Avnet, Inc. (AVT) Earnings Call Transcript

Welcome to the Avnet First Quarter Fiscal Year 2027 Earnings Call. I would like to turn the floor over to Lisa Mueller, Director of Investor Relations for Avnet.

Thank you operator. I'd like to welcome everyone to Avnet's First Quarter Fiscal Year 2027 Earnings Conference Call. This morning, Avnet released financial results for the first quarter of fiscal year 2027, and the release is available on the Investor Relations section of Avnet's website, along with the slide presentation which you may access at your convenience. As a reminder, some of the information contained in the news release and on this conference call contain forward-looking statements that involve risks, uncertainties and assumptions that are difficult to predict. Such forward-looking statements are not a guarantee of performance, and the company's actual results could differ materially from those contained in such statements. Several factors that could cause or contribute to such differences are described in detail in Avnet's most recent Form 10-Q and 10-K and subsequent filings with the SEC. These forward-looking statements speak only as of the date of this presentation, and the company undertakes no obligation to publicly update any forward-looking statements or supply new information regarding the circumstances after the date of this presentation. Please note, unless otherwise stated, all results provided will be non-GAAP measures. The full non-GAAP to GAAP reconciliation can be found in the press release issued today as well as in the appendix slide of today's presentation and posted on the Investor Relations website. Today's call will be led by Phil Gallagher, Avnet's CEO; and Ken Jacobson, Avnet's CFO. With that, let me turn the call over to Phil Gallagher. Phil?

Thank you, Lisa, and thank you, everyone, for joining us on our first quarter fiscal year 2027 earnings call. We are off to an outstanding start to the new fiscal year. Our first quarter results came in well above our expectations with record performance across all regions in both our Electronic Components and Farnell businesses. We achieved record sales of $10.7 billion, above the high end of our guidance and record adjusted earnings per share of $3.63, also well above our expectations. Importantly, the strength we saw at the top line translated into meaningful operating margin and earnings expansion, once again demonstrating the earnings power and operating leverage embedded in our business model as demand continues to strengthen. I'm extremely proud of how our team is executing in this dynamic business environment and I want to thank them for their hard work and dedication. Our results show the strength and resilience of Avnet's position at the center of the technology supply chain, supported by our global scale, broad component line card diverse end markets, deep customer and supplier relationships, experienced and dedicated employees and the differentiated capabilities we offer across the business. And as we look across the market today, the environment continues to evolve in ways that play to those strengths. Supply conditions continued to tighten during the quarter, with lead times extending across most semi locker and IP&E, which is our interconnect passive electromechanical product categories as demand broadened across all of our end markets and applications. Pricing increases also began to extend beyond memory with additional increases expected in the new calendar year. Given these dynamics, there has been considerable discussion across the industry about what is driving the recent acceleration in growth. The question we frequently get is whether our growth is from true underlying demand or just inventory replenishment. So let me take a few minutes to share our point of view on the question. From what we see in our business today, we believe underlying market conditions and demand are improving across all of our core end markets. There may always be some replenishment for changes in customer ordering patterns as markets tighten, but the breadth of the demand across geographies, technologies and end markets gives us confidence that we are experiencing is much broader than any one factor like inventory replenishment. Our key demand indicators continue to support that view. Book-to-bills remain solidly above parity in all regions. Our backlog is healthy and growing. The amount of backlog delinquencies continue to increase as lead times extend. We are monitoring it closely. As investment in AI infrastructure increases, it drives demand for more latest processors. Those solutions require a wide range of other semiconductors and IP&E technologies. As those investments move through the technology supply chain, they create opportunities across Avnet's world-class fire line card and our diversified customer base. While we are seeing accelerated growth in the data center market and are experiencing the ripple effects of that growth in our business, the opportunity for Avnet extends well beyond direct AI-related data center sales. This is demonstrated by the breadth and quality of the demand we are seeing outside of the data center. That diversity continues to be one of Avnet's important strengths. We have a globally scaled Electronic Components of line card. We operate across a broad set of higher growing end markets and maintain deep relationships across our customers and supplier base. And from Farnell, we engage with customers early in the product design process and support them from new product introduction through their journey to higher volume production. Now with that, let me turn to the first quarter highlights for our businesses. Our Electronic Components business delivered another record quarter with stronger-than-expected sequential and year-over-year growth across all 3 regions. We saw profitable growth across all end markets, led by data center, aerospace and defense and networking. In Asia, the region is entering its third consecutive year of growth. with another record quarter of sales reaching $5 billion and demand was higher across all end markets year-on-year, led by data center and industrial. As a reminder, Asia is regionally led by Taiwan followed by China, Southeast Asia and Japan. In the Americas, sales more than doubled year-over-year, resulting in another record quarter for the region. Demand was broad-based and highest in data center, aerospace and defense and networking. One contributor to the Americas regions, record performance was our Avnet Integrated Solutions business, which we discussed in our last earnings call. Integrated Solutions provides advanced systems integration and services for customers using purpose-built IT hardware. We have long served industries such as industrial and health care, and we are seeing strong demand from our customers serving enterprise, hyperscale and deal cloud data centers. AI infrastructure build-out is a key contributor to that demand. And as we scale the business, it is contributing to greater operating leverage and profitability in the region. In EMEA, sales grew both sequentially and year-on-year for the fourth consecutive quarter reflecting continued improvement in the region. The region also achieved record sales during the quarter, which was led by demand across several verticals, including industrial and transportation. Across EC, we also continue to see strong momentum in the capabilities that differentiate Avnet well beyond fulfillment component distribution. Our demand creation activity remains healthy with new design registrations continue to provide a strong pipeline of future opportunities. Our higher-margin IPD business also continues to perform well nearing $1.7 billion in sales for the quarter or more than $6 billion of sales when annualized. As we have said before, every simulator-based solution requires a complement of connectors, passives, sensors, power and other technologies around it and next-generation systems will require ever-increasing connectivity. The growth we are seeing in these complex systems plays directly into the full suite of solutions we provide our customers combining both semiconductors and IP&E. Momentum in our Supply Chain Solutions business continues to also grow as large OEMs increasingly rely on our capabilities to provide resiliency to complex and evolving supply chains. Our supply chain services engagements are expanding across a growing set of customers, particularly in data center infrastructure networking and transportation where demand trends remain favorable. Now turning to Farnell. Farnell delivered a record sales quarter and returned to a double-digit operating margin benefiting from strong execution by the team and the broader market recovery. We are seeing improving demand across all regions while our PowerOne focus continues to create opportunities by combining Farnell's digital and high-service distribution capabilities and for our customer base with Avnet's global scale and customer and supplier relationships. Farnell's growth for 1 of the 4 components comprised of semiconductors and IP&E was similar to the growth we saw across the EC business. We are pleased with what the Farnell delivered this quarter. The results demonstrate the strength of the business and the operating leverage Farnell can achieve as it grows. Farnell also gets added in an important position early in the product life cycles allowing us to engage engineers during the design phase and complementing our capabilities as customers move toward higher volume production. As I step back in the quarter, I think there are several points worth emphasizing. First, as we've been stating for some time now, we embrace our position at the center of the technology supply chain. We are primed to benefit from robust growth in the traditional markets we serve, including the powerful emerging megatrends driving electronic component demand, including drones, robotics and edge intelligence, which are still in the early stages of growth. Second, our growth is broad based, and we believe it is sustainable. We are seeing improving market conditions and demand across all of our geographies and end markets and our book-to-bill, backlog and other leading indicators continue to support our confidence in the underlying demand environment and our current outlook. Finally, we also know the strong markets alone don't deliver results, execution matters. The capabilities, scale and infrastructure we have across Avnet allow us to support higher levels of revenue efficiency. The margin expansion, EPS growth and return on working capital we delivered this quarter demonstrate the operating leverage and earnings power in our business model. We will continue to stay close to our customers and suppliers, manage inventory and expenses with discipline while still making investments and focus on delivering growth profitability and returns for all of our stakeholders. So with that, I'll turn it over to Ken to dive deeper into our first quarter results. Ken?

Thank you, Phil, and good morning, everyone. We appreciate your interest in Avnet. Our sales for the first quarter were $10.7 million, up 82% year-over-year. On a sequential basis, sales were higher by 29%. The first quarter had 14 weeks compared to a typical 13-week quarter. Normalizing the first quarter growth by excluding the impact of the extra week, sales grew 71% year-over-year and 21% sequentially. Foreign currency did not have a meaningful impact on our sales growth this quarter. Regionally, on a year-over-year basis, sales increased 19% in the Americas, 79% in Asia and 64% in EMEA. . On a sequential basis, sales increased 39% in the Americas, 30% in Asia and 19% in EMEA. During the first quarter, sales from Asia represented 48% of total sales compared to 47% of sales last quarter and 49% of sales last year. From an operating group perspective, Electronic Components had record sales during the quarter, increasing 84% year-over-year and 30% sequentially. Normalized for the impact of the extra week, EC sales grew 73% year-over-year and 22% sequentially. Farnell also had record sales during the quarter, increasing 46% year-over-year and 17% sequentially. From a pricing perspective, memory prices increased during the quarter at similar levels to last quarter. As a result, approximately 1/3 of both the sequential and year-over-year sales growth was attributable to pricing increases in the memory product category. We did not see a meaningful impact from pricing in other electronic component categories beyond memory during the quarter. Gross profit margin of 10% decreased about 40 basis points year-over-year and sequentially, primarily due to product and customer mix in the quarter. Electronic Components gross profit margin was down about 30 basis points year-over-year and sequentially. EC gross margin declined primarily due to the growth in our Avnet Integrated Solutions business, which had a lower gross margin than the EC average, but contributed meaningfully to the operating margin expansion. Farnell gross margin increased about 200 basis points year-over-year and declined about 60 basis points sequentially. The year-over-year improvement in gross margin is primarily due to the growth of on-the-board components which come with a higher gross margin. Farnell's gross margins at the product category level remained stable. Turning to operating expenses. SG&A expenses were $576 million in the quarter, up $112 million year-over-year and $29 million sequentially. The sequential increase in SG&A is primarily due to a combination of higher sales, annual pay increases for our employees that took effect in the new fiscal year, the impact of the extra week in the quarter and from an increase in stock-based compensation expense. As a percentage of gross profit dollars, operating expenses were 54%, exceeding our near-term target by approximately 600 basis points. We expect to continue to drive Avnet operating expense to gross profit dollar ratio to low 50s through the remainder of fiscal 2027. Our EC business had a record low operating expense gross profit dollar ratio of 46% for the quarter compared to 69% last year and 56% last quarter. The Farnell operating expense to gross profit dollar ratio was 65% in the quarter, which is the lowest level since the first quarter of fiscal 2023. As we move through fiscal 2027, we will continue to maintain a high level of cost discipline, while still making the necessary investments in the business to enable profitable growth. For the first quarter, we reported adjusted operating income of nearly $500 million, and the Avnet adjusted operating margin was 4.7%, an increase of more than 200 basis points year-over-year and more than 80 basis points from last quarter. This represents the fifth consecutive quarter of adjusted operating margin expansion and the highest Avnet operating margin since fiscal 2023. Adjusted operating income also grew approximately 3x greater than sales compared to last year and approximately 2x greater than sales compared to last quarter. This is consistent with our continued expectation of driving operating income growth at least twice the rate of sales growth. By operating group, Electronic Components operating income was $484 million and EC operating margin was 4.8% in the first quarter, a 71 basis point sequential increase. Similar to last quarter, the sequential improvement in the EC operating margins was led by the Americas, including both the core and Avnet Integrated Solutions business with all regions increasing their operating margin over 45 basis points sequentially and even more year-over-year. We expect EC operating margin to reach a near-term goal of 5% in the second half of fiscal 2027. Farnell operating income margin of 10.1% was the highest operating margin in more than 3 years. Farnell operating income margin grew by over 100 basis points sequentially, achieving our near-term target of returning the business to a double-digit operating margin. We expect to continue to expand Farnell operating margin beyond 10% as they continue to grow and the product mix of only components improves. Turning to expenses below operating income. First quarter interest expense was $92 million, a sequential increase of $25 million, mainly due to higher debt levels to support working capital investments for stronger-than-expected sales growth. The increase in interest expense negatively impacted adjusted diluted earnings per share by $0.23 quarter-over-quarter. Our adjusted effective income tax rate was 23%, consistent with expectations. Adjusted diluted earnings per share of $3.63 was a quarterly record for Avnet and was well above the high end of our guidance. Adjusted diluted earnings per share grew 4.1x greater than sales compared to last year and grew 2x greater than sales compared to last quarter. Turning to the balance sheet and liquidity. During the quarter, we invested $1.2 billion in working capital sequentially to support our profitable sales growth. Of this increase, approximately $2.1 billion came from inventories, substantially offset by $1.8 billion increase in accounts payable. Accounts receivable increased by approximately $900 million, which was the primary driver for the use of operating cash flow during the quarter. The increase in inventory was driven by a few factors. Roughly 1/3 of the inventory increase was due to memory-related pricing. Another 1/3 was attributable to increases specific to supply chain services engagement. The final 1/3 was primarily due to a combination of sales growth as well as the timing of inventory set near quarter ended October 3, which is later than the quarter end of many of our suppliers. Inventory continues to be a key driver for our business and helped enable us to achieve record sales and earnings during the quarter. We are positioning ourselves appropriately from an inventory perspective so that we can capitalize on the numerous opportunities we see in the markets we serve. Inventory days remained relatively flat sequentially. Our accounts payable and accounts receivable days improved quarter-over-quarter. Overall, working capital days decreased 5 days quarter-over-quarter to 64 days. We continue to focus on disciplined inventory and working capital management, which is contributing to the improvement in our return on working capital. Our return on working capital improved by approximately 600 basis points sequentially to 25%, which is the highest level of returns in the past 10 years. The increase in working capital led to an increase in debt of approximately $950 million and an approximate $842 million use of cash from operations for the quarter. Because we expect strong sales growth in the coming quarter, we also anticipate using cash to support that growth. As growth moderates, we expect cash generation to catch up, and we are currently expecting to generate positive cash flow by the end of fiscal 2027. During the quarter, we raised additional capital, primarily through various debt instruments and facilities to support these increased working capital requirements. We expect to continue to raise additional capital over the coming quarters as we support the anticipated growth through the remainder of fiscal 2027 and beyond. We ended the first quarter with a gross leverage of 3.1x, down from 3.2x in the fourth quarter and approximately $1.2 billion of available committed borrowing capacity. We anticipate reaching our target of 3x leverage by the second half of fiscal 2027. Cash used for capital expenditures was $24 million during the quarter as expected. With regard to our capital allocation strategy, we continue to prioritize supporting our profitable growth while maintaining a strong and flexible balance sheet. We also increased our quarterly dividend by approximately 6% to $0.37 per share this quarter. Over the past decade, we have more than doubled the dividend with the average annual increase exceeding 10%. During that same time, we have also returned approximately $1 billion to shareholders through these dividends. We also expect to continue to explore potential tuck-in M&A opportunities that equip us with the capabilities needed to further advance our strategic priorities and provide a strong risk-adjusted return on capital. Finally, as cash generation improves, we'd also expect to revisit our share buyback program, which still have $226 million of authorization remaining. Turning to the second quarter guidance. We're guiding sales in the range of $11.1 billion to $11.4 billion and adjusted diluted earnings per share in the range of $3.90 to $4.10. Our second quarter guidance assumes current market conditions and electronic component availability, including in the memory product category for SIT. Our guidance implies a sequential sales increase of 5% at the midpoint. Adjusted for the extra week in Q1, Q2 sales are expected to increase 12% sequentially at the midpoint on a comparable basis. This guidance also assumes similar interest expense compared to the first quarter, an effective tax rate of between 21% and 25% and 87 million shares outstanding on a diluted basis. In closing, we're optimistic about the strong start to the fiscal year and the continued momentum we see in our leading indicators for fiscal 2027. Our first quarter results and second quarter guidance demonstrate that our team continues to deliver profitable growth on the value proposition we bring to our customers and suppliers. With that, I will turn it over the operator to open it up for questions. Operator?

[Operator Instructions] Our first question is from Mr. William Stein with Truist Securities.

Congrats on the great results and outlook. I'm hoping you can talk to us a bit about lead times. We know they're stretching, you cited it in your prepared remarks. I'm wondering if challenging your ability to grow to deliver products and grow? And if so, maybe quantify any impact from that?

Yes. Thanks, Will. Thanks for your comments. I appreciate it. This is Phil. Yes. So we did comment on that. And we are seeing we kind start to lap more, I would say, more broadly. It's -- we know what's happening in memory and the likes. We're starting to now see it power -- well, power has been out, start to season passes, MLCC discrete. So it's much more broad controllers. But I can't say -- and with that, as we also talked about, we're starting to see some additional inflation in pricing as well with ASP starting to get impacted again, probably most of that probably starting in the new calendar year. To date, I want to say -- well, to date, we've not seen that directly inhibiting our growth currently through the quarter or in our guidance tough to call into next year yet as things tighten up. So right now, I would say, not a lot. Are some customers struggling, particularly there heavy concentration of memory in their bomb. They're having a tougher time. Yes, we have some customers that maybe aren't producing maybe as many tables as they were before or things along those lines. So I talk to measures, I mean, they're done or just slowed down, but it's not really broad-based at this point. But of course, we're watching it because we know -- we know what has happened in previous cycles where lead times go out. we started to get into some challenges there. But to date, again, we're not seeing that as an impact to the growth or forecast guidance.

Great. I appreciate that. As a follow-up, I'd like to ask about guidance and maybe going out a little bit further. You gave us a great December quarter guide, even considering the extra week that I think you just had in September, the December guide is still, I think, points above typical seasonality. And understanding you're not guiding further than a quarter. When we look to March, I think normal seasonality is approximately down 1% or 2%. Would that be an appropriate way to think about growth in this part of the cycle? Or considering the strength that we're seeing, should we expect stability or sequential growth into March?

Yes. Well, let me take a shot at that and I'll pass over to KJ for some comments. Yes, we don't guide out that far. So you're right. So thanks for saying that. But as far as we look out -- the March quarter has kind of been a wildcard over the last several years, if you look at it with the Lunar New Year last year did not have much of an effect that before it bid. You write typical, which is a word we don't use much anymore because it's typical. March would be down more dramatically in Asia Pac to the Lunar New Year and the West would come back up. And it would almost offset, but you're down 1% or 2%. Right now, as we look at it, again, we're not guiding in the wildcard being little New Year, we feel the West is going to still be pretty strong into the March quarter. And just looking at the backlog, which I'm looking at as we speak, the backlog looks good for March quarter overall. So the book-to-bills, we talk about, continue to be positive. So we're -- I'll just say we're optimistic about the March quarter, maybe even be a little bit better than what you called out as typical seasonality. Ken?

Yes, Will. I'd just add that I think at that kind of growth rate you described, let's say, a typical seasonal, that would that also imply, call it, 20 to 40 basis point uplift in gross margin because of the mix shift to the West. And so I think the West is looking good. the wildcard is the impact of Lunar year in Asia. So the count of that is would be if you have higher growth than that above seasonal, that's likely because Asia isn't declining as much to in the year or holidays, similar to the last couple of years.

Our next question is from Ms. Melissa Fairbanks with Raymond James.

So we heard from one of your suppliers earlier this morning. they noted that channel inventories are pretty tight across most geographies, which I think is pretty consistent with what you're seeing as well. but actually exceptionally low in Asia. I know that you've -- Asia has been a very strong market for you for several quarters now. Just wondering what you're seeing in terms of your ability to address upside demand in Asia and what your own inventories in Asia look like today?

Yes. Thanks, Melissa. I think I know what you're referencing there. Anyway, so Again, right now, again, as you saw, we grew inventories, I'm sure we'll give you a breakout on where that growth was in inventory. We're comfortable. We're very confident with our inventory position now. But at these times go out, we're going to invite punishing appropriately. I'm looking at our Asia inventory actually grew sequentially quarter-to-quarter in total dollars in Asia Pac and the inventory days actually went up about a day, 1.5 days or so. So again, right now, we're feeling pretty good about the inventory position we have, again, it can change quickly based on the market and Will's previous questions, but right now, we feel pretty good about it. Now as you need [indiscernible]. It's a broad question, right? The sort of so certain areas in power and discrete and power caps and things like that those lines anything around power where I don't get a lot tighter than some other products. So inventories, so I give you a broad answer to a broad question, you really need to break it down by commodity and see where we're appropriately pipeline and where we have the inventory positions we need. So there could be some pockets that were shorter than we need to be. But in total, our inventory is in pretty good shape.

Okay. Great. I would be happy to break it down by component. If you want to give me that data. So -- look at those sheets, I want to zoom in -- so you mentioned that demand creation activity remains healthy. How much with as much as your mix or just the market mix in general is pivoting to data center, aerospace and defense, networking kind of some of these higher touch areas? How much is that impacting your demand creation business? Are you able to engage with customers? Are they reaching out to you earlier in the design cycle?

Well, it's a really good question because some of that, obviously, what we're dealing directly into the data center. So that might be more just fulfillment. So when it would have demand creation tied to it in many cases, particularly if it's a hyperscale because a lot of that's probably don't direct and we're doing the fulfillment and supply chain piece for that. However, again, good question because you would think with the growth that we had and fulfillment increasing in that space and maybe it's not all the it's not on demand creation, you think the percentage of demand creation would come down as a percentage of our sales. And it's actually flat, which is really good news. Demand creation revenue, yes, as a percentage of our total revenues actually stayed roughly flat as a percentage, dollars were up, obviously, it had to be up to keep pace to stay flat as a percentage of total sales. So we're really pleased with that, frankly, because it's critical -- well, it's critical [indiscernible], it's credit our suppliers, and it helps the margin profile as well.

Our next question is from Mr. Ruplu Bhattacharya with Bank of America.

First question is on inventory. Ken, I think you said of this $2 billion sequential increase. There was 1/3 was due to chain services. How much revenue did supply chain services account for in the quarter? And how should we think about the impact of this going forward? And what inventory days are you targeting? And I have a follow-up.