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spk06: Good day. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Arrow Electronics fourth quarter 2022 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press the star one. Thank you. Rick Seidlitz, you may begin your conference.
spk09: Thanks, Rob.
spk07: Good day, and welcome to the Arrow Electronics fourth quarter and full year 2022 earnings conference call. With us on the call today are Sean Cairns, President and Chief Executive Officer, and Raj Agarwal, Senior Vice President and Chief Financial Officer. During this call, we'll make forward-looking statements, including statements about our business outlook, strategies, and future financial results, which are based on predictions and our expectations as of today. Our actual results could differ materially due to a number of risks and uncertainties, including the risk factors in our most recent 10-K and 10-Q filings with the SEC. We undertake no obligation to update publicly or revise any of the forward-looking statements as a result of new information or future events. As a reminder, some of the figures we will discuss on today's call are non-GAAP measures. We have reconciled those to the most directly comparable GAAP financial measures in our earnings release. These non-GAAP measures are not intended to be a substitute for our GAAP results. You can access our earnings release at arrow.investor.arrow.com, along with our CFO commentary, the non-GAAP earnings reconciliation, and a replay of this call. Following our prepared remarks today, we will be available to take your questions. I will now hand the call to our President and CEO, Sean Cairns.
spk00: Thank you, Rick, and thanks to all of you for joining us today. Before I talk about our most recent results, I wanted to reflect a bit on the past year in total. which continued to present Arrow with unique market conditions and challenges. It was truly special to lead this great company and our 22,000 dedicated employees as we met those challenges head-on and helped both our customers and suppliers succeed in this environment. In turn, we have delivered the strongest financial results of any year in the history of the company. And while I'm extremely proud of what we've accomplished, I know that the market conditions continue to evolve as we enter 2023. We'll be faced with new challenges and opportunities through which Arrow will continue to differentiate itself in the markets we serve, reflecting the commitment, strengths, and aspirations of our entire global team. Now, turning to our results. I'm delighted to report that the fourth quarter was in line with our expectations and one of our best quarters ever, despite some challenging conditions. Our sales grew by 8% year over year on a constant currency basis, fueled by both growth in our global components and our global enterprise computing solutions businesses. In our global component segment, sales grew 6% as compared to last year on a constant currency basis. While demand for electronic components and associated design, engineering, and supply chain services generally remained healthy in the West, We did experience software demand in Asia relative to our sales guidance, especially in China. It's important to remember that we are not too concentrated in any one area. We're proud to service a variety of industries and provide products from a diverse group of suppliers to a diverse group of customers around the world. Additionally, design and engineering capabilities remain a key part of our strategy, and our ongoing investments continue to contribute to our success in all three regions. As we discussed last quarter, supply and demand conditions have been moderating somewhat. However, we are comfortable with our near-term outlook based on the quality of both our inventory and our backlog. While conditions may continue to moderate as we enter 2023, we remain focused on helping our customers secure the products they most need. Both the Americas and European regions produce strong year-over-year growth as both regions experience healthy demand across several major end markets and industries, particularly industrial, transportation, aerospace, and communications. In the Americas, we are continuing to see normalization in our shortage market services as supply continues to improve. This contributed to the sequential sales decline in the Americas, and it was the primary driver for margin compression in our global components business overall. Sales in our Asia region decline due to weakening demand in most end markets. We believe demand will likely remain soft in the near term as the region recovers from COVID-related disruptions and market headwinds. Despite the sales decline in the fourth quarter, design activity was quite robust and will no doubt contribute to our longer-term prospects in the region. With our diverse portfolio of customers and suppliers, along with our differentiated services offerings, we believe we are well positioned for when the market in this region eventually recovers. In the enterprise computing solutions business, we delivered year-over-year sales growth for the third consecutive quarter, Sales for the fourth quarter grew 12% year over year on a constant currency basis and finished above the high end of our guidance. Hardware supply constraints are easing somewhat and demand remains strong for most of our key technology categories. We continue to see strength in cloud, software, and enterprise IT content and are well positioned for the transition to IT as a service. In Europe, we experienced strong growth In all of our markets and technologies, in the Americas, our growth came primarily from strength and security, compute, and infrastructure software. We continue to measure this business on operating profit growth, and we are pleased to report full year growth of 4% year over year. Before handing over the call, I want to reiterate my confidence in our ability to help our customers and suppliers meet the challenges that lie ahead. While supply and demand conditions may continue to moderate over the coming quarters, we believe that we'll retain much of what we achieved over the past few years in terms of scale, capabilities, and an improved margin profile. We'll continue to help our customers and suppliers, and in doing so, we are confident that we will continue to generate attractive returns. With that, I'll now hand the call over to Raj to provide more details on our results and our expectations moving forward.
spk05: Thanks, Sean. Fourth quarter sales grew by 3% versus prior year or 8% on a constant currency basis. Changes in foreign currencies impacted sales growth by approximately $357 million year over year, which was less than our expectation of $420 million. Sequentially, the business grew by 1% and currency impacts were minimal. The average euro dollar exchange rate for the quarter was 102 to one euro compared to our previous expectation of 98 cents to one euro. Fourth quarter gross margin of 12.9% was down 40 basis points year over year, driven mostly by the normalization of shortage market activities we began to see in the third quarter. Sequentially, our margins improved by 10 basis points due to favorable product mix in the enterprise computing solutions business. Operating expenses as a percent of sales were 7.2%, down 20 basis points year over year and 10 basis points sequentially. Interest and other expense of $62 million has significantly increased year over year and sequentially due to higher rates on floating rate debt and higher borrowings, but was in line with our prior expectations. The effective tax rate for the quarter was 24.8%. This was slightly higher than our prior expectation, of 23.5% due to timing of certain items within the year. For the full year, our effective tax rate was 23.8%. Both the fourth quarter and full year rates are within our long-term range of 23 to 25%, which we continue to see as our appropriate target range going forward. Turning to cash flow and the balance sheet, our fourth quarter operating cash flow was $109 million. Our cash cycle of approximately 66 days increased three days from the third quarter and 12 days year over year, primarily due to inventory increases, which are largely related to pricing. As a reminder, our inventory investments allow us to support customer demand, and we have continued to generate strong returns in the process. Our return on invested capital and return on working capital remain well above pre-pandemic levels. At the end of the quarter, net debt totaled $3.6 billion, and our liquidity remains very strong at approximately $2.3 billion, including cash of $177 million. Our strong financial position and flexible balance sheet positioned us to repurchase $300 million of shares during the quarter. At the end of the fourth quarter, our remaining repurchase authorization stood at $329 million. We are also pleased to announce that our Board of Directors has approved an additional $1 billion to our share repurchase authorization. Returning cash to shareholders through our stock repurchase plan remains one of our priorities, and this authorization reflects that commitment. Please keep in mind that the information I've shared during the call today is a high-level summary of our financial results. For more detail regarding the business segment results, please refer to the CFO Commentary, which we published on our website this morning. Also note that the CFO commentary includes information on our fiscal calendar closing dates. Now, turning to guidance. Midpoint sales and EPS guidance reflect the continuation of current market conditions, which we have discussed, particularly the impacts of normalizing shortage market activities. Midpoint global component sales reflects an expected decline of 7% compared to prior year and 5% on a constant currency basis. Our forecast suggests enterprise computing solutions will grow 3% year-over-year and 6% on a constant currency basis. We estimate that the strengthening of the US dollar compared principally to the Euro will result in a reduction to sales growth of $182 million and EPS growth of 13 cents compared to prior year. Compared to the prior quarter, we estimate that the impact will be a positive $175 million to sales and 11 cents to EPS. I will now turn the call over to the operator for Q&A.
spk06: At this time, I would like to remind everyone in order to ask a question, press star, then the number one on your telephone keypad. Your first question comes from a line of Rupal Bhattacharya from Bank of America. Your line is open.
spk04: Hi, thanks for taking my questions. Sean, I wanted to start with a high-level question. I mean, when you look at in-market demand today versus 90 days ago, I mean, how would you say, I mean, are things materially weaker? Are they the same? Or how do you see that trending over the next quarter? And then specifically on the component side, I think you said bookings were below parity in all regions. Is that concerning? And do you think backlog will continue to decline? Or do you think that that can also grow over the next couple of quarters?
spk00: Sure, Ruth. Let's start with just our feelings about the market overall. And I would say it's sort of mixed. You know, if you look at our guide for the first quarter, we're basically at or above normal seasonality in all of our Western markets. So maybe not quite as broad based in the West as it was maybe 90 days ago, but we're still seeing activity levels in things like transportation, industrial, aerospace and defense, and medical device sectors holding up. and certainly, you know, other sectors like compute, communications, consumer, and things like lighting slowing down. Obviously, demand trends in Asia, you know, specifically China, have been impacted by, you know, market headwinds and COVID disruption. It obviously was initially all about, you know, consumer and PC, but that's now bled into other key verticals as well. But by and large, we still see enough activity in the West to feel good about our outlook in the first quarter. And to that point, your question about backlog, look, our backlog is down from its all-time high, but it's still well, well, well beyond historical levels. Our teams do a pretty good and active job throughout the world to continue to validate that backlog. And we believe The majority of it is still firm versus forecasted. And, you know, that work yields or has yielded certainly more reschedules and pushouts than cancellations. So we feel pretty good about, you know, the backlog. And as we said earlier, you know, the quality of our inventory to support the guidance we've shared.
spk04: Okay. Thanks for the details there, Sean. Maybe I can ask Roger a couple of quick questions. On the... On the inventory, it looks like sequentially it was up 5%. I know you're guiding, there's some seasonality in the March quarter, but can you just talk about what drove the increase? And as you think about this year and free cash flow and working capital days, how should we think about that? Do you think inventory remains high for a while, or do you think that we're at the point now where it's peaked and it can actually come down and free cash flow can be better?
spk05: Yeah, I would say the majority, the majority of the increased inventory, whether it's quarter over quarter or year over year, is driven by pricing environment that we've been in. And so that's really what's driving it. You know, we do, as Sean said earlier, we have a good, strong backlog. We think we can sell through most of the inventory. And it's hard for me to say what the peak level is going to be. But, you know, we continue to have good demand in the West. And that's really what we're looking at. And, you know, from a cash flow standpoint, I think we're going to, you know, we'll generate some cash flow this year, just given the market dynamics. But overall, we feel good about where we sit.
spk00: And Ruth, you know, I would just add some color to that, which is, look, you know, I look at inventory as a function of customer service, you know, especially in this environment. So, you know, we really spend as much time as we can to help our customers deliver on their production schedules, even as they change. And as you might imagine, there's a fair bit of change in this environment. But You know, I look at the increase in Q4, for example, I would call it, for the most part, modest. But I think a healthy inventory investment now, you know, will set us up for attractive returns in the future.
spk04: Okay. That makes sense. And finally, if I could just ask, you know, I think one concern that many investors have is, you know, are margins at their peak? I mean, as suppliers lower their prices, I mean, when you see ASP pressure and, you know, how you think about margins, And in that context, if you can give any of your views on how you think margins can trend. But also, do you have cost levers? And I guess my question is on general risk management. Like if we go into a recession or a slowdown, do you think OPEX as a percent of sales or as a percent of gross profit still has, you have levers to lower that, meaning you can take more costs out? So just your thoughts on your ability to manage your costs and how you think margins will trend. maybe in a deflationary environment or in a recessionary environment. Thank you. Thanks for all the details.
spk00: Sure, Ruflu. So, you know, of course, I always like to talk more about growth and cost, but I'll start with the second part of your question. You know, we feel like our FX is fairly well managed. As you can see, we landed at historical lows on both a percent of sales and a percent of gross profit basis. We've got all kinds of levers in place to make sure that, you know, we're protecting our investment priorities. and continuing to work on structural costs over time. You were obviously going to be very surgical in this environment. If things were to slow more dramatically, I think we know where to go and remember that variable costs in a more recessionary environment would come down substantially. I think to the first part of your question, and it's the right one, we spent a lot of time looking at how the complexion of our business has changed over the past couple, three years. And as the supply-demand market continues to normalize, I can tell you that we feel pretty confident about our ability to retain some of the structural benefits that we've built into our model. So, you know, I can't sit here today and say exactly when. The market will fully normalize, but it will. And, you know, we'll reach something that we might call a steady state. You know, when we do, I'm confident that operating margins in our components business are going to land well north of The last long-term target we set for that business, and for those of you that maybe weren't as involved, that was 5% at the time. I think now we're looking at something in the range of 5.5% all the way to maybe 6 points. So, you know, the reason we have conviction around that is because of the structural investments we've made over time and You know, I can talk a lot about engineering resources that help us capture design wind margin potential. We think there's still runway there. I can talk about supply chain capabilities and what that's doing to help us serve our customers in different and value adding ways. I can talk about design services, which are especially interesting to some of our larger OEM customers for which we enjoy you know, really accretive returns. So there's some real thought behind that statement. And I think, you know, while you might want to ask me when, and we won't commit to a timeframe, again, the market's got to normalize, but we feel really good about, you know, the next target range for that business.
spk04: Okay. Thanks for all the details. Appreciate it. That's helpful.
spk06: Your next question comes from the line of Matt Sheeran from Stiefel. Your line is open.
spk03: Yes, thank you. Good afternoon, everyone. Just a little bit more color in terms of what you're seeing. It sounds like the Western markets are holding up better. Your big competitor last night is seeing a below seasonal demand in all regions, although like you, I'm calling out Asia as the weakest area. And they're seeing an inventory correction start to play out across their businesses. It doesn't sound like You're seeing that yet? Are there any other than your commentary about some push outs and no cancellations? Anything else you're seeing there? Are your book to bills going negative in those markets?
spk00: Well, as I think maybe the CFO commentary or someone suggested, book to bills are below parity in all three of our regions, but Matt, I'll go back to what I shared about the guide. Again, in most of our Western markets, we're at or above normal seasonality in our Q1 outlook. China really is the only place where, you know, we're sub-seasonal here. You know, from an inventory perspective, as I mentioned, you know, I never like to see it creep up, but I have confidence in what it will help us deliver. Our Asian PAC team, you know, funny enough, kept inventory flat. sequentially quarter over quarter. So we are managing that as well as we can under the circumstances, especially while we try and juggle the balance between working capital and customer service. I think we're in pretty good shape on that front moving forward.
spk03: Okay. In components you talked about, you know, weakness in that shortage market in North America, which makes sense. Do you think that's bottomed in terms of fundamentals there, or is that going to get weaker before it bottoms?
spk00: You know, Matt, I think we're getting closer. I think we'll still see some of that pressure in Q1. But then I think, you know, we'll see that become less impactful over the balance of this year, assuming all else remains equal.
spk03: Okay, great. And just a question on ECS where it looks like you've had, you know, nice, strong results, still good demand drivers. We are hearing some concern about the backlog and as that's filled as component shortages get easier, the backlog, you know, working off and forward. Are you seeing that in any of your businesses or do you have any kind of outlook? in terms of IT spending for the year as you're talking to your customers?
spk00: Sure. Maybe I'll start with your question about backlog. I think in my opening comments, I talked about the fact that the hardware supply chains are easing somewhat. It hasn't completely flushed, and our backlogs are still close to all-time highs in that business. So there's still a ways to go, but it was nice to see some relief in the fourth quarter, and I think we'll see you know, some relief throughout the year. I think the broader market, while it was rebounding from, you know, the pandemic, I think has maybe moderated somewhat. I'd at least call it mixed. We talked about supply chains. You know, cloud adoption is slowing somewhat, at least from its pandemic levels. Given some recessionary concerns, you know, we have seen some evidence of slowing sales cycles surrounding enterprise IT more generally. But, you know, at the same time, pipelines related to cybersecurity, infrastructure software, things like digital automation, they're all still pretty active and healthy. So, you know, while we're not super billish about the growth outlook for the year, by no means, you know, do we see it going south.
spk09: Okay, great. Thank you.
spk06: Your next question comes from a line of Jim Suba from Citigroup. Your line is open.
spk01: Thank you, Sean. Sean, before you were at Arrow and before COVID, there were some supplier consolidations, some supplier changes about using distribution, not using distribution, giving more value-added demand creation, giving less value-added creation to the distributors. I'm just wondering now that hopefully if we exit COVID and hopefully get to more normalized supply chain, are you seeing or having discussions with suppliers for any changes? And are they positive, negative, or no changes? I'm wondering if there's actually more opportunity or is there like more consolidation or kind of what's going on? Because the past three years have been challenging for everybody. Thank you.
spk00: They certainly have. Thanks, Jim. So maybe take your question in a couple pieces. I mean, first, from a consolidation perspective, that's a little tough for us to call. You know, consolidation will likely continue in the industry, but we don't have any specific knowledge of anything, you know, in play. We've tended to benefit from some of that and at times maybe get hurt from some of that. So that one's a little bit tough to call. But from a program perspective, look, we're always having conversations with our suppliers. Our suppliers are always looking at ways in which they can work with us to rely on more of our capabilities. I would say in general, not less. I do believe there's more demand creation potential in the overall semiconductor supplier market in total. We saw our demand creation mix improve year over year. You know, we look at design activity every quarter pretty closely throughout the world, and we see design registrations, design wins still going up. You know, so while you might from time to time catch wind of a supplier that's looking to trim, you know, the margin profile in their channels, you know, I'm comfortable that there's plenty that still place a lot of value on, you know, the engineering investments we make for demand creation and you know, give us a chance to be rewarded accordingly. So I think the outlook for, you know, that particular piece of the question is still very valid and very promising.
spk01: Thank you so much for your details. Congratulations on good results and such a challenging time. Thank you.
spk00: Thanks, Jim.
spk06: Your next question comes from a line of William Steen from Truist Securities. Your line is open.
spk09: Great. Thank you for taking my question.
spk08: First, I'd like to ask about the trend in lead times broadly. I think it's clear that they're coming down, but I wonder where you think we are in that normalization process. Are we somewhere in the middle innings, or are we still in the beginning of that process? Would you expect that to continue throughout the year?
spk09: And then I have a follow-up.
spk00: Hi, Will. So, you know, it's funny because, you know, I think you read some headlines specific to certain components of the technology mix, and people broadly assume, you know, the supply constraints have gone away, but, you know, we still see it as very mixed. I mean, lead times have come in in certain cases, but on average, you know, the lead times we see across, you know, our whole electronic components business is twice the pre-pandemic average. Now, that's down from some of the higher levels it once sat at, but it's still not sufficient to satisfy the backlog that we still see. So I call it mixed on a technology basis. Hard to say when it all fully normalizes. I don't see that happening probably anytime soon. Maybe it will gradually improve throughout the year. Don't know. We really don't want to speculate too far ahead of the quarter in front of us and maybe just a little bit more. Remember, you know, all the capacity investments that we read about over the past couple of years, that takes time to materialize and really change the structural, you know, supply formula for the industry in total. So I think it's still going to be kind of mixed and, you know, it's going to be a little bit of an ebb and flow here over the course of the year. But, you know, we're going to focus mainly on what we can see over the next 90 plus days.
spk09: Okay. Thank you. As a follow-up,
spk08: Arrow has a well-known, significant supplier that went through a consolidation process with distribution partners, I think, a couple years ago now. But they've been pretty aggressively deploying some features in their sort of supply chain, if you will. For example, a new distribution center in Europe where they're doing same-day delivery they've developed these APIs for customers to hook directly into their website. I wonder, it seems relatively clear that this is targeted at the types of services that you have provided to their customers and to your customers over the years. I wonder if you see this as a threat that's sort of materializing to that portion of your revenue today or if it's something in the future or You just don't think that this is going to have a meaningful impact on your business. Thank you.
spk00: Yeah, well, you know, look, I'm not going to claim ignorance here, but I think you can appreciate we would never talk about any of our suppliers in particular. So, you know, I can't really help you out a whole lot with that one. I can say that, you know, overwhelmingly, as I said earlier, most of our conversations with most of our suppliers are all about how we can help them do more. So I feel pretty good about what that means for us, not just now, but into the future.
spk02: Thank you.
spk06: And again, if you would like to ask a question, press star, then the number one on your telephone keypad. Your next question comes from the line of Joe Quattrochi from Wells Fargo. Your line is open.
spk10: Yeah, thanks for taking the question. In the past, you guys have talked about kind of a customer survey approach. on the number of customers that don't have enough inventory or have too much inventory. Is there any color you can provide on where we stand and the kind of results of that survey?
spk00: Sure, Joe. You know, I guess the short answer is mixed. You know, we continue to perform the survey of late. It's been really hard to see any consistent patterns. You know, you'll see The numbers move around a little bit, one quarter to the next, for those that say they have too much versus those that say they have too little. And then you'll see it move again in the other direction in Q4. So I would not place a whole lot of stock in what that's telling us in this environment because this is such an abnormal supply environment. So it's a little less predictable for us. We're relying on lots of other vectors that we have access to, including our backlog and including our inventory turns, et cetera.
spk10: Okay, that's helpful. And then on the shared purchase program that you guys announced, is there an expiration to that authorization? And then how do you think about balancing that activity relative to your working capital need, just given the increase in short-term borrowing rates that we've seen kind of flow through your interest expense line?
spk05: Hey, Joe, this is Raj. There is no expiration to the share buyback authorization, which is similar to what we've done in the past. So no change there. And our capital priorities continue to be the same. And so if we have a need to invest in the business, that'll be our first priority. And then we always are looking for the right kind of M&A opportunity at good returns. And then To the extent we have excess capacity, we'll buy back our stock, and that's really what we've been doing. And in terms of short-term rates, we've taken that into account. That's certainly driven up interest expense in the fourth quarter, but the things that we're doing more than pay for that incremental cost. So I think we're positioned well.
spk09: Got it. Thank you. Sure.
spk06: And there are no further questions at this time. Mr. Rick Silas, I'll turn the call back over to you for some final closing comments.
spk07: All right. Thank you, Rob. I just want to thank everyone for your interest in aeroelectronics and wish you have a nice day. Thank you.
spk06: This concludes today's conference call. Thank you for your participation. You may now disconnect.
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