Q2 2024 Avnet Inc Earnings Call
Please standby our presentation will now begin.
Welcome to the Avnet second quarter fiscal year 2024 earnings conference call I would now like to turn the floor over to Joe Burke, Vice President of Treasury and Investor Relations for Avnet.
Joseph Burke: Thank you operator, I'd like to welcome everyone to the Avnet second quarter of fiscal year 'twenty 'twenty four earnings conference call.
Joseph Burke: This morning, Avnet released financial results for the second quarter of fiscal year 'twenty 'twenty four and the release is available on the Investor Relations section of that that's website, along with a slide presentation, which you may access at your convenience.
Joseph Burke: As a reminder, some of the information contained in the news release and on this conference call contain forward looking statements that involve risk uncertainties and assumptions that are difficult to predict.
Joseph Burke: Such forward looking statements are not a guarantee of performance and the company's actual results could differ materially from those contained in such statements.
Joseph Burke: Several factors that could cause or contribute to such differences are described in detail in that.
Joseph Burke: In its 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.
Joseph Burke: Today's call will be led by Phil Gallagher Avnet C E O and Ken Jacobson Avnet CFO.
Joseph Burke: With that let me turn the call over to Phil Gallagher.
Joseph Burke: Yes.
Philip R. Gallagher: Thank you Joe and thank you everyone for joining us on our second quarter of fiscal year 'twenty 'twenty four earnings conference call.
Philip R. Gallagher: I'm pleased to share that we delivered another quarter of solid financial results, which was in line with our guidance.
Philip R. Gallagher: In the quarter, we achieved sales of $6 $2 billion. This was slightly above the midpoint of our guidance down 2% sequentially and down 8% year over year.
Philip R. Gallagher: We achieved operating margins of three 9% highlighted by a four 3% operating margin in our electronic components business.
Philip R. Gallagher: We've been working through an inventory correction on a global basis over the past couple of quarters in.
Philip R. Gallagher: In addition, we're also facing a weak and uncertain economic conditions, which began in Asia, including China and are now present in the west.
Philip R. Gallagher: This economic softness has resulted in lower demand with some of our customers, which is being magnified by elevated inventory levels across the supply chain.
Philip R. Gallagher: In the quarter demand was mixed across the diverse end markets, we serve defense and transportation markets continued to show relative strength, while demand in the industrial consumer and communications verticals was relatively soft.
Philip R. Gallagher: And sent me back to lead times continue to improve the pricing environment remains stable, which is a positive sign for the majority of the products. We did not expect overall pricing to decline meaningfully in the near term as we see it today.
Philip R. Gallagher: We continue to manage our backlog in close coordination with our customers and suppliers to align with current softening market conditions.
Philip R. Gallagher: Our backlog activity is centered on push outs and reschedule is rather than cancellations, which are within the normal range shorter lead times. However are contributed to backlogs being lower year over year and sequentially.
As a result of these factors our book to Bill ratio continued to be below parity the modestly above last quarter.
Philip R. Gallagher: Although our reported inventory levels were up the increase was driven by a combination of supply chain as a service engagements and foreign currency exclude.
Philip R. Gallagher: Excluding these items inventory for our core E. C business was relatively flat and our teams are confident that the inventory levels for this core business will come down over the remainder of fiscal 'twenty 'twenty four.
Philip R. Gallagher: Ken will provide further color on inventory in our supply chain as a service offerings.
Philip R. Gallagher: As I mentioned previously we're in the midst of an inventory correction.
Our team has done a really nice job navigating it with a focus on optimizing our inventory investments today and.
Philip R. Gallagher: Reducing inventory levels in the coming quarters.
Philip R. Gallagher: We provide her supplier partners with our best read on true end market demand for our customers.
Philip R. Gallagher: I've said it before we view inventory as a vital asset to fuel our business well.
Philip R. Gallagher: But with the near term sales outlook, we are focused on reducing inventory were elevated and improving our cash conversion cycle.
Speaker Change: With that let me turn to the highlights for our business.
Speaker Change: At the topline our electronic components business saw mixed results across the regions and.
Speaker Change: In constant currency electronic component sales were down 1% sequentially and 9% year over year.
Speaker Change: Sales in the Americas were up 1% sequentially and declined 6% year on year with defense and transportation as the strongest end markets.
Speaker Change: Sales in Asia were up 2% sequentially and down 10% year on year, and Asia Transportation and communications were our strongest end markets.
Speaker Change: EMEA sales were down 7% sequentially and 10% year on year in constant currency. It is worth noting that EMEA had near record sales in the December quarter last year.
Speaker Change: We're going to go up against the tough compare.
Speaker Change: In EMEA, we are seeing softening in the industrial and transportation sectors.
Speaker Change: For our farnell business as expected sales and profitability were impacted by softening demand product mix and competitive pricing pressures.
Speaker Change: Now sales were down 6%, both sequentially and year over year in constant currency.
Operating margins for farnell, where 4% during the quarter, which is disappointing but in line with our stated outlook.
Despite the greater than expected sales decline, we were able to hold our operating margin as we began to see the benefits from some of the cost reduction actions we've already taken.
Speaker Change: We still believe for now has a great potential to deliver value to customers suppliers and there's an important part of the avnet portfolio. We are focused on improving operating margins near term, while further leveraging the breadth of bad debts customer base and sales force to identify growth opportunities.
Speaker Change: Our team is focused on several growth and margin expansion opportunities.
Demand creation I P N E and embedded solutions.
Speaker Change: In the quarter, our demand creation design winds in registrations remained strong.
Speaker Change: Demand creation revenues as a percentage of total revenue was stable on a sequential basis.
Speaker Change: We're also pursuing growth in our <unk> business.
Speaker Change: I painted products have higher gross margins and there are many cross selling opportunities with IPD components that are complementary to our semi doctor visits.
Speaker Change: Finally, we see exciting opportunities with our embedded business, where we offer embedded board and display solutions.
Speaker Change: We have the capability to offer both custom solutions and third party solutions, both of which come with higher gross margins.
Speaker Change: We continue to find ways to leverage our global sales force and technical capabilities to capitalize on these embedded growth opportunities.
Speaker Change: Our supplier partners value, adding its ability to create solutions for customers that leverage their entire portfolio of products.
Speaker Change: The importance of solution selling highlights wire suppliers continue to support our demand creation efforts.
Speaker Change: They're also focused on increasing customer count and leveraging the long tail of the industrial sector to generate growth.
Speaker Change: Our suppliers continue to partner with that debt and distribution general to help them drive the growth they're seeking.
Speaker Change: As exciting as these opportunities are we are still in the midst of an uncertain market.
Speaker Change: Over the past several weeks I've met with several Ceos and decision makers at our supplier partners.
Speaker Change: Representing nearly half of our revenues.
Speaker Change: Consensus sentiment. Among this group is that overall market softness will continue for at least a couple more quarters.
Speaker Change: Well it could extend through calendar 2024.
Speaker Change: Yeah.
Speaker Change: To conclude we are confident that our strong competitive position and our experience managing through many prior market cycles will serve us well as we navigate through these choppy waters.
Speaker Change: I want to thank our team for their dedication and commitment.
Speaker Change: We believe our people and our culture are key differentiators for Avnet, which enables us to compete well in any market environment.
Speaker Change: With that I'll turn it over to Ken to dive deeper into our second quarter results.
Ken Jacobson: Thank you Phil and good morning, everyone.
Ken Jacobson: We appreciate your interest in Avnet and for joining our earnings call.
Ken Jacobson: Our sales for the second quarter were approximately $6 $2 billion in line with guidance and down 8% year over year.
Ken Jacobson: On a sequential basis sales were down 2% in constant currency as expected due to seasonal declines in the western regions in the December quarter.
Ken Jacobson: From a regional perspective sales in EMEA and the Americas, each declined by 6% and Asia sales declined 10% from the year ago quarter.
Ken Jacobson: From an operating group perspective, electronic components sales declined 8% year over year and 9% in constant currency.
Ken Jacobson: E C sales declined 1% quarter over quarter in constant currency.
Ken Jacobson: Farnell sales declined 4% year over year and 6% in constant currency.
Ken Jacobson: For now sales were also 6% lower sequentially in constant currency.
Ken Jacobson: Sales of single board computers continue to ramp increasing 32% quarter over quarter.
Ken Jacobson: For the second quarter gross margin of 11, 4% was 29 basis points lower year over year, and 43 basis points lower quarter over quarter.
Ken Jacobson: E C. Gross margin was flat year over year and declined sequentially, primarily due to a seasonal mix shift to Asia.
Ken Jacobson: Cornell gross margin was down sequentially and year over year, largely due to an unfavorable sales mix and from competitive pricing pressures for on the border components.
Ken Jacobson: Turning to operating expenses adjusted operating expenses were $464 million in the quarter down 4% year over year and down 5% sequentially operating expenses were down 6% in constant currency year over year.
Ken Jacobson: As a percentage of gross profit dollars adjusted operating expenses were 66% in the second quarter 68 basis points higher than last quarter.
Ken Jacobson: But the second quarter, we reported adjusted operating income of $242 million, which decreased 19% year over year. Our adjusted operating margin was three 9%, which decreased 57 basis points year over year and decreased 23 basis points quarter over quarter.
Ken Jacobson: By operating group electronic components operating income was $248 million down 16% year over year, you see operating margin was four 3% down 43 basis points year over year, and 34 basis points lower sequentially.
Ken Jacobson: The sequential decline was primarily due to a combination of lower sales in our seasonal mix shift of.
Ken Jacobson: Sales to Asia.
Ken Jacobson: For now operating income was $16 million down 57% year over year.
Ken Jacobson: We're now operating margin was 4% in the quarter down 20 basis points quarter over quarter and was impacted by lower sales and unfavorable sales mix and competitive pricing pressures related to on the board components, which was partially offset by lower operating expenses.
Ken Jacobson: As we discussed last quarter Farnell has begun undertaking a wide range of restructuring actions to reduce operating expenses and improved gross margins.
Ken Jacobson: Overall, we are targeting annual expense reductions of between 50 million to $70 million of which approximately 25% was already completed as we exited the second quarter.
Ken Jacobson: The majority of the restructuring restructuring actions that for now will be completed by the end of the fiscal year.
Ken Jacobson: We anticipate the next few quarters will be challenging for a friend al as continued demand and competitive pressures for on the board components may dampen the expected benefits of lower expenses.
Ken Jacobson: Although these restructuring actions are necessary to ensure farnell has a sustainable operating expense model through any cycle, we do not take these actions lightly as they impact our people.
Ken Jacobson: Turning to expenses below operating income second quarter interest expense of $74 million increased by $15 million year over year and increased $4 million quarter over quarter, primarily due to higher average borrowings as higher interest expense negatively impacted adjusted diluting earnings per share by 12 cents year over year.
Ken Jacobson: Our adjusted effective income tax rate was 24% in the quarter as expected.
Ken Jacobson: Adjusted diluted earnings per share was inline with expectations at $1 40 for the quarter.
Turning to the balance sheet and liquidity during the quarter working capital increased by $328 million sequentially, including an increase in reported inventories of $361 million $171 million decrease in receivables and $138 million decrease in payables.
Ken Jacobson: As a result of this working capital increase working capital days were 107 days for the quarter, an increase of six days quarter over quarter. Our return on working capital decreased accordingly on the higher working capital and lower operating income.
Ken Jacobson: Let me take a moment to give more color on inventory and a sequential increase in inventory this quarter.
Ken Jacobson: The overall increase in reported inventories was driven by an increase in inventory specific to supply chain service engagements and also from changes in foreign currency exchange rates inventory related to our traditional core E. C business remained flat and was stable in the December quarter. We continue to have line of sight on incoming inventory, while we work through the.
Ken Jacobson: LNG is created by elevated inventory levels across the supply chain.
Ken Jacobson: Although we are disappointed the inventory for our core E. C business remains flat. We are confident these inventory levels will start to decline in the March and June quarters.
From a supply chain as a service perspective, we continue to see an increase in opportunities for this service offering.
Ken Jacobson: The customer base for these engagements are typically large Oems, who have historically done their business directly with our suppliers.
Ken Jacobson: These Oems and suppliers I perched prioritizing resiliency in their supply chains as a lesson learned from the past few years of component shortages, which is driving an increase in these opportunities.
Ken Jacobson: As a reminder, these service engagements are separate from our traditional core EC business.
Ken Jacobson: As the associated inventory is really the inventory of the OEM and the supplier that we hold on their behalf.
Ken Jacobson: The inventory is contractually restricted and the risk profile is different compared to inventories held for our core E C distribution business.
Ken Jacobson: The increase in inventories for supply chain services was specific to a few newer engagements that ramp towards the end of the quarter. We would expect inventories for supply chain services to be flat to down slightly in the third and fourth quarters for our existing engagements.
Ken Jacobson: Our team remains highly focused on reducing inventory levels were elevated which will help us drive cash flow from operations in the second half of fiscal 'twenty 'twenty four.
Ken Jacobson: The increase in working capital led to an increase in debt of $279 million.
Ken Jacobson: During the quarter, we used $42 million of cash for operations. However over the past four quarters, we generated $169 million of cash from operations.
Ken Jacobson: We expect to generate positive cash flow in the third quarter in excess of the cash used for operations during the first half of fiscal 2024.
Ken Jacobson: We ended the quarter with a gross leverage at two six times and we had approximately $493 million of available committed borrowing capacity.
Ken Jacobson: With regard to our capital allocation, we continue to prioritize our existing business needs, including working capital and capital expenditures during the second quarter cash used for Capex was $82 million, primarily to support a new distribution center being constructed in EMEA.
We expect Capex to return to historical levels in the second half of fiscal 'twenty 'twenty four of approximately 25 million to $35 million per quarter.
Ken Jacobson: In the second quarter, we repurchased approximately $59 million of the shares we use the cash proceeds from a recent legal settlement to buy back shares during the first and second quarters, we have $232 million left on our current share repurchase authorization entering the third quarter.
Ken Jacobson: We also paid our quarterly dividend of 31 cents per share or $28 million.
Ken Jacobson: For the long term, we remain committed to our roadmap of delivering a reliable and increasing dividend and share repurchases to increase our shareholder value. When we believe our shares are undervalued by the market.
Ken Jacobson: Book value per share improved to approximately $55 a share or a sequential increase of approximately $3 a share as.
Ken Jacobson: As we generate cash flow from operations in the second half of fiscal 'twenty 'twenty four we expect to use the cash for a combination of debt pay down and for buying back shares.
Ken Jacobson: Turning to guidance for the third quarter of fiscal 2024, we are guiding sales in the range of $5 five 5 billion.
Ken Jacobson: To $5 $85 billion and diluted earnings per share in the range of $1 five to $1 15.
Ken Jacobson: Our third quarter guidance is based on current market conditions and implies a sequential sales decline of 6% to 11%.
Ken Jacobson: This guidance assumes sales declines for the western regions versus typical seasonality of sales growth and a seasonal decline in sales from Asia due to the lunar new year.
Ken Jacobson: This guidance assumes similar interest expense compared to the second quarter, an effective income tax rate of between 22% and 26% and 91 million shares outstanding on a diluted basis.
Ken Jacobson: Implied in our guidance as an E C operating margin above 4%.
Ken Jacobson: Although there is some uncertainty in the overall market environment. We are currently in our team will continue to focus on the things that we can control or influence. This includes being disciplined with our operating expenses driving working capital reductions in cash flows and winning new opportunities to drive profitable growth and continued market share gains.
Speaker Change: With that I will turn it back over to the operator to open it up for questions operator.
Speaker Change: Thank you, ladies and gentlemen, we will now be conducting a question and answer session. If you'd like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue. You May press star two if you'd like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the Marquis.
Speaker Change: One moment, please while we poll for questions.
Speaker Change: Thank you. Our first question is from William Stein with Truth Securities. Please proceed with your question.
William Stein: Great. Thank you.
William Stein: I'd like to ask it was going to ask about inventory, but maybe given the.
William Stein: We addressed it already it sounds like its really more of a supply chain issue a.
Supply chain engagement issue. So let me instead to ask about that we've heard avnet talk about.
William Stein: Supply chain, Inc.
William Stein: Engagements.
William Stein: For quite some time.
William Stein: Wonder if you can talk to us about the differences between that business and the more traditional electronic components distribution.
Whether it might warrant reporting the revenue separately and and the inventory.
<unk> for that separately and maybe talk about the different dynamics there sort of.
William Stein: Inventory turns in that business versus the core.
William Stein: Returns on invested capital on other metrics that you're targeting in that business and I do a follow up if that's okay.
William Stein: Yeah well. Thanks. This is a this is Phil and I'll, probably turn it over to Ken.
Ken Jacobson: So that's what we're working to clarify it in the script, okay to start breaking that out a little bit more and we'll pull that string as we move forward. It was.
Supply chain is kind of a generic term to that's why we're kind of defining it as as a service because supply change what we do and you're right. We've been doing that for years with our traditional supply chain in our traditional core customers, whether it would be consignments implant stores combined point of use were appointed to the systems et cetera et cetera. That's still exists that's still at a big part of our <unk>.
Ken Jacobson: Business the ones that were kind of breaking out in the call today and we started to a couple of calls ago, the supply chain as a service or.
Ken Jacobson: Really large Oems that maybe traditionally work utilizing our supply chain services that are now coming to us and they are different financial models are different inventory carrying the working capital models, even with different financing.
Ken Jacobson: With that let me turn it over to Ken and he can give them articulate a little bit more color on that but I. Appreciate the question and we will continue to work to break that out and explain more in the future.
Speaker Change: Can I just say.
Ken Jacobson: The message, we want to attack and days that the broader inventory for the EC business is stable now we're disappointed that it hasn't gone down yet, but that's something the team is actively driving to do but we do see line of sight to some reductions in that quarter and I'm going to go onto the next couple of quarters and the supply chain and service inventory I mean that happens to be our accounting or reporting it.
Ken Jacobson: Within our inventory beginning to give a little bit more color at least on the balance sheet will so I think the path for further clarity would be you know first on the balance sheet and then moving to the P&L as those engagements ramp itself. So here's how I'd characterize the difference I mean, I think the first thing and these are really large engagements.
Ken Jacobson: Typically right. So the magnitude of the throughput of components is it's much bigger and thats, mostly driven by the fact that the let's say the end customer here in these service ranges are typically large Oems and what we tried to comment on and these are the ones that we typically havent been.
Doing business with because they have direct relationships with suppliers and they have their own.
Ken Jacobson: Partners they use and so this is new opportunities for us because we haven't really played on the big OEM space. So transportation is one opportunity, but it's really across all end markets that we're seeing including you know, let's say communications and networking and things like that but typically the engagements are driven by the OEM and typically.
Ken Jacobson: What's happening is we're kind of procuring.
Ken Jacobson: Procuring on their behalf the inventory that they were normally buying at their pricing most likely right. So they might have a direct contract or other pricing. So it's not let's say normal course fulfillment or anything that this is really you know buying based on their contract and so the main difference. We see is the inventory profile. We try to talk about you know that's not really our inventory even.
Ken Jacobson: Though we report it as such its their inventory there's contractual restrictions right. So it's.
Ken Jacobson: You know really providing a service on their behalf. So from an overall profile typically the gross margin is better, but it's not really a top line revenue because of the fact that it services revenue versus revenue from the sale of components from a return on invested capital return on working capital you know, it's it's at or above typically where other engagements would be at you know we look to.
Ken Jacobson: Find creative working capital solutions for these types of engagements in some cases, we'll finance it or who will fund it through our own working capital or borrowing capacity, but a lot of times, we're either trying to have the Oems bring cash to the table or looking for third party programs.
Ken Jacobson: Programs to help us finance that and in our commitment really not only to our supplier partners, but also to our teams is the fact that we're really not trying to restrict our existing business right. We want to have this be an and not an or and so we really don't want to consume our working capital to fund. These engagements because we want to protect that for the normal course of business to grow our long.
Ken Jacobson: Our customers and things like that so hopefully that adds the color you were looking for and again, we'll continue to add transparency as these things ramp and get bigger.
Ken Jacobson: Exploration Kennan.
Ken Jacobson: It's a good question and apologize for the lengthy answer because it is complex and we want to be transparent and what brought some of these on is the breakdown in supply chain right over the last three years and.
Ken Jacobson: Customers got caught short as we all know rabbit shortages.
Stoppages and supply chain. So some of these opportunities even come to us from our suppliers that are being asked to be beginning to be asked to do things that maybe it's not in their core I'll say they they bring it to us when we go work it together so I'll leave it at that and then we can pick it up later if you like.
Speaker Change: I could just ask one follow up so I think you've.
Speaker Change: You've made this explanation of.
Speaker Change: Increased inventory from the.
Speaker Change: Uh huh.
From the supply chain engagements.
Speaker Change: The engagements of our supply chain as a service engagements, but I think you said that the for the core E C and for Enel business It was flattish.
Flattish and you were trying to bring it down.
All of a semi company as I cover have or most of them have talked about a significant decline in channel revenue in the last couple of quarters.
Speaker Change: I'm just trying to I, obviously don't cover every.
Speaker Change: Semi company in the World, but I'm wondering if you can help me sort of reconcile these data points when many of the larger semi companies are talking about.
Channel sales being down.
Speaker Change: Any any way that you might be able to reconcile that that I can't recognize it's not so obvious to me. Thank you.
Speaker Change: A clarification channel our sales to the channel as well you're talking about or ourselves out.
And sales into us.
Speaker Change: And while our sales out I think we guided I mean, so we hit we hit December. So we were pleased with that so and then we we believe we again gained some share.
Speaker Change: Sales in all of the suppliers are a little bit different I would say theres, a theres a few that probably need a little bit more help than others.
Speaker Change: But we're even even lever up in inventory I've said this before it's not across all of the suppliers that meet or are in the.
Use more inventory and a lot of areas you know that you're still it still might be a little tight you know it's in a in a handful of our suppliers it might even be heavier ship and debit. So I think the important thing is will work on our suppliers as we said in the script I mean every day with our customers trying to balance the true demand.
Speaker Change: As best we can see it in the outlook and we pipeline accordingly, but overall the behavior from the suppliers. It's been it's been good they've been good partners and as we said hang two calls the gutters, there's one or two we've had a some opportunistic opportunities that we've we've taken advantage of and it's been a win win.
Speaker Change: <unk>.
I think I understand thanks, guys.
Speaker Change: Thank you will.
Speaker Change: Thank you. Our next question is from <unk> <unk> with Bank of America. Please proceed with your question.
Speaker Change: Hi, Thanks for taking my questions.
Speaker Change: Fill in the prepared remarks, I think you said that you can your conversations at the C. E O had been showing that market softness can last a couple of quarters or two.
Speaker Change: 24.
Speaker Change: Last quarter when we spoke.
Speaker Change: The thought was that the channel is going through an inventory correction, which is nice.
Speaker Change: Pillar mid of 2024 has your thought process on that changed has your viewpoint changed do you think that the inventory correction takes longer and do you see like it just sounded like you think that the markets are going to be weaker longer but just your overall thoughts on that.
Yeah, I think I I still think it's somewhere around mid year might stretch into the September quarter. Roop will you know things have changed everything has changed in 90 days.
Speaker Change: From 90 days ago with some of the softness in industrial and whatnot that we pointed out in our suppliers or are pointing out but I still think it's you know mid 24 in the December pretty inventory correction and then we will see that there's growth. There of his statement remains flat through 2024 are just too far out to call that but I do think as we.
Speaker Change: We bring our inventory down, which we believe we would do the next several quarters that'd be a positive sign will spin off cash will go from there and see what kind of.
Speaker Change: Growth of the market dictates at that point in time.
Speaker Change: Okay. Thanks for that let me ask.
Speaker Change: Ken a question on margins.
Ken Jacobson: I think you said you see margins in the guide can stay above 4%. So can you comment on what revenue level, you need to see to keep those margins above 4%.
Ken Jacobson: The same question on Farnell margins, how should we think about that trending over the next couple of quarters. What are the puts and takes there I mean it was at 4% this quarter or do you think theres a chance that.
Ken Jacobson: You know how quickly can that recover what do you need to see that.
Speaker Change: Yeah, maybe I'll take the final question first throughput I would just say you know I think in this in the December quarter, you know the farnell sales were a little softer than we had anticipated which kind of hurt the ability to provide a healthier operating margin you know we had these expense actions ongoing.
Speaker Change: But I think you know that the challenge with Farnell is really you know.
Speaker Change: Competitive pressures on the on the board components, you know now that the on the board components are more available with lead times coming down right Theres less demand from the catalog our high service distributors and then on top of that you know the high service.
Speaker Change:
Speaker Change: <unk> have a lot of inventory, including Farnell I haven't a lot of inventory. So that's putting further pressure on the pricing so were seeing those too.
Speaker Change: Headwinds and so that's why we kind of gave the outlook that it's going to be tough couple of quarters for now is as you know that business gets through the inventory, we feel decent debt margin levels have stabilized, but unfortunately, there is a little lower than we had anticipated isn't it you know the cost actions are going to take a little time as well. So that's why we.
Speaker Change: Kind of signal, it's gonna be perhaps more of the same for the next couple of quarters, you'll find out with opportunity to kind of uplift that margin modestly over the as we exit the year.
Talking about the EC business, you know what I would say is I think implied in the guidance, which I talked about a little bit as normally we would get a seasonal uplift in the west right. So we get a robust shift in business from Asia to the west which helps on the margin we're still seeing some of that but because the west is expected to be down.
Speaker Change: In in the March quarter versus typically up you know, we're not getting the uplift that we normally would see they're with favorable mix and so you know what I would say is hey, you know, where where you know kind of at the revenue levels right to kind of maintain that but typically we're not going to get into the fourth quarter, but typically you'd see a.
Speaker Change: Asia rebound a little bit coming off.
Speaker Change: The the lunar new year.
Speaker Change: So so that would be typically what would happen in the fourth quarter and you'd see Asia up a little bit from whatever they do and in the March quarter, but with that being said, we're continuing to drive it and as Phil noted, we know we're going to control expenses and we're going to you know continuing to work on that core inventory than we wanted we wanted to go from stable to down you know where that inventory is elevated the teams working on it.
Speaker Change: And so we're going to focus on the cash flow and getting the inventory down and try to compete well in the market, where we have opportunities we're still seeing some opportunities out there, but it's definitely more challenging than it was 90 days ago.
Speaker Change: Okay. Thanks for all the details there and let me just sneak one more in you mentioned our expenses.
Speaker Change: Maybe both for you and Phil Phil I think you said, you're making investments.
Speaker Change: In the sales force I mean, you you talked about demand creation, and IP and EDA and embedded so I guess my question is do you need to invest in more sales force to train them on to hire more people at the same time, you're doing restructuring in for now so I mean, if you can even like what your expectation is for Opex as a percent of gross profit going forward.
Speaker Change: And the type of investments you see happening over the next couple of quarters. Thank you so much.
Speaker Change: Yes, you got it so I'll, let Ken answer in it are another reason that G. P. Well, we've been managing our expenses. So I mean, we we have not increased our expenses as a percent and we've been actually I always say that yeah, we're always reducing expenses, while we need to make investment investments and some investors might be and productivity tools are P. A.
Speaker Change: These things all the same things on those lines are now artificial intelligence slash machine learning, so, we're putting more and more investment behind the I'll call. It the digital side of the equation as far as.
Speaker Change:
Ken Jacobson: Our sales force our field application engineers are designing solutions and yes, we mentioned embedded we're well staffed there we've invested there appropriately we are not removing our investments in that space.
Ken Jacobson: The growth in it.
Ken Jacobson: Profitability of the company so.
Ken Jacobson: There's there's no movement afoot in the core to adjust anything in those in those areas and we've articulated clearly will come back more on the fornell restructuring as separate as Ken pointed out Canada.
Speaker Change: I think you know sales are coming down obviously <unk> implied in our March guidance. So the OE. The G. P is gonna be impacted accordingly in terms of percentage, but I would just think about it as kind of flattish I mean, where we are making investments we're trying to self fund.
Speaker Change: Where we are focused on expense discipline. So you know what I would say as you know we're kind of more of the same outside of farnell, but you know it depending on our view of how long the demand softness may may look at who might have to take a hard look at it and more expense actions, but again anything we do there we're going to protect for the medium term and long.
Speaker Change: Term in and really focus on the opportunities we see out beyond the horizon of where demand is soft.
Speaker Change: Okay. Thanks for all the details appreciate it.
Speaker Change: Thanks.
Speaker Change: Yeah.
Speaker Change: Thank you. Our next question is from Joe Quattrochi with Wells Fargo. Please proceed with your question.
Yeah. Thanks for taking the questions a couple if I could maybe just kind of first thinking about the farnell the the cost restructuring or restructuring that you are putting in place do we think about that that $50 million to $70 million is flowing to the bottom line for the total company P&L or are there areas that need.
Speaker Change: There's a little bit of offset from a cost perspective, just as we're thinking about opex.
Speaker Change: I think first thing I'd say is it's an annual amount and I think there are you know.
Speaker Change: Other factors to consider so so I would say I don't know that I would be a direct one for one it depends on volume and other things but.
Speaker Change: But you know I think from a foreign al perspective, right I think that you can kind of start to build that in to.
Speaker Change: The operating margin as we exit the year.
Speaker Change: Okay and I assume you meant typical year and then just.
Speaker Change: A follow up to that maybe just kind of trying to understand whats changed from from 90 days ago, and just understanding maybe it's the kind of the mix of demand in the areas that are starting to see incremental weakness I guess, how do I think about just you know the ear exposure the mix exposure say industrial to like.
Speaker Change: Western regions relative to Asia, and just kind of what's.
Speaker Change: Incrementally weaker relative to last quarter.
Speaker Change: Yes.
Speaker Change: Take that Joe Thanks.
Joe: I think what we've seen is that really on a global basis.
Joe: Some of that where we've seen probably the greater weakness and its been very strong over the last several years will be in the industrial space, Okay, and and that's our best that's let's call. It between 25 and 33% of our business is industrial it's really broad okay, but that's that's come down a little bit sequentially and year on year.
That's been particularly strong on the industrial has been particularly strong in Europe.
Joe: In Europe as we pointed out has had three record quarters and until this past quarter. So we've been performing walls that got salt that obviously affects us.
Joe: If you look at the transportation overall I noticed so automatic signals out on transportation.
Joe: Still holding up pretty good down sequentially and down.
Year on year, but I would say modestly in single digit.
Joe: So it's still holding up and it's actually up in the Americas. It was more more down in.
Joe: Europe, again, which is our second largest oh.
Joe: Vertical.
Joe: Defense, Unfortunately, with what's going on in the World today is.
Joe: Actually quite healthy.
Joe: We see that continue to stay strong.
Speaker Change: Thank you.
Speaker Change: Got it Joe Thank you.
Speaker Change: As a reminder, if you'd like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue.
Speaker Change: Our next question is from Matt Sheerin with Stifel. Please proceed with your question.
Matthew John Sheerin: Yes, Thank you and good morning, everyone.
Matthew John Sheerin: Phil and I wanted to get back to the inventory issues.
Matthew John Sheerin: I appreciate the commentary about the supply chain engagements.
Matthew John Sheerin: As a service, but it seems like it's more true did you actually you were buying the inventory you're carrying the inventory.
Matthew John Sheerin: You know that's a working capital burden for you and so when you talk about inventory and I know, it's restricted but that's still inventory on your books right. So so when we think about you know you're over 100 days of inventory what what's the target for the next two to three quarters in and.
Matthew John Sheerin: Is there a thought to giving two working with OEM customers, where they are actually owning the inventory it's more consigned. So it's a true as a service model because it seems like it's a traditional model where youre carrying the cost of that inventory.
Matthew John Sheerin: Hey, Matt This is Ken I guess, what I'd start with is I think there's you know alternative forms of funding of the inventory in general right are the components.
Ken Jacobson: Now part of what you're talking about is really an accounting versus how you actually perform the service right. So you need physical custody you need in our warehouses to move it right. You think about the OEM that may not have manufacturing and things like that so there's it gets to a lot of complications in terms of you know there's there's one how you account for it and how we reported in our financials when there's two.
Ken Jacobson: How do you actually conduct the service.
Ken Jacobson: For Oems that are you know without manufacturing footprint and things like that right. So there's no tax things legal entity things that get into you know why someone like avnet needing to step in to provide the service versus other parties. So I guess, how I'd characterize it as you know we do feel it's a different risk profile, we do feel that we've you know.
Ken Jacobson: Got enhanced protection for this product versus let's say normal course of business product.
Ken Jacobson: So you know we do view it differently, even if it's you know currently reported in the same line item is the other inventory and that's what we're trying to convey but part of that becomes then how do you provide the service and.
Ken Jacobson: If it's consigned and that means that the Oems can already do the supply chain on their own right in some cases, it's not consigned, but its the capital is provided by the Oems in some cases they want.
Ken Jacobson: Capital being part of the service right. So it's a mixed bag and in our view is we're trying to maintain flexibility to provide the services they need but measure it based on the returns we get and the.
Ken Jacobson: The fact that it wont restrict our normal course of business opportunities right with the the capital restrictions right. We've got enough, let's say elevated inventory levels in a normal course of business. We're not compounding the issue. If you will with with these engagements and that's been transparent with the customers, we're working with them and so they kind of understand.
Ken Jacobson: So this is kind of a separate.
Speaker Change: Yeah, Matt So just jumping to face can.
Inventory days are certainly up a little bit higher than we'd like it to be and as I've said in the script, but we're not I mean inventory is not a bad thing you know it may be a little too much but it's not aged a it's not a liability we do want to start bringing it down in the March quarter as we bring it down relative to the sales you know, it's a math issue I mean, the days of inventories so we wouldn't.
Speaker Change: Spectra days, you start to come down as well, but the key is just making sure. We've got the the quality of inventory as we bring it down start generating more cash.
Speaker Change: So again.
Speaker Change: Got to support the market that we see going forward and balance the right investments in inventory as one of the big ones.
Speaker Change: Got it and then just related to that your interest expense, obviously has gone up significantly it looks like it's kind of a it's not a $300 million run rate for fiscal 'twenty for two years ago. It was 100 million. That's obviously a huge swing in EPS. So Ken is is that a priority in terms of working down that.
Speaker Change: Short term borrowings and getting that interest expense down.
Ken Jacobson: Yeah, Matt.
Ken Jacobson: Hundred percent I mean, I think the now we need to get the cash flow and that cash is going to be used in part for debt pay down right. I mean, it's a combination of factors driving that but clearly the elevated inventory is a big piece of that over the past year and even longer than that so I would say that is a focus.
And you know it is the cost of borrowing is definitely much more expensive than it was in the past so we need to and get that down and then it's going to take some time, though I would I would caution.
Speaker Change: Okay perfect. That's it for me thank you.
Speaker Change: Thanks, Matt.
Speaker Change: Cash management services.
Speaker Change: Thank you. Our last question is from Toshi Hari with Goldman Sachs. Please proceed with your question.
Toshi Hari: Hi, good morning. Thank you so much for taking the question. The first one is on long term margins.
Toshi Hari: And Ken I think this this predates you as a CFO, but.
Toshi Hari: Back in June 22 at the.
Toshi Hari: Analyst day or Investor day.
Toshi Hari: Throughout our medium term operating margin target of above 5%.
Toshi Hari: I realize we're at the.
Toshi Hari: Close to the trough of the cycle.
Toshi Hari: But for now I think at the time, you know operating margins were in the mid teens.
You're currently up four or five I think she has held in really well, but do you think the above 5% cross cycle or medium term target is still intact and youre comfortable with that or have there been sort of fundamental permanent changes that would kind of swing that view.
Speaker Change: Yeah. Thanks, Toshi I mean, I'm, just I'm generally familiar with obviously those targets you put out and I would say you know.
Speaker Change: We are not coming off of those targets, we see opportunity now clearly, we're a little bit backwards right. So we've got to get back to where we were but you know again, the EC business holding up in the in the third quarter. You know you mentioned the trough I just knocked on wood, there, but let's.
Speaker Change: We see opportunity and we see that you know in some of the markets were in have growth. We do see right now so I made some commentary that you know pricing in general is holding up pretty well you know we are still focused on gross margin. So even if there is pressures on on some level of pricing you know what we're focused on those higher margin opportunities.
Speaker Change: Supply chain as a service as higher margin, Phil talked about demand creation I P. Any some of our embedded solutions products. So those are all higher margin type opportunities relative to kind of the baseline margin. We have and then farnell, obviously getting that back is key and that's going to take longer than we would've liked or our expected because of.
Speaker Change: Where how far down it's come but we still see those opportunities medium term and we think the overall health of our business and the overall opportunities. We're seeing when we talk to our supplier partners. I mean, I think we're definitely excited for the future, even though it's going to be some choppy waters here for the next couple of quarters.
Speaker Change: Okay. That's helpful. Thank you and then as my follow up on free cash flow generation going forward.
Speaker Change: You guys spoke to to a declining inventory or managing that better going forward. You also noted that capex should normalize lower I forget about what point, but you talked about that so it feels like you've got a pretty good tailwind from a free cash flow perspective.
Speaker Change: You know middle part of the year or back half of the year is that the right way to think about sort of the trajectory of free cash flow and b.
Speaker Change: If theres any quantitative guidance you can provide on that that would be super helpful. For perhaps calendar 'twenty four. Thank you yeah, I think that's right I mean, I I wouldn't get into calendar 'twenty four but what we did say for this next quarter for the March quarter was cash flow in excess of what we used in the first half of the fiscal year and in that you know the capa.
Speaker Change: Cause levels are normalized so we would expect positive free cash flow in the third quarter.
Speaker Change: And to answer your question as the inventory goes down right then the cash flow accelerates.
Speaker Change: So we see line of sight to that in Q3 and Q4, you know, we're not going to give quantitative numbers, but you know.
Speaker Change: We see lots of opportunity and we want to drive you know.
Large cash flow numbers.
Got it thank you.
Speaker Change: Thank you.
Speaker Change: Ladies and thanks, Josh I appreciate that.
Speaker Change: There are no further questions at this time I'd like to hand, the floor back over to Phil Gallagher for closing remarks.
Philip R. Gallagher: Great. Thanks, a lot and I want to thank everyone for attending today's earnings call and look forward to speaking to you again at our third fiscal quarter earnings report in May. Thank you very much have a great rest of the week.
Speaker Change: Ladies and gentlemen, this does conclude today's conference you may disconnect. Your lines at this time. Thank you for your participation.