So, good morning, everyone, and thanks for joining us today, and thanks for your interest in Avnet. Just a little bit about Avnet. We're, as some of you may know, if you don't, we're, we serve an important point in the technology supply chain. You know, we connect the technology with the main manufacturers of electronic components to the ever-evolving needs of large OEMs, contract manufacturers, large corporations around the world. And, you know, we do this through a great global footprint. You know, in our business, scale and scope is key to the business. And, you know, we are able to reach, ship into 140 countries around the world. You know, we have 250 office locations.
We have 15,000 employees around the world, and we have engineers that help our customers design new and ever-changing applications into their production needs. So, you know, we have been doing this for a while. This isn't new to us. We've been in the business since 1921, so we've been in this game for over 102 years.
Excellent. Great. So I definitely want to focus more on the longer-term, you know, kind of dynamics of the business, but I think it would be helpful to review some of the more recent trends or near term, what you saw in the December quarter, what you're seeing in March. You know, I know a lot of investors kind of use you as a channel check, for lack of a better term, but you know, you've got bird's eye view into a very broad-based supplier base and customer base, so I think that would be helpful to review.
Sure. Our second quarter, which ends in December, it was largely as expected. You know, sales were down year-over-year, approximately, you know, 7 or 8%. We saw, you know, all regions contribute to that. Asia was down about 10%, the Americas down, you know, roughly 6%, and EMEA down, you know, around 8%. But, you know, underlying demand still was holding up pretty good. We started to see some weakness in the industrial segment, specifically in Europe, but markets like aerospace and defense in the Americas, as well as transportation. Overall, we define, you know, automotive as broader than automotive because of all the applications, and golf carts, e-bikes, you know, trucks, all kinds of things have electronics in them besides just, you know, autos. You know, that demand was holding up pretty good still.
So mixed across our end markets. You know, our guidance for the third quarter, which is the March quarter, you know, was roughly down 7% or 8% as well from the December quarter, you know, and largely more of the same demand environment. You know, that's below seasonal for us. Typically, in the March quarter, we would see growth in the West, followed by, you know, shrinking in Asia due to the Lunar New Year. So we saw the impact of the broader demand is starting to impact the West, where that was generally holding up over the past several quarters.
So still think, you know, the underlying demand is still reasonable. You know, clearly working on inventory. I'm sure we'll get some questions on inventory.
Oh, yeah.
You know, we generally feel really good about our position with our supplier partners, our customers, even though kind of demand's down, really well positioned to capitalize on the secular growth we see in the semiconductor industry here over the next few years. You know, to remind everyone, we're very diversified, so we don't have any real concentration of end markets. You know, industrial is our biggest. It's the long tail. It's very broad-based. Transportation is very big for us, aerospace, defense. We also can participate in consumer and communications kind of markets, but think about industrial, transportation and aero defense being, you know, roughly 50% of our business.
We've seen across your supplier base kind of a rolling correction going on over the past, you know, couple of years. Obviously, consumer PC was among the first to recover, you know, more recently, you know, industrial, because it's so broad-based, we've seen a couple of waves of correction, and now maybe a little bit of a correction in the auto space. Are you seeing the same trends that a lot of your suppliers are also seeing in those end markets?
It's interesting because it's hard to triangulate us versus what any one of our suppliers says. Every supplier is different. Some are saying transportation is great for them, and they see the good outlook. Others are saying, you know, it's down, you know, 20% +. So I do think we are a snapshot of the broader semiconductor industry. You know, we have a very varied line card. So think about all the top semiconductor companies, we typically participate, you know, in selling their products. So very broad-based, but every company's a little different, and every company's, you know, inventory or customer's inventory situation is a little different.
Different suppliers had different timing when they started to, you know, soften some of their stances on, you know, required purchases and as lead times came in and things like that. So everyone's a little bit different position there.
So I think that's why you're seeing the mixed results. But in general, I'd say, you know, we're generally seeing what they're seeing, you know, but, but it's not any one, end market that sticks out. But, but we're clearly seeing benefits on softening of the policies, the lead times coming in, you know, the inventory inputs are coming down for sure. Now it's working through the, the end inventory with our customers.
So I guess a year ago, when we were sitting up here, you know, we were still kind of in the middle of some supply chain crises, where some of the supply was, you know, we saw some easing a year ago, but there was a lot of tight supply. Maybe, you know, just briefly discuss what you're seeing in terms of, you know, broad-based supply availability, your ability to ship to customer demand and what those trends are looking like.
Well, I would say, you know, lead times have come down as a result. You know, inventory has, you know, started to come in a little bit more, and as a result, you know, we're working our best to get that inventory out to the customers. Customers have ordered it, you know, perhaps not ready for it now, but, you know, we, you know, it's still inventory is there, but the lead times have come down, but they're still above the pre-pandemic levels, I would say. So, that's important to note.
Yeah. I'd say just lead times are pretty stable right now, still elevated relative to pre-pandemic levels. You know, and we don't necessarily see that changing in the near term, but, you know, clearly more predictable of when you order a product, when you'll get it. And some of these really extended lead times, we don't see a lot of products that have, you know, that out there. There's still some parts that are, you know, hard to come by, that we're still chasing a little bit. But I think that's maybe back to a more normal level, that you always had some of that in the past.
Yeah. I love the CEO, Phil Gallagher. He uses the term: You serve as the shock absorber for the industry. You kind of, you know, are in between the suppliers and your customers, and I think that's, like, the perfect description. So, moving on to some of, like, the longer-term trends, maybe talk about your margin targets, how you think about return on invested capital, where you expect the model. First, I think it would be helpful to say where you were, because this industry has definitely kind of become a far more sustainable, far more predictable generator of returns. But discuss where you're kind of heading and what's going to drive that.
Yeah, I mean, I think the current snapshot is, you know, broadly speaking, you know, we're a 4% operating margin business. We've got pockets of our business that can run double-digit operating margins, and, you know, and, and the core business is, is you know, a little bit north of 4%. The trailing twelve months is, like, 4.3%, just to give you some context. And so a lot of the, you know, claim to fame with our business is scale. You know, as a distributor, we can really leverage top-line growth to expand operating income and, and operating income percent, and that's what you've seen over the past few years.
We had a couple unforced errors, but if you look at the kind of growth from FY 2019 to this last year, normalized for some of the loss of business we had, it's, it's, you know, pretty robust, double-digit growth. And, you know, some of that was attributed to pricing of the ASP inflation we attributed in fiscal 2021 and 2022. About 25% of our growth was attributed to, you know, ASP inflation because of the input costs going up, but, but the rest was just organic growth. And so, you know, we feel that's the good roadmap for the next 5 years of, you know, scale the top line, you know, compete well for business, and then, you know, manage our operations effectively, like we have been able to do.
We don't have to add costs every time we grow the top line, and so we can kinda continue to create operating leverage. And so, you know, we think about our model being, you know, mid-single digit growth when the kinda market recovers and, you know, stable gross margins. You know, there's gonna be puts and takes on our gross margin. We've got higher gross margin type opportunities we'll talk about a little bit later, but there's clearly gonna be competitive pressures on margin, like there always is, whether it's our competition or whether it's, you know, broader industry kind of pressures on gross margin. But I think we can keep a stable gross margin, and we keep an effective cost base, continue to focus on execution, operational efficiencies, you know, digital tools and capabilities.
We think longer term, you know, we can get a 5% operating margin and kind of go from there with, you know, our Farnell business running, you know, greater than 10% operating margin. Return on invested capital, you know, should be in the mid- to high teens, with a return on working capital, you know, higher than that.
I would just add that, you know, as we think about the opportunities for us, you know, the markets that we serve, the way we look at it, you know, including certain types of memory product, DRAM, things like that, it's roughly $500 billion for FY, for calendar year 2024, it's roughly $533 billion-dollar total addressable market. We think there's plenty of opportunity for us and others as well. But, you know, where we are today, we look at, you know, some of the growth in the end markets that we serve, notably, industrial, transportation and defense, and these are some of the highest, CAGRs that you see out the next 3-4 years of mid to high single digits.
So we feel good about our ability to grow that, to scale up and to get the benefits, as Ken mentioned, of leverage as we grow.
I mean, going to your capital allocation priorities, I mean, I think we are definitely interested in returning more cash to shareholders. We have a dividend that's been growing. You know, our CapEx is pretty manageable relative to the free cash flow we should generate. So, you know, we have a lot of cash trapped on the balance sheet in the form of inventory that we're working down. But absent that, you know, we've generated cash flow in the past, expect to generate in the future with those kind of growth rates, and that should deliver lots of excess capital to buy back shares.
We're currently trading at, you know, below tangible book value, 20% below book value, so we definitely feel it's an attractive share price, and you know are gonna put some capital into share repurchases as we start to generate free cash flow in the next upcoming quarters.
Excellent. Excellent. That's what we all want to hear. I'm just curious, do you think the past few years, this whole supply chain disruption that we went through over the past few years, has it permanently changed the way that distributors are used, just from a fundamental standpoint? Are your customers looking at distribution a little bit differently? Are your suppliers looking at distribution a little bit differently? And do you think some of these changes, you know, are going to stick?
Well, we think there's a new, a new appreciation or renewed appreciation for the value distribution brings to supply chains, and, you know, that's been our expertise for 100 years. You know, supply chain became front and center with these shortages and all different reasons that it was caused by. But we would say, you know, a lot of the major OEMs and overall, you know, all of our customers really are thinking about how they can improve their supply chains, how they make it more resilient. You know, we kinda talk about everyone was a just-in-time kinda inventory model, and we're learning that maybe that, that's not the best approach.
You know, some critical parts, you need to have sufficient buffer stock to make sure you can keep production going, in times of natural disasters or, blockages in canals or COVID, whatever it is. So we're actually seeing, you know, a renewed appreciation for what we bring to the technology supply chain. But I'd also say it's actually, a silver lining is a lot of business opportunities. You know, one thing we talk about is we'll call supply chain as a service, and that's where we step in.
That's my next question.
We step in to help facilitate supply chains. Think about a major OEM that's buying components directly from a supplier. You know, they got short in this environment. They don't want that to happen again, so they bring someone like Avnet in to help them make sure they get that assurance of supply. We take the parts from the supplier, get it to all their tier ones that need it, give them visibility, you know, optimize, but, but also have the buffer stock. Those are opportunities where we weren't talking to OEMs like that.
That was typically direct business with the suppliers, but we're seeing ourselves being able to get in and provide kind of a logistics-as-a-service or supply chain services offering for them, where they still own that relationship with the end supplier, but we help you know optimize their supply chain and make sure they don't get caught short again. So we're actually seeing that as a silver lining, and that would be business on top of, let's say, the normal core business we have. Supply chain's always been things we do, you know, in-plant stores MRP planning and forecasting, right? We've always been helping in those kind of services, but this is a new customer base that we see as a great opportunity, that are really focused on making sure shortages don't happen again for them.
So I love that we've been talking about the supply chain as a service business offering for a couple of quarters now, because you've kind of seen this acceleration with large customers coming in and, and requesting it. Longer term, do you see is this something with some of your existing customers? Or as we get to more electrification, more, you know, complexity, more electric components or electronic components in things that we never. I always use, my favorite example is, like, a La-Z-Boy, you know? Are you seeing opportunities longer term for customers that maybe never used to have to procure electronic components, and is this a place where you can, you can grow longer term into that business?
Yeah, I think, I think the short answer is, you know, the things we're providing for these, let's think about major OEMs. We can scale for our smaller customer base, right? And maybe a little bit different model, may not be a service model, but it may be, similar types of, things we provide. I guess what I would say is, yeah, part of the lesson learned is a lot of these companies that weren't used to dealing with components, electronics, right? Think about non-technology companies. You know, I'll use an automaker as an example. Well, they knew about steel, they knew about leather. They've mastered those commodities, right? But, but semiconductors, they didn't know too much about, so, you know, they're educating themselves.
We're finding that we can add value to that education part and, you know, just understanding that overall environment, you know, so we're seeing a lot of opportunities with, let's say, nontraditional OEMs that haven't typically dealt with electronics or maybe only been dealing with them for the past 10 years, let's say, versus, you know, technology companies have always been dealt with electronics. So, we are seeing those as a great opportunity for a customer base, but it's not limited to those types of customers, but they're definitely in a sweet spot where they're trying to educate themselves, and someone like Avnet can really help them, you know, redesign their supply chain for components and understand. You know, even when we come to the to the capacity expansions that are happening, a lot of that's cutting-edge nodes.
Some of these companies that may be in the medical space or the, you know, defense space, you know, they don't want to design in those cutting-edge parts. They need to keep the same designs, so they don't have to do redesigns. So there's some, you know, supply chain nuances that happen with, with, some of the, the higher node technologies that may become short, you know, into the future because capacity is not going into those type of applications.
So while we're kinda on this track of margin-accretive businesses, I'd love to talk about the programming business, because I think this is something that is kind of unique to Avnet, just in terms of, you know, getting the registrations. You own more of the supply chain, and obviously, that becomes margin accretive. So I think in the past, we've talked double-digit margins for that business. I don't wanna, I don't wanna put words in your mouth, but-
Yeah. We, we don't really quote what the margins are, but it definitely is part of the value proposition that we provide to our, our customers. You know, examples are, you know, we do have six programming centers around the world, where we're programming millions of chips around the world for customers who wanna buy, you know, chips from us, but they want some software on it. So we're happy to take that software, load it up on a spool, reel, and just ship it out to them, so that goes right into their production. So again, programming is another one of those things that we've been doing for a long time, and it, it does, it does add some. How should I say?
I wanna say stickiness to the business, but it, you know, we're very nimble with that business. We can take, you know, designs of a program and just anywhere around the world, have, you know, prototypes delivered back to the, customer in a day and then have it, you know, programmed on a spool anywhere around the world, basically, in the, in the major regions that we deal in. I t's a very good business for us.
Any other margin-accretive kind of initiatives that you're investing in in the near term? I know you've got a lot of opportunities.
The one I'd mentioned that we've talked about a little bit, but it's beginning to kind of ramp would be, we call our embedded business. So think about, you know, embedded boards and displays, you know, kind of full solutions. So instead of just selling components, we're actually selling, you know, boards. A lot of those boards are boards that Avnet designs or works with our customers to design, so it's kind of our IP. And so that tends to be more of a solution sale, but tends to come with a lot higher margin. And then, you know, you think about if we've got that design, then it, the business kinda lasts longer.
So that we acquired a company back in 2013, 2014, called MSC, a Munich-based or Germany-based company, and they've got a lot of capabilities for embedded boards and displays. And we also partner with third parties that create embedded boards and displays. So we kinda have, you know, our internal brands, but also, you know, third-party brands. And so, you know, we're seeing a lot of customers wanna go to the whole solution versus, let's say, you know, designing their own boards. It's really let's go and design a whole board. So seeing a lot of opportunity there, and that's, you know, 2x type gross margin than our typical core business. So we find that very attractive and, you know, should be a double-digit operating margin type of business. So that's another one we have.
And then, you know, we haven't talked much about Farnell, which you get into, but Farnell is our high service, high service business. You know, and they're more of a speed and convenience type of distributor, small quantities for engineers. And they've got a pretty broad SKU count base, but they, you know, also generate a gross margin 2.5 x Avnet's gross margin. So really focusing on growing those businesses, which again, help to keep our overall gross margin stable, hopefully grow, but at least keep it stable while we're getting the, you know, profitable growth on the top line.
Through the cycle.
Through the cycle.
Is really important. I wanna pause here in case any. Are there any questions? Yep.
Could you talk about, you know, you said you think inventory levels are higher, higher, higher level post-COVID. If that's true, I have two questions. One is, where are your inventory levels relative to that? Because you said you thought you bring your working capital down. Then the second piece is, whatever that new normal is and the higher carrying cost, do you get paid for both of those, or that is, you know, your customers just expecting you to do that?
Yeah, a couple of questions there. I think what we said was lead times are still extended from pre-COVID. You know, inventory levels are clearly greater than pre-COVID as well. I guess what I'd say is, you know, our inventory levels are elevated. We believe that's more of a byproduct of excess inventory or a lot of inventory on the customer side of things, right? So they need less replenishment, you know, as a broad statement, than what they normally need, 'cause they're sitting on whatever, many, many weeks of inventory. Now, the demand softness that we've seen over the past couple of quarters is kinda compounding that a little bit, but really, the issue got created a little bit with the lead times coming down.
You know, if I had a 52-week lead time, you know, I guess by definition, I need 52 weeks of parts before I get replenished, so to be able to build. And as lead times came down, people still had those, you know, longer times, and our customers, you know, can only make so much product, right? If they've got six weeks of inventory, by definition, it takes them six weeks to build that, you know, if they were going full steam ahead. So what we're seeing is, you know, clearly, more inventory than we need or our customers needs, and we're in kind of a hand-to-hand kinda combat to try to get the customers to take it, right?
Phil, Phil's here, he'd say, "You know, we expect our customers to be responsible, right, in their role in some of these supply chain things, and we're having some difficult conversations with customers that may not want the product, but, you know, going back to your point, it's not free for us to sit on it." So we have those conversations as, you know, the customers wanna potentially push out. How do we get paid more margin? Is there a working capital cost for us? You know, I wish we could say we're successful in all those discussions, but, you know, we do our best. But I think as we look to the more medium term to longer term, you know, clearly, the dynamic during COVID was the cost of capital going up. You know, our interest expenses, you know, almost tripled.
Clearly, that's a drag on EPS and earnings, but, you know, we're focused on getting the inventory levels corrected, and then the secondary step after that is to, you know, have those conversations. You know, if a customer wants 60-day terms, Melissa mentioned we're the shock absorber. We wanna give you 60-day terms. We wanna hold four weeks of inventory for you, but the cost of doing that, I need more margin or you need to have less terms, you know, either way. So, you know, those conversations are ongoing, but we're trying to get the inventory corrected first before we start having, you know, some of those conversations. And I think customers get it. You know, our team is definitely being more educated on working capital, the cost of capital, all those things.
So it's definitely front and center when we have our internal discussions with the teams. You know, easier said than done to affect that, but we definitely think, you know, in order to get those returns that we want, you know, we need to make sure we're getting the proper margin. So that is, you know, being ingrained in our team, and I think with our general health of our business over the past few years, relative to, you know, let's say, FY 2019 or FY 2020, we're in a much better position to make sure, we're being disciplined as we look at new business, right? We're not chasing business. We wanna make sure it's the proper returns, it's the proper margin, right, for us, and, you know, we tell the team it's okay to say no sometimes, right?
If someone else wants to give those terms that don't make the proper return, you know, that's on them. We can, we can make sure we're getting, you know, paid properly. But clearly, there's plenty of work to do on the inventory side, and we've, you know, underdelivered on that aspect. You know, one of the benefits to our business is what we refer to as a countercyclical balance sheet. As sales start to go down, we start to burn off working capital in the form of receivables and inventory, and the inventory hasn't moved. You know, the AR is coming down nicely, and we're doing good on the collections there, but, but the inventory hasn't corrected like it should at this point in the cycle, so that's what we're focused on.
I think it's important to note, though, you've had a couple of, you know, unique instances, either acquiring a portfolio of products that were going end of life opportunistic supply that, you know, you brought into inventory that you're carrying, that over time, that becomes margin accretive as well. And so it's not, it's not exactly like a one-to-one like we would normally see in a typical cycle.
Yeah, I think if you look at the past couple of quarters, inventory has increased both quarters, but our messaging has been kind of a core business inventory, the inventory that everyone's worried about, lead times and customer excess and all those things, that's been stable. So it hasn't gone down like it should, but it's not going up. The reasons for the inventory increase were specific to some opportunistic deals with suppliers and or our supply service growth in the inventory for that business. So it's different than the broader dynamic, and that's what we've tried to explain. But, you know, optically, inventory is up the past couple of quarters, even though our view is it's stable, and working on getting it down, right? So while we're disappointed, it should be down versus stable, but at least stable is better than up in the core business.
Yeah. No, I think you've done a really good job of, of explaining the distinction there, and I think it is kind of unique versus past cycles. Any other questions before I move on? Okay. All right, we'll keep going.
So you touched on capital allocation. Obviously, the buyback is a priority for you. In terms of internal investment, either investing more in programming, investing more in the supply chain as a service, you know, opportunities for automation. I think you have a new facility in Germany that is among your most automated and highly advanced facilities. How do you balance, you know, between internal investment versus just kind of keeping with the normal, you know, kind of, fulfillment business?
I just say, in general, you know, we're not a capital-intensive business like a EMS company or a semiconductor manufacturer.
How we look at it is, you know, a lot of our investment is the working capital, right? The working capital is the intensity. But from a CapEx perspective, you know, think about a normalized $100 million ± $20 million a year. You know, our big investments for CapEx would be distribution centers, which is kind of the lifeblood of getting product in and out and getting it to our customers, and, you know, IT systems to make us better, you know, whether it's to operate more globally or to have digital tools and capabilities to make our employees more efficient. So that's where we're really best in terms of CapEx.
You know, we've had a big investment in a warehouse in Bernburg, Germany, outside of Leipzig, which is just going to give us additional capacity for the future growth we expect in the Europe market. Europe's one of our, you know, strongest performing businesses. You know, and so this gives us, you know, the long runway to be able to support the growth we see there. But that's few and far between. It's not like we have to build a new warehouse every couple of years with the growth, but we're always looking, you know, three, five years out, where do we need capacity? You know, so you'll see CapEx for warehouses, you'll see some, you know, IT type of investments.
But, you know, I think we're still within that, fitting within that average range. And then, you know, really, OpEx is where we make investments, right? We talk about technical resources, we talk about capabilities-
Talk about AI.
So we want to invest in our people. Yeah, yeah.
Just to throw that in there.
Yeah, I mean, I think, you know, again, we may not participate in a lot of those servers and things like that, but we do participate in a lot of our supplier partners have technologies that sell into the AI makers, right? And so we do see it as just another secular trend in terms of. We talked about transportation being a great big growth area, EVs, things like that. AI would just be another vertical market that we see, you know, being meaningful to the broader semiconductor growth. And, you know, internally, we see that as being a tool to make us more efficient, better at what we do. You know, we want to scale our business without adding all people.
It helps our technical resources be more efficient if we can give them tools like AI to help them make design decisions and kind of get more coverage for each individual technical resource. So we want to continue to invest in feet on the street, you know, growing our capabilities. We talked about the embedded business, so we'll invest some OpEx. A lot of times we'll try to repurpose it and take OpEx out of one area where we are overinvested and remove it to areas we want to invest in. And we're very disciplined in our OpEx. But, you know, that's where we see a lot of the investments going, and again, it should be ratable over the years, so it's not going to constrain us from some of the other return to shareholders things we want to do.
Okay. We've just got a couple of minutes left, maybe one quick one. In terms of M&A, are there opportunities or technologies or capabilities that you're looking to invest in that maybe, you know, you might be able to find it externally rather than, than investing internally on that?
I guess my two cents would be. I mean, I think there was there's a transaction in our space that was announced recently.
You know, and so our industry is generally consolidated, and we think about distribution in the 1990s and 2000s. Avnet did 114 acquisitions and kind of rolled up the industry. There's a few big players out there, but you know, there's always our IP&E business is interconnect, passive, electromechanical. You know, that's a higher margin. It's all the components around the semiconductor on a board. You know, there are some markets that we're underpenetrated in, that we might be interested in, but I think it's really. We probably want to prioritize organic growth, investing in our business, buying back shares, than any kind of transformative M&A.
You know, we're always listening, but we just don't see that being, you know, key over the next several years, that M&A is going to be a big part of. You never say never, but that's just not in our wheelhouse right now. We think we want to go get share through more organic means, you know, and probably more investment in OpEx than M&A.
Great.
O ne quick one. Yeah.
On that capital allocation, is there a sort of target leverage number that you need to get to first, and then kind of what's the, what's your appetite for?
W here we're at right now is we've had the appetite. We've got $230 million left on our authorization, which, you know, gives us plenty of runway. You know, we're focused on not borrowing to buybacks. Our constraint has really been because we haven't generated positive cash flow the past few quarters, we haven't been as active in buybacks. Once we generate positive cash flow, we'll put some of that positive cash flow back into buybacks. So, you know, we feel good about our leverage, and we're about 2.6 xs, you know, anything under three, we feel pretty good about. It's more a byproduct of not wanting to borrow additional money to do buybacks in the near term.
But we see the line of sight to positive cash flows to be able to get back into use that authorization.
Excellent. I think that's it for time. We'll head downstairs for the breakout session, if anyone has any more questions.
All right.
Thanks very much.