Arrow Electronics, Inc. (NYSE:ARW) Q4 2022 Earnings Call Transcript

Arrow Electronics, Inc. (NYSE:ARW) Q4 2022 Earnings Call Transcript February 2, 2023

Operator: 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. . Thank you. Rick Seidlitz, you may begin your conference.

Richard Seidlitz: Thanks, Rob. 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 Kerins, President and Chief Executive Officer; and Raj Agrawal, 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 Kerins.

Sean Kerins: 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 continue 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 help 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 growths in our global components and our global enterprise computing solutions businesses. In our Global Components 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 softer 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 produced strong year-over-year growth as both regions experienced 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 was the primary driver for margin compression in our global components business overall. Sales in our Asia region declined 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 in 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.

Rajesh Agrawal: 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 $1.02 to one EUR compared to a previous expectation of $0.90 to one EUR. 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 repurchase — 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 a 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% and year-over-year and 6% on a constant currency basis. We estimate that the strengthening of the U.S. dollar compared principally to the euro will result in a reduction to sales growth of $182 million and EPS growth of $0.13 compared to prior year. Compared to the prior quarter, we estimate that the impact will be a positive $175 million to sales and $0.11 to EPS. I will now turn the call over to the operator for Q&A.

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Q&A Session

Operator: Your first question comes from the line of Ruplu Bhattacharya from Bank of America. Your line is open.

Ruplu Bhattacharya: Thanks, for taking my question. Sean, I wanted to start with a high-level question. I mean when you look at end market demand today versus 90 days ago, I mean, how would you say — I mean, are things materially weaker? Or are they the same? Or — and how do you see that trending over the next quarter? And then specifically on the components 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?

Sean Kerins: Sure, Ruplu. Let’s start with just our feelings about the market overall. And I would say it’s sort of mix. 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, other sectors like compute, communications, consumer and things like lighting slowing down. Obviously, demand trends in Asia, specifically China, have been impacted by market headwinds and COVID disruption. It obviously was initially all about 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 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 that work yields or has yielded certainly more reschedules and pushouts than cancellations. So we feel pretty good about the backlog. And as we said earlier, the quality of our inventory to support the guidance we’ve shared.

Ruplu Bhattacharya: Thanks for the details there, Sean. Maybe I can ask Raj, a couple of quick questions. 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 like 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?

Rajesh Agrawal: Yes, Ruplu, I would say that 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 actually, what’s driving it. 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 we continue to have good demand in the West, and that’s really what we’re looking at. And from a cash flow standpoint, I think we’re going to — we’ll generate some cash flow this year just given the market dynamics. But overall, we feel good about where we sit.