Good day. 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 Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions]. Thank you. Rick Seidlitz, you may begin your conference.

Thanks, Rob. Good day, and welcome to the Arrow Electronics Fourth Quarter and Full Year 2022 Earnings Conference Call. With us on the call today are Sean Kerins, President and Chief Executive Officer; and Raj Agrawal, Senior Vice President and Chief Financial Officer. During this call, we'll make forward-looking statements, including statements about our business outlook, strategies and future financial results, which are based on predictions and our expectations as of today. Our actual results could differ materially due to a number of risks and uncertainties, including the risk factors in our most recent 10-K and 10-Q 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. We have reconciled those to the most directly comparable GAAP financial measures in our earnings release. These non-GAAP measures are not intended to be a substitute for our GAAP results. You can access our earnings release at arrow. -- investor.arrow.com, along with our CFO commentary, the non-GAAP earnings reconciliation and a replay of this call. Following our prepared remarks today, we will be available to take your questions. I will now hand the call to our President and CEO, Sean Kerins.

Thank you, Rick, and thanks to all of you for joining us today. Before I talk about our most recent results, I wanted to reflect a bit on the past year in total, which continue to present Arrow with unique market conditions and challenges. It was truly special to lead this great company and our 22,000 dedicated employees as we met those challenges head on and help both our customers and suppliers succeed in this environment. In turn, we have delivered the strongest financial results of any year in the history of the company. And while I'm extremely proud of what we've accomplished, I know that the market conditions continue to evolve as we enter 2023, we'll be faced with new challenges and opportunities through which Arrow will continue to differentiate itself in the markets we serve, reflecting the commitment, strengths and aspirations of our entire global team. Now turning to our results. I'm delighted to report that the fourth quarter was in line with our expectations and one of our best quarters ever, despite some challenging conditions. Our sales grew by 8% year-over-year on a constant currency basis, fueled by both growths in our global components and our global enterprise computing solutions businesses. In our Global Components segment, sales grew 6% as compared to last year on a constant currency basis. While demand for electronic components and associated design, engineering and supply chain services generally remained healthy in the West. We did experience softer demand in Asia relative to our sales guidance, especially in China. It's important to remember that we are not too concentrated in any one area. We're proud to service a variety of industries and provide products from a diverse group of suppliers to a diverse group of customers around the world. Additionally, design and engineering…

Thanks, Sean. Fourth quarter sales grew by 3% versus prior year or 8% on a constant currency basis. Changes in foreign currencies impacted sales growth by approximately $357 million year-over-year, which was less than our expectation of $420 million. Sequentially, the business grew by 1%, and currency impacts were minimal. The average euro-dollar exchange rate for the quarter was $1.02 to one EUR compared to a previous expectation of $0.90 to one EUR. Fourth quarter gross margin of 12.9% was down 40 basis points year-over-year, driven mostly by the normalization of shortage market activities we began to see in the third quarter. Sequentially, our margins improved by 10 basis points due to favorable product mix in the enterprise computing solutions business. Operating expenses as a percent of sales were 7.2%, down 20 basis points year-over-year and 10 basis points sequentially. Interest and other expense of $62 million has significantly increased year-over-year and sequentially due to higher rates on floating rate debt and higher borrowings, but was in line with our prior expectations. The effective tax rate for the quarter was 24.8%. This was slightly higher than our prior expectation of 23.5% due to timing of certain items within the year. For the full year, our effective tax rate was 23.8%. Both the fourth quarter and full year rates are within our long-term range of 23% to 25%, which we continue to see as our appropriate target range going forward. Turning to cash flow and the balance sheet. Our fourth quarter operating cash flow was $109 million. Our cash cycle of approximately 66 days increased three days from the third quarter and 12 days year-over-year primarily due to inventory increases, which are largely related to pricing. As a reminder, our inventory investments allow us to support customer demand, and we have…

[Operator Instructions] Your first question comes from the line of Ruplu Bhattacharya from Bank of America. Your line is open.

Thanks, for taking my question. Sean, I wanted to start with a high-level question. I mean when you look at end market demand today versus 90 days ago, I mean, how would you say -- I mean, are things materially weaker? Or are they the same? Or -- and how do you see that trending over the next quarter? And then specifically on the components side, I think you said bookings were below parity in all regions. Is that concerning? And do you think backlog will continue to decline? Or do you think that, that can also grow over the next couple of quarters?

Sure, Ruplu. Let's start with just our feelings about the market overall. And I would say it's sort of mix. If you look at our guide for the first quarter, we're basically at or above normal seasonality in all of our Western markets. So maybe not quite as broad-based in the West as it was maybe 90 days ago, but we're still seeing activity levels in things like transportation, industrial, aerospace and defense and medical device sectors holding up and certainly, other sectors like compute, communications, consumer and things like lighting slowing down. Obviously, demand trends in Asia, specifically China, have been impacted by market headwinds and COVID disruption. It obviously was initially all about consumer and PC, but that's now bled into other key verticals as well. But by and large, we still see enough activity in the West to feel good about our outlook in the first quarter. And to that point, your question about backlog, look, our backlog is down from its all-time high, but it's still well beyond historical levels. Our teams do a pretty good and active job throughout the world to continue to validate that backlog. And we believe the majority of it is still firm versus forecasted. And that work yields or has yielded certainly more reschedules and pushouts than cancellations. So we feel pretty good about the backlog. And as we said earlier, the quality of our inventory to support the guidance we've shared.

Thanks for the details there, Sean. Maybe I can ask Raj, a couple of quick questions. On the inventory, it looks like sequentially, it was up 5%. I know you're guiding -- there's some seasonality in the March quarter. But can you just talk about like what drove the increase? And as you think about this year and free cash flow and working capital days, how should we think about that? Do you think inventory remains high for a while? Or do you think that we're at the point now where it's peaked and it can actually come down and free cash flow can be better?

Yes, Ruplu, I would say that the majority of the increased inventory, whether it's quarter-over-quarter or year-over-year is driven by pricing environment that we've been in. And so actually, what's driving it. We do -- as Sean said earlier, we have a good, strong backlog. We think we can sell through most of the inventory. And it's hard for me to say what the peak level is going to be, but we continue to have good demand in the West, and that's really what we're looking at. And from a cash flow standpoint, I think we're going to -- we'll generate some cash flow this year just given the market dynamics. But overall, we feel good about where we sit.

And Ruplu, I would just add some color to that, which is, look, I look at inventory as a function of customer service especially in this environment. So we really spend as much time as we can to help our customers deliver on their production schedules even as they change. And as you might imagine, there's a fair bit of change in this environment. But I look at the increase in Q4, for example, I would call it, for the most part, modest. But I think a healthy inventory investment now will set us up for attractive returns in the future.

Okay. That makes sense. And finally, if I could just ask. I think one concern that many investors have is our margins at their peak I mean, as suppliers lower their prices, I mean, when you see ASP pressure? And how you think about margins. And in that context, if you can give any of your views on how you think margins can trend. But also, do you have cost levers and I guess my question is on general risk management. Like if we go into a recession or a slowdown, do you think OpEx as a percent of sales or as a percent of gross profit still has -- you have levers to lower that, meaning you can take more cost out. So just your thoughts on your ability to manage your costs and how you think margins will trend maybe in a deflationary environment or in a recessionary environment? Thank you. Thanks for all the detail.

Sure, Ruplu. So of course, I always like to talk more about growth and cost, but I'll start with the second part of your question, we feel like our OpEx is fairly well managed. As you can see, we landed at historical lows on both a percent of sales and a percent of gross profit basis. We've got all kinds of levers in place to make sure that we're protecting our investment priorities and continuing to work on structural cost over time. You were obviously going to be very surgical in this environment. If things were to slow more dramatically, I think we know where to go. And remember that variable cost in a more recessionary environment would come down substantially. I think to the first part of your question, and it's the right one, we spend a lot of time looking at how the complexion of our business has changed over the past couple three years, and as the supply/demand market continues to normalize, I can tell you that we feel pretty confident about our ability to retain some of the structural benefits that we built into our model. So I can't sit here today and say exactly when the market will fully normalize, but it will, and we'll reach something that we might call a steady state. When we do, I'm confident that operating margins in our components business are going to land well north of the last long-term target we set for that business. And for those of you that maybe weren't as involved, that was 5% at the time. I think now we're looking at something in the range of 5.5%, all the way to maybe six points. So the reason we have conviction around that is because of the structural investments we've made over time. And I can talk a lot about engineering resources that help us capture design win margin potential. We think there's still runway there. I can talk about supply chain capabilities and what that's doing to help us serve our customers in different and value-adding ways. I can talk about design services, which are especially interesting to some of our larger OEM customers for which we enjoy really accretive returns. So there's a real thought behind that statement. And I think while you might want to ask by when, and we won't commit to a time frame, again, the market's got to normalize, but we feel really good about the next target range for that business.

Okay. Thanks for all the details. I appreciate it. That's helpful.

Your next question comes from the line of Matt Sheerin from Stifel. Your line is open.

Yes. Thank you. Good afternoon, everyone. Just a little bit more color in terms of what you're seeing kind of like the Western markets are holding up better. Your big competitor last night is seeing below seasonal demand in all regions, although like you calling out Asia as the weakest area, and they're seeing an inventory correction start to play out across their business. It doesn't sound like you're seeing in that yet? Are there any -- other than your commentary about some pushouts and no cancellations. Anything else you're seeing there or your book-to-bills are going negative in those markets?

Well, as I think maybe the CFO commentary or some much suggested, book-to-bills are below parity in all three of our regions. But Matt, I'll go back to what I shared about the guide, again, in most of our Western markets, we're at or above normal seasonality in our Q1 outlook. China really is the only place where we're sub-seasonal here. From an inventory perspective, as I mentioned, I never like to see it creep up, but I have confidence in what it will help us deliver. Our Asia Pac team funny enough kept inventory flat sequentially quarter-over-quarter. So we are managing that as well as we can under the circumstances, especially while we try and juggle the balance between working capital and customer service. I think we're in pretty good shape on that front moving forward.

Okay. And in components, you talked about weakness in that shortage market in North America, which makes sense. Do you think that's bottomed in terms of fundamentals there? Or is that going to get weaker before it bottoms?

Matt, I think we're getting closer. I think we'll still see some of that pressure in Q1, but then I think we'll see that become less impactful over the balance of this year, assuming all else remains equal.

Okay. Great. And just a question on ECS where it looks like you've had nice strong results, still good demand drivers. But we are hearing some concern about the backlog and as that build as component shortages get easier, the backlog working on and forward. Are you seeing that in any of your businesses? Or do you have any kind of outlook in terms of IT spending for the year as you're talking to your customers?

Sure. Maybe I'll start with your question about backlog. I think in my opening comments, I talked about the fact that the hardware supply chains are easing somewhat. It hasn't completely flushed and our backlogs are still close to all-time highs in that business. So there's still a ways to go, but it was nice to see some relief in the fourth quarter. And I think we'll see some relief throughout the year. I think the broader market, while it was rebounding from the pandemic, I think, has maybe moderated somewhat at least call it mix. We talked about supply chains cloud adoption is slowing somewhat at least from its pandemic levels, given some recessionary concerns, we have seen some evidence of slowing sales cycles surrounding enterprise IT more generally. But at the same time, pipeline is related to cybersecurity, infrastructure software, things like digital automation, they're all still pretty active and healthy. So while we're not super bullish about the growth outlook for the year, by no means, do we see it going south.

Okay, great. Thank you.

Your next question comes from the line of Jim Suva from Citigroup. Your line is open.

Thank you, Sean. Sean before you were at Arrow and before COVID, there were some supplier consolidation, some supplier changes about using distribution, not using distribution giving more value-added demand creation, giving less value-added creation to the distributors. I'm just wondering now that hopefully, if we exit COVID and hopefully get to more normalized supply chain, are you seeing or having discussions with suppliers for any changes? And are they positive, negative or no changes. I'm wondering if there's actually more opportunity? Or is there like more consolidation? Or kind of what's going on because the past three years have been challenging for everybody. Thank you.

They certainly have. Thanks, Jim. So maybe take your question in a couple of pieces. I mean, first, from a consolidation perspective, that's a little tough for us to call. Consolidation will likely continue in the industry, but we don't have any specific knowledge of anything in play. We've tended to benefit from some of that and at times, maybe get heard from some of that. So that one is a little bit tough to call. But from a program perspective, look, we're always having conversations with our suppliers. Our suppliers are always looking at ways in which they can work with us to rely on more of our capabilities I would say, in general, not less. I do believe there's more demand creation potential in the overall semiconductor supplier market in total. We saw our demand creation mix improved year-over-year. We look at design activity every quarter pretty closely throughout the world, and we see design registrations, design wins still going up. So while you might from time to time catch wind of a supplier that's looking to trim the margin profile in their channels, I'm comfortable that there's plenty that still place a lot of value on the engineering investments we make for demand creation and give us a chance to be rewarded accordingly. So I think the outlook for that particular piece of the question is still very valid and very promising.

Thank you so much for your details. Congratulations on good results in such a challenging time. Thank you.

Your next question comes from the line of William Stein from Truist Securities. Your line is open.

Great. Thank you for taking my question. First, I'd like to ask about the trend in lead times broadly. I think it's clear that they're coming down, but I wonder where you think we are in that normalization process. Are we somewhere in the middle innings? Or are we still in the beginning of that process. Would you expect that to continue throughout the year? And then I have a follow-up.

Hi, Will. So it's funny because I think you read some headlines specific to certain components of the technology mix and people broadly assume the supply constraints have gone away. But we still see it as very mixed. I mean, lead times have come in, in certain cases. But on average, the lead times we see across our whole electronic components business is twice the pre-pandemic average. Now that's down from some of the higher levels at one set at, but it's still not sufficient to satisfy the backlog that we still see. So I call it mix on a technology basis. Hard to say when it all fully normalizes, I don't see that happening probably anytime soon. Maybe it will gradually improve throughout the year. Don't know. We really don't want to speculate too far ahead of the quarter in front of us and maybe just a little bit more. Remember, all the capacity investments that we read about over the past couple of years, that takes time to materialize and really change the structural in a supply formula for the industry in total. So I think it's still going to be kind of mixed and it's going to be a little bit of an ebb and flow here over the course of the year. But we're going to focus mainly on what we can see over the next 90-plus days.

Okay. Thank you. As a follow-up, Arrow has a well-known significant supplier that went through a consolidation process with distribution partners, I think, a couple of years ago now. But they've been pretty aggressively deploying some features in their sort of supply chain, if you will, for example, a new distribution center in Europe, where they're doing same-day delivery. They've developed these APIs for customers to hook directly into their website. I wonder, it seems relatively clear that this is targeted at the types of services that you have provided to their customers and to your customers over the years. I wonder if you see this as a threat that's sort of materializing to that portion of your revenue today or if it's something in the future? Or if you just don't think that this is going to have a meaningful impact on your business? Thank you.

Yes. Well, look, I'm not going to claim makers here. But I think you can appreciate, we would never talk about any of our suppliers in particular. So I can't really help you a whole lot with that one. I can say that overwhelmingly, as I said earlier, most of our conversations with most of our suppliers are all about how we can help them do more. So I feel pretty good about what that means for us, not just now but into the future.

Thank you.

[Operator Instructions] Your next question comes from the line of Joe Quatrochi from Wells Fargo. Your line is open.

Yes, thanks for taking the question. In the past, you guys have talked about kind of a customer survey on the number of customers that don't have enough inventory or have too much inventory. Is there any color you can provide on where we stand in the kind of results of that survey?

Sure, Joe. I guess the short answer is mixed. We continue to perform the survey of late, it's been really hard to see any consistent patterns. You'll see the numbers move around a little bit 1 quarter to the next for those that say they have too much versus those they have -- say they have too little. And then you'll see it move again in the other direction in Q4. So I would not place a whole lot of stock in what that's telling us in this environment because this is such an abnormal supply environment. So it's a little less predictable for us. We're the line on lots of other vectors that we have access to, including our backlog and including our inventory turns, et cetera.

Okay. That's helpful. And then on the share repurchase program that you guys announced. Is there an expiration to that authorization? And then how do you think about balancing that activity relative to your working capital need just given the increase in short-term borrowing rates that we've seen kind of flow through your interest expense line?

Joe, this is Raj. There is no expiration to that share buyback authorization, which is similar to what we've done in the past. So no change there. And our capital priorities continue to be the same. And so if we have a need to invest in the business, that will be our first priority. And then we always are looking for the right kind of M&A opportunity at good returns. And then -- to the extent we have excess capacity, we'll buy back our stock, and that's really what we've been doing. And in terms of short-term rates, we've taken that into account. That's certainly driven up interest expense in the fourth quarter, but the things that we're doing more than pay for that incremental cost. So I think we're positioned well.

Got it. Thank you.

And there are no further questions at this time. Mr. Rick Seidlitz, I'll turn the call back over to you for some final closing comments.

All right. Thank you, Rob. I just want to thank everyone for your interest in Arrow Electronics, and wish you have a nice day. Thank you.

This concludes today's conference call. Thank you for your participation. You may now disconnect.