Avnet, Inc. (NASDAQ:AVT) Q3 2024 Earnings Call Transcript

Avnet, Inc. (NASDAQ:AVT) Q3 2024 Earnings Call Transcript May 1, 2024

Avnet, Inc. misses on earnings expectations. Reported EPS is $1.1 EPS, expectations were $1.11. AVT isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to the Avnet Third Quarter Fiscal Year 2024 Earnings 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. I’d like to welcome everyone to the Avnet Third Quarter Fiscal Year 2024 Earnings Conference Call. This morning, Avnet released financial results for the third quarter 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. 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-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 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. 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?

Phil Gallagher: Thank you, Joe, and thank you, everyone, for joining us on our third quarter 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 $5.7 billion and adjusted operating margin of 3.6%, highlighted by a 4.1% operating margin in our Electronic Components business. And we generated nearly $500 million of cash flow from operations. This demonstrates that we can maintain reasonable profit margins even during the challenging cycles we face. As I have mentioned on previous calls, we’ve been working through an inventory correction on a global basis over the past couple of quarters. And while we have made progress in working down our inventory levels, we, like many in the industry, still have 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 second quarter continued in the third quarter. 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&E side, lead times and pricing are generally stable, and we are seeing increasing demand for interconnect products and capacitor families, most notably channel. 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 remained below parity at the end of the third quarter, 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.

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 Avnet to meet their needs. With that, let me turn to the third quarter results. At the top line, our Electronic Components business declined in revenues across all the regions, but I will note that the third quarter of fiscal year ’23 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 decreased 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. In the quarter, our engineering teams continued to engage with our customers and suppliers on the 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 now 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 veterans, EMEA core business leaders, to temporarily assume executive oversight for the Farnell organization. I want to reiterate that Farnell remains a critical part of Avnet’s overall success and value proposition, so stay tuned for upcoming announcements on the Farnell leadership transition. In the third quarter, Farnell’s sales were up sequentially, led by strength in IP&E 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, 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&E, and embedded computing. With our global sales force and our technical capabilities, I believe we have all the right resources to grow the 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. First, current business activity in our Asia region is indicating that we are likely near the bottom and may potentially see some sequential growth as we move through the balance of calendar 2024.

Second, we are seeing a nice pickup in bookings in our IP&E business and at Farnell as well. Finally, the industry sources we follow as well as the customer supplier 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. 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 third quarter results.

Ken Jacobson: Thank you, Phil. Good morning, everyone. We appreciate your interest in Avnet, and for joining our third quarter earnings call. Our sales for the third quarter are approximately $5.7 billion, 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. 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 Components 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 third quarter, gross margin of 11.8% was 62 basis points lower year-over-year but up 46 basis points sequentially. 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 the pricing stability and an improved demand for IP&E products. Turning to operating expenses. Selling, general and administrative expenses were $467 million 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 third quarter. For the third quarter, we reported adjusted operating income of $203 million and our adjusted operating margin was 3.6%. By operating group, Electronic Components operating income was $217 million and EC operating margin was 4.1%. This was the ninth consecutive quarter of EC operating margin being above 4%. Farnell operating income was $16 million 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 million to $70 million. We had completed approximately 2/3 of the reductions as we exited the third quarter.

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 million to $60 million 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. Third quarter interest expense of $73 million increased by $2 million year-over-year and was down approximately $1 million sequentially. Our adjusted effective income tax rate was 24% in the quarter as expected.

Adjusted diluted earnings per share was in line with our expectations of $1.10 for the quarter. Turning to the balance sheet and liquidity. During the quarter, working capital decreased $574 million sequentially, including a decrease in reported inventories of $364 million, $194 million decrease in receivables, and a $16 million increase in payables. Working capital days increased 8 days quarter-over-quarter to 115 days. 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 decline in EC inventories were net of increases in inventory 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 fourth quarter, excluding these strategic arrangements. As Phil has mentioned many times, part of our role at the center of the technology supply chain is to play a 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’s a proper ROI for Avnet in any such arrangements. Our decrease in working capital led to a decrease in debt of $495 million. We generated nearly $500 million of cash from operations in the quarter, and we have generated $650 million of cash from operations over the past 4 quarters.

We expect to generate positive operating cash flow in the fourth quarter, although more modest in this past quarter. We ended the quarter with a gross leverage of 2.5x, and we had approximately $890 million 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 million, primarily to support a new distribution center being constructed in EMEA. We expect CapEx to return to historical levels in the fourth quarter of fiscal 2024 of approximately $25 million to $35 million per quarter. In the third quarter, we paid our quarterly dividend of $0.31 per share or $28 million.

We have $232 million left on our current share repurchase authorization entering the fourth quarter. As a result of our strong cash flow generation, we expect to repurchase Avnet shares in the fourth quarter. Our shares continue to trade at a meaningful discount to book value as book value was $55 a share for the third quarter. Turning to guidance. For the fourth quarter of fiscal 2024, we are guiding sales in the range of $5.2 billion to $5.5 billion, and diluted earnings per share in the range of $0.90 to $1. Our fourth quarter 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 region and below seasonal growth in sales in Asia.

This guidance assumes similar interest expense compared to the third quarter, an effective tax rate of between 22% and 26%, and 91 million shares outstanding on a diluted basis. 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?

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Q&A Session

Operator: [Operator Instructions] Our first question is from Matt Sheerin with Stifel.

Matt Sheerin : 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 EMEA. And do you expect — do you think that’s sort of the last drawdown, if you will, in terms of inventory? 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?

Phil Gallagher: Coming down. Could you hear me?

Matt Sheerin : Yes, I didn’t hear you the first part, Phil.

Phil Gallagher: Okay, let me start again. That’s fine. So thanks, Matt. Appreciate it. I said I’d start with Asia. As we said in the script, we do believe we’ve hit 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 time to sign start in Asia and circle around to the West and then kind of where you’re going, I think. In Europe, I mean, part of the challenge in Europe with the year-on-year drop is we just — we’re coming off record highs, so it’s compounding the image, if you will. But tough to call if that’s the bottom. It feels like it might be, Matt, but there are 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.

Matt Sheerin : Okay. And then on the cost cutting, I think you said it was a $40 million annual run rate. When should we think about those costs coming out? Will it start in the June quarter? And what should we think about OpEx sequentially? Will that be down or will that be up?

Ken Jacobson: 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 ’25 kind of benefit. And think about OpEx being down next quarter slightly due to the Farnell actions plus the volume decline.

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

Ken Jacobson: 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 to up slightly in the EC business.

Operator: Our next question is from Joe Quatrochi with Wells Fargo.

Joe Quatrochi : Maybe just on that on the EC 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?

Ken Jacobson: Yes, Joe, I guess I’d characterize it as it could be slightly below, it could be slightly above the 4%, right? It’s kind of within that range. So depends on how the regional mix shakes out ultimately. But it’s — the guidance implies it right around the 4%, but could be slightly below, could be slightly above.

Joe Quatrochi : Okay. And then as 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 any change really in how you think about the trajectory of inventory reductions to the base of this year?

Ken Jacobson: 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 in the last couple of quarters. So feel good about the direction we’re headed. Still a lot of work to do is how I’d characterize it. So think about it through the remainder of the calendar year, still knocking away at that because the sales levels are down as well.

Operator: Our next question is from William Stein with Truist Securities.

William Stein : First, I’m hoping you can comment on order trends in the first 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.

Phil Gallagher: Yes, I’ll take that, Will. Thanks. Yes, the order — the book-to-bills had improved but 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&E, and even within the IP&E, it’s probably more — it’s connectors and [indiscernible] is balanced. So we are seeing some recovery in book-to-bill. The real issue is with the lead times down and the inventory out there, we’re just trying to get customers to give us a pipeline and more visibility is key. And of course, we’re the middle guy to help the suppliers get the visibility that they’re looking for, and that’s still just not happening on a wholesale basis, if you will. But that’s what we’re working on. But it has slightly improved beginning this quarter versus last quarter.

William Stein : 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. 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 upticking. I wonder if — is this because they sort of all pipelined material for EVs demand for that material so they’ve got to go place a bunch of new orders for internal combustion and hybrids? Or is there some other dynamic? Like is it an inventory mismatch or did they just take inventory too low? However you might help us understand, this would be really helpful.