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?
Yep.
But Phil, I think it might be beneficial just to do a quick review of your most recent quarter results, your expectations for the December quarter outlook.
Yeah. OK. 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, well, 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 take a tour around the world real quick, the good news Asia Pac. At least we called Asia Pacific bottom in March quarter. And Prince Yun, our leaders there. We've grown June over March. We've grown September over June. And September actually grew year- on- year Asia Pac, which is a really good sign.
Because typically, as I said in the earnings call, typically, not the earnings typical anymore, the ups and downs of the markets typically start and stop Asia Pac. So we think that's a good sign. And we'll see some sequential growth in December 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 those two are getting hit pretty hard in Europe. And we don't see that really changing a whole lot as we're getting through the quarter. Matter of fact, as you get into later December with European shutdowns and whatnot, it will actually more than likely stay about where we're seeing it now. The Americas is somewhere in between.
Americas is kind of bouncing on the bottom, and 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's 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 comments?
Yeah. 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 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 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 foreign currency out of the equation. But we bought back about 100 million shares in the quarter as well at pretty attractive prices.
OK. 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. That's why I touched on the verticals. Industrial is still soft. And as Ken said, there's just some inventory issues out there, as you guys all know. Transportation is still soft. Consumer, we're doing actually OK in. defense, aero , as I said, is doing fine. It's going to continue to grow. But there's no real signal changes across the board.
OK. Great. One question that 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?
Yeah. I think we got a pretty hot hand right now from a line card standpoint. Wouldn't like to get into any if I start mentioning lines.
Yeah, yeah, yeah.
I'll miss one. I'll get a call from some CEO you didn't mention last, but you know our line card, so we're very confident with the supply relationships we have now as well. Because that's another question we constantly get, supplier lineup.
Yep.
I think Asia Pac, yeah. I know you referred to it. We're definitely outgrowing the market. We have a great team there. I know that sounds soft, I get it . But we have a very senior executive team there led by Prince Yun. 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 if something happens in China, although we're seeing China, actually, China is actually flattening out. We're 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 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 AI, artificial intelligence, you have to bring that up at least once, right?
Oh, you have to.
We don't have a lot of exposure to that. So it's not like we have an AI solution. We're selling into that market. We're getting some benefit. But it's not really what's swinging anything.
Melissa, I would also add that just I think we're holding up overall just because of the diversification. Not only the supplier lines, 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's, I think, a good thing for us.
Yep. 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-ones, so far, particularly in the higher-end technology products, prices are holding up OK.
Great.
We're not seeing the ASP degradation we've typically seen in the past. Matter of fact, without naming names, a few suppliers probably start raising some prices again, high-end stuff. Commodities, standard products, multi-source products, that always goes up and down. And there, that doesn't hurt us that much. We just buy better. So you buy smarter, sell smarter. So that doesn't really have a big effect on the margins overall.
OK. Great.
But stable, 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 use, 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?
Yeah. So just for the folks that haven't heard me use that before, it's kind of the role we play. We're the middle guy. We play bank, in many cases, for our suppliers and/or for our customers. So we're as much a financial services company as anything. And our backlog, our inventory adjusts roughly 20%, 25% per day between cancellations, push-outs, pull-ins. So when you've got $5 plus billion of 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. I've been with Avnet, I should note, for 42 years. So we've seen a few cycles. This one's definitely a little choppier than we thought and going a little bit longer than we thought.
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. When they need help, we help them. There's a lot more give and take. I should note the inventory is good inventory. Inventory and distribution is not a bad thing. It's not wine, so you don't want it around too long. The inventory, the quality of the inventory is really good right now. 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 up.
I mean, in the IP&E, passive, electromechanical, discrete, our inventory is fine. It's really concentrated. We pre-drilled it out. It's really concentrated in a few technologies and a handful of suppliers.
OK. All right.
I think we just remain focused on adjusting inventory where 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 out on some opportunities, so we're trying to be very balanced with our inventory reductions. Although, be clear, it's a priority for us to continue to drive it down.
Yeah. I was just going to say, so Ken mentioned the customers, so we'll work with our customers. If customers have 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 it. It's just going to cause a problem on the receivable side, so we're doing everyone's a, wish it was easy just to hit a button. It's not. Everyone's kind of a one-off conversation, but quality of inventory is good. We do expect to bring inventory down, and we do expect to generate cash.
Great. Yep. 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?
Yeah. It's a common question we get. Actually, we got it three, six months ago, right, before the elections. My first response is, hey, we manage the business to go drive the business, 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 that's not one of the things that keep me up at night. We have a process to handle it. We definitely pass it on. The 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 Guadalajara, 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 over-engineer or be overly concerned so you actually know what's going on.
Sure.
Now, we are talking to customers. Customers are talking to us. And we get this question from many of you. Are they going to take it early, maybe, so they can avoid the tariffs?
Right. Right.
They just want more fines. We're not overselling that. If the customers want to take it early, fine. That's great. But we also don't want to mortgage my March quarter.
Yeah.
So we don't have many takers on that, though.
OK.
Now, it's early December, so we'll see how the rest of the month goes.
OK. All right.
Anyone add on that?
No. I think we have the playbook. It was painful the last time to develop it. But it's now ready to go. So hopefully, it'll be a little easier this time around.
Perfect.
But we don't anticipate a significant impact.
OK. 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. And so you basically take the China-produced goods, and you force it on the Europe and the Asia markets. And you try to get as much as you can of non-China content in the U.S. And that's the biggest way to avoid it in the first place, is to route your sourcing the right way.
Yeah. That's really good. There's a lot more dialogue up front about that. If it's XYZ supplier, and they make widget A in Europe, and they make the same widget in China, hey, ship the stuff from Europe to us, OK, versus the stuff in China. So those dialogues are all happening as well.
Interesting. OK. Great. Thanks. 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'd be great.
Yeah. So first, let me just be very clear, and I was very transparent on the earnings call as well. I'm really disappointed in the Farnell drop, so that's one of those. And we need to go resolve that, and we will. We've made a handful of executive changes already. We're restrategizing the whole position with Farnell. The opportunistic part that you alluded to, Melissa, was in the tight market conditions a couple of years ago, nontraditional customers kind of swooped 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 looked great, and then when things came back down, the negative drop-through was as good as the positive drop-through. At one time, Farnell 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. We got 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 are not overconcentrated. Their largest region is Europe. So it's kind of a double indemnity for them. They're getting hit. Not only is the market down, but their concentration in Europe's higher. And then we're calling it a Power of One . So what we're doing is the previous leadership kind of had a moat around Farnell. It was kind of isolated. And we're like, no, no, no. This should be closer to the Avnet core.
Not going to integrate it, but what Farnell brings to Avnet is that e-commerce, digital front end, and a long tail of customers, new product introductions, and whatnot, and what Avnet brings to Farnell, that 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 roadmap to get it back to at least double-digit now operating margins.
Great.
The expectation is just get better. 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.
Excellent.
Anything you want to add to that?
Now, the gross margins.
A lot of moving parts.
Gross margins 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 IP&E products as the growth comes back. And so the margin should boost up as well.
And actually, we're making investments there, too. So we made the structure changes. So Rebeca Obregon's leading that now. Then I went and just announced, and we press released it, our Chief Digital Officer, Dave Youngblood. And he came from two of our suppliers we don't have, one in Texas, one in Boston. And he built out their dot-coms. This guy is super talented. Brought him in about six weeks ago. And his primary charter is to go focus on Farnell Digital Customer Experience.
Excellent. 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.
Yeah. Good to see you. Well, I haven't studied the business for a while. But just a lot of your suppliers have consolidated over the years. What's going on with distribution in terms of consolidation opportunities? Obviously, you have a large competitor, starting with the letter A.
Yeah.
Is it still very fragmented, the opportunity?
You get IP&E space, interconnect, passives, electromechanical, much more fragmented. So there's still a lot of smaller regional, like in Europe, for example, by country type of distributors IP&E space. And that's an opportunity. There is an opportunity there. A lot of them are private. Actually, almost all of them are private, actually, IP&E. On the semi side, you got us. You mentioned the guys in Denver. Then you got a couple of Taiwanese guys. And then you got the Berkshire Group. I mean, after that, the tail, Brian, really, really drops off. So I think the industry has been consolidated for the most part. Maybe there's another move or two. I mean, one Taiwanese guy just bought the guys in Canada. So that came together.
But I don't see a whole lot more on the active side, on the semi side. But definitely IP&E, there could be some opportunity.
OK. Great. Anyone else? OK. 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 into my model.
Yeah.
I'm teasing.
So what we're talking about here, just for quick education, so we sell chips, as everybody knows. And a lot of chips need to be programmed for software. You got the hardware, then the software gets loaded onto the chip. And it gets into your, whether it be your phone, whatever the application. We do that programming. So in Chandler, Arizona, in Singapore, Hong Kong, Asia, Europe, our programming centers are all tied together. Because you might do a prototype in Boston or in New York, I should say. It could be in production in China. You got to go through that certification and that approval. So the programming business is a great business for us. It's sticky. So once you have it, it's sticky. And the margin's another 5%-10% margin, depending on the device.
OK.
But the other value-added stuff that you talked about before, Melissa, we need to continue to drive value equals benefit minus cost. 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 or 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, 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, IP&E, the question IP&E, why is that important for us? Well, it's $3-$3.5 billion of business for us a year. Although we're known as a semi house, it was about $400 million more margin. So you get higher margins IP&E space than you do in the semis, as a general statement.
OK, 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?
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. That's why we need to get that right. Because that gives us that reach into the customer base. They got a million plus customers. They define a customer as an engineer. And as Farnell sells products, they sell a Xilinx FPGA development kit. That sales lead then goes directly, if it's an assigned account, that goes directly to the account manager on the core side. That's differentiating. We're getting reach into the market that otherwise, within the core, we wouldn't touch some of those customers. You mentioned programming services. Supply Chain as a Service is a big differentiator. And that actually reports directly into Ken.
Because when we talk about these large supply chain deals, if you will, they're finance models as much as they are distribution models. 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 bill out, effectively, gross profit dollars. We believe design services, as I mentioned, is a big differentiator for us. We got 2,000 FAEs. We actually build our own boards. And that's you get higher margin. And it's super, super sticky.
Yeah. I mean, 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 go to a 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 business migration team. There's nothing we can't track designs anywhere they go in the world. 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 move the supply chain anywhere they want to go. So they want to go to Vietnam, South Korea, back to Guadalajara, back to the U.S. We just lift and shift the supply chain. So it's a differentiated value we actually bring to the end customer. But very little risk.
OK. 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?
I would say the big one's digital. Of course, artificial intelligence and some proof of concepts. We've got some case studies going. The amount of information that we have being at the center of technology, like we are, and you 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. Then what we're trying to do is figure out how to best leverage that data for better value proposition back to the customers and upstream to the suppliers. That would be probably the biggest thing we have going right now. That's part of the Chief Digital Officer, bringing him in.
I just wanted to be sure that at Avnet, I call it up periscope, so we're looking ahead out into the marketplace. Somebody's dedicated full time just making sure we've got the right digital solutions for our customers and suppliers. Because we've got to get more efficient and we've 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've got to find a way to grow without adding that percentage of SG&A as well to drive efficiency and productivity.
Okay. All right. So you touched on this, or you mentioned it just a little bit ago, about some of the competition, the consolidation that happened with the Taiwanese player, took out someone in Canada. I do get asked quite a bit, this 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're talking about WT and Future. And they're 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're still competing with Future. We're still competing with WT. Will there be in the future? We'll see. No pun intended. But we'll see. 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.
OK. 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.
Yeah. I would agree.
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?
Yeah. So we've generated over $800 million of cash over the last four 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 some CapEx just to invest in the digital tools and warehouses and some other things.
All of those are kind of balanced. But none of them are overweighted into one particular area. 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.
OK. 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 upcycle, 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 inventory as far enough? Or does that actually provide you with an advantage to respond to changes in demand?
Yeah. 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, we're going to be investing in inventory. But we think there's enough inventory in totality. We've 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 right size the inventory, then we would be able to grow without 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.
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. Yeah. Feel free to put an exact date on when that will happen.
Yeah. 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? Srini?
Yeah. So you talked about embedded business and demand creation opportunities. I'm just curious, as we think about AI longer term, there's been a lot of talk about AI at the edge. We used to call it factory automation, I guess.
Or IoT.
Yeah. Do you see an opportunity to invest more to be able to capture? I don't know. Do you think they're seeing any more interest since Gen AI kind of started within those end markets? Or do you expect an inflection? If so, I guess how can you add more value? I mean, do you need to invest more in R&D or for customers going direct to their suppliers to be able to implement this solution?
Yeah. No. It's a really good question. The answer is yes. There's definitely going to be an opportunity on the edge. 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 onto the edge is security, and they are experts in building software security on the edge, and that's where we're actually working with, I want to mention, so you can guess who the top controller suppliers are. We have it on our line card. Some are Europe. Some are 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 as they're working direct. So it is a real opportunity. And it's definitely going to come. Some of it's already here, obviously. But it's going to accelerate. And we think we're positioned well. Because a lot of it's going to be industrial automation, building automation. All those, that's 37% of our business is industrial. It's that the application is perfect.
OK. Amazingly, I think we are out of time. But I just wanted to say thank you again, Ken, Phil, and Joe. Always great to have you.
Thank you, Melissa, and I just can make a closing comment.
Absolutely.
Just thanks again for your interest. Thanks for the questions. I know there's a lot of uncertainty out there in the marketplace. 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 in the center of technology supply chain. Yeah, 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's positioned for the growth. We're not doing any major restructure. We're not doing any, we're of course managing expenses well. We're managing the balance sheet well. So that we could be positioned for the next three to five years, this industry is going to grow 5%-7%. It's a huge opportunity for us. We're positioned in the right spot.
So we're just going to focus on the execution and doing the right thing every time. So I just want to share that.
Excellent. Yeah. Thanks very much, guys.
Thank you, Melissa.