Avnet, Inc. (NASDAQ:AVT) Q2 2023 Earnings Call Transcript

Avnet, Inc. (NASDAQ:AVT) Q2 2023 Earnings Call Transcript February 1, 2023

Operator: Welcome to the Avnet Second Quarter Fiscal Year 2023 Earnings Conference Call. I would now like to turn the floor over to Joe Burke; Vice President, Treasury and Investor Relations for Avnet.

Joe Burke: Thank you, operator. Earlier this afternoon Avnet released financial results for the second quarter fiscal year 2023. The release is available on the Investor Relations section of the company’s website. A copy of the slide presentation that will accompany today’s remarks can be found via the link in the earnings release, as well as on the IR section of Avnet’s website. 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-K and subsequent filings with the SEC. These forward-looking statements speak only as of the date of this presentation and the company undertakes no obligation to publicly update any forward-looking statement or supply new information regarding the circumstances after the date of this presentation. Today’s call will be led by Phil Gallagher, Avnet’s CEO; and Ken Jacobson, Avnet’s CFO. With that, let me turn the call over to Phil Gallagher. Phil?

Phil Gallagher: Thank you, Joe, and thank you everyone for joining us on our second quarter fiscal year 2023 earnings conference call. I am pleased to share that we delivered another quarter of solid financial results, which exceeded the higher end of our sales and earnings guidance. More importantly, we achieved these results despite the macro headwinds affecting certain areas of our business, which I’ll touch on in a minute. In the quarter, we grew sales 21% year-over-year in constant currency, making it our eighth consecutive quarter of double-digit year-over-year sales growth. We believe this growth resulted in another quarter of gaining market share, thanks in large part to our customer partnerships and the dedication and execution of our employees.

Efficient management of our operations also enabled us to drive solid operating margin of 4.5%, which is the fourth consecutive quarter of greater than 4% operating margin. Further, the combination of strong sales growth and effective management of operations allowed us to increase operating income nearly three times faster than that of revenue on a year-over-year basis. During the quarter, we saw continued strength in the Americas and EMEA regions and began to see signs of slowing in Asia beyond the COVID-19 customer shutdowns, which had some impact on both electronic components and Farnell. Our team has executed very well in helping our customers manage market complexities, as they face dynamic supply chain conditions and uncertainties. From a demand perspective, in the quarter, we saw continued strength in key vertical segments, most notably transportation and industrial.

In the last earnings call, we indicated that lead times were improving. And in the second quarter lead times continued that trend for many products. Although, for certain products, lead times still remain extended. Across all regions, we’ve been coordinating closely with customers and suppliers to effectively manage our backlog. As a result of those actions our overall book-to-bill ratio softened during the quarter and we exited the second quarter below parity on a global basis. Across the supply chain, inventory levels remain elevated, including that of many of our customers. In order to support our customers, as they continue to be challenged with higher inventory and obtaining all the key parts required to complete their products, our inventory levels also increased this quarter, which Ken will speak to further in his commentary.

Overall, we remain comfortable with the quality of inventory and are working to improve our inventory turnover heading into the third quarter. Our role as a distributor is particularly critical in these types of uneven environments. As we have proven over the years, the value of Avnet and the complex operating environment is our ability to serve as a control tower for our customers and suppliers, helping them to proactively manage their supply chains. With the changes we have made to organization over the past two-and-a-half years, I’m confident that we are a much stronger and more resilient company today and are well positioned to deliver value and quickly adapt as marketing conditions change in the future. So with that, let me turn to the highlights for our business.

Electronic Components business drove year-over-year sales growth across all three regions. In constant currency, Electronic Component sales were up 23% year-over-year the seventh consecutive quarter of 20% or greater organic sales growth in constant currency. I am particularly proud of our EMEA team, delivering record sales and operating income for the quarter. The Americas team also continued to make steady progress and delivered another strong quarter with sales, and achieving the highest operating income in several years. The Americas and EMEA regions both benefited from strength in key verticals, notably, industrial and transportation. In Asia, we experienced a softening of demand as we worked with customers to adjust their backlogs due to lead time improvements.

Additionally, many of our customers across the region experienced challenges with their operations due to the rise in COVID-19 cases. I’m proud of our Asia team’s continued success not only in ensuring business continuity, but it consistently gaining market share in the region at the same time. Although our Asia business saw signs of slowing, they continue to get market share during the quarter and a favorable sales mix led to operating margin expansion during the second quarter both sequentially and year-over-year. Overall across all regions we continue to benefit from our unique engineering and demand creation capabilities with our field application engineers and digital design tools once again achieving record revenue and gross profit dollars for demand creation.

We believe this ongoing strength is indicative of the increasing value of the capabilities we provide to both our customers and suppliers. Now let’s turn to our Farnell business. Farnell sales declined sequentially and year-over-year and continue to be impacted by product availability and pricing. As shortages for certain parts begin to moderate, customers will shift some of their orders to volume distributors thereby affecting demand and pricing at Farnell. As we announced last quarter, we are the exclusive distributor for the Raspberry Pi single-board computer, which continues to see more potential in industrial applications. The backlog for single-board computers remains robust. And when certain key semi-electronic components become more available towards the end of our fiscal year, we expect to realize such sales.

Operating margins for Farnell were over 9% during the quarter. Our operating margins are lower this quarter. It’s really important to note that Farnell’s margins are still two times that of Avnet’s overall operating margin. Our investments in Farnell’s eCommerce platform and improved user experience continued to yield results with 55% of Farnell’s total sales and 73% of total orders placed through the eCommerce platform this quarter. We are pleased with these results and expect to see increased traffic and new customer acquisitions in the quarters to come as certain components for new product introductions and single-board computer products become more available. Additionally, Farnell has a diverse product mix that not only solves customers on-the-board needs, but also supports test and measurement as well as industrial maintenance and repair operations as needed.

For the long-term, we remain very excited about Farnell and continue to see opportunity to leverage Farnell’s and Electronic Components’ unique and synergistic collaboration. This allows us to better serve our customers and suppliers for new product introduction to mass production and is a key differentiator for Avnet. To recap, while we are pleased with the strong finish of the calendar year 2022 and the better-than-expected results for the quarter, we are closely monitoring market visions and the impact of component lead times on our backlog and inventory levels as products become more available. We expect to experience a high end of seasonal sales declines in the Asia region due to the Lunar New Year with some uncertainty on how COVID-19 may impact the return of the workforce once the holiday is over.

We’re also keeping an eye on the impact of rising interest rates inflation and the signs of slowing growth in the global economy. We continue to be confident in our team’s ability to execute in a dynamic and uncertain environment by delivering value to our supplier and customer partners. We have been in the business for over 100 years. We have weathered many market cycles and our team is up to the challenge. There has never been a greater need for the capabilities that Avnet has to offer and we look forward to continue to play a critical role at the center of the technology supply chain. So with that I’ll turn it over to Ken to dive deeper into our second quarter results.

Ken Jacobson: Thank you, Phil. Good afternoon, everyone and thank you for your interest in Avnet. The Avnet team delivered another strong quarter of sales and operating income growth compared to the year ago quarter. We are very pleased with our second quarter and the calendar year 2022 financial performance. We believe we continue to be well-positioned to deal with the market challenges and uncertainties that Phil previously mentioned. In the second quarter, our sales were $6.7 billion, up nearly 15% year-over-year, exceeding the top end of our guidance range. This represents our 10th consecutive quarter of year-over-year sales growth. In constant currency, sales growth was 21% year-over-year with each region contributing to the growth.

Sales were flat on a sequential basis in constant currency, which was above our typical seasonal trend and included a higher mix of sales from our Western regions. We had year-over-year sales growth across all of our regions led by EMEA, which delivered a record $2.3 billion of sales. On a year-over-year basis in constant currency, sales grew 38% in EMEA, 21% in the Americas and 9% in Asia. From an operating group perspective, Electronic Component sales grew 16% year-over-year or 23% in constant currency. Electronic component sales were flat quarter-over-quarter in constant currency. Farnell sales declined nearly 8% year-over-year and was flat with the prior year in constant currency. Excluding sales of single-board computers, Farnell sales grew 4% year-over-year in constant currency.

For the second quarter, gross margin of 11.7% improved 29 basis points quarter-over-quarter and was down 49 basis points year-over-year. The sequential improvement was primarily due to higher gross margins across all three regions as well as a shift in sales mix from Asia to the Western regions. We continue to maintain discipline around SG&A expenses as adjusted operating expenses were $484 million for the quarter, down 3% year-over-year and up 2% sequentially. Adjusted operating expenses increased 4% year-over-year in constant currency to support the 21% sales growth. As a percentage of gross profit dollars, adjusted operating expenses were 62% in the second quarter, a full eight percentage points lower than the 70% a year ago. Adjusted operating income of $301 million increased 39% year-over-year and grew 2.7 times greater than sales.

This is the eighth consecutive quarter of operating income growth exceeding our sales growth. Our adjusted operating margin was 4.5% in the second quarter, which improved 80 basis points year-over-year and improved 12 basis points quarter-over-quarter. By operating group, Electronic Components operating income was $297 million, up 57% year-over-year. EC operating margin was 4.7%, up 122 basis points year-over-year and up 47 basis points quarter-over-quarter. All three EC regions saw year-over-year and quarter-over-quarter operating margin expansion led by our EC EMEA business, which expanded operating margin by more than 200 basis points year-over-year. Farnell operating income was $37 million, down 39% year-over-year. Farnell operating margin was 9% in the quarter, down 461 basis points year-over-year and down 308 basis points quarter-over-quarter.

The decline in Farnell operating margin was primarily driven by a combination of lower sales in part due to the lack of availability of certain components for single-board computers and from a lower gross profit margin. The expected decline in gross profit margin was primarily related to the unwinding of pricing premiums as certain components became more available. Farnell continues to be the highest margin within Avnet and their operating income margin continues to be two times greater than Avnet’s overall operating income margin. We expect Farnell operating margins to remain at similar levels for the second half of fiscal 2023 as seasonal sales growth will be offset by the continued unwinding of pricing premiums on certain components. Turning to expenses and gains below operating income.

Second quarter interest expense of $59 million increased by $37 million year-over-year and $14 million quarter-over-quarter primarily due to a combination of increases in interest rates and higher borrowing amounts to support working capital increases. This increase in interest expense negatively impacted adjusted diluted earnings per share by $0.31 year-over-year. During the second quarter, we entered into legal settlements, which resulted in a one-time gain of $62 million. This gain benefited second quarter GAAP earnings per share by $0.51. Our adjusted effective income tax rate was 23.6% in the quarter. Adjusted diluted earnings per share were $2 for the quarter, which increased 32% year-over-year and were flat quarter-over-quarter. Turning to the balance sheet and liquidity.

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During the quarter, working capital increased by $876 million including a $318 million increase in inventories. As a result of this working capital increase, working capital days was 84 days for the quarter which increased 11 days quarter-over-quarter. Our inventory days increased by approximately six days and our receivable days increased by approximately four days quarter-over-quarter. Our return on working capital continues to be higher than our cost of capital and improved over 100 basis points year-over-year. Our inventories grew during the quarter due to a combination of factors, including customers requesting delays of product shipments changes in foreign currency exchange rates compared to last quarter and an increase in Farnell inventories, as components became more readily available.

We have seen an increasing trend of customers rescheduling product shipments as they manage their inventory, production timing and cash flow challenges. This contributed to the increase in days of inventory, as turns slowed during the quarter. The quality and freshness of our inventory continues to improve year-over-year. During the second quarter we also saw a slowdown in the collection of receivables. Our team continues to work diligently with customers to collect past due receivables and effectively manage bad debt risks. Our team has done a tremendous job since the onset of the pandemic in minimizing bad debts by proactively managing the credit and collection activities with our customers. While we continue to focus on improving inventory turns our top priority is to ensure we are managing overall customer risks appropriately.

The increase in working capital led to an increase in debt of approximately $850 million and a corresponding $321 million use of cash from operations. The increase in debt led to a gross leverage of 2.4 times at the end of the quarter. At quarter end, we had approximately $300 million of available borrowing capacity and our teams continue to work on selling inventory on hand and collecting receivables to provide additional liquidity. In the second quarter, we repurchased approximately $64 million worth of shares, which represented nearly 2% of shares outstanding. We have $319 million left on our current share repurchase authorization entering the third quarter. We continue to prioritize our existing business needs including working capital and capital expenditures when we evaluate share repurchases.

During the second quarter, cash used for investing activities including capital expenditures was $107 million or an increase of approximately $90 million quarter-over-quarter, primarily to support a new warehouse being built in EMEA. During the quarter, we also paid our quarterly dividend of $0.29 per share or $26 million. Book value per share improved to approximately $48 per share or an increase of approximately $6 per share due to a combination of strong earnings, lower share count and changes in foreign currency exchange rates compared to last quarter. Turning to guidance, for the third quarter of fiscal 2023, we are guiding sales in the range of $6.15 billion to $6.45 billion and adjusted diluted earnings per share in the range of $1.75 to $1.85.

Our third quarter guidance is based on current market conditions and implies a sequential sales decline of 4% to 8%. This guidance assumes a seasonal decline in sales from Asia, primarily due to the Lunar New Year and below seasonal sales growth for the Western regions. This guidance assumes similar interest expense compared to the second quarter an effective tax rate of between 22% and 26% and 92.5 million outstanding shares on a diluted basis. In closing, I want to thank our team for delivering another strong quarter of sales and earnings growth. During calendar year 2022 we delivered sales of over $26 billion and adjusted diluted earnings per share of over $8. Avnet’s diversification of suppliers, products and the end markets we serve are key differentiators that will enable us to be resilient, despite uncertain and challenging market conditions.

With that, I will turn it back over to the operator to open it up for Q&A. Operator?

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Q&A Session

Operator: Thank you. Ladies and gentlemen, we’ll now be conducting a question-and-answer session. Thank you. Our first question is from Melissa Fairbanks with Raymond James. Please proceed with your question.

Melissa Fairbanks: Hi guys. Thanks very much. Great work navigating kind of uncertain times today. It’s really great to see these results and the outlook. You did mention that lead times are improving for a lot of the products. Last quarter you gave us some detail on to which products still had the longest lead times. I was wondering if you could maybe give us a little bit more detail on that.

Phil Gallagher: Sure Melissa. This is Phil and thanks for your compliment there. Appreciate that. So yeah, I know this is a hot one, right? So yeah, we did say that we’re seeing some modest improvement right, maybe a little bit better than modest. But at the end of the day lead-times they’ve stabilized in the vast majority of the products but are still at levels 20% to 60% higher than pre-pandemic, okay? So, while some products are coming in products like MCU particularly in automotive analog power, IGBTs, MOSFETs, 45-nanometer, FPGA programmable logic are still in many cases significantly constrained. So, that’s what makes this market so much more complex than what we’ve maybe experienced in the past. And IP&E and passives ceramics 12 to 18 weeks, some cases 26 to 32.

are still 26 to 56 weeks. Resistors like thick films still 52 to 72 week lead-times. So, it’s kind of a mixed bag. The connector guys overall, again as a general statement are probably the lowest of all the categories in interconnect. They’re probably averaging 13 to 16 weeks depending again on the type of connector products. So, I was just summing up, high-end controllers, anything around power, op amps, voltage regs, things along those lines are still pretty tight as well as I said automotive. But — yes — no — so, probably cleared as much for you, right? But it’s kind of — it’s still a little bit all over the map.

Melissa Fairbanks: No, that’s actually really helpful. Absolutely. Yes, I really appreciate the detail. Maybe one for Ken on the growth in inventory. This is something that obviously everyone is paying really close attention to. You highlighted a few different factors behind the growth this quarter. And I think it’s fairly well understood what’s driving it. But can you maybe quantify was the majority of it due to Farnell? Was the — what was the kind of breakdown the contribution there?

Ken Jacobson: Yes, I would say about 50% was actually driven by FX that we did have some challenges there. Farnell is about another let’s say 25% of that and then the rest was call it just slower turns and those types of things. But I will comment that the FX impact kind of offsets what was last quarter so it would be kind of a wash over the past two quarters the FX has kind of normalized. So, clearly just some broader growth in the regional inventories this quarter mostly in the West versus last quarter it was mostly Asia.

Melissa Fairbanks: Okay, great. Thank you very much guys. That’s all from me now.

Phil Gallagher: Thanks Melissa.

Operator: Thank you. Our next question is from Ruplu Bhattacharya with Bank of America. Please proceed with your question.

Ruplu Bhattacharya: Hi, thanks for taking my questions. I was wondering if you can delve a little bit deeper into the margin performance for each of the segments. So, in components on flat sequential revenue, you had 50 basis points of margin improvement. Is there any way that you can parse out how much of that was because of pricing versus say volume versus mix versus FX? And how should we think about the sustainable level of margins in the component segment? And same question for Farnell, I mean 300 basis points sequential decline any way to parse that out between all of these factors?

Phil Gallagher: Yes, I’ll go first and let Ken jump in. You kind of answered the first part of that question Ruplu. A lot of that is mix, okay? Regional mix. Very little on ASP inflation this quarter although we had a lot of supplier price increases that would not really affect the margin necessarily maybe some of the dollars, but not the percent in the margin. But most of it is the mix. We noted that we said that we saw some softening coming out of Asia at the end of the quarter and we had strengthening in the West. And when that happens we pick up some margin. So it’s really just good execution by the team. On Farnell, yes, so, again we’ve signaled this as well. They get some appreciation in a upmarket or a more constrained market so they get some let’s call it a natural upside.

And some of that as products are coming into — back to the question we just got from Melissa where some lead times are starting to come in the more the — some of those customers they get I’ll call it nontraditionally come back into the volume space. So, they’ve seen some margin pressure and of course some of the volume decline. Thus the negative drop-through. Ken do you want to comment?

Ken Jacobson: Yes. On the components business, I would say it’s regional mix but then we did have a more favorable let’s say product customer mix. If you recall what we said last quarter was because gross margin was down a little bit there. All of our regional businesses had a more favorable mix and then the regional mix between the West versus Asia was the bigger driver there with controlled expenses obviously, right? And then when you get to Farnell, I would say, approximately 50-50 between the sales piece and then the deterioration of the gross profit margin due to the unwinding of the premiums. That’s probably the right way to think about it.

Phil Gallagher: I do want to highlight though Farnell — we’re still extremely pleased with Farnell. Their operating margins are two times the core. So we’re going to continue to be doubling down on the Farnell performance and growth.

Ruplu Bhattacharya: Okay. Thanks for the details there. Phil, you made a comment that Asia is softening. And for the next quarter you’re guiding below seasonal growth in the West. So, can you maybe touch a little bit deeper into that like which end markets or which verticals are softer now and in Asia versus in the West? And how do you see that progressing as you go through the year?

Phil Gallagher: Yes. So, tough to call throughout the year. So I want to be careful on that one, because the market fluctuates so much. But right now, look, as we’ve already talked about there’s a bit of inventory oversupply right in Asia-Pac in general, okay? And Ken just talked about we had some inventory increase last quarter there. Except in the automotive, automotive is still strong. Matter of fact automotive and industrial, we’ve got great momentum in Asia-Pac. It’s really the end consumer, the applications, your PC, mobile, they continue to look pretty weak. And then you got to remember the — just a reminder, we’re no more traditional, if you will, whatever that word means anymore with the Lunar New Year, right? So that’s kind of been on and off the last couple of years with COVID.

So we’ve got to see how that affects the market and the volumes of people that come back to work if they come back to work, right, when they go into the Lunar New Year. So we’ve got to watch that. And then, of course we got the unpredictability of the COVID, right? And what’s going to happen that had a negative impact on us as well. But overall, I want to be clear, we’re really pleased with our Asia performance and we believe we’re gaining share. We have a really diverse market in Asia, a lot of times you think Asia everything is China. I mean we’re doing really well in Southeast Asia, the Greater Taiwan. We have a nice business in Japan. So a little bit more diversified outside of just China. But of course we have a good presence in China as well.

So, a bit of a mixed bag. On the West, I can comment on this a little bit. I mean the West — and you’re right, typically we’ll see a sequential increase quarter-on-quarter from December to March. But again, a lot of these are the old traditional curves, if you will from the quarter-to-quarter seasonality, I should say. They’ve all been kind of thrown out the last couple of years. But typically, you do see the West come back. And we’re having a good performance in the West. We just — frankly as we said had pretty much record quarters in Europe. And so they’re just going against a tough compare but the number in Europe is solid for the March quarter we believe as the Americas.