Greetings and welcome to the Avnet First Quarter Fiscal Year 2024 Earnings Call. At this time all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Joe Burke, Vice President of Investor Relations. Thank you, Joe. You may begin.

Thank you, Paul. I’d like to welcome everyone to the Avnet first quarter fiscal year 2024 earnings conference call. This afternoon, Avnet released financial results for the first 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 in advance 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. 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 2024 earnings conference call. Before we get into the quarter, I want to take a moment and remark on recent events in the Middle East in general and specifically, our operations in Israel. Our thoughts and prayers are with our employees and all those in the region affected by recent events. We hope this devastating conflict will be resolved as soon as possible. As of this date, all of our employees in Israel are safe and accounted for, and we continue to service our customers to the greatest extent possible under these circumstances. Moving on to our results. I’ll start with a reminder that in fiscal year 2023, we delivered double-digit sales growth in constant currency, record earnings per share and ended the year with a strong balance sheet and great momentum. I’m pleased to share that we kicked off the new fiscal year with another quarter of solid financial results, continuing that momentum and underscoring our strength and resiliency in the current market environment. In the quarter, we achieved sales of more than $6.3 billion. This was above the midpoint of our guidance, down 3% sequentially and down 6% year-over-year. Continued efficient management of our operations enabled us to drive solid operating margins of 4.1%, highlighted by a 4.6% operating margin in our Electronic Components business. Our team continues to compete well in this market by working with our customers to provide the flexibility they need to manage their component supply chains and by working with our suppliers to provide visibility to end-customer demand and the impact to our customers’ current inventory levels have or near-term demand. In the quarter, demand was mixed across our diverse verticals. Transportation remains strongest, while demand in…

Thank you, Phil, and good afternoon, everyone. Thanks for joining our earnings call. As Phil mentioned, we had a solid start to 2024. Our sales for the first quarter were approximately $6.3 billion, down 6% year-over-year and in line with guidance. On a sequential basis, sales were down 3% in constant currency. From a regional perspective, sales from the Western regions were 61% of sales in the first quarter compared to 64% last quarter and 56% in the year ago quarter. The sequential decline was expected due to seasonal mix shifts from the Western regions to Asia in the first half of each fiscal year. From an operating group perspective, Electronic Components sales declined 7% year-over-year and 8% in constant currency. Sales declined 3% quarter-over-quarter in constant currency. Farnell sales declined 1% year-over-year and 4% in constant currency. Farnell sales were 5% lower sequentially in constant currency. Excluding sales of single-board computers, Farnell sales declined 8% year-over-year and 7% quarter-over-quarter in constant currency. For the first quarter, gross margin of 11.8% improved 43 basis points year-over-year and was 67 basis points lower quarter-over-quarter. EC gross margin improved year-over-year primarily due to a greater mix of sales from our Western regions. EC gross margin declined sequentially primarily due to a seasonal mix shift to Asia. Farnell gross margin was down year-over-year largely due to the unwinding of pricing premiums and unfavorable sales mix and from competitive pricing pressures. Farnell gross margin was down sequentially primarily due to an unfavorable sales mix and from competitive pricing pressures for on-the-board components. Turning to operating expenses. We continue to focus on controlling and reducing costs in specific areas, but we aren’t currently planning any broad-based cost-reduction actions while we navigate through this market correction. We want to build on the momentum we created over…

Thank you. [Operator Instructions] Our first question is from Melissa Fairbanks with Raymond James. Please proceed with your question.

Hi guys, thanks so much. Great quarter. Congratulations on another great quarter in a little bit of a challenging time. I was wondering if we could dig in on the strategic investment in inventory that you made. Are you able to give us a little more color on maybe is that targeting a specific end market or specific customer sets or just kind of understand what’s going on there?

Yes. Melissa, it’s Phil. And by the way, thanks for the comments. Appreciate that. It’s really for specific – it’s a specific supplier with a handful of customers, okay? And so it’s very limited. And I think it’s important. That’s why we noted on the last call to let everybody know, hey we planned this, we know about this. And we don’t do that without all the ROIC measures in place and be sure it’s good for Avnet and good for the customer, good for the supplier. So it’s very specific in nature.

Okay. Great. Is it safe to assume that that’s already in the backlog, whatever that level of fulfillment is going to be?

Yes. Yes, this was not – that’s actually a great question. Because it wasn’t a broad-based, say, go bring in inventory and go try to find homes. It’s brought it in, it has specific homes.

Great, great. Thanks. And then maybe just one kind of quick – I don’t know if this is a quick answer, but maybe discuss some of the actions that you’re taking at Farnell. You mentioned return to high single-digit operating margin within the near term. Just wondering if you could give a little bit more detail on – is near term by fiscal year-end? Or what should we be thinking there?

Yes. I mean, I think specific to some of the cost actions; it’s a combination of factors. I think it’s things like optimized freight, looking at warehouse footprint as well as some people actions, right? But it’s trying to look at where we have some areas for improvement that we’ve been planning for a couple of quarters, but hadn’t really pulled the trigger and now need to accelerate some of those things. There’s also opportunities in terms of new supplier lines and shared strategic customers between Avnet and Farnell. And I do think that time line is exiting the fiscal year in that mid- to high-single digits is the expectation.

Okay, great. Thanks so much. That’s all for me now.

Thanks, Melissa.

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

Hi, thank you for taking my questions. Phil, I want to start with a higher-level question. I think I heard you say that the industry inventory correction, you think it will take till the middle of next year. And so I guess my question would be, why is that the right time frame? Why not earlier or later? What are some of the things that are leading you to think that it will be till the middle of next year? And what can drive that – what can help in that process? Like what are some of the factors that go into that?

Yes. Thanks, Ruplu. Well, it’s our best estimate on how – by what we’re seeing in lead times, combined with our backlog and the book-to-bills. So there’s a lot that goes into that, not to mention our own analytics that we put to the historical versus future. So that’s just what we’re seeing today, Ruplu. Hey, it could be sooner, I mean, no question. I just didn’t think we need to be overly bullish there. I think as we’re seeing the market softening a bit, the book-to-bills have been below parity for a while, which again, I think is fine at this point because we want to get that backlog right. So we’re making the adjustments in the backlog. But that’s just what we see. And based on those factors I shared and the different verticals that we study, I think the good news is, we’re so diversified that we’re not any too over – or top-heavy on any one vertical, which I think helps us give a pretty good view to the market. And as I’ve said before, this is a – in my 47-year that – it’s a different market. I mean there’s so many mixed signals. There’s still some lead times that are out there tied to certain products. There are some verticals and customers still doing really well, others not so well. So it’s definitely a bit of a mixed bag, but that’s just how we see it. We don’t press them with our regions. We get the roll up in the forecast and do a rolling four quarter, and that’s about what we see.

Okay. Thanks for details there. If I can ask you a question on margins. I think overall, you’ve said that as long as revenues can stay above $6 billion, then the operating margin for the company can stay above 4%. When you look at the operating environment today, I think you said that you saw unwinding of pricing premiums at Farnell and you saw some competitive pricing there. Are you also seeing competitive pricing in the core business? And does that range still hold valid that as long as revenues are above $6 billion [ph] above 4%. Can you just give us your thoughts on that?

Yes. Let me touch on the first part with Farnell, and I’ll let Ken touch on the $6 billion or 4% EC. The difference there in Farnell versus what we’re seeing in the core – and we’ve talked about this over the last several years. The catalog guys, in general, get an unnatural lift in tight times or extended lead times, where they’ll get premium pricing as well as nontraditional customers kind of swooping in large volumes and they get the lift in both margin and in revenue. So when we say the unwinding and the pricing pressure there, some of those customers have gone away. And the margins have come just normalizing, particularly in semiconductor and IP&E, okay? Right now, as we look at and we talked about in the script, we’re not seeing as much of that ASP pricing pressure on the component side on EC. And we’ve said that before, we don’t believe we’re going to see the pressures or deflationary pricing. It’s always competitive, Ruplu. In commodity standard products, it’s always up and down. I’m just talking as an overall view. That’s our take. I’ll let Ken comment on the $6 billion and 4%.

Yes. I think the guidance obviously is above $6 billion. And I think the 4% is really, if you dial it back to a couple of quarters ago, it was really an EC-focused kind of commentary. Clearly, with Farnell being down, let’s say, from 8% to 4% caused some pressure on the overall corporation margin. But I think the EC is very healthy implied in the guidance. And remember, when we get into the March and June quarters, we go into our seasonal mix shift where we get a little bit more out of the West and less from Asia. And the only other comment I would give is, I think we are seeing like in Asia, for example, we’d expect in the first half of FY 2024 – first half calendar 2024 to kind of start to think about year-over-year growth because of how early Asia started to seeing some of the softness.

Okay, okay. I appreciate the details there. If I can sneak one more in. Once the warehouse in Europe is done, and I think this quarter, you said that inventories, you had expected it to be up because of certain – because of a specific program. So then how should we think about the cash conversion cycle and free cash flow over the next couple of quarters. Any thoughts on that? And will your CapEx be coming down year-on-year next year, because you already have – you’ll have that warehouse already factored in? Thank you.

Yes. I think you’ll see another quarter – next quarter should be another elevated quarter of cash – of CapEx similar to this past quarter as that warehouse gets constructed. And then you start to see it taper off in the first half of 2024, I guess, similar to what I would say at historical levels. From a free cash flow standpoint, as Phil said, going to be challenging on the inventory side to really work it down over the next couple of quarters. So we’d expect cash flow from our earnings and some collection of receivables from the sales decline. So we’d expect cash flow over the next couple of quarters – trailing 12-month cash flow, I think I mentioned was about $110 million usage. So, I think there’s another bad quarter falling off of cash flow usage from a year ago. So that’s how I think we should think about it.

Okay, thank you for all the details. Appreciate it.

Thanks, Ruplu.

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

Yes, thanks for taking the questions. I just wanted to kind of understand talking about maybe a cycle correction kind of last until mid-2024. And in the context of kind of maintaining revenue above $6 billion, and that’s kind of the low end of your guide for the December quarter. Are we to take that as you’re kind of viewing things bouncing along the bottom here? Or should we think about the potential of further correction as we get into the first half of next year?

Yes. Thanks, Joe. Good question. I think it’s going to be more bouncing along the bottom. I mean – and Ken, I think it’s just what I just shared, I think with Melissa, maybe with Ruplu, the mixed signals in the market. Again, we are still seeing – as of today, we’re still seeing transportation overall pretty positive. The industrial segment had a few bumps in it. But again, part of the – industrial is so broad. Parts of that customer base is still really good and other parts, a little bit softer. And defense/aero, unfortunately, what’s going on in the world is going to continue to be a pretty strong market for us, and that’s sizable for us in the Americas. So – and sooner or later, I guess the wildcard is China and Asia Pac, right? I mean – so what happens there is that pops back sooner than people think. That could have a greater lift. So right now, we’re just rolling up what we see. We do a rolling forecast with our teams, and what we’re sharing is what we’re getting from them. And looking at the backlog in a 0 to 30, 31 to 90, 91 to 180 day and look at it daily and see what is our backlog today versus a year ago, and it’s telling us that’s about where we’re going to be. And again, you’re going to have the mix shifts, too, Joe. As Ken pointed out, Asia is going to be stronger this quarter. It typically comes back down in the March quarter. So we have a stronger mix in the West. So...

Got it. And then maybe – yes, sure. I appreciate that. Maybe just a question on the Farnell side in terms of the cost actions you’re taking. I think in the past, you had chose to leave the lead facility open or online just given the demand you’re seeing. Is that part of the cost actions of closing that? And then can you revise it is [ph]? Can you remind us of the cost savings related to that?

Yes. No, what we’re talking about is separate from that. What you’re referring to, Joe, would have been bringing up a new warehouse in leads and shutting down the old warehouse. And a lot of that’s behind us, although I’d say some of the – now with that warehouse online, there’s more optimization on the broader warehouse footprint. So it’s maybe more adjacent warehouses, not primary warehouses that provide some of the cost savings. So, I think it was a subcomponent of some of those numbers we talked about before.

Okay, thank you.

Thanks, Joe.

Thank you. Our next question is from Matt Sheerin with Stifel. Please proceed with your question.

Yes. Thank you, and hello everyone. Phil, just another question regarding the inventory that you’re building and the supply chain engagements that you’re talking about for the December quarter. Is that mostly Asia business?

I think, Matt, it depends – this is Ken. It depends on the engagement. Some of its global. A lot of its physically in Asia, but I wouldn’t characterize it as something predominantly Asia. I’d say it’s more global engagements in nature. Although a lot of the global production does happen in Asia, but some of its Americas-based, a little bit EMEA-based. But it’s – I think it’s across the board rather than something Asia-specific.

I fair to say it’s more Americas and Asia than Europe, okay, but it’s not primarily – it’s not [indiscernible].

Okay. That’s helpful. And so this is more of a fulfillment, so lower margin, but good returns. Is that how we think about that?

Yes. And some of its maybe buffer stock, and some of it may be fast-turning. It’s kind of a mixed bag.

But for sure, the returns are there, though, Matt. That’s your point. They are always modeled there.

Yes. And then – and I think you said that inventories will remain elevated in the December quarter. Is that because you expect some of those supply engagements to carry over until March? Or are there other reasons why you wouldn’t start cutting inventory or your portfolio? I would imagine that some of your products with lead times in where you can prune where others you said there was elevated lead time. So I’m trying to figure out why you’re not – you’re talking about more significant cuts to your inventory when a lot of suppliers are basically blaming all the distributors for cutting orders, yet you don’t seem to be doing that.

Yes. Hey Matt, I would say its net new inventory coming in specific for the supply chain engagements as they begin to ramp, and that would be offsetting anything we’re doing organically to get inventories down. So that’s kind of how we’re trying to signal it as there’s net new coming in, not, let’s say, normal course of business but specific to some supply chain engagements that’s been having a flattening effect of overall work we’re doing on inventory in the base business – in the core business.

Yes. It’s complex, Matt. So your questions are right on. And I guess the net-net is we’re confident with the inventory levels. We’ll start to bring them down. But right now, the inventory is fresh, it’s good inventory, it’s not aging. To Ken’s point, the newer stuff is what we’re talking about that’s stopping it from coming down.

Okay, okay. Thank you for that. And I appreciate that the visibility behind Q2 is difficult, but you did talk about this inventory correction taking at least a couple of more quarters. And traditionally, in your March quarter, you’re sequentially up in the Western markets, in North America and in Europe. In past cycles, that hasn’t happened because of some of the issues that you’re facing now. So the question is, how should we think about how the rest of the year plays out to the best that you can tell us?

Yes. Matt, I guess what I’d say is I think we’ll still get a mix shift to the West. Now whether it will be normal seasonality or let’s say, normal pops, I still think that’s to be determined. We still feel confident above $6 billion and we’ll get a little bit of gross margin lift from mix shifts. That’s how I’m seeing. I think a lot of what Phil’s commentary on the mid-2024 is really about inventory levels, right? The inventory is stable. We’re not going to see the inventories really come down meaningfully through that time frame because there’s still plenty of work to do there.

Yes, Matt, we’re not talking about the inventory levels. We’re talking about the market. We think – we track like you do all the inventory levels by EMS, us end markets, et cetera. And that’s our estimate based on current pull and demand at the inventory. The inventories burn off out there, end-customer inventory. To sum it up, we estimate that mid-2024. Could be sooner, like it could come quicker.

Okay. Thank you. And just lastly, relative to the interest expense, which was down sequentially, but still up significantly from where it was a few quarters ago. And I would think that would be one area where you can drive profitability growth as you continue to generate more cash, inventory comes down, you bring down your short-term borrowings. So how should we think about that as a potential driver of profitability over the next few quarters?

Yes. I think, Matt, definitely, as we get back to cash flow generation, paying down debt will be a part of that, especially as sales are down, trying to keep leverage in the same ballpark we’ve had it. But then we’ll try to be more opportunistic on buybacks as well. We think there’ll be enough cash to do both, but got to get back to that generation before we can start to work down the debt and/or increase the buybacks.

Okay, well, sounds good. Thank you very much and best of luck to your baseball team tonight.

Thanks, Matt.

Thank you. Our next question is from Joseph Cardoso with JPMorgan. Please proceed with your question.

Hey, thanks for the question guys. So first one here is just can you provide a bit more color on what you’re seeing out of Asia? Obviously, it was another quarter of softness. But just curious, it sounds like you’re expecting some improvement there. And just wanted to touch on, is that just more of a function of typical seasonality and the easier comps or if you’re actually seeing any green shoots in the region around improvement? And if so, where that is materializing, if you have any color on that?

Yes. Sure, Joe, I’ll go first. And – so thanks for that. Overall, we’re competing well in Asia. We think we’re picking up some share as well. But the – if you look at it Q-on-Q, just looking at the numbers for – the industrial and Asia held up pretty well. It was down year-on-year as we talked about in the script in general, because we had such a record-breaking numbers a year ago. Transportation was up both Q-on-Q and year-on-year. So there’s some signs of positiveness in Asia, and Japan has been good. Japan has been positive for us. So it’s really – there’s no one thing. We just feel that – and Ken, I were just over there and talking to the team and our leader there that feeling that it is going to start to turn a bit. Now, we’re not – it’s very important. We’re not overly exposed to any one vertical, right? And I think that’s really, really important. And we’re not overly exposed to China, right? We do our business in China, but we’re not overexposed. So it gives us maybe a little bit more of a balanced portfolio in the Asia Pac region.

Yes. My only other comment would be our team over there is really competing well in the markets they serve. And so we’re seeing very good progress there in terms of trying to take share.

Got it. That sounds great. And then – and maybe this one is a little bit more random. But just within the automotive transportation business, some folks across the supply chain have just been highlighting headwinds, either in the form of UAW strikes or increased competition in China around some of the new applications being deployed there. Just curious, and it doesn’t sound like it, but are you guys seeing any of those headwinds at all materialize in your business? Or is that largely a noise for you guys? Thanks for the question.

Yes. Well it’s not noise. It – there’s certainly some reality to the competitive nature of what’s going on in automotive. Again, this past quarter, we just did not see that and we still see it pretty positive. The auto strike, we really didn’t see any real effect on that, at least to date. And it sounds like they’re working to resolve some of those. But again, when you look in automotive, in total, it’s just – we’re not overexposed. It’s maybe 15%, 16% of our business is – approximately or something along those lines. So it’s not like 50% or 60%. So even if there is a slight tick down, it’s not going to have a huge effect on us. And we also look at transportation beyond just automotive. It’s got to – we put in that bucket transportation, it’s golf carts, dump trucks, trains, e-bikes, so – which is battery and a lot of that semiconductor. So we kind of broaden that vertical as well.

Got it. Appreciate the colors guy.

Thanks, Joe.

Thank you. Our last question is from William Stein with Truist Securities. Please proceed with your question.

Great, thanks for taking my questions. I want to offer my congratulations and also add on to Matt’s comment. I was surprised to see the Avnet logo on the Diamondbacks. But all good stuff. I have a couple of questions. First – and I apologize if you had touched on this already. But I think you said in automotive or transportation as a strong end market. And I even think you cited industrial, at least in Asia, as a relatively stronger end market. These have been sort of the standout weakening end markets among the semi suppliers as the – as we progress through earnings season early so far, but enough to have said it that it’s been pretty significant misses actually. And I wonder if you’re not seeing the same trends, is this a matter of you think inventory in the channel that you guys – that you’re not ordering as much from the suppliers? Or is it inventory at end customers? Or any clarification on this would be really helpful.

Yes. Let me give a shot at that. Yes, transportation, if you look at globally, was up modestly Q-on-Q and up year-on-year as well for us. And industrial, first of all, it’s really a broad – so it maybe depends on how people define industrial. It’s our largest segment by a long shot. So it’s really a long tail. And if you look at some regions, it’s stronger than others. I think what we said in the script, we called out that it’s moderating though. We definitely see some moderation in industrial. So we did call that out, William, and that we saw it. So we saw a stronger strength in transportation than we did in industrial. And then we called out defense/aero. It was a little softer in September, but we don’t expect that that’s going to continue to be a growth market as well. We separate that out from industrial. But it depends – it just depends on the market – the submarkets within industrial because it’s so broad. And that’s why I keep talking about the mixed signals because there’s still some nice pull on demand, and there’s others that are just a little over-inventory. But I think they’ll be burning that off, like I said, through the first half calendar 2024.

Great. And the follow-up, recently, WT Micro acquired Future. And that’s a pretty unusual, rather large combination of competitors. And I wonder if the company has any view as to whether that would increase or decrease competitive pressures. And any description of the sort of change in competitive dynamics that you anticipate from that or ones that you’ve already seen? Thank you.

Yes. Thanks, Will. Thanks for your comments. We don’t make comments on the competition nor certainly that merger. We want to focus on our execution and our operational focus and just continue to deal with our suppliers, who we value greatly and our customers. I think we do that, we’ll be fine. So you got – we already compete with WT in Asia, and we compete with Future in the West. So they’re going to combine together. We’ll see how that works out. But in the interim, we’re stable and balance sheet solid, and we want to continue to drive growth with our current suppliers and customers. I wish them luck.

Thank you.

Thank you.

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

Thank you. I want to thank you for attending today’s earnings call, and I look forward to speaking to all of you again at our fiscal second quarter earnings report in January. And as – since it was noted today, it does mark Game 5 of the World Series in Major League Baseball. On behalf of Avnet – Team Avnet, I want to say, go Diamondbacks. Okay. Have a great rest of the week. Thank you.

This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.