Avnet - Q4 2023

Transcript

Operator (participant)

Please stand by. Our presentation will now begin. Welcome to the Avnet fourth quarter fiscal year 2023 earnings conference call. I would now like to turn the floor over to Joe Burke, Vice President, Treasury and Investor Relations for Avnet.

Joe Burke (VP of Treasury and Investor Relations)

Thank you, Paul. I'd like to welcome everyone to the Avnet fourth quarter fiscal year 2023 earnings conference call. This afternoon, Avnet released financial results for the fourth quarter fiscal year 2023, and a release of it is available on the Investor Relations section of Avnet's website. A copy of the slide presentation that will accompany today's remarks can be found via the link in the earnings release, as well as on the IR section of our website. 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 the 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. 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?

Phil Gallagher (CEO)

Thank you, Joe, and thank you everyone for joining our fourth quarter and fiscal year 2023 earnings conference call. I am pleased with the execution of our team throughout the year as we continue to drive growth while navigating through market uncertainty. We maintain our momentum for fiscal year 2022 to deliver robust financial results for fiscal 2023, including a record of over $8 of earnings per share. Our sales were up more than 13% year-over-year in constant currency. Operating income grew 2 times greater than sales, and our business units achieved operating leverage as Electronic Components delivered 4.8% operating margin, and Farnell delivered 9.5% operating margin for the fiscal year.

As we look ahead with the breadth of our supply line card, our diversified customer base, and the strength of the end markets they serve, we are well positioned to capitalize on the industry growth expected over the next several years. Now, let's turn to fourth quarter results. In the quarter, we grew 3% year-over-year in constant currency, and we delivered adjusted EPS of $2.06, which is six consecutive quarters of adjusted EPS of $2 or greater. Similar to last quarter, we continued to drive efficiency in our operations while still making the necessary investments in our business. These efficiencies, coupled with stronger than expected sales in our Americas and EMEA businesses, helped us achieve a 5.1% operating margin at electronic components in the quarter.

It's notable that this is the second consecutive quarter of 5% or greater operating margin at EC and 4.8% adjusted operating margin for Avnet overall, delivering on the margin targets we communicated our Investor Day in June last year. During the quarter, we saw continued year-over-year sales growth in the Americas and EMEA regions, partially offset by expected sales declines in Asia, which was a continuation of the slowdown in demand in certain Asian end markets. From an overall demand perspective, we experienced continued strength in key verticals, most notably transportation, automotive, and industrial. We also saw continued solid demand at defense and aerospace. Average lead times for many components continue to come down, although lead times are still elevated for certain product categories, such as high-end microcontrollers, some power, and many of the components that go into the automotive segment.

Lead times for these constrained categories have improved, but more modestly than other categories. As a result of the current demand and lead time conditions, our book-to-bill ratio remains below parity in all regions, similar levels to last quarter. Our backlog remains relatively steady and consistent with last quarter as well. While cancellations are elevated, the impact on our backlog has been minimal to date. The pricing environment also remained stable during the quarter, with declines in some standard product pricing. We are hearing from some of our supplier partners that they don't expect input costs to come down anytime soon, which was a big driver of price increases over the past few years. As we value our customer relationships, our historical approach in our EC business was to merely pass along price increases to our customers without marking them up.

We believe this approach is a reason we've seen stable gross margins in our EC business year-over-year, including this past quarter. Turning to our operating group highlights. Electronic Components had a strong year, reaching nearly $25 billion in sales. Sales for the fourth quarter increased 3% year-over-year and were flat sequentially. This marks the 12th consecutive quarter of year-over-year sales growth in our EC business. As I mentioned earlier, EC achieved a 5.1% operating margin for the quarter, noting our EMEA region achieved a second consecutive record sales quarter with very strong operating margin, and the Americas team delivered another solid quarter of sales and market share gains. From a demand creation standpoint, once again, we had a great quarter for design and engineering activity across all regions.

High levels of design registrations and wins in prior quarters resulted in yet another quarter of record demand creation, sales and gross profit. Customers are engaging our FAEs for new designs for the next generation products, as opposed to the redesign activities that were occurring in the past couple of years to overcome some component shortages. Demand creation continues to be an essential capability needed in today's technology supply chain. Our EC inventory levels were relatively flat on a sequential basis, and as I mentioned on last quarter's earnings call, we expected it will take a couple of quarters for the inventory correction to play out. This quarter, we will characterize our inventory levels as stabilizing, and we're optimistic that as we enter calendar 2024, they'll more closely align with sales.

We continue to be confident in the quality of the inventory and our ability to work down inventory days in the quarters to come. Moving on to Farnell. Following a record sales and margin year in fiscal year 2022, Farnell had a solid year in fiscal 2023, with sales of $1.7 billion and operating margins of 9.5%. In the fourth quarter, Farnell sales were up 1% year-on-year and down 3% sequentially in constant currency. Operating margins were affected primarily due to an unfavorable sales mix of lower margin products. As constraints on components related to single-board computers have now eased, Farnell is making strides in filling the backlog for single-board computers, which will help their sales and operating income dollars in coming quarters.

As I reflect back on fiscal year 2023, I'm very pleased with the progress we've made with the near-term goals we communicated at Investor Day just over a year ago. We've grown our revenues, gained market share, attained our operating margin goals, and achieved a record EPS for the year. I'm especially proud of the commitment of our team to execute and deliver in one of the most dynamic and uncertain markets I've seen in my career. There is still more to accomplish and the future is really bright for Avnet. As we head into fiscal year 2024, we will continue to make good on our commitments to focus on reducing our inventory levels to be in line with sales, generating cash, and growing operating profits greater than sales.

Our supplier partnerships continue to be one of our key strengths, which has helped lead to market share gains for several quarters. We are confident that our supplier partners see the value we bring in helping to increase both their sales and customer accounts. We are extremely well-positioned for the industry growth expected over the next several years. Our line card features substantially all the key technologies our customers need, and our high-performance line card is unmatched. The key end markets we serve, which include industrial, transportation, and defense, are expected to have high growth rates over the next three-four years. When combined with our Supply Chain as a Service capabilities and the overall market need for customers to have resilient supply chains, we are really excited about our opportunities at the center of the technology supply chain.

With that, let me turn it over to Ken for a look at the financial results for Q4 and the fiscal year. Ken?

Ken Jacobson (CFO)

Thank you, Phil. Hello, everyone, and thank you for your interest in Avnet. We believe our fourth quarter and full fiscal year 2023 performance are a positive validation about our strategy over the past couple of years to focus on efficient and effective operations while working closely with our supplier and customer partners at the center of the technology supply chain. This continued focus has helped us gain share and makes us a stronger, more profitable company. Our sales for the fourth quarter were approximately $6.6 billion, exceeding the top end of our guidance range and up 3% year-over-year. On a sequential basis, sales were up slightly in constant currency. Sales growth year-over-year was led by a record quarter for EMEA, with nearly 19% growth, and the Americas with 7% growth.

This growth was partially offset by an expected sales decline in Asia of 12%. In constant currency, year-over-year sales grew 17% in EMEA, 7% in the Americas, and declined 11% in Asia. From an operating group perspective, electronic component sales grew 3% year-over-year, both as reported and in constant currency. Quarter-over-quarter, electronic component sales were 1% higher in constant currency. Farnell sales grew 1% year-over-year, both as reported and in constant currency. Farnell sales were 3% lower sequentially in constant currency. For the fourth quarter, gross margin of 12.5% improved 25 basis points year-over-year and was relatively flat quarter-over-quarter. Gross margin improved year-over-year, primarily due to a greater mix of sales from our Western regions.

Electronic Components gross margin was up both year-over-year and sequentially, primarily due to a greater mix of sales from our Western regions. Farnell gross margin was down both year-over-year and sequentially, primarily due to a combination of the unwinding of pricing premiums, as on-the-board component lead times have improved and from unfavorable foreign exchange rate impacts from when products were purchased versus when products were sold. We continue to remain focused on maintaining efficient and effective operations. Our operating expenses continue to be well controlled as we have been able to grow our sales without any significant increase in overall expenses. During the quarter, adjusted operating expenses were $505 million, up 3% year-over-year and up 2% sequentially. Foreign currency negatively impacted operating expenses by $3 million sequentially.

As a percentage of gross profit dollars, adjusted operating expenses were 62% in the fourth quarter, 132 basis points lower than a year ago, and 53 basis points higher than last quarter. For the fourth quarter, we reported adjusted operating income of $313 million, which increased 9% year-over-year and grew 3 times faster than sales in constant currency. This is the 10th consecutive quarter of operating income growth, exceeding our sales growth by more than 2 times. Our adjusted operating margin was 4.8% in the fourth quarter, which improved 26 basis points year-over-year and was flat quarter-over-quarter. By operating group, Electronic Components operating income was $210 million, up 21% year-over-year.

EC operating margin was 5.1%, up 77 basis points year-over-year, and essentially flat quarter-over-quarter. The improvement was led by our EC Americas and EC EMEA businesses, which both expanded operating margin year-over-year by more than 80 basis points. Farnell operating income was $36 million, down 43% year-over-year. Farnell operating margin was 8.1% in the quarter, down 90 basis points quarter-over-quarter. Farnell operating margin continued to be impacted by the unwinding of pricing premiums, foreign exchange rate impacts, and from an unfavorable sales mix of lower margin products. Our combined operating groups, when excluding our corporate expenses, delivered on our targeted margin goals by achieving a 5.1% operating income margin for fiscal 2023, with a fourth quarter exit operating income margin of 5.3%.

Turning to expenses below operating income. fourth quarter interest expense of $75 million increased by $45 million year-over-year, and $3 million quarter-over-quarter. The sequential increase was primarily due to increases in market interest rates. Increased interest expense negatively impacted adjusted diluted earnings per share by $0.39 year-over-year. Our adjusted effective income tax rate was 21.6% in the quarter and was 23.9% for the full year. Adjusted diluted earnings per share were $2.06 for the quarter, which decreased $0.01 year-over-year, but was $0.06 higher quarter-over-quarter. A better-than-expected effective income tax rate benefited adjusted diluted earnings per share by approximately $0.06 in the quarter. Turning to the balance sheet and liquidity.

During the quarter, working capital decreased by $33 million, including an increase in payables of $237 million, offset by a $111 million increase in inventories. As a result, our working capital days increased by one day quarter-over-quarter to 97 days. Our inventory days increased by approximately four days, and our receivables days decreased by approximately one day quarter-over-quarter. Our return on working capital continues to be 2x our cost of capital. Our inventories increased 2% during the quarter, primarily due to increases at Farnell, largely for replenishment and continued investment in inventory breadth. As Phil mentioned, we believe our inventory levels have stabilized. Near term, we expect inventory levels to be generally consistent with the fourth quarter levels when adjusting for the effects of any strategic initiatives, which would create temporary increases in inventory levels.

We continue to work collaboratively with customers to purchase the inventory ordered on their behalf. We remain confident in the quality of our inventories and are focused on improving inventory turnover and our related inventory days over the next few quarters. Looking to the first quarter, we expect to see a temporary increase in inventories for our EC business due to a strategic opportunity for which inventories will come in towards the end of the first quarter and are expected to ship out during the second quarter. In the fourth quarter, we generated $235 million of cash flow from operations. We expect to generate cash flow from operations in the first quarter. Our debt decreased by approximately $51 million during the quarter, with a gross leverage of 2.2x, which was a sequential improvement.

At quarter end, we had approximately $844 million of available committed borrowing capacity. With regard to our capital allocation, in the near term, we continue to evaluate all opportunities to drive shareholder returns, including dividends, share buybacks, and M&A. The priority remains to support the needs of our business, including working capital and capital expenditures. During the fourth quarter, cash used for capital expenditures was $57 million, and as a reminder, our capital expenditures during fiscal 2023 were elevated due to investments in a new warehouse in Europe. In the fourth quarter, we paid our quarterly dividend of $0.29 per share, or $27 million. We have $319 million left on our current share repurchase authorization.

For the long term, we remain committed to our roadmap of delivering a reliable and increasing dividend and share repurchases to increase our shareholder value when we believe our shares are undervalued by the market, which continued to be the case in the fourth quarter. Book value per share improved to approximately $51 a share, or a sequential increase of approximately $1 per share. Turning to guidance. For the first quarter of fiscal 2024, we are guiding sales in the range of $6.15 billion-$6.45 billion, and adjusted diluted earnings per share in the range of $1.45-$1.55. Our first quarter guidance is based on current market conditions and implies a sequential sales growth rate of down 2% to down 6%.

This guidance assumes a seasonal mix shift in sales, with western regions declining more and Asia sales increasing less than a typical first quarter. For Farnell, we expect near-term reduced operating margins due to a combination of factors, including seasonal sales declines, which includes reduced demand in on-the-board components and gross margin levels continuing to be pressured due to similar factors that impacted fourth quarter gross margins. In response to the expected decline in Farnell operating margins, we are evaluating the acceleration of previously identified opportunities related to Farnell operating expenses. This guidance also assumes similar interest expense compared to the fourth quarter on effective tax rate of between 22% and 26%, and 93 million shares outstanding on a diluted basis.

In closing, I would like to take this opportunity to thank the entire Avnet team around the world for their outstanding efforts in the fourth quarter and for their hard work in closing out a record year for the company. With that, I will turn it back over to the operator to open it up for questions. Operator?

Operator (participant)

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question is from Ruplu Bhattacharya with Bank of America. Please proceed with your question.

Ruplu Bhattacharya (VP and Equity Research Analyst)

Hi, thanks for taking my questions. Phil, can you talk about what surprised you in the quarter and led to the revenue outperformance? You, you beat the high end of the guidance. Part of that, can you talk about the linearity in the quarter? You know, you had talked about an inventory correction last quarter. Is, is the industry still experiencing that? How long do you think that's going to last, and what parts are in excess supply?

Phil Gallagher (CEO)

Yeah, thanks, Ruplu. Yeah, let me start with the first part of your question. I wouldn't say it was a surprise. I, I would just say it was just, you know, terrific execution in, in the quarter by the teams, you know. You know, the inventory came in, and, and as we've been saying, we're working with the customers to get it back out, and I think the teams just did a, a really nice job. We saw continued strength in, in the markets we're very strong in, you know, industrial, transportation, automotive, and, and of course, defense. As the quarter went on, it just continued to stay strong. Maybe, maybe that's a surprise, just, it, it stayed strong, but I think it's, it's really execution, by the team.

As we've been saying for quite a long time, Ruplu, inventory is not a bad thing, okay, when you have the right inventory, right? We were able to get the inventory in and get it, get it back out. On the inventory itself, as we touched on the call, you're right. Last quarter, I, I said I think it's an industry inventory correction. I think that's still playing out in a two- to three-quarter timeframe. I think that's basically what we saw as the inventory sequentially were up really modestly. I think that's still, still playing out, and again, the inventory is, is, is healthy. I mean, it's not, it's not a bad thing. I also want to just note, I mean, when we talk about inventory, you know, it's, it's not everything, okay?

There, there, there, there is a handful of suppliers that tend to be heavier weighted, where we're, where we're growing the inventory. There's other areas, trust me, we, we, we'd like to have more inventory. We kind of generalize inventory often as, as one lump sum, but it's not, not all inventory is the same. Hopefully that answered, answered your question there, Ruplu.

Ruplu Bhattacharya (VP and Equity Research Analyst)

Yeah, thanks for the details there. Phil, if I can ask you about the Farnell operating margins. You mentioned a couple of things for fiscal 1Q. You said that, you know, the single-board computers, they're more available, so that should help sales and operating income dollars. You also talked about some, you know, mix issues that maybe persist, and I think, Ken talked about some opportunities to reduce costs. Net of it, if you can talk a little bit about what opportunities you have to reduce cost in Farnell, and how should we think about segment operating margins? Do they remain below 10% over the next couple of quarters? Or how should we think about this in the near term and medium term?

Phil Gallagher (CEO)

Yeah, let me, let me work backwards, and I'll turn it over to Ken on the expense. Yeah, we're going to take a few quarters to get back over to 10%, you know, Ruplu, in Farnell. Again, we hit some as we talked about, we had some FX issue in Farnell and some product mix shipments where some of the products we were getting the upside on, which we had talked about in the previous years, last 18 months, you know, is flattening out or coming down from a pricing pressure standpoint, where we had some what's called non-traditional customers coming in and buying more product from Farnell.

I'd say the on-the-board components coming down a little bit with some margin headwind, with things like single-board computer, which we've been talking about, that we're heavily backlogged in, that's starting to catch up with the long pole in the tent parts that we were looking for there, and those shipments are going up, and that's good business for us. Make no mistake, it just tends to be lower calorie margin. It still drives dollars, just not %. Yeah, long and short, it's going to take us, you know, a couple quarters or so, to get back into that double-digit, maybe two or three quarters. Ken, on OpEx?

Ken Jacobson (CFO)

Yeah, I, I think, Ruplu, you should think about it as, hey, the OpEx, you know, is, is things that we have to go after. It's not all people. I want to be clear that a lot of it's, you know, opportunities, freight savings and some of those things, and just looking at, at the operations of this little poster that we've had, you know, kind of on the radar, but we need to pull in, you know, due to the, to the overall demand and margin environment Farnell is experiencing. I think you can think about it as being meaningful to Farnell, but not necessarily meaningful to Avnet overall.

Ruplu Bhattacharya (VP and Equity Research Analyst)

Okay. Okay, if I can sneak one more in, Ken. You know, inventory was up, I think, 2% sequentially. Are we now at a, at a peak for inventory, for your, for Avnet's own inventory? I think you said something about EC inventory maybe going up a little bit in, in the first quarter. Just in terms of, you know, your thoughts on cash conversion cycle and working capital requirements over the next couple of quarters and, and free cash flow.

Ken Jacobson (CFO)

Yeah, so, so I think, you know, EC inventory was up modestly, you know, this quarter compared to last quarter. You know, we, we, we like the term, the word stabilized, you know, so flattish inventory levels. What we did comment on is there is an opportunity we have where we're going to inventory late in the quarter and ship it out next quarter. There, there is likely to be a temporary increase in inventory going into the first quarter, but, but we still believe stabilizing is the right term. From a cash flow perspective, we're happy to generate, you know, over $200 million this quarter. You know, I think the cash flow will continue. You know, you see the sales guidance being down.

... a little bit sequentially, you know, but it's probably still gonna take a few quarters to get the cash flow generated out of the inventory, is how we look at it, you know, with stable inventory levels.

Phil Gallagher (CEO)

Yeah, I'll add to that, Ruplu. It's good, a good pickup, thanks, Ken. Any of these opportunities we get, and they come along every now and again, whether it be for a customer or a supplier, they go through a pretty rigorous ROIC modeling with the finance involved and what's the cash flow impact and the return. They're not, not just something that is, is happening. It's very strategic. It's positive for the company. It'll just drive up the inventory a bit. Probably neutral to working capital, and should be good returns for the company. Outside of that, the inventory should be stable, flattened down a little bit.

Ruplu Bhattacharya (VP and Equity Research Analyst)

Okay. Thanks for all the details. Appreciate it.

Operator (participant)

Thank you.

Phil Gallagher (CEO)

Thanks.

Operator (participant)

Thank you. Our next question is from Joe Quatrochi with Wells Fargo. Please proceed with your question.

Joe Quatrochi (Director and Equity Research Analyst)

Yeah, thanks for taking the questions. The comments on, on some pricing pressure that you saw, is that solely in the Farnell business, or are you also seeing that in the Electronic Components business as well?

Phil Gallagher (CEO)

Yeah, good, good question, Joe. Predominantly, it's in Farnell. It's just the way that they... It gets pretty complex, I'm gonna try to explain it, but the way that they procure product, and, and sit on it, they have a lower inventory turns, you know, one to two per year. They just got caught upside down a little bit on the FX, and then just the natural pricing pressures where they had some, again, as we spoke about before, some additional inflation on the component, you know, in prior 18 months or so with pricing. You know, on the, on the component side, as we said in the script, you know, when we got the pricing passed on, the increased pricing from the suppliers, you know, we just passed that on.

We didn't mark it up again to the end customer, right? We, it was long-term arrangements. What we're seeing is actually stabilization in pricing. In commodities, you know, I call, you know, standard products, yeah, you're seeing a little pricing pressure there, but you always do. You know, it's multi-source. That's about how you buy and how you sell, so that's not really, that's not unusual. In the higher-end products, higher micros and whatnot, you know, the input as long as the input costs are continuing to stay where they are or go up, you know, we don't believe there's gonna be the pricing pressures or ASP erosions that, you know, maybe we've seen in the past.

I mean, as you know, Joe, I mean, gold, silver, palladium, palladium down a little bit, but silver, copper, they're still up, okay? Labor costs remain elevated. As long as they remain elevated and the input costs are up, we don't, we don't see the suppliers, for the most part, bringing prices down. We'll see, but we don't think so.

Joe Quatrochi (Director and Equity Research Analyst)

Got it. Maybe as a follow-up to that, I mean, we're starting to see some reports of just price cuts from some of the foundries in Asia. I mean, I guess, how do you think about the, the flow through of that? I assume that probably takes some time to play out, to you know, kind of get to where you are in the overall kind of distribution supply chain.

Phil Gallagher (CEO)

Yeah, short term, yeah, we're, we're reading the same things and seeing some of the same talk with the suppliers, but, you know, short term, we don't see that have short to medium term, any major effect on us. Probably a better question for the suppliers.

Joe Quatrochi (Director and Equity Research Analyst)

Fair enough. Then just maybe as a follow-up, you know, Asia, China weakness, you know, continuing. I think last quarter, you talked about, you know, that, that lasting for at least the next two quarters. Has anything changed, I guess, from that view from last quarter? Or are you seeing things maybe, you know, finding a bottom or, or getting maybe slightly better just from maybe shipping closer to what in demand is rather, rather than inventory reduction?

Phil Gallagher (CEO)

Yeah, no, great, great question. Here's how I'd answer. I was just there last week, as a matter of fact, in Asia Pacific. Ken was with me, and did business reviews across all the regions, spent a lot of time in Taiwan with the Taiwan team, but also the regional leaders from, you know, China, Southeast Asia, and Japan. As you said, yeah, the demand is definitely down a bit, no question about it. There's some, there's some good signs around optimism over the next, let's say, several quarters. Tough to call, to call it, because there's might be more optimism in, in some industrial applications, versus consumer or vice versa, you know.

We, we did hear a lot about, and you're reading a lot about the, the wind, solar, the energy storage and charging that in China is basically backing, and we're well positioned there. As we position ourselves, we're... I'm not bullish by any stretch, but I'm not negative either. I think, I think it's there's some positive signs, China will, will bounce back. There's no doubt we're well positioned there. Across Asia Pac, overall, again, stable. Japan been, been positive for us. I should add also that we're not overly weighted, Joe. We're not, we're not overly weighted to, to China within Asia, or certainly within the total core.

Joe Quatrochi (Director and Equity Research Analyst)

Helpful. Thank you.

Operator (participant)

As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. Our next question is from Matt Sheerin with Stifel. Please proceed with your question.

Matt Sheerin (Managing Director and Senior Equity Research Analyst)

Yes, thank you, and hello, Phil, and everyone. Phil, just following up on the first question, just regarding the cycle. Obviously, things seem to be holding up, you know, better than most people expected, particularly in EMEA, in North America, and particularly compared to your, your bigger competitor. As you think about this below seasonal guide for the next quarter, should you expect that to continue into December, where that should be below seasonal, you know, with this whole correction and, you know, downcycle? Would you expect March to be similar, or would that, would that be back to seasonality, or, or is the visibility too, too tough at this point?

Phil Gallagher (CEO)

Yeah, thanks, Matt. I'll let Ken jump in as well and appreciate the, the compliment. Yeah, well, just to reiterate what you said, yeah, Europe just remained continuously strong. I mean, December, March, June, back to Ruplu's first questions, like, it's, it's been pretty phenomenal. We're just as an, as a company and industry, we're well positioned there with the industrial and transportation play. The Americas has been, has been terrific under Dayna's leadership, and the, the team doing a nice job. As far as seasonality, but, you know, beyond, you know, we don't typically guide, as you know, into December or March, and because it is tough to call. There's, there's a lot of mixed signals, Matt, out there. I've been using that term, no pun intended, but there, there's just so many mixed signals.

As I said in the script, I haven't seen this much complexity in, in our industry in a long time because there's, there's still a lot of really good things happening, in transportation, even still in charging, in battery, in industrial, that's offsetting some of the other, the other markets. I, you know, again, I'm going to stick with what I said last quarter. I think it's a two to three quarter more of an inventory correction. I, I think as we get into 2024, we're going to start seeing, seeing some additional growth. December quarter is tough one to call because the, the East, you know, what's going to happen in Asia with the starting September, as you know, into October, November, we start to see an uptick there, and we do think that will happen. That I can say.

We do think we'll see, an uptick, a modest uptick, but an uptick, in Asia Pac in the, well, this quarter as well in December.

Matt Sheerin (Managing Director and Senior Equity Research Analyst)

Then the next three quarters. Yep, go ahead.

Ken Jacobson (CFO)

I'll just add, you know, we, we feel pretty good about the $6.3 billion, down 4%. You know, the good news is there's still seasonal growth in Asia. In Europe, you know, it's a really big holiday period here in the summertime. When you get into the December quarter, there's also, you know, the Christmas holiday time, and those are maybe going to be more normal than they have been. You know, still pretty good, pretty healthy about, you know, having an outlook of, you know, $6 billion per quarter kind of sales levels. We don't see ourselves dipping below there still is kind of what we commented on last quarter.

Phil Gallagher (CEO)

Yeah, Matt, I think let me just jump in. I think we are going to start seeing some more normal seasonality. Whether, you know, define normal, Matt, after the last three years, right? I, I, I do think we're going to start to see more of a typical summer quarter in Europe, where we hadn't seen that in the last several years due to COVID and whatnot. I think we'll start seeing more of a typical seasonality coming out of Asia as well.

Matt Sheerin (Managing Director and Senior Equity Research Analyst)

Got it. Okay, that's helpful. Just on the margins, you know, backing into -- based on your guide, it looks like gross margin and operating margin will be down sequentially, and it looks like operating margin will be down year-over-year in, like, the low 4%, 4.41%. You talked about some of the headwinds with Farnell, but what's the other factors there? Is that just the, the function of the mix of business with Asia growing and EMEA and North America down? Is there anything else to read into that?

Ken Jacobson (CFO)

Yeah, Matt, I, I guess I'd say that you've captured the things, but I'll kind of frame it for you a little bit more. You know, think about half of it coming from just the sales decline, right? It's gonna, gonna create, you know, less gross profit dollars, and we're not necessarily doing anything different on, on the cost side. And then you've got, you know, let's say another 25% of that approximately is coming from, you know, just the normal seasonal shift in mix, you know, higher Asia, lower EMEA, you know, and then the other 25% is probably coming from, you know, the, the pressure on Farnell. That's kind of the, the right way to size it.

You know, there's always puts and takes on the overall gross margin on EC, but the comment I will make is we still see year-over-year operating margin expansion in EC with the guidance.

Matt Sheerin (Managing Director and Senior Equity Research Analyst)

Okay, in the EC, okay, but not for the company, though. Yeah. Yep. Okay.

Ken Jacobson (CFO)

Got it.

Matt Sheerin (Managing Director and Senior Equity Research Analyst)

Got it. Okay. Okay, just lastly on the interest expense, which you said in the presentation, obviously that's been a big, you know, EPS headwind. Is that a priority in terms of, you know, your free cash use to bring down that those borrowings, particularly if you see margin pressure on mix and continued, you know, correction here, as a headwind to operating margin to offset that?

Ken Jacobson (CFO)

Yeah, I'd say, Matt, I mean, definitely, you know, we will look to deploy some of our cash to pay down some debt, especially just to make sure if sales start to go down, you know, we want to make sure we're keeping the balance sheet strong. We'll look at other capital allocation priorities as well, right? You know, we do see the cash flow starting to come in, so feel good about that. Now we got to make sure we put it to the work in, in the best ways possible. You know, clearly paying down some interest is, is top of mind, just because it's getting so expensive. You know, we also see, you know, great value in the shares right now, as well, continuing to trade below book value.

Matt Sheerin (Managing Director and Senior Equity Research Analyst)

Right. Okay. Thank you very much.

Ken Jacobson (CFO)

Thanks, Matt.

Operator (participant)

Thank you. Our next question is from Melissa Fairbanks with Raymond James. Please proceed with your question.

Melissa Fairbanks (Equity Research Analyst)

Hi, guys. Thanks very much. Most of my questions have been asked and answered, but Phil, I just had one for you. It's great to hear both Europe and the Americas margins were up really nicely year-on-year. I think Europe is still your highest margin market. Just wondering if you could give us an update on closing that gap between those markets, and then maybe highlight any opportunities, if you have any opportunities, to drive margin in, in Asia closer to the Western markets.

Phil Gallagher (CEO)

Yeah. Hi, Melissa. Thanks. Yeah, we're really pleased with the Americas from where we were through four or five years ago, and what we're working to, and we're still about 80% there, probably back to the issues we had with the ERP, which is well behind us. We're, we're about 80% to where we think we need to be. Closing it to, to, to Europe. Europe's al-- well, always strong message, but for the last 10, 15 years, it's been, it's, it's been a higher margin operating business for us. We tend to get higher gross margins in Europe as well. So I don't know that we'll close the gap with Europe. I'm certainly challenging America's team to do that. I want America's to I want America's to catch Europe, not Europe catch America's.

That, that's, that's, that's really it on that. So we're, we're, we're pleased with the progress overall. Melissa, what was the second part of your question?

Ken Jacobson (CFO)

Asia.

Melissa Fairbanks (Equity Research Analyst)

Just if there's any opportunities. Yeah.

Phil Gallagher (CEO)

Yeah, Asia, a lot of that's mixed. It's just volume. I mean, we're, we're, we're pleased with the returns in Asia. We measure Asia both on operating margin as well as return on working capital. They'll have a higher returns model. The returns in Asia have come up nicely. We've had particular success as well in Japan, which has been, you know, really terrific, and that's getting, you know, closer to some of the models in the West. Overall, Asia, I think we're in about the right spot in Asia based on the volume that drives for us and the drop through we get with that. You know, Asia, we could shrink Asia and grow the operating margins, right?

That always isn't the most strategic thing to do.

Ken Jacobson (CFO)

Just comment, Melissa, that, you know, there are some opportunities to think about, you know, Supply Chain as a Service type of engagement, as well as Farnell. You know, Farnell makes a really healthy margin in Asia, and there's plenty of opportunity to grow there. You know, the base is so big, too, it's, it's hard to move the needle, you know, overnight. We do see some, some good margin opportunities in, in some of the markets that Phil mentioned. Japan, for example, does definitely has a better margin than, than other markets. So there's some opportunity, but it's just, it's such a big base that it's hard to move the needle.

Melissa Fairbanks (Equity Research Analyst)

Okay, great. Thanks very much, guys.

Phil Gallagher (CEO)

Thanks, Melissa.

Operator (participant)

Thank you. There are no further questions at this time. I'd like to hand the floor back over to Phil Gallagher for any closing remarks.

Phil Gallagher (CEO)

I want to thank everyone for attending today's earnings call, and wish you all a great rest of the summer, and look forward to speaking to you again at our next fiscal quarter earnings report in November. Thanks a lot.

Operator (participant)

Ladies and gentlemen, this does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.