Start: 9:30 ET
End: 9:55 ET
Avnet, Inc. (NYSE:AVT)
UBS Global Technology and Services Conference
November 17, 2011, 9:30 ET
Raymond Sadowski – Senior Vice President and Chief Financial Officer
Vince Keenan – Vice President, Investor Relations
Good morning, everybody. Welcome to our third and final day of the UBS Global Technology and Services Conference. My name's Amitabh Passi. I'm the senior research analyst covering technology supply chain and wireless handset companies. It's my pleasure to welcome Avnet. Presenting on behalf of Avnet would be the Chief Financial Officer, Ray Sadowski. Accompanying him is Vince Keenan from Investor Relations. Thank you.
Thank you, Amitabh. Good morning, everyone. Just going to spend a couple minutes with some opening remarks about Avnet in general, in case anyone here is not familiar with the company overall. I'll go quickly through the Safe Harbor statement which I think everyone's fairly familiar with overall.
First to start off, just an understanding of the market position, the market place available to Avnet overall. If you look at the total available market, and this takes into account various sources in compiling these numbers, but, essentially, we're in a $1.3 trillion industry today. Although the majority of this does go direct, the distribution portion of this is roughly in the $300 million, $300 plus million range. The market overall that we participate in growing roughly 5% to 6%, that's the expectations over the next few years.
So, the key takeaway from this slide essentially is that there's a lot of opportunities for Avnet to grow as we move forward. Obviously, our goal is to see how we can take advantage of those opportunities to grow faster as we move forward.
Two business segments for Avnet are Electronics component. The business overall represents a little bit less than 60% of our business overall. It markets and distributes a variety of different components and embedded systems to a number of different customers in the OEM, ODM and EMS provider space.
Our Technology Solutions business again representing a little bit more than 40% of the business as you can see here. It does a variety of different things, more on a high-end complex computer products. We sell those to VAR system billers and OEMs, and ISVs as well.
The importance of down on the bottom is a recognition of the different business models between EM and TS as you can see with the split of 57% sales for EM and the balance going to TS. Yet, EM makes up roughly 75% of our profits overall. So a higher margin business is the takeaway from there.
However, they also consume a significantly higher amount of working capital than does our TS business. When you pull that together, the way we run our business, is from a return perspective. Both return on total capital and return on working capital. These two businesses just get their different ways from an earns and turns perspective.
It's important to keep that in mind because as those businesses grow, depending on how they grow relative to one another, it certainly is going to have an impact on Avnet's margins overall. Less of an impact on our returns, but more of an impact on our margins overall.
The same is true if you do a deep dive within both EM and TS. Whereas an example, if you look at an EM business, you'll have different earns and turns characteristics with our Asia business than you will see in the EMEA or Americas business. How they grow relative to one another will have an impact on our margins and that's something that's important to note as you look at the company overall.
This is a slide that we've shown not too often and something where we'll continue to show as we go forward. It's trying to give you a sense of how we look at the company overall from a portfolio perspective. The size of the bubbles are simply how large the particular business operation is. The blue is essentially our TS businesses. The green is our electronic marketing businesses.
If you look on a horizontal axis, it's looking at what expected market growth will be over the next three years. On a vertical axis, it's looking at their return on working capital relative to what our individual targets are for those regions. Good thing to be above that line and not such a great thing to be below the line.
The importance here is to show what the possibilities are without a significant amount of growth, just getting all of our businesses up to what our long range targets are. It has a fairly significant impact on our profitability potential going forward. Hence the reason for the slide performance and potential.
Clearly, you can see the biggest bubble down there that we struggled with over the last couple years has been TS EMEA. We've made good progress. The acquisition of Bell certainly helped that business overall.
We've seen some improvement over the last few quarters. Our expectation is that we'll see continuous improvement as we move forward as they move higher towards that long-term planning target line that you see there. That again will impact profitability very nicely for us, just as a way of continuing to improve on what we've done so far.
If you look at current market conditions, this just gives you a snapshot of what happened during Q1 towards the top there. EM doing about $3.8 billion, TS doing about $2.6 billion. It provides our guidance for the second quarter. We're at the midpoint.
We would expect EM to do about $3.6 billion and TS to do about $3.2 billion. Those numbers are at the low end for TS. Low end for what we'd consider a normal seasonality. For EM, slightly below a normal seasonality for EM overall is what we're seeing.
If we look at the electronics marketing overall, book-to-bill has been improving. It improved through March and that trend seems to be continuing so far through the November time frame. We're in a situation where, for the most part, average selling prices seem to be stable and lead times, as well, earn a normal low range about six to eight weeks overall.
Looking at TS, a lot of the growth has been driven by industry standard servers and storage as of late, and as we go into the December quarter, we're looking for a fairly good quarter. No indications at this particular point in time that would suggest hitting those numbers are going to be a challenge in any way.
Now, just take a look back over the past five, six years relative to our performance overall. You can see here from a top line perspective, we've grown about 13% over the last five years on a compound annual growth rate. A mix between, obviously, acquisition activity and organic growth, as well.
We had a strong recovery, as you can see here, after the downturn in fiscal year 2009, hitting record sales in fiscal '11, a little bit over $26 billion with fairly significant growth, and a lot of that growth obviously due to acquisitions with the Bell acquisition occurring at the beginning of fiscal year 2011. Good growth and we would expect going forward after we get past this little soft patch that we're into today that we would expect growth to continue.
From a bottom line perspective, similar story, record earnings per share in our fiscal 2011 time frame. Last five years growing significantly faster than sales, compound annual growth rate of a little bit less than 20%, coming in at 19% overall. So, again, a fair amount of leverage in our business as we've grown the business over the last few years.
Important slide to us just in the way we run our business which is from a return on capital perspective. Our long term goals are 14% to 16%. As you can see here in the most recent two fiscal years, within that range overall at 14.7% in fiscal '10 and 15.4% in fiscal '11. Our expectation is that we'll be able to hopefully maintain.
We'll have some ups and downs, obviously, based upon what business conditions are overall, but this demonstrates that achieving our goals is certainly possible in maintaining this as something that we will continue to work very, very hard in doing. Again, we run our businesses from a return on capital perspective, and that's why, as I mentioned earlier, if you look at the business mix between EM and TS as well as the additional business mix between, let's say the Asia region and the other regions, they have different earns and turns perspectives that may impact margins overall. However, they should not have a significant impact on returns because we're basically holding, regardless of the earns and turns, we're holding them to similar return capital targets overall.
This is our long-term business model. We update this once a year, in December. We'll take a look at it for our Analyst Day that's coming up mid-December this year, but right now, we're looking, as I just mentioned, from a return perspective 14% to 16% is our goal overall and we've been cheating that over the last couple years. Return on working capital, we've been a little bit below that, but moving forward quite nicely and getting towards that goal of 30%.
We look at a margin perspective overall, EM in the 5% to 5.5% range. They did hit that back in fiscal year 2011. However, with the slowdown that we've experienced so far during this fiscal year, it's come down a little bit, but still maintaining in that range overall, we think, certainly on a go-forward basis. You have to keep in mind that these are rates that are looking to blend over the ups and downs of the industry overall and that's why they're longer term targets.
From a TS perspective, 3.4% to 3.9% of the goal. They're below that. As you saw in the earlier slide, that I talked about our performance and potential. The big reason for that is quite frankly our TS EMEA business being below what our expectations are and TS Asia business being below, as well. But both businesses have made good progress from a margin perspective and, therefore, we would expect the entire TS organization moves much more closer to those targets in the relatively short term.
Blending those together you get the Avnet's 4% to 4.5% margin target. We did at 3.8% last year, a little bit below the low end of that target primarily due to the TS operations that I just mentioned. So, just closing out before I open up for questions, reasons why we think investors should consider making investments in Avnet. One, serve market is large and growing. We do expect it to grow faster than GDP overall. So, there's a lot of opportunities (inaudible) to continue to grow its business and increase profitability overall.
That growth opportunity comes in a number of different ways, not only organically, but through value-creating M&A, as well. Opportunity is out there for it to continue to grow our business from a M&A perspective and we will continue to pursue those as we go forward. As we drive our business with a value-based management philosophy, it does allow us to deliver industry leading economic profit dollars which then drives higher cash flow generation, which allows us to invest back into the business for continued growth overall.
We do have a proven leadership team. We've demonstrated, over the years, our ability to manage the business in almost any type of environment. So we've seen very challenging years back in the 2000-2001 time frame. It was not quite a similar situation back in 2009, but in 2009 we came out a stronger company. Now we're having a little bit of a soft patch, as you can see in the most recent quarter or two, but our expectation is that we'll work our way through that and come out of it as an even stronger company, as we go forward.
With that, thank you for allowing me a few minutes to give you a quick synopsis of the Avnet story overall and, at this stage, open it up for a few minutes of questions.
Thank you, Ray. If you have questions raise your hand. I'll kick it off. You talked about improving booking strengths through October and November. Can you dissect that further, maybe give us a sense of how that's trending across geographies and then perhaps across both EM and TS?
So, if you look overall, not much has changed from where we were a few weeks ago when we did our first quarter call. Certainly the biggest area of weakness is over in Europe in our EM business. Their book-to-bill suffered the most I guess I would say. But keep in mind that they had a number of consecutive quarters of fairly robust book-to-bill. Any time you have situation like that and then you have some moderating growth as we're seeing today, they're going to be impacted the most. The good news story is it certainly does not seem to be getting any worse. It's actually strengthening a little bit, but not dramatically so.
Next impacted has been our EM Asia business, although not to a significant extent, it still has been impacted, with book-to-bills coming down to some extent, but still relatively firm, moving up, as I said, through October and November.
Then probably the least impacted has been the Americas' business. Americas' business has held up quite nicely overall and continues to perform well. So as we look as the book-to-bill, it's one indicator of what do we think might happen to the marketplace overall. Obviously a lot of things could change, but we do view the relative strength in book-to-bill through October and November as a sign that the downturn or softness that we're experiencing today, hopefully will not be long-lived and that's a little bit of our expectation at this point.
And just on TS, Technology Solutions?
As far as TS is concerned, it's fairly similar across all three regions I would say, though the Americas is certainly the strongest and has always been. There's a little bit more weakness in Europe and Asia is doing fairly well over all. So I'd say it's a similar pattern as you'd see in EM, but probably not quite as severe, especially as you look at the EMEA business overall.
The question is about the electronic OEMs seem to constantly be trying to push inventories further down the supply chain. Every quarter Cisco moves stuff to hubs and talks about just-in-time inventory and vendor-managed inventory. How does Avnet play into that or is that mostly direct from the component or semi producer to the OEM.
Yeah. I think it's certainly not a new phenomenon. You know, distribution just, where we play in the supply chain overall, there's always, I guess, a reasonable amount of [SP] pressure from an inventory perspective and how much inventory gets pushed down to us. But I think one of the things that's changed from our perspective, I'll say over the last 7, 8, 9, 10 years, is as we embrace return on capital what it says to us, if you look at our business, what's really changed over the last, you know again 5, 6, 7, 8, 10 years, whatever time frame you want to look back on what return on capital has done for us is a much higher level of discipline relative to working capital.
It's had a bigger impact there, value-based management philosophy, it's been a bigger impact on inventory velocity, receivable velocity, versus, let's say, margins overall. As a result of that, when you look at inventory, we look at it very, very closely in terms of what's appropriate level of inventory for us to hold in order to satisfy our customers. As a result of that, you do occasionally hear there's more push back where distribution is not as receptive to taking inventory and quite frankly, it's a very simple reason, which is we don't think we can sell it in a reasonable period of time based upon our returns models and things like that and we don't want to buy the inventory.
But, that's a pressure situation that happens on a continuous basis that we work through, and in some cases, we manage to deal with it. We look at it from an investment perspective. What's our return going to be on that inventory, and if we need it, when are we going to need it, how much are we going to need, what's the pricing, and so on and so forth. We manage that on a continuous basis.
You showed a slide about your CAGR for the last 5 years and you said that acquisitions are part of that. What is your CAGR looking back five years, ten years on an organic basis and how does it compare with your (inaudible)?
I don't know the exact number, but depending upon which period of time we look at, I would say that roughly 50/50 is a number I would quote or indicate. I don't have the exact number, but it's in that ballpark, where organic growth and M&A growth have been that kind of a split overall, generally speaking. I don't think it's dramatically different with our competitor.
If that were the case, you'd see dramatic shifts in market share gains one way or another, and we really haven't seen that. You've seen some during certain periods of time, but nothing dramatic where either one is, you know, pulling way ahead of the other. I think the story will be relatively similar, but I certainly haven't analyzed their numbers that closely.
(inaudible) for the organic growth if I remember correctly (inaudible).
It depends on what time frames you're looking at. I don't think you'd see dramatically different organic growth. If I sat and analyzed it, I don't know what they're showing, but I'd be surprised if it's dramatically different than what we're showing.
Ray, can you just quickly update us on the situation in Thailand? We definitely know you've got some direct exposure via your hard disk drive business. Maybe just give us a sense how broad-based of an impact you are seeing and remind us what exactly is embedded in your guidance for the HDD business.
OK. So, if you'll look at the, and it's really been a lot of questions we received so far this morning, and I would expect for the balance of the day. So first, maybe, put things in perspective. We look at the disc drive business I guess in two ways. One, is the commercial-type business, which is the lower margin commodity-type business and then the balance or the more high-end business that gets imbedded in other components.
In the Thailand situation for the most part, at least in the way it's impacted our business, it's been more towards the lower-margin-type business. So the commercial side of things. Keep in mind for us it's roughly 4% of our business overall. So it's not a huge part of our business and it's not been a huge part of our profit pool either. We acquired a significant piece of that, I don't the exact number, but we acquired a significant piece of that business when we did the Bell acquisition back at the beginning of fiscal 2011. So it's relatively new to us.
Tt's a business, quite frankly, some of you may have heard that we've talked about as a business that we've been analyzing and looking at basically saying, "Could we make money, could we generate the kind of return?" So I showed you a portfolio slide there earlier and part of as we go even below that, we look at different businesses that we have and, basically, say, "Can they hit the return targets that we set forth?"
And that business, if you would ask me that question a quarter ago, we'd be having a conversation about, can we make that business profitable enough from keeping it around. Now, all of a sudden it's the most important topic we see.
So, it's important to keep relative to what it is to have, roughly, a 4% business. It is a business that, so far, we've owned it, we've made some shifts in the way we manage the business, so it does look it can be profitable for us. The decision's been made, yet but it's moving forward.
In the current environment with the shortages coming out because of the Thailand situation, it's certainly having an impact on our business. It's moving up prices, obviously, but it's also moving up cost.
Fortunately, for us we did have some orders in place at the end of September quarter, which are allowing us to fulfill most of the demand that we have our customers overall. How that shifts when we get to the March quarter, not quite sure at this particular point in time.
So, the impact overall, I think, will be positive for us in the December quarter. Is it going to be a huge positive? I don't think it will be that huge in the scheme of things just because it's a relatively small part of business overall.
If you're seeing book-to-billing improving in October and November, does that mean that in terms of your own inventory management that you think that exiting this quarter that you'll actually be at levels where you where you want to be, you won't have access inventory?
I'm sorry, say that last part again?
Yes, sorry I wasn't very clear. Exiting the December quarter, will you be comfortable with your own inventory levels internally?
So, if you look at inventory in the September quarter, it's probably a little bit higher than we've would have liked and simply I think the main reason being sales came in a little bit softer than we expected.
If we look at the December quarter, we would the inventory to come down. How much it comes down it's hard to say at this particular point in time, but I wouldn't be surprised if it comes down in line from a percentage perspective similar to how EM sales are going to decline, so in that 4, 5% range-type situation. So very rough order of magnitude, not exact by any means but maybe in that $100 million range. All right? What does that mean as we go forward? I would say at this particular point in time, we'd say that we'd be reasonably comfortable in that position. There's a big 'however' associated with that, which is what's going to happen in March.
As I said a little bit earlier, the book-to-bill has turned a little bit positive. It's not something that that is saying, hey, the worst is over, anything like that. It's just an indication that maybe things are not going to be as bad as we've seen during other cycles. We don't know that today, but as we go further along into the quarter, we'll make those judgments and that will help us determine what inventory we do need for the March quarter.
Remember, the inventory we end up with the end of December, it's factoring in a couple of different things. One, how strong or not so strong business was in December, but also what we think is going to happen in the March time frame, as well, because we need to make sure we have inventory to service what we think demand is going to be in the March time frame. Having said that, we still think inventory will be down for the quarter.
OK, we'll do one quick last question.
Let's followup on that question. The other sessions, the semiconductor manufacturers were talking about inventory correction going on in the market right now. Some of them mentioning it being about a two quarter cycle. What do you see from your perspective with that?
Can you say it again, because I'm getting an echo.
Other sessions today the semiconductor manufacturers were talking about an inventory correction going on in the channel, about a two quarter cycle they're saying with excess inventory. From your perspective, what do you see happening?
Oh, I think so. If we're talking about length of correction from an inventory perspective? Inventory is not that dramatically out of line, so from where we sit today, you're looking at a couple of quarters. Again, a lot of it depends on what we see demand going to be as we go forward through the balance of fiscal year, early 2012. It doesn't seem like it's more than a quarter or two at this particular point in time.
OK, thank you, Ray. Thank you, Vincent. We’ll move down the breakout in the Julliard Room. Thanks.
Thank you very much.
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