Avnet Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
November 1, 2023

There are 9 speakers on the call.

Operator

Greetings, and welcome to the Avnet First Quarter Fiscal Year 20 24 Earnings Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Joe Burke, Vice President of Investor Relations.

Operator

Thank you, Joe. You may begin.

Speaker 1

Thank you, Paul. I'd like to welcome everyone to the Avnet First Quarter Fiscal Year 2024 Earnings Conference Call. This afternoon, Avnet released financial results for the Q1 Fiscal year 2024 and the release is available on the Investor Relations section of Avnet's website, along with a slide presentation, which you may access in advance at your convenience. As a reminder, 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 Such differences are described in detail in Avnet's most recent Form 10 Q and 10 ks and subsequent filings with the SEC.

Speaker 1

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.

Speaker 2

Today's call will

Speaker 1

be led by Phil Gallagher, Avnet's CEO and Ken Jacobson, Avnet's CFO. With that, let me turn the call over to Phil Gallagher. Phil?

Speaker 3

Thank you, Joe, and thank you, everyone, for joining us on our Q1 fiscal year 2024 earnings conference call. Before we get into the quarter, I want to take a moment and remark our recent events in the Middle East in general and specifically our operations in Israel. Our thoughts and prayers are with our employees and all those in the region affected by recent events. We hope this devastating conflict will be resolved as soon as possible. As of this date, all of our employees in Israel are safe and accounted for, and we continue to service our customers to the greatest extent possible under these circumstances.

Speaker 3

Moving on to our results. I'll start with a reminder that in fiscal year 2023, we delivered double digit sales growth in constant currency, Record earnings per share and ended the year with a strong balance sheet and great momentum. I am pleased to share that we kicked off the new fiscal year with another quarter of solid financial results, continuing that momentum and underscoring our strength and resiliency in the current market environment. In the quarter, we achieved sales of more than $6,300,000,000 This was above the midpoint of our guidance, down 3% sequentially and down 6% year over year. Continued efficient management of our operations enabled us to drive solid operating margins A 4.1 percent, highlighted by a 4.6% operating margin in our Electronic Components business.

Speaker 3

Our team continues to compete well in this market by working with our customers to provide the flexibility they need to manage their component supply chains I've been working with our suppliers to provide visibility to end customer demand and the impact our customers' current inventory levels have on near term demand. In the quarter, demand was mixed across our diverse verticals. Transportation remained strongest, While demand in the industrial and aerospace and defense verticals were a bit more moderate. Overall, semi electric lead times continue to improve slightly, but still remain higher than pre pandemic levels. Shortages continue in some areas, particularly MCUs And Power Products targeting automotive and industrial applications.

Speaker 3

While pricing has generally stabilized, We do not expect overall pricing to decline in the near term due to the increased cost for producing components, including higher costs for labor, raw materials and general inflationary pressures. We continue to coordinate closely with customers and suppliers to effectively manage backlog, which is down from a year ago. As a result, overall book to bill ratios continue to be below parity, though modestly above last quarter. We communicated on our August call that we expect inventory levels to be up this quarter As we supported a specific strategic initiative, our ending inventory levels were in line with those expectations, which Ken will discuss in his comments. I do want to emphasize that as a distributor, inventory is the lifeblood of our business and having the right inventory is a strategic advantage.

Speaker 3

We're always working to ensure we have the right mix and right levels. Our suppliers continue to work with us on inventory, and I want to thank them for their partnership and support as we work through the correction together. Before we move on to operating group results, I wanted to provide my thoughts from recent conversations I've had with key stakeholders across the supply chain. I was recently in the Bay Area with a large group of procurement leaders from several of our customers and suppliers. The consensus of the group is that inventory levels for certain parts across the supply chain continue to be elevated And that additional flexibility to delay inventory replenishment is necessary.

Speaker 3

Although demand across end markets remain healthy, Customers have enough supply of many components, which will take multiple quarters to burn off. The conversations with these procurement leaders also Our belief that Avnet is well positioned with our supply chain capabilities. Our customers continue to have a need for our services as they transition from a JIT to a more resilient supply chain. With that, let me turn to the highlights for our businesses. At the top line, Electronic Components business saw mixed results across the regions.

Speaker 3

In constant currency, Electronic Components sales were down nearly 3% sequentially and 8% year over year. Sales in the Americas were down 9% sequentially and 6% year on year With transportation and industrial as the strongest end markets. Sales in Asia were up 4% sequentially and down nearly 17% year on year coming off a record sales quarter last year. In Asia, transportation continues to be our strongest end market and China Continues to have the softest demand. Coming off a record sales quarter in Q4, EMEA sales were down 5% sequentially and up 2% year on year in constant currency.

Speaker 3

In the quarter, EMEA continued to see strength in transportation, Industrial and the Aerospace and Defense end markets. Despite some of the broader market challenges we've been facing, We're encouraged by how demand is holding up in some of our key markets. We believe that our diversification and focus on high growth verticals It's helping to keep sales above the $6,000,000,000 per quarter level as previously communicated. We continue to benefit from our unique engineering capabilities, with our field application engineers and digital design tools resulting in another strong quarter for demand creation. As component lead times stabilize, our field application engineers are now busy spending more time on product innovation and developing new design starts rather than chasing down parts to maintain existing designs.

Speaker 3

Customers are also evaluating more redesigns as they look to optimize costs or to mitigate future risks related to older technologies. Turning to our Farnell business. As expected, Farnell sales and profitability were impacted by product mix and competitive pricing pressures. Farnell sales were down 5% sequentially and up 4% year over year in constant currency. In the quarter, we made progress working through the backlog for single board computers, but the shipments have yet to fully ramp.

Speaker 3

We also had a good quarter for test and measurement component sales. Sales of the onboard product lines Apprised of semi lifters and IP and E products saw the greatest decline in sales driving the unfavorable sales mix. Operating margins for Farnell were above 4% during the quarter, and we expect them to be at or above similar levels in the December quarter, which is traditionally the lowest sales quarter from a seasonality standpoint. We remain excited about Farnell despite the disappointing near term outlook and see additional opportunity to leverage Parnell's and Electronic Components' unique and synergistic collaboration to better serve Avnet customers. Farnell also has growth opportunities with recent line card additions and from investments in new products that should materialize over the next few quarters.

Speaker 3

Given the recent results, however, we are taking certain cost actions to reduce the operating expense base at Farnell, which Ken will touch on in his remarks. To conclude, as we navigate the current market environment, we continue to demonstrate our strength and resiliency. I believe our recent results reflect that. I want to thank our teams for delivering under such challenging conditions. Given the macro and industry specific backdrop, It is difficult to gauge when the correction will finish, but our best estimate is it will last through mid-twenty 24.

Speaker 3

This time frame is also consistent with some of the recent conversations I've had with top executives of several of our major suppliers who share the view that the correction will subside sometime in the middle of 2024. We continue to believe our diversified end markets and our broad customer base positions us well for profitable growth for all of our stakeholders. As I've said before, while we cannot control the overall market, I am confident in our team's ability to execute in a challenging and uncertain environment and to in a challenging and uncertain environment and to continue to deliver value to our suppliers and customer partners. With that, I'll turn it over to Ken to dive deeper into our Q1 results. Ken?

Speaker 4

Thank you, Phil, and good afternoon, everyone. Thanks for joining our earnings call. As Phil mentioned, we had a solid start to 2024. Our sales for the Q1 were approximately $6,300,000,000 down 6% year over year and in line with guidance. On a sequential basis, sales were down 3% in constant currency.

Speaker 4

From a regional perspective, sales from the Western regions were 61% of sales in the Q1 compared to 64% Last quarter and 56% in the year ago quarter. The sequential decline was expected due to seasonal mix shifts from the Western regions to Asia in the first half of each fiscal year. From an operating group perspective, electronic components sales declined 7% year over year and 8% in constant currency. Sales declined 3% quarter over quarter in constant currency. Farnell sales declined 1% year over year and 4 Farnell sales were 5% lower sequentially in constant currency.

Speaker 4

Excluding sales of Singapore Computers, Farnell sales declined 8% year over year and 7% quarter over quarter in constant currency. For the Q1, Gross margin of 11.8 percent improved 43 basis points year over year and was 67 basis points lower quarter over quarter. EC gross margin improved year over year, primarily due to greater mix of sales from our Western regions. EC gross margin declined sequentially, primarily due to a seasonal mix shift to Asia. Farnell gross margin was down year over year largely due to the unwinding of pricing premiums and unfavorable sales mix and from competitive pricing pressures.

Speaker 4

Farnell gross margin was down sequentially primarily due to an unfavorable sales mix and from competitive pricing pressures for on the board components. Turning to operating expenses. We continue to focus on controlling and reducing costs in specific areas, but we aren't currently planning any broad based cost production actions while we navigate through this market correction. We want to build on the momentum we created over the past couple of years and to be fully resourced to take advantage of the opportunities we see coming out of the correction. During the quarter, adjusted operating expenses were $486,000,000 down 4% sequentially, but 2% higher year over year.

Speaker 4

Operating expenses were down slightly in constant currency year over year. As a percentage of gross profit dollars, Adjusted operating expenses were 65% in the Q1, 320 basis points higher than a year ago and 323 basis points higher than last quarter. For the Q1, we reported adjusted operating income of $262,000,000 which decreased 11% year over year. Our adjusted operating margin was 4.1%, which decreased 22 basis points year over year and decreased 64 basis points quarter over quarter. By operating group, Electronic Components operating income was $273,000,000 up 2% year over year.

Speaker 4

EC operating margin was 4.6%, up 38 basis points year over year, but 47 basis points lower sequentially. The year over year improvement was led by EC EMEA and EC Americas businesses, each of which expanded operating margin year over year by more than 20 basis points. The sequential decline was primarily due to a combination of lower sales and a seasonal mix shift of sales to Asia. Farnell operating income was $18,000,000 down 66% year over year. Farnell operating margin was 4.2% in the quarter, down 3.89 basis points quarter over quarter.

Speaker 4

Farnell operating margin continued to be impacted by sales mix and competitive pricing pressures related to on the board components. In order to improve margins, Farnell has implemented a series of expense management activities to reduce operating expenses. While we anticipate Q2 to be another challenging quarter for Farnell, we expect these actions will support its path back to high single digit operating margins in the near term and have returned double digit operating margins in the medium term. Turning to expenses below operating income. 1st quarter interest expense of $71,000,000 increased by $26,000,000 year over year, but decreased $40,000,000 quarter over quarter.

Speaker 4

Increased interest expense negatively impacted adjusted diluted earnings per share by $0.21 year over year. Adjusted effective income tax rate was 24% in the quarter as expected. Adjusted diluted earnings per share were better than expected at $1.61 for the quarter. Turning to the balance sheet and liquidity. During the quarter, working capital increased by $134,000,000 including an expected increase in inventories of $290,000,000 partially offset by an $84,000,000 decrease in receivables and a $72,000,000 increase in payables.

Speaker 4

As a result of this working capital increase, working capital days was 101 days for the quarter, which increased 4 days quarter over quarter. Our return on working capital decreased accordingly, but remains well above our cost of capital. Inventories grew during the quarter due to two factors. The largest was the expected increase in inventories for EC Business due to the strategic opportunity we communicated last quarter. The second was an increase in inventory investments made at Farnell.

Speaker 4

Note, we don't expect any further investments in Farnell as they have sufficient inventory to support current business conditions. As we move into our 2nd quarter, We are seeing a ramp in our supply chain services, which will result in an increase in inventories. For Q2, we expect inventory levels to remain flat to up slightly As a result of the inventory growth for those engagements, which are expected to be cash flow and working capital neutral. We continue to characterize our inventories as stable. And as Phil mentioned, we believe it will take multiple quarters for customers to burn off their elevated inventory levels.

Speaker 4

While we continue to focus on improving inventory turns and generating cash flow, Our top priority is to ensure we continue to support our customers' and suppliers' needs as we work through these challenges together. The increase in working capital led to an increase in debt of $112,000,000 During the quarter, we used $41,000,000 of cash for operations. We used $110,000,000 of cash for operations over the past 12 months. We ended the quarter with a gross leverage of 2.3 times And we had approximately $732,000,000 of available committed borrowing capacity. Our teams continue to work on selling inventory on hand and collecting receivables to provide additional liquidity in the coming quarters.

Speaker 4

From a capital allocation perspective, we continue to prioritize our existing business needs, including working capital and capital expenditures. During the Q1, cash used for capital expenditures was $76,000,000 primarily to support a new distribution center being constructed in EMEA. We increased our quarterly dividend by approximately 7% to $0.31 per share, And we repurchased approximately $27,000,000 worth of shares. We have $291,000,000 left on our current share repurchase authorization. For the long term, We remain committed to our roadmap of delivering a reliable and increasing dividend and share repurchases to increase our shareholder value when we believe our shares are undervalued by the market.

Speaker 4

Book value per share improved to approximately $52 a share or a sequential increase of approximately $1 per share. Turning to guidance. For the Q2 of fiscal 2024, we're guiding sales in the range of $6,000,000,000 to $6,300,000,000 and diluted earnings Per share in the range of $1.35 to $1.45 Our 2nd quarter guidance is based on current market conditions and implies a sequential sales decline of 1% to 5%. This guidance assumes a seasonal decline in sales from the Western regions primarily due to holidays. This guidance assumes similar interest expense compared to the Q1, An effective tax rate of between 22% 26% 92,000,000 shares outstanding on a diluted basis.

Speaker 4

In summary, We're pleased with our performance and execution during the quarter within this current market environment. We will continue to focus on execution, managing through the correction and achieving our stated financial goals. With that, I will turn it back over to the operator to open it up for questions. Operator?

Speaker 3

Thank you. We will now

Operator

be conducting a question and answer session. A confirmation Thank you. Our first question is from Melissa Fairbanks With Raymond James, please proceed with your question.

Speaker 5

Hi, guys. Thanks so much. Great quarter. Congratulations on another great quarter and Little bit of a challenging time. I was wondering if we could dig in on the strategic investment in Inventory that you made, are you able to give us a little more color on maybe is that targeting a specific end market or specific customer sets or just kind of Understand what's going on there.

Speaker 3

Yes. Melissa, it's Phil. And Bobby, thanks for the comments. Appreciate that. It's really for specific a specific supplier with a handful of customers, Okay.

Speaker 3

And so it's very limited. And I think it's important that's why we noted it on the last call. So we know, hey, we plan this, we know about this. And we don't do that without all the ROIC measures in place and be sure it's good for Avnet, Good for the customer, good for the supplier. So it's very specific in nature.

Speaker 5

Okay, great. Is it safe to assume that that's already in the backlog, Whatever that level of fulfillment is going to be?

Speaker 3

Yes. Yes, this was not that's actually a great question. It wasn't a broad based, hey, go bring in inventory and go try to find homes. It's brought it in to have specific homes.

Speaker 5

Great, great. Thanks. And then maybe just one kind of quick, I don't know if this is a quick answer, But maybe discuss some of the actions that you're taking at Farnell. You mentioned return to high single digit Operating margin within the near term, just wondering if you could give a little bit more detail on is near term by fiscal year And or what should we be thinking there?

Speaker 4

Yes, I mean, I think specific to some of the cost actions, it's A combination of factors, I think it's things like optimized freight, looking at warehouse footprint, as well as some people actions, right? But it's Trying to look at where we have some areas for improvement that we've been planning for a couple of quarters, but hadn't really pulled the trigger and now need to accelerate some of those things. There's also opportunities in terms of new supplier lines and share strategic customers between Avnet And Farnell, and I do think that timeline is exiting the fiscal year in that mid to high single digits is the expectation.

Speaker 5

Okay, great. Thanks so much. That's all for me now.

Speaker 3

Thanks, Melissa.

Operator

Thank you. Our next question is from Ruplu Bhattacharya with Bank of America, please proceed with your question.

Speaker 2

Hi, thank you for taking my questions. Phil, I want to start with a higher level question. I think I heard you say that the industry inventory correction you think it will take till the middle of next year. And so

Speaker 6

I guess my question would

Speaker 2

be why is that the right timeframe? Why not earlier or later? What are some of the things That are leading you to think that it will be till the middle of next year. And what can drive that what can help in that process? Like what are some of the factors that go

Speaker 3

Yes. Thanks, Ruplu. Well, it's our best estimate on how by what we're seeing in lead times combined with our clog and the book to bills. So there's a lot that goes into that not to mention some of our own analytics that we To the historical versus future. So that's just what we're seeing today, Ruplu.

Speaker 3

Hey, it could be sooner. I mean, no question. I just didn't I think we need to be overly bullish here. I think that's what we're seeing in the market softening a bit. The book to bills have been below Parity for a while, which again, I think is fine at this point because we want to get that backlog right.

Speaker 3

So we're making the adjustments in the backlog, But that's just what we see. And based on those factors I shared and the different verticals that we study, I think the good news is we're so diversified that we're not any too over or top heavy on any one vertical, which I think helps us give a pretty good View to the market and as I said before, this is a in my 40 some years, it's a different market. I mean, there's so many mixed signals, but There's still some lead times that are out there tied to certain products. There are some verticals and customers still doing really well, others not so well. So it's just It's definitely a bit of a mixed bag, but that's just how we see it.

Speaker 3

We don't press it with our regions. We get the roll up in the forecast and Do a rolling 4 quarter and that's about what we see.

Speaker 2

Okay. Thanks for the details there. If I can ask you a question on margins. I think overall you've said that as long as revenues can stay above $6,000,000,000 then the operating margin for the company can stay above 4%. When you look at the operating environment today, I think you said that you saw unwinding of pricing premiums at Farnell and And you saw some competitive pricing there.

Speaker 2

Are you also seeing competitive pricing in the core business? And does that Range still hold valid that as long as revenues are above $6,000,000,000 can you every quarter keep the margins above 4%? Can you just give us your thoughts on that?

Speaker 3

Yes. Let me touch on the first part with Farnell and I'll let Ken touch on It's $6,000,000,000 to 4 percent EC. The difference there in Farnell versus what we're seeing in the core, and we've talked about this over the last several years, The catalog guys in general get a unnatural lift in tight times or when extended lead times where they'll get Premium pricing, as well as non traditional customers kind of swooping in large volumes And they get the lift in both margin and in revenue. So when you say the unwinding in the pricing pressure there, some of those customers have gone away And the margins are just normalizing, particularly in semi leptor and IP and E, okay? Right now, as we look at it and we talked about in the script, we're not seeing as much of that ASP pricing pressure on the component side on EC.

Speaker 3

And we've said that before, we don't believe we're going to see the pressures or deflationary pricing. Always competitive, Rupl. In commodity standard products, it's always up and down. I'm just talking as overall view. That's our take.

Speaker 3

I'll let Ken comment on the $6,000,000,000 $4,000,000

Speaker 4

Yes, I think the guidance obviously is above $6,000,000,000 I think the 4% really, if you dial it back to a couple of quarters ago Really an EC focused kind of commentary clearly with Farnell being down, let's say, from 8% to 4%, causes Some pressure on the overall corporation margin, but I think the EC is very healthy implied in the guidance. And remember, when we get into the March June quarter as we go into our seasonal mix shift where we get a little bit more out of the West and less from Asia. And the only other comment I would give is, I think we are Like in Asia, for example, we'd expect in the first half of FY 'twenty four first half calendar twenty twenty four to kind of Start to think about year over year growth because of how early Asia started to seeing some of the softness.

Speaker 2

Okay. Okay. I appreciate the details there. If I can sneak one more in. Once the warehouse in Europe is done and I think this quarter you said that inventories you had expected Good to be up because of certain because of specific program.

Speaker 2

So then how should we think about the cash conversion cycle and free cash flow Over the next couple of quarters, any thoughts on that? And will your CapEx be coming down year on year next year, Because you already have you'll have that warehouse already factored in. Thank you.

Speaker 4

Yes. I think You'll see another quarter next quarter should be another elevated quarter of cash of CapEx similar to this past quarter As that warehouse gets constructed and then you start to see it taper off in the first half of twenty twenty four, I guess, similar to what I would say is historical levels. From a free cash flow standpoint, as Phil said, going to be challenging on the inventory side to really work it down over the next couple of quarters. So you'd expect cash flow from our earnings and some collection of receivables from the sales decline. So we'd expect cash flow Over the next couple of quarters, trailing 12 month cash flow, I think I mentioned was about $110,000,000 usage.

Speaker 4

So I think there's another Bad quarter falling off of cash flow usage from a year ago. So that's how I think we should think about it.

Speaker 2

Okay. Thank you for all the details. Appreciate it. Thanks

Operator

Ruplu. Thank you. Our next question is from Joe Caccichi with Wells Fargo. Please proceed with your question. Yes.

Operator

Thanks for taking the questions. I just wanted to kind of understand, talking about maybe a cycle correction Kind of lasting until mid-twenty 24. And in the context of kind of maintaining revenue above $6,000,000,000 and that's kind of The low end of your guide for the December quarter, are we

Speaker 2

going to take that as you

Operator

kind of viewing things bouncing along the bottom here? Or should we think about The potential further correction as we get into the first half of next year.

Speaker 3

Yes. Thanks, Joe.

Speaker 1

It's a good question.

Speaker 3

I think it's going to be more bouncing on the bottom. I mean, and it's Ken, I think it's just because I just shared, I think with Melissa, maybe it was Rupu, The mixed signals in the marketing, Andrew, we are still seeing as of today, we're still seeing transportation overall, pretty positive. The industrial segment, They had a few bumps in it, but again, parts of the industrial is so broad, parts of that customer base is still really good and other parts a little bit softer. Yes. And defense aero, unfortunately, what's going on in the world is going to continue to be a pretty strong market for us and that's Sizable for us in the Americas.

Speaker 3

So and sooner or later, I guess, the wildcard is China and Asia Pac, right? I mean, so What happens there that pops back sooner than people think that could have a greater lift. So right now, we're just rolling up what We see, we do a rolling forecast with our teams, and what we're sharing is what we're getting from them and looking at the backlog in a 0 to 30, 31 to 90, 91 to 180 day. I look at it daily and see what is our backlog today versus a year ago and it's telling us that's about where we're going to be.

Speaker 2

Again, you're going to have

Speaker 3

the mix shifts too, Joe. As Ken pointed out, Asia will be stronger this quarter. It probably comes back down into March quarter, so we'll have a stronger Yeah, mix in the West. So

Speaker 1

Got it. And then maybe just Complex.

Operator

Yes, sure. I appreciate that. Maybe just a question on the Farnell side in terms of the cost actions you're taking. I think in the past, You had chose to leave the lead facility open or online just given the demand you're seeing. Is that part of the Cost actions of closing that?

Operator

And then can you remind if it is, can you remind us of the cost savings related to that?

Speaker 4

Yes. No, what we're talking about Separate from that, what you're referring to, Joe, would have been bringing up a new warehouse and leads and shutting down the old warehouse and a lot of that's behind us. Although I'd say some of the Now with that warehouse online, there's more optimization on the broader warehouse footprint. So it's maybe more adjacent warehouses, not primary warehouses that provide some of the cost savings. So I think it was a subcomponent of some of those numbers we've talked about before.

Speaker 1

Okay. Thank you.

Operator

Thanks, Joe. Thank you. Our next question is from Matt Sheerin with Stifel. Please proceed with your question.

Speaker 7

Yes. Thank you and hello everyone. Phil, just another question regarding the inventory that you're building and that the Supply chain engagements that you're talking about for Q for the December quarter, is that mostly Asia business?

Speaker 4

I think Matt, it depends this is Ken. It depends on the engagement. Some of its global, a lot of its physically in Asia, but I wouldn't characterize it as something predominantly Asia. I'd say it's more global engagements in nature, although a lot of the global production does happen in Asia, but Some of it's Americas based, a little bit of media based, but it's I think it's across the board rather than something Asia specific.

Speaker 3

It's fair to say it's more Americas and Asia than Europe, But it's not primarily not it's not always the best.

Speaker 7

Okay. That's helpful. So this is more of a fulfillment, so lower margin, but good returns. Is that how we think about that?

Speaker 4

Yes. And some of it may be buffer stock and some of it may be fast turning. It's kind of a mixed bag.

Speaker 7

And I think

Speaker 3

The returns are there, though, Matt. That's your point. There are always models there.

Speaker 7

Sure. Yes. And then and I think said that inventories will remain elevated in the December quarter. Is that because you expect some of those supply engagements To carry over until March or are there other reasons why you wouldn't start cutting inventory or your portfolio? I would imagine that some of Your products with lead times in, where you can prune, where others you said there's elevated So I'm trying to figure out why you're not you're talking about more significant cuts to your inventory When a lot of suppliers are basically blaming all distributors for cutting orders, yet you don't seem to be doing that.

Speaker 4

Yes. Hey, Matt, I would say it's net new inventory coming in specific for these supply chain engagements as they begin to ramp and that would be offsetting Anything we're doing organically to get inventories down. So that's kind of how we're trying to signal it is there's net new coming in, Not, let's say, normal course of business, but specific to some supply chain engagements that's then having a flattening effect of overall work we're doing on inventory in the base business, in the core business.

Speaker 3

Yes, it's complex, Matt. So your questions are right on. And I guess that the net net is We're confident with the inventory levels. We'll start to bring them down. But right now, the inventory is fresh.

Speaker 3

It's good inventory. It's not aging. To Ken's point, the newer stuff is what we're talking about that's stopping it from coming down.

Speaker 7

Okay. Okay. Thank you for that. And I appreciate that the visibility behind Q2 is difficult. But you did talk about this inventory correction taking At least a couple more quarters.

Speaker 7

And traditionally, in your March quarter, you're sequentially up in the Western markets in North America and in Europe. In past cycles, that hasn't happened because of some of the issues that you're facing now. So the question is, how should we think about How the rest of the year plays out to the best that you can tell us?

Speaker 4

Yes. Matt, I guess what I'd say is that I think we'll still get a mix shift to the West. Now whether it will be normal seasonality or let's say normal pops, I still think that's to be determined. We still feel confident above $6,000,000,000 and we'll get a little bit of gross margin lift from mix shifts. That sounds I think a lot of what Phil's commentary on the mid-twenty 24 is really about inventory levels, right?

Speaker 4

The inventory is stable, but we're not going to see the inventories really Come down meaningfully through that timeframe, because there's still plenty of work to do there.

Speaker 3

Yes, Matt, we're talking about the inventory levels. We're talking about the market. We track like you do all the inventory levels by EMS, us end markets, etcetera. And that's our estimate based on And demand at the inventory at the inventories burn off out there and customer inventory, to sum it up, We estimate that's mid-twenty 24. Could be shown or like could come quicker.

Speaker 7

Okay. Thank you. And just lastly, relative to the interest expense, which was down sequentially, but still up significantly from where it was a few quarters ago and I would think that would be one area where you can drive profitability growth as you Continue to generate more cash, inventory comes down, you bring down your short term borrowings. So how should we think about that as a potential driver Profitability over the next few quarters?

Speaker 4

Yes. I think, Matt, definitely, as we get back to cash flow generation, paying down debt will be A part of that, especially as sales are down, trying to keep leverage in the same ballpark we've had it, but then we'll try to be more opportunistic on buybacks as well. We think there'll be enough cash to do both, but got to get back to that generation before we can start to work down the debt and or increase the buybacks.

Speaker 7

Okay. Well, sounds good. Thank you very much and best of luck to your baseball team tonight.

Speaker 3

Thanks, Ben.

Operator

Thank you. Our next question is from Joseph Cardoso with JPMorgan. Please proceed with your question.

Speaker 8

Hey, thanks for the question guys. So first one here is just can you provide a bit more color on what you're seeing out of Asia? Obviously, it was another quarter of Softness. But just curious, it sounds like you're expecting some improvement there and just wanted to touch on, is that just more of a function of typical seasonality And the easier comps or if you're actually seeing any green shoots in the region around improvement? And if so, where that is materializing, if you have any color on that?

Speaker 3

Yes. Sure, Joe. I'll go first. And so thanks for that. Overall, we're competing well in Asia.

Speaker 3

We think we're picking Some share as well, but the if you look at it in Q on Q, just looking at the numbers for the industrial in Asia held up pretty well. It was down year on year as we talk about in the script in general because we had such a record breaking numbers a year ago. Transportation was up both Q on Q And year on year. So there's some signs of positiveness in Asia and Japan has been good. Japan has been positive for us.

Speaker 3

So it's really there's no one thing. We just feel that and Ken and I were just over there talking to the team and our leader there that Feeling that it's going to start to turn a bit. Now, we're not it's very important, we're not overly exposed to any one vertical, right? And I think that's really, really important. And we're not overly exposed to China, right?

Speaker 3

We do our business in China, but we're not overexposed. So it gives us maybe a bit more of a balanced portfolio in the Asia Pac region.

Speaker 4

And my only other comment would be our team over there is really competing well in the markets they serve. And so we're seeing Very good progress there in terms of trying to take share.

Speaker 8

Got it. That sounds great. And then And maybe this is one is a little bit more random, but just within the automotive transportation business, some folks across the supply chain have Just been highlighting headwinds either in the form of UAW strikes or increased competition in China around some of the new applications being deployed there. Just curious and it doesn't sound like it, but are you guys seeing any of those headwinds at all materialize in your business or is that largely noise for you guys? Thanks for the question.

Speaker 3

Yes. Well, it's not noise. It's certainly some reality to the competitive nature of what's going on in automotive. Again, this past quarter, we just did not see that, and we still see it pretty positive. The auto strike, We really didn't see any real effect on that, at least to date and it sounds like they're working to resolve some of those.

Speaker 3

But Again, when you look at in automotive, in total, it's just we're not overexposed. It's maybe 15%, 16% of our business is approximately or something along those lines. So it's not like 50% or 60%. So even if there is a slight Ticked down. It's not going to have a huge effect on us.

Speaker 3

And we also look at transportation beyond just automotive. It's got We put in that bucket transportation. It's golf carts, dump trucks, trains, e bikes, so which is battery and a lot of that semi lifter. So we kind of broaden that vertical as well.

Speaker 8

Got it. Appreciate the color, Scott.

Speaker 3

Thanks, Joe.

Operator

Thank you. Our last question is from William Stein with Truist Securities. Please proceed with your question.

Speaker 6

Great. Thanks for taking my questions. I want to offer my congratulations and also add on to Matt's Comment, I was surprised to see the Avnet logo on the Diamondbacks, but

Operator

all good stuff. I have a couple of questions.

Speaker 6

First, And I apologize if you touched on this already, but I think you cited automotive or transportation as a strong end market and I even think You cited industrial leased in Asia as a relatively stronger end market. These have been sort of the standout weakening end markets among the semi suppliers as we progress through earnings season or at least so far, but enough to have said it that it's It's been pretty significant misses actually. And I wonder If you're not seeing the same trends, is this a matter of you think inventory in the channel that you guys that maybe you're not ordering as much from the suppliers or is it inventory at end customers or any clarification on this would be really helpful.

Speaker 3

Yes. Let me give a shot at that. Yes, transportation, if you look at globally, was up modestly Q on Q and Year on year as well for us. And Industrial, first of all, it's really a broad Yes, it may be depend how people define industrial. It's our largest segment by a long shot.

Speaker 3

So it's really long tail. And if you look at Some reasons it's stronger than others. I think what we said in the script, we called out that it's moderating though. We definitely see some moderation in industrial. So we did call that out, William, you may not have saw it.

Speaker 3

So we saw a stronger strength in transportation than we did in industrial. And then we called out Defense Aero. It was a little softer in September, but we don't expect That's going to continue to be a growth market as well. We separate that out from industrial. But it depends just depends on the market, The submarkets within industrial because it's so broad, then that's why I keep talking about the mixed signals because there's still some nice pull in demand and there's others that are just a little over inventory.

Speaker 3

But I think they'll be burning that off, like I said, through the first half calendar twenty twenty four.

Speaker 6

Great. And the follow-up, Recently, WT Micro acquired Future and that's a pretty unusual rather large Combination of competitors and I wonder if the company has any view as to whether that would increase or decrease competitive pressures And any description of the sort of change in competitive dynamics that you anticipate from that or ones that you've already seen? Thank you.

Speaker 3

Yes. Thanks, Will, and thanks for the comments. We don't make comments on the competition No, certainly that merger, we want to focus on our execution and our operational focus and Just continue to do what we're doing with our suppliers who we value greatly and our customers. I think we do that and we'll be fine. So you got We already compete with WT and Asia and we keep compete with future in the West.

Speaker 3

So they're going to combine together and we'll see how that works out. But in the interim, We're stable and balance sheet solid and we want to continue to drive growth with our current suppliers and customers. I wish them luck.

Speaker 6

Thank you.

Operator

Thank you. There are no further questions at this time. Would like to hand the floor back over to Phil Gallagher, CEO, for closing comments.

Speaker 3

Thank you. I want to thank you for attending today's earnings call, and I look forward to Speaking to all of you again at our fiscal second quarter earnings report in January. And since it was noted, today does mark Game 5 Of the World Series and Major League Baseball, on behalf of Avnet, team Avnet want to say go Diamondbacks. Okay. Have a great rest of the week.

Speaker 3

Thank you.

Operator

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.

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Avnet Q1 2024
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