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

Welcome to the Avnet's First Quarter Fiscal Year 2023 Earnings Conference Call. I would now like to turn the floor over to Joe Burke, Vice President of Treasury and Investor Relations for Avnet.

Thank you, Paul. Earlier this afternoon, Avnet released financial results for the first quarter of 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 statements 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?

Thank you, Joe, and thank you, everyone, for joining us on our first quarter fiscal year 2023 earnings conference call. In the prior fiscal year, we delivered record results and continued to take strategic steps to position Avnet as a more durable company with an increasingly critical role in the global technology supply chain. We are well positioned to continue to deliver value to our customers, suppliers and shareholders, even in the face of a more challenging and uncertain operating environment. I am pleased to share that we kicked off the fiscal year with another quarter of solid financial results, including meaningful sales growth across all regions and improved profitability year-over-year. 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 achieved sales of $6.8 billion. This exceeded the higher end of our guidance, up 6% sequentially and over 20% year-over-year. On a constant currency basis, sales increased nearly 29% year-over-year. Efficient management of our operations also enabled us to drive solid operating margins of 4.3%, which is the third consecutive quarter of greater than 4% operating margin. Further, the combination of a solid sales and effective management of operations allowed us to increase operating income 3x greater than revenues on a year-over-year basis. A significant driver of our results in the quarter was, of course, the continued execution by our incredible global team. Our team has effectively managed market complexities, and has served as great partners to our customers and suppliers as they faced fast-changing supply chain conditions and uncertainties. We are more deeply engaged with our customers and suppliers than ever before, which enables us to maintain the necessary expertise and capabilities to help them navigate today's supply chain complexities. And with the structural and organizational changes we've made to our business over the last 2 years, we are well positioned to continue serving as a control tower for our customers and suppliers. In the quarter, demand remained strong globally and in key vertical segments like transportation, industrial and aerospace and defense, and we have continued to invest in inventory to meet this demand. You will see that inventory levels were higher at the end of the first quarter as compared to the prior quarter, which Ken will speak to you further in his commentary. This reflects our need to support sustained sales levels in Asia and quarterly increases for specific supply chain engagements. Overall, we continue to be very comfortable with our days of inventory heading into our second quarter. With that, let me turn to the highlights for our business. At the top line, our Electronic Components business saw a sequential and year-over-year growth across all 3 regions. In constant currency, Electronic Components sales were up nearly 9% sequentially and up over 31% year-over-year, reaching $6.3 billion in the quarter. These results were primarily driven by another record quarter of sales in Asia and consistent strong sales growth in both the Americas and EMEA regions. Increased sales in Asia were driven primarily by growth in the transportation and industrial markets. The team in Asia was also successfully gaining share in the region, leading to record quarter billings. The Americas and EMEA regions both benefited from strength in key verticals, notably industrial, transportation and aerospace and defense. We are very pleased with the growth in these markets as highlighted at our Investor Day in June. This is proof that we are well diversified across the end markets we serve and reinforces our expectation that these end markets will continue to have positive long-term growth prospects. Further, our enhanced focus on growing key supplier relationships and addressing their supply chain needs continues to bring benefits across all of our regions. We continue to coordinate closely with customers and suppliers to effectively manage our backlog. As a result of those actions, our overall book-to-bill ratio continued to moderate as was near parity leading into our second quarter. We continue to benefit from our unique engineering capabilities with our field application engineers and digital design tools, resulting in another record revenue quarter for demand creation. We believe this continued strength is indicative of the increasing value of the capabilities we provide to customers and suppliers, and is important to supporting our margins in a more uncertain operating environment. Turning to our Farnell business. Farnell sales and profitability were impacted by currency fluctuations, particularly weakness in the British pound, and ongoing component shortages that are affecting Farnell's ability to fully meet demand for single-board computers. Even with that, the backlog for single-board computers remains robust, and we expect to realize such sales when product becomes available. Additionally, Farnell recently became the exclusive licensed distributor of the Raspberry Pi single board computer. We are really excited about this development, which will increase our market share and favorably impact Farnell's revenue in the midterm. Operating margins for Farnell were above 12% during the quarter, impacted by a weakening of the British count. We expect currency fluctuations to have a continued impact on Farnell into the second quarter. We remain excited about Farnell and continue to see opportunity to leverage Farnell's and Electronic Components' unique and synergistic collaboration to better serve our Avnet customers. To conclude, I want to reiterate that we are a stronger and much more durable company today due to the changes we've made to our business. And I believe our recent trends and results reflect that. While we cannot control the overall market, I am confident in our team's ability to execute in a challenging and uncertain environment and continue to deliver value to our supplier and customer partners. There's never been a greater need for the capabilities that Advent has, and we look forward to continuing to play a critical role at the center of the technology supply chain. With that, I'll turn it over to Ken to dive deeper into our first quarter results.

Thank you, Phil. Good afternoon, everyone, and thank you for participating on today's call. As Phil mentioned, we are very pleased with our first quarter performance. Our team's continued execution resulted in significant sales and operating income growth with excellent returns and we are encouraged by the great start to fiscal year 2023. In the first quarter, our sales were $6.8 billion, up 21% year-over-year, well exceeding the top end of our guidance range. Sales growth in constant currency was 29% year-over-year with each region contributing to the growth. We also grew sales 6% quarter-over-quarter or over 8% in constant currency, which was well above our typical seasonal trend. We had strong sales in the first quarter across all of our regions, led by our Asia team, which delivered a record $2.9 billion of sales. On a year-over-year basis, sales grew 33% in the Americas, 42% in Europe in constant currency, and 18% in Asia in constant currency. From an operating group perspective, Electronic Components sales grew 23% year-over-year or 31% in constant currency. Electronic Components sales grew 7% quarter-over-quarter or 9% in constant currency. Farnell's sales declined 6% year-over-year, but grew 2% in constant currency. Farnell's sales continue to be negatively impacted by the continued shortage of certain components needed to complete single-board computers. Excluding sales of certain single-board computers, Farnell sales grew 7% year-over-year. For the first quarter, gross margin of 11.4% was down 85 basis points quarter-over-quarter. This decline was primarily driven by higher Asia regional sales mix and from declines in gross margin due to product and customer mix. We continue to maintain discipline around expenses in the quarter as adjusted operating expenses were $475 million for the quarter, down 4% sequentially and down 1% year-over-year. Adjusted operating expense, this as a percentage of gross profit dollars, was less than 62% in the first quarter, which is the lowest it has been over the past several years. Adjusted operating income of $293 million increased 64% year-over-year and grew 3x greater than sales, demonstrating our ability to continue to drive operating leverage as we grow our business. Our adjusted operating income margin was 4.4% in the first quarter, which is the third consecutive quarter with greater than 4% operating income margin. Electronic Components operating income was $267 million, up 65% year-over-year. Electronic Components operating income margin was 4.2%, up over 100 basis points year-over-year. Most notably, our Americas business continued to make progress towards our operating margin improvement goals. This is the eighth consecutive quarter of Americas' year-over-year operating margin improvements, and we are encouraged by the momentum our Americas team has coming into the December quarter. Farnell operating income was $52 million, up 4% year-over-year despite the 6% decline in sales. Farnell operating income margin was 12.1% in the quarter, up over 120 basis points year-over-year. The quarter-over-quarter decline in Farnell operating income margin was primarily driven by a combination of lower sales and a lower gross margin because of the foreign currency impact on Farnell's pricing and related gross margin. Turning to expenses below operating income. Interest expense of $45 million in the first quarter increased by [ $15 ] million quarter-over-quarter primarily due to higher debt balances to support working capital investments and from rising interest rates. This increase in interest expense negatively impacted adjusted diluted earnings per share by $0.12 quarter-over-quarter. Our effective income tax rate was 23% in the quarter as expected. Adjusted diluted earnings per share was $2 for the quarter, which increased 64% year-over-year. Turning to the balance sheet and liquidity. During the quarter, we invested in working capital to support our sales growth, resulting in approximately $700 million increase quarter-over-quarter. Of this working capital increase, approximately $300 million came from additional receivables and approximately $400 million came from additional inventories. With respect to our inventory, we are comfortable with the quality and age of our inventory. The increase in inventory was driven by several factors, including support for sustained sales levels in Asia and an approximately $120 million increase specific to a single supply chain engagement that came in at the end of the quarter. We expect the inventory related to this specific engagement to ship early in the quarter. Additionally, we continue to work with our customers and suppliers to come to mutually beneficial solutions as certain customers have higher levels of inventory as they wait for the golden screw components. As a result of this working capital increase, working capital days was 73 days for the quarter, which is within our acceptable range of working capital days. Our returns on working capital continue to be significantly higher than our cost of capital. The increases in working capital led to an increase in debt of approximately $700 million and a corresponding $650 million use of cash from operations. The increase in debt led to a gross leverage of 1.9x at the end of the quarter, still well within our required leverage ratios. At the end of the quarter, we had approximately $600 million of available borrowing capacity, and we expect to generate positive operating cash flows in our second quarter because of seasonal declines in sales from our Western regions. In our first quarter, we purchased approximately $150 million worth of shares, which represented nearly 4% of outstanding shares. Over the last 2 quarters, we've retired approximately 6% of outstanding shares. There's $383 million left on our current share repurchase authorization entering the second quarter. We expect to continue to buy back shares at similar levels during the second quarter as our shares continue to trade at a meaningful discount to book value and at a lower multiple than our shares have historically traded at. During the quarter, we also increased our quarterly dividend to $0.29 per share, an over 11% increase from the prior quarterly dividend. During fiscal 2023, we expect our capital expenditures to increase primarily to support a new warehouse in Europe. Turning to guidance. For the second quarter of fiscal 2023, we are guiding sales in the range of $6.35 billion to $6.65 billion and adjusted diluted EPS in the range of $1.80 to $1.90. Our second quarter guidance today is based on current market conditions, including a $60 million negative impact on our sales guidance at the midpoint from the recent strengthening of the U.S. dollar as compared to the first quarter. This guidance implies a sequential sales decline of down 1% to down 5% in constant currency and assumes a typical seasonal decline in sales in our Western regions as those regions have fewer shipping days compared to last quarter because of the holidays. This guidance assumes similar interest expense to the first quarter, an effective tax rate of between 21% and 25%, and 94 million outstanding shares on a diluted basis. In closing, I want to thank our team for delivering another quarter of sales and earnings growth. We believe that we are well positioned to continue to gain market share in the future. Avnet's diversification of suppliers, products and the end markets we serve are key differentiators that will enable us to continue to deliver positive financial results despite uncertain and changing market conditions. With that, I will turn it back over to the operator to open it up for Q&A. Operator?

[Operator Instructions] Our first question comes from Melissa Fairbanks with Raymond James.

Congratulations on a great quarter and guide. Really refreshing to see amid all this uncertainty. I was just wondering for modeling purposes, OpEx was at kind of a record low as a percentage of sales. Just wondering, going forward, how sustainable that is? If OpEx needs to kind of trend higher as we go forward or can we expect to see this kind of operating leverage in the model?

Melissa, this is Ken. I would say, in general, the absolute level of OpEx did -- it would sustain around the same levels. If sales continue to decline, we have some levers on the overall OpEx side. But we feel pretty good about the absolute number of OpEx. Now depending on the level of sales, the percentage of GP might change a little bit. But we feel pretty good of the [ recent ] OpEx we had this last quarter and that can be sustainable into the fiscal year.

Okay. Great. Great. And maybe just one quick follow-up. I imagine you're probably going to get a lot of questions on the inventory balance. I'm just wondering, is there any risk to the inventory due to price inflation? Meaning as you've been able to accumulate the inventory as some of these supply constraints ease, is there any risk going forward as we get into maybe some normalization of pricing next year that the value of inventory is overstated?

Yes. I would say we don't see a huge risk there. We do have some price protections on lowering prices if it happens to come from the suppliers. But at the same time, we have commitments from our customers and we work through the inventory levels, but we don't see a huge risk in terms of taking inventory losses and things like that because of pricing.

Melissa, I apologize for my voice on the call. Everybody is fighting some allergies here. But we're well within our range for inventory and the returns we model around the inventory. And that's important. So I'll get ahead of the next question. The quality of inventory is extremely good. Our reserves are well in line and the aging inventory is not increasing. So it's relatively current.

Our next question is from Matt Sheerin with Stifel.

Phil, just trying to get your perspective on the outlook. It looks like you're down a little bit seasonally. Your book-to-bill is finally at parity after how many quarters of very positive. Some of the suppliers, the semiconductor suppliers and other component suppliers are modeling or at least looking more cautiously to Q4. Texas Instruments last night, guided down double digits. Other component suppliers are starting to see some inventory correction going on at customers. It doesn't sound like you're seeing that in a big way yet. Is it that you're lagging the cycle? Or are there still those hard to get parts where customers are still dealing with that imbalance and they're not going to start cutting their inventory until that straightens out?

Yes. It's probably the $64,000 question, Matt, thanks. Well, look, we're -- given the outlook as we see it today, with our backlog today, and the next 3- to 6-month backlog, and it is a straight roll-up from the regions. We're not pressing them. We're not pushing them. It's the number we feel that we can hit at this point in time. And if you look -- and we called out intentionally in the industrial, defense aero, transportation, as we see it today, those still look pretty solid. We're not as exposed in the consumer and some of the compute even, okay, that others are. So the other thing, Matt, that -- believe me is we're watching the backlog. I'm pleased the book-to-bills are coming down. We're helping to drive some of that because we -- you and I both know that's not realistic what's kind of been going on here in the last 12 to 24 months. We're not seeing as of yet the cancellations as much. We're seeing some pushouts and we're managing our customers' backlog with them if they can't get the golden screw and all that kind of stuff. But we're not seeing them want to remove it off the books. So we're driving, frankly for some of that, okay, because we want to make sure it's real. In the next 3 months or so, this is the outlook we see based on the roll-up of the teams.

Okay. And then on the gross margin, I understand why that was down sequentially because of the mix. Looking forward, as you said, North America and Europe have fewer selling days. So would you expect gross margin to remain at these levels and be down, I guess, meaningfully year-over-year? Or is there some pricing power? Or are the reasons why gross margin could be higher?

Yes, Matt, I would say flattish, but we're still going to have a higher mix of Asia in our second quarter due to the holidays, but that gets offset by a better product and customer mix than we had this quarter to kind of offset some of that impact. So flattish is probably the right way to think about it. And then when you get into the third and fourth quarters, you'd have a higher mix of West, you get some of that margin back on a gross margin perspective.

Okay. And just lastly, on the SG&A, it was noted that it was down year-on-year. How much of that is related to FX and the natural hedge that you have in regions like the U.K. and Europe, where the currency is basically a favorable swing for you on the OpEx side?

Yes. From a currency perspective, somewhere between $35 million and $40 million, Matt, was the benefit, I guess, we got with overall OpEx as a -- from a reported perspective.

On a year-over-year basis?

Year-over-year basis, yes.

Our next question comes from Jim Suva with Citigroup.

A quick question on your operating margins. Given the state, I think Phil mentioned there's a few pushouts, but nothing material to keep an eye on that as far as cancellations and such. What about operating margins? Do you think they're kind of sustainable at these levels? Because the investor concern out there, of course, is that if ASPs come down and order push-outs and cancellations ratchet up that operating margins could be under pressure. If you could just kind of help address that elephant in the room, that would be great.

Yes. I guess I would say we feel pretty good about the second quarter operating margin still being above 4%. It's implied in the guidance. As you look out, clearly, there would be an impact on our operating margins if we have a deterioration in sales or a meaningful deterioration. So that's a given. I think when we think about it, we feel really good in the mid- to long term that we can sustain that level of margins. And so there might be some temporary declines as those market factors come through the model. But in general, we feel good about our OpEx levels. We feel good about some opportunities like demand creation, supply chain services, IP&E that can help still give us some positives on the gross margin, but clearly, we would lose some in the -- say if the sales go down meaningfully.

Great. And a quick follow-up. Interest expense outlook, a little bit more on that, and does it include a planned November increase by the Fed, just so we can kind of think about that?

Yes. I would say it contemplates a potential increase there and we're looking at kind of flattish from the first quarter.

Congratulations.