Avnet, Inc. (AVT) Earnings Call Transcript & Summary

[Audio Gap] third and final day of our technology and Internet conference. My name is Toshiya Hari, and I cover the semiconductor and semiconductor capital equipment space here at Goldman Sachs. I'm very excited and very honored to have the team from Avnet with us this morning. We have Phil Gallagher, Chief Executive Officer; Tom Liguori, Chief Financial Officer; and Joe Burke from Investor Relations. The fireside chat will be about 40 minutes long. I'll go through a list of questions I put together, but also do my best to weave in any questions that investors may have that come through the webcast. Before we do any of that, though, I'd like to pass the mic over to Joe for the safe harbor.

Thanks, Toshiya. Good morning, everyone. Today's discussion may include forward-looking statements that involve risks, uncertainties and assumptions that are difficult to predict, and actual results could differ materially. Several factors could cause or contribute, the such differences are described in detail in Avnet's most recent filings with the SEC, include the scope of duration of COVID-19 outbreak and its impact on global economic systems and the company's operations, employees, customers and supply chain. Any forward-looking statements are only as of the date of this investor call, and Avnet undertakes no obligation to update or supply new information after this call. So Toshiya, thank you very much for that. I'll hand it back to you.

Great. Thanks, Joe. And Phil, Tom and Joe, first of all, thank you so much for making time this morning. I know it's a busy time, so I really appreciate you supporting the conference. Before diving into detailed questions, Phil, I was hoping you could kick us off by reflecting on 2020. Maybe touch on the key achievements at the company and perhaps the challenges you face in the year. But more importantly, if you could discuss what the key objectives and goals are for both you and the broader team and Avnet for 2021, that would be super helpful.

Sure. Thank you, and thank you all for attending the conference, and we're thrilled to be a part of it. So we very much appreciate the time and the interest in Avnet. Well, reflecting on 2020, that's a -- could be a [ trickier ] conversation, right? I mean it's a heck of a year from start to finish. And we all expected 2020 coming out of '19 to be an exciting year for growth in the industry. And obviously, we all got hit with the pandemic, and we adjusted accordingly, which is however in Chinese New Year I think the -- 2020 was the Year of the Rat, okay, and 2021 was Year of the Ox. So I think we're looking forward to getting into the ox mode, if you will. So if you look at it, it was really a tale of 2 halves. We had the pandemic. But coming into January, we're pretty excited, coming out of CES, then we had the pandemic, and we had all that uncertainty through the March, June, arguably into September quarter. And as we called out on our earnings call in September quarter, we started to see Asia come out pretty nicely and Europe and the Americas near the end of the September month within that quarter and that certainly carried through into the December quarter as we had our results just 2 weeks ago. So we're really proud of the team. We're proud of what we've accomplished. I think we accelerated our -- as did many, by the way, or most, if you want to survive the digital equation, if you will, to working from home and the adaptability and the perseverance of our employees really made us -- helped us to attain the goals that we've set and the commitments that we've made while keeping everybody, obviously, safe and healthy. And I wish that to all those on the call as well. So again, without our employees -- I always talk about, without our employees, we wouldn't have a business. Particularly proud that we've not had 1 day that we've not been able to keep our supply chains moving through the pandemic globally through all logistics centers. So the adaptability and the perseverance, while keeping health front and center, we've kept all our logistics centers moving. And I think everyone has a -- everyone on the call and everyone around the world has a new appreciation for logistics, supply chain services because until you don't have, you don't realize how critical that role really is. And we see ourselves as we move into 2021, and we celebrate our 100-year anniversary this year that we are in the center of the technology supply chain. And I think we've lost some of that messaging, in my opinion, in the last several years. I've been around for almost 4 decades with Avnet. I've been around 6 decades. But we're kind of rebalancing our priorities, okay? And so you asked specifically what are our focus. We're partnering with our suppliers. Suppliers are not vendors. They're our partners, okay? We need to strengthen our relationships with our suppliers and make them the best of the best in the world. They -- by bundling what they do and bundling that with what we do, that's the value proposition we bring to the marketplace, okay? The size and scale, the demand generation, demand creation through supply chain, that's been at that center of technology that we talk about so much. So we're getting back to -- not going backwards, but focusing on our fundamentals, okay, focusing on the execution, focusing on our suppliers, focusing on our customers, focusing on how we drive more automation. And I always talk about 3 pillars, our suppliers, customers and our employees. And they're the 3 pillars of our business. Now I think they always have been. Relationships and partnerships and trust matter. And I don't think what we do hasn't changed a lot since I have been here at least. How we do it has. So we need to drive more automation, digital. Those types of things obviously drive more efficiency and productivity through EDI, self-serve tools, all those things we need to continue to do. But customers and suppliers do business with people that they like and they trust. And that's what we're focused on at Avnet through the core and in Farnell, okay? There are 2 major front ends we have that will drive success moving forward.

Got it. Thank you for the overview, Phil. I guess I wanted to ask about the overall demand environment. Avnet, obviously, you've got both breadth and depth in terms of your customer relationships. You touch a very wide range of end markets and applications. You just reported very strong December quarter results and guided March above typical seasonality. From a demand perspective, Phil, what are you seeing? Are there any standouts from an end market or regional perspective?

Yes. It's -- it's actually right now is that the more we go into it, the more broad-based it is. I think in the beginning, we saw predominantly automotive and still is. Don't get me wrong. I mean automotive is really strong. And we talked about in our last earnings call, we've got -- we're above parity very positively in book-to-bills and backlog continuing to build in all regions around the world, including Farnell as well as the core. But certainly, seen the growth in automotive. And a lot of that is -- I mean the amount of content in the automotive and electronics is continuing to increase. And then you got, of course, within the car -- traditional car, you've got the ADAS systems. And you've got the EV continuing to grow. Then you've got the grid battery management systems, et cetera, all plays perfectly right into what we do. And that tail of customers, we hear about the big 3 or big 6 between the U.S. and Germany and, of course, in the Asia. But the tail of contractors, okay, supporting them with this new technology really, really pervasive, and it's a sweet spot for us. So that's -- we'll continue to see nice growth there. And that's pushing over 10% to 13% of our business just in that transportation, automotive segment, where 20 years ago, that wouldn't have been the case. So again, it's a very exciting opportunity for us. We're also seeing that in the industrial segment, which is around 30% to 35% of our business, and that's really broad. That's -- and we have some of our medical in there as well. And that's a tail that's exciting to see growing because it's a long tail of customers. It tends to be a lower volume, higher mix, which again falls into our sweet spot. So that's been really positive, and we're seeing that continue to grow in all regions of the world. You have defense continuing to grow. Aerospace still a little bit down, but the defense industry and what's going on around the world continues to be a strong segment for us. We're probably more in the consumer space as well. So that's actually about 7%, 8% of our business, and that's been really steady, when you see some of those guys reporting themselves some really good numbers, and we're playing with many of them. So it's more broad-based than it's been, which is a good thing.

Great. And then, Phil, from a regional standpoint, you spoke to Asia sort of coming out of the pandemic, if you will. Sometime in Q2, Q3 of last year, the U.S. and Europe being a little weaker, but more recently, coming back nicely or at least showing signs of a recovery. What kind of, I guess, assumptions are you making internally for both the U.S. and Europe for the balance of 2021?

Well, we don't go out through the whole year, but it's positive. I mean we're definitely seeing the, what we call, the West getting stronger in Europe and the Americas. Again, book-to-bill is really positive. So we're going to -- we can see continued strength through this quarter in those regions and more likely end of the June quarter. But again, we don't forecast out that far. Asia continues to look very good. Again, [indiscernible] we tend to say "Oh it's just China." It's really across Asia we're seeing good growth, which is good. Greater China being the largest piece for us, but it's all, Southeast Asia is good. And so interestingly Chinese New Year this year is impacting this quarter, which is typical. And actually, we figured that in. It might be even a shortened Chinese New Year based on the pandemic as to how long people are out celebrating, if you will. So we'll see how that impacts the quarter in a more likely positive way. So China continues -- Asia continues to be strong, and that continues to drive our mix, okay? And when Tom talks about that [ drive forward ] we'll deal with that. We want to drive growth, drive scale. And right now, we're seeing that in Asia, and we're seeing good response to the market in Europe and the Americas.

Got it. And then from a supply perspective, the constraints, the shortages are certainly top of mind. We've hosted several companies already at this conference, and it's a topic that comes up literally every single session. On your call, you mentioned -- you mentioned...

I haven't heard about it. What are you talking about?

It's a big secret. No. So you mentioned on your call how supply has been tightening in microcontrollers. I think you threw out FPGAs and analog broadly as well. When you think about the overall portfolio that you guys have from a product perspective, what's sort of the rough delta between supply/demand for your business? I'm sure it's kind of case by case, maybe product by product, application by application, but just curious how big is that delta between supply and demand. And at what point do you think you and your suppliers together can start to fully meet customer demand?

That's a really good question. I don't know if I can even answer that statistically, what percentage do we have and inventory ready-to-go versus parts we don't have. It's a really difficult question. Look, we think we're well -- I mean I need to first say, we think we're well positioned from an inventory standpoint. We take in -- just to share with the audience, we're taking in thousands of customer forecast daily, weekly, monthly in an automated fashion. So we're -- we've got really good visibility to what they share. And then we do our own analytics around it. We say, okay, what do we think is accurate, okay? And that's not a statement of active integrity. And that's just the statement a lot of our customers don't know what they want 60, 90 days out, right? Inside of 30 days, it's probably 60%, 65% accurate. So we put our own analytics around it, say, what is it that they really need, and we track that as best we possibly can. And then we obviously are -- again, I call it center of technology, right? So we take that, we drive it into our suppliers, come back to us, and we -- it's a continual massaging, okay, of the forecast and the backlog. We probably adjust our backlog 20%, 25% of it on a daily basis. It's just being pulled in, pushed out, pulled in -- and that's what we do. It's what we've always done. That's not a bad thing. That's the buffer and the shock absorber that we play for the industry. Now that said, it's not -- there are shortages across the board. I think it's really important people understand it. It's not like you can't get any products. It's just you can't get -- some of the products are tougher to get than others, okay? And it's still -- a lot of it's still the high-end controllers. A lot of it's driven certainly by the automotive industry, but not exclusively. But then you'll find that you can't get a power discrete product or something. And that [indiscernible] expedited as I speak right now for a medical company. It's a high priority. It's an old design. That's not a matter -- that's just an old technology that they've got to wind down. We're trying to work with the supplier to get a tester up and running, okay, to help them get these products to go build this life-saving, frankly, by the way, this is kind of high priority medical devices. It's really -- it's not like -- in 2017, I get -- I compare this to '17. It's not like all MLCCs or all product. It's really -- even in the high-end MCU 32 bit, it's certain packet sizes, it's not all 32 bit. But we are just seeing a steady increase in lead times in MCUs. It has come into the 8 and 16-bit controllers, memories 16 to 18 weeks. Some DRAMs go on for 26 weeks, so it's really a daily, weekly -- and we publish it, by the way, on our website, and we push it out to our customers so they can feed and insert to their MRPs. But it's not -- and we got to -- Tom would say "We've got plenty inventory," okay? Like I just keep telling the team just show what we got on the shelf, it's easy. But fact is there's the long poles in a tent, okay, that are pretty much isolated. Yes, #1 our job is to service our customers and suppliers. So I'm on a lot of expedited calls with our factories and trying to work through them. That's what we do. But it's not across the board, and there's a lot of opportunity out there for continued growth in our job. And the word I use very often with our customers and with our suppliers, let's be responsible. What is it we really need? Because I know one of your questions will be something around bookings, but what is it we really need, okay, versus what you want? Okay, and there's a difference, okay? And we all need -- we're responsible, I think we can fill most, if not all the need, as an industry, okay, moving forward because we got to watch, and we got to be careful of it. You've got a lot of the big guys consuming things, whether they forecast it or not, but we've got to take care of the smaller companies, okay? Okay, that's -- it's also our future. So that's what we try to balance out. That's our responsibility.

That's helpful. Phil, you talked about having analytics in place to sort of gauge what is true demand, what is perhaps excess ordering. Can you sort of elaborate on that? And are the analytics that you have today significantly better than we used to have? What sort of visibility do you have into the true business, if you want to call it that, versus excess bookings?

Yes. No. We got much better analytics. And the automations, the digital side's much more increased than in the past. And the key is what do we do with this. So how do we take data -- everyone talks about data. Well, how do we turn the data into information that's actionable, right? We're still buying -- I'm drowning in data, but I don't have a bit of information. So we need to take that data that we're getting in and turn that into information. And we do that. And there's a customer that's coming in, and we're taking our MRP into forecast on a daily, weekly or monthly basis, whatever that is. And they're using 100 pieces a week and all of a sudden it goes to 1,000. Well, it kicks out right away. So rather than go right through our asset team to go buy that, if it stops, and we better then go back to, why did it go to 1,000? Are you building inventory? Did you have a real increase in demand? Or did you not? Or what's going on? So that's how we track a lot of it, okay? And in fact, we don't see a whole lot of that going on right now, right? A lot of the booking activity is largely due to lead times going out. So we're seeing higher bookings because customers are planning further out, right? So if a part goes from 8 weeks to 20 weeks, our customers put that into their ERP/MRPs, and then the [indiscernible] kicks out their forecast. So we're getting broader bookings windows as well. So that's driving some of the rather above parity book-to-bills. But no, we do the best we can, but it still comes down to boots on the ground. Once that kicks out, you got to have a conversation with the customers. It's not all automated. If we're all automated, we wouldn't have any employees, it'd be just robots doing all this stuff. And by the way, we have our robots, too, to help us with this. But it's complicated. And -- but we're not -- I can't say that we're seeing a lot of the proverbial double booking, which we're getting to the supply. We work with suppliers on that as well. They see that -- they would see that as quick as we would because they could see the same customer placing the same part of 3 different distributors, I'd say. So then the supplier kicks that back, and they've gotten really much better about that as well. So -- and we try to attack the inventory inside the customers. What kind of visibility do we get to that, right? And I've called a major supplier yesterday on that very question, we're working, but it's -- some of it's automated. Some of it's you got to get on the phone and get in touch with the customer.

Got it. Helpful. And then, Phil, taking a step back, I wanted to get your view on the current cycle versus prior cycles. As you mentioned earlier, you've been at Avnet for nearly 40 years, not quite 40, but very close to 40 years. You've seen many, many cycles. How would you compare and contrast this sort of ongoing upturn versus past upturns? You just spoke to how customers are placing longer lead time orders as opposed to rush orders, which I think is very healthy, but anything else that you can point to?

Well, it's certainly different. I think, yes, I've been through a lot of cycles. And probably the most notable one would have been -- to me anyway, outside the financial crisis, would have been the 2000, 2001 crash, if you will, of the perfect storm, and could see that coming. That was driven mostly by telecom, the networking guys. I don't want to mention any of their names. We all know who they are. With the dot-com and the Y2K and it just all came together, I think 1 publication put out about a month before it crashed, "There'll never be a cycle downturn in the electronics industry, again, it's too pervasive." A month later, the market completely crashed. And that was, I think, people not being responsible for the most part, to be honest with you from the supply chain. It was just supply chain broke down, precariously broke down. But there was a real -- you could pinpoint why and what happened. In this case, it is different. I mean you had the COVID come in. We were coming out of 2019. '17, good. '18 and '19 down. And it's yes, partially things were looking really good. Demand was like it's coming back. And of course, you get the COVID. A lot of industries shutdown. You got the uncertainty, demand start to swing back up. So now we're trying to -- I'm trying to understand the demand versus the replenishing. So we stopped manufacturing for a period of time, and the consumer, whoever or investors is buying that product, are we filling a hole, okay? Or is there a hole plus true new demand out there? I think that's what, in my opinion, the difference is right now that we're trying to all figure out. Now using common sense around things, I had one of our top 3 suppliers on the call yesterday for an hour and they're like, "Well, if you think about it, people aren't traveling. So we know which industries are getting hit," right, which is sad, and we feel bad for anybody in those -- we've been blessed in a way. But if you look at, people aren't traveling, they are -- home improvements are up through the roof. People buy new appliances. People aren't buying cars. People are -- and all that stuff just has electronics in it, right? So you've got to believe that, that demand, and in its way -- trying to get out to where you live, trying to get a contractor come to your house to do something. It's tough right now, okay? So it makes sense, right, what's happening. And it does feel like it's real demand, but it's not a typical cycle. I just mentioned Chinese New Year is not going to be a typical Chinese New Year. How's that impact the manufacturing, right, where it's typically down for 2 to 3 weeks, maybe going down a week. We don't even know how that's going to impact manufacturing yet. So it definitely feels a lot different. Again, I asked about the '17 to this shortages sort of -- this one was definitely driven more by the semiconductor market, where in the past, shortages in '17, '18 were more passes, okay? This was definitely led by the semiconductor. It doesn't mean the passes won't follow. They might start going out, but it's definitely led by high-end controllers, which I think has to do with the products that they're going into. And they had the COVID. So they had the packaging and things were shut down in Malaysia and Asia, where a lot of that is done.

Many of your suppliers have talked about raising pricing. And again, Phil, to your earlier point, it does feel like the severity of the shortage is really dependent upon which market you're talking about and perhaps there are many markets where supply is very healthy. From a pricing perspective, what are you seeing from your suppliers? What are you guys doing in terms of your pricing? And how should we think about the implications for the economics of Avnet going forward?

Yes. No. It's a tricky one. And yes, it's not all suppliers, it's not all products, okay? But yes, we're definitely seeing the price increases. And we're going to pass those on as best we possibly can. It's not as black and white as everyone would like to believe it is. We have customer contracts. We have long-term contracts and things along those lines in ship and debit, which is another conversation that gets involved who owned ship and debit last and when do they cancel that or renew that. But long and short, we have processes in place to track by partner or by supplier, where they're raising prices, okay? And how does that affect the price we add to the customer and then how do we pass that on. And we have exception reports that we can -- I mean we're probably elder. We're -- we think we're fair value and fair margin. We can't absorb [ anything. ] So we need to find ways to pass that on, and that's what we're doing. Will we have an increase in our margin percent? Not sure. Will we have an increase in our average selling prices and our gross profit dollars? The answer is it should. Okay, but that's early days. Yes, there's a -- I got the sheet right here, it's about 12 suppliers have publicly gone out and put out letters, right, communications into the market that they're going to be raising prices. And that helps us because then many of them will help us with our customers, okay, go back and say, we need to raise the price here. And I -- and it's important, costs are getting raised to them. If you see what's happening in the fabs and see what's happening in the [ DFCs ] or what have you, if the supply and demand curve inverts and costs are going up, we need to share in that or customer needs to share in that. So I think it's fair and I think when I'm talking to customers right now and suppliers, it -- it's parts overpricing. Okay, they need parts, okay? And the content still in some where these parts are going are still very low cost as a percentage to the total cost of the end product. So pay a nickel, dime, 27 whatever it might be could be absorbed, okay? But we're not being unfair. I want to also be clear that we're not being unfair, okay? And we're not selling the brokers. We're not doing that kind of thing. We're protecting our products for our customers, and we're being very transparent. And in cases where it's going up quite a bit, suppliers are going with us to talk to the customers. So got to be responsible and be trusted partners.

Got it. And then, Phil, I guess, shifting gears a little bit. I wanted to talk about the TI dynamic that sort of went on last year. It was pretty abrupt. But that said, you guys managed it really, really well last year. Can you walk us through the progress you've made in replacing that revenue stream as it relates to the TI business?