Avnet - Earnings Call - Q3 2021

Transcript

Speaker 0

Greetings, and welcome to the Avnet Third Quarter Fiscal Year twenty twenty one Earnings Call. I would now like to turn the floor over to Joe Burke, Vice President of Treasury and Investor Relations for Avnet.

Speaker 1

Thank you, operator. Earlier this afternoon, Avnet released financial results for the 2021. The release is available on the Investor Relations section of the company's website. A copy of the slide presentation that will accompany today's remarks can be found via the link in the earnings release as well as on the IR section of AFNIP's website. Lastly, some of the information contained in the news release and on this conference call contain forward looking statements that involve risks, uncertainties and assumptions that are difficult to predict.

Such forward looking statements are not the guarantee of performance and the company's actual results could differ materially from those contained in such statements. Several factors that could cause or contribute to such differences are described in detail in Avnet's most recent Form 10 Q and 10 ks and subsequent filings with the SEC. These forward looking statements speak only as of the date of this presentation, and the company undertakes no obligation to publicly update any forward looking statements or supply new information regarding the circumstances after the date of this presentation. Today's call will be led by Phil Gallagher, Avnet's CEO and Tom Liguori, Avnet's CFO. With that, let me turn the call over to Phil Gallagher.

Phil?

Speaker 2

Thank you, Joe, and thank you, everyone, for joining us for our third quarter fiscal year twenty twenty one earnings conference call. I hope everyone is safe and healthy. Overall, we were very pleased with our third quarter results and I'm excited to talk through some of the quarter's highlights. Over the past year, our employees have continued to demonstrate incredible resilience despite the enduring challenges associated with the pandemic. And I'm personally impressed by and proud of the strides we've made as an organization, sticking to the plan we set for ourselves even in the face of what can only be described as a complex operating environment.

Let me kick this call off by providing a bit of insight about what that operating environment looks like today from our seat in the center of the technology supply chain. As many of you know, while there's a glimpse of light at the end of the tunnel as countries around the world work to vaccinate their populations, we are still operating in an unpredictable market. Supply constraints combined with a recent strong rebound in demand have resulted in the kind of widespread inflation we have not seen for many years. As we highlighted in our second fiscal quarter, we saw notable demand increases across the automotive, consumer and industrial segments. Those end markets, in addition to communications and computing, drove end market demand throughout the third quarter.

Customers are seeking to reduce supply chain risk by securing longer term supply agreements and exploring second sources, providing welcomed opportunities that we were not previously seeing. On top of that, many suppliers are also experiencing raw material price increases for items such as resins, coppers, and more. Avnet is, in most cases, able to pass along these price increases to our customers. While this type of operating environment is not ideal, we've certainly navigated similar circumstances throughout our one hundred year history and have a number of systems and processes in place that enable us to effectively serve our customers and suppliers. Those systems are incredibly effective and enable us to continue to compete in this market.

But what really has achieved our success is our commitment to prioritizing strong partnerships. Avnet is and will continue to act responsibly and transparently in both how we manage and how we communicate about the supply and demand curves. Our teams have established relationships that are unmatched in this industry by remaining in constant contact with our customers and suppliers and working collaboratively upstream and downstream to manage forecast and mitigate supply chain risk. These deep relationships, some of which extend four to five decades or more, provide us with strong visibility into potential pricing shifts and customer response. We take great pride in the supply chain engagement practices we've built with both our supplier partners and customers and we'll strive to maintain this approach.

Of note, we continue to see strong design activity coming off record registrations in the second quarter. In our fiscal third quarter, our demand creation revenue, design registrations, and design wins increased sequentially and year over year. Really proud of that. We tied this success directly to investment in relationships and our engineering capabilities, which include digital, self serve, and design tools, and, of course, our account management team and field application engineers. Not only does this result in engagements with stronger margins, but it improves our revenue visibility, which in turn allows us to operate our business more intentionally with fewer surprises.

Our success in stabilizing our business by prioritizing strong partnerships has proven effective as the environment has become more dynamic, and I'm confident it will enable us to continue to adapt to the changes as we have for the past one hundred years. Now turning to Slide five, you'll see evidence of our progress in the 2021. In the third quarter, revenues were $4,900,000,000 up year over year and sequentially, exceeding our guidance range and also up sequentially and year over year on a constant currency basis. Excluding TI in both periods, sales grew 22% year over year on a constant currency basis. We were pleased with how we performed in The Americas and the EMEA regions and we are encouraged by the continued progress we are seeing at Farnell.

In the Asia region, a shortened Chinese New Year and continued strong demand in all end markets contributed to continued momentum in the region. Looking at our core Electronic Components business on Slide six. Revenues were up year over year and sequentially in the quarter at $4,500,000,000 As mentioned earlier, strong continued growth in Asia drove the outperformance in this segment, demonstrating solid execution against our China growth plan as we gained share across the entire APAC region. We were also encouraged by better than expected results in Americas and continued incremental improvement in Europe, our strongest region. Lead times of course lengthened throughout the quarter, driving very high book to bill ratios in every region.

We are continuing to tightly manage our backlog and our teams are working closely with our customers to gain extended visibility, which we're then sharing with our supplier partners. While it is difficult to forecast how long the supply constraints will continue, most market participants expect it to extend through at least the second half of calendar year 2021. Turning to Farnell on Slide seven, revenues were up year over year and sequentially in the quarter at $396,000,000 and operating margins increased sequentially to 6% progressing towards our target of 10%. We made the conscious decision this quarter to continue to maintain operations at both the Leeds distribution center and the existing facility for the foreseeable future. This decision is in line with our commitment to provide seamless service to our customers as we continue to see increased demand out of Farnell.

We remain steadfast in our commitment to continue to invest in this critical aspect of Avnet and are excited about the clear potential of Farnell as we further digitize our business. Case in point, Farnell saw e commerce sales up 20% year over year. We are bullish about the contributions Farnell can make to Admins value proposition and continue to invest in Farnell. We added 67,000 SKUs through the first nine months of fiscal year twenty twenty one and progressing on our plans to add up to 250,000 SKUs through the fiscal year twenty twenty two. So with that, I'll turn it over to Tom and so he can dive a bit deeper into our third quarter

Speaker 3

Thank you, Phil. Good afternoon, everyone, and thank you for attending today's call. As Phil stated, we are pleased with the progress we made and the results we posted in the third fiscal quarter. Looking at the key highlights on Slide nine. In the third quarter, we grew our top line by 14.1% year over year and expanded operating margins for the third consecutive quarter.

Our efforts to date have put Avnet in a much stronger position to execute in this dynamic operating environment, and I am excited to walk you through more of the highlights from the quarter as I continue to indicate Avnet's critical role in the center of the technology supply chain. Our revenues for the third quarter were $4,900,000,000 and adjusted EPS was $0.74 Both our revenues and adjusted EPS exceeded our guidance range and grew from $4,300,000,000 and $0.38 in the prior year's quarter. As Phil mentioned, strong revenues were primarily driven by an exceptional quarter in Asia and Farnell and better than expected performance across Americas and EMEA. Used $10,000,000 of cash flow for operations to support our top line growth. While working capital was up slightly in the quarter, we further reduced our net working capital days to 72, the lowest level in several years, further demonstrating our team's success in managing cash and working capital as we continue to navigate a volatile market.

We are seeing strong returns from our investments in low touch e commerce and in our steadfast commitment to deep supplier and customer relationships, which are yielding exciting design wins. Looking at the income statement on Slide 10, Gross margin of 11.6% was up sequentially, primarily due to increased prices we are passing through and regional mix. Farnell, EMEA and Asia each increased their gross profit margin sequentially, an encouraging trend. As far as our revenue mix by region, Asia revenues, while better than typical seasonality, were a bit lower than last quarter, while Americas and EMEA revenues both grew sequentially, thus contributing to the higher gross margin. OpEx as a percentage of gross profit continues to decrease, reaching 80.6% from 84.4 last quarter.

Adjusted operating expenses of $458,000,000 were up by 6.1% sequentially. The dollar increase was primarily due to increased volume, strong euro and pound exchange rates against the dollar, the discontinuation of temporary cost containment measures and higher distribution costs as we continue to maintain operation of both Farnell warehouse. As Phil mentioned, the decision to continue to operate both warehouses was primarily driven by strong demand and a decision to prioritize customer service over cost savings. Of course, this means we will maintain higher operating expenses in the near term. But with continued growth at Farnell and improving e commerce results, we continue to expect to achieve our 10% operating margin target by the end of fiscal year twenty twenty two.

On the non operating front, interest expense is slightly up sequentially due to slightly higher debt through the quarter for working capital. Though interest expense declined year over year by 25%, hitting $22,300,000 this quarter. The decrease year over year was due to lower debt levels, which reflects our continued commitment to maintain an investment grade profile. We recorded foreign currency transaction gains of $1,200,000 this quarter due to some favorable one off items. And we revised our annual tax rate expectations for fiscal year twenty twenty one to 16%, up from 15%.

As a result, we booked 20% tax rate in the third quarter to true up the year to date amount to 16%. On Slide 11, we highlight results across our three geographic regions and from our two business segments. Total revenue growth was largely driven by strong sales in Asia, which benefited from more shipping days in the region due to the shorter than expected Chinese New Year and broad end market demand. Revenues grew substantially as our e commerce and inventory investments are paying off and Farnell is capturing increased demand. We saw signs of continued recovery across The Americas and EMEA regions.

Looking at the Electronic Components segment, we achieved revenue of $4,500,000,000 increasing 4.1% sequentially and 13.7% versus the prior year. The Electronic Components segment operating margins were 2.6%, a 23 basis point improvement from last quarter. Cornell revenues for the quarter totaled $396,000,000 up sequentially and year over year, primarily driven by our improving ability to capture share and increase demand. We saw strong e commerce revenues that were up 20% year over year, indicating that investments to improve customers' online experience are drawing a notable return. We are continuing to invest in the business by adding SKUs and prioritizing excellence in customer service.

The Farnell segment had an operating margin of 6% in the quarter, while the OpEx was higher than anticipated, primarily due to our decision to maintain operation of the existing facility and Lee's distribution center. We expect Farnell operating margins to continue to steadily improve over the coming quarters, and we remain on track to achieve a 10% target operating margin by the end of fiscal Turning to cash, liquidity and the balance sheet on Slide 12. Our liquidity position remains strong and our debt leverage continues to improve. We ended the quarter with cash and equivalents of $323,000,000 and with $1,700,000,000 of available lines of credit.

We are comfortable with our debt position, especially as the macro environment continues to recover. We maintained moderate debt levels quarter over quarter, with debt coming in at $1,200,000,000 and net debt at $873,000,000 Our gross debt leverage was 2.7 and net debt leverage was two point zero. We intend to refinance 300,000,000 of capital market notes due in December. We continue to support our dividend and returned $21,000,000 to shareholders in the quarter. Our net book value per share was $39 Turning to Slide 13.

I will wrap up with some comments about our expectations for the next quarter. For our fiscal Q4, we are guiding revenue in the range of $4,700,000,000 to $5,100,000,000 and adjusted diluted EPS in the range of $0.71 to $0.77 Our guidance is based upon current market conditions and inventory availability. Before I turn it back over to Phil, I just want to reiterate how incredibly proud we are of our team's efforts. Today, thanks to their work, Avnet is in a much stronger position to deliver to its stakeholders, especially as we navigate this dynamic market and capitalize on growth opportunities. I am excited and optimistic about what lies ahead.

Phil?

Speaker 2

Thanks, Tom. Before we turn it over to Q and A, I just wanted to reiterate my excitement about celebrating ADNET's one hundred year anniversary. As many of you know, I've been with ADNET for nearly forty years. And despite the macro challenges we've had to navigate over the past year and the uncertainties associated with the supply constraints, the digital transformation that companies like Avnet are undergoing is significant. Those of us who have been running complex businesses for a long time understand what a game changer digitization is.

It has been one of the most exciting times to be at Avnet and in our industry, and I'm proud to be leading such a tremendous team at this time. It is because of our team's hard work that we continue to play a pivotal role at the center of the technology supply chain. I just want to thank our employees for their continued support and dedication to our customers, suppliers and Avnet. So with that, I'll turn it over to the operator for questions and answers.

Speaker 0

Thank you. Ladies and gentlemen, we will now be conducting a question and answer session. Thank you. Our first question comes from Adam Tindle with Raymond James. Please proceed with your question.

Speaker 4

Okay, thanks. Good afternoon. I just wanted to start with a question on margins and the trajectory. You talked about being on track for the 10% Farnell margin by the end of fiscal twenty twenty two. We can clearly see progress this quarter.

I wanted to ask in core components, you said you're around 2.6% now. Americas, I think, beat expectations in this quarter and is maybe turning. How do you think about the core components opportunity ex that Farnell piece during this time to fiscal twenty twenty two and the key drivers? And if you want to touch on near term Americas performance in that response, that'd be helpful. Thank you.

Speaker 3

Sure, Adam. Thanks for the question. Electronic Components was at 2.6% this quarter. Our target is 3% to 3.5%. And we see that as very doable by the 2022.

A lot of that is continued revenue growth while we hold our OpEx relatively constant and get drop through. When we look at it, we will get some benefits from pricing. And again, we're just passing on price increases. That would more be a benefit on the Fresnel side. With Region mix, if you look at it today, Asia is very strong, and I think that's not unique to Avnet.

Americas and EMEA, they did very well this quarter. But Adam, I would consider them recovering. They are still on an upward track. We're very happy with EMEA. They're up 17%, I think, sequentially.

They grew their operating margin 100 basis points, but there's more to go. And as we look at our budgets for next year, that's what we're seeing from the team. And lastly, demand creation. As Phil said, demand creation is very, very strong. On the Farnell side, we see a lot of good things happening.

The investment from adding SKUs is paying off. You see that in the revenue number. The investments in e commerce are paying off. You see that on the online sales growing 20% year over year. And Adam, that's important because online revenues are at a slightly higher gross margin because people are coming in and they're electing to choose a market price.

I've been choosing that because they can get the inventory, have it on their desk in two days. We see National Instruments starting to contribute in fiscal year twenty twenty two. And one thing we didn't say Raspberry Pi has been very strong. So there's a lot of levers here for operating margin improvement. Electronic components 3% to 3.5%.

For now, getting from 6% up to 10%, very positive story going forward.

Speaker 2

Yes, Tom, I'll just jump on that. Thanks, Adam. Appreciate that. And just specifically on The Americas, I think Tom answered everything you asked. I just want to reemphasize it's a real opportunity for us still.

We saw the improvement that we were looking for. They hit the number we wanted them to hit or they they work to hit, and that's still one of the bigger needle movers. I mean, we talk a lot about Farnell, as you know, but the The Americas is one of the bigger needle movers, and we we we have a plan to get that back to where it needs to to get to. So just FYI, we're pleased with our momentum in all the regions. So just wanted to highlight that.

Speaker 4

Yes. That's helpful. And maybe just as a follow-up, in terms of the near term guidance, I just have to ask, why would revenue and EPS be flat sequentially in the June? On revenue, you typically get a little bit of an uptick sequentially. And I know that there's typically some margin pressure from mix and stuff sequentially, but pricing's only getting tighter on a go forward.

You've got more wood to chop in Farnell. There's some good guys happening, you know, on margins. So maybe what are the main offsets near term? I think we went through a long term trajectory, but just in near term guidance, why would BV flat on revenue and EPS? Thanks.

Speaker 3

I think part of it, Adam, is March was very strong, right? Asia revenues, they were much higher than seasonality, higher than expected and probably true for our peers as well. I would say that's really the main reason why it's flat. When we look at what our peers are reporting, I think generally, peers are reporting June revenues up versus consensus, but somewhat flat to March. That said, what would be the drivers to exceed?

Well, would be inventory availability, depends on things like auto production and how successful are people in continuing the strong demand. We believe the demand is still there. Those would all drive some margin upside as well. But I think really the main thing is March was a very strong quarter.

Speaker 2

Adam, this is Phil. And typically, I'm just looking at multiple years of history here in front of me. And, typically, March is our one of our stronger quarters. Right? So that that's not really totally atypical to be flattish in June.

Now with the current market environment, yeah, you know, so there's a possibility we can exceed that, obviously, but there are a lot of factors out there playing right now. But the agent strength, you know, know, you know, growing at 50, you year on year without without the guys in Texas is is is pretty phenomenal growth. So we're just we're we're just watching that closely.

Speaker 4

Understood. That's fair. Congrats on

Speaker 2

a strong March. Appreciate it. Adam.

Speaker 3

Thanks, Adam.

Speaker 0

Thank you. Our next question comes from Nick Todorov with Longbow Research. Please proceed with your question.

Speaker 5

Yes. Thanks for that. Good afternoon, everyone. Phil, you talked about customers exploring second sources. I guess, can you talk about this opportunity, what it means to Avnet?

And what can you do to turn those potential opportunities to longer term relationships rather than than than one offs?

Speaker 2

Yeah. Thanks, Nick. Yeah. Well, I was referring to a couple of things, really. There's a obviously, there's there's some some we'll get the questionnaire sooner or later on some of the the tightness in the market of certain technologies.

And had a conversation yesterday with the supplier that might be seeing some opportunities around they can't get certain parts, they gotta do redesigns and and try to check the source or source a different platform, if you will, but it's it's not an easy redesign. But that's that's happening out there right now too. They can't get the parts. They they they've gotta do something to fill that application. What I was also was was referring to is is both on the supplier and the customer side that they are looking for options.

And and and one of the silver linings, in here is that we're we're seeing, new opportunities from suppliers coming to us to help manage supply chains. But we're supply chains. We're that's our expertise, and it's what we do as a fitness center technology supply. And then we get customers, obviously, coming to us, and and they want options. Right?

So on both sides, you know, customs and suppliers, we're we're maybe we were playing, we're not playing, or we're playing at a smaller level are bringing us in to to to help with their supply chains, architect new ways to go to market and to move their products around. I think that the the takeaway is people can take supply chains for granted until they can't get the product. Okay? That's whether it's a consumer or an industrial. Right?

We all went through that in the last year, year and a half in certain things even around our household, and people start to relook at the supply chain. So that's what I was referring to on both sides of both sides of the aisle, if you will, for us upstream and downstream.

Speaker 5

Got it. And and as a follow-up as a follow-up I got it. As a follow-up, your inventory declined on an absolute basis, basis, and you mentioned inventory availability a couple of times by now. So can you talk about whether inventory constraints is limiting your sequential performance in June? I wonder what's your ability to build inventory at this time.

I guess it's limited, but when do you think you're going to be able to potentially put some inventory on your books?

Speaker 2

Well, let me take a crack at that. It's tough when we work backwards with the first part of that, which really ties back to Adam's question probably on the on the June June guidance. It's it's tough to say what kind of, constraints might be there that, could affect billings. I mean, I know we've got another question. Our customers are not taking other products because they can't get certain technologies, and we're really not seeing that a whole lot right now.

That could come into play. So it's tough to forecast that. As far as inventory, yeah, we we we would like to have a little bit more inventory. And, we have an inventory minute call weekly with our asset folks around the world, and they all came in at their inventory below their inventory forecast. That's just a fact of the market.

That's that's just what it is. So we could if you get another 10%, we we take it and another you know, 10% on working on the inventory days. You know? So we're yeah. We're managing that up and down.

I work you know, daily calls with suppliers and customers. It's it's a it's a complex market, but, as I remind our sales team, we still got a lot of inventory in the shelf. So it's easy to sell what you can't get. Goes go it's gonna sell what we have on shelf. So for the average people listening, they chuckle out of that, I guess.

Right. Okay. Yeah.

Speaker 5

Let me just quickly sneak one more if I can. I'm just wondering, because now TE is gone on the equation, at what sales level would you consider America and EMEA recovered as those we everybody understands those are central to your gross margin improvement?

Speaker 2

You you said t meant TI, I think.

Speaker 5

Yeah.

Speaker 2

We're we're we're getting close to full lapse on that right now, Nick. We're probably in Asia, we're pretty much there. And in Americas and Europe, I think, we'll be there or close to it through this year. And we said remember, we said it'll take about eighteen months to two years, and we think we'll have that gap filled as we get into fiscal twenty two.

Speaker 5

Got Our

Speaker 0

next question comes from Jim Suva with Citigroup Investment Research.

Speaker 6

Thank you very much, and congratulations, and thank you so much for the detail and color. I just have a kinda longer term strategy question, especially with the tenure of how long you've been there. With the pandemic now behind us or at least making progress coming out of it, at least in certain countries, and now with the supply chain shock from the semiconductors, as the management team there at Avnet, do you ever talk with customers or your board of directors or CFO and CEO about structurally, do you need

Speaker 3

to kinda really change things? I mean, mentioned and I don't

Speaker 6

mean in a bad way, but you mentioned some of your customers and suppliers are looking at new ways to come to market. Can you explain a little bit about what does that mean? Does that mean like changes like maybe it's worthwhile to hold a lot more inventory for the next shock that we can't participate or anticipate? How should we think about that kind of longer term of what we've learned through these two very different but challenging situations, the pandemic and the semiconductor shortage? Thank you.

Speaker 2

Jim, thank you. Good to hear your voice, Jim. So look forward to catching up more. Sure. We're having these conversations.

I think the biggest thing, well, let's go back to what Nick's question was. Yeah. The the supply chain, you know, services, if you will, roughly 55% of our business today is in some type of, you know, MRP management where we're getting feeds and some kind of electronic format, automation that we're getting, you know, daily, weekly, monthly from thousands of customers. So but that's I think that's just gonna continue to, accelerate. And I think there's gonna be opportunities already.

There's opportunity today with some let's just say large OEMs that are coming to us for new models, okay, to look at and, you know, service models and and things along those lines. It might require more inventory or just different types of inventory or different types of managing the inventory in BMI and consignment program. So I think what our suppliers do, you know, what what they wanna invest in is is technology, r and d, engineering, fabs possibly. And what we do really well is help with design services and supply chain services. That's our core, if you will, and it's contacts me and our suppliers.

So I think this is, accelerating some of the thought process of some of the tier one, customers and, of course, with our suppliers. I think that's gonna accelerate. I think the big change is gonna be the world going through, and it's exciting. That's kind of the point of my closing comments there is is digitization. Right?

So this is just accelerated, okay, digital. Right? Maybe what whether it's three years, five years, what have you. So we're absolutely looking at our our go to market strategy, you know, you know, physical go to market strategy aligned with digital. I'm still you know, demand creation, Jim, for example.

I mean, alright. I'm being very clear. FAEs, I don't think are going away and account managers aren't going away. But the end to that is how do we put more digital online tools, self serve, design tools, things on those lines where we can make our our our, feed on the street that much more valuable, okay, on the valuable items we want them to spend time on. So they're the two big areas.

One, it wasn't brought up, and it didn't bring up the and then, of course, has ESG effect all that, but that's a separate topic, altogether. We we have initiatives around. That's gonna be a big play in the next several years as well as it already is. So they're the two big ones, I I would say, Jim. The digital and then, you know, the workplace, you know, working back to the office, all those things that that we're looking at footprint, you know, we're looking at.

So if there's yeah. There's a lot of dialogue with the board and with the Tom and the the executive leadership team.

Speaker 6

Well, thank you for the details, and that's encouraging.

Speaker 2

That's encouraging. Yes. Thank you, Jim.

Speaker 3

Thanks, Jim.

Speaker 0

Thank you. Our next question comes from Matt Sheerin with Stifel. Please proceed with your question.

Speaker 7

Yes. Thank you. I wanted to ask about the premier Farnell growth that you saw. You know, certainly accelerated growth there. And just trying to figure out whether that's just a function of design activity, know, picking up as you talked about, Phil, in terms of demand creation, or or is it also due to the fact that, you know, shortages are driving customers to, you know, the so called tech catalog distributors or small volume distributors where they may have inventory.

I know you saw some of that last cycle. Is is that part of it at all?

Speaker 2

Yeah, Matt. Thanks. Good question. I think it's a little bit all of them. You know, it's kind an end.

I don't know. Designs are I'll touch on designs later, but our designs overall are are way up. Registration is designed within revenue. We're we're leveraging the core and Farnell really well. So we're getting some some really good sharing of leads back and forth from the AdNet core to Farnell and Farnell to the AdNet core.

We've invested quite a bit in the in the quick side of things with the ecommerce and and and the digital with, with Farnell and Chris Breslin and his team. And then I think as big as anything, the SKUs that we've added. We've added another another 67,000 SKUs, and and work into the 250,000 SKUs you wanna add in fiscal twenty two. And just remind many in the line that years ago, this didn't have the capital to do that or or the cash to do that. And and under Adventist, do.

The part of that SKU count was not only the dollars and expanding the SKUs was having the warehouse be able to put it in. Okay? And that that's the leads you can reference in the script. That's allowing us to expand our SKU count because we're kind of at capacity in the previous facility. So I think it's a little bit of a those three three or four things, man, I think are contributing to the growth.

Speaker 7

Okay, great. And then in terms of the gross margin, you saw some nice sequential growth there. I know a part of it may do maybe because of the mix of business. You saw growth sequentially in EMEA, in North America and the OTI business. But you would think that in terms of the overall pricing environment would be favorable for you now.

I know there may be some input costs such as freight. It sounds like you're passing them along. So should we expect gross margins to improve here as we go through this cycle?

Speaker 3

I think we'll see

Speaker 2

gross margins improve modestly. Again, tough to forecast out. We are seeing, it's a good point, a little bit of inflation, okay, in freight and some things along those lines. But we we we are planning on on margin to expand a bit. And on price increases, you know, a lot of that is first, we got about 40 suppliers.

We're managing through that, and we feel confident our teams are working really well with the customers to to pass on, the cost where we can. We we it's impossible for us to absorb all that. But but in doing that, we're not we're not looking to gouge them. We're just pretty, very transparent about the what the increase is and, you know, where we have contracts. We manage through that.

Whether there's a shipping debit that's canceled, we get a new one. We manage through that. So it's it's as you can imagine, it's it's hundreds of thousands of money that we're managing in that. But we we feel confident we're having good success in passing on the increases, which should have a bit on ASP, and modestly on the margin percent.

Speaker 7

Okay. Alright. Thanks a lot, Phil.

Speaker 2

Thanks, man.

Speaker 0

As a reminder, if you would like to ask a question, please press star one on your telephone keypad. Our next question comes from Rupul Vadakaria with Bank of America.

Speaker 8

My first one is on free cash flow. Can you give us your thoughts on how component shortages would impact your working capital needs? How do you see your inventory turns versus a normal year? And as part of this, can you also talk about your capital allocation strategy, buybacks versus dividend versus any thoughts on M and A at this point?

Speaker 3

Sure, Ruplu. As we go forward and revenues grow, we will be using some cash for working capital. Think this quarter, we were up about $130,000,000 most of that's receivables. We're fine with that level of investment because it's higher margin business. And as Phil said, little up on the gross margin going forward, a little ways to go on the operating margin.

These are good return on capital. With our capital allocation, really our priorities are just that in the near term liquidity and reinvest in the business As revenue grows and we see that continuing for some time, we will use some cash for working capital. We're clearly going to support our dividend going forward. Debt, we're very happy with our debt levels. Our gross leverage is down to 2.7.

You see that coming down into the low 2s. And that's probably more from earnings momentum than actually paying down more debt. But we think debt is in a very good position. And then every quarter, we do we talk to our finance committee about buybacks and M and A. And with M and A, we continue to be focused on what we've said in the past.

To the extent that we find a company that either adds a product, a supplier, a new market, something that makes the greater Avnet a healthier, stronger business, we will continue to look at that. We have a pipeline. Most of them are companies in the revenue range of $100,000,000 to 200,000,000 But that's how we view our capital allocation priorities going forward. Thank you for that.

Speaker 8

Thanks, Tom. Thanks for the details on that. I have another question for Phil. Can you talk about give us some color on what you saw by end market? I think in the prepared remarks, you said that EMEA and Americas came in better than expected.

So were there any particular end markets that drove that outperformance? And also, I think you talked about design activity trending strong for Avnet. Can you just talk about like are these related to the initiatives that you have around Avnet integrated and IoT? And just in general, how does the pipeline of new business look for you?

Speaker 2

Okay. Let me start with the end markets, Wu Fu. Thank you. I think we're really seeing strong across the board, as I did say in the prepared remarks. I know EMEA and Americas came in at a little above where we thought they would come in.

Asia, we already spoke about kind of across the board. All regions in Asia, including Japan, are performing very well, of course, by China and in in Greater China area. But the other regions are performing well as well, and that's, you know, automotive, telecom, consumer, industrial, medical. So it's really across all of the segments in Europe and Americas. And again, we're playing more in automotive.

We know this we all know that some of the challenges there, we're still playing there, but we saw a strong rebound in the industrial space, which is which is in particular, in Europe, it's extremely strong position for us there and the long tail of customers, is good good revenue as well. So it's really and I think that's what's causing some of the challenges in the marketplace, which are, you know, positive challenges, but challenges nonetheless with demand that it's it's much more, you know, diverse, if you will, from the standpoint of the portfolio. And, course, our EMS sector isn't necessarily vertical. Our country manufacturers, but that that's going well for us as well. Still roughly 3030% of our business with all the EMS guys out there.

Second part of the question, I think, was demand creation and the pipeline. We had phenomenal, actually, demand creation quarter, one of the highest revenue quarters we've ever had and actually demand, you know, design win revenue, as we call it, since pushing 30% to 32% of our revenue out of the out of the core. We saw registration activity up year on year and quarter on quarter as well as actual registered design wins. So new design wins came in at a really high number of over 15% year on year and Q on Q. So the funnel, to your question, from a design standpoint, it's looking really positive, which is almost kind of people wonder how is that happening with the work from home, but there's that much more accessibility to the engineers and design engineers and with our suppliers and our FAEs and digital, you know, all connecting.

You know, pretty pretty bullish on the demand creation very bullish on the demand creation side of the equation.

Speaker 8

Great. Alright. Thanks for all the details. Appreciate it. Thank you so much.

Speaker 2

Thanks, Benoit.

Speaker 0

Thank you. Our next question comes from Steven Fox with Fox Advisors. Please proceed with your question.

Speaker 1

Hi. Good afternoon. Couple from me, please. First off, I was wondering if there's any way to put in perspective how things have maybe tightened up further since your last update either a month ago or ninety days ago. What's the differences?

And along those lines, how I think you guys mentioned that there's a path to maybe seeing the current constraints end by the end of this calendar year. So what is that path to sort of normalizing?

Speaker 2

Yes, Steve, I'll go first. I'll start off with the second question first. We're just trying to get a good handle on what we think the balance of the demand is going be through the calendar year. It's tough to get visibility much beyond that. There's based on technology, supplier, vertically in the summer, as you know, and I'm going quote who say, hey, it could be through 2022.

I'm just giving a look as been around a long time that, hey, we definitely see it through 2021. We're not saying something over 2020, but that's what we see. So just just to clarify that, and that's what we're we're we're planning for. But it's I think there's probably gonna still be constraints in the 2022 at least based on the dialogue I'm having with some of the key suppliers that we we are partnered with. As far as, the first part of the question, you know, we talked a lot and I'm not I yep.

We Steve, I'm sorry. Are you there?

Speaker 3

Yeah. You cut out

Speaker 1

when you started to the first part of the question. Sorry. If you

Speaker 2

could if you could start again. That's fine. No. No. No problem.

Sorry about that. Yes. On the first part of the question so you heard my the the second question. So the first part Yeah. Is like, six months ago, let's call it, you know, get don't hold me to the to the month.

You know, it was their top of the conversation was was in the controller space. Right? The the high end controllers and then got into the lower end controllers, thirty two sixteen eight

Speaker 1

I I might have lost you again.

Speaker 2

I I

Speaker 1

I can take it off.

Speaker 2

No. No. It's not your fault. It's I think it's on our end, so I apologize. Let me let me try again at least I'm getting a couple cracks at it.

So, you know yeah. There you go. Okay. So about six months ago, we talked about the high end controllers and then it leaked into the, you know, you know, it's called sixteen, eight bit, etcetera, and that and that continues. That that's that's continuing to be the I'd still say the private longest pole in the tent when it comes to the, to the lead times extending.

I think we're starting to spread out now. It's a little little bit more pervasive than that in, in some other commodities, even in some power areas, some analog areas, you know, op amps, things along those lines. It's starting to get a little little broader. And what we haven't talked a lot about is in the in the IP and E and, you know, the interconnect passive. And and they're all going okay right now, but there are some signs that there's some lead time extensions coming out of some of the passive guys, and some of the capacitors and in the, connectors too now.

You know, with the it's pretty you know, the certain resins, plastics, etcetera, we're starting to see some lead times in the connector area as well. So I think it's just it's just broadened a little bit, Steve. And, again, think that's based on what I said in answering answering Ruplu's question because of the the, widespread growth of of the different verticals. It's just affecting different technologies. That's what we see right now.

Speaker 3

And then just as a quick follow-up, can you talk about what you do

Speaker 1

to sort of avoid double ordering by your customers? I know you could probably extend the window on non cancelable orders, things like that. Are you taking any of those steps to try and I mean, I know it's hard to tell if it's happening in the moment, but are you doing anything to try to make sure your orders are real?

Speaker 2

Yeah. You answered part thanks, Steve. You answered part of the question with the, NT and Rs. And for those who don't know, that's noncancel, nonreturnable. So as some of that is getting imposed on us for products getting post sorry about that.

So the NCNR is noncancel, nonreturnable. Some of that's just being imposed on us from the suppliers where maybe the products weren't typically NCNR. You know, we're passing on to our to our customers. Obviously, we That's gonna help limit some of the, double booking. But I when I talk about double booking, it's, it's more difficult for us to catch that.

What we'll catch, Steve, is inflated, demand. You know? So we've taken these forecasts from the from the customers, thousands of them. And, you know, if you're you see Fox Industries using 50 pieces a week of something, and all of sudden, you're coming in for 250 pieces a week. If we catch that right away, we go back and have that dialogue with the customer, and make sure we're we're scrubbing that backlog appropriately.

And that and so that's what we catch more of the, I'll call it, more of the inflated. The I had a conversation yesterday with a supplier on the double, and and they tend to catch that more. And the ones part of the estimate, they're they're not really seeing that. Probably, although it's there somewhere, we're not really seeing that. So but the NCNR is helping.

You answer part of the question. That is helping. And the cops tell you, we're sitting and noticing it. It's there's there's certainly a lot of stress in the supply chains and the deliveries and all that. But I think as we just continue to work through it responsibly, you know, we'll we'll guys are tough challenges, but we'll get through this.

We've been here before. This one's a little bit different than we've been here before.

Speaker 1

Great. That's all very helpful. Thank you very much.

Speaker 2

Yeah, Steve.

Speaker 0

Our next question comes from David Williams with Loop Capital. Congrats

Speaker 9

on the solid execution. But I wanted to see maybe tie into the last question and just think about some of at the OEM and maybe EMS. We're hearing that maybe they're trying to build a little bit of inventory from a couple of different channels. Are you seeing that at all? Any inventory builds, I guess, beyond your direct customer, maybe at the EMS or even the OEM level?

Speaker 2

Yes. Thanks, David. It's tough for us to really manage that, to be honest with you, to get visibility into their end inventories. Because you got there's finished products inventory could be built up a little bit and then there's raw material. So really difficult for us to see that, to be candid with you, and rather not comment on any one customer segment building inventories or not.

We we I'll back to them first answering Steve's question. What we look for is inflated bookings and inflated backlog, And a lot of the book to bill is because of lead times are going out too. So as the lead times go out, the MRPs get adjusted, and we pipeline further that with our suppliers, which they want the visibility for. But tough for us to call that, and you know, we we we try to watch that. We do surveys and things along those lines, but we don't have direct access to the end customer bill.

And it was Great.

Speaker 9

And then I guess between if I can ask one more real quick. What do you think the the largest execution hurdles are between here and the end of the year? Just kind of thinking about what you're doing with Farnell and the margin profiles. Do you think is there anything there that we should be thinking about?

Speaker 2

No. I think the biggest challenge is going be us just, again, I call it center of technology. Just be sure we're managing the suppliers and staying in close communication with them, which we're doing, and with our customers, And and then it shouldn't get all all the information flow that's coming in to be sure we're we're helping as much as we possibly can fill any any products that are needed by our customers from our suppliers. And that's I think that's I think right now, that's that's one of the biggest things that that may sound easy, but it's it's certainly not. We got teams, you know, full board ahead and focused on that externally.

Internally, Tom, probably, we we think we have a line of sight to the to to the projections for Farnell and The Americas, which are the two big needle movers. Asia looks really good right now still as does Europe. So I think that's what we need to focus on, I think. And of course, getting the appropriate inventory to fill those needs, which, again, that's back to work with the suppliers, which we do. We feel good about where we are right now.

Thank you. Thank you, Daniel.

Speaker 0

Thank you. Our next question comes from Joe Quatrochi with Wells Fargo. Please proceed with your question.

Speaker 10

Yes. Thanks for taking the question. Congrats on the results. I was curious on the change in book to bill relative to last quarter. I guess how do we think about the makeup of that change?

Is it more a strengthening of kind of the inside ninety to one hundred and twenty days? Or is it customers giving you, I guess, indications into late twenty twenty one?

Speaker 2

Yes, Joe. So looked at it. Yeah. Our book our book to bill, yeah, was was was high last quarter as well. Just looking at it, and and it was high this quarter.

And it's it's so much with what I just said. The the demands, we're getting a lot more visibility on the demand from the customers based on the lead times going out, the lead times go out. They change their internal process schedules and needs and demands, and of course, we get fed that. So that I would say that's the majority of it. The inside of ninety days, a 100 a 100 a 120, it looks really solid actually, you know, from a from a a coverage standpoint of what's in the pipeline to go out in the next thirty, sixty, ninety, hundred twenty days.

We don't see that moving that much. It's actually a great question because what we also track, which really ties to this, Joe, is we track our cancellations and reschedules daily, obviously. And in the normal market, we we we flex our our backlog. There's the buffer. That's what we do.

We're the buffer in the supply chain. You know, 25% is normal. You know? So we go up and down 25%, and that's about where it is right now. So it's no.

We're not seeing anything that's say, you know, all of sudden, reschedules getting pushed out of things along those lines. We're not seeing that yet. When we do, that's the first indicator we know something's going on, then we we drill down. But right now, the cancellation windows and the reschedules look pretty consistent what we typically see.

Speaker 3

Phil, if I could add, Joe, if you look at, what are we, three and a half, four weeks into the quarter, if you look at what we've shipped in our backlog, it's a very healthy percentage, very similar to last quarter, which is encouraging. It's not getting worse. It's not changing. So we're pretty much on track. It it's far better than it was 12 ago.

Right? I think, you know, we would all agree with that. So, you know, things are looking internally where they should be. They're looking stable. Backlog is a good indicator.

Speaker 2

And, Tom, it's you know, Johnny is other thing that ties a lot of the questions, I think, is the the diversification of our portfolio. I mean, you know, you were talking about hundreds of thousands of customers that we're managing, which helps, you know, level those much of the questions that were brought brought up today. And and no one customer is, you know, any more than 5% of our revenue, and we don't have any supplier that's that's, greater than 10%. Okay? So that that helps smooth some of this out from a vulnerability standpoint, if you will, but, helps derisk, you know, some of the what you asked and and some of the other questions as well.

Speaker 10

That's really helpful. And then just, you know, you talked about customers looking to sign maybe longer term supply contracts. Can you just kind of help us understand what do those look like in terms of, you know, the contract length, your volume commitment? Is it based on fixed pricing? Just any any type of detail like that would be helpful.

Speaker 2

What did all those? I mean, some of the, some of those complex supply chains we've been managing, Joe, been we've had them for years. They they they just get more complex. And I'm talking ten, fifteen years, you know, that we've been we've been ingrained with these, again, some of them household names, customers. And imagine their supply, you know, for for the suppliers, and and and we're we're kind of let's call look at us as as a hub.

So we're integral to almost everything that they do from a supply chain standpoint. Some of them are traditional. Have a consignment in place to order, but that's fine. No problem. That's a typical contract.

Some we have engagements where we got forty, fifty people on-site managing the intake of demand, the forecast, the orders, receiving, take it right to the shelf. That's customer at the top of my head that we've been engagements for twelve years. Okay? And so it's really you really become integral. You know, you you almost go into some of these customers.

You wouldn't know who the ad net person was versus the the customer person, you know, so which which is great. But they're for the most part, they're typically longer, okay, when you get really complex because you gotta make investments. Right? So you're making investments upfront, and we're transparent on that, and you need to get a return on that investment. So they typically tend to be much more strategic, much more longer term in nature.

Speaker 0

There are no further questions at this time. I would like to turn the call back over to Phil Gallagher for any closing comments.

Speaker 2

Thank you, operator, and thank you all for attending today's earnings call. We really appreciate it. I look forward to speaking to everyone again in August for our fiscal fourth quarter earnings report. In the interim, stay safe, and have a great rest of the week. Thank you.