Avnet Earnings Call NUGGETS: Operating Margins Trend, TS EBIT Margins

On Wednesday, Avnet Inc (NYSE:AVT) reported its fourth quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Operating Margins Trend

Brendan Furlong – Miller Tabak: Just a quick question on the gross margin and more importantly the SG&A trend on how we should see the operating margins trend through the balance of the calendar and I guess the fiscal year.

Rick Hamada – CEO: Ray, want to jump on SG&A trend for the next couple of quarters?

Raymond Sadowski – SVP and CFO: Yeah, if we were going forward for a couple of quarters, I mean if you look out just in the first quarter, we would expect SG&A to rise probably in the range of about $5 million to $10 million and that’s composed of a number of different item. One what we mentioned already is the year-over-year impact of increasing our – I should say sequential impact of our stock-based compensation and that’s roughly going from Q4 to Q1 about to $12 million. In addition to that we have a slight increase in pension cost and then more importantly being the beginning of our fiscal year, we do have inflation increases tied to merit increases across the globe which we do in the beginning of our fiscal year and a rough estimate of that is about $25 million on an annualized basis, so about $6 million in the quarter. So if you take all of those pluses and you make another adjustment for currency which should bring down expenses in the maybe $10 million range sequentially. The difference you’ll come up with the benefit essentially of some of the reductions and costs that we’ve taken during the year which will be fairly significantly. So, a number of different moving pieces impacted by; stock compensation, as I mentioned, inflation also pulling the number up, and then the – offset a little bit by FX and offset to some extent by some of the savings. So, when you net all of that out, we’re expecting a sequential increase in expense of roughly $5 million to $10 million.

Brendan Furlong – Miller Tabak: And I guess, through the fiscal year then, you’re talking about aligning your business model with the current slow environment. How should we view the SG&A then the following three quarters just in a general sense?

Raymond Sadowski – SVP and CFO: So, I think in the following three quarters you’ll start to see expenses come down, and again, obviously, a lot of this is impacted by what happens with currency and M&A by the way. So, again, numbers that would impact moving forward, we – obviously any M&A activity as that gets baked into the numbers as well as any impact of currency. If you exclude those items, you would expect to see expenses coming down; certainly in the second quarter to some extent due to the normalization of the stock-based compensation, which as we’ve discussed in the past is fairly high in the first quarter and then levels off. So that should come down as we go forward in the $5 million, $6 million range. And then you get benefits kicking in going forward, which will be a combination of the expense reductions we’ve taken last year, as well as what we’re just announcing today in the $40 million to $50 million range, so you would see expenses trending down as you go out through the year based upon all those factors, with one caveat, which is, keep in mind that December is typically a strong quarter for us. We’re not giving guidance for December at this particular point in time, but based upon a normal seasonal uptick within our TS business, we would expect some variable expense to impact that and increase it to some extent. But again, overall you’ll see expenses trending down as you go throughout the year.

TS EBIT Margins

Shawn Harrison – Longbow Research: I’m having some trouble I guess getting to the EBIT margin implied within the guidance. I understand that you have some seasonal increases in SG&A. But one way or the other it implies a sharp decrease in profitability either at EM or at TS, and maybe if you could just help me out in terms of where the profitability dip sequentially, because it looks as if you’re seeing greater than normal incremental margin pressure?

Rick Hamada – CEO: Yeah, Shawn, I’ll take a stab and maybe turn over to Ray or even Harley at this point. I believe that this is a question we get every year at this particular time particularly when it comes to the EM mix of the business. The Q1 tends to be one of the weaker quarters for both businesses. At EM, what typically happens from Q4 to Q1 is a bit of a geographic mix shift from west to east, which definitely has an impact. And so, I don’t know exactly what your model is showing, but we are showing sequential up-margin deterioration for EM as part of our outlook, and a slight deterioration at TS based on the fact of the revenue decrease sequential. So, that may be something that’s missing from your overall equation.

Shawn Harrison – Longbow Research: And I guess within that, would you expect TS EBIT margins to be down on a year-over-year basis because it looks as if EM would be down?

Rick Hamada – CEO: So for TS year-on-year, yeah, I think of it more as flattish.

Raymond Sadowski – SVP and CFO: Right, so TS will be flattish and EM would be down year-over-year.

Shawn Harrison – Longbow Research: Then just as a follow-up, considering the cash flow generated this quarter coupled with the expanded buyback, what is your maximum appetite for share repurchase activity during the quarter and have you been buying ahead of the call today?

Rick Hamada – CEO: We’ve had an active program in place Shawn and as you saw with the fiscal year totals, we have not completely the original 500 million authorization, so that has remained active through the quarter and we’ve maintained our disciplined approach, we will continue to maintain our disciplined approach. We haven’t ever talked specifically about exactly what levels of formula we’re using but we do factor in proximity to our book value and we take a look at our internal financial projections and take a look at future earnings, factor all that into the equation and produce a schedule that gets more aggressive as the equity drops.

Shawn Harrison – Longbow Research: So just, not to put words in your mouth, but given the stock down today, we should expect you being closer to book value, we should expect you to be more aggressive quarter-to-quarter?

Rick Hamada – CEO: If the stock price is down quarter-to-quarter, you could expect for a more aggressive quarter-to-quarter. That’s correct.