Avnet Inc (AVT) Q2 2022 Earnings Call Transcript

Please standby. Our presentation will now begin. Welcome to the Avnet Second Quarter Fiscal Year 2022 Earnings Call. I would now like to turn the floor over to Joe Burke, Vice President of Treasury and Investor Relations for Avnet.

Thank you, operator. Earlier this afternoon Avnet released financial results for the second quarter of fiscal year 2022. The release is available on the Investor Relations section of the company's website. A copy of the slide presentation that will accompany today's remarks can be found via the link in the earnings release as well as on the IR section of Avnet's website. Lastly, some of the information contained in the news release and on this conference call contain forward-looking statements that involve risks, uncertainties and assumptions that are difficult to predict. Such forward-looking statements are not a guarantee of performance and the company's actual results could differ materially from those contained in such statements. Several factors that could cause or contribute to such differences are described in detail in Avnet's most recent Form 10-Q and 10-K and subsequent filings with the SEC. These forward-looking statements speak only as of the date of this presentation and the company undertakes no obligation to publicly update any forward-looking statements or supply new information regarding the circumstances after the date of this presentation. Today's call will be led by Phil Gallagher, Avnet's CEO; and Tom Liguori, Avnet's CFO. With that, let me turn the call over to Phil Gallagher. Phil?

Thank you, Joe and thank you, everyone, for joining us for our second quarter fiscal year 2022 earnings conference call. I hope your 2022 is off to a great start. As many of you are aware, our priority since I took the helm has been to make durable changes to our business that would yield more consistent results, drive sustainable growth and position us to capture share across regions and segments. I am pleased to say our team's focus on execution has yielded strong competitive gains and financial performance which is again evident in our second quarter results. In the quarter, revenues were $5.9 billion, up both sequentially and year-over-year and our adjusted diluted earnings per share was $1.51. Our adjusted operating income increased 21% from the prior quarter and our adjusted operating margin also increased sequentially to 3.7%. We are competing favorably across the board but we're particularly pleased to see further evidence that Farnell is a needle mover for total Avnet. Looking at our core Electronic Components business on Slide 5. Revenues were up both sequentially and year-over-year in the quarter and we posted sequential growth across all 3 geographic regions. EMEA and Asia delivered solid results, while we saw a nice rebound in our Americas region which was up double digits year-over-year. We were pleased with the Americas team's ability to maintain expense levels while capturing significant business opportunities from new customers and expanded scope of work from existing customers and that will be critical to continued success in the region. We're especially excited about the prospects for the region as 23-year company veteran, Dayna Badhorn, takes the reins as the new President of the Americas. In her prior positions at Avnet, Dana has served in sales management, supplier management and customer technical support and most recently, as our strategy leader, where she played an integral role in identifying growth opportunities to enhance Avnet's overall business portfolio. We are confident she will leverage her breadth of knowledge in guiding the Americas team to capture market share as well as new and expanded business opportunities with existing customers in the future. Our book-to-bill ratios at the end of the quarter remained strong. Lead times remain extended with certain products like microprocessors, microcontrollers and power continue to have extended lead times. We experienced continued strong demand in key verticals such as automotive, industrial, defense, communications and health care, pretty much across the board. We continue to tightly manage our backlog and we're satisfied with our inventory levels which increased later in the quarter, primarily to support past dues and firm orders. It should be noted that investment is usually made in the December quarter to support the traditionally strong start to the calendar year in the Western regions. Further, our continued investments in digital and design tools and field application engineers are paying off as demonstrated by another strong quarter of design and engineering activity across all regions. Strong levels of design registrations and wins in prior quarters resulted in record demand creation sales and gross profit in the current quarter. Turning to Farnell on Slide 6; sales were up 35.3% year-over-year to $441 million with notable performance from Farnell's Americas business. We continue to execute on our commitment to our Farnell segment. We added over 22,000 SKUs in the quarter which gets us to about 55% of the way toward our plans to add up to 250,000 SKUs through the fiscal year 2022. Supplementing our inventory investments, we're continuing to enhance and invest into Farnell's e-commerce capabilities. In the second quarter, 54.5% of total sales and 71.5% of total transactions were placed through Farnell's e-commerce platform. With additional critical updates to the platform and sustained investment in improving the user experience, we expect we'll continue to see increased traffic and new customer acquisitions in the quarters to come. In summary, we're pleased with our performance in calendar year 2021 and feel that the business is well positioned to weather macro challenges and continue to capture exciting new opportunities heading into 2022. Our incredible employees have demonstrated their strength and commitment to the business and our customers over the last year and I'm confident in our team's ability to achieve even greater success in the quarters to come. With that, let me turn the call over to Tom to report on the financials for the quarter. Tom?

Thank you, Phil. Good afternoon, everyone and thank you for attending today's call. As Phil stated, we are pleased with our results this quarter. I am encouraged by our momentum as we head into the second half of fiscal year 2022 and I'm excited to share some highlights from the second quarter. Turning to Slide 8; our revenues of $5.9 billion and adjusted EPS of $1.51 both exceeded guidance. Consistent with our objective of growing higher-margin businesses, our Farnell revenues grew 35.3% year-over-year, while Electronic Components grew 24.9%. Our gross margin improved to 12.2%, while our adjusted operating expenses continued to decline both as a percent of sales and as a percent of gross profit dollars. Our adjusted earnings per share of $1.51 is a company record and provided a return on invested capital of 12.5%. Narrowing in on our two operating segments; year-over-year Farnell revenues grew 35.3% to $441 million and Electronic Components grew 24.9% to $5.4 billion. We continue driving operating margin growth, posting operating margin of 3.5% for Electronic Components and 13.7% for Farnell. Solid execution in our core business and continued progress with e-commerce and expanding inventory breadth in Farnell remain key priorities and were critical to our achievement of an adjusted operating margin of 3.7% for total Avnet in the quarter. Moving to the second quarter income statement on Slide 10; gross margin of 12.2% was up from 11.8% last quarter, primarily due to sequential margin expansion in Farnell as well as strong pricing in all businesses. Compared to the prior year quarter, gross margin improved by 121 basis points. Adjusted operating expense of $498 million were up $17 million or 3.5% sequentially, primarily driven by costs associated with higher volume. As a percent of revenue, adjusted operating expenses declined to 8.5% from 9.3% in the prior quarter. On the non-operating front, interest expense decreased $1.2 million sequentially to $21.6 million. We recorded foreign currency transaction losses of $3.2 million which represents an improvement of $2 million over the prior quarter. We booked a 23% adjusted tax rate in the second quarter, the high end of our guidance range. On Slide 11, we highlight results across our Electronic Components segment. Sales growth across every region, Americas, EMEA and Asia, contributed to the 24.9% year-over-year sales growth to $5.4 billion in the quarter. As Phil noted, we were especially pleased by our performance in the Americas which grew sales double digits year-over-year and is poised to sustain solid growth in the seasonally strong third quarter. Our Electronic Components operating margin of 3.5% improved 31 basis points from last quarter, with all regions contributing to the sequential improvement. Turning to Slide 12; Farnell achieved another solid sales quarter with revenues totaling $441 million. Farnell's operating margin increased 276 basis points sequentially to 13.7%. The Farnell team continues to improve the business through investments in SKU expansion, e-commerce capabilities, our online engineering community and new product introductions, all major contributors to sustainable operating margins. Turning to cash, liquidity and the balance sheet on Slide 13; we increased receivables and inventory in the second quarter as customer demand remains strong. Our liquidity position remains solid with cash and equivalents of $168 million and $1.5 billion of available lines of credit. Our gross debt leverage was 1.9 and net debt leverage was 1.7. The cash outflow of $232 million was primarily the result of an increase in accounts receivable from higher sales as well as inventory which we secured late in the quarter. We anticipate a positive cash flow in the third quarter as we collect our accounts receivable and maintain our control of inventory and payables. Turning to Slide 14; we repurchased 921,000 shares in the quarter and our dividend of $0.24 is a 14% increase over the prior year. We remain committed to increasing shareholder value by delivering a reliable and increasing dividend, opportunistic buybacks and investments in both organic and inorganic growth. Let me wrap up on Slide 15 with guidance. Our third quarter guidance today assumes ongoing strong demand, continuing supply constraints and COVID restrictions similar to the December quarter. For our fiscal Q3, we are guiding revenue in the range of $5.4 billion to $5.8 billion and adjusted EPS in the range of $1.45 to $1.55. In summary, we remain committed to excellent execution in our core business, continued growth and margin expansion in Farnell and reliable shareholder returns. With that, I'll turn it over to the operator for questions and answers.

Our first question is from Nik Todorov with Longbow Research. Please proceed with your question.

Thanks and good afternoon, guys. And congrats on great results and execution. Phil, a couple of quarters ago, you talked about how you see the current conditions sustainable at least through the March quarter. We're at the March quarter now. Can you give us an update how you're thinking about the sustainability of those conditions? And related to that, are you seeing any changes in customer behavior recently?

Yes. Thanks, Nik. I did say that a few quarters ago and it looks like I was right, at least to date. We'll continue to see strong demand, Nik. And while it's obviously difficult to forecast how long the supply constraints and the high demand will last, most of the market participants, including our suppliers, think it's going to extend well into the calendar year. So we guided through March. It definitely feels like it's at least going to be pretty solid through June and then we'll take it from there. There are a lot of variables, right, as we outlined in the script. But as we see it right now, the bookings are strong, backlog's strong, demand's high, and products are still pretty extended on lead time.

Okay. Second question, you guys have achieved the near-term margin targets that you gave several quarters ago. How should investors think about the next near-term margin targets as we go forward?

Sure. In the near term, we expect margins to remain in the high-3% range, around 3.7%, similar to this quarter, for the foreseeable future, including March and likely June. Looking further ahead, one to two years from now, assuming a growing economy, we are currently investing in our core business, specifically in Farnell, focusing on SKUs, e-commerce, and online community enhancements. Therefore, we believe we can exceed 4% in the mid to long term. Achieving this will also depend on our ability to grow higher-margin businesses at a quicker pace than our base distribution business, as demonstrated by Farnell. With Farnell’s performance exceeding 13%, we commend the Farnell team for their excellent work. They are now competitive with the Americas, and if we can expand margins more rapidly, our investments alongside the growth of Farnell will enable us to achieve our long-term goals.

Okay, great. And speaking of Farnell, sequentially, it seems sales were down. But obviously, margins increased quite nicely. Can you give us the puts and takes between that dynamic in Farnell in the quarter?

Yes. Part of the sequential revenue, I think it was 3%, is a very slight decrease. That was mix. That was a single board computing and that's a product that we had shortages in. So there were some lower revenue, could also contribute part of that to seasonality. But that said, the mix of business was higher margin. The gross margins expanded, to be honest with you, several hundred basis points. They did a very, very good job with pricing, mix, management and things of that nature. So those are the puts and takes. Phil?

Yes. No, I'll just add to that. Thanks, Nik. And year-on-year is 35% growth. So we were really pleased. But I'll highlight the seasonality aspect of it, particularly in Europe which is our largest piece of the Farnell business. Europe does tend to shut down a bit more firmly, if you will, than the other regions in December. So with the concentration mix of Farnell in Europe, we expected that.

Got it. Thanks, guys. Good luck.

Thanks, Nik.

Operator, is there another question on the line? Hello?

Hello, everybody. Give us a minute while we check with the operator.

Hey, this is Nik. Can you guys hear me?

Yes, Nik. You can move around.

This is Avnet, we can hear you.

Yes, I’m here on the call. It seems my mic is still on, but I'm not sure what's happening.

I apologize for the technical difficulty. One moment and we will resume the question-and-answer session.

All right, Nik. We'll catch up with you later then, Nik.

Okay.

Thank you. Our next question comes from Melissa Fairbanks with Raymond James. Please proceed with your question.

Hi guys, great quarter. Really strong margin performance in both businesses, very impressive results overall. Last quarter, you guys mentioned that pricing was a 200 basis point tailwind in Farnell. Just wondering how much benefit you saw in the quarter in the December quarter. And then also, typically, you're able to pass through higher costs on the Electronic Components side. Just wondering if you saw any margin benefit there as well or if that was just kind of the benefit from mix?

Yes. So pricing benefited across the board, good pricing discipline. Farnell, if you took out the benefits of the market, including pricing, about a 9.5% to 10% operating margin which is slightly ahead of where we expected them to be by this time but things are going very well. And the good news is on the 9.5% to 10%, there's plenty of roadway ahead to continue to improve that.

Yes, Melissa, I want to add regarding the overall price increases. We have customer contracts where we are passing those increases on as quickly as possible. It's important to note that over 50 suppliers have raised prices multiple times in the past year. However, we are not seeing much increase in margin percentage, just in dollar amounts from an average selling price perspective for those parts. There are competitive pressures in other products, making this a general statement. There may be opportunities to increase margins where we do not have contracts, but typically, we just pass the increases on to the customer where we do have contracts.

Okay, perfect. Great. As a follow-up, I'm just wondering it's pretty clear the industry is starting to better understand the value of supply chain partners. Just wondering if you see any opportunities out there emerging for some inorganic growth or maybe different areas, different markets you might be able to address organically?

We're definitely seeing both customers and suppliers recognizing the value of what we offer from a supply chain perspective. There is a noticeable increase in awareness and interest from customers who are working with us, looking to deepen their engagement. Additionally, we've noticed larger customers and suppliers, who may not have used our services before, are now involving us in their supply chain efforts. We refer to these customers as supply chain architects, as we are in the process of developing new supply chains together, which takes time and may not yield immediate results. However, we are also seeing large OEMs that were not traditional users of our services starting to engage with us. We consider these opportunities as organic growth, and they are significant and promising.

Excellent. Great. Thanks very much, guys.

Thanks, Melissa.

Thank you. Our next question comes from Matt Sheerin with Stifel. Please proceed with your question.

Yes, thanks. And hello, everyone. Phil, just another question, if I can, regarding the pricing environment. Is there a way that you can tell the growth rate, that 20% plus year-over-year growth rate that you saw in the business, how much of that is related to just the pass-through of higher ASPs which have been pretty broad? Do you have any sense of that?

Yes. We will continue to evaluate that, Matt. Currently, the best estimate we have is a few percentage points. It's not as significant as some might think. The reason is that within a supplier's portfolio, they may be increasing prices in certain areas while not doing so in others. Additionally, there are products we offer where prices remain unchanged and are either flat or competitive, meaning we still need to secure that business. Overall, the situation averages out to show more demand than inflation impact. We can estimate it to be around 0% to 3% at this stage. We are still analyzing this further.

Okay. And then you talked about the margin tailwind that you're seeing from Premier Farnell on the premium pricing. Are you getting a sense of that benefit in the core business as well? I mean margins obviously are up significantly year-over-year. How much of that is attributed to just favorable pricing and less typical price competition that you normally see?

Matt, so on the core side, 20 to 30 basis points. So it's much more pronounced on the Farnell side.

Okay. And then, Phil, just a different question just regarding the whole supply environment. It looks like you were able to produce some significant upside. So you're able to get your hands on components. You talk about some building inventory late in the quarter. But still a lot of your customers, including some big EMS guys, are missing numbers and guiding down because they can't get parts. So are you still seeing a mismatch of parts? How are you helping your customers manage that so that there's not an inventory mix and negative mix? And any signs of when this starts to ease at all?

That's a great question. I want to acknowledge our asset and procurement teams who are doing an excellent job, and our supply chain team is collaborating effectively with our suppliers and customers. We're handling thousands of MRPs weekly and monthly, attempting to balance all the SKUs with the demand and supply situations. The team has performed remarkably well. I'm still actively engaged with several customers in the OEM and EMS sectors addressing urgent needs. I understand there are certain chips that are unavailable, which is impacting some of them from meeting their targets. I recognize the issue you're highlighting. Looking ahead, it's challenging to predict. Currently, as I review the lead times, there hasn't been much improvement across various components, including ceramics, microcontrollers, and power devices. This situation is quite widespread. The demand remains very strong, and in some cases, we are working in a very reactive manner. Overall, the situation is robust across the board, with nearly every vertical experiencing high demand, which intensifies the challenges with many technologies involved. I can say that the more we collaborate with our customers from the beginning, the better visibility we gain. With the efforts of our supply chain team, we'll continue to do our utmost to support them.

Okay, great. And just lastly, you talked a couple of times about the margin expansion you're seeing in North America components, where I know that over the last three or four years, it's underperformed other segments because of some prior issues. How much progress have you made there? And at what point do you expect that to get to kind of the corporate margins or above?

Matt, they made a big lead this last quarter and it's very promising. More to come in the March quarter from Americas. And when would they get to where we expect? I would say, four to six quarters.

No, I think that's right, Tom. Yes, we've been very transparent with that, Matt. The two main contributors for us are Farnell and the Americas. Europe and Asia are more about maintaining our current course. In terms of progress, they are probably about 55%, 60%, or 70% of where we need them to be. We have a plan to reach our goals in four to six months. Farnell is also doing well but still has some room for improvement in Chris Breslin's area, and they have really made a significant impact.

Okay, sorry. Thanks a lot.

Thanks, Matt.

Thank you. Our next question comes from Ruplu Bhattacharya with Bank of America. Please proceed with your question.

Hi, thanks for taking my questions. Phil, could you share your perspective on the overall inventory in the channel? I'm interested in your views on your own inventory as well as the distribution and inventory at OEMs. Do you think there's any inventory buildup, possibly in Asia? Overall, do you believe the inventory in the channel remains relatively lean without substantial buildup yet?

Yes, that's an excellent question, Ruplu. I wish I could see everyone's inventory exactly, but unfortunately, I can't. I'm sure there is some buildup out there, but it's challenging to determine the extent and location of it. Regarding our inventory, we are quite satisfied with our current position, which is positive, as we highlighted earlier in our access. Our inventory situation is clean. We monitor inflated bookings and forecasts as they come in, looking for any buildup. Our asset and supply chain teams are proactive in identifying excessive purchasing patterns compared to typical forecasts, and we address those situations directly. However, when it comes to Avnet, we currently do not observe excess inventory relative to the demand. It’s hard to make definitive assessments about what's happening in the market, especially with some customers facing component shortages that may delay their products. I acknowledge there could be some of that happening, but it's tough for me to make a clear judgment.

Okay, I understand. Phil, you mentioned a while back regarding Farnell that you aimed to reach 250,000 SKUs by the end of fiscal '22. I'm curious about your progress on that. Do you need to hire additional salespeople or field application engineers? How should we consider the SG&A and OpEx costs?

Yes. Regarding the SKUs, we are approximately 55% to 60% towards our goal. Part of this expansion relies on product availability; we might have items in backlog that are not yet shipping. We are monitoring this with Chris and the asset teams in Farnell, and we are satisfied with the progress. Some of the results are already visible, and we acknowledged the contribution of the Americas Farnell team, which often doesn't receive much attention; that's the Newark team. They are expanding SKUs and experiencing growth in components, particularly in MRO and test and measurement, which is encouraging. We are on schedule to meet our objectives, and if we can speed things up, we will, as the outcomes for Farnell are very positive. Regarding account managers and field application engineers, that’s mostly a question for the core team. Although Farnell has a sales team, they have limited field application engineers as typically defined. They are sufficiently staffed from a sales perspective. We continue to invest in the core team, with authorization to enhance account management and field application engineers. We believe our staffing is solid and will continue to hire as necessary. Additionally, a significant amount of traditional technical support will come from digital resources, and we are increasing our investment in digital design support alongside the field application engineers.

Got it. I'm going to try and sneak one more in and I apologize if you've already addressed this. But are you seeing your suppliers continue to raise prices? And at some point, do you think some of that pricing has to come down? And if it does, in some time in 2022, how quickly would you have to pass those savings on to your customers? Is there a delay? Or do you think pricing can remain elevated over the next couple of quarters?

That's a good question and it's difficult to answer. Firstly, yes, we are still experiencing price increases from suppliers. There are significant additional costs in the supply chain from fabrication, wafer production, logistics, plastics, and chemicals. As suppliers incur these costs, they will continue to pass those increases along, and we will do the same. Regarding corrections based on supply and demand, we will have to see what happens with average selling prices this time around. It's uncertain whether they will decrease as they have in the past. While some reduction is possible, the extent and speed are hard to predict. We will stay competitive in the market, and if adjustments to our resale prices are necessary in light of reduced costs, we will be transparent with our customers, who are well-informed about the situation. We have strong, long-standing partnerships with them, and we'll collaborate on this. However, I believe this scenario is still a bit away.

Okay. Thanks for all the details. Congrats on the execution. Thank you.

Thanks, Ruplu.

Thank you. Our next question comes from Jim Suva with Citigroup. Please proceed with your question.

Thank you. And now that we've been through this pandemic for two years now, I'm wondering if your suppliers, the chip companies have talked to you about different agreements, whether it's you hold more inventory, you hold more buffer for them, risk mitigation for future shocks, any of that going on? Or is it just still right now kind of fork-to-mouth selling stuff as quickly as you can? I was kind of wondering, structurally, if there's any thoughts about adjusting what you get paid and what you hold to prevent risks in the future.

Yes, we're definitely having different conversations with suppliers. It's not just suppliers; we are also engaging with OEMs and customers. In some instances, they are taking us along to their end customers to help reassess their supply chain and evaluate how they're managing buffers. The just-in-time approach has sometimes gone too far, leading them to reconsider their strategies. We're definitely seeing discussions about longer-term agreements with suppliers, and we're involved in these conversations with customers. The dynamics are changing, and while I can't predict how dramatic it will be, I believe some changes will be lasting. As we establish new arrangements with suppliers and customers, I see this as a positive development. We are starting to play a role in orchestrating supply chains, providing command controls, and helping everyone gain better visibility into market conditions. Some companies seem to have lost track of the visibility regarding their manufacturing and the supporting supply chains, but we view this as an opportunity for improvement.

Thanks so much. Thank you.

Thanks, Jim.

Thank you. There are no further questions at this time. I'd like to turn the floor back over to Phil Gallagher for any closing remarks.

Thank you very much for joining the call and for your questions. I appreciate everyone attending today's earnings call, and I look forward to speaking with all of you again before our first fiscal third quarter earnings report in April. Have a great rest of the week. Thank you.

Ladies and gentlemen, this does conclude today's conference call. You may disconnect your lines at this time. Thank you for your participation.