艾睿電子 (ARW) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Arrow Electronics, Inc., third-quarter earnings conference call. My name is Patrick, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will facilitate a question-and-answer session toward the end of the conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to Mr. Greg Hanson, Vice President and Treasurer. Please proceed, sir.

Thank you, Patrick. Good afternoon and welcome to the Arrow Electronics third-quarter conference call. I am Greg Hanson, Vice President and Treasurer of Arrow. I will be serving as the moderator on today's call.

If you would like to access today's call via webcast, please visit our investor relations website at www.arrow.com/investor and click on the webcast icon.

With us on the call today are Mike Long, Chairman, President, and Chief Executive Officer; Paul Reilly, Executive Vice President, Finance and Operations, and Chief Financial Officer; Andy Bryant, President of Global ECS; Peter Kong, President of Global Components.

By now, you should all have received a copy of our earnings release. If not, you can access our release on the investor relations section of our website, along with the CFO commentary and the non-GAAP earnings reconciliation for the third quarter.

Before we get started, I would like to 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. Detailed information about these risks is included in Arrow's SEC filings.

We will begin with a few minutes of prepared remarks, which will then be followed by a question-and-answer period. As a reminder to members of the press, you are in a listen-only mode on this call, but please feel free to contact us after today's call with any questions you may have.

At this time, I would like to introduce our Chairman, President, and CEO, Mike Long.

Thanks, Greg, and thanks to all of you for taking the time to join us today.

Arrow once again had a strong quarter with year-over-year sales and diluted earnings per share up 2% and 8%, respectively. Revenue of $5 billion and non-GAAP diluted earnings per share of $1.18 were both in line with guidance.

Our businesses executed well. Operating margins were up quarter over quarter and year over year with good returns on invested capital and cash flow generation. While executing well in the short term, we continue to advance our long-term strategy, deploying capital to both organic growth initiatives and acquisitions. We're investing in several sales initiatives focused on further expanding our solution selling to the small and medium account base.

Finally, we have made excellent progress on our annualized $75 million productivity initiatives and expect to exceed the targeted savings by the end of 2013.

As you saw, we closed Computerlinks acquisition just two days ago. This acquisition advances our matrix strategy in Europe. It gives us a stronger presence in the large German market and access to fast-growing products.

We believe we provide the most comprehensive solutions to our customers in both Europe and North America. We will continue to deploy capital to accelerate our strategy of providing full-service value-added services to our customers.

Turning to global components, we view the overall market as stable. Conversations with our industry partners indicate that the supply chain continues to be tightly managed and lead times unchanged. Our sales of $3.5 billion were in line with seasonality and expectations. Book to bill, which was the highest third-quarter level in three years, was near parity. Sales advanced year over year in the Americas and Europe and were flat in Asia.

Our core gross margins expanded quarter over quarter, both in Europe and Asia, and modestly down in the Americas. Operating income also improved year over year.

In our enterprise computing solutions, we also see a stable market. Our North American business saw growth in storage services and software. In Europe, results were modestly below our expectation due to a pushout of activity in the UK. Both regions were also somewhat affected by the early quarter-end cutoff when compared to several of our suppliers. We estimate the impact to be somewhere between $50 million and $70 million.

ECS margins in the third quarter were 4%, advancing year over year. Our strategic transformation towards a comprehensive selling solution with focus on high-growth, high-margin products continues to provide good results.

Looking to the fourth quarter, we're not expecting to see a meaningful change in the macro economy. Currently, our view is we would expect to see sales in line with traditional seasonality in the fourth quarter in both segments of our business. We continue to pursue a balanced approach to maximize our performance in the short term, without sacrificing our long-term goal.

Paul will now provide an update on our financial results for the third quarter.

Thanks, Mike.

Third-quarter sales of $5 billion were in line with our expectations and guidance. Adjusted for the impact of acquisitions and changes in foreign currency, sales were flat year over year.

In global components, sales of $3.5 billion increased 3% year over year and were in line with our expectations.

In the Americas, our sales were up 2% year over year, and in the core sales business in Americas, we were flat quarter over quarter, which is in line with traditional seasonality. In Europe, sales and constant currency advanced 4% year over year. Sequentially, core sales in Europe increased 1%, which is at the high end of traditional seasonality.

Sales in Asia were flat year over year. Core sales in Asia-Pacific grew 7% year over year and were flat quarter over quarter. The sales comparison in Asia is somewhat negatively affected by our decision to exit a customer engagement that did not meet our financial hurdles.

Sales in our enterprise computing solutions business were $1.6 billion, also in line with our expectations. In the Americas, sales grew 3% year over year, were down 14% sequentially. In Europe, sales in constant currency fell 14% year over year and 26% sequentially.

Sales were below our traditional seasonality. As Mike mentioned, we saw a pushout of sales in the UK, and as was expected, there was an impact due to our quarter-end cutoff, which was earlier than several of our suppliers. The silver lining of the difference in the third-quarter cutoff is that we are off to a good start in the fourth quarter.

Our consolidated gross profit margin was 13.3%, an increase of 30 basis points quarter over quarter, as core margins advanced in global components and ECS. Year over year, gross margins were virtually flat.

Operating expenses were essentially flat year over year on an absolute-dollar basis, and adjusted for the impact of acquisitions and changes in foreign currency, operating-expense dollars declined 2% year over year and were 20 basis points lower as a percentage of sales, as our efficiency initiatives more than offset our investments for future growth.

Operating income was $194 million. Both operating-income dollars and margins advanced year over year, and that's the first time we have seen that in seven quarters. Revenue growth, stabilizing gross margins, and our efficiency efforts all contributed to this improvement.

Global components' operating margin of 4.9% was at its highest quarterly level since the second quarter of 2012. Operating margin increased 10 basis points year over year and 60 basis points sequentially, well ahead of traditional seasonal trends, as a higher mix of sales in Europe, stronger gross margins, and the benefits of our productivity initiatives improved results.

Global enterprise computing solutions' operating margins were up 30 basis points year over year to 4%.

Our effective tax rate for the quarter was 29.4%, which is a little higher than our traditional range and cost us $0.01 versus our guidance. We expect to move back to the 27% -- 29% range in the fourth quarter.

Net income was $120 million and earnings per share were $1.19 and $1.18 on a basic and diluted basis, respectively, up 8% year over year. Cash generation from operating activities in the third quarter was $81 million and $423 million on a trailing 12-month basis, once again exceeding our targeted level of 70% of GAAP net income.

Return on working capital for the third quarter was 23.5% and return on invested capital was 9.6%, well ahead of our weighted average cost of capital.

While we did not repurchase any shares in the third quarter, as capital was directed towards our acquisitions, please keep in mind this aligns well with our strategy of allocating capital first towards strategic growth initiatives, then to M&A, and, finally, to return excess cash to shareholders. Year to date, we have repurchased nearly $300 million of our equity.

This is a high-level summary of our financial results for the third quarter. For more detail regarding the business-unit results, please refer to the CFO commentary published this morning.

Now turning to guidance, as Mike mentioned, we are not expecting to see a meaningful change in the macro environment in the fourth quarter. We believe that total sales will be between $5.6 billion and $6 billion, with global components sales between $3.2 billion and $3.4 billion and global enterprise computing solutions sales between $2.4 billion and $2.6 billion.

We expect earnings per share on a diluted basis, excluding any charges, to be in a range of $1.56 to $1.68. Our guidance assumes an average tax rate in the range of 27% to 29%, average diluted shares outstanding are expected to be 102.5 million, and the average US dollar to euro exchange rate for the fourth quarter to be $1.37 to EUR1.

Thank you, Paul. Patrick, at this time, please open the line to questions.

(Operator Instructions). Amitabh Passi, UBS.

Paul, just a question for you. On the fourth-quarter outlook, can you give us some sense of how you are thinking about the contribution from Computerlinks, and then how we should be thinking about gross margin and OpEx?

Sure. So let me work in reverse order. When you compare it to the third quarter, we would expect that seasonal trends, much stronger global ECS business, would result in a downward move on gross profit, not meaningful, but you would see 10, 20, 30 basis points downward.

That also would result in a downward trend in the operating expense to sales ratio so that when you look at it, operating-income percent should be up both over the third quarter and over the fourth quarter of 2012.

We will have the Computerlinks acquisition in our results for two months this quarter, and as our previously published information had said, it's immediately accretive upon closing to our results. So we would expect that the impact would be -- I'm going to put a round number out there of about $0.06 in the quarter, maybe a little bit more, a little bit less, as we get to understand the pace and activity of that business. But we feel good about it being immediately accretive in the first quarter that we own them.

Okay. Again, we will double-check our numbers, but it looks like we have to assume operating margins going up to, like, the mid-4% range just to get to your EPS target. And that just seemed like a pretty strong sequential uptick, and I wanted to confirm we're from the right track there.

It sounds directionally correct.

Okay. And then, just a quick one for you guys. On the component side, what needs to happen for you to get back to, say, the 5%-plus range? Is it simply a function of the macro environment, developed markets? Any color you can give us in terms of, A, how the business is trending and, B, what you would need to get to that 5%-plus operating-margin target?

Sure. We are actually in pretty good shape. As you saw, we were at 4.9% for the quarter, and our core margins did expand quarter on quarter. They were both up in Europe and Asia and modestly down in the Americas. Certainly, if we had some better market conditions, it would drive volumes. We would go right past that right now.

And although we see somewhat of a lag there, we're going to continue to drive our gross margins, which should get us back into that range. We have made really great progress with that business, and without the -- if we don't get the market improvements that we are expecting, we are seeing benefits in Europe right now on the ERP implementation, coupled with some of our efficiency programs, so we're pretty sure that we can improve that business back to those margins that we had put in our timeless business model.

Okay, I appreciate it. I will jump back in the queue for now.

Paramveer Singh, Stifel Nicolaus.

This is Param Singh on for Matt Sheerin. So first of all, I want to get a little color on your components side. We have heard that some of the Asia OEMs are weakened a little bit, and how this compares to your guidance, especially as it relates to MediaTek. And how are your book to bills quarter to date? And then, I had a follow-up.

Sure, I can talk to you about that. Sales in the third quarter in Asia for us were somewhat negatively affected as we decided to exit a customer engagement that was not meeting, and we didn't think was going to meet, our financial hurdles.

We did see growth in other areas, including our vertical markets where both lighting and transportation were up quarter over quarter. We expect, actually, in the fourth quarter that the Asia sales will be right at the midpoint of seasonality. Book to bill is running strong for total Asia and the core business itself is above 1. So most of the indicators we have out of Asia is looking pretty good.

I was actually looking -- wanted to know what the book to bill overall was for the components segment, and for my follow-up, on the computing side, I know you had that one day or two days off and those sales were recovered in the December quarter. But have you guys seen any impact from the shutdown? And I know that some of the OEMs have guided slightly differently than the distributors have, and do you think there is a disconnect?

I think as we said before, the day shutdown for us was somewhere $50 million to $70 million. The October rates are already up over that, what we would normally see going forward. So the truth is when you look at the guidance and the seasonality, it will all fall. That one day we view as that was our main impact on the ECS side.

And on the book to bill, just as a reminder, for third quarter we were at 0.99, which is the highest third-quarter book to bill we have had in three years in the components business, and we are above 1 in the month of October.

Okay, great. Thanks, Paul.

Mark Delaney, Goldman Sachs.

I was hoping you guys could elaborate a little bit more on the Computerlinks acquisition, maybe first if you can talk about how the margins of Computerlinks are, relative to the rest of the ECS business?

Mark, it is Andy Bryant. So Computerlinks' margins are pretty much at par with our ECS business today. We may see a little bit of an uptick in our European performance because of their mix around network security. They have operations in the Americas that will be about at par. So in general, their value add and our datacenter value add are very much matched up pretty closely.

Thank you. That's helpful. For my follow-up, I also want to just talk on Computerlinks. Paul, I think you said $0.06 of quarterly accretion. The press release you guys had put out in the past, I think, had said $0.20 to $0.24 for the full year, and you guys just have a partial quarter for the fourth quarter of this year. So is it $0.06 on a runrate basis when you have it fully integrated for a full quarter or is $0.06 the benefit that you expect to get this year?

$0.06 is what we will deliver for the months of October -- I am sorry, November and December of this year, Mark. So any synergies that will happen are further out, obviously driven by things like regulatory requirements, which take longer.

So any expense synergies are further out in the year, but the $0.06 is for two months. Keep in mind, this business is similar to what we do in our North American VAD business and our European business, so it's more heavily weighted to Q4 being the best quarter, if you will, with the summer quarter being the softest quarter.

Got it, thank you.

Shawn Harrison, Longbow Research.

This is Chris Dankert calling in for Shawn. So you guys said that you were expecting the cost-savings program to exceed targets in the December quarter. I was wondering if you could just say what you are targeting now and what the incremental is for the December quarter?

Sure. So what we gave was $75 million, and right now, we are looking to be substantially higher than that by the end of the fourth quarter. We had a lot of items that came up for us where we were able to reposition in our business, and that will cause that $75 million number to be exceeded.

All right, great. I guess also, with -- I might have missed it if you already addressed it earlier, but with the announcement by Avnet on the dividend, I guess where does the dividend rank as far as your outlay of cash?

Our deployment of capital is to invest in initial sales initiatives. It is to then proceed with M&A, and it is then to return to the shareholders.

So far this year, we have returned over $300 million to the shareholders, and I think Paul can probably give you a number over the last couple of years. So we are quite comfortable with where we are in our capital deployment at this point.

Right. Just as a retrospective look, we have returned over $1 billion of capital to investors over the last five years.

Okay, great. And then, sorry, just coming back to the restructuring, can you just remind us where you are at now on a dollar basis?

I guess maybe what we can do is take it offline if you are just trying to understand what the incremental impact would be in the fourth quarter. Happy to take that offline and try to figure that out and help you out from a modeling point of view. Maybe Greg can help you with that, Chris.

Great. Thanks for the help, guys.

(Operator Instructions). Brian Alexander, Raymond James.

Paul, could you just talk about the nature of the disengagement you alluded to in the Asia components business, just what changed in the relationship and what is the significance from a revenue perspective, and what does that do to your Asia profitability with that out of the model?

Right, so the nature of the relationship was that when we first entered it, it was an engagement that was going to be much larger, much more impactful. In the end, it didn't really grow and get to enough size and scale where we could hit our hurdles on operating income or return on working capital.

So the run rate was about $30 million per quarter, so we will drop about $120 million engagement on an annualized basis that we've had for about nine months. And it has an impact that, obviously, as you would imagine, because it had low margins and low returns, it will increase the core business performance in Asia-Pac.

If I pro forma and go back to Q2, and take that roughly $30 million run rate out and adjust for the whole engagement, we are still up in GP percent on a sequential basis in the core business and the operating-income percent is still up meaningfully on a sequential basis.

So while it certainly impacts the margins, it doesn't really distort the real performance, which is meaningful uplift in operating-income dollars and percent on an apples-to-apples-like basis.

Great, and then just a follow-up. If you normalized for Computerlinks and for the timing of the cutoff, the $75 million I think you referenced earlier, I don't have my model in front of me, but what would that equate to in terms of normalized sequential growth per your December guidance for ECS? If we were to adjust for both of those, what is the midpoint of your guidance assuming sequentially?

Right, I think I could put it this way. In Europe, we would be above the midpoint of traditional sequential performance, or midpoint to upper end, and then if I look at in North America, we would be below the low end to midpoint.

Great, thanks.

Steven Fox, Cross Research.

Just two questions from me. I was just curious if there is any change in your design win activity on the component side that would signal any changes in the economic environment.

And then, secondly, just again following up on the disengagement in Asia, is there any broader statement to be made about your ability to win acceptable high-volume business going forward or do think this is more of a one-off? And if it is a one-off, can you go through some of the -- any of the specifics that would be around that? Thanks.

I think the -- I would call it a one-off. But as does happen, basically a customer commits and commits certain volumes to get a certain price, which requires a certain amount of inventory to be held for them, and the volumes don't come in and the ratios don't work, and at that point, we made a decision to exit.

I think it was a pure business decision on a deal. It doesn't impact anything or the ability to capture future deals. It's just one that was fairly tight and ultimately did not pan out, so we made the decision to exit. I think anytime where our capital deployed in a deal becomes more than the value we're getting out of that deal, we would make the same decision tomorrow. So for that one, I don't have any problem with.

As far as the design activity goes, we are seeing designs registrations up about 4% right now, or I should say a little over 4% for the third quarter. And Europe actually being the leader. They were up the most during the third quarter and we have seen a higher growth of activity there. Asia, we saw as up, and North America, we are seeing relatively flat. So hopefully, that gives you an idea of where we are seeing the mix come now.

Great, and then very quick follow-up. I just want to make sure I am clear. Relative to the government shutdown and its impact on your North American business, are you saying it had an impact or too early to tell? I just want to clarify that. Thanks.

I think we did see an impact a little bit in the first part of October in both the core and the specialty businesses. But we're only actually expecting that to impact timing for us within the quarter.

And remember, this only affects our North America business, so we don't expect it to be that big. And in fact, in our guidance we really account for that, but we are not expecting that to be something we hang our hat on in the fourth quarter.

Great, thank you. That's very helpful.

Lou Miscioscia, CLSA.

If we take out the acquisition in ECS, it looks like that business on a year-over-year basis is still flat for second quarter, whereas, obviously, in March and June you guys had very nice year-over-year gains. I guess maybe you could just remind us as to why that business, VAD, is go back to the macro. Obviously, you had some -- a year or two of really great results there.

Lou, can I ask a point of clarity? Did you say Q4? Or Q3 versus Q3?

Q4, the guidance for Q4 for ECS (multiple speakers)

No, we think we will still see some growth both in the North American VAD business in the fourth quarter. It may be a bit more modest, but we still think there will be growth there.

And in the European business, on a euro basis, it will be flattish to marginally up, so I think really when you take a stop and think about it, North America economy is a little bit better than Europe, so we will see a bit of an uplift there. And being flat in probably what's a little bit weaker economy in Europe is pretty good.

Okay, maybe then just compare that to the results you had over the last few quarters where you are up -- many quarters in double digits. Is it just that you had some really good wins, they added in, but then they grandfathered?

I'd give you my view, which is that there is a change of mix also that goes on, right? Andy was just telling us this and reminding us this earlier today that in the fourth quarter, we see a bit more in the way of software sales. Software sales come at net revenue, not gross revenue, in certain instances.

So that while we may sell service, which come in gross revenue in Q2, which give you a bigger uplift, if you expand quickly the net revenue part of our business software and some services, you don't get the same uplift in revenues, but the billings uplift would be stronger than what I just talked about in revenues.

Okay, great. And then maybe just on a similar topic, but slightly different, flash arrays, either all flash or hybrids, are starting to come to market. Some of those companies are coming public. You mentioned in your CFO comments that you guys are doing well in storage. Maybe you could give us a couple of lines as to whether you are also participating in this, and is that where you're getting the majority of the storage growth from?

Hi, Lou, it's Andy. So, yes, we have signed several of the new players in that market, and you know who those players are. We are participating with one of our bigger supplier partners in that market, IBM, and as you can see, storage was still a double-digit growth for us in the summer quarter at 11.2%.

So it's all part of our strategy to continue to add to the line card what we think are the emerging technologies that serve the data center, and so we are very much on top of that.

And do you think that was most of your growth in storage or did most of the lines grow in storage?

The growth right now, I think, Lou, is still coming from traditional disk. I think you are seeing some changeover there, as you mentioned, but no, the growth is still coming from the traditional side.

Okay, great. Thank you, guys.

At this time, I am showing there are no additional questions in queue. I would now like to turn the call back over to Mr. Greg Hanson -- actually, I apologize. I do see we have one additional question. Scott Craig, Bank of America Merrill Lynch.

Paul, I was wondering if you could give us the book-to-bill numbers on a regional basis.

And then, Mike, with regards to walking away from that business in Asia, I know you guys consistently look at business like that and are always evaluating it, but do you see other opportunities where you are looking at some similar businesses, either in components or in ECS, where you can improve the profitability as it relates to getting into the ranges that you've put out there for your business models? Thanks.

Yes. Look, we do this all the time, whether it's with an acquisition, whether it's with a customer, or even if it's a supplier that falls out.

There are certain requirements that we have in house. There are certain things that we need to do or certain levels that we need to be at to deploy our capital, and if we're tying a lot of capital up in a deal that is taking away from capital we need to employ in a deal that is going to produce acceptable results, well, then that would be a bad thing.

So we strive to not make that happen, and we are going to pretty much stick to our guns of how we deploy capital and the profitability required in house. It's a way we have manage the business. We have managed the business that way for a long time. It just so happens I think we have a deal here that we probably exited at a time when you guys are watching the sales growth closer than maybe normal.

As far as the book to bills, the book to bill we are seeing in North America is at 1 or it is above 1, I should say, right now. The book to bill in Europe that we are seeing is above 1, and Asia is at 0.99 right now.

Thank you.

Sherri Scribner, Deutsche Bank.

This is [Karithe Shari] here. I am calling on behalf of Sherri Scribner. So the question is just with regards to trends in ECS, which seem to be a bit lower than expected, perhaps you can shed some more detail on servers as well, and then I have a follow-up question.

Sure. We saw year-over-year change in industry-standard servers were up about 10%, and having said that, we have seen proprietary servers continue their decline, and that was in the mid-20 range. Services, we have still seen it being up at 12%; software is still up. Storage is still up. And networking is up meaningfully for the quarter.

It is a slow server quarter, which is typical, but as we have been seeing over the last few years, proprietary servers are continuing to get hard -- hit hard, just like they have been hit hard all year long. My guess is if there would have been one more day in the quarter, we probably wouldn't even be having this question, but that's pretty much how it fell, given where our cutoffs were.

Okay, great, thank you. And the follow-up is just how much government exposure do you have?

So, it's Andy. So first of all, again, the government exposure, we are talking about our North American ECS VAD business only. It's in the high single digits as it relates to our forecast, and already half of that has been booked and will ship.

So the exposure is not that big, and we anticipate throughout the balance of November and December that the orders that were pushed out due to the shutdown will come in. So as Mike mentioned, we don't see it as a significant risk.

Okay, thank you. That was helpful.

Lou Miscioscia, CLSA.

Andy, I guess one more time with ECS. I know you described the business as stable, but any additional type of color or comments we could get at as folks -- or CIOs decide what to do with, and small and medium businesses decide what to do with, their IT budgets as they close out the year?

Yes, so just maybe adding to Mike's comments, because Mike took you through the segments, it's very clear that we're executing to our strategy to play more in the software and services part of the market, and Computerlinks is going to add network security, one of the fastest-growing segments in the market. So we are well positioned, and even with the client and the server business, you see our operating margins hitting record levels for summer quarter at 4%.

So there is really, from my perspective, no change to our strategy and our execution. It is going well, and I think CIOs' top of mind is going to be security, network security, and top of mind is going to be perhaps software as a service in the cloud, and we are well positioned to capitalize on both.

I think to highlight that a little bit, IDC predicted growth of somewhere around 3.8% in 2014, and they're at somewhere 4.5% for 2014, and the Gartner numbers are a little lower than that. I think they are around 3.6% or 3.7%, something like that.

So that would indicate to me that we are still seeing a stable market. We have shown that we can outgrow that market over the last few years, especially with the changes we are making in it. So we are pretty comfortable that the market's relatively stable and we're pretty comfortable that we are performing very well within that marketplace.

Okay, thanks.

There are no remaining questions at this time. I would now like to turn the call back over to Mr. Greg Hanson for closing remarks.

Thank you, Patrick. If you have any questions about the information presented today, please feel free to contact me. Thank you and have a nice day.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.