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Edited Transcript of ARW earnings conference call or presentation 2-May-19 5:00pm GMT

Q1 2019 Arrow Electronics Inc Earnings Call

MELVILLE May 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Arrow Electronics Inc earnings conference call or presentation Thursday, May 2, 2019 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher David Stansbury

Arrow Electronics, Inc. - Senior VP & CFO

* Michael J. Long

Arrow Electronics, Inc. - Chairman, President & CEO

* Sean J. Kerins

Arrow Electronics, Inc. - President of Global Enterprise Computing Solutions

* Steven J O'Brien

Arrow Electronics, Inc. - VP of IR

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Conference Call Participants

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* Adam Tyler Tindle

Raymond James & Associates, Inc., Research Division - Research Analyst

* Adrienne Eleanor Colby

Deutsche Bank AG, Research Division - Associate Analyst

* Joseph Michael Quatrochi

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* Mark Trevor Delaney

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Matthew John Sheerin

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst

* Shawn Matthew Harrison

Longbow Research LLC - Senior Research Analyst

* Steven Bryant Fox

Cross Research LLC - MD

* William Stein

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Zhen Yang

Citigroup Inc, Research Division - Assistant VP

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Presentation

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Operator [1]

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Good afternoon, my name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Arrow Electronics First Quarter 2019 Earnings Conference Call. (Operator Instructions) Thank you. Mr. Steve O'Brien with Arrow Electronics Investor Relations, you may begin your conference.

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Steven J O'Brien, Arrow Electronics, Inc. - VP of IR [2]

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Thanks, Rob. Good day, and welcome to Arrow Electronics First Quarter 2019 Earnings Conference Call. With us on the call today are Mike Long, Chairman, President and Chief Executive Officer; Chris Stansbury, Senior Vice President and Chief Financial Officer; Andy King, President, Global Components; and Sean Kerins, President, Global Enterprise Computing Solutions.

As a reminder, some of the figures discussed on today's call are non-GAAP. You can access our earnings release at investor.arrow.com along with the CFO commentary, the non-GAAP earnings reconciliation and a webcast of this call. Please note certain 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.

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [3]

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Thanks, Steve. Thanks to all of you for taking the time to join us today. After 2 years of favorable industry conditions, a market change is underway in the global component space. We're seeing this in the form of less favorable regional sales mix, less favorable product sales mix within the regions, the near-term impacts at lower margins and delayed cash flow. We've seen market corrections before and expect these conditions to persist into the second quarter.

However, unlike other correction, this one looks unusual because we're not seeing lower sales volumes. For the time being, global components market conditions have had a minimal impact on our enterprise computing solutions business. We see this as the validation of our broad portfolio of technology solutions. However, we're also aware that parts of our business see earlier- and later-cycle economic impacts. We have been and continue to make tough decisions around the timing of our investments. Those decisions are informed by what we see as the length and depth of this challenging environment.

Over the last 2 quarters, we saw decelerating growth rates for our industry. In the first quarter, this resulted in a change to our product and customer mix. The broader industrial decline reduced purchases for products and services that carry higher margins. This was offset by strong demand for lower-margin products. Due to timing of this change, our countercyclical cash flow performance was temporarily impacted. We received inventory at the beginning of the quarter that we paid for, but did not sell-through during the quarter. We also had to buy more inventory of lower-value products to meet demand.

In addition, collections were delayed as customers evaluated tariffs and preserved cash. Some customers are moving manufacturing into lower-cost regions to avoid tariffs and other unnecessary economic burdens. Despite these challenges to our business, we delivered sales that were above our expectations. We leveraged higher volume across our expense base to preserve profits and to secure cash flow in the coming quarters.

To provide some dimensions around the first quarter performance compared to the prior year, approximately 1/3 of the margin decline came from market pressure in all regions, 1/3 from less favorable mix within the Asia components region and 1/3 from write-downs by an ancillary business within global components that is a vestige of prior acquisitions.

We expect the first 2 items to normalize as the industry returns to balance, the third item is within our control and we're addressing the situation. For the long run, we again showed we are a trusted partner to our customers and suppliers in good times and bad. We do business the way our customers and suppliers need us to do that business.

During the first quarter, we made progress towards our long-term goals of expanding and leveraging our engineering services. On March 14, we launched ArrowPlus, an engineering marketplace platform that allows companies to securely design and build products through access over a 0.5 million engineers. In addition to our wealth of engineering workflow tools, data and existing partnerships, we obtained with Freelancer.com, the world's largest freelancing and crowdsourcing firm by a number of workers, and we believe ArrowPlus will transform the way products are designed, manufactured and delivered to the market and will radically change companies approach to research and development by reducing both time and cost to market.

Importantly, for Arrow, ArrowPlus will allow us to better leverage our own existing engineering workforce. Our engineers will carry projects, identify existing solutions and pinpoint the appropriate talent to deliver successful outcomes to our customers. Our engineers will provide concierges like high-touch service that customers appreciate, but they will also be able to work on many more projects than they have in the past. We believe ArrowPlus, alongside our field application engineers, Arrow.com and eInfochips round out a complete omni-channel approach to engineering services.

As we discussed last quarter, we continue to see the convergence of information technology with operational technology leading to new opportunities that we did not see in the past. For example, we're representing a leading microprocessor manufacturer, whose products are used by an OEM specializing in digital displays for indoor experiences. We're helping to engineer the software and cloud-based solutions that support those displays.

In the future, we expect to sell the reoccurring wireless connectivity and other services to the consumers of these displays. Our work with this OEM brought Arrow together with their OT partner who specializes in installation. This OT specialist enables our customers' products to be deployed at scale, and this is a great example of a new nontraditional partner for our enterprise computing business outside the realm of the typical VARs and MSPs.

Overall, we're delivering unmatched capabilities to a component supplier, a component customer and its customers' customer. At a recent event highlighting this collaboration, we're proud to hear the OEM customers say, "Arrow helps us solve problems we didn't even know we had."

Now turning back to the near market term conditions. Leading indicators have changed, design activity grew very modestly year-over-year, backlog declined from the first quarter and did not grow year-over-year for the first time in 5 years. Lead times contracted modestly from last quarter but remained extended and aggregate. Cancellation rates have not significantly changed, but we have seen pushouts of high-value orders. Overall, book-to-bill was at parity, exiting the first quarter. However, Europe, which has delivered exceptional performance for over 5 years, saw book-to-bill fall below parity for the first time since 2012. This mirrored some of the recent unfavorable economic data from the region. Book-to-bill for the month of April was above parity, but down compared to April of 2018.

In the Americas, customers are moving portions of their manufacturing outside the United States to avoid tariffs and to reduce build material and labor cost. For example, we can identify $200 million that was shipped in the second quarter alone. In just 2 quarter's time, our customer sentiment survey results dramatically changed. Exiting the third quarter of 2018, the tone was positive. Exiting last quarter, the portions of customer saying they had too much, too little or the right amount of inventory were in line with long-term averages. Exiting the first quarter, we saw a large portion of customers say they had too much inventory and a very small portion say they didn't have enough.

Despite these challenges, we continue to believe our business is better positioned than it was in the past. We have more than doubled our customer count over the last 3 years, expanded geographically and have no reliance on any one industry. However, in the short run, we're not seeing a region or an industry that is unaffected.

In the first quarter, the demand environment for our enterprise computing solutions business was consistent with recent quarters. Billings grew year-over-year across all product categories. For the fifth straight quarter, sales of hardware outgrew sales of infrastructure, software and security. Despite this dynamic, our efforts to improve profit performance was successful this quarter.

Enterprise computing solutions returned to a profitable year-over-year growth. In closing, at Arrow, we're committed to doing things the right way. Our employee satisfaction and productivity are helped by working on solutions that make a difference in people's lives.

Recently, we along with We Care Solar, were awarded the Gold Award in the 2019 Thomas Edison Awards in the category of Humanitarian Technology. We were honored to receive this award for the joint development of the Solar Suitcase 3.0, a portable and durable power system that provides energy for remote maternal health facilities around the world. We believe in the power of innovation that makes life better. I look forward to updating you on our performance and our progress in the coming quarters.

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

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Christopher David Stansbury, Arrow Electronics, Inc. - Senior VP & CFO [4]

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Thanks, Mike. First quarter sales of $7.16 billion were at the high-end of our prior guidance range. Sales increased 4% year-over-year and 7% adjusted for changes in foreign currencies. The actual exchange rate for the quarter was $1.14 to EUR 1, in line with the rate we had previously used for our forecast.

Global component sales of $5.19 billion increased 5% year-over-year and increased 8% year-over-year adjusted for changes in foreign currencies. Sales were above the high end of our prior expectation. We had record first quarter sales in all 3 regions.

In Europe, sales increased 10% year-over-year adjusted for changes in foreign currencies and increased 2% as reported. Europe sales have increased year-over-year for 24 straight quarters, adjusted for acquisitions and changes in foreign currencies.

In the Americas, sales increased 6% year-over-year, growth was driven by demand for lower-cost commodity parts. Asia sales increased 8% year-over-year. Our strong volume in the region is partially attributable to an upsurge in our lower-margin wireless device business due to increased customer preference for local brands. Global components operating income increased 2% year-over-year and increased 6% adjusted for changes in foreign currencies. Operating margin decreased 10 basis points year-over-year.

We continue to believe the 5% operating margin level we achieved in 2018 is an appropriate benchmark for global components. However, in the near term, our product and regional mix dampens this. In addition to current market pressures, Mike previously mentioned an ancillary business, whose results are dragging down global components performance. Last year, it was operating near breakeven. However, conditions worsened resulting in an operating income loss of $10 million in the first quarter, and we expect a $12 million loss in the second quarter. We will announce a change to our approach to this operation by midyear.

Enterprise computing solutions' sales of $1.96 billion increased 6% year-over-year, adjusted for changes in foreign currencies and 3 divestitures. Sales increased 1% year-over-year as reported and were above the midpoint of our prior expectation. Billings increased at a high single-digit rate year-over-year, adjusted for changes in foreign currencies and increased in both regions. Growth was driven by servers, infrastructure software, storage and security. Enterprise computing solutions Americas sales growth remained steady. Sales in the Americas increased 4% year-over-year adjusted for last year's unified communications divestiture and changes in foreign currencies. Sales were flat year-over-year as reported.

Europe sales increased 10% year-over-year adjusted for changes in foreign currencies and 2 divestitures, 1 completed this quarter and 1 completed at the end of the first quarter 2018. Sales increased 2% year-over-year as reported. Enterprise computing solutions' operating income increased 3% year-over-year, adjusted for changes in foreign currencies and dispositions. Operating income increased 1% year-over-year as reported. We made progress towards our profitable growth objectives during the first quarter. Operating margin was flat year-over-year.

Returning to consolidated results for the quarter, total company operating expenses decreased 1% year-over-year. The decrease was primarily attributable to lower incentives on lower profit achievement. Consolidated operating income increased 3% year-over-year adjusted for changes in foreign currencies and decreased 1% year-over-year as reported.

Interest expense was $52 million, below our prior expectation, mainly due to postponed interest rate increases as well as some benefit from hedging arrangements. The effective tax rate for the first quarter was 25.6% at the high-end of our 23.5% to 25.5% target range as we expected. As I've mentioned on recent earnings calls, we're seeing some variance quarter-to-quarter due to the timing of discrete items. However, we believe this range is accurate when looking at full year period.

Net income was $158 million, down 1% year-over-year adjusted for changes in foreign currencies and down 6% year-over-year as reported. Earnings per share were $1.84 on a diluted basis at the low end of our prior guidance range. Earnings per share increased 2% year-over-year adjusted for changes in foreign currencies but decreased 3% year-over-year as reported. We estimate the stronger dollar negatively impacted earnings per share by approximately $0.09 and negatively impact earnings per share growth by approximately 5 percentage points compared to the first quarter of 2018.

Operating cash flow was negative $329 million. Operating cash flow was normally negative during the first quarter, but the magnitude was greater than we expected due to several factors, including inventory mix, which is temporary, and changes in collection timing as many of our customers look to preserve cash. We repurchased approximately 0.5 million shares of our stock during the quarter for $40 million. We repurchased approximately $230 million of stock over the last 12 months and approximately $1.2 billion over the last 5 years.

Entering the second quarter, authorization remaining under our share repurchase programs is approximately $689 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 second quarter sales will be between $7.525 billion and $7.925 billion with global component sales between $5.5 billion and $5.7 billion and global enterprise computing solutions sales between $2.025 billion and $2.225 billion. We expect interest expense to be approximately $57 million. Our guidance assumes an average non-GAAP tax rate at the high end of our target range of 23.5% to 25.5%.

We expect average diluted shares outstanding of $86 million. As a result, we expect earnings per share on a diluted basis, excluding any charges, to be in the range of $1.94 to $2.06. The average U.S. dollar to euro exchange rate we're using for forecasting purposes is $1.12 to EUR 1. This was the average for the month of April. We estimate changes in foreign currencies will have negative impacts on growth of approximately $138 million or 2% on sales and $0.07 or 3% on earnings per share compared to the second quarter of 2018.

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [5]

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Thank you, Chris. Rob, would you please open up the call to questions at this time?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question comes from the line of Shawn Harrison from Longbow Research.

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Shawn Matthew Harrison, Longbow Research LLC - Senior Research Analyst [2]

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To an extent, Mike, your commentary sounded a bit like déjà vu of everybody else's earnings season 90 days ago. And so wondering maybe why some of these weak dynamics that you're experiencing are a bit delayed relative to maybe what your peer down in Phoenix highlighted 90 days ago? Or what the suppliers have been highlighting for a while, just mix of business, other factors that could be at work in terms of why you're seeing some of this delayed weakness that everybody else is seeing?

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [3]

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Yes. I think if you historically look at it, we've typically seen a delayed weakness from the suppliers, largely due to their initial business in China versus what our magnitude used to be in China. And I'm talking most of the big wireless phone-type activities that existed that we didn't participate in, those were usually the industries that got hit first and I think that continued on. Plus there has been, over time, as you know we've had some favorable sales conditions here that has also elevated our backlog, that has helped us work our way through this process. I think what you largely see -- one of the things that got us off guard is that during the supply chain, we had a lot of high-dollar product in our inventory that was engineering-based. Those products started to get pushed out in March, which was late in the quarter and replaced with inventory that people use more of or didn't sort of hoard during tough conditions. So we had to buy inventory to support more commodity products. And I think that what you saw largely as a timing issue there. But in general, this is acting just like any historical downturn albeit, more muted. The other thing that's interesting about this downturn is we've yet to see the sales decline. We're still seeing sales growth, and that's largely just because of the mix of product and the mix in regions that's materializing right now.

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Shawn Matthew Harrison, Longbow Research LLC - Senior Research Analyst [4]

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And then as a follow-up, I guess, the duration of this margin pressure, if you were to hazard a guess inclusive of that, I don't know if noncore-type business, that's a $10-plus million drag. But when would you expect to see kind of a normalization as the more highly engineered demand coming back along with the shift in the business mix? Is this a 2-quarter event? Do we have to wait till 2020?

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [5]

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We're anticipating around the 2-quarter event. And I'd say that's based upon the same information you guys are seeing and hearing and our current bookings. Our design win activity grew about 3% year-over-year, which means the products are still being designed albeit at a much lower pace. And I think what you're seeing in our second quarter guidance is the downside of the product mix changes, also some regional mix changes of Asia growing faster than the Americas. And really, to me, this equation starts to change if the Americas starts to strengthen, and we've just seen them go in. So I would anticipate right now from what we see, a quarter or 2, but idling more towards the 2-quarter end of it.

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Operator [6]

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Your next question comes from the line of William Stein from SunTrust.

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William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [7]

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Mike, frankly, I'm more confused than I have been in quite some time with Arrow. I think the words fit very well with sort of long-term narratives and the long-term sort of timing difference in the cycle of the distributors relative to the suppliers, namely you're seeing things a little bit later, and that's not terribly surprising. But something you mentioned on the call aligns more with the numbers that we're seeing, which is, it looks like you're talking about a downturn, but the way it's materializing in the P&L is revenue in Q2 that's being guided what I think is above normal seasonality, but more to hit on margins. So is there something going on here that's driving revenue above normal seasonality despite the narrative of a weaker demand environment? Like, is the company going after or doing something unusual with regard to revenue or taking business that it wouldn't normally take in order to counter the more normal effects of a downturn? Any -- sorry for the long-winded question, but I'm really confused.

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [8]

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Yes, I know, I think I can maybe piece it together a little bit for you. We're still seeing faster growth out of Asia than we have seen. Also, there is some work that has been going on there for quite some time, and we're seeing divestitures of a sales increase. What's interesting about that for Q2, that sales increase comes in, but as you know, our returns in Asia are less than in the U.S., so the mix of Asia product is growing at a faster clip than we're seeing in the U.S. and/or Europe. So while I would say this, what we're taking in Asia is good for Asia sort of returns, it is different than what we're seeing and we're seeing more of the slowdown happen in the U.S. and possibly in Europe for the second quarter given the bookings we've seen. So you have 2 things really 1 with product mix that we talked about, the other 1 is now regional sales mix within that product, but the operation themselves are remaining, frankly, much healthier than we've seen in past downturns, even into the first one. We're talking basis points here on profits that we've been able to offset this with. And so that's our struggle right now. It's a pretty dramatic sales mix change between the regions. And I would say a lot of it had to do with the fact of what we've been working on and now more customers are coming to us and we're still seeing more new business that we have a chance to sell more engineering services to. So that remains intact. That thesis remains intact, but right now, that's what we're dealing with.

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William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [9]

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So maybe said another way, a more typical seasonal and -- more typical cyclical downturn or the beginning of a cyclical downturn in the richer margin Western regions and somehow Asia just keeps going and that drags profitability, okay.

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [10]

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Exactly.

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William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [11]

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So one more -- okay, that seems helpful. One more if I can. The mix with -- the product mix you discussed, you said there was a push out of some of the products that were design win based, is that concentrated in any particular category that you could tell us about? And is it like suddenly you're selling a lot more of IP&E? Or what's -- any clarity there?

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [12]

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Yes. Yes. Typically -- and I'm going to start off with that's normal. We've seen that in other downturns. I'm going to say that a lot of manufacturers went into their inventories and started to assess their inventories in -- during the first quarter. And what we saw was, if you remember last year, customers were building up their inventory of these highly engineered products from all manufacturers were doing well, those products were tough to get and they wanted to make sure that they had enough to manufacture, so they probably were carrying more than the normal standard 13 weeks of product that a manufacturer would carry, and they went through that. Secondly, when you're trying to preserve cash as a manufacturer, you go to your highest-dollar products that you have on the shelf. And if you have some to get you through for a quarter, you stop buying. That was the phenomena we saw, and the lower commodity product that have less of a lead time issue, in fact, not really much of a lead time issue, we saw those purchases continue to go. And as a result, that was the mix change. Not really uncommon. That's kind of something that we do see. And then on top of that, we had customers -- frankly, some customers that at the end of the quarter played some games with us on paying, and we expect to go right back after that and get that solved. So that was really the 2 items that gave us the headaches in the first quarter and it all hit in March.

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Operator [13]

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And your next question comes from the line of Adam Tindle from Raymond James.

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Adam Tyler Tindle, Raymond James & Associates, Inc., Research Division - Research Analyst [14]

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I just wanted to ask, I mean, it's obviously quite an uncharacteristic first half of the year. So just trying to figure out how we can think about the second half from an margin and EPS perspective. Gross margins typically down in the back half, but does that not happen this year? And then on an EPS perspective, the first half is normally around 45% of the full year, is there something different about 2019 like the business that's losing money that may exit or something like that, where the first half of the year can represent a different number than it has historically from an EPS perspective?

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [15]

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Yes. What I can tell you is, we just highlighted that there was 3 buckets, right, of margin decline and 1 bucket that was -- that is totally in our control. And I do expect to have that bucket handled by the first half here. So we would expect that third to come back in the second half. Automatically, the other 2 are going to depend as the other regions start to return back to normal sales. So we will correct the one. It's unfortunate that came late in the quarter [too]. But as I said, that was sort of some vestiges of some old acquisitions that we just need to get cleaned up, and we'll get cleaned up by the first half.

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Christopher David Stansbury, Arrow Electronics, Inc. - Senior VP & CFO [16]

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And Adam, just one thing to add to that. In the back half, tax and corporate expense are going to be lower than they are in the first half as well. So that helps.

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Adam Tyler Tindle, Raymond James & Associates, Inc., Research Division - Research Analyst [17]

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Okay. That's helpful, Chris. I -- and I wanted to ask you a question, you touched on this, but I want to revisit. Understand that mix impacted margins, but you often repoint to attractive returns on capital in the lower-margin stuff because asset velocity is high. One of your competitors generated significant cash flow, for example, but Arrow used over $300 million in the quarter, just help us bridge this. And I imagine you're going to talk about, it's a snapshot and timing related, so help us with the expectations on the June quarter and maybe even the full year. And if you could tie in capital allocation priority, it would be helpful.

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Christopher David Stansbury, Arrow Electronics, Inc. - Senior VP & CFO [18]

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Yes. Sure thing, Adam. So if you look at our cash flow metrics for the quarter versus last year, the obvious one that sticks out is DSO creeping up a couple of days. And as Mike touched on, as I touched on as well, customers are a little slower to pay, we're all over that. We did expect in the quarter -- going into the quarter to have a slight improvement on inventory turns as well as DPO, that didn't happen because of this mix shift that happened mid-quarter, where we had to catch up. So when you look at the efforts against that, you'll definitely see an improvement in Q2. And I think the back half of the year will be strong. It's just going to take us a quarter to adjust back to where we need to be. As our capital allocation statement same as we've said, very consistent, which is we're very focused on getting the debt down a little bit and returning everything we can to shareholders through buybacks.

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Adam Tyler Tindle, Raymond James & Associates, Inc., Research Division - Research Analyst [19]

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Okay. And if I could just sneak one last one. Mike, I understand that Asia and mix that we're talking about is diluting margins and returns. So just wanted to clarify and ask, why even pursue this? You often say growth is the mindset, so is this just where the growth is and you're going towards that? Did you consider other options to walk away and maybe see revenue declines, but not dilute returns? Just clarification on that would be helpful.

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [20]

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Yes. I think right now there is some business that we're working on in conjunction with our suppliers that we know we can improve the situation of the business we're looking at. We're not looking at filling the boat with low-margin business that is not going to give us a return. All that does, as you know, is eats our cash that hasn't been our style. So sort of big supply chain deals. I don't have to tell you who with, none of that is coming in house. So we're not changing our portfolio of business one bit from what we have been doing. And I think we have proven the fact that we can bring this business and do engineering to it and raise the margin profile over time. I don't think our strategy stops with that, just because there is a downturn. So hopefully, that clarifies that for you, and there is obviously work to do, but we need some economic health in the Americas and Europe to get it done too.

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Operator [21]

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

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Joseph Michael Quatrochi, Wells Fargo Securities, LLC, Research Division - Associate Analyst [22]

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I was wondering if you could kind of remind us on some of the organizational things that you've done on the component side. I know that you've done some things to improve the margins there. And with the kind of change in mix, I was wondering if there is any additional flexibility that you can kind of work within that business aside from the kind of businesses losing some money?

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [23]

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Yes. Obviously, we've increased our digital business. That is still growing at a good clip, and that is a higher-margin profile than frankly all the businesses. So that one is one to continue to drive. As I said before, we've just -- we've kicked off our engineering services with Freelancer, which are much more online, which starts to take care of our tail of customers. Some of the smaller customers wanting to do designs and need viable engineering services that we can provide like that. And I would think of that sort of as like the Uber of Engineering or something of that sort of ilk. We do have our eInfochips, which is picking up on pure designs or customers and OEM manufacturers and then our FAE. And as I've said before, in the engineering, the design win type activity was up 3% year-over-year. So that has not gone away. We just need to continue to drive that, and we will certainly be putting our efforts to that during this downturn because customers will be designing products and hopefully, releasing that as the market starts to change. So that's going to be where our effort is going to continue to be placed and it has serviced us well in the past, and we expect to service it this time.

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Joseph Michael Quatrochi, Wells Fargo Securities, LLC, Research Division - Associate Analyst [24]

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Okay. And then just a follow-up on the cash flow discussion. I just want to understand the high-value inventory that you took on this quarter, should we expect all that to kind of flesh out during this current June quarter? Or how do we think about that? And then just the same way as kind of the creep up in DSO, should we see that kind of correct this quarter as well?

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [25]

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Yes. So on the inventory, definitely, we expect to bring that down in Q2. And on the DSO, yes, I would expect to also bring that down in Q2. That is what we're focused on right now on both fronts.

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Operator [26]

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And your next question comes from the line of Matt Sheerin from Stifel.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [27]

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One other question if I can just regarding the components business. It sounds like both North America and Europe could be below seasonal for a couple of quarters, and you talked about the mix shift working against you. You haven't talked about the pricing environment yet, and I would think that as volumes do come back and as customers work through inventories, we could see a return to at least more normal pricing. I know last year pricing was favorable for suppliers and distributors. So is that factored into your thinking as we get through the year?

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [28]

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Yes. Absolutely, Matt. As I said before, I think about 1/3 or $10 million of the decline was market pressures. We do expect that to return. What's interesting, Matt, and you probably know this because I remember you being around the last time we went through one of these. That is really a pretty minimal decline for a downturn compared to historic. So the good news is we have better control on our margins than we had sort of the last couple of downturns. And so we fully believe to get a complete recovery of the market pressure as things start to loosen up a little bit.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [29]

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Okay. Is it likely that things could get worse before they get better though?

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [30]

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No. I think what you're going to see in the second quarter is the regional mix, and we believe that's about where it will shake out. That's our belief right now as we sit here today.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [31]

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Okay. Great. And on the enterprise computing business, looks like that's chugging along. You're seeing modest growth, I know net billings is up, the mix is still working against you a little bit on the hardware side. We're also looking like we're at the later stages of this multiyear refresh cycle, particularly on servers. So how do you see that business playing out? It looks like it's seasonal IT spending slowing a little bit, what's your take there?

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [32]

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Yes. Sean, do you want to...

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Sean J. Kerins, Arrow Electronics, Inc. - President of Global Enterprise Computing Solutions [33]

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Yes. Matt, I think I largely agree with your observation. There have a good handful of refresh cycles that we've been able to participate in and just due to the size of our installed base. I think as we look to the rest of the year, we're going to continue to drive more software-based solution selling. And as you know, we always work to bring on more customers and part of the challenge is to help pivot them to the places that will lead to more software, and that's good for our mix and margins over time. To your point, we made some progress in that regard in Q1, but we still got some more work to do. We do know what that work is, and we're going to continue to make progress against this. I would also agree that I think the outlook is -- there's a little bit of uncertainty surrounding IT spending as we look to the full year, I would say, different people have different views. We intend to grow this quarter, but again, the focus is on basically improving the profitability of the business we do take on.

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Operator [34]

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

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Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [35]

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First one, I was hoping to better understand around OpEx. Very good leverage there in the first quarter with OpEx dollars down. Chris, how should we think about that in the second quarter, the company is guiding for year-over-year revenue growth. So should we be thinking about OpEx growing as well? Or is this leverage going to be sustained and keep OpEx pretty flattish still year-over-year? And maybe if you could extend that as well into the second half how we should think about OpEx growth on a year-over-year basis?

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Christopher David Stansbury, Arrow Electronics, Inc. - Senior VP & CFO [36]

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Yes. You just nailed it. We're going to be holding OpEx very tightly. I think if you look at our strategic initiatives as we've talked about, we've invested in those over the years. We like where we are in OpEx. We like the leverage we're driving. So our ability to hold that relatively flat is the goal for right now. So I don't think you will see that change as we move through the year.

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Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [37]

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And just is that on a dollars basis that you're referring to, just to be clear?

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Christopher David Stansbury, Arrow Electronics, Inc. - Senior VP & CFO [38]

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That's a dollars basis. So with continued growth, we obviously get additional leverage.

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Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [39]

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Yes, okay. And then my last question is to revisit this commentary about the first quarter mix changes between higher margin and lower margin part. I appreciate all the thoughts on this from your team, it's been helpful. The one aspect that I still am a little confused on about the first quarter is whether it be upside for lower margin types of parts? I mean I understand why high margin would see some pushouts if the cycle is weakening, but can you just better explain why across all regions, there was upside demand for lower-margin parts in the first quarter?

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [40]

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Well, the interesting thing is, I would say, the demand for those products would have been normal had the high-dollar products not shut down. The mix would have been back dramatically different. So we see this -- a good portion of the commodity product come in during the quarter, and I think as customers went through their inventories, they were figuring that, that was an area that they have been deficient of holding products so they continued their orders and pulled some of those orders in. I think we're really into more of inventory rebalancing situation by the customers, the manufacturers right at this point in time, plus an uptick in business from Asia. So those are really the 2 phenomenas that drove that, and we expect that -- most of that to fully shake out by the second quarter. Then it's going to be on the economy at that point.

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Operator [41]

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

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Steven Bryant Fox, Cross Research LLC - MD [42]

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A couple of questions, please. First of all, with the Asia component mix. My understanding was that you were putting field application engineers on the ground to go after more traditional distribution business normal to like what you do in Europe and in the U.S. So if that was the case, why would you task these FAEs were taking just lower-margin business? It sounds like they are not as effective as you'd like them to be and some discipline or some kind of controls was lost in the process, can you just sort of address that, please? And then I had a follow-up.

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [43]

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Actually -- sure. Actually, the vast majority of our sales that came into Asia -- came in through the industrial base, they matched Asia's returns, but Asia's overall profit profile is less than the U.S. and less than Europe. So we didn't see a lot of low-profit business coming in to Asia's P&L compared to what it has been. So it has truly just been a regional mix change for Asia itself.

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Steven Bryant Fox, Cross Research LLC - MD [44]

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So sort of the bar is lower for those industrial customers in Asia versus say Western regions, is that correct?

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [45]

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Yes. It has been for forever in the business. And what's happening now is that margin will work up over time, but the P&L profile was not same in Asia as it is in the U.S. and Europe.

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Steven Bryant Fox, Cross Research LLC - MD [46]

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Okay. I think I understand that. And then in terms of just the trends in the U.S. and Europe, just to be clear, there is no component mix issue that you're seeing there? You're just saying that that's downturn, and if that's correct, can you sort of highlight what end markets or served markets you think you're being most affected by in terms of top line, bottom line pressures in those regions?

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [47]

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Yes. I'm taking a look at it right now and the ranges are across the board, but the biggest changes for us were in communications, contract manufacturing and industrial.

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Operator [48]

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Your next question comes from the line of Tim Yang from Citi.

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Zhen Yang, Citigroup Inc, Research Division - Assistant VP [49]

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So you just mentioned that industrial saw demand softness, and can you give us some color on how large is your industrial exposure? And how much of this softness actually contributed to your component margin softness? Then I have a follow-up.

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [50]

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Well, industrial is about half. So that should help you there.

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Zhen Yang, Citigroup Inc, Research Division - Assistant VP [51]

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Got it. Overall, is that -- like the half is the contribution -- or half of the margin softness it's from industrial, North America industrial or is the...

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [52]

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No. It would have come from all the categories that I just listed out on the call before, communications, contract manufacturing and industrial were the biggest decliners. And as I said, most of that is because of the high product parts that got pushed out. And if you look at all 3 of those categories, it totally makes sense that they'd be rebalancing because they are still manufacturing, but that was really, really what it is.

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Zhen Yang, Citigroup Inc, Research Division - Assistant VP [53]

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Got it. And then on your ECS operating income, you had year-over-year growth for the quarter. And in the previous 2 quarters, you've had operating income year-over-year decline due to some ramping of hardware sales for your new value added reseller relationship. Given this operating income back to positive growth, does that mean that those hardware ramping is almost done? And then how should we think about the operating income growth for ECS going forward?

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [54]

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Well, we committed that we would have business rightsized and organized by midyear, we're still on that same track.

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Operator [55]

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And your next question comes from the line of Adrienne Colby from Deutsche Bank.

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Adrienne Eleanor Colby, Deutsche Bank AG, Research Division - Associate Analyst [56]

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Most of my questions have been answered, but from the prepared remarks on the component side, you had mentioned growth in transportation in the Americas and Asia versus flat growth in Europe. And given your commentary about some of the mix shift you're seeing for lower sort of commodity parts, I'm interested if you're starting to see signs of growing caution within that vertical in Asia and the Americas?

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [57]

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Yes, we're seeing cautious signs across every industrial, every category of vertical market performance right now. But it's not one where we're not seeing any signs that are going to be fantastic. There's nothing we can hang our head on that way.

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Adrienne Eleanor Colby, Deutsche Bank AG, Research Division - Associate Analyst [58]

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Understood. So the strength that you commented on in the first quarter, that's something that you started to see shifting in April and then, I guess, a couple of days into May?

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Michael J. Long, Arrow Electronics, Inc. - Chairman, President & CEO [59]

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We actually saw it starting in March, and we have seen some growth and it wouldn't be surprising because as you know, we had a big automotive push going on with our engineers and things like that. So some of those are having delayed growth, and are customers that we didn't do business with before. Remember, we also increased our customer base. So we're juggling the fact that we've increased our customer base and we have some declines in certain types of products. So we're not seeing the total picture yet. We've got a great idea of the picture, but we're not seeing the whole picture of what the decline is. And as I say, that part is going to be economic, not necessarily controllable here. And we've told you what's controllable in here, and we think we're in for a couple of quarters, but we don't think it's going to be an overall disaster. I guess that would be the way that I could put it to you.

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Adrienne Eleanor Colby, Deutsche Bank AG, Research Division - Associate Analyst [60]

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Okay. That's helpful. And Chris, as we think about cash flow for this year, is there any commentary you could offer about CapEx plans?

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Christopher David Stansbury, Arrow Electronics, Inc. - Senior VP & CFO [61]

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Our CapEx this year, the only investments that we've really got to make that are different from a normal year is some investments in warehousing, which I know I talked about it at various conferences and investor meetings just given our growth. But otherwise, our ERP investments have come down significantly. So we're managing that tightly, and we've got to get those behind us to support future growth.

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Operator [62]

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And there are no further questions at this time. I'll turn the call back over to Steve O'Brien for some closing remarks.

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Steven J O'Brien, Arrow Electronics, Inc. - VP of IR [63]

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Thanks, Rob. 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 information about these risks is included in Arrow's SEC filings. If you have any questions about the information presented today, please feel free to contact me. Thank you for your interest in Arrow Electronics, and have a nice day.

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Operator [64]

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This concludes today's conference call. You may now disconnect.