Okay, we're going to go ahead and get started here. Thanks everybody for joining. My name is Adam Tindall. 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. I thought I would just begin with a brief overview for the business, more long term, and then we'll talk about some short term events. Long term, we've 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? We sell 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, et cetera. That's in the early innings. 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, and because of that, they'll pay a higher price, and we'll have a gross margin in the mid 30%. Once that product moves into production, then it's being served by a mainline large scale Avnet, where we're supplying thousands, tens of thousands or hundred thousands of components. Today, that same customer that's been with us for several years, they're adding connectivity, right? In the middle market to smaller markets, they don't necessarily have the skills in-house to be able to do that. What do we mean by a connected device?
They take their product, they add the sensors, they're collecting data. They need connectivity to put it into the cloud. They're doing some sort of analytic, and they're probably putting it on a mobile device for people to manage the device. We've added a couple of software companies, Softweb, Witekio. Softweb develops mobile apps for companies. Witekio develops basically secure devices for the software. 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 Farnell. We've added some software applications and those are the basic building blocks we've put together. Now, in the near term, yeah, 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? It hasn't been totally severe, but it's been a significant revenue decline. During that time, we're focused on controlling those factors we can control. We can't control the end market, but what we can control is, number 1, our cost structure. We've made a lot of progress on our OpEx. In June, we reported our end of fiscal year, $117 million lower operating expense, and that's in the P&L, right, net of any investment we have made.
Today, we're at about $150 million 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 a $245 million reduction. 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. Year, year and a half ago, we had 96 days of working capital. Now we're down to 84. We have a path to get to the low 70s. In the last nine months, we generated $800 million of cash flow. To put that in perspective, in the last nine months, our earnings per share have been $2.60, and our cash flow per share has been $7.50, okay. 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 till now predominantly for buybacks and also, to some extent, M&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. A lot of effort. Farnell is 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 the decision to go direct, to consolidate down to one distributor. We'll be transitioning their business away between now and the end of December 2020.
That creates a challenge because it was lower fulfillment type business, 8% gross margin, but it's close to $150 million. There's a near-term gap that we're working to fill, and that's a significant challenge. Part of this is to continue to do well in Americas. I was at dinner last night. I was getting peppered with some questions about, "Are you losing market share?" and things of that nature. 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. 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, it was a 15% decline in revenue. Our revenue in 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. Challenges over the next 12 to 15 months, working very hard to replace the TI business, specifically the TI gross profit dollars, that $150 million. TI in total is $1.7 billion. We feel that we need to replace about $1 billion of that revenue, and we've done that before. About $1 billion, it'll be more of the supply chain demand creation type revenues. That's why we need less. We've taken some cost actions on it.
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 million gap. 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 Farnell and as we recover electronic components and continue to grow Americas, long term, because of the building blocks, the story remains intact. With that, Adam.
Okay. Come on and join. Thanks. Very helpful overview, Tom. Maybe we'll just start with the key high-level questions. You obviously have a good feel for where we are in the semi-cycle. You generally generate nearly $20 billion 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. 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.
Yeah. 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. 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. Since that time, from the summer to now, they stabilized. We actually had some revenue growth this last quarter. They continue to stabilize, be it at a lower revenue level, 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 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. 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. 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 through 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. These are all good signs.
I'm not predicting where we're at, but internally, we're starting to feel that there's a bottom and there's a place to go up again.
As we sit here in mid-December, by each region, you would say that book-to-bills are probably a little bit better than they had been over the past quarter?
Yeah, I think that's fair.
Okay.
Yeah.
Helpful. Maybe just, you 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? Then Avnet's inventory levels as well.
Yeah. 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 an inventory correction as a macro picture, so that's good. Americas, it depends on how the 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 people ask us, "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've 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, and we'll see inventory payables, receivables. If I don't like receivables, we'll click in. Hey, here's who's past due today. It's just this focus on detail and execution. And part of the reason I say that is 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 12-18 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, given a normal payment pattern, what will your receivables be at the end of the quarter if you don't do anything? In inventory, this customer historically buys 100 units, but they only use 95, and guess what? They only take 80 in the first month. If you know that, then you can start making better decisions on your working capital you bring in.
Maybe touch on near-term, the benefit to Avnet would be in cash flow.
Would be cash flow.
How can we think about Q4 cash flow and 2020 cash flow? You've done so well. You alluded to the operating cash flow that you've generated. Q4 and 2020, how can investors think about cash flow?
Yeah. I think we've generally talked about $500 million of cash flow a year. We've done much better this last 12 months or nine months. I would think in those terms.
Okay.
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'll be a consistent trend.
Okay. 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. Has this downturn been different from previous? Just interesting takeaways on this.
Well, they're all different, right? I would say this has probably been, if you compared downturns, this is like a negative conversation.
We'll get to the positive.
If you compare downturns, this is right in the middle of it, right? It's not as severe as it could be. It's better than some others. Farnell's 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, that's a good learning experience. Why is that? Well, you have people going online. When parts are tight during an up economy, you have more people coming online to secure their inventory for their production line. They're not really the typical Farnell customer. 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.
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. This is going to be a larger, I wouldn't put a thing, than Avnet traditionally has.
Still some upside to margins there and maybe allude, because Phil Gallagher has a background in a competitor-.
Yes
in that space and would suggest that, hey, mid-teens margin is not uncommon. It's hard for us to see because a lot of these companies are private. Maybe just talk about where Farnell margins can go, and then why that's supported by your view of other competitors in the space.
We believe Farnell margins can go to 15%. We've been pretty consistent on that, and that's a combination of Part of it is lower cost base by integrating back offices with traditional Avnet, 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. As you said, our two main peers, it's widely known they have operating margins of 15%-20%, right? 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, that's very encouraging.
As you say, Phil's been with the company 35 years. He is Mr. Avnet supplier relationship. He does a phenomenal job, and Phil spent a few years over with the Warren Buffett companies, you know, Berkshire. He's very familiar with the catalog space. 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 adds a totally different economics because they have a 35% gross profit. We have a 11% to 12% gross profit in the mainline distribution. It's just a very, very important business to us and something that we're keenly focused on. Yeah, 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.
Sure.
It sounds like Asia is really, it's been a long drawdown, as you said, pretty dramatic, so sounds like maybe some cautious refill there. 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 how.
Sure. No. We assumed Americas was going to decline following a similar timeframe and degree as Europe. What we're seeing is that they're performing a little bit better than that. What we're seeing is that their book-to-bill is improving, and that would indicate a shorter downturn in Americas. Again, I don't want to predict anything, I'm just trying to give you where we're at. 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 of the revenues by region together. Thank you. Does that make sense?
It does. Thanks.
Maybe shifting gears, I just want to tackle TI.
Yes
this is obviously a main topic with investors right now. Reducing the number of distribution partners, adopting a more direct model. So 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 with Avnet.
First of all, we've had a relationship with Texas Instruments for 30, 40 years, 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. I don't want to speak for them, the intent is that while they offer a broad line, they feel they're a very competitive technology, therefore that customers will search them out on their website to do ordering. That was known. Three years ago, they made the decision not to do demand creation anymore. Demand creation is where we send out engineers to get their product designed into product. They said they were going to do that themselves. 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. Our gross margin was in the 7%-8% range. That's how we came up with the $150 million. They decided that they're going to speed the clock, or from our impression, speed the clock, to go direct, and in the meantime, consolidate to one distributor. It wasn't a surprise that TI wants to go direct. When we received the letter, that was a surprise. We didn't expect that timeframe. What's number one important to us over the next 15 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 supplier parts to them. 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 market and customers were somewhat surprised. We're going to work in conjunction with TI to serve customers and do this in an orderly process the best we can.
It's only been 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 have TI?
No, we haven't seen any customers defect. Right now we haven't seen any impact, and I think we kind of indicated that on our call. I think you'll probably start to see it in March, and the question would be, is it going to take 4 quarters? Is it going to take two, or will it take longer than 4 quarters? Time will tell on that. Just keep in mind, that's a good question, will the customers defect? 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. It's not a case of customers defecting. It's the case that the share between us and our main competitor will change with them.
Okay. 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?
Complete honesty, we haven't heard any other supplier talk about trying to take things direct. 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. We haven't seen any sign of that. Most of our suppliers, they see us as part of them. If 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 or smaller customer. Like our challenge is, though, is we try to grow their sales and distribution faster than they can grow to the direct.
If we do that, they're always very happy with that.
Yeah. 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.
Yeah. The good news is Phil has a very detailed plan down to the branch level by customer, I don't want to telegraph really what the strategies are. Yeah, it's clearly there's some cases where we can replace a component. Within a week after issuing our 8-K 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?" There's many ways. Our target is to replace about $1 billion of revenue. There'll be a time lag. It'll leave faster than it comes back. We're going to do some level of cost reduction, we said $35 million. That'll go out as TI leaves. Hey, look, over time, that's going to get added back as we replace the revenue.
That was variable costs associated with things like distribution center or things that were completely variable with TI. Does that make sense?
Yep. Then maybe some silver lining to it. I think you also get some cash benefit as well.
We got some cash benefit.
Maybe just touch on that and then wrap in capital allocation and all that stuff.
The TI inventory has always been consigned. 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. 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 in Asia. As that business does get transitioned out of Avnet, I think we quoted $300 million or $350 million 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. Over time, as we replace it, we're not going to use $350 because we're only going to grow back $1 billion in revenue.
Well, I appreciate you bearing with me through some of the challenging questions and tackling them head on.
Sure. It's really important.
Maybe just zooming out to kind of an industry overview question, and we'll wrap it up here in a second. We tend to find a lot of attractive characteristics to this industry. Maybe if you'd touch on the industry structure, kind of end market growth rates, and kind of the attractive aspects of component distribution.
Yeah. We continue to think that over time, those that will do well in distribution are those that have a component catalog distributor that It's really important, especially 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 failed to mention, Farnell, we have an engineering community of 1 million members, where they go online, and it's just pictures and social media for engineers, but that's what brings them in. 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'll 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 also pay a lot of attention to return on invested capital, which is why we have a focus on working capital and cash flow. We think over time, those are really important.
You're going to need to be able to show that you have a return on invested capital better than your WACC. That will help keep things sane over the long term.
Sure. 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. 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.
Yeah. 2020 is the year of getting Farnell back to double digits and working through the TI transition. We thank all of you for staying with us. We delivered a pretty tough message this last quarter about where we'll be. Hopefully, we've laid out a compelling plan. I'm really looking forward to next year coming to the conference and getting a different flavor of questions.
Yeah.
That'll be very enjoyable. 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 going forward.
Good. Well, we appreciate you addressing things head on. Thanks for your time, Tom.
You bet. Thank you.
All right.
Thanks, everybody, for coming.