Welcome to the Avnet Second Quarter Fiscal Year 2024 Earnings Conference Call. I would now like to turn the floor over to Joe Burke, Vice President of Treasury and Investor Relations for Avnet.

Thank you, operator. I'd like to welcome everyone to the Avnet second quarter fiscal year 2024 earnings conference call. This morning, Avnet released financial results for the second quarter fiscal year 2024 and the release is available on the Investor Relations section of Avnet's website, along with a slide presentation which you may access at your convenience. As a reminder, some of the information contained in the news release and on this conference call contains forward-looking statements that involve risks, uncertainties, and assumptions that are difficult to predict. Such forward-looking statements are not a guarantee of performance, and the company's actual results could differ materially from those contained in such statements. Several factors that could cause or contribute to such differences are described in detail in Avnet's most recent Form 10-Q and 10-K and subsequent filings with the SEC. These forward-looking statements speak only as of the date of this presentation, and the company undertakes no obligation to publicly update any forward-looking statements or supply new information regarding the circumstances after the date of this presentation. 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.

Thank you, Joe, and thank you, everyone, for joining us on our second quarter fiscal year 2024 earnings conference call. I am pleased to share that we delivered another quarter of solid financial results, which was in line with our guidance. In the quarter, we achieved sales of $6.2 billion. This was slightly above the midpoint of our guidance, down 2% sequentially and down 8% year-over-year. We achieved operating margins of 3.9% highlighted by a 4.3% operating margin in our Electronic Components business. We've been working through an inventory correction on a global basis over the past couple of quarters. In addition, we're also facing weak and uncertain economic conditions which began in Asia, including China, and are now present in the West. This economic softness has resulted in lower demand with some of our customers, which is being magnified by elevated inventory levels across the supply chain. In the quarter, demand was mixed across the diverse end markets we serve. Defense and transportation markets continue to show relative strength, while demand in the industrial, consumer and communications verticals was relatively soft. As semiconductor lead times continue to improve, the pricing environment remains stable, which is a positive sign. For the majority of the products, we do not expect overall pricing to decline meaningfully in the near term as we see it today. We continue to manage our backlog and close coordination with our customers and suppliers to align with current softening market conditions. Our backlog activity is centered on pushouts and reschedules rather than cancellations, which are within a normal range. Shorter lead times, however, are contributing to backlogs being lower year-over-year and sequentially. As a result of these factors, our book-to-bill ratio continued to be below parity, though modestly above last quarter. Although our reported inventory levels were up, the increase was driven by a combination of Supply Chain as a Service engagements and foreign currency. Excluding these items, inventory for our core EC business was relatively flat. Our teams are confident that inventory levels for this core business will come down over the remainder of fiscal 2024. Ken will provide further color on inventory and our supply chain as a service offerings. As I mentioned previously, we are in the midst of an inventory correction. Our team has done a really nice job navigating it with a focus on optimizing our inventory investments today and reducing inventory levels in the coming quarters. We provide our supplier partners with our best read on true end market demand for our customers. I've said it before, we view inventory as a vital asset to fuel our business. But with the near-term sales outlook, we are focused on reducing inventory that are elevated and improving our cash conversion cycle. With that, let me turn to the highlights for our business. At the top line, our Electronic Components business saw mixed results across the regions. In constant currency, electronic component sales were down 1% sequentially and 9% year-over-year. Sales in the Americas were up 1% sequentially and declined 6% year-on-year with defense and transportation as the strongest end markets. Sales in Asia were up 2% sequentially and down 10% year-on-year. In Asia, transportation and communications were our strongest end markets. EMEA sales were down 7% sequentially and 10% year-on-year in constant currency. It is worth noting that EMEA had near-record sales in the December quarter last year, so we are up against a tough compare. In EMEA, we are seeing softening in the industrial and transportation sectors. For our Farnell business, as expected, sales and profitability were impacted by softening demand, product mix, and competitive pricing pressures. Farnell sales were down 6%, both sequentially and year-over-year in constant currency. Operating margins for Farnell were 4% during the quarter, which is disappointing but in line with our stated outlook. Despite the greater-than-expected sales decline, we were able to hold our operating margin as we began to see the benefits from some of the cost reduction actions we have already taken. We still believe Farnell has a great potential to deliver value to customers, suppliers and is an important part of the Avnet portfolio. We are focused on improving operating margins near term while further leveraging the breadth of Avnet's customer base and sales force to identify growth opportunities. Our team is focused on several growth and margin expansion opportunities, including demand creation, IP&E, and Embedded Solutions. In the quarter, our demand creation design wins and registrations remained strong, and demand creation revenues as a percentage of total revenue was stable on a sequential basis. We are also pursuing growth in our IP&E business. IP&E products have higher gross margins, and there are many cross-selling opportunities with IP&E components that are complementary to our semiconductor business. Finally, we see exciting opportunities with our embedded business, where we offer embedded board and display solutions. We have the capability to offer both custom solutions and third-party solutions, both of which come with higher gross margins. We continue to find ways to leverage our global sales force and technical capabilities to capitalize on these embedded growth opportunities. Our supplier partners value Avnet's ability to create solutions for customers that leverage their entire portfolio of products. The importance of solutions selling highlights why our suppliers continue to support our demand creation efforts. They are also focused on increasing customer count and leveraging the long tail of the industrial sector to generate growth. Our suppliers continue to partner with Avnet and distribution in general to help them drive the growth they are seeking. As exciting as these opportunities are, we are still in the midst of an uncertain market. Over the past several weeks, I have met with several CEOs and decision makers at our supplier partners, representing nearly half of our revenues. The consensus sentiment among this group is that overall market softness will continue for at least a couple more quarters, but could extend through calendar 2024. To conclude, we are confident that our strong competitive position and our experience managing through many prior market cycles will serve us well as we navigate through these choppy waters. I want to thank our team for their dedication and commitment. We believe our people and our culture are key differentiators for Avnet, which enables us to compete well in any market environment. With that, I'll turn it over to Ken to dive deeper into our second quarter results.

Thank you, Phil, and good morning, everyone. We appreciate your interest in Avnet and for joining our earnings call. Our sales for the second quarter were approximately $6.2 billion, in line with guidance and down 8% year-over-year. On a sequential basis, sales were down 2% in constant currency as expected due to seasonal declines in the Western regions in the December quarter. From a regional perspective, sales in EMEA and the Americas each declined by 6% and Asia sales declined 10% from the year-ago quarter. From an operating group perspective, electronic component sales declined 8% year-over-year and 9% in constant currency. EC sales declined 1% quarter-over-quarter in constant currency. Farnell sales declined 4% year-over-year and 6% in constant currency. Farnell sales were also 6% lower sequentially in constant currency. Sales of single board computers continue to ramp, increasing 32% quarter-over-quarter. For the second quarter, gross margin of 11.4% was 29 basis points lower year-over-year and 43 basis points lower quarter-over-quarter. EC gross margin was flat year-over-year and declined sequentially primarily due to a seasonal mix shift to Asia. Farnell gross margin was down sequentially and year-over-year, largely due to an unfavorable sales mix and competitive pricing pressures for on-the-board components. Turning to operating expenses, adjusted operating expenses were $464 million in the quarter, down 4% year-over-year and down 5% sequentially. Operating expenses were down 6% in constant currency year-over-year. As a percentage of gross profit dollars, adjusted operating expenses were 66% in the second quarter, 68 basis points higher than last quarter. For the second quarter, we reported adjusted operating income of $242 million, which decreased 19% year-over-year. Our adjusted operating margin was 3.9%, which decreased 57 basis points year-over-year and decreased 23 basis points quarter-over-quarter. By operating group, Electronic Components operating income was $248 million, down 16% year-over-year. EC operating margin was 4.3%, down 43 basis points year-over-year and 34 basis points lower sequentially. The sequential decline was primarily due to a combination of lower sales and a seasonal mix shift of sales to Asia. Farnell operating income was $16 million, down 7% year-over-year. Farnell operating margin was 4% in the quarter, down 20 basis points quarter-over-quarter and was impacted by lower sales, an unfavorable sales mix, and competitive pricing pressures related to on-the-board components, which was partially offset by lower operating expenses. As we discussed last quarter, Farnell has begun undertaking a wide range of restructuring actions to reduce operating expenses and improve gross margins. Overall, we are targeting annual expense reductions of between $50 million to $70 million, of which approximately 25% was already completed as we exited the second quarter. The majority of the restructuring actions at Farnell will be completed by the end of the fiscal year. We anticipate the next few quarters will be challenging for Farnell as continued demand and competitive pressures for on-the-board components may dampen the expected benefits of lower expenses. Although these restructuring actions are necessary to ensure Farnell has a sustainable operating expense model through any cycle, we do not take these actions lightly as they impact our people. Turning to expenses below operating income, second quarter interest expense of $74 million increased by $15 million year-over-year and increased $4 million quarter-over-quarter, primarily due to higher average borrowings. This higher interest expense negatively impacted adjusted diluted earnings per share by $0.12 year-over-year. Our adjusted effective income tax rate was 24% in the quarter as expected. Adjusted diluted earnings per share was in line with expectations at $1.40 for the quarter. Turning to the balance sheet and liquidity. During the quarter, working capital increased by $328 million sequentially, including an increase in reported inventories of $361 million, a $171 million decrease in receivables, and a $138 million decrease in payables. As a result of this working capital increase, working capital days were 107 days for the quarter, an increase of 6 days quarter-over-quarter. Our return on working capital decreased quarterly on the higher working capital and lower operating income. Let me take a moment to give more color on inventory and the sequential increase in inventory this quarter. The overall increase in reported inventories was driven by an increase in inventory specific to supply chain service engagements and also from changes in foreign currency exchange rates. Inventory related to our traditional core EC business remained flat and was stable in the December quarter. We continue to have line of sight on incoming inventory while we work through the challenges created by elevated inventory levels across the supply chain. Although we are disappointed that inventory for our core EC business remains flat, we are confident these inventory levels will start to decline in the March and June quarters. From a supply chain as a service perspective, we continue to see an increase in opportunities for this service offering. The customer base for these engagements are typically large OEMs who have historically done their business directly with our suppliers. These OEMs and suppliers are prioritizing resiliency in their supply chains as a lesson learned from the past few years of component shortages, which is driving an increase in these opportunities. As a reminder, these service engagements are separate from our traditional core EC business as the associated inventory is really the inventory of the OEM or the supplier that we hold on their behalf. The inventory is contractually restricted, and the risk profile is different compared to inventories held for our core EC distribution business. The increase in inventories for supply chain services was specific to a few newer engagements that ramped towards the end of the quarter. We would expect inventories for Supply Chain Services to be flat to down slightly in the third and fourth quarters for our existing engagements. Our team remains highly focused on reducing inventory levels where elevated, which will help us drive cash flow from operations in the second half of fiscal 2024. The increase in working capital led to an increase in debt of $279 million. During the quarter, we used $42 million of cash for operations. However, over the past 4 quarters, we generated $169 million of cash from operations. We expect to generate positive cash flow in the third quarter in excess of the cash used for operations during the first half of fiscal 2024. We ended the quarter with a gross leverage of 2.6x, and we had approximately $493 million of available committed borrowing capacity. With regard to our capital allocation, we continue to prioritize our existing business needs, including working capital and capital expenditures. During the second quarter, cash used for CapEx was $82 million, primarily to support a new distribution center being constructed in EMEA. We expect CapEx to return to historical levels in the second half of fiscal 2024 of approximately $25 million to $35 million per quarter. In the second quarter, we repurchased approximately $59 million of the shares. We used the cash proceeds from our recent legal settlement to buy back shares during the first and second quarters. We have $232 million left on our current share repurchase authorization entering the third quarter. We also paid our quarterly dividend of $0.31 per share or $28 million. 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. Book value per share improved to approximately $55 a share or a sequential increase of approximately $3 a share. As we generate cash flow from operations in the second half of fiscal 2024, we expect to use the cash for a combination of debt paydown and for buying back shares. Turning to guidance. For the third quarter of fiscal 2024, we are guiding sales in the range of $5.55 billion to $5.85 billion and diluted earnings per share in the range of $1.05 to $1.15. Our third quarter guidance is based on current market conditions and implies a sequential sales decline of 6% to 11%. This guidance assumes sales declines for the Western regions versus typical seasonality of sales growth and a seasonal decline in sales from Asia due to the Lunar New Year. This guidance assumes similar interest expense compared to the second quarter, an effective income tax rate of between 22% and 26% and 91 million shares outstanding on a diluted basis. Implied in our guidance is an EC operating margin above 4%. Although there is some uncertainty in the overall market environment we are currently in, our team will continue to focus on the things that we can control or influence. This includes being disciplined with our operating expenses, driving working capital reductions and cash flows and winning new opportunities that drive profitable growth and continued market share gains. With that, I will turn it back over to the operator to open it up for questions.

Our first question is from William Stein with Truth Securities.

I would like to ask about inventory, but since you've already addressed it, it appears to be more of a supply chain engagement issue. Instead, I want to know about the differences between Avnet's supply chain engagements and traditional electronic components distribution. Is there a possibility of reporting the revenue and inventories for that separately? Could you also discuss the different dynamics in terms of inventory turns in that business compared to the core returns on invested capital and other metrics you're targeting? I have a follow-up question as well, if that's alright.

Yes, thanks for the question. This is Phil, and I will likely hand it over to Ken. We're working to clarify that in the script to break it down more. Supply chain is quite a broad term; that's why we define it as a service since supply chain is what we focus on. We've been engaged in this for years with our traditional supply chain and core customers, including consignments of implant stores and point of use replenishment systems. That aspect still exists and remains a significant part of our business. The area we're highlighting in this call, which we began addressing a few calls ago, involves supply chain as a service for large OEMs that may not have previously utilized our supply chain services and are now reaching out to us. They operate with different financial models, inventory carrying, and working capital strategies, sometimes with distinct financing approaches. I will now pass it over to Ken so he can provide more detail on that. I appreciate the question, and we will keep working on clarifying this and providing more information in the future.

I'd just say, the message we want to kind of convey is that the broader inventory for the EC business is stable. We're disappointed that it hasn't gone down yet, right, because that's something the team is actively driving to do, but we do see line of sight to some reductions in that core inventory in the next couple of quarters. As the supply chain as a service inventory, I mean that happens to be our accounting, our reporting, is within our inventory. We're beginning to give a little bit more color at least on the balance sheet will. So I think the path for further clarity would be first on the balance sheet and then moving to the P&L as those engagements ramp. And so here's how I'd characterize the difference. I mean, I think the first thing, these are really large engagements typically, right? So the magnitude of the throughput of components is much bigger. And that's mostly driven by the fact that the, let's say, the end customer here in these service arrangements are typically large OEMs. What we try to comment on is that these are the ones that we typically haven't been doing business with because they have direct relationships with suppliers and they have their own partners they use. This is new opportunities for us because we haven't really played in the big OEM space. So transportation is one opportunity, but it's really across all end markets that we're seeing, including, let's say, communications and networking and things like that. But typically, the engagements are driven by the OEM. And typically, what's happening is we're kind of procuring on their behalf the inventory that they were normally buying at their pricing most likely, right? So they might have a direct contract or other pricing. So it's not, let's say, normal course fulfillment or anything like that. This is really buying based on their contract. The main difference we see is the inventory profile we try to talk about. It's not really our inventory even though we report it as such. It's their inventory; there are contractual restrictions, right? It's really providing the service on their behalf. From an overall profile, typically the gross margin is better, but it's not really a top-line revenue because of the fact that it's services revenue versus revenue from the sale of components. From a return on invested capital, return on working capital, it's at or above typically where other engagements would be at. We look to find creative working capital solutions for these types of engagements. In some cases, we'll finance it or we'll fund it through our own working capital or borrowing capacity. But a lot of times, we're either trying to have the OEMs bring cash to the table or looking for third-party programs to help us finance that. Our commitment really not only to our supplier partners but also to our teams is the fact that we're really not trying to restrict our existing business, right? We want to have this be and, not an or, and so we really don't want to consume our working capital to fund these engagements because we want to protect that for the normal course of business to grow our long tail of customers and things like that. So hopefully, that adds the color you're looking for. Again, we'll continue to add transparency as these things ramp and get bigger.

Great explanation, Ken. And well, it is a good question. Apologize for a lengthy answer because it is complex, and we want to be transparent. What brought some of these on is the breakdown in the supply chain late over the last 3 years, and where customers got caught short, as we all know, with the shortages and the stoppages in supply chain. Some of these opportunities even come from our suppliers being asked to do things that maybe is not in their core. They bring it to us, and we go work it together. So I'll leave it at that, and then we can pick it up later, if you like.

If I could ask a follow-up question, you've explained the increased inventory due to supply chain engagements, but you mentioned that for the core EC and Farnell business, it was flat and that efforts are being made to reduce it. I've noticed that most semiconductor companies I've been tracking have reported a significant drop in channel revenue over the past few quarters. I'm not covering every semiconductor company, but I'm trying to understand how to reconcile these figures with what many larger semiconductor companies are saying about declining channel sales, as it isn't clear to me.

Clarification on channel sales. You're referring to our sales out and sales into us. I believe we guided our sales out and we met our goals in December, which was encouraging. We also think we gained some market share. Sales from our suppliers vary; some need more assistance than others. Even when we have higher inventory levels, it's not consistent across all suppliers. There are areas where we could use additional inventory, despite tightness in some cases. A few suppliers may be experiencing heavier shipping issues. The key point is that we are actively engaging with our suppliers and customers daily to align with actual demand and adjust our pipeline accordingly. Overall, supplier behavior has been positive and they have been supportive partners. As mentioned in a previous call, we've identified a couple of opportunistic chances that we capitalized on, leading to beneficial outcomes for both parties.

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

Phil, in your prepared remarks, you mentioned that your discussions with CEOs indicate market softness over the last couple of quarters and extending into 2024. Last quarter, we talked about the idea that the channel is experiencing an inventory correction expected to last until the middle of 2024. Has your perspective on this changed? Do you believe the inventory correction might take longer? It seems like you think the markets will remain weak for an extended period. Can you share your overall thoughts on this?

Yes. I still believe it will be around midyear, possibly extending into the September quarter. Conditions have changed in the last 90 days, particularly with some softness in the industrial sector, as noted by us and our suppliers. However, I still anticipate an inventory correction occurring from mid-2024 into December. It’s too early to predict whether there will be growth or if the situation will remain flat throughout 2024. I do think that as we reduce our inventory over the next several quarters, it will be a positive sign. This should generate cash flow, and we will then assess the kind of growth that the market demands at that time.

Can you provide insights on margins, particularly EC margins which you mentioned can stay above 4%? What revenue level do you need to maintain those margins above 4%? Additionally, regarding Farnell margins, how should we view the trends for the upcoming quarters? It was at 4% this quarter, so how quickly do you anticipate it can recover, and what factors do you consider important?

I will address the question about Farnell first. In the December quarter, Farnell's sales were slightly below our expectations, which impacted our ability to achieve a better operating margin. We are implementing cost-cutting measures, but the main issue for Farnell is intense competition in board components. With improved availability and shorter lead times for these components, demand from catalog or high-service distributors has decreased. Additionally, both high-service competitors and Farnell itself have substantial inventory, which is putting further pressure on pricing. These two challenges are why we anticipate a tough couple of quarters for Farnell as they work through their inventory. We believe margin levels have stabilized, though they are somewhat lower than we initially expected. The cost reduction initiatives will take time, which is why we indicated that conditions for Farnell may remain similar in the upcoming quarters, with some potential for modest margin improvement as we approach year-end. Regarding the EC business, I mentioned earlier that our guidance implies we typically see a seasonal increase in the West, aided by a shift in business from Asia, which generally boosts margin. However, the West is expected to decline in the March quarter instead of the usual increase, so we are not experiencing the favorable mix we typically would. We are currently at the revenue levels necessary to maintain that margin, although we don't usually carry this into the fourth quarter. Typically, we would expect to see a slight rebound in Asia after the Lunar New Year. We are actively managing expenses and working on reducing core inventory, aiming to shift from stable to decreasing levels. Our team is focused on cash flow and inventory reduction while seeking competitive opportunities in the market, despite it being more challenging than it was a short time ago.

Okay. Let me just sneak one more in. You mentioned expenses. Maybe both for you and Phil. Phil, I think you said you're making investments in the sales force? I mean you talked about demand creation and IP&E and embedded. So I guess my question is, do you need to invest in more sales force to train them or to hire more people? At the same time, you're doing restructuring in Farnell. So I mean if you can reason like what your expectation is for OpEx as a percent of gross profit going forward and the type of investments you see happening over the next couple of quarters?

Yes, that's correct, Ruplu. I'll have Ken address that in relation to the ease of that gross profit. We have been managing our expenses carefully and have not increased them as a percentage. In fact, we are continuously finding ways to reduce expenses even as we make necessary investments. These investments may include productivity tools, robotic process automation, and now artificial intelligence and machine learning. We are increasingly focusing our investments on digital initiatives. Regarding our sales force, including our field application engineers and design solutions, we are well-staffed and have made appropriate investments in those areas that contribute to the company's growth and profitability. There are no changes planned in the core areas. We will provide further updates on the Farnell restructuring separately, as Ken mentioned.

Yes. I mean I think sales are coming down. Obviously, Ruplu, implied in the March guidance that the OpEx to GP is going to be impacted accordingly in terms of percentage. But I would just think about it as kind of flattish. I mean, where we are making investments, we're trying to self-fund. We are focused on expense discipline. So what I would say is we're kind of more of the same outside of Farnell. But depending on our view of how long the demand softness may look at, we might have to take a harder look at more expense actions. But again, anything we do there, we're going to protect for the medium and long term and really focus on the opportunities we see out beyond the horizon of where the demand is soft.

Our next question is from Joe Quatrochi with Wells Fargo.

A couple if I could. Maybe just kind of first sticking with the Farnell. The cost restructuring that you're putting in place, do we think about that $50 million to $70 million flowing to the bottom line for the total kind of company P&L? Or are there areas that maybe there's a little bit of offset from a cost perspective just as we're thinking about OpEx?

Yes. I think first thing I'd say is it's an annual amount, and I think there are other factors to consider. So I'd say I don't know that I would be a direct one for one. It depends on volume and other things. But I think from a Farnell perspective, right, you can kind of start to build that into the operating margin as we exit the year.

And I assume you meant fiscal year. And then just as a follow-up to that. Maybe just kind of trying to understand what's changed from 90 days ago and just understanding maybe it's the kind of the mix of demand of the areas that are starting to maybe see incremental weakness I guess, how do I think about just your exposure, the mix exposure of, say, industrial to like Western regions relative to Asia and just kind of what's incrementally weaker relative to last quarter?

Yes, I'll address that, Joe. Thank you. We've noticed variations on a global scale. I would summarize that the most considerable weakness has been in the industrial sector, which makes up about 25% to 33% of our business. This sector has been quite broad but has decreased slightly both sequentially and year-on-year. Specifically, the industrial sector was particularly strong in Europe, which recorded three consecutive quarters of high performance until this last quarter. As that sector softened, it obviously impacted us. Regarding transportation, there are mixed signals; however, it remains relatively stable. It has declined both sequentially and year-on-year but only modestly in single digits. It is performing better in the Americas while seeing a larger decline in Europe, which is our second-largest vertical. On a different note, the defense sector, in light of current global events, remains quite robust, and we expect it to continue to perform well.

Our next question is from Matt Sheerin with Stifel.

Phil, I wanted to revisit the inventory issues. I appreciate your insights on the supply chain engagements as a service. However, it seems that you are purchasing and holding the inventory, which adds a working capital burden for you. When discussing inventory, and I understand it's restricted, that still counts as inventory on your balance sheet, correct? Considering your over 100 days of inventory, what is the target for the next two to three quarters? Additionally, is there any consideration being given to collaborating with OEM customers who would own the inventory, making it more consigned for a true as-a-service model? It appears this is still a traditional model where you bear the cost of that inventory.

This is Ken. I think there are alternative ways to fund inventory in general. Part of what you're mentioning involves accounting versus how the service is actually performed. Physical custody is necessary; we need the inventory in our warehouses to manage it. Consider OEMs that lack manufacturing; this introduces complications related to accounting and our financial reporting, as well as how we provide services for those without manufacturing capabilities. There are tax and legal entity considerations that explain why a company like Avnet needs to offer these services instead of others. I would describe it as a different risk profile, and we believe we have better protection for this product compared to standard business products. We perceive it differently even though it is currently categorized with other inventory in our financials. A part of this is about how the service is provided. If it's consigned, that implies OEMs could potentially handle the supply chain themselves. In some scenarios, the capital comes from OEMs because they want it included as part of the service. It's a mixed situation. Our objective is to maintain flexibility in providing the necessary services while monitoring our returns and ensuring it doesn’t hinder our regular business opportunities because of capital restrictions. We already have elevated inventory levels in our regular operations, so we are mindful not to exacerbate the situation with these arrangements. We have been transparent with our customers about this and they understand it is somewhat distinct.

Yes, Matt, thanks, Ken. The inventory days are a bit higher than we would like. As mentioned earlier, having inventory is not necessarily a negative; we might have a bit too much, but it's not outdated or a liability. We aim to reduce it in the March quarter. As we lower it in relation to sales, the days of inventory will also decrease. The important thing is to ensure we have quality inventory as we reduce it and start generating more cash. We need to support the market outlook while balancing the necessary investments in inventory.

Your interest expense has increased significantly, reaching a $300 million run rate for fiscal '24, compared to $100 million two years ago. This represents a substantial change in earnings per share. Ken, is reducing short-term borrowings and decreasing that interest expense a priority for you?

Yes, Matt, absolutely. We need to generate cash flow, and part of that cash will be used to pay down debt. There are various factors influencing this, but the elevated inventory from the past year and beyond is a significant aspect. This is a priority for us. The cost of borrowing has certainly increased compared to the past, and we need to reduce it. However, I must emphasize that this will take some time.

Our last question is from Toshiya Hari with Goldman Sachs.

The first one is on long-term margins. And Ken, I think this predates you as a CFO. But back in June '22 at the Analyst or Investor Day, you guys threw out a medium-term operating margin target of above 5%. I realize we're at the close to the trough of the cycle. But Farnell, I think at the time, operating margins were in the mid-teens. You're currently at 4% or 5%. I think EC has held in really well. But do you think the above 5% cross cycle or medium-term target is still intact and you're comfortable with that? Or have there been sort of fundamental permanent changes that would kind of swing that view?

Yes. Thanks, Toshiya. I mean I'm generally familiar with, obviously, those targets to put out. I would say we are not coming off of those targets. We see opportunity. Now clearly, we're a little bit backwards, right? So we've got to get back to where we were, but again, the EC business holding up in the third quarter. You mentioned the trough. I've just knocked on wood there. But we see opportunity, and we see that some of the markets we're in have growth. We do see right now, Phil made some commentary that pricing in general is holding up pretty well. We are still focused on gross margin. If there are pressures on some level of pricing, what we're focused on those higher margin opportunities. We use supply chain as a service as higher margin. Phil talked about demand creation, IP&E, some of our embedded solutions products. Those are all higher-margin type opportunities relative to kind of the baseline margin we have. Farnell, obviously, getting that back is key; and that's going to take longer than we would have liked or expected because of how far down it has come, but we still see those opportunities medium term. We think the overall health of our business and the overall opportunities we're seeing when we talk to our supplier partners, I mean I think we're definitely excited for the future, even though it's going to be some choppy waters here for the next couple of quarters.

Okay. That's helpful. And then as my follow-up on free cash flow generation going forward. You guys spoke to a declining inventory or managing that better going forward. You also noted that CapEx should normalize lower, I forget at what point, but you talked about that. So it feels like you've got pretty good tailwinds from a free cash flow perspective, middle part of the year, back half of the year. A, is that the right way to think about sort of the trajectory of free cash flow; and b, if there's any quantitative guidance you can provide on that, that would be super helpful for perhaps calendar '24.

Yes, I think that's right. I mean I wouldn't get into calendar '24, but what we did say for this next quarter for the March quarter was cash flow in excess of what we used in the first half of the fiscal year. The CapEx levels are normalized, so we would expect positive free cash flow in the third quarter. To answer your question, as the inventory goes down, right, then the cash flow accelerates. We see line of sight to that in Q3 and Q4. We're not going to give quantitative numbers, but we see lots of opportunity and we want to drive large cash flow numbers.

Ladies and gentlemen, there are no further questions at this time. I'd like to hand the floor back over to Phil Gallagher for closing remarks.

Great. Thanks a lot. I want to thank everyone for attending today's earnings call, and I look forward to speaking to you again at our third fiscal quarter earnings report in May. Thank you very much. Have a great rest of the week.

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