Okay. We're going go ahead and get started here. Thanks, everybody, for joining. My name is Adam Tyndall. I cover the IT supply chain and connected devices here at Raymond James.
Very happy to be hosting some time for Fireside chat afterwards. Tom?
Thank you, Adam. Thanks for having us today. Thank you all for attending. So I thought I would just begin with brief overview for the business, more long term, and then we'll talk about some short term events. So long term, we spent the last two or three years putting in the building blocks for what we believe is relevant three, five, seven years out in the future.
Think about a distributor. We are serving the middle market, okay? So middle to smaller end customers. What are they doing today? They're developing new products that are connected.
They need engineering. They need components. They need connectivity, software, etcetera. And that's in the early innings. So what we've done is two or three years ago, we acquired Farnell.
Farnell is a catalog distributor that serves engineers and entrepreneurs, meaning when the engineer is designing a product, they go on to Farnell, totally different than mainline Avnet. An engineer is buying one, two, three components or three quantities, their complete bill of material, they want it on their desk tomorrow. Because of that, they'll pay a higher price and we'll have a gross margin in the mid-thirty percent. Once that product moves into production, then it's being served by mainline, large scale, Avnet, where we're supplying thousands, tens of thousands or hundreds of thousands of components. And today, that same customer that's been with us for several years, they're adding connectivity, right?
And in the middle market to smaller markets, they don't necessarily have the skills in house to be able to do that. So what do mean by connected device? They take their product, they added sensors, they're collecting data, they need connectivity, they put it into the cloud, they're doing some sort of analytics, they're probably putting it on a mobile device for people to manage the device. So we've added a couple of software companies, Softweb. Softweb develops mobile apps for companies.
Wittechio develops basically secure devices for the software. And what we're trying to do, we're not trying to create a market, we're trying to serve the market that's coming to us from our existing customer base where they're trying to develop connected devices. We think it's rather unique in that we're probably the only mainline distributor with a catalog distributor such as Fresnel. We've added some software applications. And those are the basic building blocks we've put together.
Now in the near term, yes, we are in a macro slowdown, no surprise, right? I will say this, we are starting to feel a little bit better about where we're at. We're starting to feel a little bit better about either at the bottom or near the bottom. And I know that's some of the questions you'll go through, so we'll talk about that. From our peak quarter to where we are, today, we're down about 14% in revenue, right?
So it hasn't been totally severe, but it's been a significant revenue decline. And during that time, we're focused on controlling those factors we can't control. So we can't control the end market, but what we can control is, number one, our cost structure. We've made a lot of progress on our OpEx. In June, we reported our end of fiscal year $117,000,000 lower operating expense, and that's in the P and L, right, net of any investment we have made.
Today, we're at about $150,000,000 annual run rate lower than where we're at. And we've laid out a plan and we have committed projects now to get to $245,000,000 reduction. So why is that important? Well, as the economy recovers, we'll have a lower cost structure with which to build on. In the same time, we've been focused on generating cash, specifically lowering our working capital.
So year, year and a half ago, we had ninety six days of working capital. Now we're down to eighty four. We have a path to get to the low 70s. In the last nine months, we generated $800,000,000 of cash flow. So to put that in perspective, in the last nine months, our earnings per share have been 2.6 and our cash flow per share has been $7.5 okay?
So just like the cost, we're putting in a leaner structure. This will serve us well as we recover. We've been using that cash up until now predominantly for buybacks and also, to some extent, M and A. Our near term focus is getting Farnell back to double digit operating margins. One thing we learned is that catalog space where they're serving engineers and entrepreneurs, They feel the downturn maybe a little later, but more severe than the mainline distributors.
So a lot of effort for Nell. It's very, very important business to us because it's a higher value add and it's a higher margin. The second thing is to continue on our core component revenue and margin expansion. Many of you know that Texas Instruments made a decision to go direct to consolidate down to one distributor. Will be transitioning their business away between now and the December 2020.
So that creates a challenge because that's about a it was lower fulfillment type business, 8% gross margin, but it's close to $150,000,000 So there's a near term gap that we're working to fill, and that's a significant right, significant challenge. Part of this is to continue to do well in Americas. I was at dinner last night, we I was getting peppered with some questions about are you losing market share and things of that nature. And don't confuse market share shifts because you're offering better distribution services than market share shifts because you're lowering margins on fulfillment type business or TI type business, okay? If you look at Americas, and I say this because it's a pretty good testament to our service offering.
If you look at Americas over the last five quarters, we have five quarters in a row of year over year revenue growth. If you look at one of our main competitors, they have five quarters in a row of lower revenue. And during that time, there was a 15% decline in revenue. Our revenue, Americas Components, is up. So we're very confident that we've gained share.
And this is in more of the higher margin supply chain type distribution engagements and demand creation. So challenges over the next twelve to fifteen months, working very hard to replace the TI business, specifically the TI gross profit dollars that were 150,000,000 TI in total was $1,700,000,000 We feel that we need to replace about $1,000,000,000 of that revenue, and we've done that before, right? But about $1,000,000,000 it will be more of the supply chain demand creation type revenues. That's why we need less. We're taking some cost actions on it.
But these are the top two initiatives. If you came with an Avnet, it's getting Farnell back to the double digit margins and getting electronic components to make up that $150,000,000 gap. So in the meantime, we try to be very transparent. Between now and the summer, we'll be operating in the low 2% type operating margin range. And as we recover for now and as we recover electronic components and continue to grow Americas, long term, because of the building blocks, we remain the story remains intact.
So with that, Adam?
Okay. Come on and join. Thanks. Very helpful overview, Tom. And maybe we'll just start with kind of the key high level questions.
You obviously have a good feel for where we are in the semi cycle. You generate nearly $20,000,000,000 in revenue with exposure to all the major regions. We're hearing conflicting views from suppliers. Some say we're taking off from the bottom. Some say we've kind of worsened into Q4.
So maybe just to start update us, we're sitting here in mid December, the pace of business with some color by region and then any leading indicators like book to bill cancellation rates, stuff like that?
Yes. So our guidance for December was lower. I think what we're hearing from everybody is December will be a low quarter. March is probably not that much better. But when we go around the globe, we do feel better about the outlook, and I'm not trying to sell you on it.
I'm just trying to give you a feel for where we're at. If we look at Asia, they went into the downturn first. About this time last year, their revenues were down 20% in March. But since that time, from the summer to now, they've stabilized. We actually had some revenue growth this last quarter.
They continue to stabilize at be it at a lower revenue level. But we feel that we have a base there, and we feel that the inventory correction in the region is probably done and back to normal. EMEA felt has a region. Their economy went slower in the summer and this was driven by automotive and industrial. EMEA revenues will be down in December.
But we're starting to see some improvement in their book to bill and that's a really positive sign. And they're hearing good things from their customers that maybe in the March to April timeframe, things will start to recover. So we feel good about that. Americas, I think all distributors started to see some slowness in Americas this last quarter. And in our guidance, we guided Americas down for December thinking they were going to follow the same cycle as Asia and EMEA.
They seem to be doing a little bit better than we expected. And Americas book to bill is promising. So these are all good signs. I'm not predicting where we're at, but we're internally, we're starting to feel that there's a bottom and there's a place to go up again.
So as we sit here in mid December by each region, would say that book to bills are probably a little bit better than they had been over the past I think that's fair. Okay. Helpful. And then maybe just alluded to this, but on inventory levels, maybe just touch on the current inventory levels that you're seeing at the customer base. Are they still at the high end?
Has it moderated? And then Avnet's inventory levels as well.
Yes. So we think the Asia inventory levels in the supply chain are more normal than they've been. We think EMEA is much of the way through in inventory correction as a macro picture, so that's good. Americas, it depends on how the Americas Americas demand continues. If we're seeing a more promising book to bill, then I'd have to say that Americas customers' inventories are probably where they need to be.
We still have opportunity to reduce our inventory and that's people ask as well, how can you continue to decrease your working capital? Well, days. That's really because of the people we have in place and some of the systems we put in place. I love when we have an investor meeting. I'll whip out my phone, and I'll show an app we developed that we can look at our working capital by region every day, every day.
And we'll see inventory payables, receivables. If I don't want receivables, we'll click in. Hey, here's who's past due today. And it's just this focus on detail and execution. And part of the reason I say that is, right, like as we come out of the downturn, we think we have really good people in place and we think they're supported by systems that really we've changed over the last twelve to eighteen months.
We put more of a focus on SaaS based tools like business analytic tools. Our working capital is now supported by an AI vendor, where in addition to being able to see data every day, it's looking at things like, well, giving a normal payment pattern, what will your receivables be at the end of the quarter if you don't do anything or on inventory. This customer historically buys 100 units, but they only use 95, and guess what, they only take 80 in the first month. Well, if you know that, right, then you can start making better decisions on your working capital you bring in.
And maybe touch on kind of near term, the benefit to Avnet would be in cash flow.
It would
be cash flow. So how can we think about kind of Q4 cash flow and 2020 cash flow? You've done so well. You alluded to the operating cash flow that you've generated. But Q4 and twenty twenty, how can investors think about cash flow?
Yes. We generally I think we've generally talked about $500,000,000 of cash flow a year. We've done much better this last twelve months or nine months, but I would think in those terms. We should be continuing to reduce our net working capital days, which will increase our cash flows above our operating income levels. And it's not going to be a smooth walk to low 70s, but it will be a consistent trend.
And then maybe just wrapping up on the macro level. As you've reflected on the current downturn, is there anything that has surprised you? You kind of alluded to this in Farnell. And has this downturn been different from previous? So just interesting takeaways on this.
Well, they're all different, right? And I would say this has probably been if you compare downturns, this is like a negative conversation. If you compare downturns, it's It's right in the middle of it, not as severe as it could be. It's better than some others. Farnell is a new business to us.
So the concept that they're going to feel the downturn later than our mainline distribution business and more severe, okay, so that's a good learning experience. And why is that? Well, you have people going online, right? And when parts are tight during an up economy, you have more people coming online to secure their inventory for their production line. But they're not really the typical Farnell customer.
And when they come online and they start creating even more demand for product and raising prices that when the economy turns and they go back to their normal buying patterns, you see both a revenue decline and a price decline. So now when we look at Farnell margins, we think of it through a cycle. And that through a cycle, when parts are tight, they'll have peak margins. When parts are plentiful, they'll have lower margins. And this is going to be a larger what is it the spend curve than Avnet traditionally has.
But still some upside to margins there and maybe allude because Phil Gallagher has a background in a competitor in and that would suggest that, hey, mid teens margin is not uncommon. It's hard for us to see because all these companies are private. But maybe just talk about where Farnell margins can go and then why that's supported by what you your view of other competitors in the space?
Yes. We believe for now margins can go to 15%. We've been pretty consistent on that. And that's a combination of yes, part of it is lower cost base by integrating back offices with traditional Avnet, and so that's totally controllable. Part of it is by we want to add more SKUs.
We're kind of at a competitive disadvantage with the SKU count versus our peers. Part of that is because we're space constrained. We're opening the new distribution center in December. But as you said, our two main peers, it's widely known, they have operating margins of 15% to 20%, right? So we feel that that's a positive because we have a game plan internally to get Farnell to 15%.
We know that with the same suppliers and customers, other people are operating out of 15% plus, so that's very encouraging. And as you say, Phil worked Phil's been with the company thirty five years. He is Mr. Avnet supplier relationship. He does a phenomenal job.
And Phil spent a few years over with Warren Buffett companies, founder. And so he's very familiar with the catalog space. And it is we do feel that having Farnell with Avnet is unique. We do feel that it provides a lot of long term synergies with working with the engineer and entrepreneur and carrying that through production. We do believe that it has a totally different economics because they have a 35% gross profit.
We have 11% to 12% gross profit in the mainline distribution. So it's just a very, very important business to us and something that we're keenly focused on. And yes, Phil brings a lot of strength to the table on that.
We're going to transition into some more specifics on TI. But any questions on the macro environment so far for Tom?
Sure.
So it sounds like, Tom, that Asia is really it's been a long drawdown as you said pretty dramatic. So it sounds like maybe some cautious refill there. And then in The Americas, your comments were a little more nuanced, maybe not as much visibility near term or does it feel like things are pretty lean? I just want to make sure I understand
that Sure. No. We assumed Americas was going to decline following a similar timeframe and degree as Europe. And what we're seeing is that they're performing a little bit better than that. And what we're seeing is that their book to bill is improving.
And that would be that would indicate a shorter downturn in Americas. And again, I don't want to predict anything. I'm just trying to give you where we're at. But put all these together, really the takeaway is that we're feeling like we're either at bottom or we're getting close to bottom when you add all the revenues by region together. That makes sense?
Maybe shifting gears, I just want to tackle TI. I know this is obviously a main topic with the investors right now. Reducing the number of distribution partners, adopting the more direct models, just give us maybe some quick background on the relationship and their move to go more direct and starting with moving away from demand creation several years ago and now disengaging that?
Yes. So first of all, we've had a relationship with Texas Instruments for thirty, forty years. So it's a pretty long relationship. Texas Instruments made it known to all of us, right, that three to five years ago, they wanted to take their business direct. And I don't want to speak for them, but the intent is that, well, they offer a broad line.
They feel they're a very competitive technology and therefore that customers will search them out on their website to do ordering. So that was known. And three years ago, they made the decision not to do demand creation anymore. Demand creation is where we send out engineers to get design to get their product designed into product. So they said they were going to do that themselves.
So that's why when you look at our business today, it's what we call fulfillment. We're not doing demand creation. What we're doing is we stock Texas Instruments and we resell it. And fulfillment of everything in distribution, that's the lower margin. So our gross margin was in the 7%, 8% range.
That's how we came up with $150,000,000 And they decided that they're going to speed the clock or from our impression, the clock to go direct and in the meantime consolidate to one distributor. So it wasn't a surprise that TI wants to go direct. When we received the letter, that was a surprise. Like we didn't expect that timeframe. So what's number one important to us over the next fifteen months is, so we got to continue to serve these customers with TI parts because they're going to continue to remain customers, right?
We sell many, many supplier parts to them. So we're working with TI. We gave all of you some indications of how we saw the timing. We're going to plan on a quicker exit, right, that it moves more by the summer to TI or to another distributor. Time will tell on that.
I think just like we were surprised, I think the marketing customers were somewhat surprised. So we're going to work in conjunction with TI to serve customers and do this in an orderly process the best we can.
And it's only a couple of months, I think, since it was announced. What's the early feedback from customers? Are you seeing customers defect at this point to other distributors who would have TI? What's
No, we haven't seen any customers defect. I mean, right now, we haven't seen any impact. And I think we kind of indicated that on our call. I think you probably start to see it in March. And the question would be, is it going to take four quarters?
Is it going to take two? Or will it take longer than four quarters? Time will tell on that. Just keep in mind, that's a good question, both customers affect just about every customer we have or our peers have, they buy from multiple distributors because they have to. You can't come to Avnet and buy every component you need.
You can't come to a competitor and buy every component you need. So, it's not a case of customers affecting, it's a case that the share between us and our main competitor will change with them.
And then maybe just talking about how other suppliers are thinking about their go to market strategies outside of TI. On one hand, the bear would say we could see other suppliers pursue this path. On the other hand, the bull would say, look, does it make more sense to use distribution as a competitive advantage to some extent?
So complete honestly, we haven't heard any other supplier talk about trying to take things direct, okay? And I think it goes just back to the economics of distribution. If I'm a supplier, I do a parade of my customers. It gets to a certain size, it's no longer economical to send out a salesperson or an engineer, but we can send it out because we're supplying many, many parts to that supplier. So we haven't seen any sign of that.
Most of our suppliers, they see us as part of them, right? You think of semiconductor companies, they're all about next generation technology, chip out to the market. We're their tool to get to the middle market for smaller customer. So like our challenge is always we try to grow their sales and distribution faster than they can grow to the direct. And if we do that, they're always very happy with that.
And
then maybe just wrapping up on TI, just talk about how we backfill this. You mentioned it's not the first time you've done this. Would it be more growing with existing? Would it be new relationships? Just kind of the thoughts around backfilling it.
Yes. The good news is Phil has a very detailed plan down at the branch level by customer. And I don't want to like telegraph really what the strategies are. But yes, I mean, it's clearly there's some cases where we can replace a component. The week within a week after issuing our eight ks on TI going away, we had many CEO to CEO letters from other suppliers talking about, hey, how can we work with you?
How can we use your resources to use this as an advantage? So there's many ways. Our target is to replace about $1,000,000,000 of revenue. There will be a time lag, right? It will leave faster than it comes back.
We're going to do some level of cost reduction. We said $35,000,000 That will go out as TI leaves. But hey, look, over time, that's going to get added back as we replace the revenue, right? That was variable costs associated with things like distribution center or things that were completely variable with TI. Does that
make sense? Yes. And then maybe some silver lining to it. I think you also get some cash benefit We got some cash as as So maybe just touch on that and then wrap in capital allocation along the way.
Yes. So the TI inventory has always been confined. So if you think about it, that means we don't have inventory, we don't have payables. As a distributor, you try to match your inventory and payables. And therefore, really what you have left is receivables.
That business was a little bit more weighted toward Asia than Europe, than Americas. You tend to see longer terms, right, in Asia. So as that business does get transitioned out of Avnet, I think we quoted $30,000,000,350,000,000 dollars of cash flow that would be coming in because of those receivables and that would just become part of our capital allocation that we're doing. And over time as we replace it, we're not going use $350,000,000 because we're only going to grow back $1,000,000,000 in revenue.
Well, I appreciate you bearing with me through some of the challenging questions and tackling that on. Maybe just zooming out to kind of an industry overview question and we'll wrap it up here in a second. But we tend to find a lot of attractive characteristics to this industry. Maybe if you could touch on the industry structure, kind of end market growth rates and kind of the attractive aspects of component distribution.
Yes. We continue to think that over time, the those that will do well in distribution are those that have a component catalog distributor that it's really important, especially in today's market with connected devices. And it's never been really I don't want to say easier because it's very hard to go to market. It's never been easier for an entrepreneur to get a product and go to market that you're supporting both the engineer, the entrepreneur. One thing I'd tell to mention, Farnell, we have an engineering community of 1,000,000 members where they go online and it's just pictures and social media for engineers, but that's what that brings them in.
And being able to combine that with a broad line distributor and as they all move to connected devices, being able to offer things like the software and the mobile apps and things of that nature. Our business is predominantly industrial, automotive, aerospace, some medical, some computing, but that's kind of the order that you'll see. We focus on the middle market. So middle market companies need supply chain capabilities, meaning we're not just bringing in parts and shipping it to them, we're actually taking their MRP runs, we're managing their inventory, We're determining how much to order. And that will continue going forward.
I think overall, you'll see by having a catalog distributor, mainline distributor and adding the higher value services, our belief is this will bode well for getting the operating margins back to the first 3% and then 4% type level. We pay up we also pay a lot of attention to return on invested capital, which is why we have a focus on working capital and cash flow. And we think over time, those are really important, right? And you're going to be able to you're going to need to be able to show that you have a return on invested capital better than you lack, and that will help keep things sane over the long term.
And you're right. I think they're starting to get a better appreciation for the industry. You mentioned Buffett. He's obviously bid on another tech distributor. Apollo is now taking them out.
So hopefully, that bodes well moving forward. But just wrap us up with any kind of final closing thoughts that you want to leave with investors as they think about Avnet in 2020 and beyond. Yes. So 2020 is the
year of getting Farnell back to double digit and working through the TI transition. We thank all of you for staying with us, right? We delivered a pretty tough message this last quarter about where we'll be. Hopefully, we've laid out a compelling plan that we will I'm really looking forward to next year coming to the conference and getting a different flavor of questions. That will be very enjoyable.
But we think we're feeling the floor. We think we see the path to recovery. We think that the catalog the Farnell, Avnet software combination is going to serve us well
in the marketplace. Good. We appreciate you addressing things head on. Thank You bet. For your time,
Thank you. Thanks, everybody, for coming.