艾睿電子 (ARW) 2018 Q3 法說會逐字稿

Very good day, and welcome, everyone, to the Arrow Electronics Third Quarter 2018 Earnings Conference Call. (Operator Instructions) I'd also like to advise all parties this conference is being recorded for replay purposes.

And now I would like to hand over to your host for today, Steve O'Brien. Please proceed.

Thanks, Mark. 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 a webcast of this call. Please note, prior period figures have been adjusted for the adoption of 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.

Thanks, Steve, and thanks to all of you for taking the time to join us today. The third quarter was another great quarter. We again showed that our strategy to be the foremost life cycle solution provider is working and working well. Our position in the marketplace is stronger than ever. Our cross center and product solutions have never contributed more to the bottom line. Compared to 2 years ago, we're generating 21% more sales and 33% more profit. That's not a cycle, that's differentiated scale. We achieved record third quarter sales, gross profits, operating income and earnings per share. We said that our investments in engineers and working capital would bear fruit and the result are proof. Leverage was exceptional. Operating income and earnings per share grew 2x faster than sales. Returns on invested capital and return on working capital increased significantly, and we also generated $0.5 billion in cash.

This quarter, we reached several key milestones. We announced an expanded collaboration with wireless carriers to develop industry-specific digital transformation solutions. This collaboration takes advantage of the emerging technologies like 5G, artificial intelligence, software-defined networking and the Internet of Things to drive successful outcomes for manufacturing, resale, finance, health care and the public sector. We announced plans to open our Colorado Open Lab next year, and we're working with 19 municipalities and agencies, along with private businesses, universities and research institutions that make up the Colorado Smart Cities Alliance, and we're going to use the lab as a place to showcase ideas, such as data-driven smart street lighting, smart parking and connected automated vehicles. The Open Lab will also be test bed for suppliers establishing standards on edge computing and artificial intelligence.

We also announced an alliance with the world's largest infrastructure services firm. This firm is a leader in construction, civil engineering and smart city transformation. The alliance will accelerate the digital transformation in smart cities on a global scale. We're collaborating to integrate IoT technology into the physical environment. This will drive improvements in asset management, worker safety, public safety and security. Arrow will provide a library of pre-integrated technologies that can priced into proposals and deployed as a part of contracts.

During the third quarter, our leadership in cloud, IoT and virtualization solutions gave us an opportunity to expand our virtual GPU offering. These offerings will create new data center business opportunities for VARs and MSP. Opportunities include infrastructure fulfillment, virtual desktop infrastructure, virtual graphic processing, servers, supercomputer and storage. We can cross-sell all virtual GPUs with our existing infrastructure and solutions from global market leaders. We'll encrypt VARs and MSPs to address their customers use cases such as artificial intelligence, IoT, blockchain and other technologies that would drive extensive data and volumes requiring high-speed computing. We're excited about the growing number of cross enterprise engagements. We see these engagements as one of our biggest sources for sustained long-term margin and returns improvement. We have triple-win opportunities from these engagements. For example, we're working with an intelligent lighting company that is intersecting IoT and smart cities. First, we're helping design and supply components for their connected control units. Second, we're selling those control units through our network of system integrators and managed service providers to their enterprise and municipal customers. Third, we're attaching a connectivity and end-of-life solutions for all those control units, and we're the only company with the capability to capture these 3-pronged opportunities.

Returning to the near-market condition. Leading indicators remain healthy. Design activity grew at the mid-teens rate year-over-year and grew double digits in all 3 regions. Backlog remain significantly up year-over-year, but the rate of growth slowed for the second straight quarter as we expected. Customers are getting the parts they need when they need them. They're feeling less of an urgency to put in longer duration orders. Lead times were stable across our portfolio and unchanged from last quarter. Book-to-bill was 1.03 for the third quarter, still above parity, but down from 1.07 in the third quarter of last year as we were building our business. Cancellation rates remain within typical ranges. Conditions point to normal, steady growth for the future.

As you know, the list of tariffed products increased significantly since our last call. In the short term, demand has been inelastic in the face of these effective price increases. We've been helping customers and suppliers mitigate this burden on their business. At their request, we're assisting customers who are moving manufacturing locations and rerouting supply chains. We've been using our information advantage to help suppliers manage tariff impact to customers. Our proprietary real-time database of electronics components is the world's largest. We're providing tremendously valuable information to help guide customers' decisions to mitigate tariff impacts. Tariffs are not the reason we developed the database, however, the value it's providing confirms our belief in the power of data.

As we discussed in the past, changes in enterprise computing solutions competitive landscape resulted in the on-boarding of a significant number of value-added resellers over the past year. These VARs were hardware-oriented and have contributed meaningfully to our hardware growth. VARs want to be part of the software-led solution approach, but this requires some heavy lifting on our and their part to pivot their business. We expect to be able to ship their business to more value-added software solutions in the coming quarters. This motion is like what you've seen on our global components business where we brought in a large amount of fulfillment business last year and are just now seeing that mix of business change. In the meantime, our enterprise computing solutions investments are in place ahead of that mix shift.

As I mentioned last quarter, we're starting to see a meaningful amount of business shift to as a service and consumption-based model. We're very pleased by this trend as it creates a growing backlog of ratable revenues that will be recognized in the future quarters. However, as you've seen in the software industry, our expense base to support this business is in place but sales that we formerly recognized upfront are now being recognized over time. We fully expect the business mix of our VARs to improve in the next few quarters. We're already seeing signs of this. In addition, as ratable revenues reach critical mass, we expect them to contribute to improving margins. To be clear, we expect improving profits and margins from this.

In closing, we're ahead of pace to deliver a record year in 2018. We delivered a record third quarter result and expect a strong close to the year. I look forward to updating you on our performance and the progress in the coming quarters.

I'll now hand the call over to Chris to provide more detail on third quarter sales and our expectations for the fourth quarter.

Thanks, Mike. Third quarter sales of $7.49 billion were near the high end of our prior guidance range. Sales increased 9% year-over-year and 10% adjusted for changes in foreign currencies. Acquisitions and divestitures does not meaningfully impact the consolidated sales growth rate. The actual exchange rate for the quarter was $1.16 to EUR 1, slightly below the $1.17 rate we previously used for our forecast. This had a very small negative impact on growth rates.

Third quarter global components sales of $5.38 billion increased 11% year-over-year. Sales were above the midpoint of our prior expectation. We had record third quarter sales in all 3 regions. In Europe, sales increased 13% year-over-year adjusted for changes in foreign currencies and increased 11% as reported. Europe sales have increased year-over-year for 22 straight quarters adjusted for acquisitions and changes in foreign currencies as we continued to gain share in the marketplace. In the Americas, sales increased 13% year-over-year and increased 12% adjusted for acquisitions. Demand continues to be strong across our base of industrial and manufacturing customers. Asia, again, produced strong growth this quarter. Asia sales increased 8% year-over-year. Transportation and IoT continue to be growth drivers for the region. Though we are not immune to economic conditions, we believe our large geographically diverse customer base, with no significant industry vertical concentration, helps insulate our performance. Global components operating income increased 28% year-over-year and increased 2.5x faster than sales growth. Operating margin increased 70 basis points year-over-year to 5.2% and increased in all 3 regions.

Record third quarter enterprise computing solutions sales of $2.11 billion, increased 9% year-over-year adjusted for changes in foreign currencies, the divestiture of the unified communications business in the Americas and both a small acquisition and a small divestiture in Europe. Sales increased 6% year-over-year as reported. Billings increased at a high single-digit rate year-over-year adjusted for changes in foreign currencies. Growth was driven by storage, infrastructure software, industry-standard servers and security. Enterprise computing solutions America sales growth remain strong. Sales in the Americas increased 13% year-over-year as adjusted and 7% as reported. Record third quarter Europe sales increased 3% year-over-year. Europe sales increased 2% as adjusted. Our product mix in Europe is more skewed towards software, so net sales growth tends to be dampened by agency accounting.

Enterprise computing solutions operating income decreased 15% year-over-year. Operating income decreased 7% adjusted for an acquisition, divestitures, changes in foreign currencies and a $6 million sales tax adjustment, which was entirely recognized during the third quarter. As we stated in the past, this business is best judged by operating profit to our growth on a multi-quarter basis. Over the last 12 months, operating income dollars are approximately flat adjusted for the divestiture of the unified communications business and for the $6 million sales tax adjustment.

Returning to consolidated results for the quarter. Total company operating expenses increased 5% year-over-year. Operating expenses decreased 30 basis points as a percentage of sales on a year-over-year basis. Consolidated operating income increased 19% year-over-year and operating margin increased 30 basis points. During the third quarter, corporate expense was lower than the recently -- recent quarterly run rate. This was partially due to lower expenses related to our ERP implementation that we completed earlier this year. Interest expense was $54 million approximately in line with our prior expectation. We expect interest expense to be slightly higher in the fourth quarter due to higher interest rates on floating rate debt. The effective tax rate for the third quarter was 24.4% in line with our 23.5% to 25.5% target range.

Net income was of $193 million, up 20% year-over-year. Earnings per share were $2.18 on diluted basis toward the high end of our prior guidance range of $2.09 to $2.21. Earnings per share increased 21% year-over-year. We estimate the strengthening of the dollar negatively impact earnings per share by approximately $0.02 and negatively impacted earnings per share growth by approximately 140 basis points compared to the third quarter of 2017.

Operating cash flow was $494 million as the slowing growth environment allowed cash flow to normalize. As a reminder, third quarter cash flow benefited by approximately $200 million at the expense of second quarter cash flow due to timing of a new large customer engagement. We expect the working capital requirements for this engagement to be mostly cash flow neutral going forward.

Return on invested capital increased 80 basis points year-over-year, the fourth quarter in a row of nearly 1 percentage point increases. We are capturing higher returns on our organic investments in the business. We repurchased approximately $20 million of our stock, approximately $105 million over the last 12 months and approximately $1.1 billion over the last 5 years. Entering the fourth quarter, authorization remaining under our share repurchase program is approximately $279 million.

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

Now turning to guidance. We believe that total fourth quarter sales will be between $7.7 billion and $8.1 billion, with global components sales between $5.175 billion and $5.375 billion and global enterprise computing solutions sales between $2.525 billion and $2.725 billion. We expect interest expense to be approximately $57 million in the fourth quarter. As a result, we expect earnings per share on a diluted basis, excluding any charges, to be in the range of $2.46 to $2.62. Our guidance assumes an average non-GAAP tax rate of 23.5% to 25.5%. We expect average diluted shares outstanding of 88 million and the average U.S. dollar to euro exchange rate we're using for forecasting purposes is $1.16 to EUR 1.

Thank you, Chris. Mark, would you please provide the instructions and open up the call to questions at this time?

(Operator Instructions) Your first question comes from the line of Steven Fox, Cross Research.

Mike, I was wondering just if we could step back a little bit and talk about how you guys determine when to make investments like you highlighted in the ECS business today? It seems over the last few years, you have taken the opportunities to reinvest some of the -- your profits in terms of building up scale and services. And I'm curious how we can think about that over the long term going forward? Do we expect to see every few quarters that we'd have a dip down for further reinvestments? Where you think you are in that path? And then if you could just direct -- directly talk more about when margin headwinds from some of the models that you just laid out start to abate?

Yes. Maybe, Steve, I'll really separate the businesses. First off on the ECS side from a high-level, if you remember, we went out into the market, brought in several VARs over the course of the last year after there were some changes in the marketplace. Those VARs came in and largely were in as of the third quarter. And so what we saw was a faster mix in hardware sales versus software. And as you know, the software sales is the more profitable piece -- software and services is a more profitable piece of our business on a go-forward basis. So we put in investment to help bridge -- those VARs bridge the gap into software sales, and we're now starting to see some benefit from that, but it does take those businesses time to get up to speed, get their infrastructure in place, get the technical knowledge they need to add software to their portfolio, and we've seen that. We believe that the ECS business will actually bottom in the next quarter, and we believe that from there, we'll see some sustained growth out of those investments. On the component side, if you remember, we spent the last couple of years bringing in volume that was primarily supply chain type business, and we have been improving that. So really, the ECS story is the same story as the components in many ways. And from what you can see, this time, the components business just gave another record by the way of 5.2%, I believe, it was for the quarter, surpassing where we even thought it would go over the course of this year. And largely, that because the design win year-over-year activity has helped tremendously and that's up 15% year-over-year. And I think we're going to continue to see that because the demand in the engineering business is continuing on into the fourth quarter with growth, which is another reason we expect a soft landing. Largely, the investments are in. We don't expect any more investments around things that we've talked about today. And we do expect it to improve from here. Albeit, the guidance for the fourth quarter is yet one more record for the company. So I might want to point out that with the investments that we've given, Arrow Electronics is going to deliver one more record next quarter, which puts us well past the 2-year mark of continuing to develop record profits in earnings and sales records. But hopefully, Steve, that answers your question.

Yes, it does. And sorry for burying the lead on your record profits. And then just as a follow-up, maybe given what's going on in terms of some of the capabilities you're adding at these VARs. Does that mean that when we look at your ECS business right now, it's not a true reflection of what you're seeing in terms of end markets or maybe you can just comment on where you're lining up to end demand versus maybe things are a little skewed?

Yes. Well, first off, I think what we're seeing is really record levels of hardware growth because most of the VARs that we brought in were selling hardware. And we're also seeing record levels of hardware growth in, what I would say, our industry-standard servers, services, networking and software, but software is growing at a less rate than the hardware. What we said is that, that creates a mix issue for us, and while software is growing at market right now and starting to grow above market, given some of the VARs coming on, we need all of the VARs to be selling the software which will help increase the profitability of that business. And again, it's just like when we brought in the fulfillment business on the component side and then started to do the design activity, you saw that business go up. We think it's going to be exactly the same, and I'm not expecting any big changes in that business coming into next year.

Your next question comes from the line of Matt Sheerin, Stifel.

Just regarding the strong margins in the components business, Mike, you talked about design activity being a contributor, so more value add. But are you getting any lift at all in just -- in terms of gross margin because of the -- that you said lead times are normal, but there has been tight supply certainly in a lot of areas, and we've seen mostly from suppliers that there has been less ASP pressure than normal. Are you benefiting at all from that now given where we are in the cycle?

Yes, Matt, there is still -- on the margin side, fulfillment business is fulfillment business. There is sort of a bid ask on pricing there. While it is elastic, it's not overly elastic. If you remember when we went into sort of, what we would all call, allocation mode, our contracts are out as such, you don't have the price elasticity that you used to have in the business because you've guaranteed that you're going to supply that part over a certain period of time, which is one of the reason you see the inventories go up. Then when you do more design work, that design work is much more profitable than is the fulfillment work. And what we're seeing now is the margins increase largely because of the design activity in those customers just like we said that would happen in the beginning. And if we can continue to grow our mix on the design side, there is no reason that it shouldn't continue, and you wouldn't continue seeing that type of leverage. And if you look at the number of engineers we have out there, which is a lot. We made a -- we made big investments over the last few years in engineering. We expect that piece to keep going, and I guess, you saw some evidence of that this quarter, and it'll keep going through next quarter from what we can see and all indications are for a soft landing. The design win activity shows for a soft landing, the backlog is still up, cancellation rates remain normal. So we're not seeing the quick drop-off. I might also note, we're not hugely big in wireless, and the wireless activity is one of the big reasons that you've seen some changes in the marketplace. We're more demand-driven industrial-type accounts and that type of things. So anything we would see would come from more of a, what I would say, an economic downturn than we would see from a cycle in wireless or a refresh or anything like that. So hopefully that helps?

Yes, that's helpful. And 2 other quick questions, if I may. Just one on the inventory, you're still about a turn higher in terms of inventory turns than you were a year or so ago. And given at least slower growth as you talked about, if not a full-blown correction, do you think you can get that down and see accelerated cash flow next year? And then the second question unrelated. Your commentary, Mike, about seeing a lot of activity from customers potentially moving manufacturing and you helping with them with that, are you actually seeing that now? Or is it -- it just seems like companies are talking about it, but we're actually not seeing full-blown manufacturing move out of China into other areas yet?

Yes, so the tariff piece, we are seeing companies that are already set up in other location increase their production in locations that are non-tariff locations. So if a company has a factory in the U.S., in Mexico and in Asia, they may decide that their mix of production is going to be in Asia and in Mexico, and they're going to drop down the amount of what they're manufacturing in the U.S., so we are seeing those supply chains. There is about 1/3 of the business that came in here, shipped out of here, about 1/3 of that has gone down and then rerouted at this point. So the answer to your question there is, Matt, yes, I mean, manufacturers is smarter than you think. They got to make a buck too and these kinds of tariffs makes the difference. And so everybody is going to do what they have to do to improve their situation profitable wise and you guys would be all over them if they didn't, so they are doing it. As far as the -- I guess, the other one was...

Inventory turns.

On the inventory, yes, the inventory is in there because we're largely seeing the same lead times that we've said we were seeing before. As those lead times abate, yes, that will convert to cash. The second reason it would convert to cash is as business slows, we would find ourselves as you suggest into what we might consider an over inventory position, I don't believe we're there now, although at these rates, the inventory will follow it down, probably one quarter behind, just like if you remember the last downturns we've been through with you, then our strategy is pretty much not changed. It will be about a quarter behind and then you would see accelerated cash flow from that just like Q3. That cash flow model is intact, and as the business flows, you'll see a lot more cash flow.

Your next question comes from the line of Param Singh, Bank of America.

So just while looking at the operating income in ECS this quarter, if I exclude the divestiture and the $6 million expense you talked about, you're still down a lot year-over-year. How much of that is your investing piece versus other revenue segments being down? I mean, are you generating less profitable revenue from the individual segments itself not just mix? And at what level -- go ahead.

Yes, I would say that what you're looking at, I think, is about an additional $3 million roughly that you're talking about, and I'm going to say, 2/3 of that is mix and about 1/3 of that was investment.

And then Mike, at what revenue level within ECS would you get to year-over-year operating income growth within that segment?

The expectation for us is to start improving in the January and the March quarters, and we expect that mix. We're seeing it now. The question becomes how fast will the resellers implement it, how will their business change as a result of it. And as I said, we expect the December mix -- the reason that December mix is going to continue like it is, is it's -- don't forget about the year-end flushes that happen in this business and it happened for the last 30 years. They are less than what they used to be, but they are still there. So as we brought in more hardware guys, the December flush is going across hardware sales to run off faster than our software and then the market will return to a more normal mix in the January and March quarters. And that's what we're expecting. Hopefully that gets you where you want to be.

Got it. And then as my follow-up, on the component side, obviously, you're seeing better end-market demand and some your competitors versus, say, what TI and Maxima have openly reported. So what do you attribute that disconnect to? And then the other concern I've heard from investors is how much channel inventory do you think is above normal levels given the current demand environment, i.e., looking at prior cycles, do you think there's some compression factor that might play out over the next few Qs?

Yes. If you take one of the worst downturns, which I think, was back in 2009 right around in there, the inventory came down nicely and it followed the sales one quarter. So that was the difference you saw on the inventory. That's about where you are right now. We're not expecting that downturn, so we wouldn't expect the same type of decline. But if you take one of the worst, then unfortunately, yes, I was here growing that one too, so I guess, shows my age a little bit. But the truth is the inventory is acting normal. I'm not worried about the inventory because the inventory is basically cash, that's convertible cash. And as it goes down, the more it goes down, the more cash it throws off. So I like the fact that the market looks like it's going to grow single digits into next year. That's where we'll produce cash flow, and that's where the business will have its best balance and it looks like the year is shaping up for that thing to happen.

Your next question comes from the line of Adam Tindle, Raymond James.

I hate to beat a dead horse, but I want to start on ECS. I know there's always a ton of moving parts here, but profit dollar growth has been the metric that you've rightfully conditioned us to focus on. You've got a year-over-year mix issue on hardware. But if we look at a 2-year basis, profit dollar growth has been elusive for this time period. I know there has been some divestitures along the way, but you do this based on returns framework and pretax ROA is also tracking down about 100 basis points during this time. So a long-winded question, but how do you measure success over the next 2 years? What changes over that time frame to enable profit dollar growth and better returns in that business? Is there a time line you put on thinking about strategic optionality if it doesn't -- if the current trends continue?

Well, first off, to that last quarter, that's always on the table, that's never been off the table whether there is strategic things that we do or whatever that is. So that's a given if we don't see a balance there. Let's also remember what happened in the overall marketplace over the last few years. You've had the HP split, you've had IBM with their struggles in purchases and products coming in. You've had the Dell going private. You've had the EMC being purchased by Dell. You've had the solid-state storage piece go from rotating. There kind of been a ton of technical changes in the computer business over the last couple of years that most people would think that that's pretty good performance compared to what you've seen with others in the same space. So I think the question is, is, if you believe the IT space is here for the long haul, then that last couple of years shouldn't be something that you're overly worried about, but you should actually be saying, wow, they converted their business. They pivoted their business the way their business was heading not where it was. So that's the question you're free to ask, that's the question you're free to put pressure on us. But right now, we believe that we're getting a place of normal growth in the computer business where we think that can come back sometime during the first half of next year. So we're still bullish on the business. That doesn't mean we don't answer those questions every quarter ourselves, that doesn't mean that I don't put internal pressure on my management team to deliver growth. But right now, I think we have a plan that will be good for the IT business, so we're sticking with it right now. Does that answer your question?

It does. And I think the frustration comes from the valuation and maybe lack of recognition of what you've done over that time frame that's baked into the stock right now. But I wanted to ask...

I got to tell you that the frustration is ours too because you come off of 2 years quarter-on-quarter record every single quarter in earnings per share, sales growth, margin, and so I got it. But my job is to put the profits on the board, which we've done. Your job is to report on and my guess, it's the Street's job to buy the stock, right?

Fair enough. And if I could ask a follow-up for Chris real quick on capital allocation. Cash flow was, obviously, strong, and I know you've talked about wanting to buy back stock given valuation that we just talk about. Maybe it was a little bit too late to accelerate buybacks in the quarter, but there was no additional authorization and maybe hoping you can touch on that point or are there perhaps things in the ECS business where you would be better off making acquisitions there to fortify trends?

Yes. I mean, on the latter part, again, we're always looking at that landscape. But I will just reiterate, again, what our capital allocation strategy is. And it is, we will do organic investment first, which we've done a lot of over the last couple of years and that's, obviously, beared fruit. We'll do accretive M&A where it makes sense. And I think we have said that there is not as much of that available right now and then everything else goes back to shareholders through buyback. A lot of our cash flow was late in the quarter. There's been a lot of focus on driving positive working capital metrics, which we did, but it did come a little late in terms of our ability to buyback. But that capital allocation remains the same, so you know what our next move is. And we'll talk more about it with our board in December about authorizations and where we are at that point.

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

Were there any regions where the book-to-bill dipped below parity for the September quarter? And not to be extremely shortsighted, but have you seen a continued moderation of the book-to-bill through the month of October? Or is it been more than just a stabilization dynamic?

Actually, it's been more of a stabilization dynamic. It was Asia that had the negative book-to-bill coming off of just huge growth year-over-year that we saw. And I'm not even going to speculate whether it's tariffs or anything else, but do we see continued growth there, but the growth did abate and moderate from a bookings point of view. I will tell you though the design win activity went up. So we're expecting it to be sort of a blip right now and will see that there goes. But all in all, the other 2 regions we're still very strong and very strong in design win and that being North America and Europe, which we view as positive.

Got you. And then as a kind of a follow-on or tied together, Mike, on the demand creation of the supplier share gains that you picked up last year. Where are you at on that curve? And then, Chris, I think, you said the EBIT leverage in the components business is about 2.5x for this quarter. Is that the peak of the EBIT leverage, and we should expect to see that normalize a bit during the next couple quarters? Can you continue to see that type of leverage going forward?

I think as you see increases in volume and an increase in design win mix, which is what we're driving for, you'll continue to see increased profits, and that's the same story we've been saying all along. We don't see anything to change that. We also believe that as the market goes the other way, if that will provide a little more of a soft landing for us too if there was a downturn because having a better balance in your business and increasing -- this is just economics 101, as you increased higher margin portion of your business as your mix, you make more money, and that's really our goal.

Yes, and I would just add, Shawn, to your question. I wouldn't want to predict a high point. Again, our focus is on continuing to drive value added for customers and differentiated growth for suppliers, and we're doing that. I think when you look at the kind of implied guidance for components in Q4, we're showing significant margin improvement year-over-year, again. So that's our focus and we're going to push it every quarter.

Thank you. I think just an interesting comment is we do look at the returns are very important to the business, and so our investments that we make are always towards the high-margin business to try to improve the high margin business mix of the business.

Your next question comes from the line of Joe Quatrochi from Wells Fargo.

First on the component side, if I could. I was wondering if you could kind of talk about customer inventory levels and how you think about that relative to the tariffs going up to 25% at the first quarter next year. Have you seen or any of your conversations with the customers indicated that they're looking to kind of higher -- hold higher levels of inventory in anticipation of that?

Well, first off, we're not seeing a change in customers saying that they don't have enough inventory, which is good. We do have some customers that don't have enough of certain types of inventory, so there's still a push there. We like where they are right now because we've seen their inventory sort of mitigate as ours are also, which shows for more appropriate supply demand, which we all would rather have because you have less shortages, the businesses become more efficient, they make more money because they don't ever have a slowed down of products they're trying to get out the door. I will tell you right now that these tariffs have not substantially hurt our business because most people are reacting to them as they should. And anything that is artificially created, we're against. We believe that tariffs are a bad thing in general. But if one government anywhere in the world decides they're going to increase tariffs, don't be surprised that worldwide manufacturers don't move their manufacturing around. I don't see why that would be a surprise to anybody. And unfortunately, that sneaks up later in terms of jobs and things like that, but the bottom line is everybody needs to make money, manufacturers need to make their money. They're all smart enough to manufacture anywhere in the world. Most of them are manufacturing in more than one place, as you know. And upping the manufacturing in those places is pretty is easy, declining in others are pretty easy, so I don't see it as an activity that frankly, doesn't happen all the time anyway.

Yes, that's perfect. And then just a follow-up, kind of bigger picture one. You talked about in your prepared remarks, you're moving into facility, virtual GPUs, data center fulfillment. I was wondering if you could kind of talk about your opportunity there and how that opens up maybe a different type of customer base and maybe your ability to leverage your ECS business as it exists today.

Yes. Joe, it's Andy. First of all, yes, the opportunity around GPUs basically come from a couple of areas, actually. Firstly, the whole drive of autonomous machines into the industrial segment, which probably sits my side of the house. And then, of course, the increasing data center penetration that we're seeing from high-performance compute, which firmly sits Sean's side of the house. So one of the reasons we're able to pursue these opportunities is that we have this kind of unique go-to-market model that enables us to get those technologies deployed into multiple end markets. And that's really been the uniqueness of our capabilities and why those people want to partner with us.

Yes, I would just want to add that, Joe, that from a traditional IT perspective that this is no different than other next-gen technologies that we brought to our channel partners, both our existing partners as well as the new ones that we're on-boarding. We're very familiar with -- help them ramp up into our new demand trend and a new technology as things like machine learning, go mainstream in traditional corporate environments, this is going to be a great opportunity for those partners to build their businesses going forward.

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

And I have one question for Mike and one for Chris, and I'll just ask them both now and you can answer them however you want for the order. But Mike, in your prepared comments, you mentioned about some efforts for operating margins and things like that, again, in your prepared comments. Can you give us a little more details about kind of timing and magnitude and what some of those efforts are just, sort of, we can better understand those? And then, for Chris, regarding cash flow, your year-over-year revenue growth projections will likely moderate like you mentioned many times about a soft landing and things like that. In doing so, I would assume that as in past cycles, you'll generate a lot more cash flow. And given the stock price performance of the stock year to date, does that kind of put stock buyback up here a little bit higher than maybe it would have in past cycles? We're just trying to get a grasp on that allocation.

I'll answer the last one first and just say, yes.

Yes. I think, Jim, the truth is as things change, I would think you would see us react just like you did the last time. The playbook hasn't changed here. We've been very clear on what we do with our cash. And I would expect that you're going to see buybacks increase. I wouldn't suspect. I'll just tell you they're going to increase from where they were, a whole lot more just given the marketplace and how the market is growing. That's where we use it. If you remember the last few years has been what I would consider, pretty explosive growth around here, it has taken every dime of cash that we have to support that growth plus try to build engineering and try to build a bigger technical-type business which right now what I think we're the world's largest engineering company for electronics that's out there. You just don't just build that without putting some cash towards it. I would expect that what you're going to see is a bigger improvement of, what I would say, computing type activities here whether that's building those products, designing those products, supplying the parts for those products. The stuff is being done now, I'm expecting some of the early things I talked to you about start having impact on the second half of the year. And that's why I'm fairly confident in the year itself that I believe the year is probably going to carry itself through the first half and then some of the activities that we've done will increase as things carry us through the second half. That's pretty much how we've been running the place for a long time, but we try to consider that and think of it in that point of view. As always, the newer stuff coming later, the more efficiency on the stuff that's coming today. And hopefully that answers that question for you.

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

I have 2. First on the component margins. So EBIT margins in that segment are above 5% for a couple quarters now. I'm hoping you can deconstruct some of the regional dynamics behind that? Because I know Arrow had invested for -- quite a while in engineering and resources, specifically for Asia and hoping to better understand to what extent some of the margin gains are coming in from Asia to greater-than-average extent or is it more broad-based across geographies?

Yes. Actually, it's -- Mark, every region has increased design wins and every region has increased profitability. So you can call it even. You could call it, say, one is a little better than another. But Asia has had a big profitability increase, North America has had a profitability increase and so is Europe, and It's primarily been the design engineering strategy and suppliers continue to like that and suppliers and customers continue to pay for that, we expect that to continue.

Got it. My follow-up question is related to the cyclical outlook. I believe Arrow said in the past that its business can lag semi suppliers on both the way up and the way down by 1 to 2 quarters. So I'm -- want to better understand if you think there is a timing dynamic at play and if lower guidance from semi companies like the TIs of the world, if that's maybe a leading indicator for whatever we may see next year? Or is that the investments in engineering, the business mix and you do think those are sufficient so that Arrow is not going to see it or if you do, it's just going to be a much lesser extent?

Yes, so as I said before, our wireless percentage of our business and our automotive while growing are the 2 areas that we have been less impacted by or the channel has been less impacted by. So I think, the wireless is the biggest slowdown that the market has seen right now. And so for whatever reason or another, we're not seeing that because it's not a big piece of our mix. I think the question that everybody has to have, are you expecting a general market downturn next year. You're expecting an economic downturn in which case, we'll feel it. I believe right now if you were to say in general, it's the 3 to 6 months that you've seen, we could pretty much see out and things look pretty good going into next year. I think the design activity we have is certainly going to help the second half of that year because that's usually the time frame you have on those. So we're actually feeling pretty good that if there is a downturn, it could be minimized by the business that we have in-house and that's what we've been striving for. So if there is one, we're going to be in about the best shape that we've ever been at.

Your final question comes from the line of William Stein at SunTrust.

I want to add my congratulations to the good top margin, especially in the components business and look forward to getting even better there. But I did want to ask another question about this GPU commentary you had, Mike. Very interesting because we know on that, that's a great growth area in semis right now. But I have maybe 3 sort of little questions about it. First, are these long-standing relationships or new ones? Also, are you dealing with sort of the big vendor that we all know in this space? Are there potentially multiple vendors that you're helping? And we know that you used to have a great relationship with one of the big FPGA companies that are similarly linked to this dynamic, but they're under a new ownership. Maybe you can update us as to whether they're a part of this effort?

I mean, it would be hard not to just say, yes to virtually, every one of your questions. It is interesting if you take a look at our line card, we're well poised here. Obviously, the growth that is projecting for this market is high. We're already in it with a lot of design activity. And yes, we have some new relationships that only augment that. That's the interesting thing about this business, you're constantly adding new suppliers, you're adding new capability. What's also interesting is the software that goes around all of this, which is been something that we've done very well on the ECS side of the house. So we do see ECS is part of these conversations. And most of it is related to the edge and what's happened out there. So whether it's fully autonomous, whether it's artificial intelligence, most of these programs, I'm going to say programs are new, the words and the verbiage and all of that is getting a couple of quarters old, but no, we're poised very well. That's where we focus our engineers going into the second half of next year and you saw the smart city lab. You take a look at that and some of the -- through the press releases, you can see which suppliers have joined in on that and which ones are going to be a big part of those solutions. And all those questions get answered pretty quick when you see Arrow as the person that's bringing them altogether through the lab work. And we think that's going to pay off in heavy dividends.

Thank you. We have no final questions, and I would like to hand the call back over to Steve O'Brien.

Thanks, Mark. In closing, I'll 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 informations 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.

Thank you all presenters. Ladies and gentlemen, that concludes your conference call for today, you may now disconnect. Thank you for joining, and enjoy the rest of the day.