Avnet Inc: Form 10-Q for the period ended Dec 30, 2023

For a description of the Company’s critical accounting policies and an understanding of Avnet and the significant factors that influenced the Company’s performance during the quarter ended December 30, 2023, this *Management’s Discussion and Analysis of Financial Condition and Results of Operations (“*MD&A”) should be read in conjunction with the consolidated financial statements, including the related notes, appearing in Item 1 of this Quarterly Report on Form 10-Q, as well as the Company’s Annual Report on Form 10-K for the fiscal year ended July 1, 2023.

The discussion of the Company’s results of operations includes references to the impact of foreign currency translation. When the U.S. Dollar strengthens and the stronger exchange rates are used to translate the results of operations of Avnet’s subsidiaries denominated in foreign currencies, the result is a decrease in U.S. Dollars of reported results. Conversely, when the U.S. Dollar weakens, the weaker exchange rates result in an increase in U.S. Dollars of reported results. In the discussion that follows, results excluding this impact, primarily for subsidiaries in Europe, the Middle East and Africa (“EMEA”) and Asia/Pacific (“Asia”), are referred to as “constant currency.”

In addition to disclosing financial results that are determined in accordance with generally accepted accounting principles in the U.S. (“GAAP”), the Company also discloses certain non-GAAP financial information, including:

• Operating income excluding (i) restructuring, integration, and other expenses, and (ii) amortization of acquired intangible assets is referred to as “adjusted operating income.”

The reconciliation of operating income to adjusted operating income is presented in the following table:

Management believes that providing this additional information is useful to financial statement users to better assess and understand operating performance, especially when comparing results with prior periods or forecasting performance for future periods, primarily because management typically monitors the business both including and excluding these adjustments to GAAP results. Management also uses these non-GAAP measures to establish operational goals and, in many cases, for measuring performance for compensation purposes. However, any analysis of results on a non-GAAP basis should be used as a complement to, and in conjunction with, results presented in accordance with GAAP.

OVERVIEW

Organization

Avnet, Inc., including its consolidated subsidiaries (collectively, the “Company” or “Avnet”), is a leading global electronic component technology distributor and solutions provider that has served customers’ evolving needs for more than a century. Founded in 1921, the Company works with suppliers in every major technology segment to serve customers in more than 140 countries.

Avnet has two primary operating groups — Electronic Components (“EC”) and Farnell (“Farnell”). Both operating groups have operations in each of the three major economic regions of the world: (i) the Americas, (ii) EMEA, and (iii) Asia. EC markets, sells, and distributes (i) semiconductors, (ii) interconnect, passive and electromechanical components, and (iii) other integrated and embedded components, to a diverse customer base serving many end-markets. Farnell distributes electronic components and industrial products to a diverse customer base utilizing multi-channel sales and marketing resources.

Results of Operations

Executive Summary

Consolidated sales decreased by $512.6 million or 7.6% to $6.20 billion, from the prior year’s second quarter sales of $6.72 billion. The decrease in sales is primarily due to softening demand for electronic components, driven in part by customers having sufficient inventory on hand to meet their near-term production requirement. The Company expects these market conditions to continue potentially throughout 2024.

Gross profit of $706.2 million for the second quarter of fiscal 2024 decreased $77.9 million from the second quarter of fiscal 2023 primarily due to the decline in sales and to a lesser extent, unfavorable changes in sales mix.

Second-quarter fiscal 2024 operating income was $236.3 million, down $62.7 million or 21.0% from the prior year’s second-quarter operating income of $299.0 million. Operating income margin was 3.8% in the second quarter of fiscal 2024, as compared to 4.5% in the second quarter of fiscal 2023. The year-over-year decrease in operating income and operating income margin is primarily due to lower sales and gross margins, partially offset by lower operating expenses.

Sales

The following table presents sales growth rates (declines) for the second quarter and first six months of fiscal 2024 as compared to fiscal 2023 by geographic region and operating group.

Sales of $6.20 billion for the second quarter of fiscal 2024 decreased $512.6 million, or 7.6%, as compared to $6.72 billion for the same quarter last year. The year-over-year decrease in sales is primarily due to the changing market conditions discussed above. Sales in constant currency decreased 8.7% in the second quarter of fiscal 2024 year over year.

EC sales of $5.81 billion in the second quarter of fiscal 2024 decreased $497.4 million or 7.9% from the prior year second quarter sales of $6.31 billion with all three regions contributing to the decrease. EC sales decreased 8.9% year over year in constant currency.

Farnell sales for the second quarter of fiscal 2024 were $392.8 million, a decrease of $15.2 million or 3.7% from the prior year second quarter sales of $408.0 million. Farnell sales in constant currency in the second quarter of fiscal 2024 decreased by 6.0% year over year primarily due to a decline in demand for on-the-board electronic components from high service distributors and competitive pricing pressures.

Sales for the first six months of fiscal 2024 were $12.54 billion, a decrease of $927.1 million as compared to sales of $13.47 billion for the first six months of fiscal 2023 driven by lower demand across all regions.

Gross Profit

Gross profit for the second quarter of fiscal 2024 was $706.2 million, a decrease of $77.9 million or 9.9% from the second quarter of fiscal 2023 gross profit of $784.1 million. Gross profit margin of 11.4% decreased 29 basis points compared to the second quarter of fiscal 2023 gross profit margin of 11.7%. The decreases in gross profit and gross profit margin in the second quarter of fiscal 2024 as compared to fiscal 2023 are primarily due to decreased sales, and unfavorable shifts in product mix, respectively. EC gross profit margin decreased year over year primarily due to unfavorable product mix shifts. Farnell gross profit margin decreased year over year primarily due to the unwinding of component shortage pricing premiums, a lower sales mix of on-the-board electronic components, and from competitive pricing pressures for on-the-board components.

Gross profit and gross profit margin were $1.45 billion and 11.6%, respectively, for the first six months of fiscal 2024 as compared with $1.55 billion and 11.5%, respectively, for the first six months of fiscal 2023.

Selling, General and Administrative Expenses

Selling, general and administrative expenses (“SG&A expenses”) were $464.7 million in the second quarter of fiscal 2024, a decrease of $20.4 million or 4.2% from the second quarter of fiscal 2023. The year-over-year decrease in SG&A expenses was primarily a result of declines in sales partially offset by the impact of changes in foreign currency translation rates.

Metrics that management monitors with respect to its operating expenses are SG&A expenses as a percentage of sales and as a percentage of gross profit. In the second quarter of fiscal 2024, SG&A expenses were 7.5% of sales and 65.8% of gross profit, as compared with 7.2% and 61.9%, respectively, in the second quarter of fiscal 2023. The year-over-year increase in SG&A expense as a percentage of both sales and gross profit is primarily due to the decrease in sales and gross profit.

SG&A expenses for the first six months of fiscal 2024 were $952.0 million, or 7.6% of sales, as compared with $962.8 million, or 7.1% of sales, in the first six months of fiscal 2023. SG&A expenses as a percentage of gross profit for the first six months of fiscal 2024 were 65.5% as compared with 62.0% in the first six months of fiscal 2023.

Restructuring, Integration and Other Expenses

The Company recorded restructuring, integration, and other expenses of $5.2 million during the second quarter of fiscal 2024. The after-tax impact of restructuring, integration, and other expenses were $4.0 million and $0.04 per share on a diluted basis.

During the first six months of fiscal 2024, the Company incurred restructuring costs of $2.8 million and other expenses of $9.5 million. Restructuring expenses consisted of severance costs of $2.8 million related to the reduction, or planned reduction of over 50 employees in the Company’s Farnell operating group. The after-tax impact of restructuring, integration, and other expenses were $9.3 million and $0.09 per share on a diluted basis.

The Company expects to incur approximately $15.0 million to $25.0 million of restructuring, integration and other expenses in the second half of fiscal 2024 primarily related to Farnell. The expected benefits from the Farnell restructuring actions, once completed, are $50.0 million to $70.0 million of annual operating expense reductions.

Operating Income

Operating income for the second quarter of fiscal 2024 was $236.3 million, a decrease of $62.7 million or 21.0%, from the second quarter of fiscal 2023 operating income of $299.0 million. The year-over-year decrease in operating income was primarily driven by the decrease in sales, partially offset by the favorable impact from foreign currency exchange rates. Adjusted operating income for the second quarter of fiscal 2024 was $242.2 million, a decrease of $58.3 million or 19.4% from the second quarter of fiscal 2023. Operating income margin was 3.8% in the second quarter of fiscal 2024, a decrease of 64 basis points compared to 4.5% in the prior year second quarter.

EC operating income margin decreased 43 basis points year over year to 4.3% and Farnell operating income margin decreased 504 basis points year over year to 4.0%. The decline in operating income margin in both operating groups was primarily driven by lower sales and declines in gross profit margin as discussed further above.

Operating income for the first six months of fiscal 2024 was $490.0 million, a decrease of $99.5 million, from the first six months of fiscal 2023 operating income of $589.5 million. The year-over-year decrease in operating income was primarily due to the decrease in sales, and lower gross profit margin, partially offset by the favorable impact from foreign currency exchange rates. Adjusted operating income for the first six months of fiscal 2024 was $503.9 million, a decrease of $89.9 million or 15.1% from the first six months of fiscal 2023. Operating income margin was 3.9% in the first six months of fiscal 2024, a decrease of 47 basis points compared to 4.4% in the prior year first six months.

Interest and Other Financing Expenses, Net and Other (Expense) Income, Net

Interest and other financing expenses in the second quarter of fiscal 2024 was $74.3 million, an increase of $15.3 million, as compared with interest and other financing expenses of $59.0 million in the second quarter of fiscal 2023. Interest and other financing expenses in the first six months of fiscal 2024 was $145.1 million, an increase of $41.0 million, as compared with interest and other financing expenses of $104.1 million in the first six months of fiscal 2023. The increases in interest and other financing expenses in the second quarter and first six months of fiscal 2024 compared to fiscal 2023 are primarily a result of higher outstanding borrowings and increases in average borrowing rates.

The Company had other expenses of $8.4 million in the second quarter of fiscal 2024 compared to other income of $1.5 million in the second quarter of fiscal 2023. The $9.9 million increase in other expenses in the second quarter of fiscal 2024 was primarily due to foreign currency translation losses. The Company had other expenses of $2.4 million in the first six months of fiscal 2024, compared to other income of $1.8 million in the first six months of fiscal 2023.

Gain on Legal Settlements and other

During the first six months of fiscal 2024 and the first six months of fiscal 2023, the Company recorded a gain on legal settlements and other of $86.5 million and $61.7 million, respectively, in connection with the settlements of claims filed against certain manufacturers of capacitors.

Income Tax

The below discussion of the effective tax rate for the periods presented in the consolidated statements of operations is in comparison to the 21% U.S. statutory federal income tax rate.

The Company’s effective tax rate on its income before taxes was 23.2% in the second quarter of fiscal 2024. During the second quarter of fiscal 2024, the Company’s effective tax rate was unfavorably impacted primarily by (i) increases to unrecognized tax benefit reserves, (ii) U.S. state taxes, partially offset by (iii) the mix of income in lower tax foreign jurisdictions.

During the second quarter of fiscal 2023, the Company’s effective tax rate on its income before taxes was 19.5%. During the second quarter of fiscal 2023, the Company’s effective tax rate was favorably impacted primarily by (i) increases in unrecognized tax benefit reserves, partially offset by (ii) the mix of income in higher tax foreign jurisdictions.

For the first six months of fiscal 2024, the Company’s effective tax rate on its income before taxes was 23.7%. The effective tax rate for the first six months of fiscal 2024 was unfavorably impacted primarily by (i) increases to unrecognized tax benefit reserves, (ii) U.S. state taxes, and (iii) the mix of income in higher tax foreign jurisdictions.

During the first six months of fiscal 2023, the Company’s effective tax rate on its income before taxes was 22.0%. The effective tax rate for the first six months of fiscal 2023 was unfavorably impacted primarily by (i) the mix of income in higher tax foreign jurisdictions, partially offset by (ii) decreases to unrecognized tax benefit reserves.

Net Income

As a result of the factors described in the preceding sections of this MD&A, the Company’s net income for the second quarter of fiscal 2024 was $117.9 million, or $1.28 per share on a diluted basis, as compared with $243.9 million, or $2.63 per share on a diluted basis, in the second quarter of fiscal 2023.

As a result of the factors described in the preceding sections of this MD&A, the Company’s net income for the first six months of fiscal 2024 was $327.2 million, or $3.54 per share on a diluted basis, as compared with $428.1 million, or $4.55 per share on a diluted basis, in the first six months of fiscal 2023.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flow

Cash Flow from Operating Activities

During the first six months of fiscal 2024, the Company used $83.6 million of cash flow for operations compared to $966.5 million of cash used for operations in the first six months of fiscal 2023. These operating cash flows were comprised of: (i) cash flow generated from net income, adjusted for the impact of non-cash and other items, which includes depreciation and amortization expenses, deferred income taxes, stock-based compensation expense, amortization of operating lease assets, and other non-cash items, and (ii) cash flows used for working capital and other, excluding cash and cash equivalents. Cash used for working capital and other was $539.4 million during the first six months of fiscal 2024, including an increase in inventories of $610.0 million, and decreases in accounts payable of $78.1 million, and accrued expenses and other of $138.7 million, partially offset by a decrease in accounts receivable of $287.3 million. Comparatively, cash used for working capital and other was $1.48 billion during the first six months of fiscal 2023, including increases in accounts receivable of $469.7 million, and in inventories of $686.9 million, and a decrease in accounts payable of $341.2 million, partially offset by an increase in accrued expenses and other of $20.0 million.

Cash Flow from Financing Activities

During the first six months of fiscal 2024, the Company received net proceeds of $272.7 million under the Credit Facility, $58.6 million under the Securitization Program, and $30.8 million under other short-term debt. During the first six months of fiscal 2024, the Company paid dividends on common stock of $56.1 million and repurchased $86.0 million of common stock.

During the first six months of fiscal 2023, the Company received net proceeds of $1.13 billion and $352.2 million under the Credit Facility and the Securitization Program, respectively, and $47.7 million under other short-term debt. During the first six months of fiscal 2023, the Company paid dividends on common stock of $53.3 million and repurchased $221.3 million of common stock.

Cash Flow from Investing Activities

During the first six months of fiscal 2024, the Company used $158.1 million for capital expenditures as compared to $111.4 million for capital expenditures in the first six months of fiscal 2023. The increase in capital expenditures is primarily due to distribution center expansions in EMEA.

Contractual Obligations

For a detailed description of the Company’s long-term debt and lease commitments for the next five years and thereafter, see Long-Term Contractual Obligations appearing in Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended July 1, 2023. There are no material changes to this information outside of normal borrowings and repayments of long-term debt and operating lease payments. The Company does not currently have any material non-cancellable commitments for capital expenditures or inventory purchases outside of the normal course of business.

Financing Transactions

See Note 4, “Debt” to the Company’s consolidated financial statements included in this Quarterly Report on Form 10-Q for additional information on financing transactions including the Credit Facility, the Securitization Program, and other outstanding debt as of December 30, 2023. The Company was in compliance with all covenants under the Credit Facility and the Securitization Program as of December 30, 2023, and July 1, 2023.

The Company has various lines of credit, financing arrangements, and other forms of bank debt in the U.S. and various foreign locations to fund the short-term working capital, foreign exchange, overdraft, capital expenditure, and letter of credit needs of its wholly owned subsidiaries. Outstanding borrowings under such forms of debt at the end of second quarter of fiscal 2024 was $105.1 million.

As an alternative form of liquidity outside of the United States, the Company sells certain of its trade accounts receivable on a non-recourse basis to financial institutions pursuant to factoring agreements. The Company accounts for these transactions as sales of receivables and presents cash proceeds as cash provided by operating activities in the consolidated statements of cash flows. Factoring fees for the sales of trade accounts receivable are recorded within “Interest and other financing expenses, net” and were not material to the consolidated financial statements.

Liquidity

The Company held cash and cash equivalents of $272.9 million as of December 30, 2023, of which $178.7 million was held outside the United States. As of July 1, 2023, the Company held cash and cash equivalents of $288.2 million, of which $194.5 million was held outside of the United States.

During periods of weakening demand in the electronic components industry, the Company typically generates cash from operating activities. Conversely, the Company will use cash for working capital requirements during periods of higher growth. The Company generated $169.2 million in cash flows for operating activities over the trailing four fiscal quarters ended December 30, 2023.

Liquidity is subject to many factors, such as normal business operations and general economic, financial, competitive, legislative, and regulatory factors that are beyond the Company’s control. To the extent the cash balances held in foreign locations cannot be remitted back to the U.S. in a tax efficient manner, those cash balances are generally used for ongoing working capital, including the need to purchase inventories, capital expenditures and other foreign business needs. In addition, local government regulations may restrict the Company’s ability to move funds among various locations under certain circumstances. Management does not believe such restrictions would limit the Company’s ability to pursue its intended business strategy.

As of the end of the second quarter of fiscal 2024, the Company had a combined total borrowing capacity of $2.20 billion under the Credit Facility and the Securitization Program. There were $1.09 billion of borrowings outstanding and $0.9 million in letters of credit issued under the Credit Facility, and $614.4 million outstanding under the Securitization Program, resulting in approximately $493.0 million of total committed availability as of December 30, 2023. Availability under the Securitization Program is subject to the Company having sufficient eligible trade accounts receivable in the United States to support desired borrowings.

During the second quarter and first six months of fiscal 2024, the Company had an average daily balance outstanding of approximately $1.30 billion and $1.23 billion, respectively, under the Credit Facility and approximately $612.3 million and $618.6 million, respectively, under the Securitization Program.

As of December 30, 2023, the Company may repurchase up to an aggregate of $232.5 million of shares of the Company’s common stock through the share repurchase program approved by the Board of Directors. The Company may repurchase stock from time to time at the discretion of management, subject to strategic considerations, market conditions including share price and other factors. The Company may terminate or limit the share repurchase program at any time without prior notice. During the second quarter of fiscal 2024, the Company repurchased $59.0 million of common stock.

The Company has historically paid quarterly cash dividends on shares of its common stock, and future dividends are subject to approval by the Board of Directors. During the second quarter of fiscal 2024, the Board of Directors approved a dividend of $0.31 per share, which resulted in $27.8 million of dividend payments during the quarter.

The Company continually monitors and reviews its liquidity position and funding needs. Management believes that the Company’s ability to generate operating cash flows through the liquidation of working capital in the future and available borrowing capacity, including capacity for the non-recourse sale of trade accounts receivable, will be sufficient to meet its future liquidity needs. Additionally, the Company believes that it has sufficient access to additional liquidity from the capital markets if necessary.

Recently Issued Accounting Pronouncements

See Note 1, “Basis of presentation and new accounting pronouncements” to the Company’s consolidated financial statements included in this Quarterly Report on Form 10-Q for a description of recently issued accounting pronouncements.

The Company seeks to reduce earnings and cash flow volatility associated with changes in interest rates and foreign currency exchange rates by entering into financial arrangements, from time to time, that are intended to provide an economic hedge against some or all, of the risks associated with such volatility. The Company continues to have exposure to such risks to the extent they are not economically hedged.

See Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in the Company’s Annual Report on Form 10-K for the fiscal year ended July 1, 2023, for further discussion of market risks associated with foreign currency exchange rates and interest rates. Avnet’s exposure to such risks has not changed materially since July 1, 2023, as the Company continues to economically hedge the majority of its foreign currency exchange exposures. Thus, any increase or decrease in the fair value of the Company’s forward foreign currency exchange contracts is generally offset by an opposite effect on the related economically hedged position. For interest rate risk, the Company continues to maintain a combination of fixed and variable rate debt to mitigate the exposure to fluctuations in market interest rates.

See Liquidity and Capital Resources — Financing Transactions appearing in Item 2 of this Quarterly Report on Form 10-Q for further discussion of the Company’s financing transactions and capital structure. As of December 30, 2023, approximately 48% of the Company’s debt bears interest at a fixed rate and 52% of the Company’s debt bears interest at variable rates. Therefore, a hypothetical 1.0% (100 basis points) increase in interest rates would result in a $4.5 million decrease in income before income taxes in the Company’s consolidated statement of operations for the second quarter of fiscal 2024.

The Company’s management, including its Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the reporting period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s disclosure controls and procedures are effective such that material information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified by the Securities and Exchange Commission’s rules and forms and is accumulated and communicated to management, including the Company’s principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

During the second quarter of fiscal 2024, there were no changes to the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II

OTHER INFORMATION

The discussion of the Company’s business and operations should be read together with the risk factors contained in Item 1A of its Annual Report on Form 10-K for the fiscal year ended July 1, 2023, which describe various risks and uncertainties to which the Company is or may become subject. These risks and uncertainties have the potential to affect the Company’s business, financial condition, results of operations, cash flows, strategies or prospects in a material and adverse manner. As of December 30, 2023, there have been no material changes to the risk factors set forth in the Company’s Annual Report on Form 10-K for the fiscal year ended July 1, 2023.