Avnet Inc: Form 10-Q for the period ended Mar 30, 2024

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 March 30, 2024, 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:

• “Adjusted operating income,” which is operating income excluding (i) restructuring, integration, and other expenses, and (ii) amortization of acquired intangible assets.

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 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. 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.

Industry outlook

The global electronic components market has a history of cyclical downturns followed by periods of increased demand. Beginning in the second half of calendar year 2023, the industry began to experience a downturn marked by a decrease in sales due to a combination of elevated customer inventory levels and lower underlying demand for electronic components. As a result, the Company has seen elevated inventory levels and decreased sales, resulting in lower operating income. The duration of the current downturn is uncertain, although there are some encouraging signs, such as indications of potential sequential growth in Asia and increases in IP&E orders in EMEA and Farnell. The Company expects sales in the fourth quarter of fiscal 2024 to be 3% to 8% lower than third quarter sales, which will negatively impact operating income and diluted earnings per share.

Results of Operations

($ in millions, unless otherwise stated)

Sales

The following table presents sales decline rates for the third quarter and first nine months of fiscal 2024 as compared to fiscal 2023, by geographic region and operating group.

Sales of $5.65 billion for the third quarter of fiscal 2024 decreased $861.0 million, or 13.2%, as compared to $6.51 billion for the same quarter last year. Sales for the first nine months of fiscal 2024 were $18.19 billion, a decrease of $1.79 billion, or 9.0%, as compared to sales of $19.98 billion for the first nine months of fiscal 2023. The decrease in sales on both a quarterly and year-to-date comparison basis is driven by a reduction in sales volume primarily due to the on-going market downturn occurring across the electronic components industry and, to a lesser extent, an unfavorable product mix of lower priced electronic components.

EC sales of $5.25 billion in the third quarter of fiscal 2024 decreased $813.9 million, or 13.4%, from the prior year third quarter sales of $6.06 billion, with all three regions contributing to the decrease. The decrease in sales is primarily due to sales volume decreases due to the market downturn in the electronic components industry and, to a lesser extent, an unfavorable product mix of lower priced electronic components.

Farnell sales for the third quarter of fiscal 2024 were $407.8 million, reflecting a decrease of $47.2 million, or 10.4%, compared to the same period in the prior year. Farnell sales in constant currency for the third quarter of fiscal 2024 decreased by 11.2% year over year. The decrease in sales in the third quarter of fiscal 2024 is primarily due to lower demand, including lower demand for on-the-board electronic components, partially offset by increases in availability and demand for single board computers.

Gross Profit

The Company’s gross profit is primarily affected by sales volume and geographic sales mix. Gross profit for the third quarter of fiscal 2024 was $142.6 million, or 17.6% lower than the third quarter of fiscal 2023. Gross profit for the first nine months of fiscal 2024 was $240.6 million, or 10.2% lower than the first nine months of fiscal 2023. These decreases are primarily due to sales volume decreases in both operating groups in all three regions.

Gross profit margin decreased by 62 basis points to 11.8% for the third quarter of fiscal 2024 when compared to the third quarter of fiscal 2023 and decreased by 16 basis points to 11.7% for the first nine months of fiscal 2024 when compared to the first nine months of fiscal 2023. The quarter and year to date decreases in gross profit margin are primarily due to an increase in product mix to lower margin electronic components and, to a lesser extent, shifts in geographic sales mix. Sales in the higher gross profit margin western regions represented approximately 61% of sales in the third quarter of fiscal 2024, versus 63% during the third quarter of fiscal 2023.

EC gross profit margin decreased year over year largely due to an increase in product mix to lower margin electronic components. Farnell gross profit margin decreased year over year, primarily due to lower sales of higher margin on-the-board electronic components.

Selling, General and Administrative Expenses

Selling, general, and administrative expenses (“SG&A expenses”) decreased $30.9 million or 6.2% from the third quarter of fiscal 2023 and decreased $41.7 million, or 2.9%, from the first nine months of fiscal 2023. The quarterly and year-to-date decreases in SG&A expenses are primarily due to decreases in variable operating expenses associated with the decrease in sales volumes discussed above, partially offset by increases in costs due to inflation. Additionally, the first nine months of fiscal 2024 benefited from the impact of changes in foreign currency translation rates.

Management monitors SG&A expenses as a percentage of sales and as a percentage of gross profit. In the third quarter of fiscal 2024, SG&A expenses were 8.3% of sales and 69.8% of gross profit, as compared with 7.6% and 61.4%, respectively, in the third quarter of fiscal 2023. SG&A expenses were 7.8% of sales and 66.8% of gross profit in the first nine months of fiscal 2024 compared with 7.3% and 61.8%, respectively, in the first nine months of fiscal 2023. The year-over-year increases in SG&A expenses as a percentage of both sales and gross profit are primarily due to the decrease in sales and gross profit without a proportional reduction in SG&A expenses, resulting in lower operating leverage.

Restructuring, Integration, and Other Expenses

During the third quarter of fiscal 2024, the Company implemented a plan to reduce SG&A expenses at Farnell and deliver $50 million to $70 million in annual benefits. Additionally, the Company began expense reduction initiatives within EC and for corporate expenses, which are expected to yield additional annual cost savings of between $40 million to $60 million when completed.

The Company recorded restructuring, integration, and other expenses of $11.8 million during the third quarter of fiscal 2024, comprised of severance and other employee-related expenses of $14.8 million for reductions in headcount, $2.3 million of integration expense for the consolidation of certain warehouses, and other costs of $0.2 million. Additionally, the Company recorded a reduction of $5.5 million to environmental remediation reserves after entering into a favorable consent decree with a state agency for a certain environmental cleanup matter. The after-tax impact of restructuring, integration, and other expenses were $9.1 million and $0.10 per share on a diluted basis. Approximately half of the planned annual expense reductions were completed by the end of the third quarter of fiscal 2024 and the remaining actions will be completed by the end of fiscal 2024.

During the first nine months of fiscal 2024, the Company incurred restructuring costs of $17.6 million and integration and other expenses of $6.6 million and $5.5 million, respectively. Restructuring expenses consisted of severance and other employee-related expenses of $17.6 million associated with the reduction, or planned reduction of approximately 400 employees predominately in the Company’s Farnell operating group, integration costs of $6.6 million related to the Company’s consolidation of several smaller warehouses, and other costs of $5.5 million related to certain legal and accounting costs associated with M&A activity that did not lead to a transaction. Additionally, the Company recorded a reduction of $5.6 million, primarily related to environmental remediation reserves as discussed above. The after-tax impact of restructuring, integration, and other expenses were $18.4 million and $0.20 per share on a diluted basis.

The Company expects to incur incremental restructuring, integration, and other expenses in the fourth quarter of fiscal 2024 similar to the amounts incurred in the third quarter of fiscal 2024. See Note 14 “Restructuring expenses” to the Company’s consolidated financial statements included in this Quarterly Report on Form 10-Q.

Operating Income

Operating income for the third quarter of fiscal 2024 was $190.2 million, a decrease of $123.5 million or 39.4%, year over year. Operating income margin for the third quarter of fiscal 2024 was 3.4%, a decrease of 145 basis points compared to 4.8% in the third quarter of fiscal 2023. On a year-to-date basis, operating income was $680.2 million for the first nine months of fiscal 2024, a decrease of $223.0 million, or 24.7%, from the first nine months of fiscal 2023. Operating income margin was 3.7% in the first nine months of fiscal 2024, a decrease of 78 basis points compared to 4.5% in the first nine months of fiscal 2023. The decreases in operating income and operating income margin for both the quarter and year-to-date periods are primarily due to the decrease in gross profit primarily from lower sales without a proportionate decrease in SG&A expenses, as discussed above. Additionally, the Company incurred restructuring, integration, and other expenses during the third quarter and first nine months of fiscal 2024, whereas there were no such expenses in the third quarter or first nine months of fiscal 2023. Finally, the first nine months of fiscal 2024 benefited from the impact of changes in foreign currency translation rates.

Comparing the third quarter of fiscal 2024 to the third quarter of fiscal 2023, EC operating income decreased 29.0% to $216.8 million, and EC operating income margin decreased 91 basis points to 4.1%, with all three regions contributing to the decrease. Farnell operating income decreased 60.1% to $16.3 million in the third quarter of fiscal 2024 and Farnell operating income margin decreased 499 basis points year over year to 4.0%. The decreases in operating income and operating income margin in both operating groups are due to the decrease in gross profit primarily from lower sales without a proportionate decrease in SG&A expenses. Corporate operating expenses were $30.4 million in the third quarter of fiscal 2024, a decrease of 3.8% when compared with $31.6 million in the third quarter of fiscal 2023.

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

Interest and other financing expenses in the third quarter of fiscal 2024 were $73.5 million, an increase of $1.8 million as compared to $71.7 million in the third quarter of fiscal 2023. Interest and other financing expenses in the first nine months of fiscal 2024 were $218.6 million, an increase of $42.8 million as compared to $175.8 million in the first nine months of fiscal 2023. The increases in interest and other financing expenses in the third quarter and first nine 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 $14.7 million in the third quarter of fiscal 2024 compared to other income of $1.7 million in the third quarter of fiscal 2023. The $16.4 million increase in other expenses in the third quarter of fiscal 2024 is primarily due to foreign currency translation losses. The Company had other expenses of $17.1 million in the first nine months of fiscal 2024, compared to other income of $3.5 million in the first nine months of fiscal 2023. The increase in other expenses is primarily due to foreign currency translation losses.

Gain on Legal Settlements and other

During the first nine months of fiscal 2024 and the first nine 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

Income tax expenses were $13.1 million and $114.9 million for the third quarter and first nine months of fiscal 2024, respectively, reflecting an effective tax rate of 12.9% and 21.6%, respectively. In comparison, for the third quarter and first nine months of fiscal 2023, income tax expenses were $56.2 million and $176.9 million, respectively, reflecting an effective tax rate of 23.1% and 22.3%, respectively. The decrease in the effective tax rate for the third quarter of fiscal 2024 as compared to the third quarter of fiscal 2023 was primarily due to the mix of income in lower tax foreign jurisdictions and decreases to unrecognized tax benefit reserves, net of settlements. The decrease in the effective tax rate for the first nine months of fiscal 2024 as compared to the first nine months of fiscal 2023 was primarily due to the mix of income in lower tax foreign jurisdictions, partially offset by increases to unrecognized tax benefit reserves, net of settlements. See Note 8 “Income taxes” to the Company’s consolidated financial statements included in this Quarterly Report on Form 10-Q.

Net Income

As a result of the factors described above, the Company’s net income for the third quarter of fiscal 2024 was $88.8 million, or $0.97 per share on a diluted basis, as compared with $187.4 million, or $2.03 per share on a diluted basis, in the third quarter of fiscal 2023.

As a result of the factors described above, the Company’s net income for the first nine months of fiscal 2024 was $416.0 million, or $4.52 per share on a diluted basis, as compared with $615.6 million, or $6.58 per share on a diluted basis, in the first nine months of fiscal 2023.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flow

Operating Activities

Net cash provided by operating activities was $499 million for the third quarter of fiscal 2024. Net cash provided by operating activities was $415.7 million for the first nine months of fiscal 2024, compared to net cash used by operating activities of $948.2 million for the first nine months of fiscal 2023. The $1.4 billion increase in net cash provided by operating activities year over year is primarily due to improvements in cash used for working capital and other as working capital levels have begun to be more in line with sales, offset by lower cash provided by net income. Cash used for working capital and other was $152.6 million during the first nine months of fiscal 2024, compared to $1.70 billion during the first nine months of fiscal 2023, with the difference attributable primarily to inventories. During the first nine months of fiscal 2024, the Company used less cash for inventories as less inventory was purchased due to inventory levels already being elevated and because of lower sales. The Company also had decreases in accounts receivable due to lower sales when compared to the prior year. The Company received $90.7 million of cash from legal settlements during the first nine months of fiscal 2024 as compared to $51.2 million of cash received from legal settlements during the first nine months of fiscal 2023.

Financing Activities

Net repayments of debt totaled $106.3 million during the first nine months of fiscal 2024, including the repayment of $49.1 million under the Credit Facility and $80.1 million under the Securitization Program, offset by net proceeds of $22.9 million for other debt. This compares to $1.43 billion of net borrowing during the first nine months of the prior fiscal year. The Company paid cash dividends to shareholders of $0.93 per share, or $84.2 million, during the first nine months of fiscal 2024 as compared to $0.87 per share, or $79.8 million, during the first nine months of fiscal 2023. The Company has repurchased $86.0 million of common stock under the share repurchase plan through the third quarter of fiscal 2024 compared to $221.3 million in the same period of the prior year.

Investing Activities

The Company’s purchases of property, plant and equipment increased during the first nine months of fiscal 2024 by $62.4 million, when compared to the same period in fiscal 2023, primarily due to distribution center investments 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 March 30, 2024. The Company was in compliance with all covenants under the Credit Facility and the Securitization Program as of March 30, 2024, 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 third quarter of fiscal 2024 was $96.4 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 $218.5 million as of March 30, 2024, of which $114.2 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 $650.3 million in cash flows from operating activities over the trailing four fiscal quarters ended March 30, 2024.

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. Cash balances held in foreign locations that cannot be remitted back to the U.S. in a tax efficient manner 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 third 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 $745.1 million of borrowings outstanding and $0.9 million in letters of credit issued under the Credit Facility, and $475.7 million outstanding under the Securitization Program, resulting in approximately $889.7 million of total committed availability as of March 30, 2024. 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 third quarter and first nine months of fiscal 2024, the Company had an average daily balance outstanding of approximately $1.23 billion under the Credit Facility, and approximately $620.3 million and $619.2 million, respectively, under the Securitization Program.

As of March 30, 2024, 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 third quarter of fiscal 2024, the Company did not repurchase any shares. The Company expects to use cash to repurchase shares during the fourth quarter of fiscal 2024.

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 third quarter of fiscal 2024, the Board of Directors approved a dividend of $0.31 per share, which resulted in $28.0 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 through financial arrangements that are intended to provide an economic hedge against 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 March 30, 2024, approximately 56% of the Company’s debt bears interest at a fixed rate and 44% 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 $3.2 million decrease in income before income taxes in the Company’s consolidated statement of operations for the third 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 third 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 March 30, 2024, 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.