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spk01: Good day and welcome to Arrow Electronics' fourth quarter and full year 2023 earnings call. Today's call is being recorded. And at this time, I would like to turn the conference over to Anthony Benzvega, Vice President of Investor Relations. Please go ahead, sir.
spk05: Thank you, Operator. I'd like to welcome everyone to the Arrow Electronics' fourth quarter and full year 2023 earnings conference call. Joining me on the call today is our President and Chief Executive Officer, Sean Cairns, our Chief Financial Officer, Raj Agrawal, our President of Global Components, Rick Marano, and our President of Global Enterprise Computing Solutions, Kristen Russell. During this call, we'll make forward-looking statements, including statements about our business outlook, strategies, and future financial results, which are based on our predictions and expectations as of today. Our actual results could differ materially due to a number of risks and uncertainties, including the risk factors described in our most recent 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, which are not intended to be a substitute for our GAAP results. We've reconciled these non-GAAP measures to the most directly comparable GAAP financial measures in this quarter's associated earnings release or Form 10-K. You can access our earnings release at investor.arrow.com, along with a replay of this call. We've also posted a slide presentation to accompany our prepared remarks and encourage you to reference these slides during the webcast. Following our prepared remarks today, we'll be able to take your questions, and I'll now hand the call over to our President and CEO, Sean Cairns.
spk03: Thanks, Anthony, and thank you all for joining us. We appreciate your interest in Arrow Electronics. For some context, I'd like to first review our 2023 full year financial results before commenting on our fourth quarter performance and the overall state of the market. I'll then turn things over to Raj for more detail on our financials, as well as our outlook for the first quarter. As I reflect on our performance over the past year, I want to start by thanking our global team. for their persistence, resilience, and dedication to our suppliers and customers. Through their efforts, we were able to deliver solid financial performance given the market backdrop. Despite excess inventory throughout the supply chain leading to softer demand in our components business and a mixed IT spending environment for our enterprise computing solutions business, we executed well in a challenging environment. Arrow posted $33.1 billion in full year 2023 revenue and achieved an operating margin of 4.8% on a non-GAAP basis. In addition, we generated healthy cash flow from operations, which enabled us to repurchase approximately $750 million in shares throughout the year. Now, moving to our fourth quarter results. To close out the year, we delivered sales of $7.8 billion in the fourth quarter. just better than the midpoint of our guidance. Based on healthy operating margins in each of our segments, we generated non-GAAP earnings per share of $3.98, comfortably above the high end of our guided range. Taking a closer look at our components business, the industry-wide inventory correction appears to be taking longer than anticipated when compared to prior cycles. This is likely due to the breadth and magnitude of the shortages that precipitated the inventory buildup along with continued softness for components in many industrial markets. However, we do believe markets will eventually improve and see gradual signs of normalizing trends. Our book to bill ratios have stabilized overall, with our IP and E portfolio trending closer to parity. Pricing is generally holding up as reflected in our fourth quarter gross margins, which were sequentially better than in the prior quarter. Our demand creation pipeline is growing as customers continue to develop new products. And while order rescheduling activity persisted, we focused on backlog conversion during the quarter and reduced inventory by over $600 million sequentially. From a regional perspective, in Europe and the Americas, customers continue to moderate their supply as reflected by their reluctance to place new orders. While we expect sub-seasonal performance in the near term, and continued softness in industrial markets, we were encouraged by robust design activity and relative strength in verticals such as aerospace and defense and medical devices. And in Asia, we expect results to normalize somewhat with respect to typical seasonality when compared to the West. And while we can't predict the timing of a broader macroeconomic recovery, we were pleased by sequential growth in segments such as data center compute and to a lesser extent, transportation. Shifting to our global ECS business. During the quarter, we continued to execute on all things IT as a service, which led to a higher mix of infrastructure software, cloud solutions, and related services when compared to the prior year. Over time, this mix drives a growing portfolio of recurring revenue volumes, as well as better contribution margins for the business overall. And given the annual nature of this business model, fourth quarter results were up sequentially as expected. From a regional perspective in Europe, we delivered year-over-year billings and gross profit dollar growth amidst the mixed IT spending environment. While storage and compute were down, they were more than offset by strength in infrastructure software and networking products. And in North America, our results for the fourth quarter reflect a muted IT spending environment with softness in storage, compute, and cybersecurity, partially offset by strength in infrastructure software and networking. As we've stated in the past, we're in the process of optimizing our customer mix and supplier line card in the region to better serve the mid-market. We've made progress in this area and are optimistic about improving our results in the region this year. Before I hand things over to Raj, I do want to reflect a little bit on the future. Despite the ongoing cyclical correction and a weaker macro demand environment, we remain optimistic regarding the overall industry backdrop and believe longer term technology trends will benefit Arrow. We're at the center of large and growing markets driven by the electrification of everything, renewable energy, autonomous vehicles, and artificial intelligence, just to name a few. Given a longer horizon, we remain committed to the growth initiatives we've previously shared with you, where our differentiation provides value to both our suppliers and customers. First, in demand creation, we added engineering resources throughout 2023, which helped demand creation revenue outpace the rest of the portfolio. Second, our engineering services have been gaining traction across attractive verticals such as renewable energy, automotive, and medical devices as a result full year engineering services revenue grew meaningfully third in supply chain services we expanded our customer base in 2023 with further penetration in the data center and automotive verticals and looking ahead we see additional opportunities to extend this offering to other verticals and oems next we've maintained our differentiated focus on interconnects passives and electromechanical components, a margin accretive growth area within our components business, and finally, in our ECS business, over the course of the year, we enhanced our digital distribution platform, AeroSphere, while onboarding new channel partners and supplier lines, demonstrating our commitment to the market's transition to IT as a service. In the meantime, as we navigate a challenging near term, We will continue to prudently manage our cost structure and working capital portfolio with an eye towards emerging even stronger as market conditions improve. And with that, I'll hand things over to Raj.
spk07: Thanks, Sean. I'll be speaking to our financials on an as reported and GAAP basis, unless otherwise specified. Consolidated revenue for the full year 2023 was $33.1 billion, which was down 11% versus prior year. Global component sales were $25.4 billion, which was down 12% from the prior year, driven primarily by softness in the Asia market and reduced shortage market activity in the Americas, partially offset by growth in our European market. Enterprise computing solution sales were $7.7 billion, which was down 8% versus prior year. Importantly, our full-year global ECS fillings were flat from prior year, reflecting growth in Europe offset by a decline in North America due to a softer IT spending market in that region. Moving to other financial metrics for the full year, consolidated gross margin of 12.5% for the full year was down 50 basis points from prior year. Non-GAAP operating expenses were down $157 million from prior year to $2.6 billion. The OPEX decline came from a favorable legal settlement in the third quarter, reduced variable expenses, and our continued efforts to control spending. Non-GAAP operating income was $1.6 billion, or 4.8% of sales, with global components operating margin coming in at 5.8% and enterprise computing solutions coming in at 4.8%. Non-GAAP diluted EPS for the full year was $17.12, based on an average outstanding share count of 57 million shares. Now turning to our fourth quarter results. Consolidated revenue for the fourth quarter was $7.8 billion within our guidance range and down 16% versus prior year. Global component sales were $5.6 billion, meeting the midpoint of our guidance and down 10% versus prior quarter or 17% versus prior year due to the ongoing semiconductor inventory correction. Enterprise computing solution sales were $2.2 billion, also in line with guidance and down 11% versus prior year. This was partly a function of product mix and partly a function of lower discretionary IT spending in North America. Moving to other financial metrics for the quarter. Fourth quarter consolidated gross margin of 12.6% was down 30 basis points versus prior year, driven primarily by overall mix in global components. Sequentially, our gross margin was higher by 40 basis points due to the typical seasonality within the ECS business, as well as favorable mix and components business in the West. Our fourth quarter non-GAAP operating expenses declined sequentially when normalized for certain previously announced third quarter items. Our Q4 GAAP operating expenses included restructuring, integration, and other charges of $40 million related to facility consolidation and other operating expense reductions. We generated non-GAAP operating income of $364 million in Q4, which was 4.6% of sales, with global components operating margin coming in at 5.1% and enterprise computing solutions coming in at 6.6%. Interest and other expense was $82 million in the fourth quarter, which was flat quarter over quarter and better than guided due to lower than expected average daily borrowing. Our non-GAAP effective tax rate was also favorable to our guide at 21.8%, resulting from certain domestic and foreign tax credits. And finally, non-GAAP diluted EPS for the fourth quarter was $3.98, which is above the high end of our guidance range and based on a 55 million share count. Turning our attention to working capital. Networking capital for Q4 was flat from Q3 at $7.4 billion. Accounts receivable and accounts payable both increased in the fourth quarter due to normal seasonality in the ECS business, along with activity in our supply chain services offering. Inventory at the end of the fourth quarter was $5.2 billion, decreasing more than $600 million from Q3, with inventory days declining to 69. The combination of ECS seasonality along with the decline in inventory drove a reduction in our cash conversion cycle. Our cash flow from operations was $287 million in the fourth quarter and $705 million for the full year. Net debt at the end of the fourth quarter was lower compared to Q3 at $3.6 billion. Aristotle liquidity at the end of the fourth quarter stands at $2.4 billion, including our cash balance of $218 million. We remain confident in the strength of our balance sheet, which gives us the financial flexibility to effectively manage our working capital needs. We repurchased shares in the amount of approximately $50 million in the fourth quarter and approximately $750 million for the full year. At the end of the fourth quarter, our remaining stock repurchase authorization stands at approximately $580 million. Please keep in mind that the information I've shared during this call is a high-level summary of our financial results. For more details regarding the business segment results, please refer to the press release and earnings presentation published on our website this morning. Now turning to Q1 guidance. We expect sales for the first quarter to be between $6.7 billion and $7.3 billion. We expect global component sales to be between $5 billion and $5.4 billion, which at the midpoint is down 8% from prior quarter. We expect enterprise computing solutions sales to be between $1.7 billion and $1.9 billion, which at the midpoint represents a 4% decrease year on year. We're assuming a tax rate in the range of approximately 23 to 25% and interest expense of approximately $80 million. And our non-GAAP diluted earnings per share is expected to be between $2.20 and $2.40, which reflects unfavorable leverage in the business due to current market dynamics. And finally, we estimate changes in foreign currencies to have an immaterial effect on our Q1 guide. The details of the foreign currency impact can be found in our press release. With that, Sean and I are now ready to take your questions. Operator, please open the line.
spk01: At this time, if you would like to ask a question, please press star followed by the number one on your telephone keypad. If you would like to withdraw your question, please press star one. Your first question comes from the line of Matt Sheeran from Stiefel. Please go ahead.
spk08: Yes, thank you very much. The first question, just regarding the inventory reduction in the quarter, which was nice to see. But on a day's basis, particularly year over year, you're still up. So the question is, A, looking at your customer's inventory, how long do you think this is going to take to wash out? And B, in terms of your own inventory target over the next couple of quarters, what should we be thinking about?
spk03: Sure, Matt. Welcome. So, you're right. We focused pretty intently on backlog conversion in the quarter, and that helped us drive the reduction that you saw. I think part of this comes from our focus on the mass market, which is really a sweet spot for us, where we're seeing a little better sell-through velocity than we are in the higher end of the market. The other thing to point out about inventories is that our units were down. in the quarter both sequentially and year over year. So part of the excess you're still seeing is really a function of price versus, you know, a lot of inbound volumes. The rate of inbound has certainly slowed for us as lead times have normalized. The other thing I would tell you is that if you look at it region by region, you know, we exited the quarter within a turn or less as compared to our historical norms. So we think the right things are happening by way of normalization. There is still a piece of the excess inventory that's really a function of, you know, some of the long-term supply agreements that were in play. Most of those have wound down or are winding down, and the impact of that is abating for us over time. So, yeah, hard to say exactly when things fully normalize. suppliers are now you know behaving much like they would have been in pre-pandemic days you know with lead times much more normal they're certainly flexible with regards to reschedule and cancel cancellation activity for us that's been a little more rescheduled and cancellation for sure but it does mean the time it takes to you know work your way through the backlog is extending um but the right things are happening and as we said in our prepared remarks you know, book to bills stabilizing and improving slightly, inventories coming down. We feel good about where we are. Probably still need, you know, this quarter and next just from an inventory perspective to see things, you know, fully normalized yet again.
spk08: Okay. Thank you for that. And then just a question regarding margins in the March quarter. It looks like your operating margin is going to shake out in the mid 3% range or so, so down year over year on the volumes, obviously. But can you give us a sense what the gross margin might look like sequentially? Is that expected to be down? And then also on OpEx, I know you have some restructuring programs. So are you expecting to get OpEx dollars down quarter and quarter or year on year?
spk03: Sure, Matt. So let me start with global components because that represents the lion's share of our volume. you know, what you're seeing from an operating margin perspective is really more a function of regional mix than anything to do with pricing pressure. We've got a little bit less EMEA on a relative basis, you know, in this outlook than what normal seasonality might imply. But if you look at all of our forecasts across the business, you know, we kind of see gross margins holding up pretty well sequentially. So really what we've got here is just, you know, a loss of operating leverage at these sales levels. We know that as demand improves, the leverage piece of the equation is going to take care of itself. We're pretty comfortable that the structural contributors to our margin strength are holding up. From an OPEX perspective, you're right. We've always been pretty vigilant when it comes to our cost structure. That's not changing, especially in this market environment. We are taking appropriate actions in the near term. You know, I can pretty confidently tell you that, you know, you'll see our absolute operating expense dollars trend downward over the course of the year. At the same time, you know, even though this correction is taking a little bit longer to play out, I would say we ultimately see this as, you know, short-term in nature. So, we do intend to protect our growth priorities and the associated selling and engineering capacity for the long haul.
spk07: And Matt, maybe I could just add, we also see in first quarter the typical seasonality for ECS where they have their largest quarter in the fourth quarter, and they also have their softest quarter in the first quarter. And so you're going to get a natural step down in margins just in the ECS business. So that's why you're sort of seeing the margin step down that you're seeing.
spk08: Understood. Okay. Thank you very much.
spk01: Your next question comes from the line of Melissa Fairbanks from Raymond James. Please go ahead.
spk02: Hi, guys. Thanks very much for taking my question. I just had a quick one maybe to go back on the inventory from a little different perspective. As we've heard from a number of your suppliers this quarter, some have managed their channel inventories better than others. Pretty much all are seeing the same demand dynamics as the supply has eased as what you're seeing. Are you starting to see any suppliers trying to push more inventory through to you as they work to manage their own working capital? Or is it still pretty much a fair balance?
spk03: Hi, Melissa. Welcome. And I'm glad you asked the question because I wanted to clarify my last remark. The short answer is no. We're not seeing that really at all. In fact, as lead times have normalized, for the most part, completely, suppliers again have returned to a more flexible posture with regard to the backlog that we're still managing through. So that means that we're able to reschedule as necessary, cancel on occasion. That takes a little bit longer to convert the backlog. And our backlog still remains at significant levels beyond pre-pandemic days. But we're not seeing any pressure from our suppliers in this environment, I think we're getting to, you know, the other side of, you know, what you typically expect in that regard.
spk02: Okay, great. That's great to hear. Maybe as a follow-up, just kind of dig in on, Sean, what you mentioned on the transport in Asia. You were actually starting to see a little bit of growth there on a sequential basis. What we've heard from a lot of your suppliers and maybe some of your own customers is that The demand has been, outside of a few pockets, has actually been fairly resilient. It's just been a matter of up and down the supply chain, people now have enough buffer inventory. Are you starting to see goods sell through, or is it demand improvement, or maybe a balance of both?
spk03: I'd say in general, Melissa, it's a balance of both. And again, my comments were more on a relative basis. I think we all know the Chinese market remains down, certainly soft, and the period for recovery is a little unclear. But transportation, and specifically EV, has been a little bit healthier for us as compared to most other verticals. So demand hasn't probably ticked up dramatically. At the same time, we've been able to sell through pretty consistently some of the inventory we do carry for that space. And I think that will be kind of the same posture for us in this quarter as well.
spk02: Okay, great. Thanks so much. That's all for me.
spk01: Your next question comes from the line of Jill Cartucci from Wells Fargo. Please go ahead.
spk04: Yeah, thanks for taking the question. I just wanted to kind of understand, you talked about your IP and you've booked a bill approaching parity. In that context, can you help us just understand it, you know, when we think about that relative to other cycles and the rest of your components, has that been like a leading indicator of a recovery? Just kind of help us maybe understand the importance of that comment.
spk03: You know, Joe, I would really, I probably wouldn't link IP&E to the broader correction cycle in that way necessarily. Remember that IP&E, as compared to semiconductor, never really had the same shortage and capacity challenges as we saw in the semiconductor space. So, you know, lead times never went out as long. Shortages never got to be that severe. And so, we're really not in the same kind of correction in that piece of the market as we are in the semiconductor piece of the market. Yeah, it's been more resilient, more predictable for us. Hence the reason book to bill is closer to parity. And as you know, we like the space. It's margin accretive. And our new leader for our global components business is doing a nice job of really standing up a differentiated go to market model for that piece of the market. And we think, you know, over time and long term, it's really going to be quite attractive for us.
spk04: Thanks for that. And then just I guess as we're looking beyond the March quarter and trying to think about the regional mix and impact to margins on the business, as we think about seasonality into the June quarter, is it fair to assume that that's a bit of a negative headwind, just given that it sounds like Asia is maybe working through inventory a little bit faster than the western regions?
spk03: You know, probably too early to call Q2 from a seasonality perspective. Joe, I can tell you when we look at Q1, you know, we are guiding below normal seasonality overall. You know, that's really a function of, you know, some more macro pressure in the West, you know, with evidence of, you know, some softness in industrial and parts of automotive. I think in Asia, you know, we're not necessarily assuming the typical uptick that you'd see post the Chinese New Year. But as we work through backlog and as, you know, inventories start to normalize, you know, we're going to get better visibility to near-term demand, and that's going to be a good signal for the business and the market overall.
spk06: Got it. Thank you.
spk01: Your next question comes from the line of William Stein from Truist Securities. Please go ahead.
spk06: Great. Thanks for taking my questions. And congratulations on the good results this quarter. I'm hoping you can linger a little bit on the legal settlement. If you can maybe remind us what that's related to. How big was it and in which segment?
spk03: Sure, Will. And thank you. I'll let Raj speak to the number. But just for context, the settlement was related to a commercial dispute. with a subset of our supplier base that dates back well more than a decade ago. Many of us weren't even on the scene when this played out, but we are very pleased with this result, and we anticipate no ongoing consequences. Raj, maybe you can speak to our numbers.
spk07: Well, this was all in the third quarter, as you know, that the settlement that we took into our op-eds, there was $62 million, the legal benefit settlement that we got for the benefit of that, and that was in the components business. And that was worth about 100 basis points to the components margins in that quarter.
spk06: Great, thanks. And then share count, I know you're, I know you have, well, maybe you can just update us on what your expectation is for the share count in the current quarter.
spk07: Yeah, we didn't give a guide to share count because we don't typically, you know, guide the amount of share we purchase, because that's going to vary from quarter to quarter, as you can see, based on what we did in the fourth quarter. So we felt that giving you an actual share count wouldn't be appropriate either. We gave you the most important piece, though. Well, we gave you the EPS number that we're targeting and some of the other components to in the P&L that you can sort of back into, you know, some of those key assumptions So nothing unusual there, just, you know, we don't really guide the number of shares we purchase, so we didn't give a share count either.
spk03: Well, I would also add, just to reconfirm, our capital allocation priorities have not changed. You know, number one is, you know, organic investment or investment for organic growth. Number two being appropriate M&A. And then number three, of course, returning cash to shareholders. As you can imagine, in this environment, you know, we're, we're going to be pretty surgical when it comes to organic investment. So in lieu of an appropriate M&A target, we're still very prone to buybacks, as it makes sense, relative to our debt capacity.
spk00: Thank you. Thanks, Will. Thank you.
spk01: Your next question. If you would like to ask a question, please press star 1 on your telephone keypad. Your next question comes from the line of Ruplo Bhattacharya from Bank of America. Please go ahead.
spk09: Hi, thanks for taking my questions. I have one for Sean and one for Raj. Sean, you were talking about investing organically. So in this weaker environment, can you talk about what areas you're going to be investing in? And in the prepared remarks, you talked a lot about, several times about IT as a service. So how relevant is this to revenues How should we think about that progressing over the next couple of years? And in terms of your growing portfolio of recurring revenue, how should we think about that?
spk03: So, okay, Ruflu, you got a few different threads there. Let me try to take them one at a time. Again, my comments about investment in this environment, you know, again, the key word there is surgical. We're, you know, taking the right steps and making, you know, the right moves to protect our cost structure and our profitability while we navigate this correction. To the extent that we have the ability to invest, we just remain focused on the things that are core to our strategy, demand creation, value-added offerings and capabilities, certainly our IP&E selling motion, and then, of course, the transition to IT as a service in our ECS business. And so we're We're going to make sure that we're careful with respect to, you know, what's happening in the broader market in the meantime, but our investment priorities are fairly focused. With regard to your question about IT as a service, it's basically changing the shape of our sales number in that business. You know, the more we drive infrastructure software, cloud-related solutions and services, the more you'll see our mix shift. to a model that's more about GP dollars than it is reported sales. And really the right way to look at that business over time is through the lens of GP dollar and OI dollar growth as a result. But a good consequence of that pivot, and as you know, we've been on that journey for a good couple plus years now, has been the growth and the recurring piece of our total ECS business. We think now when you look at cloud, When you look at things like the transition for software from perpetual to subscription-based licensing models, you know, the recurring piece of our total mix is now approaching a third. And so, you know, we like that. It's predictable. It's sticky. And ultimately brings about, you know, accretive contribution margins for, you know, that piece of our business. So we're staying the course there as well. And you'll have to forgive me, but I think you had a third question in there. I want to make sure we don't forget it.
spk09: I didn't, but I'm going to put one in just in terms of IT as a service. What are people buying? Are they buying hardware or is it just software at this point?
spk03: You know, ultimately we think it's about both, but in the near term and recently it's been more about software.
spk09: Okay, great. Thanks for all the details there. Raj, I just want to have a quick follow up with you on margins. With respect to component margins, you know, there were 5.1% this quarter. is there a revenue level you need to keep the segment margin above 5%? And then the same question on the ECS side, I think Sean talked about optimizing customers and line cards in Americas. Does that impact how we should think about margin trends in ECS this year? Or is it the 1Q is the lowest and then we should see sequential margin improvement until 4Q? So just your thoughts on on on these on the margins for both of these segments.
spk07: Yeah. Well, let me there's a few questions in there. Let me take the first one to start on the component side. You know, I don't think we have a set revenue level in mind for the higher margin target. And we still are comfortable with the five and a half to 6% in the components business in a normal environment. Right now we're going through the down cycle and As you heard some of the commentary, the gross margins seem to be relatively steady and stable, and it's really a function of negative leverage with the reduced revenue level. So given the structurally higher margins that we have today, based on all the things that we did, we know that when revenue returns to a more normal environment, and that's to be defined, we're going to get that leverage back and margins will take care of themselves. So we're confident about the long-term target that we have. And I'm going to turn to Sean a little bit on the second question. Can you just repeat your question, Rupal?
spk09: Yeah, I just referred to what Sean had said about in the ECS segment, I think in the Americas region, you're trying to optimize customers and line cards. And so, like, where are you with that? And how does that impact how we should think about margins? Like, I mean, does that impact your margins positively this year versus prior years? And how do we think about the trend in ECS margins?
spk03: I'm happy to take that with Blue. So again, for context, we've got kind of two different models in our ECS business. We've got a regional business in Europe that really suits our strategy nicely. It's a mid-market region. It's one that lends itself nicely to a channel-based selling motion. The mix as we grew up in that business was more about software and now cloud as compared to the mix in the way that we grew up in North America, which was historically about hardware and larger enterprise accounts. So we're on the same path in North America to create the same model that we enjoy in Europe. And ultimately, that should be accretive on the margin line. But we're not calling it out for the full year yet at this point. We're just guiding one quarter at a time for all the reasons that you'd expect. But we think that that destination is a good one. We recognize we still have some work to do. relative to more mid-market scale in North America, and we expect to see, you know, better progress across the course of 24.
spk06: Okay. Thanks for all the details. Appreciate it. Thanks very much.
spk01: We have no further questions in our queue at this time. I will now turn the conference back over to Anthony Bencivega for closing remarks.
spk05: Yep. Thank you, Operator, and thank you, everyone, for joining us on today's call. We look forward to meeting you in the near future at upcoming investor events. Have a great day.
spk01: This concludes today's conference call. Thank you for your participation, and you may now disconnect.
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