Q4 2019 Earnings Call
Ladies and gentlemen, this is the operator today's conference is scheduled to begin momentarily until that time Airlines will again be placed on hold thank you for your patience.
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For standing by and welcome to the Arrow Electronics fourth quarter and year end 2019 earnings conference call. At this time all participants are in listen only mode. After the speakers presentation. There will be a question and answer session. If you.
To ask a question during the session you will need to press star one on your telephone keypad.
Todd.
Please be advised that today's conference is being recorded if you were far require any further assistance. Please press star zero. Thank you I would now let's turn the call over to your speakers. They Steve O'brien. Please go ahead Sir.
Thank you Jacqueline good day, and welcome to Arrow electronics fourth quarter and you're right.
In 2019 earnings conference call with Us on the call today, or Mike Long, Chairman, President and Chief Executive Officer, Chris Stansbury, Senior Vice President and Chief Financial Officer, and became President Global components, and Sean Kerins, President Global Enterprise Computing solutions as a reminder, some of the figures discussed on todays call.
Our non gap you can access our earnings release at Investor Day Aero Dot com, along with the CFO commentary the non-GAAP earnings recommendation in a webcast of this call will begin with a few minutes of prepared remarks, which will then be followed by a question and answer period I'll now hand, the call to our chairman President and CEO, Mike long.
Thank you Steve Thanks, all of you for taking the time to join us today.
During the fourth quarter, thanks to our commitment to solving or customers engineering design and supply chain needs.
Pretty strong earnings per share in cash flow results.
Well again increased the scale of our Asia components business and that scale wall.
Three sales across certain line card and lead the future profit improvement.
Enterprise computing solutions delivered operating income growth.
Driven by the newer technologies in the non traditional customers.
As we begin 2020.
We're well positioned to drive profit growth and margin expansion.
And as soon as the demand in conditions improve.
We are concluding our cost optimization actions, which has streamlined organization and have enabled us to quickly adapt industry corrections in economic conditions.
The wind down of the PC in mobility asset disposition.
Let's say sharpened our focus and we remain focused on the opportunities that will enhance long term shareholder value.
The economic and demand backdrop, where business in the fourth quarter showed no improvement.
We saw hopeful signs in the fourth quarter, but no changes it would alter our stance that the industry.
Bouncing along the bottom.
However by remaining nimble and flexible during the quarter, we were able to see a cheap sale inline with our expectation.
My adapting to the current macro conditions, we delivered strong cash flow, while improving economic returns through working capital real.
Right.
To provide some additional tax on the near term market conditions were facing our customers remain very cautious during the fourth quarter.
And generally pared back their inventories.
Demand from smaller customers, who utilize more of our engineering and design services weaken the beyond what.
We had originally anticipated.
Manufacturing engineering and design work continued to move off shore at the same time consumption of our European exports continue to decline.
While customers and suppliers are starting to see signs of improvement our business.
Additionally, trailed the market.
With that said, we are saying some signs of stability.
Backlog did increase from the third quarter, which is the first again sequential improvement since the third quarter of 2018.
Design activity increase year over year in total.
And increased quarter over quarter in all regions and given a 12 to 24 month cycle from design to production, there's a lag between higher design activity and improved mix and margins. However throughout this market correction, we have been very pleased with the stability in our design activity.
Other indicators appear consistent with an approach to the end of the market correction lead times are shorter than last year, but remain consistent with the third quarter in long term average it.
Overall, our book to Bill was <unk> 0.99, exiting the fourth quarter book to Bill with that.
Near parity in all regions and showed improvement compared to the third quarter in all regions.
Our Americas customer sentiment survey results.
Improved over the last three quarters.
The proportion of customers, saying, they had an appropriate levels of inventory returns.
To normal historic level.
Appropriate levels is normally the largest category. However, the proportion of customers, saying they had too much inventory also remained hike.
Despite a challenging backdrop I want to emphasize that arrow remains committed to driving innovation through.
Our engineering and technical leadership, we're not changing the way, we do business to respond to the near term market pressures with this understanding we saw no incremental contribution to the fourth quarter results.
From any supplier program changes.
And our first quarter guidance assumes no significant.
Incremental contribution from recent changes, we continue to listening closely to our suppliers and customers to address the requirements and to do business, the where customers and suppliers would like us too.
Now turning to our enterprise computing solutions business.
In the fourth quarter demand.
For our software led solutions was inline with our expectation.
We did well to meet our guidance commitment.
While the peso smaller extent expenditures continued the appetite to purchase large scale I T solution with notably less than last year.
In aggregate.
Grew it so slow low single digit rate year over year in the fourth quarter or portfolio approaches to the designed to deliver consistent result.
The success of our approach Drover returned to operating income growth in the third quarter as we expected and operating income increased again.
Fourth quarter, even with unfavorable foreign currency changes.
For the full year of 2019 Enterprise computing solutions operating income also grew slightly compared to 218.
Adjusted for currency.
Behind this small profit growth.
With the significant realignment to newer software hardware and hybrid cloud architectures offsetting declines in legacy systems.
In closing we continue to proactively address what we can control while remaining adaptable to face external challenges head on.
Our engineering capabilities remain to be our key strategic advantage, we're confident that our engineering know how we'll continue to set us apart over the long term leading to tremendous opportunities to expand our business drive innovation and improve the performance of then customers everywhere I look forward.
To updating you on the progress in performance chemicals coming quarters, I'll now hand, the call over to Chris.
To provide more details on our fourth quarter results and our expectations for the first quarter.
Thanks, Mike.
Fourth quarter sales were $7.32 billion, excluding the PC and mobility asset.
Some business sales decreased 5% year over year adjusted for that kind of down and changes in foreign currencies. The actual exchange rate for the quarter was $1.11 cents to one euro which is in line with the rate. We had previously you used for our forecast.
Global components sales were $4.72 billion excluding.
In the PC and mobility asset disposition business.
This is in line with our prior guidance and represents an 8% year over year decrease adjusted for the wind down and changes in foreign currencies.
Asia sales increased 4% year over year on reached an all time record quarterly and annual level the sales contribution.
It's from Asia was also an all time record for the quarter in the year our performance in Asia continues to be strong and as we add new customers, we often find new cross sell opportunities to offer other products in our line card to those customers.
For higher Asia contribution as a headwind to margins, we do not anticipate higher Asia.
Next we'll be a headwind to returns.
In Europe sales decreased 12% year over year as adjusted.
In the Americas sales decreased 16% year over year as adjusted.
We are experiencing lower demand across all of our key verticals in the western regions in the coming quarters, we expect sales performance the Americas.
In Europe to continue to lag Asia due to several factors first Asia has higher asset velocity and customers in the region tend to carry less inventory second we expect demand for western customers products to be more elastic in the face of uncertain economic conditions.
And third we continue to see.
A large america's customers offshore manufacturing to lower cost regions.
Global components operating income decreased 35% year over year operating margin was 3.6%.
It was the third consecutive quarter of year over year margin decline for global components during past market corrections, we've typically.
We seen five consecutive quarters of margin decline.
Well no two downturns are the same we continue to expect margin recovery to first come through our cost optimization program and then from a return to a more optimal product in regional mix when demand conditions improve.
Enterprise computing solutions sales of 2.6 billion.
In dollars decreased 1% year over year as adjusted and we're at the midpoint of our private expected range.
Billings increased at a low single digit rate year over year adjusted for changes in foreign currencies and increase in both regions growth was driven by infrastructure software services and nexgen hardware, including.
Storage and networking.
Europe Enterprise computing solutions sales increased 4% year over year as adjusted.
Americas sales decreased 3% year over year adjusted for changes in foreign currencies. During the fourth quarter America saw relatively more strength in security and services, while Europe saw more strength in infrastructure software.
Storage.
Enterprise computing solutions operating income increased 2% year over year adjusted for changes in foreign currencies and the disposition operating margin increased 20 basis points year over year.
Returning to consolidated results for the quarter total company operating expenses decreased 9% year over year.
Consolidated operating income decreased 20% year over year adjusted for the wind down disposition and changes in foreign currencies interest and other expense was $50 million slightly below our prior expectation.
The effective tax rate for the quarter with 22.1% and was near the low end of our.
Hi, good long term range of 23% to 25%.
Full year 2019 effective tax rate was within the range at 24.3%.
Net income was $181 million and was down 20% year over year earnings per share were $2 in 20 cents on a diluted basis down.
15% year over year.
We estimate the stronger dollar negatively impacted earnings per share by approximately four cents and negatively impacted earnings per share growth by approximately one percentage point compared to fourth quarter 2018.
Turning to cash flow, we reported strong operating cash flow of 400.
$95 million driven by a greater ability to convert EBITDA to cash flow in the current weak demand environment and by a reduction in working capital.
Full year 2019 cash flow totaled $858 million or 135% of our non-GAAP net income.
Okay.
Mr with our past practice, we remain committed to returning excess cash to shareholders, we repurchased approximately 1.2 million shares of our stock for $100 million during the quarter.
We repurchased approximately $390 million over the last 12 months and reduced shares outstanding by approximately 6% over that same timeframe.
During.
The fourth quarter, we also reduced borrowings by approximately $328 million, our near term capital allocation priorities will continue to be share repurchases and debt reduction.
Please keep in mind that the information I've shared during this call to the high level summary of our financial results.
For more detail regarding the business.
Results. Please refer to the CFO commentary published on our website. This morning.
Now guidance turning to our outlook our guidance exclude the wind down of the PC and mobility asset disposition business. Our first quarter of 2020 will close unusually early on March 28 by comparison, the last four first quarters.
Well as our March Thirtyth March 30, Onest April 1st in April 2nd respectively.
Not only were the first quarter be two days shorter than the first quarter of 2019, but also the first quarter of 2020 will not capture the end of quarter sales activity that has always heightened for our enterprise computing solutions business, we estimate the.
Early closing date will result in an unfavorable comparison of $225 million to sales and 11 cents to earnings per share on a diluted basis compared to the first quarter of 2019.
Our second and third quarters also closed two days earlier than normal. However, since these quarters will capture the calendar closing days from the preceding quarters.
We don't expect to you're on your comparisons to be meaningfully impacted.
Our fiscal year always quotes on December 31st So we should capture the loss sales and profits from the first quarter during our fourth quarter 2020.
In addition, as disclosed in our press release, we're seeing some delays in longer lead times of products.
In China due to business and transportation shutdowns in the extension of the new year holiday week mandated by the Chinese government. We are monitoring the situation closely by cannot quantify the impacts on our business at this time.
We anticipate that total first quarter sales will be between $6.2 billion to $5 billion and.
<unk> point $6 billion to $5 billion with global components sales between $4.55 billion and $4.75 billion, our global enterprise consuming competing solution sales will be between $1.675 billion and $1.875 billion.
We expect interest.
And other expense of approximately $52 million, an average diluted shares outstanding of 82 million.
We anticipate the effective tax rate for the quarter will be approximately 24.5% toward the higher end of our long term target range of 23% to 25%.
As a result, we are forecasting earnings per share R&D.
Diluted basis, excluding any charges to be in a range of $1.29 cents to $1.39 cents.
The average U.S. dollar to Euro exchange rate, we're using for our forecasting purposes is $1.12 cents to one euro.
We estimate the changes in foreign currencies will have negative impacts on growth of approximately $30 million.
In sales and one spent on earnings per share compared to the first quarter of 2019.
With that I'll turn the call over to the operator for QNX.
Okay.
Thank you as a reminder to ask a question you will need to press star one on your telephone Keith.
To withdraw your question.
Press, the pound or hash key your first question comes from Shawn Harrison from Longbow Research. Your line is open.
Hi.
Everybody.
My first question is there's a market share transition going on in new global components business, if there's any way to speak about.
Are you seeing.
Thing that share shifts beginning here in the first quarter and maybe how as they transition to you throughout the calendar year.
Yes.
We don't anticipate any contribution from any supplier program changes, we didn't have anything in December quarter, we're not forecasting.
Being anything meaningful in the first quarter.
If you remember.
Most of the transition supplier changes were happening sometime in the second half.
And you know if you look at it.
The other guys can ship all the way through the end of the year. So.
So.
There's nothing in there at this point.
Okay. Thanks, Mike and then as a follow up Chris do you think.
Operating cash flow conversions for either the first quarter. The first half of the year will still be in excess of 100% of net income.
I think we'll see the rates start this slow Sean.
Normally in Q1, I think the last five years in Q1, we've had negative cash flow performance and I would expect that we would all are the things being equal being that negative territory, although trying to fight our way to neutral.
That said, we do think that there's still opportunity from reduced.
Working capital in the current environment.
So.
70% of by GAAP net income is the target I think we could be a little above that and that's certainly the target, but we'll have to see.
Okay. Thank you.
Your next question comes from Adam Tindle from Raymond James Your line is open.
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Okay. Thanks, Good afternoon, Mike I, just wanted to start on some observations from this end market downturn versus prior downturns I think you mentioned in the press release, the greater resiliency. This time versus prior could you just maybe touch on what you attribute that to and on the flip side as we think about the potential ups.
Upturn should we also expect to see a slower cadence of positive operating leverage and margin improvement.
Well I think that.
What you saw this time was.
Faster reaction time.
The first quarter as you know.
With what I.
We consider the started the downturn and during that time.
We did our best to try to offset the.
The sales in the earnings to try to keep earnings per share going for the customers and then in the second quarter, we sort of restructured our business very quickly and.
Put out I think it with like a 130 million dollar targeted which we had executed on in a matter of.
A couple of weeks.
We do keep plan sort of in the drawer. The good news as we haven't had to pull them out for almost 10 years.
The bad news is the market did.
And we were sort of prepared for it. So I think we made ourselves more resilient this time around during the downturn.
Obviously things you always find that you would do a little bit different.
The next time, we put those in the driver for the next time, but.
Everything seems to be going like we've seen in the past, we've typically seen around at six quarter.
Downturn.
Five quarters of sort of.
Negative.
Sales and margin.
Backing its acting like that.
Which is which is kind of funny.
10 years later, but it's we're starting to see the backlog stabilized now in all regions.
What we Havent seen is the catalyst for growth, yet, but I would still think where a couple of quarters away from saying that if you.
Take the historical time, we've been down.
And when it does come.
We very rarely seen a bounce back that has been a one two or 3% bounced back to its usually been bigger than that.
Because it just seems to turn on and customers run themselves down in inventory.
That's the part of the surveys that we're doing right now and to have customers increasing that are saying they're at appropriate levels of inventory. I think is good news may expect station is though start running down even a little bit more until they see clarity and then they're going to want that inventory write back in there.
So we'll have the uptick of the market being filling the inventory that they feel they are below plus their forecast going out and as you know that's usually a pretty good snap back and that's what I would expect this time too.
Okay very helpful and I, just want to make sure I understand that.
Comments on the no contribution yet from supplier changes.
Is that kind of what you expected internally and just to clarify I mean is there.
Messaging that there could be a scenario, where the expected to move to erode doesn't occur or.
What has changed around it.
I don't think there's than any.
The thing that has changed I think we said the exact same thing.
Last quarter.
I think it's been the same from the beginning and.
No.
Customer transitions and most important thing.
Out there and I think it's being handled appropriately and.
Allowing the.
Supply chain to continue to go and I really don't have any more comment because I don't I don't even see it in our purview until the second half of the year and we've got enough things to worry about right now.
Got it thank you.
Yes.
Next question comes from Matt Sheerin from Stifel. Your line is open.
Yes. Thank you.
Just wanted to ask about the gross margin trends.
Particularly given it sounds like Mike said the mix I will continue to work again Chu with Asia, holding up better Europe, and North America is still under under pressure.
And the last couple of quarters, you've been running about 100 basis points down year on year.
Should we be modeling margins still to be down in below 11 kind of range until that mix changes.
I would say you know at least through the first half Matt.
I don't see any any catalysts to change that.
Not much between now and then but you know as the market changes and then new orders come in and then you have a blend into kind of get half of it back and then you get the other half back so I would say we would honestly be.
Later in the year and going into the following year from the way it looks right now.
Okay, that's helpful and.
Commentary around the Corona virus and some of the issues that you are the early issues that you're seeing.
Hi, I guess, one one good.
Positive is that you do have inventory and have you looked at your inventory position relative to the supply chain anywhere they the bottlenecks might be and could that be it put you in an advantageous position relative to competitors or supplier, yes, I Hey, I.
Thank you headed we have no problem now with inventory, we've got plenty of inventory as you can see.
It's the ability to move the inventory around.
And.
The good news is we've heard that the border is closed until the time.
No we don't know what happens on the 10.
Is there an immediate snap back from manufacturers do they slowly gear up are they going to want their product.
You know when is that going to be affected and how the orders will be affected.
But.
I think.
We're sitting on the good news.
Side of that I think I heard that.
Foxconn was going to start producing again on the 10, 10th or 11.
So it doesn't look like it's going to bring out too far and.
Like I said I hope that's true that.
We all want that to be true and I hope that's true.
But thats why we can.
Really put a frame around the guidance because we don't know the exact Dave.
Fair enough okay. Thanks, a lot Mike.
Yep.
Your next question comes from Steven Fox from Cross Research Your line is open.
Hi, good afternoon can you.
Talk a little bit about the components margins by region Directionally on a like for like basis that they trended.
Versus a year ago versus prior quarter.
Yes, probably not Steve I think thats.
That's getting a little bit too far down what I can tell you is.
With that.
Given the numbers that you saw.
Everything held up.
Better than expected for.
This time of year, but.
You know if you look at the downturn really Europe came in later in the year. So I expect.
Your to come out of it later in the year that's why.
We're sort of using the term bouncing along the bottom right now that I don't think you're going to see any any marketable change until well into the second half of the year.
Okay, and then in terms of the comment on about offshoring.
Sort of picking up.
Your customers in the western regions can you expand on that a little bit.
Specifically are you seeing are you able to follow the customers manufacturing as much as you would like gives of winding up not being as much in China going forward.
Position that thank you.
I think we're well positioned for.
For that any of the offshoring that we have seen we have followed the customer to the destination, we have captured the business.
We are seeing benefit from that.
I would like to see that slow a little bit. So you know to me getting a deal with China is important it's going to be important.
For anybody in the end the semiconductor business.
And that really depends on us I think I went on record in the beginning with said those tariffs weren't going to be good for anybody there or not I still stand there I wish my Senator would listen to it but you know the bottom line is that it is what it is.
But yes, where we're able to capture the.
Captured the sales wherever they go.
Great. Thank you. Thank you very much.
Your next question comes from Tim Yang from Citi. Your line is open.
Hi, Thanks for taking the question a follow up question on gross margin I think.
The gross margin on the performed by roughly 20 basis point last quarter was revenue roughly in line and I think in your implied guidance for gross margin to.
20 to 30 20 to 30 basis points sequentially next quarter. So my question here is that can you elaborate on the reason for the market softness.
In this last last quarter.
Volume pricing or mix and looking forward, those fencers getting better or worse compared to a quarter ago.
Well I think it's mix.
20 basis points you can you can do the math it doesn't take very much the mix change for 20 basis points I wouldn't read anything.
End of that.
We saw the margins pretty much stabilize in all regions.
Over the quarter, which is which is good news to where we we believe there's going to be a slight trend trending up.
As we go forward, but.
It's.
For all practical purposes.
The mix and it's.
Such a small amount that.
That mix can swing it either way, but right now given the market and the downside to the market I'll take the sale because the mix is.
The mix of translating into income translating into earnings per share.
And we're not using.
I think too much cash to get it. So we're doing the best we can for the shareholders and Thats what were going to continue to do.
Got it Thats very helpful. And then how should we think about that you see us operating income growth for next year.
Then that there was a strong base could impact the results, but do you feel that two important as field.
Also you affords yes operating income.
We exclude the starting base.
Yes, I'm actually going to let Sean answer that because he started taking the abuse why you had to realign.
Yes business over the last a year and I have to compensate for product changes and the cloud and everything else. So I'll let.
Him take that lap, yes sure thing thanks, Mike Thank Tim So Tim as Mike pointed out in his opening comments, we did make some progress in the back half of the year with.
Operating income growth and it certainly remains our goal for the for the full year 2020, so I actually like our position and our path forward. Our strategy is not going to change the.
Kinds of things that will help us.
Get there overtime will be to continue to lead.
New and existing channel partners to more software based solution selling that's that's certainly helped us to date. We're also executing on investments in the mid market in the longer tail.
Of our channel customer ecosystem those.
Customers tend to rely more fully on our capabilities and value and then of course, we're making steady progress with line card and customer base expansion. So again, our strategy going forward hasn't changed and I think those are the things that will.
Continue to put us in the right position.
Great. Thank you.
Your next question comes from Joe Petrucci from Wells Fargo. Your line is open.
Yes, thanks for taking my question.
Chris I was wondering if you could help us understand.
With regards to the cost optimization I think you so thats done.
How should we think about Opex I guess, though the right level.
I will open IX into the March quarter, and then I guess it as we start to see some improvement in demand in the back half this year.
So really the bulk of $130 million cost cuts as Mike said are in the PML today. So as you look at at where we closed Q4 I'd say.
Thats a good rate I think the only caution around that.
You guys in your model, we'll see that are our corporate expense was was quite a bit lower and that really relates to incentive compensation.
Given the fact that we obviously had a tough year. So that obviously re normalizes as we go into 2020.
As we look to later in the year.
To the extent that we've had some de leverage in the BNL.
When we see growth whenever that is we would expect to start to see the leverage returns. So.
As Mike said, we've got a very resilient model, we think that the.
The expense.
And structure the business.
Combined with the strategy are as good as it has ever been and when we see a return to growth you should see.
Some leverage flow through at that point.
Thanks, and then just as a follow up on the East side I was just wondering if you could kind of share your sort of expectations for just spending in.
In 2020.
Well in general I think it.
Going to be legacy products, I think you're going to be relatively anemic.
Where we're saying actually good growth is on.
Most of it you know software networking virtualization.
Sure edge those types of things, we're seeing really good.
It's the industry standard servers that we're still seeing is off and I don't really expect that the change much over the course of.
For the year and the growth rates on everything else is pretty high but as you know the hardware number than here are pretty high. So it took a little while to offset those add I think we'll start seeing.
I'm good growth this year, if the economy does participate I think I've seen numbers.
It's been anywhere from 2% to 6%.
And.
It just happens to be changing virtually every month now so we'll we'll see where it comes out but again I think it's going to be all the new products or are going to grow at a great clip and.
The old hardware.
There is going to be pushed down to one more time.
Thanks.
Yes.
Next question comes from roof who've got a chart from Bank of America. Your line is open.
Thanks for taking my questions.
Maybe another question on the Dcs margins you saw good.
About 130 basis point sequential improvement in the fourth quarter.
So trying to understand can you elaborate how much of that was mix versus how much of that was higher volume and how should we think about margins in the first quarter, how much of that can sustain.
Any guidance there would be helpful. Thank you.
So I am you'd led to yes, sure well if you look at.
Margins in the in the fourth quarter for this business I think it's more important to look at year over year versus sequentially and we certainly held the margin line.
Year over year fairly steadily tends to be more a function of mix and volume and.
We are certainly the case in Q4.
In Q1, we're looking at similar operating margins.
Year on year and again.
As long as we execute on the sales plans, we have in place in the mix Doesnt change dramatically.
This is what we see today I think we should be right in the same ballpark.
Okay. That's helpful and thanks for the details on that I appreciate that.
Maybe just on the second question on Capex.
How should we think about Capex for 2020, and specifically do you think you have enough infrastructure to support that support the incremental share shift that you're seeing with your semiconductor customer.
Or would you have to add more warehouses.
You think or I mean, how should we think about capex and Joe. Thank you.
So our capex for last year finished at a $143 million.
And as we've mentioned in the past you go back in time, we obviously had a great deal.
Spending around.
Implementations, that's largely behind us just a little bit left in the Dcs business in Europe, and 2019 and again in 2020, we are addressing the need for more warehousing of the business has grown significantly so.
That will be wrapped up in 2000.
Then 20 I think a good number for 2020 at this point is in the $150 million range and then we would expect to see it.
Come down thereafter, as that warehousing gets built out.
Okay, great. Thanks for the details.
We have no further questions at this time ill turn the call back over to the.
Sure.
Thanks, Jacqueline and clothing, 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 risk and uncertainties that could cause actual results or back to differ materially from.
Such statements for a variety of reasons and the company undertakes no obligation to update publicly revise any of the forward looking statements detailed information about these risks is included in Arrow's SEC filing if you have any questions about the information presented today, please feel free to content.
Thank you for your interest in Aero.
Electronics and have a nice day.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
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