艾睿電子 (ARW) 2018 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Arrow Electronics First Quarter 2018 Earnings Conference Call. My name is Lisa, I'll be the operator. (Operator Instructions)

I would now like to turn the call over to your host for today, Steven O'Brien. Please proceed.

Thank you, Lisa. Good day and welcome to Arrow Electronics First Quarter 2018 Earnings Conference Call. With us on the call today are Mike Long, Chairman, President and Chief Executive Officer; Chris Stansbury, Senior Vice President and Chief Financial Officer; Andy King, President, Global Components; and Sean Kerins, President, Global Enterprise Computing Solutions.

As a reminder, some of the figures discussed on today's call are non-GAAP. You can access our earnings release at investor.arrow.com, along with the CFO commentary, the non-GAAP earnings reconciliation and the webcast of this call. Please note, prior period figures have been adjusted for the adoption of the new accounting standards. We will begin with a few minutes of prepared remarks, which will then be followed by a question-and-answer period.

I will now hand the call to our Chairman, President and CEO, Mike Long.

Thank you, Steve and thanks to all of you for taking the time to join us today. I'm pleased to report a strong start to 2018. For the first quarter, we achieved record sales of $6.88 billion, gross profit of $869 million, operating income of $272 million and earnings per share of $1.88. We delivered good leverage with operating income and earnings per share growing meaningfully faster than sales.

Our strategy to be the full service solution provider in the electronics industry is working well. Our sensor to sunset capabilities are unmatched by the competition and this leads to more business from our suppliers. Our business model is performing just as we expect it to, and our broader supplier engagements brought in new sales and new customers. Our investments in working capital are driving sales, profit growth and higher returns.

We expected last year's healthy momentum for the electronics components to carry into 2018. We've capitalized on the favorable industry backdrop to increase the scale of our business. If you consider Asian and Europe components businesses are about 40% bigger than they were 2 years ago, and our Americas business is about 25% bigger. Increasingly, we are the only company where suppliers wanting to reach depth and relevance in fast-growing markets like IoT, industrial automation, smart cities, homes and vehicles.

In the first quarter, global components again, experienced robust demand. Sales were $4.93 billion, up 21% year-over-year, and were above the high end of our expectations. We captured double-digit growth in all 3 regions. We saw broad strength across our industrial, manufacturing and mass-market customers. Growing electronic content continues to be a tailwind for our transportation vertical sales in all 3 regions. We also saw strong demand from aerospace and defense customers in the Americas and Europe in the first quarter.

We see production lines continuing to operate. We believe our sales outfit validates this view. There are a few bottlenecks. However, there is some stretching of lead times across the portfolio and extended lead times have not shortened for discrete, standard logic, embedded and passives. Our book-to-bill was 1.22 for the first quarter, up from 1.14 in the first quarter of 2017. Conditions are still favorable, but our sales outlook is a better reflection of demand in orders. Cancellation rates remain within normal levels. We continue to monitor market conditions closely and work diligently to assure the supply chain of our customers.

Global enterprise computing solutions first quarter sales of $1.95 billion increased 16% year-over-year and were above our expectation. Record first quarter sales in both regions were driven by several factors. One factor, a return to growth for hardware. We anticipated a return to growth for hardware but not to the magnitude we saw in the first quarter. For example, storage grew more than 30% year-over-year and industry-standard servers grew more than 20% year-over-year. Another important factor was our success at winning new business. As we said at the start of 2017, we had an unprecedented opportunity to win over VARs who did not work with us in the past. We were confident that VARs will be attractive to our software-based solution selling strategy, and that they would appreciate our focus on value-add solutions to complex problems that offer distractions from consumer cycles. We also knew VARs would like to be in a trusted pair of hands during a time of extraordinary landscape and technology change. We help them navigate the adoption of hybrid cloud, security software, defined data center solutions. VARs know that we're constantly pushing new technologies and architectures for their customers. And customers appreciate our ability to bring together software and hardware from multiple suppliers, so they can run their workloads optimally, securely and with attractive ROIs.

A little over a year and the result is showing. Growth returned in the fourth quarter and accelerated in the first quarter. We're bringing in new business that's making a small profit contribution in the near term and will improve that profit leverage over time by selling more products on our line card and more value-added services we can bring, all the while, we delivered outstanding services to our VARs and suppliers. Only regret is they didn't move faster.

Over the past few months, we've heard comments about heightened competition in supplier program changes in the information technology industry. I'll take a heightened competition as a compliment. Program changes are business as usual as far as we're concerned. Suppliers make program changes all the time to achieve their goals. They may want to launch a new product, gain market share, or send off competitors or grow in an underserved vertical. Program changes are a fact of life and you just must adapt to or be left behind.

In closing, we're off to a great start in 2018. We delivered record results in just about all areas of our business and expect this momentum to continue. I look forward to updating you on our performance and our progress in the coming quarters.

I'll now hand the call over to Chris to provide more details on our first quarter results and our expectations for the second quarter.

Thanks, Mike. First quarter sales of $6.88 billion were above the high end of our prior guidance range. Sales increased 20% year-over-year and 14% adjusted for changes in foreign currencies. The net of 2 divestitures and 2 acquisitions does not change the consolidated sales growth rate. The actual exchange rate for the quarter was $1.23 to EUR 1, in line with the rate we previously used for our forecast.

First quarter global components sales of $4.93 billion increased 21% year-over-year and 16%, adjusted for acquisitions and changes in foreign currencies. Global component sales have been at/or above the high end of our expectations for 7 quarters in a row. We had record first quarter sales in all 3 regions.

In Europe, sales increased 32% year-over-year, and increased 16% adjusted for changes in foreign currencies. Europe sales have increased year-over-year for 20 straight quarters, adjusted for acquisitions and changes in foreign currencies as we continue to gain share in the marketplace.

Asia, again, produced strong growth this quarter. Asia sales increased 20% year-over-year, marking the seventh straight quarter of double-digit growth. Asia sales increased 19% year-over-year adjusted for changes in foreign currencies.

Our acquisition of the eInfochips closed in early January. The financial contribution was included in our first quarter guidance and was recognized in our Americas components region as the business was centered in the United States.

In the Americas, sales increased 15% year-over-year, and increased 13% adjusted for acquisitions and changes in foreign currencies. Demand continues to be strong across our base of industrial and manufacturing customers with notable growth from the aerospace and defense and transportation end markets. First quarter global components operating income increased 32% year-over-year and increased more than 21 -- than our 21% sales growth. Operating margin increased 40 basis points year-over-year. In short, we are capturing the leverage we've been expecting for this business.

First quarter enterprise computing solutions sales were $1.95 billion, up 16% year-over-year and above our prior guidance range. Sales increased 11% year-over-year, adjusted for changes in foreign currencies, the divestiture of the systems integration business in ECS Americas, and both a small acquisition and a small divestiture in ECS Europe. Our prior guidance was issued before the divestitures were announced and included a full quarter financial contribution from systems integration. That divestiture closed on March 2 and we estimate foregone sales in the quarter were approximately $25 million to $30 million and foregone operating income was approximately $2 million.

Billings increased in the mid-teens rate year-over-year, adjusted for changes in foreign currencies. Growth was driven by infrastructure software, cloud, demand from new VAR and MSP customers and strong growth in the hardware categories of storage and industry-standard servers. For the third quarter in a row, performance in Europe was very strong with sales increasing 29% year-over-year. Europe sales increased 9% as adjusted, America sales growth accelerated with sales in the Americas increasing 12% year-over-year as adjusted.

First quarter enterprise computing solutions operating income increased 1% year-over-year. The estimate operating income would have increased approximately 4% year-over-year, excluding the system integration business. As we stated in the past, we focus on driving operating profit dollar growth for this business. In the near term, ECS margin reflects the shift in product mix towards hardware and as Mike mentioned, we have the opportunity to drive leverage in the coming quarters.

Returning to consolidated results for the quarter. Total company operating expenses increased 11% year-over-year and increased 5% year-over-year adjusted for changes in foreign currencies. Operating expenses decreased 70 basis points as a percentage of sales on a year-over-year basis. The effective tax rate for the first quarter was 25.1%. Our effective tax rate was towards the higher end of our new target range of 23.5% to 25.5%. As we mentioned last year, we expect somewhat more variance quarter-to-quarter in our tax rate due to the timing of discrete items.

First quarter net income was $168 million, up 27% year-over-year. Earnings per share were $1.88 on a diluted basis, above the high end of our prior guidance range. First quarter EPS increased 29% year-over-year. First quarter operating cash flow was negative $75 million. We believe our cash flow has begun to normalize after last year's substantial working capital investments. However, our first quarter is typically negative as many of the collections on late fourth quarter enterprise computing solutions sales happened at the beginning of the second quarter.

Return on invested capital increased 100 basis points year-over-year, increasing for the third quarter in a row. We're capturing higher returns on our organic investments in the business.

We repurchased approximately $40 million of our stock in the first quarter, approximately $145 million over the last 12 months and approximately $1.3 billion over the last 5 years. Entering the second quarter, authorization remaining under our share repurchase program is approximately $319 million.

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

We believe that total second quarter sales will be between $7 billion and $7.4 billion, with global components sales between $5 billion and $5.2 billion and global enterprise computing solutions sales between $2 billion and $2.2 billion. We expect interest expense to be approximately $48 million. As a result, we expect earnings per share on a diluted basis, excluding any charges, to be in the range of $2.08 to $2.20. Our guidance assumes an average non-GAAP tax rate of 23.5% to 25.5%. We expect average diluted shares outstanding of $89 million, and the average U.S. dollar-to-euro exchange rate we're using for forecasting purposes is $1.23 to EUR 1. This is the average rate through the month of April.

Thank you, Chris. Now Lisa, please open up the call for questions at this time.

The first question comes from the line of Adam Tindle, Raymond James.

I just wanted to start to, Chris, in your comments in the CFO commentary, you talked about the substantial investments in working capital that you've made to support growth. And the opportunity moving forward to drive improvements in working capital management returns in cash flow in the coming quarters. Can you help us quantify what that means and how we can grade that as the year progresses and how you would anticipate use of capital as buybacks have been a little bit below historical levels?

Yes, so we have talked previously that if growth is in more of a normalized range, typically in the components business of 10% or less that we thought we could be in the $400 million to $500 million range of operating cash flow for the year. We've also mentioned that we would continue with buybacks but that we would be working to reduce our debt in the range of about $0.5 billion over the course of the year. I think that the challenge that we have near term is, we continue to see growth rates where they are, that challenges that somewhat. I certainly don't want to predict the year at this point. It's a great problem to have but if there's a choice point to be made, we will continue to focus on growth and the investments to fuel that growth, we will stay focus on cash flow over that time frame. And I think irregardless, we can drive an improvement in our cash conversion cycle. So more to come, I think by the time we get through Q2 and guide Q3, we'll have a better ability to give some tighter color on the year.

Okay. And just as a follow-up to for Sean. I think guidance implies well below historical level of sequential revenue growth, even if we add back the divestiture headwind. And it doesn't look like ECS margins is improving more than historical levels sequentially so I couldn't attribute it to mix necessarily. But is there something I'm not thinking about there in terms of the sequential implied revenue growth for ECS? And then maybe just bigger picture, help us understand how we can think about profit dollar growth in the business moving forward?

Sure, Adam. Well, if you start with the revenue growth and I think we talked about it in the opening comments, but we had a very strong first quarter, again, hardware. Some of that obviously was driven by the market as customers continue to move to new architectures and next-gen technologies, we're positioned for that. And some of it was driven by a really strong backlog that we brought into the first quarter from last year. Last year as you might recall, supply chain performance was fairly weak for most of the years, so we were pretty conservative in what we thought we would actually ship and bill in Q1 and that turned out to be much better than expected. So I'm looking for a normalized pivot to software as a function of our mix in Q2 and as you know, we treat that differently from a sales perspective. So it means a little bit less growth, but certainly better operating income. And then I think if we look to the full year, be it net new customers that maybe aren't as margin-rich in the short run and more mix changes that we're navigating over time to earn incentives from our various suppliers differently. I think we will continue to improve it, although it will take more than 90 days to do so.

The next question comes from the line of Steven Fox, Cross Research.

My first question was regarding, Mike, the comment you made about managing the sales and not orders given the book-to-bill. Can you sort of talk about what looks atypical to you maybe in the recent quarter into the orders? And what you're comfortable with based on what you're seeing? And then I have a follow-up.

Yes, I think you also heard in the comment that we see lead times stretching a little bit. And I think it would be a little naïve to think that the 1.22 book-to-bill is all for orders today, or this quarter, or going into the forecasted number for next quarter given that. So right now, it's best for us, our guidance, to forecast based off of the backlog that we believe is actually going to ship in the second quarter as well as our day-to-day billings or bookings that we see that are for immediate shipment and try to take that percentage out. That's one reason you'll see the difference. That's also another reason that you may see the inventory come in at a certain level. That's taken into account of what inventory is supposed to ship also. But the increased orders are likely because of the lead time stretches and that's why I use the term, we like to manage towards the order better than we like to manage to that multiple on bookings. Does that makes sense?

Yes, it makes a lot of sense. And then as a follow-up, it sounded like you captured some of the leverage during the quarter, you've been talking about with some of the supplier relationships that you've added but then there's still others to come across the 2 businesses. Can you sort of describe what maybe you've captured in Q1 that helped margins and what we should look forward to maybe in the next quarter or 2, that you would expect?

Yes, if you remember, we talked about the big extent that supply chain orders had come in here and the design win orders have not caught up. And the good news in the first quarter is that our design wins were up 27% year-over-year and the growth rate in Andy's business was up around 21%. So now, you're starting to see that leverage come in, and you're seeing our engineers go to work. Now remember, the good news with this is that before all the supply chain business came in, we had about 35% of our business with design win that would go out into a quarter. So we still have, what I think is a significant amount of room to leverage up the components business through more engineering and more design wins over the next several quarters. And that's one of the reasons we're still bullish on it. And then contrary to that, we see the same thing actually in Sean's business with some of the supply chain stuff as I recall it around hardware coming in here, which hasn't been our natural forte, and now these resellers wanting to get involved around the cloud and the software and with services. So I see the exact same thing coming into his business now that we had told you would happen in the components business prior to. So we're feeling pretty good about it.

The next question comes from the line of Matt Sheerin from Stifel.

Just a couple of follow-ups from the first couple of questions in each business. On the growth in the enterprise computing business, you did talk, Mike, about share gains. And I know going back a year plus, you've talked about the opportunity to take, I think you said about $350 million of revenue market share from the Tech Data-Avnet merger. Could you update us, is that a lot of the share gains that you're seeing? And can you give us an idea of what that run rate is?

Now, Matt, I know myself pretty well, and I'm pretty sure I didn't use the terminology or named another competitor.

Okay, will you just say market share?

Yes. I'm pretty sure...

Those are my words. Okay.

Yes. I'll let Sean answer, but yes, we are seeing some uplift from the market at this point in time.

So Matt, thanks. We recorded a run rate that we had captured at some point last year, it certainly has improved from there. But I would tell you that, that was not the majority of what drove our growth in Q1 and I do expect that there's still a little bit more of that pipeline that will still roll into the business going forward.

Well then, who are you taking the market share from? And number one and number two, it looked like the margin in that business were down, so it looks like there's either cost or perhaps some margin concession that you're making to win some business. So how should we think about that and again, where is the share coming from then?

Yes, Matt. I think if you take a look at, if I'm understanding your question is, you see the share that came in is primarily hardware share. And that would have come in from some of the conversations you're hearing about the increased competition, I think, in the marketplace that we said we were happy to welcome. You're also seeing our forecast for next quarter, show us returning to a more normal profit level as some of the software and some of the services will start penetrating some of these new VARs as well as some of the additional hardware business, our current VARs one. Don't misunderstand also, there was a huge growth rate in Europe, and Europe gained a fair amount of share. And remember, Europe's bottom line is a little less than the U.S., so that has a negative mix impact on us until those sales convert also. So a bunch of moving pieces but hopefully that hit everything that we saw this quarter.

Okay. And then on the component side, your inventory obviously remains elevated for the reasons that you stated, lead time expansions and good demand. At what point are you getting any signs from suppliers that lead times will start to come in and then you'll be able to manage down the inventory and then of course, your customer orders may also be down as well at that point, right?

We're, fortunately, right now, not seeing those indications of anything backing off. We have gone through everything over and over. And, I think, what you'll see, if the demand remains high, you'll continue to see lead times stretch at this point. But most of the lead times being out are forcing us to buy out further, so I don't think you're going to see any dramatic swings in inventory. In fact, if we look at our ratios and how far our turns are just about the same as they were a year ago. So we believe we're managing to the demand, not to some expected demand that could be out there or even the conversation around double ordering right now. Suppliers are starting to put controls in to make sure that the double ordering isn't happening, and they're even going back and checking from all of us to see if our orders are going to the same locations. So there's a bunch of work being done on that right now.

And the next question comes from the line of Param Singh from Merrill Lynch.

So we've obviously heard some parts being on allocation. And just as you mentioned, we've also heard of premium pricing of some of the lower-priced products, some lower passives and discretes. How much of your revenue and margin expansion this quarter would you attribute to that? And do you think that could actually go up as parts remain allocation possibly until the end of the year?

Andy, you want to take that?

Yes. Sure, Mike. Param, it's Andy. Yes, we've seen ASP increase from -- for sure, but the vast majority of the growth is coming from units shipped out the door candidly. And we continue to sort of see that being the big driver of the upside that you see in the actuals and in the forecast. I don't see that changing anytime soon. As Mike pointed out, the lead times, if anything, are hardening in those areas not softening. So we'll continue to see, I think those trends.

Got it. And then switching gears to the ECS side because you previously mentioned that you could see ECS margins come back for calendar '18 year-over-year given the volume leverage. I mean, would it still hold true over the higher hardware mix and then I have a follow-up.

Well, again, Param, the -- I think the hardware versus -- excuse me, software mix should normalize in Q2 and beyond. There were some things that drove abnormal hardware growth in the first quarter. So I think that you'll see the operating margin line improve from here. And we'll work on the various ways to improve that over time. As Mike mentioned, when we win new customers, we get a chance to cross-sell from our more complete portfolio and attach more services. We also learn to serve those relationships more efficiently. And as suppliers rotate their channel to new market segments and new product offerings, we get a chance to earn incentives differently. But that does take a little bit of time to play out but I do expect as you can see in our guidance sequential improvements both in leverage and continued OI dollar growth.

Right. And then one last question. You know you talked about 30% storage growth. Where do you see -- what kind of vendors are you seeing this growth from other -- the emerging vendors and some of the legacy vendors that kind of read on their platforms and also one of the largest storage vendors, which will go unnamed, had made some changes to their channel program very recently. What are you seeing as an impact from that vendor and will that change either the margins and incentives up or down for you guys?

Well, I won't talk about any specific vendor, but I can tell you that the storage uptick in the first quarter was sort of broad-based. The good news is as we talked about last quarter, we are now selling more what I call next-gen technology as a function of storage in total versus traditional spinning disk, which is a good sign for the crossover point in that segment of our business but I think we saw growth with just about every storage vendor we've worked, both the big established ones as well as the newer, smaller up and comers who focus mainly on the next-generation type of converge and related technologies.

And the next question comes from the line of Mark Delaney, Goldman Sachs.

First question is for, I think for Chris, about the OpEx leverage, and the company did a great job about 80 bps of improvement on SG&A to revenue year-over-year. How much of that leverage do we think about flowing through the rest of the year? And then maybe how much is reinvested to fund some of Arrow's investments in engineering and growth initiatives?

Yes, and if you look at -- there's a leverage that we're experiencing right now, we would expect that to continue. I mean, we are investing in the business in Q1. We're guiding into Q2. So I don't think you're going to see any step change in that. And that leverage is really a key focal point for us. And frankly, Mark, it's not just a percentage of sales, it's also a percentage of GP. So we're laser-focused on that but we're also continuing to invest in those areas that we believe will drive future growth and value for suppliers and customers.

All right. That's helpful. The second question is for, I guess, either Mike or Sean, I was hoping to better understand the strategic rationale for the systems integration business divestiture. It seems that, that type of capability would be supportive of Arrow's goal of selling a full solution, so curious why the company made the decision to divest that and related to the broader strategic and M&A environment, any areas you'd like to be investing in with additional M&A?

Yes, I think we probably misguided you on that term. Systems integration, we still have a very robust systems integration business, it's about $1 billion here. That has been, and will continue to be a highlight of our business. What we did divest was our -- basically our Avaya hardware business and we didn't see a particular need for that. When we got into that business, there was some talk that data and voice were coming together in a way that we didn't want to miss. And we haven't seen what I would say that come together in a way that was working out for us. So that's what that was, it was not a broad-based customer business. We didn't view the technologies growing at a rate that would really warrant our management time or our increased effort to make it continue to grow. And we felt it should be with somebody who does that for a living, and that's what we did. So that's the business. It was the Avaya business. It wasn't a broad-based integration business that we have.

And the next question comes from the line of Shawn Harrison, Longbow Research.

This is Gausia Chowdhury on behalf of Shawn. Could you give a little bit more color on the IT spending environment? Do you think that IT spend accelerated for you guys, or is it just the general spending environment? And how does it look for the rest of the year?

All indications that we have over the last 2 quarters and continuing on with our forecast this quarter, we still see it robust. I think product will start to get harder to get but customers are starting to place orders with longer lead times now, and I view that as a good thing. That's a little different than what we've seen in the past with customers buying a lot of products to ship tomorrow, we're not seeing overwhelming shipments to any one particular type customer that we've seen in past allocations where they just try to go out and buy everything they can buy. I think they're a little more thoughtful this go around. But it's going to be strong environment from everything we can tell right now.

Okay. And then with the components demand creation improving, that means consolidated EBIT leverage accelerates in the 1.2, that was just seen, correct?

I'm sorry, I didn't quite understand the question.

Sure, I was just talking about the EBIT leverage, I think it was 1.2 and I wanted to know if that's going to improve the components demand creation improving?

Oh, yes. Absolutely. When we get a higher percentage of our business and design wins that, that definitely will drive that leverage up. That's why we do it.

Sorry one last one for me please, just the size of your digital business. Can you give us an update on that?

We talked at the end of Q4 that we were over $1 billion run rate. And we won't comment on that quarter-to-quarter, but we'll give you an update periodically as we go forward. I will tell you that it continues to grow rapidly, and it's a major growth vehicle for us. And it is growing faster than the quarter and it should grow faster than the quarter.

And the next question comes from the line of Jim Suva, Citi.

I have one question for Mike and I have one question for Chris. Mike, in your prepared comments, you mentioned growth in the medical devices on large supply chain customers. My question was on the comment on the large supply chain customers. Is that -- are you shipping and seeing more demand to consumer devices, or EMS companies, you mentioned all 3 regions, America, Europe and Asia, which is encouraging. But how should we think about that? Is it more like PC sectors, smartphones, tablets, TVs? I was kind of curious about that.

Yes, we're seeing growth in alternative energy, aerospace and defense. Basically, some computer and data processing. Consumer is up, but it's not the overall driver. And our contract manufacturer business is up and frankly, our industrial business is up too. And then don't forget automotive, up. So when you look at it across the board, the big supply chain customers in almost every segment are still moving along. We don't have an overwhelming amount of, Jim in, and wireless and cellphones and that type of activity and what I would say, pads or computers. So we're really the broad-based type business.

Okay. And then a question for Chris. On the inventory, I assume, a large portion or some of the portion of the increase quarter-over-quarter was due to integration of eInfochips, or maybe I'm wrong on that. And more importantly, are you at the level needed of your inventory because you had some really big wins recently like with analog devices and others, or do you need to build some more inventory given the lead times?

Yes, Jim. So eInfochips is not a driver. I mean eInfochips over time, I think, I can't have more influence in terms of driving the sales of components. But the real driver here as Mike mentioned earlier is when you look at just order activity that's here, we have to make sure we have inventory stage to support that order activity. I would say that if we were looking at flat growth, I think our inventory was well positioned for all the share shifts. We're not continuing the build inventory for those share shifts. It's really building inventory to support the orders that we see.

There are no additional questions from the queue. I would like to turn the call back over to Steven O'Brien.

Thank you, Lisa. In closing, I will review Arrow's safe harbor statement. Some of the comments made on today's call may include forward-looking statements, including statements addressing future financial results. These statements are subject to a number of risks and uncertainties that could cause actual results or facts to differ materially from such statements for a variety of reasons, and the company undertakes no obligation to update publicly or revise any of the forward-looking statements. Detailed information about these risks is included in Arrow's SEC filings.

If you have any questions about the information presented today, please feel free to contact me. Thank you for your interest in Arrow Electronics, and have a nice day.

Ladies and gentlemen, you may now disconnect.