Okay, we're gonna get started here. Good morning, I'm Matt Sheerin, Senior Analyst here at Stifel, and we're happy to have Arrow Electronics, one of the largest semiconductor and component distributors in the world, and a major IT enterprise-focused ECS distributor as well. Welcoming here is the CFO, Raj Agrawal, who's been at the company for about 18 months now, I think, Raj?
Correct, yes.
Welcome. Raj is gonna go through a quick couple of slides, just to set the tone in terms of where the company is and the direction, and then we'll go into Q&A. Raj?
That's great. Thanks. Good morning, everyone. Great to be here today, and Matt, thanks for having us, and it's nice to meet you in person, finally, and look forward to our discussion. I am gonna say a few words about the company, and then get into discussion, as appropriate. If we can go to the presentation. Is it on? Arrow Electronics is a company with a rich 90-year history, and, you know, we are now a global provider of components as well as enterprise computing solutions, to a number of different end markets and geographies, all around the world. You know, we have over 20,000 employees.
We are in more than 200 locations and almost 40 different distribution centers around the world, and we serve over 80 countries. At the very basic level, we are a technology. We connect our technology suppliers to the mass market manufacturers and enterprise organizations that have a need for technology and/or solutions. We also have added on a value-added services over the last few years, which has allowed us to improve the overall margin profile of the business, and you can see some of the summary stats on this page. If you go to the next page, as we look at the two different business areas, Global Components, we are the channel.
We are providing, at a very basic level, semiconductor components and IP&E, or interconnect, passives, and electromechanical devices to different parts of the world and to a lot of different end markets. We operate in every single region, APAC, North America, EMEA. In Global ECS, Enterprise Computing Solutions, we enable the channel, so we're taking a number of different technologies from our suppliers around software and hardware, and enabling our thousands and thousands of channel partners to get to a number of different end markets. We operate in ECS, in North America, as well as in EMEA, and then we serve a number of different end markets throughout our organization, whether it's industrial, transportation, medical, aerospace and defense, and data center.
There's no single customer that's more than 2% of our overall revenues, and so we're quite well diversified from a customer standpoint. If you go to the next page, looking at a little bit more on Global Components, the foundation of this business is all around the global scale and scope that we have, right? So we are distributing semiconductor and IP&E components all over the world through 180 sales offices, 40 different distribution and value-added centers, and we have a global reach with hundreds of suppliers going to tens of thousands of customers all over the world. Because of this global capability, we really are the distributor of choice in the market.
We've layered on, as I mentioned, a number of different value-added services, which includes the thousands of engineers that we have in our business that are doing demand creation activities, designing components into printed circuit boards, all the way to more sophisticated, complete product designs for which we get paid a fee, and then supply chain services offerings. It's taking the global capabilities of our organization and the global scale that I spoke about, and delivering that for the benefit of large OEMs that may have a need for us to manage their component supply chains. It's different from our normal fulfillment process. We are earning a fee for that service that we're providing, and that is gaining more traction.
Overall, we believe that with the electronification of the space that we're in, the backdrop will have good growth for the foreseeable future, and that bodes well for our business as well. And then if you look at the next page, Global Enterprise Computing Solutions, we are taking a number of different technologies from suppliers, whether it's software or hardware-oriented, and providing solutions to our value-added resellers or managed service providers, our middle market partners, to get to the end market customers that they serve. And we are typically operating in the more complex area of the enterprise IT market. So that means that we will likely be more involved in a solution sale than just a device delivery sale, and that's really where the business is going.
We also provide training and certification programs and systems engineering capabilities, and all of this is supported by our ArrowSphere digital distribution platform, which allows us to get to the middle market. It allows us to provide the cloud services, and it allows our channel partners to manage their hybrid and multi-cloud environments in a much more efficient way for their to run their entire businesses. So that's a little bit about Arrow Electronics. I'm sorry for the slide snafu, but we'll, we'll get into the Q&A.
Yeah, that's on us, not you. Thank you for that introduction. I'll start off with some questions, and if anybody from the audience has, you can certainly raise your hand. We'll start with the component business, your biggest business, and obviously going through a really interesting cycle here in the last four years. You've had five quarters in a row of year-over-year declines. I think you were down 28%. You're guiding 28% down year-over-year. But you also talk about signs that we are closer to the bottom in terms of your book-to-bill getting a little bit, you know, toward positive or parity. So could you talk about what you're seeing in terms of demand and maybe right by region, if there are differences there?
Sure. Yes. You know, it's hard to call the inflection point in our business. In our Global Components business, we had guided in the second quarter to be down 8% quarter-over-quarter, which is similar to what we saw in the first quarter, down about 8%. We believe that we're getting closer to the bottom of the cycle. Hard to say exactly when that's going to take place, the inflection point, but as you mentioned, we look at a number of key indicators, whether it's book-to-bill ratios that have been improving the last three quarters in a row. Our backlog levels have been coming down, which they're still above the pre-pandemic highs, but you know, lower in the last three quarters, and that's probably more in line with normalized lead times.
Cancellation activity has also stabilized, and, you know, we have seen inventory levels throughout the ecosystem, including our own, inventory levels coming down. So that tells us that, you know, we're closer to the bottom than we were a few quarters ago. There are obviously soft spots in the business still, but, you know, it's going in the right direction from other players in the market as well.
Yeah. And the guidance for June suggests that you're below seasonal, and that's because your customers are still working down inventory, right?
Yes.
Are you getting a sense, and do you know, like, at different types of customers, you know, in terms of inventory levels, and, and are we talking a quarter or so when you get back to the more normal, order patterns, or is it gonna take longer? Or it really depends on end markets or customers.
It really depends on end markets and customers. There are differences in different vertical segments that we're serving. Industrial continues to have higher levels of inventory, and that's gonna take some time for it to work through, and, you know. But it is going in the right direction, Matt, and, you know, hard for us to say. We, you know, the cycle has lasted a little bit longer than anyone expected, the correction has, and so it's hard for us to say exactly when that's gonna inflect, but it is going in the right place.
Got it. And then, ASPs or pricing seems to have been holding up very well, and maybe that's because demand is still weak, and as volumes come back, maybe we'll see pricing pressure. But what's your take on that in terms of ASPs? And then not just what you're seeing from your suppliers, but obviously out there, you're competing with your big competitor, but also smaller competitors in terms of pricing dynamics. Could you share that?
Yeah. Yeah, I would say overall, the pricing environment continues to remain relatively stable. Whether it's the transactional pricing to customers or even on the supplier side, we haven't seen any significant changes in the pricing environment. You know, I would say that even though inflation isn't necessarily as high as it has been, you know, and prices aren't necessarily going up as much as they were, they're certainly not going in a downward direction in any significant way. It still costs money to design, develop, distribute, and get product all over the world, and that's really what we see in our business. Hard to say how long that's gonna last, but we don't see any price pressure in any material way that's sort of driving it down.
At some point, things will normalize, but we don't really see a big functional, you know, step function, step down in terms of pricing, at this stage.
Okay, great. And then below the top line, your margins in components have been, you know, well above five for several quarters, and I mean, you had record margins through t he cycle, right? But now there, it looks like you're guiding below 5%. You were below 5% in the March quarter. How should we think about margins? Is it really just a function of volumes coming back or other factors?
Yeah, I would say, you know, we are operating today at structurally higher margins than we have been. I would say that if you look at the last down cycle, we're still about 100 basis points above the last down cycle in our components business. And that's, you know, a reflection of some of the value-added areas and services that we're providing, whether it's the IP&E focus or the supply chain services offering, you know, or demand creation and engineering services. And all of those things have helped to drive higher structural margins. I do believe that today, the margins are lower because of the volume reductions that we've had. And so as we get that growth back, as we start to see the growth, we will start to see more margin expansion.
The other thing I would just add, Matt, is that we have also been focused on reducing costs in the business, things that we can control. And so although we'll invest some of that money back into the business, we also believe that that will help to drive more leverage on the bottom line as we get the revenue growth. And we continue to believe that components margins can be in the 5.5%-6% range on a longer term basis, in a more normalized environment.
Mm-hmm. And could you maybe expand on the cost cutting? Has there been some headcount reductions? Where are you cutting? Obviously, you probably don't wanna cut sales folks, the technical experts that you have.
Yeah.
So where are some of those cuts coming?
Yeah, you're right. We wanna protect the frontline as much as possible. We also wanna protect our engineering resources, because those are the things that are gonna make a difference when the business does turn around. You know, we have looked at, like everyone else, we're looking at facility closures, consolidating. You know, our corporate headquarters has been a part of it, you know, because I talked about the number of facilities we have. If we're not getting people coming into the office, we're gonna sort of consolidate. That's just one example. We also have continued to evaluate rebalancing our workforce in different parts of the world and leveraging more of our shared services capabilities. And I think that's gonna continue to be a theme for us. You know, we're always looking at cost takeout to optimize the business.
We know that some of the costs will come back in as we start to grow again, but some of those will be more permanent in nature as well. And again, it's a focus on the things that we can control while we're going through this correction process.
Okay, great. I wanted to ask a bigger picture question regarding the semiconductor suppliers, and some of your biggest suppliers have changed or transitioned their channel strategy. Some are going more direct to customers. Your biggest customer, your biggest supplier, sorry, TI, and then others have talked about moving more demand creation to on a direct basis. I know your biggest customer or your supplier, and then talk about other suppliers. So, how should we think about your relationship with suppliers, particularly if we see more semiconductor industry consolidation and the role that Arrow plays from demand creation, meaning you're going in, getting design wins, and then you're getting a higher margin versus just fulfillment?
And then the third part of that is that supply chain services that you're doing, which is different, but really focusing on the supplier relationships. I know there's this concern from investors that only a couple are really moving on a direct basis around distribution, but there's concern that others will. So, what's your take on that?
Yeah.
A nd how is, you know, Arrow, you know, strengthening the relationships with suppliers?
Yeah. I think it's a great question. I don't see it as a big trend, what you described. Most of our conversations with our supplier base across the board is about how we can grow the business better with them, how do we drive more volume with them? And that's gonna be around some of the value-added areas that we're always focused on. We play a very important role for the supplier base, which is to get to the mass market manufacturers and mass market enterprises that have a need for this technology, and that's a role that we're always gonna play. So we're getting more suppliers coming to us. Obviously, things will ebb and flow in the market, but this is not a new phenomenon.
And, you know, I would also say that there's no single supplier that's more than 10% of our revenues. We're very well diversified. We have lots of good things, you know, that are in the hopper, in terms of where we think the business will go. And our focus and drive every single day is really about how do we drive the long-term growth in this market the next few years? And I'm confident that, you know, we'll get to a good place with better revenue growth, good margin expansion, and we always look at the resources that we have tied up with suppliers. That's really important to us. It's important to suppliers as well, if we dedicate some engineering resources to them, and you know, it's really all for the right reasons.
And, you know, we were just in our Boston office yesterday as we came in, in the afternoon, and they described a lot of great things that are happening in the business and how they're engaging with customers, the demand creation side, which ultimately leads to more relationships with our suppliers and better margins. So that's really our focus. You also mentioned that, the supply chain services are -- I can certainly describe it a little bit more, if you'd like.
Yeah, more, more into that, yeah.
You know, it's really an interesting offering for us. You know, our traditional fulfillment model is to buy inventory from suppliers, hold it on our balance sheet, and we negotiate prices, and we sell it to the end customers that we have, and we're earning a spread on that product. With the supply chain services offering, it's a very different activity. We are earning a fee for the services that we're providing to the large OEM, ultimately. So we're sort of stepping into the middle of a relationship that an OEM already has with a supplier. We are not negotiating pricing of that product or anything of that sort. We are simply handling the supply chain for components of that end customer.
That's taken on a higher level of importance as we went through the shortage experience the last couple of years, and so we will take on that inventory. It's not on our balance sheet. It's a relatively light working capital business. We'll have accounts payable and accounts receivable associated with it on behalf of the customer, and we'll get that product to the customer whenever they want, right? And however they want it, in whichever plant or facility they want it, and they're paying us a fee for that service. That's how we earn our money. So it's not gonna be as impactful from a revenue standpoint, but it's gonna be more impactful from a margin and a profit standpoint.
Yeah.
That's why we like it. It has gained, you know, some good traction there. Some of our largest customers are the hyperscalers, for example, where we're managing their component supply chains. These are the kinds of things that our team is very focused on.
Good. Could you give us an idea, the size of that? And I know from a gross profit standpoint, it's lower because of the fee that you talked about, but in terms of, like, the volume of inventory or that you end up not selling, but distributing to that customer?
Yeah.
Are we talking about, like, $2 billion and kind of a revenue pass-through, if you will?
Yeah. Well, it's a sizable. There's sizable volumes behind it. We have not actually quantified specifics behind it. Our goal is really to go get more market share right now and go tie up those relationships wherever we can. We think it is really important to our customers, and as we, you know, as I described, the global capabilities we have, that's really what the customers are trying to leverage, those 40 distribution centers that we have and our people that have the expertise and the know-how and the knowledge, that's really what they're paying for.
You know, I see this continuing to be an important contributor to the profit line, and we are certainly, you know, with our 40 distribution centers, we're handling a lot of volume for all of our partners, including in this part of the offering.
Does the suppliers care one way or the other that you're in terms of working with those OEM customers? Are they involved in all of that?
Not necessarily, but I think it's really, you know, we're not taking over that relationship between the supplier and the customer.
Yeah.
We're just helping to sort of facilitate the delivery of that product. So the suppliers are still, you know, winning in that equation, so are the customers, and we're providing a value-added service to the customer.
Got it. Okay, great. I wanted to talk about inventory. Obviously, your inventory and everyone else was very bloated through the cycle, but you've worked down over $1 billion of inventory-
Mm-hmm.
In the last couple of quarters, pretty significantly. And that's obviously helped your free cash flow as well. So how are inventory levels tracking? I think even last quarter, you said you're probably not gonna see a big cut here, right? Where you might be, you know, where you are, but you're, in terms of inventory days, you're higher than you were pre-pandemic. And I guess the question is, is that comfortable for you or customers want you carrying more inventory, or, or, or is there more to do?
Yeah, I mean, you're right. We did reduce inventory in the last couple of quarters by over $1 billion. Inventory, actually, on an absolute basis, is the lowest it's been in a couple of years. So we, we've brought inventory levels down quite a bit, and that was the reason why we indicated that, you shouldn't expect the same kind of change in the next couple of quarters, because we, we do wanna be well-positioned, and the role that we play is to make sure that we have enough inventory on hand to be able to drive the growth. So as the business turns and as we get more growth opportunities, we certainly wanna support that with the inventory, in that regard. The turns metrics are, are very important.
It's driven in large part by where the top line is and where the overall business is, so that will correct itself naturally as we start to grow back out of this. And so, you know, having said all that, we're always trying to optimize the working capital, right? We wanna reduce working capital wherever possible, agnostic to any cycle corrections. So we always have an effort underway inside the company to keep looking at ways of optimizing our working capital, because there are always places where you can be a little bit more efficient, regardless of the cycle that you're in.
Okay. Do you have any questions from the audience? Anyone have anything? Nope. Okay. Well, we haven't spent any time on your computing business, ECS. Can you update us on demand trends there? I know that there's been basically sluggish IT spending, right? More cautious, elongated sales cycles, much more scrutiny from customers. What are you seeing in that business?
Yeah, I would say that, you know, we're seeing some pockets of relative strength, whether it's compute or, you know, business applications, you know, or for, infrastructure. But yeah, generally, I would say that we sort of have two tails in our business. You've got the European business that, in the first quarter, did have good billings growth, and had good GP dollar growth as well. And that was offset by the North American business, so that continues to be in transition. They are a little bit different from each other, and that's really where our strategy is going. You know, you've got the European business that is further along in the cloud journey and IT-as-a-service type offerings, and has that has allowed us to be more middle market focused as well.
The North American business has historically been more focused on the larger enterprise IT part of the segment, as well as a little bit more hardware so it has had a more challenging time. You know, but that business is in transition right now as we speak. You know, we've got the ArrowSphere digital distribution platform. That's gonna allow the North American business to get more access to the middle market and really scale up that middle market faster than you might be able to otherwise do with our, you know, distribution capabilities there. And, you know, so I think that's really the formula for us, on how that business can sort of correct itself. We also did assign a new leader recently.
Mm-hmm.
His name is Eric Nowak. He's a veteran of the business for more than 20 years. He actually ran our European ECS business prior to being assigned the global responsibility. So, you know, I'm not saying that he walks on water everywhere, but I think he can certainly help us to turn this business around, and he's hit the ground running, and he's got the right mindset. It doesn't necessarily mean that there's a big change or shift in strategy. It does mean, though, that we've got to execute and deliver these things, and we've got the right tools to be able to do this.
Are there certain product lines or franchise agreements that you have in Europe that you don't have in North America, and are there efforts to add?
Certainly, yeah.
Yeah.
Certainly, there will be more efforts to expand the line card, if you will, from the supplier side. We wanna make sure that we're well positioned there. I think we have some good capabilities there already, but we'll continue the expansion there. And the trick, really, for the North American transition will be this ArrowSphere digital platform and what it allows our middle market partners to ultimately do in distributing and managing their own businesses and-
So, in other words, you're trying to take share from some of the bigger players, some of the bigger broad line players, like the Synnex and Ingram Micro?
Sure. I mean, yeah, yeah, we're gonna try to - we gotta turn the business around. We gotta position it well-
Mm-hmm.
and then we'll certainly try to go after more market.
If you look at the top line, your top line hasn't really grown in a few years, partly because of the netted down.
Yeah, exactly.
We understand that. But even operating profits hasn't really grown much.
Yeah.
and I guess-
It's really the... You really look at EMEA, which is a different story. It has grown billings, it has grown profit dollars. North America is sort of the opposite story, but we're in the process of correcting that. And you know, with Eric's leadership, I think we'll get to the right place.
Okay, good enough. And then I wanted to just talk about, we talked about inventory reduction, free cash flow. You've been, the company has, I think you bought back, what? 25%-30% of the stock in the last three or four years. Very aggressive there. But your interest expense has also risen dramatically, obviously, with the working capital. What's the priority? Are you gonna try to bring down your short-term borrowings or do more buybacks? What's the capital allocation strategy?
Yeah. Capital allocation strategy is quite simple. We wanna invest in the business to drive organic growth and expansion. That's our number one priority, whether it's working capital or CapEx. CapEx has generally been, you know, less than $100 million, so it's not a significant allocation. It can vary in any given year, obviously. But, you know, we always look at M&A opportunities as another area. We've done a, you know, in the first quarter, we did a small tuck-in acquisition in the engineering space to give us more engineering resources. So that's a key use of capital, wherever we see the right fit. And then, we'll buy back stock with our excess capacity, excess cash flow.
That's all wrapped with an investment-grade credit rating, so we wanna make sure that if we're going through the low points of this cycle, which we are right now, that we have put more towards debt paydown to get the credit ratios where they need to be. But we'll get back to growth at some point. And, you know, interest expense, I would say, Matt, has been trending down. We guided to about $75 million of interest expense in the quarter. That's down from $80 million or so in the first quarter and down from last year, so it's probably going in the right direction.
Yeah. Okay, we're out of time, but thank you very much.
Okay. Thank you, Matt.
Appreciate it.
Yeah, thank you. Thanks for having us.