Avnet Q3 2024 Earnings Call Transcript

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May 1, 2024

There are 6 speakers on the call.

Operator

to the Afenet Third Quarter Fiscal Year 20 24 Earnings Call. I would now like to turn the floor over to Joe Perk, Vice President, Treasury and Investor Relations for Afnet. Thank you, operator. I'd like to welcome everyone to the Avnet 3rd quarter fiscal year 2024 earnings conference call. This morning, Avnet released financial results for the Q3 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 at your convenience.

Operator

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 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 publicly update any forward looking statements or supply new information regarding the circumstances after the date of this presentation. Please note, unless otherwise stated, all results provided will be non GAAP measures.

Operator

The full non GAAP to GAAP reconciliation can be found in the press release issued today as well as in the appendix slides of today's presentation and posted on the Investor Relations website. Today's call will 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 1

Thank you, Joe, and thank you, everyone, for joining us on our Q3 fiscal year 2024 earnings conference call. I am pleased to share that we delivered another quarter of financial results in line with our guidance. In the quarter, we achieved sales of $5,700,000,000 and adjusted operating margins of 3.6 percent, highlighted by a 4.1% operating margin in our electronic components business. And we generated nearly $500,000,000 of cash flow from operations. This demonstrates that we can maintain reasonable profit margins even during the challenging cycles we face.

Speaker 1

As I've mentioned on previous calls, we've been working through an inventory correction on a global basis over the past couple

Speaker 2

of quarters. And while we

Speaker 1

have made progress in working down our inventory levels, we, like many in the industry, still have a ways to go. Our customers are facing a variety of factors that are contributing to the current challenging business environment, including elevated inventory levels, some cash flow constraints, diminished customer visibility and shortened lead times. These market conditions are among the most challenging in recent memory. At times like this, I am proud to have one of the most experienced and dedicated teams on the field. As you all know, the economic conditions evident in the Q2 continued in the Q3.

Speaker 1

Sequentially, demand declined across most of the end markets we serve. However, defense and data center markets showed improvement. On a year on year basis, transportation was a bright spot with increasing demand globally. Semiconductor lead times have continued to decline over the last several months and are generally stable, although the growth in data center build outs is driving longer lead times for certain products, and we would expect this to continue. On the IP and E side, lead times and pricing are generally stable, and we are seeing increased demand for interconnect products and capacitor families, most notably channel.

Speaker 1

Our backlog is lower as a result of shorter lead times and customers working through their inventory on hand. Cancellations have remained at normal levels. As expected, our global book to bill ratio remains below parity at the end of the Q3, though modestly above last quarter, led by our Asia region, which finished the quarter approaching parity. I'm really pleased by the work of the team in improving our inventory position. It is worth noting that we reduced inventory and reduced our receivables at the same time, demonstrating sound working capital management.

Speaker 1

This is a key focus area for our organization, and we expect to see further progress in the current quarter, which should drive solid cash flow from operations. I'm proud of our position as a key enabler of healthy, more reliable supply chains in the semiconductor and electronic components ecosystem, and it's only getting stronger. Our position at the center of technology supply chain allows us to pursue opportunities with our long standing customers and suppliers who increasingly rely on Adnet to meet their needs. With that, let me turn to the 3rd quarter results. At the top line, our electronic components business declined in revenues across all the regions.

Speaker 1

But I will note that the Q3 of fiscal year 2023 in EMEA was a record revenue quarter. So they're going against some tough comparisons. In EMEA, we're glad to see that demand in the transportation end market increased sequentially and the defense end market increased on a year on year basis. In the Americas, demand in the transportation end market increased on a year on year basis, and in Asia, demand in the transportation, compute and consumer end markets all increased on a year on year basis. We continue to move successfully up the value chain.

Speaker 1

In the quarter, our engineering teams continue to engage with our customers and suppliers on design wins and registrations, which drove increases in revenues and margins and further validates the value proposition we deliver in any type of market. Before we get into Farnell's results, I want to let you know of a leadership change in that business. Chris Breslin, our Farnell President is leaving Avnet. I want to thank Chris for leading the Farnell team over the past 6 years. Given their close proximity, industry knowledge and proven track record, I've asked 2 of our veteran EMEA core business leaders to temporarily assume executive oversight for the Farnell Organization.

Speaker 1

I want to reiterate that Farnell remains a critical part of Adnet's overall success and value proposition, so stay tuned for upcoming announcements on the Farnell leadership transition. In the Q3, Farnell sales were up sequentially, led by strength in IPD products and single board computers. However, margins are not where they need to be. As a result, we are making cost reductions primarily related to warehousing costs, freight, marketing costs and headcount. We are well on our way to achieving our previously disclosed savings target, which should be substantially implemented by the end of June.

Speaker 1

So improvement should be apparent in the second half of the calendar year. As a key player in the supply chain, we continue to leverage our value proposition in areas such as demand creation, IP and E and embedded computing. With our global sales force and our technical capabilities, I believe we have all the right resources to grow our top and bottom lines over the long term. And while it's difficult to say just when this correction will have run its course, I am encouraged by a number of signs I see at Avnet and in the market. 1st, current business activity in our Asia region has indicated that we are likely near to the bottom and may potentially see some sequential growth as we move through the balance of calendar 2024.

Speaker 1

2nd, we are seeing a nice pickup in bookings in our IP and E business and at Farnell as well. Finally, the industry sources we follow as well as the customer support executives I meet with regularly are projecting a return to growth as we move into calendar year 2025. To conclude, we remain focused on bringing our considerable experience and relationships to bear as we navigate this choppy period. We are managing the things we can control, delivering increasing value to our customers and supplier partners, reducing working capital, especially inventory, aligning costs and driving shareholder return. I believe we have the right strategy and team members in place to both drive and benefit from the market recovery.

Speaker 1

Again, I want to thank our team for bringing their unmatched expertise to work every day. It is important to Avnet and it's important to the industry. With that, I'll turn it over to Ken to dive deeper into our Q3 results.

Speaker 2

Thank you, Phil. Good morning, everyone. We appreciate your interest in Avnet and for joining our Q3 earnings call. Our sales for the Q3 were approximately $5,700,000,000 in line with guidance and down 13% year over year. On a sequential basis, sales were down 9% in constant currency due to expected sales declines in the western regions and a seasonal decline in Asia due to Lunar New Year.

Speaker 2

On a year over year basis, sales declined in constant currency 7% in Asia, 15% in EMEA and 18% in the Americas. From an operating group perspective, electronic component sales declined 13% year over year and 10% quarter over quarter in constant currency. Farnell sales declined 10% year over year and 11% in constant currency. Farnell sales grew 3% sequentially in constant currency. For the Q3, gross margin 11.8 percent was 62 basis points lower year over year, but up 46 basis points sequentially.

Speaker 2

EC gross margin was down year over year primarily due to a lower mix of sales from the western regions. EC gross margin increased sequentially primarily due to the seasonal mix shift to the Western regions. Farnell gross margin continued to be down year over year, but was higher sequentially largely due to pricing stability and an improved demand for IP and E products. Turning to operating expenses, selling, general and administrative expenses were $467,000,000 in the quarter, down 6% year over year and largely flat sequentially with a slight increase due to differences in foreign currency exchange rates. As a percentage of gross profit dollars, selling, general and administrative expenses were 70% in the 3rd quarter.

Speaker 2

For the Q3, we reported adjusted operating income of $203,000,000 and our adjusted operating margin was 3.6%. By operating group, electronic components operating income was $217,000,000 and EC operating margin was 4.1%. This was the 9th consecutive quarter of EC operating margin being above 4%. Farnell operating income was $16,000,000 and Farnell operating margin remained at 4%. As we communicated last quarter, we have initiated cost reduction actions at Farnell, which when completed will provide annual expense reductions of between $50,000,000 to $70,000,000 We had completed approximately 2 thirds of the reductions as we exited the 3rd quarter.

Speaker 2

The remainder of the reductions are expected to be completed over the next couple of quarters. Additionally, due to our current sales outlook and demand environment, we are taking action to reduce total Avnet operating expenses by $40,000,000 to $60,000,000 per year. These actions include a combination of permanent and temporary cost reductions across all regions. We will continue to make operating expense investments where needed, but the current market conditions require some incremental cost actions. Turning to expenses below operating income, 3rd quarter interest expense of $73,000,000 increased by $2,000,000 year over year and was down approximately $1,000,000 sequentially.

Speaker 2

Our adjusted effective income tax rate was 24% in the quarter as expected. Adjusted diluted earnings per share was in line with our expectations at $1.10 for the quarter. Turning to the balance sheet and liquidity. During the quarter, working capital decreased $574,000,000 sequentially, including a decrease in reported inventories of $364,000,000 $194,000,000 decrease in receivables and a $16,000,000 increase in payables. Working days increased 8 days quarter over quarter to 115 days.

Speaker 2

Our return on working capital decreased accordingly on the lower operating income. Our inventories were down 6% during the quarter, reflecting decreases across all regions within EC and to a lesser extent Farnell. The declines in EC inventories were net of increases in inventories due to strategic opportunities. Inventories for these arrangements are expected to build into the June quarter with the underlying inventory selling through by the end of the calendar year. We expect continued overall progress on achieving inventory reductions during the Q4 excluding these strategic arrangements.

Speaker 2

As Phil has mentioned many times, part

Speaker 1

of our role at the

Speaker 2

center of the technology supply chain is to play shock absorber between our suppliers and customers. Despite the near term challenges of the current market environment, we still want to be opportunistic as new business opportunities present themselves, even those opportunities that may require additional inventory. We take a holistic approach when evaluating any such opportunities, but are disciplined in making sure there is a proper ROI for Avnet in any such arrangements. Our decrease in working capital led to a decrease in debt of $495,000,000 We generated nearly $500,000,000 of cash from operations in the quarter and we have generated $650,000,000 of cash from operations over the past 4 quarters. We expect to generate positive operating cash flow in the 4th quarter, although more modest than this past quarter.

Speaker 2

We ended the quarter with a gross leverage of 2.5 times and we had approximately $890,000,000 of available committed borrowing capacity. With regard to our capital allocation, we continue to prioritize our existing business needs. As previously noted, we are driving working capital reductions to be more in line with our current level of sales. During the quarter, cash used for CapEx was $42,000,000 primarily to support a new distribution center being constructed in EMEA. We expect CapEx to return to historical levels in the Q4 of fiscal 2024 of approximately $25,000,000 to $35,000,000 per quarter.

Speaker 2

In the Q3, we paid our quarterly dividend of $0.31 per share or $28,000,000 We have $232,000,000 left on our current share repurchase authorization entering the 4th quarter. As a result of our strong cash flow generation, we expect to repurchase Avnet shares in the

Speaker 3

4th quarter. Our shares continue

Speaker 2

to trade at a meaningful discount to book value as book value was $55 a share for the Q3. Turning to guidance. For the Q4 of fiscal 2024, we are guiding sales in the range of $5,200,000,000 to $5,500,000,000 and diluted earnings per share in the range of $0.90 to 1 dollars Our Q4 guidance assumes current market conditions persist and implies a sequential sales decline of 3% to 8%. This guidance assumes below seasonal sales declines in the Western regions and below seasonal growth in sales in Asia. This guidance assumes similar interest expense compared to the 3rd quarter, an effective tax rate of between 22% 26% 91,000,000 shares outstanding on a diluted basis.

Speaker 2

Before we take questions, I want to echo Phil's sentiment in thanking our team for staying focused on the things that will drive success for us in the coming quarters. Most importantly, closely monitoring operating expenses, generating operating cash flow from working capital reductions and winning new sales opportunities to drive profitable growth and continued market share gains. With that, I will turn it over to the operator to open up for questions. Operator?

Operator

Thank you.

Speaker 4

Thank you. Our first question is from Matt Sheerin with Stifel. Please proceed with your question. Yes. Thank you and hello everyone.

Speaker 4

Phil, first question just in terms of your forecast for below seasonal again in all regions, but sequential growth in Asia. So that would imply year over year declines of, I don't know, 20% to 25% year over year in the Americas and in EMEA. And do you expect do you think that's sort of the last drawdown, if you will, in terms of inventory? And are you getting any signs that, that may be it? And then we're going to start to see at least more stability in terms of customer orders or anything else that makes you optimistic that this may be the bottom here?

Speaker 1

Coming down, can you hear me?

Speaker 4

Yes. I didn't hear you the first part, Phil.

Speaker 1

Okay. Let me start again. That's fine. So thanks, Matt. Appreciate it.

Speaker 1

I said I'd start with Asia. As we said in the script, we do believe, look at the bottom in Asia, we're seeing some moderate forecasting through 2024, but again, moderate, but that's good news. And as we know, historically, a lot of times the signs start in Asia and circle around to the West and that kind of where you're going, I think. In Europe, I mean, it's part of the challenge in Europe with the year on year drop is we just were coming off record highs. So it's compounding the image, if you will.

Speaker 1

But tough to call if that's the bottom line. It feels like it might be, Matt, but there's so many mixed signals out there. I won't want to project that as absolute. But we do think it will start bouncing back in the second half very slowly more into 2025.

Speaker 4

Okay. Thank you for that. And then on the cost cutting, I think you said it was a $40,000,000 annual run rate. When should we think about those costs coming out? Will that start in the June quarter?

Speaker 4

And what should we think about OpEx sequentially? Will that be down or will that be up?

Speaker 2

Yes, Matt, this is Ken. I'd just say that a lot of those actions for the new incremental actions beyond Farnell are actually occurring kind of as we speak during the quarter. So, expect it to be more of an FY 2025 kind of benefit and think about OpEx being down next quarter slightly due to the Farnell actions plus the volume decline.

Speaker 4

Okay, great. And just quickly as a follow-up, that would imply that gross margin actually holds fairly steady. And I would think that might be down because of the mix?

Speaker 2

Yes. I think there's a mix offset by some opportunistic things that are kind of balancing it out. So gross margin is holding up slightly in the EC business.

Speaker 4

Okay, great. All right. Thanks a lot.

Speaker 1

Thanks, Matt.

Speaker 5

At Stifel, we continue to build upon.

Operator

Our next question is from Joe Quatrochi with Wells Fargo. Please proceed with your question.

Speaker 3

Yes. Thanks for taking the question. Maybe just on that on the ECA margin front, I guess like as you think about that mix benefit, we assume that that margin can remain still above that 4% threshold for the June quarter? Yes, Joe.

Speaker 2

I guess, I'd characterize it. It could be slightly below it could be slightly above the 4%, right? It's kind of within that range. So, it depends on how the regional mix shakes out ultimately, but it's the guidance implies it right around the 4%, but slight could be slightly below, could be slightly above.

Speaker 5

Okay. Thanks. And then as

Speaker 3

a follow-up, I think last quarter you talked about discussions with your suppliers and customers kind of suggested that you were thinking about inventory reductions continuing through the large percentage of this calendar year. And I guess my question is, is that still the right way to think about it or has that maybe even pushed a little bit into 2025 as you just think about returning to growth in 2025? I guess has there been any change really in how you think about the trajectory of inventory reductions to the base of this year?

Speaker 2

No, I wouldn't say really a change. I think that we are happy that we started some progress again. We haven't had much progress there. Flattish has been or stable has been our commentary the last couple of quarters. So, feel good about the direction we're headed.

Speaker 2

Still a lot of work to do is how I characterize it. So think about it through the remainder of the calendar year, still not going to weigh at that because the sales levels are down as well.

Speaker 3

Got it. Thank you.

Operator

Thanks, Joe. Our next question is from William Stein with Truist Securities. Please proceed with your question.

Speaker 3

Great. Thank you for taking my questions. First, I'm hoping you can comment on order trends in the 1st month of the current quarter and how they might have progressed relative to what you characterized for the last quarter? And then I do have a follow-up.

Speaker 1

Yes, I'll take that, Will. Thanks. Yes, the order the book to bills had improved modestly. We're seeing more improvement in Asia Pac. And as we called out, we're seeing some improvement in Farnell as well as in IP and E.

Speaker 1

And even within the IP and E, it's probably more I connectors and EMAC is balanced. So, we are seeing some recovery in book to bill. The real issue is the lead with the lead times down and the inventory out there, we're just trying to get customers to give us pipeline and more visibility is key. And of course, we're the middle guy to help the suppliers get the visibility of their local formats. Still just not happening on a wholesale basis, if you will.

Speaker 1

But that's what we're working on. But it is slightly improved beginning this quarter versus last quarter.

Speaker 3

Great. That helps. And one end market follow-up. Channel checks I was doing in the middle of the quarter reflected a recovery or let's say at least some better than expected conditions in automotive. And we did see that from a few semis and now you're citing the same thing.

Speaker 3

It's sort of still surprising and maybe a bit of a head scratcher to investors because they're looking at the Tier 1s and the OEs themselves and their business doesn't seem to be really up ticking. I wonder if is this because they sort of all pipelines material for EVs, demand for that didn't materialize, so we've got to go place a bunch of new orders for internal combustions and hybrids? Or is there some other inventory mismatch? Or did they just take inventory too low? However, you might help us understand this would be really helpful.

Speaker 3

Thank you.

Speaker 1

Yes. Well, it really is a mixed bag. You see the different report outs in the last week or so. Some are calling it out as negative, others as positive. I think it really depends you kind of answered the question.

Speaker 1

Really depends on the content you have in the automobile and where that content is in whether it be combustible or EV, the ADAS, again, the content in the EV is much higher. But even I'm looking at the numbers now, yes, we saw up year on year last quarter. And we call it transportation to be fair. So it's a little broader than just automotive, but automotive is the bulk of it. And on a 3 quarter trend, globally, we still saw it up year on year.

Speaker 1

So not only last quarter, but over the last 3 quarters. So it's kind of now that you're looking at by region, it might be a little bit different, but that's kind of how we're seeing it at this point in time.

Speaker 5

Okay. Thank you.

Operator

Our next question is from Ruplu Bhattacharya with Bank of America. Please proceed with your question.

Speaker 5

Hi, thanks for taking my questions. Maybe this time, I'll start with Ken. Ken, can you remind us like what revenue level do you need for keeping in order to keep the components operating margin above 4%? I know you talked about cost actions that you're going to see, Yes. I mean,

Speaker 2

I think most of the cost actions that you're going to see through the remainder of the year would be more Farnell because the core business is in the process of executing some of those things. I would kind of say, Ruplu, the question I got before was the guidance implied below 4% does imply at 4%. So, I'd kind of flip it and just say, hey, this level of revenue depending on regional mix is kind of where we're at to maintain the 4%. So the guidance implies kind of right around 4%. And there's obviously put or take of plus or minus 20 basis points depending on how much is EMEA in Americas versus Asia, some of those things, but that's we're kind of at that level.

Speaker 2

Absent some other meaningful increase in demand creation mix or supply chain and service scaling a lot more than we've had implied.

Speaker 5

Okay, okay. That's helpful. And Ken, maybe another one for you. Can you talk about how you think about the cash conversion cycle trending over the next couple of quarters? How should we think about free cash flow?

Speaker 5

And then you laid out uses of cash. I mean, can you give us your thoughts on buybacks? And any opportunity for M and A in this environment

Speaker 2

or not? Yes. I mean, I think we'd expect positive free cash flow. We are going to be in the market in the Q4 buying back shares. We believe they're still at a great value considering they're well below book value.

Speaker 2

I would not anticipate any M and A through the remainder of this calendar year. I think we're always looking, but again, looking at smaller like IP and E type acquisitions, nothing transformational. But at this point, we're probably not going to be active in M and A over the next few quarters. And CapEx should return to normal levels. So think about it as $25,000,000 to $35,000,000 a quarter as a normal run rate.

Speaker 5

Okay. Okay, that's helpful. Maybe I can sneak one more in for Phil.

Speaker 1

I

Speaker 5

mean, the operating environment is tough right now, Phil, but can you, as a high level question, talk about what are some of your focus areas to grow revenue over the next 12 months? Where do you think like either which end markets or which geography do you think comes back sooner? And when that happens, like where do you see like Avnet best positioned, like which end markets, which verticals, which geographies? And is there anything you're investing even in this climate, is there anything you're investing in right now to better position the company for the recovery? Thanks.

Speaker 5

Yes. Thanks, Ruplu.

Speaker 1

A lot packed into that question, Ruplu. I'll do the best I can to pare it down. Well, we already talked regionally. So we feel Asia Pac is going to start to bounce back, which is positive. We're well positioned in Asia Pac and continuing to gain share there.

Speaker 1

So and on a high level statement, we've shared before on the earnings call, we're trying to keep the team intact. We're not trying to overreact to the market. We've had great momentum many quarters in a row now. So we're being very careful where we reduce expenses while still making investments. And we're continuing to invest in the verticals.

Speaker 1

So we although industrial and everybody knows industrial has kind of been hit harder and that's a big play for us, we're positioned extremely well in industrial and going to continue to stay positioned there. We had talked about transportation earlier with Will a bit. That's going to be a good market for us, continues to be and will be in the future. We're continuing to invest in that space. The other vertical, the defense aerospace, unfortunately, with what's going on in the world today, that's going to continue to grow many fronts.

Speaker 1

So, there are ample verticals. And then inside the company, we talked about in the script, our continued focus on IP and E. We're starting to see that move back into a positive, which is good news, particularly from a book to bill. And we talked about ad net embedded. And again, that's a business that's continuing to grow, generates higher margins for us.

Speaker 1

That's where we're actually building, designing and building manufacturing boards that go into those same verticals I just talked about, including medical. Those will be a couple of areas that we're focused on right now. And we want to continue to maintain that focus and again not overreact, okay, and have the pendulum swings that we may have seen in the past, manage what we can, drive the inventories down, generate cash while servicing our customers and suppliers.

Speaker 5

Okay. Thanks for all the details. Appreciate it.

Operator

Thank you. There are no further questions at this time. I'd like to hand the floor back over to Phil Gallagher for any closing comments.

Speaker 1

Great. Well, I want to thank everyone for attending today's earnings call and I look forward to speaking to you again at our Q4 fiscal year 2024 earnings report in August. Have a great summary.

Operator

Ladies and gentlemen, this does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.

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