Arrow Electronics - Q1 2019

Transcript

Operator (participant)

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. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Mr. Steve O'Brien, with Arrow Electronics Investor Relations, you may begin your conference.

Steve O'Brien (Head of Investor Relations)

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 to 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.

Mike Long (Chairman, President, and CEO)

Thanks, Steve. Thanks to all of you for taking the time to join us today. After two years of favorable industry conditions, a market change is underway in the Global Components 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 are 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 corrections, 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 a 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 design reduced purchases from 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 to 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 one-third of the margin decline came from market pressure in all regions, one-third from less favorable mix within the Asia Components region, and one-third from write-downs by an ancillary business within Global Components that is a vestige of prior acquisitions. We expect the first two 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're 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 14th, we launched ArrowPlus, an engineering marketplace platform that allows companies to securely design and build products through access to over 500,000 engineers. In addition to our wealth of engineering workflow tools, data, and existing partnerships, we have teamed with Freelancer.com, the world's largest freelancing and crowdsourcing firm by 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 curate projects, identify existing solutions, and pinpoint the appropriate talent to deliver successful outcomes to our customers. Our engineers will provide concierge-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 service. 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 recurring 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 wires and MSPs. Overall, we're delivering unmatched capabilities to a component supplier, a component customer, and its customer's customer. At a recent event highlighting this collaboration, we're proud to hear the OEM customer say, "Arrow helped us solve problems we didn't even know we had." Now turning back to the near-term market 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 remain extended in 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 mirrors 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 bill of material and labor costs.

For example, we can identify $200 million that will shift in the second quarter alone. In just two quarters' time, our customer sentiment survey results dramatically changed. Exiting the third quarter of 2018, the tone was positive. Exiting last quarter, the portions of customers 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 three 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, profit performance were 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 Award 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 to make lives 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.

Chris Stansbury (VP and CFO)

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 three 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 dampen 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 mid-year. Enterprise Computing Solutions sales of $1.96 billion increased 6% year-over-year, adjusted for changes in foreign currencies and three divestitures. Sales increased 1% year-over-year as reported, and we're 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 two divestitures, one completed this quarter and one 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 and 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 expectations, 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%-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 periods. 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 did decrease 3% year-over-year as reported. We estimate the stronger dollar negatively impacted earnings per share by approximately $0.09 and negatively impacted earnings per share growth by approximately five percentage points compared to the first quarter of 2018. Operating cash flow was -$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 500,000 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 five 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 Components 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%-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-$2.06. The average US 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.

Steve O'Brien (Head of Investor Relations)

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

Operator (participant)

At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. Your first question comes from the line of Shawn Harrison from Longbow Research. Your line is open.

Shawn Harrison (VP, Senior Research Analyst, and Associate Director of Research)

Hi, everybody. To an extent, Mike, your commentary sounded a bit like déjà vu of everybody else's earnings season 90 days ago. Wondering maybe why some of these weak dynamics that you're experiencing are a bit delayed relative to maybe what, you know, your peer down in Phoenix highlighted 90 days ago, or what the suppliers have been highlighting for a while? Just a 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.

Mike Long (Chairman, President, and CEO)

Yeah, 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's been, over time, as you know, we've had some favorable sales conditions here that has also elevated our backlog, that has helped us, you know, 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's what you saw, largely 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 products and the mix in regions that's materializing right now.

Shawn Harrison (VP, Senior Research Analyst, and Associate Director of Research)

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, non-core type business, that's a, you know, $10+ million drag. But when would you expect to see kind of a normalization of the more highly engineered, you know, demand coming back, along with the shift in the business mix? Is this a two-quarter event? Do we have to wait till 2020?

Mike Long (Chairman, President, and CEO)

You know, we're anticipating around a two-quarter event. And I say that 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 slower pace. And I think what you're seeing in our second quarter guidance is, you know, 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 as the Americas start to strengthen, and we've just seen them go in. So I would anticipate, you know, right now, from what we see, you know, a quarter or two, but I'd lean more towards the two-quarter end of it.

Shawn Harrison (VP, Senior Research Analyst, and Associate Director of Research)

Okay. Thank you.

Operator (participant)

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

William Stein (Managing Director and Senior Analyst of Technology)

Great. Thank you for taking my question. Mike, frankly, I'm more confused than I have been in quite some time with Arrow. I think the words fit very well with the sort of long-term narrative 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 PNL is revenue in Q2 that's being guided, what I think is above normal seasonality, but more of a 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? Sorry for the long-winded question, but I'm really confused.

Mike Long (Chairman, President, and CEO)

Yeah, no, 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's some work that has been going on there for quite some time, and we're seeing the vestiges 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 that 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 two things, really, one with product mix, that we talked about. The other one is now regional sales mix within that product, but the operations themselves are remaining, frankly, much healthier than we've seen in past downturns, even into the first one.

You know, we're talking basis points here on profits that we've been able to offset this with. And so, that's our, that's our struggle right now. It's a pretty dramatic sales mix change between the regions. 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.

William Stein (Managing Director and Senior Analyst of Technology)

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 and, okay.

Mike Long (Chairman, President, and CEO)

Exactly.

William Stein (Managing Director and Senior Analyst of Technology)

So one more. Okay, that's been 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 any clarity there? Thank you.

Mike Long (Chairman, President, and CEO)

Yeah. Typically, I'm gonna start off with, that's normal. We've seen that in other downturns. You know, I'm gonna say that a lot of manufacturers went into their inventories and started to assess their inventory in during the first quarter. And what we saw was, if you remember last year, customers were building up their inventory of the 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 will 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, you know, for a quarter, you stop buying. That was the phenomenon we saw, and the lower commodity products 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 you do see. And then, you know, 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, you know, we expect to go right back after that and get that solved. So that was really the two items that gave us the headache in the first quarter, and it all hit in March.

Operator (participant)

Your next question comes from the line of Adam Tindle from Raymond James. Your line is open.

Adam Tindle (Managing Director)

Okay, thanks, and good afternoon. 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 a margin and EPS perspective. Gross margin is 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% or 50% of the full year. Is there something different about 2019, like the, the business that's losing money that may exit or something like that, where the first half of the year could represent, you know, a different number than, than it has historically from an EPS perspective?

Mike Long (Chairman, President, and CEO)

Yeah, what I can tell you is we, you know, we just highlighted that there was three buckets, right, of margin decline and one bucket that is totally in our control, and I do expect to have that bucket handled by the first half year. So we would expect that third to come back in the second half automatically. The other two are going to depend as the other regions start to return back to normal sales. So, you know, we will correct the one. You know, 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 it cleaned up by the first half.

Chris Stansbury (VP and CFO)

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, that helps.

Adam Tindle (Managing Director)

Okay, that's helpful, Chris. I wanted to ask you a question. You touched on this, but I wanna revisit. I understand that mix impacted margins, but you often point 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 gonna talk about it's a snapshot and timing related, so help us with expectations on the June quarter and maybe even the full year. And if you could tie in capital allocation priority, it'd be helpful.

Chris Stansbury (VP and CFO)

Yeah, sure thing, Adam. So if you look at our, you know, 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, you know, I think the back half of the year will be strong. It's just gonna take us a quarter to adjust back to where we need to be. As you know, a capital allocation statement, same as we've said, very consistent, which is we're, we're very focused on getting the debt down a little bit and returning everything we can to shareholders through buybacks.

Adam Tindle (Managing Director)

Okay. If I could just sneak in one last one. Mike, I understand that, you know, Asia and mix that we're talking about is diluting margins and returns. So I just wanted to clarify and ask, why even pursue this? You often say growth is a 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. Thank you.

Mike Long (Chairman, President, and CEO)

Yeah. I think right now there's some business that we're working on in conjunction with our suppliers that we know we can improve the situation. That's the business we're looking at. We are not looking at filling the boat with low-margin business that is not going to give us a return. All that does is, you know, it eats our cash. That hasn't been our style. So, you know, sort of big supply chain deals, I don't have to tell you who with, none of that is coming in-house.

So we are not, we're not changing our portfolio of business one bit from what we have been doing. And I think, you know, we have proven the fact that we can bring this business in, do engineering to it, and raise the margin profile over time. I don't think our strategy stops with that just because there's a downturn. So hopefully, that clarifies that for you. You know, there's obviously work to do, but we need some economic help in the Americas and Europe to get it done, too.

Operator (participant)

Your next question comes from the line of Joe Quatrochi from Wells Fargo. Your line is open.

Joe Quatrochi (Director and Equity Research Analyst)

Yeah, thanks for taking the question. 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, you know, kind of change in mix, I was wondering if, you know, there's any additional flexibility that you can kind of work with in that business, aside from the kind of business is losing some money?

Mike Long (Chairman, President, and CEO)

Yeah, you know, 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 kicked off, you know, 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 for customers, OEM manufacturers, and then our FAE.

As I said before, 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, you know, during this downturn, because customers will be designing products and hopefully releasing that as the market starts to change. So, that's gonna be where our effort is gonna continue to be placed, and, it has serviced us well in the past, and we expect to service us this time.

Joe Quatrochi (Director and Equity Research Analyst)

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

Mike Long (Chairman, President, and CEO)

Yeah. 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.

Joe Quatrochi (Director and Equity Research Analyst)

Thank you.

Operator (participant)

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

Matt Sheerin (Managing Director and Senior Equity Research Analyst)

Yes, thank you. One other question, if I can, just regarding the components business. It sounds like both North America and Europe could be below seasonal, you know, 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?

Mike Long (Chairman, President, and CEO)

Yeah, absolutely, Matt. As I said before, I think about a third, you know, 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 controls on our margin 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.

Matt Sheerin (Managing Director and Senior Equity Research Analyst)

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

Mike Long (Chairman, President, and CEO)

Well, I think what you're gonna see in the second quarter is the regional mix, and we believe that's, that's about where it'll shake out. That's our belief right now as we sit here today.

Matt Sheerin (Managing Director and Senior Equity Research Analyst)

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

Mike Long (Chairman, President, and CEO)

Yeah, Sean, you wanna?

Sean Kerins (President, Global Enterprise Computing Solutions)

Yeah, Matt, I think I largely agree with your observations. There's been a handful of refresh cycles that, you know, we've been able to participate in just due to the size of our install base. I think as we look to you know the rest of the year, we're gonna continue to drive, you know, more software-based solution selling. 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 of and margins over time.

To your point, we made some progress in that regard in Q1, but we've still got some more work to do. You know, we do know what that work is, and we're gonna continue to make progress against it. I would also agree that I think the, you know, the outlook is, you know, there's a little bit of uncertainty surrounding IT spending. As we look to the full year, I would say, you know, 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.

Matt Sheerin (Managing Director and Senior Equity Research Analyst)

Okay, thank you.

Operator (participant)

Your next question comes from the line of Mark Delaney from Goldman Sachs. Your line is open.

Mark Delaney (VP of U.S. Autos and Industrial Tech)

Yes, good afternoon, and thanks for taking the questions. First one, I was wanting to better understand around OpEx. Very, very good leverage there in the first quarter with OpEx dollars down. Chris, how should we think about that in the second quarter, company's guiding for year-over-year revenue growth? So should we be thinking about OpEx growing as well, or, or is, is this leverage gonna be sustained and, and keep OpEx pretty flattish as to 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.

Chris Stansbury (VP and CFO)

Yeah, you, you just nailed it. We're gonna be holding OpEx very tightly, and 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, for right now. So I don't think you'll see that change as we move through the year.

Mark Delaney (VP of U.S. Autos and Industrial Tech)

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

Chris Stansbury (VP and CFO)

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

Mark Delaney (VP of U.S. Autos and Industrial Tech)

Yep, okay. And then, my last question is to revisit this commentary about the first quarter mix changes between higher margin and lower margin parts. Appreciate all the thoughts on this from your team. It's been helpful. The one aspect I still am a little confused on about it, 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?

Mike Long (Chairman, President, and CEO)

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 that dramatically different. So we see this a good portion of the commodity products come in during the quarter, and I think as customers went through their inventory, they were figuring that, you know, that was an area that they've 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 a inventory rebalancing situation by the customers, the manufacturers right at this point in time, plus enough chicken business from Asia. So those are really the two phenomena that drove that, and we expect that, you know, most of that to fully shake out by the second quarter. Then it's gonna be on the economy at that point.

Steven Fox (Managing Director)

Got it. Thank you.

Operator (participant)

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

Steven Fox (Managing Director)

Good afternoon. A couple 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 the U.S. So if that was the case, why would you task these FAEs with taking just lower margin business? It sounds like they're not as effective as you would 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 have a follow-up.

Mike Long (Chairman, President, and CEO)

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, less than Europe. So we didn't see, you know, a lot of low profit business coming in to Asia's PNL compared to what it has been. So it has truly just been a regional mix change for Asia itself.

Steven Fox (Managing Director)

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

Mike Long (Chairman, President, and CEO)

Yeah, it has been for forever in the business. What's happening now is that margin will work up over time, but the PNL profile is not the same in Asia as it is in the U.S. and Europe.

Steven Fox (Managing Director)

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's no component mix issue that you're seeing there? You're just saying that that's a 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 pressure in those regions?

Mike Long (Chairman, President, and CEO)

Yeah, 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.

Steven Fox (Managing Director)

Great. That's helpful. Thank you.

Mike Long (Chairman, President, and CEO)

All right.

Operator (participant)

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

Tim Yang (Management Associate)

Hey, thanks for taking the question. So you, you just mentioned the industrial 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? I have a follow-up.

Mike Long (Chairman, President, and CEO)

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

Tim Yang (Management Associate)

Got it. Yeah, well, overall, is that like the half is the contribution, half of the margin softness is from industrial, in North America industrial, or is it?

Mike Long (Chairman, President, and CEO)

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

Tim Yang (Management Associate)

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

Mike Long (Chairman, President, and CEO)

Well, we committed that we would have the business right-sized and organized by mid-year. We're still on that same track.

Tim Yang (Management Associate)

Got it. Thank you.

Operator (participant)

Your next question comes from the line of Adrienne Colby from Deutsche Bank. Your line is open.

Adrienne Colby (Analyst)

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

Mike Long (Chairman, President, and CEO)

Yeah, we're seeing cautious signs across every industrial, every category of vertical market performance right now. There's not one we're not seeing any signs that, you know, are, are gonna be fantastic. There's nothing we can hang our hat on that way.

Adrienne Colby (Analyst)

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 days into May?

Mike Long (Chairman, President, and CEO)

We actually saw it start in March. You know, 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, you know, having delayed growth, and are customers that we didn't do business with before. Remember, we also increased our customer base, so, you know, we're juggling the fact that we've increased our customer base, yet we have some declines in certain types of products.

So, you know, we, we're not seeing the total picture yet. You know, we've got a great idea of the picture, but, we're not seeing the whole picture of what the decline is. As I say, that part is gonna 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 gonna be an overall disaster. I guess that would be the way that I could put it to you.

Adrienne Colby (Analyst)

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

Chris Stansbury (VP and CFO)

Our CapEx this year, you know, 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've talked about 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 you know, we've got to get those behind us to support future growth.

Adrienne Colby (Analyst)

Thank you.

Operator (participant)

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

Steve O'Brien (Head of Investor Relations)

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.

Operator (participant)

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