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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