way, internal tools for our people, how do we connect better with our suppliers from an API just digitally. So we're partnering with suppliers in a more automated fashion and with our customers on a global basis. So they are the things we're focused on to drive more efficiency, productivity, scalability, those are the things we need to continue to drive.

And we keep on talking about recovery. So with recovery comes demand, right? So what are you seeing on a regional basis? And what end markets and verticals are strong and which are weak? I know you mentioned Asia being stronger than other regions and growing faster. So what are the drivers for that performance? And how will you continue to sustain this -- these drivers in future?

So this is where I get the word encouraged. I'm careful, maybe encourage, optimistic, there's stabilization, these -- but if you start with Asia, a quick tour around the world, Asia Pac, we've had 5 quarters of year-on-year growth and a record -- pretty much a record quarter this quarter in December with, on top of that, positive book-to-bills. So the backlog is strong as we go into March. But we've already talked going into March. So we think there will be a Lunar New Year, whether it's a Lunar New Year every year. But post-COVID, the typical seasonality, it kind of got out of whack. This year, we expect March to be a little softer in Asia, which is fine. Europe, has been the toughest region, right? And for a lot of reasons that many of you in the audience know or online know, but we're starting to see positive signs this quarter in Europe as well, which is great news as our most profitable region. So with Asia going up, which is a little bit less margin and Europe coming down, it's created a geo mix, which we think is going to start to correct this quarter and next quarter. And in Europe, also positive book-to-bills, which is good and backlog growing. Same thing in Americas. Americas probably led Europe a little bit. But again, good billings. September quarter in Americas was our first quarter of year-on-year growth since 2023, right? So good signs in the Americas, again, good book-to-bill. And as I mentioned, Farnell. Farnell is kind of a canary in a coal mine because it's so broad, okay, and servicing, I said, 400,000 engineers around the world, their activity is up.

Let's dive into Farnell a little bit. So talk to us a little bit more about that and how it differentiates Avnet in general.

Yes. So Farnell, again, they grew September quarter 15% year-on-year. And I fall on the sword. They had -- Farnell at one time was roughly 6% of our revenues. And you kind of go, well, okay, that's not too exciting. But they're 20, 2-0, 20% of our operating income. So it's really critical to Avnet's success. And in the downturn, let's just say they got a little too top heavy. And in the downturn, they had a lot of negative leverage, got down to almost, let's call it, 1% operating margin, which is not acceptable. So we made a tremendous amount of structural changes there, including leadership. It's now led by Rebecca Obregon, who's changed over about 80% of the leadership there. And we're on the recovery. Why is it important? Farnell is kind of our digital e-commerce front end. So we call it the Power of One. You got Avnet Core, which is our -- the core business. That's the $22 billion machine, if you will. And then you have Farnell is about $1.6 billion, okay? But they service all the engineers out there. And there's not a customer that we're doing business with in the core that Farnell is not doing business with in some way, shape or form. They pretty much mirror our line card, okay? So when they sell a leading-edge product, a high-technology product, that becomes a sales lead for the core team to go follow up. Because again, Farnell is more online. They have some salespeople, but not near as much as the core. And the other thing that's nice about Farnell is they carry from a diversification standpoint, they have test and measurement. So clients like National Instruments, Keysight, Tektronix, et cetera. So that's a nice diversification to the portfolio. So we report them separately, and we think we have some runway. We know we have some runway in getting them into the double-digit operating margin.

I just think the path to recovery there is a multitude of things. I think there's some more when it comes to OpEx and really some low-hanging fruit that we have in terms of our e-commerce proposition and conversion rates, but it also gets back to some being the market recovery, which for us as the market recovers within Farnell, which is primarily a Europe-based business. You sell more on the board components, semiconductors and IP&E, but that comes with a higher gross margin. So if you think about Farnell's business model, it's 2.5x the gross margin that Avnet core has. So it's very attractive and can create a lot of operating leverage as they continue to grow. So the good thing is the gross margin is stable, but there's some more runway there as the mix improves to more on-the-board components.

So it would not be 2025 without talking about AI. So I'll let you be the witness here. Tell me a little bit about how you're using AI in the business, how it's a differentiator, you go for it.

Yes. So -- so it's almost been a tale of 2 cities when you talk about the market, right? You got the hyperscalers, the data center, AI kind of over here, everybody knows who those guys are. They're just going gangbusters and you got the balance of the semiconductor market, which has been just a little bit different. But AI for us, we actually -- there's 3 major opportunities in selling and driving revenue, let's call it. Then we'll get into some applications. But what we sell -- we do sell directly into some of the hyperscalers, mostly in Asia. And we called out on the last earnings call that's roughly 7% of our revenue. So not overly top heavy, but nice growth. And I think just a bunch of you. So we are selling into it. And then you have a lot of our customers. Again, our #1 segment vertical for customers is industrial. So anybody in -- if you think about this, anybody in power, power management, they're customers of ours. A lot of their growth is coming from -- they're all selling into data centers and selling into the hyperscalers. So we got that piece, which is a great -- including the EMS providers, one major one that's here at the conference as a matter of fact, it's a big part of their business, and they're having great success. Well, they're big customers of ours. So as they service it, we're servicing them, that's a benefit. And then the third, the real benefit, I think, is going to come for us anyway is the enablement that AI is going to drive into the edge, okay, edge computing, okay, into sensors. I mean just think about smart buildings, I mean, smart medical, the rings people like.

I can't get wait to get a ring for Christmas. It's on my list.

My daughter is still -- but everything is kind of going that way. And this is going to just time that by 10, the enablement. And that's all of our -- and I can't start naming suppliers, because I miss one and then I'll get in trouble. But we have the best line card out there for microcontrollers and microcontrollers are on the edge. So I look at those 3 vectors. So it's a great opportunity for us. As far as POCs or proof of concepts and applications, we've got a bunch of them going. I just heard the previous presenter, it's all about the data. So the data is not right, you're going to have problems on the edge in AI. So we've got a bunch of proof of concepts going. We actually have already implemented some of our supply chain areas. It's a great opportunity for us. We take in thousands literally of customers' forecast and MRPs on a daily, weekly, monthly basis via EDI, API, they can still fax it to us if they want. Then we got all the supplier data coming in. How can we make better use and intelligence and turn data into actionable information is one opportunity. We have major call centers, multiple around the world. And the #1 call we get is where is my parts? Like where are my parts, expedites. AI is an application there that we can start using. So I would just caution, and I'm not saying that everybody doesn't know already is you just got to have a discipline, because the applications are endless, and it could also cost you a lot of money and not get you any ROI. So I think we have the right pace. We're right where we need to be from the application. I just need to pick and choose carefully. Anything you want to add on that?

Yes. I mean I just think there's -- how do we make it easier for our customers to do business with us as well as how do we provide our technical resources more capacity through the use of AI. So I think there's lots of internal applications we can use in addition to some of the business we're doing actually selling parts into the AI phenomenon .

Engineering Solutions. -- for example, a lot of it can be done, maybe not finished, but started there. It's exciting. It's crazy. I mean, it's scary, crazy, fun, exciting. Go ahead, I'm on the back line. It's going to get scary. It is going to be interesting.

You've lived through all the cycles. I think you're well equipped to handle this one, too. So let's take a second to see if there's any questions in the audience.

Yes, there you go. Sure. .

And we'll have to give it one second just so we can make sure it gets recorded on the webcast. The microphone is coming.

Just given your exposure to industrial markets, can you talk about -- from our side, we look -- we've seen the large investments by different Chinese companies in lagging edge technology. Can you help us understand like how to parse that in terms of the impact on your sort of -- on your markets of these investments? And how does it impact your suppliers? How does it impact your customers? Are you making any changes to adjust for this other supply that's become available? Because as you say, this isn't a cycle like any other cycle, and that factor is obviously one of the factors.

Was it a Chinese semiconductor manufacturing about?

Just when we look at how much CapEx has gone into China and how much of that is for lagging edge semis. And given that industrials tend to use more of lagging edge semis and some of your other markets, it's like from our side, it's very difficult to sort of try and figure out like how that plays out over time? How much of it has played out? Just anything you can sort of...

Yes, that's a great question. And that's happening. There's no doubt that the Chinese investments, and I'm sure some of the semiconductor guys that are here can probably answer that even better than I can, the amount of capacity that they're putting in, you're right, on the lagging edge technologies, where a lot of the investment in the last x number of years have been leading edge, okay, which is going to -- which for sure, we see this, particularly in the industrial market, you're tying to industrial, medical, defense, aero, they don't do -- I can bring my phone. They're not respinning designs and manufacturing something new every 6 months, 18 months, they're 5 years, 10 years, 15 years. So China is doing, it's going to be interesting to see how that plays, not just for China, but for the rest of the world. Right now, their exposure to the rest of the world from my vantage point, is minimal, like in chips, if you will. But is that going to change over time? And that's not for me to answer. I would think it would, but over time, not anytime soon, but it will over time. But yes, this is going to be an issue, and it's going to be -- I think it's going to become a long pole and intent down the road for the industrial, medical, defense, aerospace that have these long 10-, 15-, 20-year manufacturing cycles. They need that lagging edge technology. Now for us, I guess, selfishly, it's an opportunity for us because we manage supply chains. So how can we help our customers, whether it be buffering or what have you or end of life with products to help them support their manufacturing needs over a longer period of time. So I think it's going to be interesting to see how this all plays out, but there's no doubt that China is going to be a player. I mean they are a player. And maybe through different things that we've done in the West, we've accelerated their progress, okay? But they're definitely for real, and they're definitely investing quite a bit in that capacity.

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Yes, that's -- you're right. It's definitely -- I think it's a secular movement as well. And we'll just have to see how the balance of manufacturers respond to that, too, right? And I think I got some of my peers here from our suppliers. Competition makes us better, right? So we just got to talk a couple of analysts about that, a couple of shareholders. I mean, so they're not going to stop it, but how can we compete with that.

I'd also point out that the capacity is still coming online. It's not fully ramped. I still think it's going to be several years before all of that investment really becomes -- the utilization goes up, so we'll continue to monitor.

It's a very good question.

Any other questions? All right. I think we're going to move on to Ken and some financial questions specifically. So obviously, for either of you, everyone to jump in. But can you remind us of the countercyclical nature of your balance sheet, touch on working capital management, the company's needs to support components growth? And then what are your thoughts on working capital requirements over the next few quarters and of course, free cash flow? .

I think we talked about a little bit about the business model is, one, when things are tough, we tend to spin off a lot of cash, right, which we can then reinvest in the business and buy back shares and be opportunistic with. But when we're growing, typically, you had to invest in working capital, primarily inventory and then accounts receivable to support customers' needs. And where I'd say we're at right now is inventory is higher than we'd like it to be. There's some pockets of excess we still need to work down. And so -- we think in the near term, we'll get into the 80s in inventory days and then eventually a 7 in front of it. But I think as we look at the prospects going into next quarter and then the rest of our fiscal year, we feel good about our overall working capital position that there's not going to have to be a lot of investment to support growth in the near term. And then when it comes to other uses of cash, we will have some light CapEx to invest in some of the digital tools and capabilities that Phil has mentioned. But for the most part, the free cash flow we generate we'll have opportunity to buy back more shares, although in the current state of where we're at with the balance sheet, our leverage is a little high. So we're going to focus on reducing leverage to a more appropriate level just to maintain the strong balance sheet -- but at less than $50 a share, we feel the shares are highly attractive. And we also have a dividend that's been increasing quarterly, so we support the dividend every quarter on top of buybacks.

So we have 2 minutes left. I'd love to end on talking a little bit about your most recent earnings call, and I know you gave some financial outlook and just some general outlook on 2026, what's ahead and what you're excited about? Let's end on a positive note .

Maybe I'll take the guidance and you can take the what we're excited about. I think our guidance for the December quarter was encouraging is the word I would use. And why I say that is because although the growth was only roughly 2% quarter-over-quarter, the EPS guidance is roughly 12% increase, right? And so what that means is you're starting to see a little bit of uptick not only in Farnell, but also in the Americas, which is our higher-margin regions, and you can start to see the operating leverage come back. So we're encouraged about the guidance in terms of -- we're starting to see that return to growth in both Farnell and the Americas. We think Europe is closely behind there. And so as we usually get into our March quarter, which is our seasonally strong quarter for not only Europe and the Americas, but also Farnell, we would expect to see overall gross margin uptick, which then creates even more operating leverage, all things being equal. Phil, what do you think about 2026?

Yes. We don't give guidance for the year. If I can give you a feel, and I think I already did. We're really feeling very good about the current quarter. We're feeling good about the book-to-bills. We're overusing the word probably encouraging for obvious reasons. So just said there's so many still uncertainties out there. You don't know what could happen tomorrow. I mean you didn't mention tariffs. Thank you. But a tariff change, a geopolitical situation, it's pretty tenuous out there. That aside, we feel very positive about the outlook. And to Ken's point, we're positioned well. We manage our expenses down well. We didn't overdo it, because we wanted to be sure we were ready for the upturn. So we get asked questions, how much you have to invest back in, there's an upturn. Not much, variable comp, which is commissions, warehouse logistics, more labor. We don't -- that's it. So the beauty of our model is when the top line comes, it drops to the bottom pretty quick. So I'm feeling really positive about where we're at and the position we're in the market.

Awesome. Well, I'm excited. I hope this was a good conversation for you all. And I really, really appreciate you joining us here at NASDAQ for the conference. .

Thanks so much. We appreciate it.

Thank you.