Ladies and gentlemen, thank you for standing by, and welcome to the Arrow Electronics Fourth Quarter and Year-End 2019 Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions] Thank you.

I would now like to turn the call over to your speaker today, Steve O’Brien. Please go ahead, sir..

Thanks, Jacqueline. Good day and welcome to Arrow Electronics fourth quarter and year-end 2019 earnings conference call.

With us on the call today are Mike Long, Chairman, President and Chief Executive Officer; Chris Stansbury, Senior Vice President and Chief Financial Officer; Andy King, President, Global Components; and Sean Kerins, President, Global enterprise computing solutions. As a reminder, some of the figures discussed on today’s call are non-GAAP.

You can access our earnings release at investor.arrow.com, along with the CFO commentary, the non-GAAP earnings reconciliation and webcast of this call. We will begin with a few moments of prepared remarks, which will then be followed by a question-and-answer period. I’ll now hand the call to our Chairman, President and CEO, Mike Long..

Thank you, Steve. Thanks to all of you for taking the time to join us today. During the fourth quarter, thanks to our commitment to solving our customers’ engineering, design and supply chain needs, we produced strong earnings per share and cash flow results.

We again increased the scale of our Asia components business, and that scale will pull through sales across our line card and lead to future profit improvement. Enterprise computing solutions delivered operating income growth, driven by the newer technologies in the nontraditional customers.

As we begin 2020, we’re well positioned to drive profit growth and margin expansion as soon as the demand conditions improve. We are concluding our cost optimization actions which have streamlined our organization and have enabled us to quickly adapt to industry corrections and economic conditions.

The wind down of the PC and mobility asset disposition business has sharpened our focus, and we remain focused on the opportunities that will enhance long-term shareholder value. The economic and demand backdrop for our business in the fourth quarter showed no improvement.

We saw hopeful signs in the fourth quarter, but no changes that would alter our stance that the industry is bouncing along the bottom. However, by remaining nimble and flexible during the quarter, we were able to see – achieve sales in line with our expectations.

By adapting to the current macro conditions, we delivered strong cash flow while improving economic returns through working capital realignment. To provide some additional text on the near-term market conditions we’re facing, our customers remain very cautious during the fourth quarter and generally pared back their inventories.

Demand from smaller customers who utilize more of our engineering and design services weakened beyond what we had originally anticipated. Manufacturing, engineering and design work continued to move offshore. At the same time, consumption of our European exports continued to decline.

While customers and suppliers are starting to see signs of improvement, our business traditionally trails the market. With that said, we are seeing some signs of stability. Backlog did increase from the third quarter, which is the first sequential improvement since the third quarter of 2018.

Design activity increased year-over-year in total and increased quarter-over-quarter in all regions. And given a 12- to 24-month cycle from design to production, there’s a lag between higher design activity and improved mix and margins. However, throughout this market correction, we have been very pleased with the stability in our design activities.

Other indicators appear consistent with an approach to the end of the market correction. Lead times are shorter than last year, but remain consistent with the third quarter and long-term averages. Overall, our book-to-bill was 0.99 exiting the fourth quarter.

Book-to-bill was at near parity in all regions and showed improvement compared to the third quarter in all regions. Our Americas customer sentiment survey results improved over the last three quarters. The proportion of customers saying they had appropriate levels of inventory returned to normal historic levels.

Appropriate levels is normally the largest category. However, the proportion of customers saying they had too much inventory also remained high. Despite a challenging backdrop, I want to emphasize that Arrow remains committed to driving innovation through engineering and technical leadership.

We’re not changing the way we do business to respond to the near-term market pressures. With this understanding, we saw no incremental contribution to the fourth quarter results from any supplier program changes. And our first quarter guidance assumes no significant incremental contribution from recent changes.

We continue to listen closely to our suppliers and customers to address their requirements and to do business the way our customers and suppliers would like us to. Now turning to our enterprise computing solutions business. In the fourth quarter, demand for our software-led solutions was in line with our expectations.

We did well to meet our guidance commitment. While the pace of smaller expenditures continued, the appetite to purchase large-scale IT solutions was notably less than last year. In aggregate, billings grew at slow, low single-digit rate year-over-year in the fourth quarter. Our portfolio approach is designed to deliver consistent results.

The success of our approach drove a return to operating income growth in the third quarter as we expected, and operating income increased again in the fourth quarter even with unfavorable foreign currency changes. For the full year of 2019, enterprise computing solutions operating income also grew slightly compared to 2018 adjusted for currency.

Behind this small profit growth was the significant realignment to newer software, hardware and hybrid cloud architectures, offsetting declines in legacy systems. In closing, we continue to proactively address what we can control while remaining adaptable to face external challenges head on.

Our engineering capabilities remain to be our key strategic advantage. We’re confident that our engineering know-how will continue to set us apart over the long term, leading to tremendous opportunities to expand our business, drive innovation and improve the performance of end customers everywhere.

I look forward to updating you on the progress and performance in the coming quarters. I’ll now hand the call over to Chris to provide more details on our fourth quarter results and our expectations for the first quarter..

Thanks, Mike. Fourth quarter sales were $7.32 billion, excluding the PC and mobility asset disposition business. Sales decreased 5% year-over-year adjusted for the wind-down and changes in foreign currencies. The actual exchange rate for the quarter was $1.11 to €1, which is in line with the rate we previously used for our forecast.

Global components sales were $4.72 billion, excluding the PC and mobility asset disposition business. This is in line with of prior guidance and represents an 8% year-over-year decrease adjusted for the wind-down and changes in foreign currencies. Asia sales increased 4% year-over-year and reached an all-time record quarterly and annual level.

The sales contribution percentage from Asia was also an all-time record for the quarter and the year. Our performance in Asia continues to be strong. And as we add new customers, we often find new cross-sell opportunities to offer other products in our line card to those customers.

While higher Asia contribution is a headwind to margins, we do not anticipate higher Asian mix will be a headwind to returns. In Europe, sales decreased 12% year-over-year as adjusted. In the Americas, sales decreased 16% year-over-year as adjusted. We are experiencing lower demand across all of our key verticals in the western regions.

In the coming quarters, we expect sales performance in the Americas and Europe to continue to lag Asia due to several factors. First, Asia has higher asset velocity and customers in the region, tend to carry less inventory. Second, we expect demand for our Western customers’ products to be more elastic in the face of uncertain economic conditions.

And third, we continue to see large Americas customers offshore manufacturing to lower cost regions. Global components operating income decreased 35% year-over-year. Operating margin was 3.6%. This was the third consecutive quarter of year-over-year margin decline for global components.

During past market corrections, we’ve typically seen five consecutive quarters of margin decline. And while no two downturns are the same, we continue to expect margin recovery to first come through our cost optimization program and then from a return to a more optimal product and regional mix when demand conditions improve.

Enterprise computing solutions sales of $2.6 billion decreased 1% year-over-year as adjusted and were at the midpoint of our prior expected range. Billings increased at a low single-digit rate year-over-year adjusted for changes in foreign currencies, an increase in both regions.

Growth was driven by infrastructure, software services and next-gen hardware, including storage and networking. Europe enterprise computing solutions sales increased 4% year-over-year as adjusted. Americas sales decreased 3% year-over-year, adjusted for changes in foreign currencies.

During the fourth quarter, Americas saw relatively more strength in security and services, while Europe saw more strength in infrastructure, software and storage. Enterprise computing solutions operating income increased 2% year-over-year, adjusted for changes in foreign currencies, and dispositions.

Operating margin increased 20 basis points year-over. Returning to consolidated results for the quarter, total company operating expenses decreased 9% year-over-year. Consolidated operating income decreased 20% year-over-year adjusted for the wind down, a disposition and changes in foreign currencies.

Interest and other expense was $50 million slightly below our prior expectation. The effective tax rate for the quarter was 22.1% and with near the low end of our target long-term range of 23% to 25%. Full year 2019 effective tax rate was within the range at 24.3%. Net income was $181 million and was down 20% year-over-year.

Earnings per share were $2.20 on a diluted basis, down 15% year-over-year. We estimate the stronger dollar negatively impacted earnings per share by approximately $0.04 and negatively impacted earnings per share growth by approximately one percentage point compared to the fourth quarter of 2018. Turning to cash flow.

We reported strong operating cash flow of $495 million, driven by a greater ability to convert EBITDA to cash flow in the current weak demand environment and by a reduction in working capital. Full year 2019 cash flow totaled $858 million or 135% of our non-GAAP net income.

Consistent with our past practice, we remain committed to returning excess cash to shareholders. We repurchased approximately 1.2 million shares of our stock or $100 million during the quarter. We repurchased approximately $390 million over the last 12 months and reduced shares outstanding by approximately 6% over that same time frame.

During the fourth quarter, we also reduced borrowings by approximately $328 million. Our near-term capital allocation priorities will continue to be share repurchases and debt reduction. Please keep in mind that the information I’ve shared during this call gives a high-level summary of our financial results.

For more detail regarding the business segment results, please refer to the CFO commentary published on our website this morning. Now guidance. Turning to our outlook, our guidance excludes the wind down of the PC and mobility asset disposition business. Our first quarter of 2020 will close unusually early on March 28.

By comparison, the last four first quarters closed on March 30, March 31, April 1 and April 2, respectively.

Not only will the first quarter be two days shorter than the first quarter of 2019, but also the first quarter of 2020 will not capture the end of quarter sales activity that is always heightened for our enterprise computing solutions business.

We estimate the early closing date will result in an unfavorable comparison of $225 million to sales and $0.11 to earnings per share on a diluted basis compared to the first quarter of 2019. Our second and third quarters also closed two days earlier than normal.

However, since these quarters will , since these quarters will capture the calendar closing days from the preceding quarters, we don’t expect year-on-year comparisons to be meaningfully impacted. Our fiscal year always closes on December 31. So, we should capture lost sales and profits from the first quarter during our fourth quarter of 2020.

In addition, as disclosed in our press release, we are seeing some delays and longer lead times of products manufactured in China due to business and transportation shutdowns and the extension of the New Year holiday week mandated by the Chinese government.

We are monitoring the situation closely, but cannot quantify the impacts on our business at this time. We anticipate that total first quarter sales will be between $6.225 billion and $6.625 billion, with global component sales between $4.55 billion and $4.75 billion.

Our global enterprise computing solutions sales will be between $1.675 billion and $1.875 billion. We expect interest and other expense of approximately $52 million and average diluted shares outstanding of $82 million.

We anticipate the effective tax rate for the quarter will be approximately 24.5% towards the higher end of our long-term target range of 23% to 25%. As a result, we are forecasting earnings per share on a diluted basis, excluding any charges, to be in the range of $1.29 to $1.39. The average U.S.

dollar to Euro exchange rate we’re using for our forecasting purposes is $1.12 to €1. We estimate that changes in foreign currencies will have negative impacts on growth of approximately $30 million in sales and $0.01 on earnings per share compared to the first quarter of 2019. With that, I’ll turn the call over to the operator for Q&A..

Thank you. [Operator Instructions] Your first question comes from Shawn Harrison from Longbow Research. Your line is open..

Hi, everybody. I guess my first question is, there’s a market share transition going on in your global components business.

If there is any way to speak about, are you seeing that share shift beginning here in the first quarter and maybe how they transition to you throughout the calendar year?.

Yes. We don’t anticipate any contribution from any supplier program changes. We didn’t have anything in the December quarter. We’re not forecasting anything meaningful in the first quarter. If you remember, most of the transition supplier changes were happening sometime in the second half.

And if you look at it, the other guys can shift all the way through the end of the year. So there’s nothing in there at this point..

Okay. Thanks, Mike.

And then as a follow-up, Chris, do you think operating cash flow conversion for either the first quarter or the first half of the year will still be in excess of 100% of net income?.

Yes. I think we’ll see the rates start to slow, Shawn. Normally, in Q1 – I think for the last five years, in Q1, we’ve had negative cash flow performance. And I would expect that we would all other things being equal, be in that negative territory, although trying to fight our way to neutral.

That said, we do think that there’s still opportunities to reduce working capital in the current environment. So 70% of GAAP net income is the target. I think we could be a little above that, and that’s certainly the target, but we’ll have to see..

Thank you..

And your next question comes from Adam Tindle from Raymond James. Your line is open..

Okay. Thanks. Good afternoon. Mike, I just wanted to start on some observations from this end market downturn versus prior downturns. I think you mentioned in the press release the greater resiliency this time versus prior.

Could you just maybe touch on what you attribute that to? And on the flip side, as we think about the potential upturn, should we also expect to see a slower cadence of positive operating leverage and margin improvement?.

Well, I think that what you saw this time was faster reaction time. The first quarter, as you know, was what I would consider the start of the downturn. And during that time, we did our best to try to offset the sales and the earnings to try to keep earnings per share going for the customers.

And then in the second quarter, we sort of restructured our business very quickly and put out, I think it was like $130 million target, which we had executed on in a matter of a couple of weeks. We do keep plans sort of in the drawer. The good news is we haven’t had to pull them out for almost 10 years.

The bad news is, the market did come and we were sort of prepared for it. So I think we made ourselves more resilient this time around during the downturn. There’s obviously things you always find that you would do a little bit different the next time and we put those in the drawer for the next time.

But everything seems to be going like we’ve seen in the past. We’ve typically seen around a six-quarter downturn, five quarters of sort of negative sales and margin. It’s acting just like that, which is kind of funny 10 years later, but it’s – we’re starting to see the backlog stabilize now in all regions.

What we haven’t seen is the catalyst for growth yet, but I would still think we’re a couple of quarters away from seeing that, if you take the historical time we’ve been down. And when it does come, we’ve very rarely seen a bounce back, it has been a 1%, 2% or 3% bounce back. It’s usually been bigger than that, because it just seems to turn on.

And customers run themselves down in inventory. That’s the part of the surveys that we’re doing right now. And to have customers increasing that are saying they’re at appropriate levels of inventory, I think, is good news.

My expectation is they’ll start running those down even a little bit more until they see clarity, and then they’re going to want that inventory right back in there. So, we’ll have the uptick of the market being filling the inventory that they feel they’re below plus their forecast going out. And as you know, that’s usually a pretty good snapback.

And that’s what I would expect this time too..

Okay, very helpful. And I just want to make sure I’m understanding the comments on the no contribution yet from supplier changes.

Is that kind of what you expected internally? And just to clarify, I mean, is there – are you messaging that there could be a scenario where the expected move to Arrow doesn’t occur or just – what has changed around it?.

I don’t think there’s been anything that has changed. I think we said the exact same thing last quarter. I think it’s been the same from the beginning. And customer transition is the most important thing out there, and I think it’s being handled appropriately. And it’s allowing the supply chain to continue to go.

And I really don’t have any more comment, because I don’t even see it in our purview until the second half of the year, and we got enough things to worry about right now..

Got it. Thank you..

Your next question comes from Matt Sheerin from Stifel. Your line is open..

Yes, thank you. Just wanted to ask about the gross margin trends and particularly given it sounds like, Mike, that the mix will continue to work against you with Asia holding up better, Europe and North America still under pressure. So in the last couple of quarters you’ve been running about 100 basis points down year-on-year.

Should we be modeling margins still to be down in the low 11% kind of range until that mix changes?.

I would say at least through the first half, Matt, I don’t see any catalyst to change that, that much between now and then. But if the market changes and then new orders come in, then you have a blend and you kind of get half of it back and then you get the other half back.

So, I would say we would honestly be later in the year and going into the following year from the way it looks right now..

Okay, that’s helpful. And your commentary around the coronavirus and some of the issues that you’re – the early issues that you’re seeing, I guess, one good positive is that you do have inventory.

And have you looked at your inventory position relative to the supply chain and where the bottlenecks might be? And could that be in – put you in an advantageous position relative to competitors or suppliers?.

Yes, I think you hit it. We have no problem now with inventory. We’ve got plenty of inventory, as you can see. It’s the ability to move the inventory around. And the good news is, we’ve heard that the board is closed until the 10th.

We don’t know what happens on the 10th, is there an immediate snapback from manufacturers, do they slowly gear up, are they going to want their product, when is it going to be affected and how the orders will be affected. But I think we’re sitting on the good news side of that.

I think I heard that Foxconn was going to start producing again on the 10th or 11th. So it doesn’t look like it’s going to string out too far. And like I said, I hope that’s true. That’s – we all want that to be true and I hope that’s true. But that’s why we can’t really put a frame around the guidance because we don’t know the exact date..

Fair enough. Okay, thanks a lot, Mike..

Yes..

Your next question comes from Steven Fox from Cross Research. Your line is open..

Hi, good afternoon.

Can you talk a little bit about the components margins by region directionally on a like-for-like basis, how they trended versus, say, a year ago versus prior quarter?.

Yes, probably not, Steve. I think that’s getting a little bit too far down. What I can tell you is that given the numbers that you saw, everything held up better than expected for this time of year. But if you look at the downturn, really, Europe came in later in the year.

So, I expect Europe to come out of it later in the year, that’s why we are – started using the term bouncing along the bottom right now. That I don’t think you’re going to see any marketable change until well in the second half of the year..

Okay. And then in terms of the comment about offshoring sort of picking up at your customers in the western regions.

Can you expand on that a little bit? Specifically, are you seeing – are you able to follow the customers’ manufacturing as much as you would like? Is it winding up not being as much in China going forward? And are you positioned for that? Thank you..

I think, we’re well positioned for that. Any of the offshoring that we have seen, we have followed the customer to the destination, we have captured the business. We are seeing benefit from that. I would like to see that slow a little bit. So to me, getting a deal with China is important.

It’s going to be important for anybody in the semiconductor business, and that really depends on us. I think I went on record in the beginning and said those tariffs weren’t going to be good for anybody. They’re not. I still stand there. I wish my Senator would listen to it. But the bottom line is, it is what it is.

But yes, we’re able to capture the sales wherever they go..

Great. Thank you very much..

Your next question comes from Tim Yang from Citi. Your line is open..

Hi, thanks for taking the question. A follow-up question on gross margin. I think the gross margin underperformed by roughly 20 basis points last quarter that was brand-new roughly in line. And I think your implied guidance for gross margin is to increase 20 basis points to 30 basis points sequentially next quarter.

So, my question here is that, can you elaborate on the reasons for the margin softness last quarter? Is it volume, pricing or mix? And looking forward, those factors getting better or worse compared to a quarter ago?.

Well, I think it’s mix, a 20 basis points. You can do the math, it doesn’t take very much of a mix change for 20 basis points. So wouldn’t read anything into that. We saw the margins pretty much stabilize in all regions over the quarter, which is good news to where we believe there’s going to be a slight trend trending up as we go forward.

But it’s – for all practical purposes, it’s mix, and it’s such a small amount that, that mix can swing it either way. But right now, given the market and the downside of the market, I’ll take the sales because the mix is – the mix is translating into income, translating into earnings per share, and we’re not using too much cash to get it.

So we’re doing the best we can for the shareholders, and that’s what we’re going to continue to do..

Got it, that’s very helpful.

And then how should we think about the ECS operating income growth for next year? I understand that those selling days could impact the results, but do you feel that 2020 is still a growth year for ECS operating income, if we exclude the selling days impact?.

Yes. I’m actually going to let Sean answer that, because he started taking the abuse while he had to realign his business over the last year and a half to compensate for product changes and the cloud and everything else. So, I’ll let him take that lap..

Yes, sure. Thanks, Mike. And thanks, Tim. So Tim, as Mike pointed out in his opening comments, we did make some progress in the back half of the year with operating income growth, and it certainly remains our goal for the full year of 2020. So, I actually like our position and our path forward. Our strategy is not going to change.

The kinds of things that will help us get there over time will be to continue to lead new and existing channel partners to more software-based solution selling. That certainly helped us to date. We’re also executing on investments in the mid-market in the longer tail of our channel customer ecosystem.

Those customers tend to rely more fully on our capabilities and value. And then, of course, we’re making steady progress with line card and customer base expansion. So again, our strategy going forward hasn’t changed. And I think those are the things that will continue to put us in the right position..

Great. Thank you..

Your next question comes from Joe Quatrochi from Wells Fargo. Your line is open..

Yes. Thanks for taking the question. Chris, I was wondering if you could help us understand with regards to the cost optimization, I think you said that’s done. How should we think about OpEx.

And I guess, the right level of OpEx into the March quarter and then, I guess, as we start to see some improvement in demand in the back half of this year?.

So really, the bulk of the $130 million cost cuts, as Mike said, are in the P&L today. So, as you look at where we closed Q4, I’d say that’s a good rate.

I think the only caution around that you guys in your model will see that our corporate expense was quite a bit lower, and that really relates to incentive compensation given the fact that we obviously had a tough year, so that obviously renormalizes as we go into 2020.

As we look to later in the year, to the extent that we’ve had some deleverage in the P&L, when we see growth, whenever that is, we would expect to start to see the leverage return. So as Mike said, we got a very resilient model. We think that the expense structure of the business, combined with the strategy are as good as it has ever been.

And when we see a return to growth, you should see some leverage flow through at that point..

Thanks. And then just as a follow-up, On the ECS side, I was just wondering if you could kind of share your sort of expectations for just IT spending in general in 2020..

Well, in general, I think it’s going to be legacy products that, I think, are going to be relatively anemic. Where we’re seeing actually good growth is on the rest of it, software, networking, virtualization, storage, those types of things, we’re seeing really good. It’s the industry standard servers that we’re still seeing is off.

And I don’t really expect that to change much over the course of the year. And the growth rates on everything else is pretty high. But as you know, the hardware numbers in here are pretty high. So, it took a little while to offset those. And I think we’ll start seeing some good growth this year, if the economy does participate.

I think I’ve seen numbers on IT spend anywhere from 2% to 6%. And it just happens to be changing virtually every month now. So, we’ll see where it comes out. But again, I think it’s going to be – all the new products are going to grow at a great clip and the old hardware is going to be pushed down one more time..

Thanks..

Yes..

Your next question comes from Ruplu Bhattacharya from Bank of America. Your line is open..

Hi, thanks for taking my questions. Maybe, another question on the ECS margins, you saw good, about 130 basis point sequential improvement in the fourth quarter.

So trying to understand, can you elaborate how much of that was mix versus how much of that was higher volume? And how should we think about margins in the first quarter, how much of that can sustain? Any guidance there would be helpful. Thank you..

Sean, you’d like to?.

Yes, sure. Well, if you look at margins in the fourth quarter, for this business, I think it’s more important to look at it year-over-year versus sequentially. And we certainly held the margin line year-over-year fairly steadily. And it tends to be more a function of mix than volume, and that was certainly the case in Q4.

In Q1, we’re looking at similar operating margins year-on-year and again, as long as we execute on the sales plans we have in place and the mix doesn’t change dramatically versus what we see today, I think we should be right in the same ballpark..

Okay, that’s helpful and thanks for the details on that. I appreciate that. Maybe, just the second question on CapEx.

How should we think about CapEx for 2020 and specifically, do you think you have enough infrastructure to support the incremental share shift that you’re seeing with your semiconductor customer or would you have to add more warehouses? Or do you think – or I mean how should we think about CapEx in general? Thank you..

Yes. So, our CapEx for last year finished at $143 million. And as we’ve mentioned in the past, if you go back in time, we obviously had a great deal of spending around ERP implementations. That’s largely behind us. Just a little bit left in the ECS business in Europe.

And in 2019 and again, in 2020, we are addressing the need for more warehousing as the business has grown significantly. So that will be wrapped up in 2020. I think a good number for 2020 at this point is in the $150 million range. And then we would expect to see it come down thereafter as that warehousing gets built out..

Okay, great. Thanks for the details..

We have no further questions at this time. I’ll turn the call back over the presenters..

Thanks, Jacqueline. In closing, I will review Arrow’s safe harbor statement. Some of the comments made on today’s call may include forward-looking statements, including statements addressing future financial results.

These statements are subject to a number of risks and uncertainties that could cause actual results or facts to differ materially from such statements for a variety of reasons, and the company undertakes no obligation to update publicly or revise any of the forward-looking statements.

Detailed information about these risks is included in Arrow’s SEC filings. If you have any questions about the information presented today, please feel free to contact me. Thank you for your interest in Arrow Electronics, and have a nice day..

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect..