Arrow Electronics, Inc. (ARW) Earnings Call Transcript & Summary

[Audio Gap] Raymond James. Very happy to have the team from Arrow here. Chris Stansbury, CFO, is going to go through a prepared presentation here. There's also a video that we're going to watch. We'll have a couple of minutes at the end for questions. We will do a breakout downstairs afterwards if you have additional questions. But with that, Chris?

Great. Thanks, Adam. Thanks, everybody, for making time today. Before I jump into the formal presentation, I just want to share a 2-minute video with you that gives you a good overview of what Arrow is and what we do. [Presentation]

So I think that gives a good background, very high level of what Arrow does. And just as I move through the formal presentation, we'll go into that in more detail. So really, when you think about where Arrow is today, we're pretty much everywhere. We want to make technology accessible broadly. We reach a very wide customer base, and we'll talk about that but we're focused on areas that we all use every day, safety and food supply, automated cities, autonomous driving, a number of different markets. And the value that we bring as we're dealing with customers who are very, very small, that don't have necessarily the technological capabilities to bring their ideas to life. And in that motion, we can help them do that. So if you look at the markets that we serve, I talked about some of these. So semi-autonomous mobility, the SAM car, that's been out for a while. We've talked about it before. But this was a vehicle that allowed a former IndyCar race car driver, Sam Schmidt, who was injured 20 years ago this year and became a quadriplegic to race again. He actually drove from the bottom of Pikes Peak to the top in under 15 minutes. And I don't know how he did it. I've tried driving the car with just my head and it's ugly. But he does a phenomenal job with that. And that really builds a lot of credibility for Arrow that in a situation that matters, we can design an engineering solution that others necessarily can't bring to life. And he's driven that car at over 190 miles an hour. And there's more innovation to come behind that. Digitruck. Here's an example of where we want to do well by doing good in the world. So this is shipping containers that have been outfitted with solar panels and satellite connectivity and laptops to bring the Internet to children and orphanages in Africa. Unlimited Tomorrow, a robotic arm for people who need a prosthetic, but an artificially intelligence-enabled arm, an arm that learns what the brain is trying to tell the hand to do. And as in the case of a child, as that child grows, a new arm is printed, that chip is moved and the arm still knows what the brain is trying to tell that hand to do. It's pretty amazing stuff. Solar Suitcase. So maternity clinics in Africa, where there is no form of natural light at night. It is pure darkness. This brings a source of light, a source of communications and a power supply to power other medical devices. The drone project, which we worked with a bunch of students on for herd monitoring and solving technology problems in agriculture. And then the last one on this slide, the Silicon Savannah. We worked with ADI to help bring tech ideas in the Savanna to life. And that was just a wonderful project to do. If you think about what we do on a broader scale, though, we manage complexity. We operate in 90 countries, over 40 fulfillment and value-added centers and 295 sales locations around the globe. And in all of that in our components business, 24/7, 365, we're doing 80 transactions a second, 2.5 billion transactions a year and growing. So one of our core capabilities is managing complexity. We're the only company in our space that has a global ERP with the capabilities that we have. And increasingly, that capability is being sought after to manage the complex supply chains of our customers and the relationships between suppliers and customers. If you think about the business in total. We're a $29 billion company, over 19,000 employees, ranked 109 on the Fortune 500 rank and over 175,000 customers. We've doubled that customer count in the last 3 years, and I'll talk a little bit about how we've done that and how we've differentiated ourselves. And as you drill down on that in a little more detail, about 2/3 of the business is our global components business and 1/3 is our enterprise computing business. And then that has led to operating income of $1.1 billion last year, even in a tougher market, where by the end of the year, all 3 major regions of the world had gone into downturn, and we generated just over $7.5 of EPS. When you look at underneath that, how the business is split, you'll see that we've got an Americas business all in, that is about 40% of what we sell in components with roughly -- sorry, Asia is roughly 40%. Europe and North America are evenly split for the balance. And our computing business is split about 50-50 between Europe and Asia -- Europe and North America. The -- our history is deep. We've been improving lives for people for a long time. And if you think about the growth of the company, really, the mid-80s and into the early 2000s was a lot of consolidation in the industry. We were driving scale. It's consistent with what suppliers have done. But what's happened since then is we've continued to expand. We've expanded into computer services. That business, we'll get into more details, has differentiated itself as well. And the result of all that is differentiated growth, differentiated margins. And from our employee standpoint, which is something we look at very closely, we want top talent in our business, we've been 7 consecutive years in the most admired company in our space on Fortune's ranking. So if you think about what we do in big picture, we create things. We make things and we manage things. And around this wheel, this visual wheel, at every dot that you see, we're involved in driving value for our customers and for our suppliers. If you look at the create side, there's obviously the conception of the idea, designing it, dealing with new product introductions. We can help make it, which provides integration services, obviously, production and fulfillment and providing routes to market. And then from a management standpoint, there's management of supply chains, dealing with product life extensions, next-gen designs as well as you're helping people deal with the complexities involved when a subcomponent is end of life and how we manage through all of those issues. Importantly, behind that, we've had to build the capability to scale our engineering services. So if you think about what Arrow was 5 years ago, 10 years ago, we had this core engineering service center layer that you see second from the top. Those are Arrow-employed engineers, where they would be developing designs that we would bid on with customers. If we were awarded that design, the supplier paid us premium margin. That still exists. But when you think about increasingly smaller and smaller customers that are trying to bring their ideas to life through technology around the world, we have to figure out a way to scale those services. That's the digital layer. We've got tens of thousands of customers where we can engage through a private pipe and share designs and do the entire engagement with a customer online. At the other end, 2 years ago, we acquired eInfochips, which is a much smaller number of customers, but highly bespoke solutions, where the customer may be looking for an industrial IoT solutions, software on a chip. And they are paying us a lot of money to give them a proprietary solution so that they can compete more effectively in their marketplace. And then last year, we added ArrowPlus, which is powered by Freelancer. So as you think about the shared job economy, this gives us scale as time goes on and engineering talent is under increasing demand. So it's a way for us to plug in a specific customer engagement where ever that engineering service layer makes sense. No one else has it. Okay. When you think about the services that we provide, they're really there to accelerate the commercialization of the products that we're designing for our customers. So in the media space, the digital space, we own AspenCore. That does a lot of media work. AspenCore created that video. AspenCore did the content for this presentation. And that is an enormous value that we can bring to our suppliers, and we can bring to our customers as it relates to product launches. SiliconExpert, the world's largest database on silicon. It's updated with about 20,000 new part numbers a week. Customers use that database to track their bills of material to see if there's an issue with a product going out of code, if there's a quality issue, if it's end of life, if there's a tariff. And so there's an enormous amount of data that we have available to us. Engineering, I've talked about the layers, but this just really gets into how deep we go into those engineering layers depending on the complexity of the solution that's required. From a supply chain standpoint, we will do everything for our customer. We will manage their supply chains, small customers and very, very large customers, where, as I said, we can manage that complexity well. We will deal with everything in the supply chain from invoicing and payment management to managing inventories, returns management, et cetera. From an integration standpoint. I mean it's great to make a gadget, right? But ultimately, that gadget has to be connected. That gadget may have warranty services around it. It needs to be manufactured or there's a kit that needs to be made that is part of an assembly down the road. We can do all of those things. And then lastly, the management services that we can provide around financial, professional services, infrastructure as a service, et cetera, really separate us apart from the competition. Now this is, I think, probably one of the more important slides in the deck. This is something we've talked about. We've talked about digital for the last number of years. But our brands, our global brands, reach 80% of the global engineering community around the world. And so we're actually having 50 million page views, unique page views, a month. What does that mean? That means that before an engineer even thinks about sitting down to do a design to solve a problem, they are interacting with Arrow. They are looking at our media properties to learn about silicon carbide or AI or whatever it happens to be, and they're engaging with Arrow. So even with all of the capabilities that I've talked about, we are top of mind before that engagement even starts. And again, no one else has this. This is impossible to replicate. Because there aren't other properties that could be acquired to replicate it. Also, importantly, all of the clicks, all of the information-seeking that comes through these websites, is what has allowed us to double our customer count in the last 3 years. We're fishing with a net now. We're not just fishing with arrow.com. No one else has this. In terms of the markets we serve, the biggest vertical that we track, which happens to be transportation is less than a 15% vertical. We participate in all of the verticals that are up here, obviously, aerospace and defense, mobility, security, lighting, data center, et cetera. But over half of our sales are broader industrial, the all other bucket, if you will. And when you look at it at a more granular level, we don't have a customer bigger than 2% of our sales. So that means we are not exposed to any one customer, really not exposed to any one vertical, we're exposed to GDP cycles. And to put it in a little more perspective, if you look at total semiconductor consumption globally. So not just distribution, total consumption. The top 10 customers of semiconductors consume 40% of production, 60% is everything else. And if we push that down a little further, the semiconductor industry produces chips, half of which go into PCs, handhelds, tablets, smartphones, et cetera. For Arrow, it's only 10%. So very clearly in the components business, we're focused on smaller, more diversified customers, the reach that we have to get to those customers through our media properties and drive that customer count growth. That's bringing us to customers that need our services. That means better margins, but it's also driving differentiated growth for our supplier community. So pre the downturn of 2019, if you look at 2017 and '18, total distribution grew about $8 billion in this space and Arrow grew $6 billion of it. Importantly, no supplier bigger than 9% of our sales as well. So no overexposure there. If you look at the computing business, so now the 1/3 of our business, that also has gone through a transformation. So years ago, over 10 years ago, 2/3 of this pie would have been hardware. Today, hardware is only about 1/3 of it. Software and services are 2/3 of it. And that 50% of the business that's software, about 40% of that is security. About 30% of it is compute environment stuff like virtualization and cloud. And the balance is data analytics. So there's almost no application software in here. Why? Because we can't add a lot of value to application software. But this pie, making this work, enabling hybrid environments with cloud, very complex, higher margin. It holds the high-margin space in this category. And increasingly, what we're seeing with edge of network computing is a blurring of the lines between the components and the computing space, where those edge environments are connecting components ecosystems to data centers, where value can be extracted. We also have scenarios where we have suppliers from both sides of the house coming because of the relationships we have on the opposite side. So ECS suppliers, who have data analytics packages, who want those packages in industrial environments to drive better results for customers. The problem is there's no data. They need the components engineers to come in and build those ecosystems. The opposite side because that's happening, component suppliers coming to us and saying, we want to work exclusively with Arrow because of the capabilities, because of the differentiated growth versus the market, in part enabled by the ECS business. So increasingly connected. Part of the reason why we have such a strong position in the AI space, the robotic arm that's up there, is because of the relationship we have with an ECS supplier, who is very strong in that space. If you look at a little deeper on ECS, the value-added really has led, as I mentioned, to industry-leading margins. We're 2x our peers in terms of margin in the computing space. A big point here for those that are new to this space, we're countercyclical in cash flow. So all this chart does is plots our operating cash flow against sales growth. And you can see that when we're growing above 10%, we don't generate much cash, heavy working capital investment when you get above 10%. Below 10%, we can generate nice cash flows while we're growing. And if you get down to the point where we're flat to declining, we generate enormous cash flow. So last year, we generated about $900 million in cash flow, of that $1.2 billion was generated in Q2 through Q4. So clearly, when the market turns, we react quickly. That cash gen was used to pay down about $0.5 billion in debt because we brought our debt levels back down to adjust to kind of near-term EBITDA and we like where our leverage is right now. A little bit goes into CapEx and the balance goes to share repurchases. We do have a disciplined approach to our capital allocation. So we've returned $1.3 billion in cash to shareholders over the last 5 years. And if you look over the last 10 years, it's about $2.6 billion. So the math remains the same. And you can see how that has manifested itself, about 90% of free cash flow has been returned to shareholders. That's a 16% reduction in shares over the last 5 years. And that's with some incredibly high-growth rates in 2017 and 2018, market growth of about 10%, Arrow growing in the neighborhood of 15% over both of those years. So that's it. And I think we've got time for questions, and we're going to do some questions downstairs afterwards.

So any audience questions to start.

Just wondering if you can comment on the current environment, just what you're seeing? What you're hearing...

Yes. I'll comment ex coronavirus first. I know that's the topic du Jour. We were seeing the Asian market starting to recover. So if you look at how the world turned into the downturn, if you will, Asia was hit right about a year ago. It was late Q1 for us. The Americas were hit mid-Q2 and Europe was hit in Q3. We were seeing strong bookings, strong book-to-bill backlog in Asia. And that's, I think, a very positive sign. North America is still flattish, bouncing along the bottom, and Europe, because they're lapping some big numbers, still showing year-over-year decline -- sequential decline as that market hasn't kind of touched bottom yet. Now with coronavirus layered in, really tough to call. We gave Q1 guidance, excluding the impact of coronavirus and have said that we would obviously provide updated guidance if we thought that needed to be done. It's, frankly, still too early to call that. I would say that yesterday when Foxconn communicated that they would have their factories back to 100% capacity by the end of March, that was very encouraging as it relates to Q2 output. But for Q1, we're still monitoring it daily, and it's too early to call.

Maybe just a strategic question. Obviously, you've got a differentiated model relative to others, where you've got both the components and computing businesses under one umbrella. On the computing side, there's been a lot of changes over the past 12 months from competitors. You've got one that's going private, one that's splitting and becoming more focused theoretically, one that may be taken over by the Chinese government, and the sequence happens. But maybe just update on how you're thinking about the competitive environment and how to respond to some of those changes?

Yes. I think as we look at the computing business, we look at it differently. I mean first of all, we hold the high ground. We don't -- as the chart show, we don't sell PCs, tablets, we're not selling industry-standard service in any great quantity. That's not what we do well. We manage complexity well. We sell in that business through value-added resellers, who own the customer relationship. But we've built enormous capabilities around things like cloud enablement, to the point where our tools are now being requested by mobile carriers in Europe to deploy cloud to meter to bill. And we're able to participate in some of the data consumption there. So the model has been differentiated for years. As that business becomes more linked to the computing business, strategically, it becomes increasingly important. It also generates a lot of cash flow. And that business has helped us to grow the components business at the rates that we did in 2017 and '18. I think if you look at the competitive environment, there's different strategies. We're seeing the connectivity in the way I just laid out between the 2 businesses. Others are really following the path of complete end-to-end broad line solutions. You can buy the laptop from us, and you can also buy cloud from us. We don't see the market really behaving that way. The internal customer you're selling to in that business are 2 different customers. It's CIO versus Chief Procurement Officer. And when we look at the multiples that have been paid for that space, we wouldn't even consider that. I mean, 7x EV to EBITDA just isn't that attractive, we see far more value coming out of the connectivity, but...

Time for one more? We'll end it there. We're going to continue the discussion downstairs. But thank you so much, Chris.

Thanks, Adam.