Arrow Electronics, Inc. (NYSE:ARW) Q4 2023 Earnings Call Transcript
Arrow Electronics, Inc. (NYSE:ARW) Q4 2023 Earnings Call Transcript February 8, 2024
Arrow Electronics, Inc. beats earnings expectations. Reported EPS is $3.98, expectations were $3.7. Arrow Electronics, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day, and welcome to Arrow Electronics Fourth Quarter and Full Year 2023 Earnings Call. Today's call is being recorded. And at this time, I would like to turn the conference over to Anthony Bencivenga, Vice President of Investor Relations. Please go ahead, sir.
Anthony Bencivenga: Thank you, operator. I'd like to welcome everyone to the Arrow Electronics fourth quarter and full year 2023 earnings conference call. Joining me on the call today is our President and Chief Executive Officer; Sean Kerins; our Chief Financial Officer, Raj Agrawal; our President of Global Components, Rick Morano, and our President of Global Enterprise Computing Solutions; Kristin Russell. During this call, we'll make forward-looking statements, including statements about our business outlook, strategies and future financial results, which are based on our predictions and expectations as of today. Our actual results could differ materially due to a number of risks and uncertainties, including the risk factors described in our most recent filings with the SEC.
We undertake no obligation to update publicly or revise any of the forward-looking statements as a result of new information or future events. As a reminder, some of the figures we will discuss on today's call are non-GAAP measures, which are not intended to be a substitute for our GAAP results. We have reconciled these non-GAAP measures to the most directly comparable GAAP financial measures in this quarter's associated earnings release or Form 10-K. You can access our earnings release at investor.arrow.com, along with a replay of this call. We've also posted a slide presentation to accompany our prepared remarks and encourage you to reference these slides during the webcast. Following our prepared remarks today, we'll be able to take your questions.
And I'll now hand the call over to our President and CEO, Sean Kerins.
Sean Kerins : Thanks, Anthony, and thank you all for joining us. We appreciate your interest in Arrow Electronics. For some context, I'd like to first review our 2023 full-year financial results before commenting on our fourth quarter performance and the overall state of the market. I'll then turn things over to Raj for more detail on our financials as well as our outlook for the first quarter. As I reflect on our performance over the past year, I want to start by thanking our global team for their persistence, resilience and dedication to our suppliers and customers. Through their efforts, we were able to deliver solid financial performance given the market backdrop. Despite excess inventory throughout the supply chain leading to softer demand in our components business, and a mixed IT spending environment for our enterprise computing solutions business, we executed well in a challenging environment.
Arrow posted $33.1 billion in full-year 2023 revenue, and achieved an operating margin of 4.8% on a non-GAAP basis. In addition, we generated healthy cash flow from operations, which enabled us to repurchase approximately $750 million in shares throughout the year. Now moving to our fourth quarter results. To close out the year, we delivered sales of $7.8 billion in the fourth quarter, just better than the midpoint of our guidance. Based on healthy operating margins in each of our segments, we generated non-GAAP earnings per share of $3.98, comfortably above the high end of our guided range. Taking a closer look at our components business, the industry-wide inventory correction appears to be taking longer than anticipated when compared to prior cycles.
This is likely due to the breadth and magnitude of the shortages that precipitated the inventory buildup along with continued softness for components in many industrial markets. However, we do believe markets will eventually improve and see gradual signs of normalizing trends. Our book-to-bill ratios have stabilized overall with our IP&E portfolio trending closer to parity. Pricing is generally holding up as reflected in our fourth quarter gross margins, which were sequentially better than in the prior quarter. Our demand creation pipeline is growing as customers continue to develop new products. And while order rescheduling activity persisted, we focused on backlog conversion during the quarter and reduced inventory by over $600 million sequentially.
From a regional perspective, in Europe and the Americas, customers continued to moderate their supply as reflected by their reluctance to place new orders. While we expect sub-seasonal performance in the near term and continued softness in industrial markets, we were encouraged by robust design activity and relative strength in verticals such as aerospace and defense and medical devices. And in Asia, we expect results to normalize somewhat with respect to typical seasonality when compared to the West. And while we can't predict the timing of a broader macroeconomic recovery, we were pleased by sequential growth in segments such as data center compute, and to a lesser extent, transportation. Shifting to our global ECS business. During the quarter, we continued to execute on all things IT as a service, which led to a higher mix of infrastructure software, cloud solutions and related services when compared to the prior year.
Over time, this mix drives a growing portfolio of recurring revenue volumes as well as better contribution margins for the business overall. And given the annual nature of this business model, fourth quarter results were up sequentially as expected. From a regional perspective in Europe, we delivered year-over-year billings and gross profit dollar growth amidst the mixed IT spending environment. While storage and compute were down, they were more than offset by strength in infrastructure software and networking products. And in North America, our results for the fourth quarter reflect a muted IT spending environment with softness in storage, compute and cybersecurity, partially offset by strength in infrastructure software and networking. As we stated in the past, we're in the process of optimizing our customer mix and supplier line card in the region to better serve the mid-market.
We've made progress in this area and are optimistic about improving our results in the region this year. Before I hand things over to Raj, I do want to reflect a little bit on the future. Despite the ongoing cyclical correction and a weaker macro demand environment, we remain optimistic regarding the overall industry backdrop and believe longer-term technology trends will benefit Arrow. We're at the center of large and growing markets, driven by the electrification of everything: renewable energy, autonomous vehicles and artificial intelligence, just to name a few. Given a longer horizon, we remain committed to the growth initiatives we've previously shared with you, where our differentiation provides value to both our suppliers and customers.
First, in demand creation, we added engineering resources throughout 2023, which helped demand creation revenue outpace the rest of the portfolio. Second, our engineering services have been gaining traction across attractive verticals such as renewable energy, automotive and medical devices. As a result, full-year engineering services revenue grew meaningfully. Third, in supply chain services, we expanded our customer base in 2023 with further penetration in the data center and automotive verticals. And looking ahead, we see additional opportunities to extend this offering to other verticals and OEMs. Next, we've maintained our differentiated focus on interconnects, passives and electromechanical components, a margin-accretive growth area within our components business.
Finally, in our ECS business, over the course of the year, we enhanced our digital distribution platform, ArrowSphere, while onboarding new channel partners and supplier lines, demonstrating our commitment to the market's transition to IT as-a-service. In the meantime, as we navigate a challenging near term, we will continue to prudently manage our cost structure and working capital portfolio with an eye towards emerging even stronger as market conditions improve. And with that, I'll hand things over to Raj.
Raj Agrawal : Thanks, Sean. I'll be speaking to our financials on an as-reported and GAAP basis, unless otherwise specified. Consolidated revenue for the full year 2023 was $33.1 billion, which was down 11% versus prior year. Global components sales were $25.4 billion, which was down 12% from the prior year, driven primarily by softness in the Asia market and reduced shortage market activity in the Americas, partially offset by growth in our European market. Enterprise computing solutions sales were $7.7 billion, which was down 8% versus prior year. Importantly, our full-year global ECS earnings were flat from prior year, reflecting growth in Europe, offset by a decline in North America due to a softer IT spending market in that region.
Moving to other financial metrics for the full year. Consolidated gross margin of 12.5% for the full year was down 50 basis points from prior year. Non-GAAP operating expenses were down $157 million from prior year to $2.6 billion. The OpEx decline came from a favorable legal settlement in the third quarter, reduced variable expenses and our continued efforts to control spending. Non-GAAP operating income was $1.6 billion or 4.8% of sales, with global components operating margin coming in at 5.8% and enterprise computing solutions coming in at 4.8%. Non-GAAP diluted EPS for the full year was $17.12, based on an average outstanding share count of 57 million shares. Now turning to our fourth quarter results. Consolidated revenue for the fourth quarter was $7.8 billion, within our guidance range and down 16% versus prior year.
Global component sales were $5.6 billion, meeting the midpoint of our guidance and down 10% versus prior quarter or 17% versus prior year due to the ongoing semiconductor inventory correction. Enterprise computing solutions sales were $2.2 billion, also in line with guidance and down 11% versus prior year. This was partly a function of product mix and probably a function of lower discretionary IT spending in North America. Moving to other financial metrics for the quarter. Fourth quarter consolidated gross margin of 12.6% was down 30 basis points versus prior year, driven primarily by overall mix in global components. Sequentially, our gross margin was higher by 40 basis points due to the typical seasonality within the ECS business as well as favorable mix in components business in the West.
Our fourth quarter non-GAAP operating expenses declined sequentially when normalized for certain previously announced third quarter items. Our Q4 GAAP operating expenses included restructuring, integration and other charges of $40 million related to facility consolidation and other operating expense reductions. We generated non-GAAP operating income of $364 million in Q4, which was 4.6% of sales, with global components operating margin coming in at 5.1%, and Enterprise Computing Solutions coming in at 6.6%. Interest and other expense was $82 million in the fourth quarter, which was flat quarter-over-quarter and better than guided due to lower-than-expected average daily borrowings. Our non-GAAP effective tax rate was also favorable to our guide at 21.8%, resulting from certain domestic and foreign tax credits.
And finally, non-GAAP diluted EPS for the fourth quarter was $3.98, which is above the high end of our guidance range and based on a 55 million share count. Turning our attention to working capital. Net working capital for Q4 was flat from Q3 at $7.4 billion. Accounts receivable and accounts payable both increased in the fourth quarter due to normal seasonality in the ECS business, along with activity in our supply chain services offering. Inventory at the end of the fourth quarter was $5.2 billion, decreasing more than $600 million from Q3 with inventory days declining to 69. The combination of ECS seasonality, along with the decline in inventory, drove a reduction in our cash conversion cycle. Our cash flow from operations was $287 million in the fourth quarter and $705 million for the full year.
Net debt at the end of the fourth quarter were lower compared to Q3 at $3.6 billion. Arrow's total liquidity at the end of the fourth quarter stands at $2.4 billion, including our cash balance of $218 million. We remain confident in the strength of our balance sheet, which gives us the financial flexibility to effectively manage our working capital needs. We repurchased shares in the amount of approximately $50 million in the fourth quarter and approximately $750 million for the full year. At the end of the fourth quarter, our remaining stock repurchase authorization stands at approximately $580 million. Please keep in mind that the information I've shared during this call is a high-level summary of our financial results. For more details regarding the business segment results, please refer to the press release and earnings presentation published on our website this morning.
Now turning to Q1 guidance. We expect sales for the first quarter to be between $6.7 billion and $7.3 billion. We expect global components sales to be between $5 billion and $5.4 billion, which at the midpoint is down 8% from prior quarter. We expect Enterprise Computing Solutions sales to be between $1.7 billion and $1.9 billion, which at the midpoint represents a 4% decrease year-on-year. We're assuming a tax rate in the range of approximately 23% to 25% and interest expense of approximately $80 million. And our non-GAAP diluted earnings per share is expected to be between $2.20 and $2.40, which reflects unfavorable leverage in the business due to current market dynamics. And finally, we estimate changes in foreign currencies to have an immaterial effect on our Q1 guide.
The details of the foreign currency impact can be found in our press release. With that, Sean and I are now ready to take your questions. Operator, please open the line.
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