Arrow Electronics, Inc. (ARW) Q1 2020 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Arrow Electronics First Quarter 2020 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remark, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the call over to Steve O’Brien. Please go ahead. Steve O’Brien: Thanks, Christy. Good day and welcome to Arrow Electronics' first quarter 2020 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. 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.

Thank you, Steve. Thanks to all of you for taking the time to join us today. I'd like to start off by thanking my colleagues around the globe for their tremendous efforts during the first quarter of 2020. I'm deeply impressed by their dedication to Arrow and to our customers, many of whom rely on us as a critical supplier for their business. Of course, the health and safety of our employees are always top of mind, and I'm grateful to report that throughout our distribution facilities and offices, our teams continue to do business while closely following the guidelines of the world's leading health authorities as well as local governments. We've also been able to leverage the early experiences and best practices adopted by our colleagues in China to maintain safe and efficient operations at our other sites around the globe. Unfortunately, our team's hard work this quarter was not as evident as it should be. We just received a legal opinion regarding foreign tax and other loss contingencies for the enterprise computing solutions business. This required us to book charges of $33 million or $0.41 a share to catch up for five years from 2015 to 2019. Our review aided by our auditors and outside counsel is ongoing, and this is the best estimate we have at this time. On February 6, we reported fourth quarter results and provided an outlook for the first quarter of 2020. At that time we couldn't accurately quantify the potential impacts from what would become the COVID-19 pandemic. Therefore, the sales and earnings per share we provided assumed no disruptions to our business as a result of COVID-19. I'm pleased to report that despite facing substantial business disruptions during the first quarter, our business largely performed as we expected. By remaining nimble and flexible, we were able to adapt to these changing conditions, and ultimately, we executed well despite adversity. We were able to properly align our working capital and deliver strong cash flow, and we also positioned our business for the future. As we reflect on the first quarter at a high level, it's important to recognize that each month saw remarkably different business conditions and operational challenges. Through January, operations were relatively normal and undisturbed by COVID-19, although broader electronic component and IT demand were softening exiting the 2019 inventory correction and tariff driven market slowdown. In February, we saw the China business come to a halt. While this presented a number of operational challenges, it underscored the essential role Arrow plays in the supply chain as we continued to deliver critical sensors and other electronic parts to our Chinese customers. In March, factories began returning to full capacity in China. In the Americas and Europe, some production lines halted. IT spending also significantly shifted toward enabling remote workers. In this context, we quickly implemented key elements of our contingency business plans to ensure our customers and suppliers were equipped to continue their business operations. In order to maintain our strong financial position, we reduced spending on discretionary projects and items and postponed some investments for the time being, all without compromising our design, engineering, sales and marketing capabilities. As we have taken swift action to adapt to support our businesses and stakeholders through this uncertain time, we have relied on our ERP for key data. We review our global ERP as a key competitive advantage that provides a detailed line of sight into the volumes, prices, inventories, regions, end markets and profits we make on the parts we sell. Importantly, Arrow remains laser-focused on maximizing our near-term results while we continue to position our business for the long term. Looking to industry needs. While near-term business conditions have remained durable in spite of the broader market headwinds, we realize and recognize that demand can change quickly. First quarter backlog increased from the fourth quarter, the second quarter in a row of sequential improvement. Design activity increased year-over-year in total for the second quarter in a row. Other indicators appear consistent with short-run stability. Lead times extended modestly from the fourth quarter but are shorter than last year. Overall book-to-bill was 1.12 exiting the first quarter. Book-to-bill was above parity in [ph] prior year in all regions. Our Americas customer sentiment survey results were similar to last quarter. The portion of customers saying they had appropriate levels of inventory increased compared to last year. The portion of customers saying they had too much inventory remained higher than normal but decreased compared to last year. To date, we have not faced significant challenges securing the parts our customers need when they need them. Nor do we see signs of hoarding or excess inventory accumulation. Turning to our enterprise computing solutions business. In the first quarter, sales were toward the higher end of our expectations. Demand for traditional ICT solutions declined relative to last year, and toward the end of the first quarter, we experienced a significant shift in demand toward the software required to enable remote workers. Sales of virtual desktop infrastructure, virtual machines and the associated infrastructure and security software were strong. Taking a step back, I want to emphasize that as a company we have long believed that doing good is also good for business. To that end, we focused on leveraging our unique technology and supply chain capabilities to help communities through the COVID-19 crisis. To highlight just a few initiatives. We're supporting the Ventilator Challenge UK consortium on their goal to produce 10,000 rapidly manufactured ventilator system units. We also helped develop and provide the artificial intelligence software for an at home monitoring system that allows COVID-19 patients to avoid hospitals or leave hospital sooner. This solution is being sold on a not-for-profit basis to caregivers. In closing, we're continuing to support our stakeholders and communities, and we're committed to providing our customers with the products and solutions they need when they need them. We remain disciplined and focused as we operate our facilities and business through significant ongoing challenges. To date, we've managed to avoid disruptions and expect to continue to do so as a critical provider of the global technology and industrial ecosystems. It's worth noting that we have built a resilient business at Arrow. We're adept at navigating through adverse financial conditions. In fact, we've always emerged from these challenges stronger, and we attempt to do just that. We will not stop looking for opportunities to expand our business, drive innovation and improve the performance of our end customers everywhere. We look forward to updating you on our performance in the coming quarters. I'll now hand the call over to Chris to provide more details on our first quarter results and our expectations for the second quarter.

Thanks, Mike. This quarter, based on feedback from investors and analysts, I'm going to keep the review of our results relatively brief to allow more time for questions. First quarter sales were $6.38 billion. Sales decreased 9% year-over-year, adjusted for the winddown, a divestiture and changes in foreign currencies. Global component sales were $4.55 billion. This was at the lower end of our prior guidance and represents a 10% year-over-year decrease, as adjusted. It's worth noting that industry destocking has been going on for more than one year. Global component sales have declined sequentially five of the last six quarters. Global components' operating margin was 3.8%. This is the fourth consecutive quarter of year-over-year margin decline for global components. During past market corrections, we've typically seen five consecutive quarters of margin decline. Were it not for COVID-19, we should be reaching a margin inflection point. First quarter operating margin increased compared to the fourth quarter despite lower sales. This was due to the normal seasonality, and this first quarter also benefited from our cost containment efforts, including last year's cost optimization program. Enterprise computing solutions' sales of $1.83 billion decreased 6% year-over-year, as adjusted, and were near the higher end of our prior expected range. As we previously outlined, first quarter enterprise computing solutions sales were negatively impacted by the earlier March 28 closing date compared to March 30, 2019. Billings were approximately flat year-over-year, adjusted for changes in foreign currencies. We experienced growth in virtualization and compute, infrastructure software, security and storage. Demand for servers, networking and services declined. Global enterprise computing solutions' operating income decreased by approximately $45 million year-over-year, including a charge of $30 million related to foreign tax and other loss contingencies related to five prior years. We previously estimated operating income would be approximately $11 million lower compared to the prior year due to the timing of the quarter end. The rest of the decline of approximately $4 million was due to less favorable sales mix than what we originally expected as spending priorities shifted during the quarter. Returning to consolidated results for the quarter. Interest and other expense of $43 million was below our prior expectation due to lower borrowings and, to a lesser extent, lower interest rates. The effective tax rate was 29.5%, well above our prior expectation of 24.5%. This was due both to the foreign tax contingencies from prior years and to the timing of discrete items. We expect a 24% effective tax rate for the second quarter, at the midpoint of our long-term target range. Earnings per share were $0.97 on a diluted basis, including $0.41 of charges from foreign tax and other loss contingencies. We estimate the stronger dollar negatively impacted earnings per share by approximately $0.02 compared to the first quarter of 2019. Turning to cash flow. We reported strong operating cash flow of $467 million. First quarter cash flow is normally negative, but we tightly managed working capital investments to drive significant year-over-year improvements. In addition, cash flow benefited from our new European accounts receivable securitization program that commenced in January. During the first quarter, we reduced borrowings by approximately $372 million. Our balance sheet is in great shape and our liquidity position is strong. Current committed and undrawn liquidity stands at over $3.1 billion, not counting our $200 million cash balance. We are also closely monitoring credit and receivables. Collections remain healthy. DSO increased in line with DPO, and this was due to an increase in our services business during the quarter that is neutral to working capital. As we've said in the past, it is fair to measure our performance by the cash conversion cycle, not by any one metric in isolation. The cash conversion cycle was 11 days shorter than Q1 of 2019. We returned approximately $150 million to shareholders during the quarter through our share repurchase plan. Our remaining authorization is approximately $188 [ph] million. Please keep in mind that the information I've shared during this call is a high level summary of our financial results. For more detail regarding the business segment results, please refer to the CFO commentary published on our website this morning. Now turning to guidance. We felt it was important to provide you with our best estimates based on orders and demand from our nearly 200,000 customers and early indications from the month of April. While many companies have chosen to forgo guidance due to market uncertainty, we want to be as transparent as possible about our expectations for the business. You may have noticed that the ranges we've provided in our earnings release for the second quarter are wider than normal, which reflects the higher than normal potential for variance to our forecast given the market conditions. With that said, we're forecasting sales to remain relatively flat compared to the first quarter for both the global components and the global enterprise computing solution businesses. This is modestly below normal second quarter results for components and significantly below for enterprise computing solutions. Despite our forecast of flat sales, we expect profits to be higher on a sequential basis as a result of improved sales mix for global enterprise computing solutions and our overall cost containment efforts that will be most visible in corporate expense. With that, I'll turn the call over to the operator for Q&A.

[Operator Instructions] And your first question is from Matt Sheerin of Stifel.

Yes, thank you. Thanks for taking my question. Just, Mike, regarding the component business. Your flat guide seems to be better if not significantly better than most of the suppliers that you represent that have reported so far in addition to your chief competitor. So obviously, your book to bill was strong, and we've seen that from others as well. What kind of confidence do you have in terms of that outlook? And related to that, are you gaining share at all, specifically the TI business, which we know at some point shifts over to you to some degree. So what is your outlook there and what can you tell us about the share shifts?

First off, Matt, thanks. But we wouldn't have put the guidance out if we weren't serious about it or I didn't think we could hit it. And you have to kind of remember that we've been in a five quarter decline already with what was the market slowdown prior to COVID hitting. And so customers were reducing their inventory. Now, are they still reducing their inventory? Possibly. I think there is a lot of question for everybody. First off, we've seen a significant uptick in China, and China has made a pretty strong comeback compared to where they were when they shut down, and we are expecting that to continue through the second quarter. Now, by no means are we projecting out the year, by no means are we saying, the market is stable and it's going to take off. We just know what we have to ship plus we're 30 day into the second quarter, and the results so far are looking pretty strong. Right now, we don't have a supplier that is more than 9% of our sales, and we're not seeing any unusual activity to date with anything that would suggest that one supplier or other suppliers are making a difference. We are seeing in China sort of broad-based increase. In the US, we're seeing a little bit less of a decrease than we had expected. And we are seeing Europe sort of hold its own. Now, saying that, also looking at the second quarter, you're seeing a reduced percentage versus the year prior also that is sort of in line with the first quarter. And as you know for some time, we've been increasing our sales to non-traditional type customers. We continue to see that happening. We continue to see an uptick in our services business. And design wins in a downturn being up is usually good news because that means the customers didn't shut down everything, and we've seen some positive input there. So hopefully, all of that mixed together, Matt, gives you a little bit better insight to what we're seeing.

Okay. And regarding any incremental wins on the semiconductor side. There has been talk about that shifting over at some point. Do you have that in your horizon in terms of bookings or what you're seeing?

I think as we've said before, the other competitors have through the end of the year to book their business and get their companies in order -- and I don't expect anything to be overly material until we get through the end of the year. And remember, this wasn't a huge windfall for us if we go back to the original piece. So don't sort of oversell it or make it a big reason because otherwise we'd have to disclose that it was massive.

Got it. And regarding the computing business. And you talked about a negative mix hurting your margins. Was that also related to lower rebates because of not hitting certain thresholds on the hardware side? And you talked about favorable mix going into next quarter. Could you be more specific about what you're seeing there?

Sean, go ahead.

Yes. Sure, Matt. Actually, it was less about the rebate thresholds in the back end that we enjoy with our mix of suppliers and more about the kind of software that we booked and billed as the market kind of shifted to remote work and distributed technologies. A lot of that software is departmental in nature. So we tend to treat it as a gross sale versus through agency accounting, which does create some gross margin pressure. But if you look forward, I do think the mix of strength in work from home and probably headwinds related to traditional data center spend, we think that's going to continue. So the mix won't shift dramatically. But we're also managing opex very carefully in this environment, given what we know now. So we do see an opportunity for sequential improvement in operating margin.

Okay. Thanks very much.

Thank you. Next question is from Shawn Harrison of Loop Capital.

Hi. Afternoon, everybody. I wanted to just dig more into the big free cash flow number this quarter and just, I guess, A, how much the receivable or the securitization dynamic in Europe helped, B, what type of kind of free cash flow should we anticipate for the second quarter, and C, will you still be buying stock in the market and look to maybe up that authorization?

Yes, Shawn. So, of the cash flow that was delivered in the quarter, about $390 [ph] million of that came from the securitization program we did in Europe. That's at very attractive rates, and the cash that we received there we basically used to pay down debt and also buy back stock this quarter. As you look at Q2, and frankly for the year, we have said obviously historically that somewhere between 70% and 100% of GAAP net income is a good target for cash flow. That didn't work last year given the wind-down, but we were at about 135% of non-GAAP income. So I think you'll see us move back to typical patterns given where volumes are. So we still see this as an opportunity to generate cash flow. We do have $188 [ph] million remaining under authorization. And as we've said in the past, we'll have a balanced approach between managing debt and buybacks as we move through this time.

Okay. That's helpful, Chris. And then, I guess going back to the ECS margin dynamic. You were on pace for it to -- where you were seeing kind of margin expansion on a year-over-year basis at least. You saw that for the third and fourth quarters of last year and we had the issues in the first quarter. Do you anticipate you will start to see or get back toward the margins you saw last year in that business with the mix shifting more favorably here in the June quarter? Or is there still some of the software dynamic mix that maybe pressure margins year-over-year?

Well, as I said, Shawn, we are seeing a similar mix as we delivered in Q1. So we do have some opportunities to drive some improvement at the gross margin line, but we're also going to have to complement that with cost containment actions we are taking. And again, we do see an opportunity for sequential improvement. It's really tough to call that beyond the June quarter given what's happening in the external environment. But what we saw at kind of the latter part of March is kind of consistent with what we see so far in Q2 and what we expect at least for the quarter. But beyond that, it's a little bit tougher to call.

Okay. Thank you.

Thank you. Your next question is from Steven Fox of Fox Advisors.

Thanks. Good morning everyone. Good afternoon, rather. A couple of questions please on the ECS side. So there has been a number of your OEM partners that have offered up vendor rebates into the channel marketing dollars and favorable credit terms. Can you just sort of talk broadly how that impacts your business? And within that context, how do you find the general health of the VARs that you are dealing with? And then I had a follow-up.

Sure. So when we look at the reseller community, obviously we're paying really close attention to credit risk. We have a larger exposure to what I would call large companies and large resellers that serve them than we do the SMB market in total. Nevertheless, we have really ramped up the process for scrutiny of our AR portfolio in a really, really robust way. We pay particular attention to the partners we know that are maybe less well capitalized and certainly those that serve the SMB space. And so far, we really haven't seen any disruption or defaults. But I would say with respect to supplier offerings and programs to potentially extend terms, we're always able to do that in a way that we pass on those offerings such that it does not negatively impact DSO. Most of those programs turn out to be working capital neutral for us and our suppliers are really good at partnering with us as opposed to rolling those things out independently in a way that hurts us. So we're not concerned about those programs. We'll take advantage of them if it helps us close business. But we won't step into unnecessary risk as we do so.

Thanks for that. That's really helpful. And then just as a follow-up on the components side of the business. Mike, you talked about I guess a little bit better environment than I would have expected and some other people might have expected. Can you just sort of dig into a little bit on the verticals, which end markets you're seeing holding up, especially given the risk that you have all these auto plant shutdowns that have some knock-on effects on some industrial customers? Thank you.

Yes. The first thing I'll say -- I'm going to turn it over to Andy, but the first thing I'll say is there is not a vertical in the world right now that I can, Steve, that is. So the thing to remember is, there was a slowdown going on before COVID. So there was already an economic decline in place that we're just seeing and if possibly being exacerbated now because of certain markets like automotive that you see and some of the other markets that are at the early stages of a shutdown or a big slowdown. So we're obviously very cautious about the market in general. But we remain committed and pleased by our performance within those markets. So I'll give it to Andy to give you some more specific of the market verticals themselves, but there's not a lot of brightness out there.

Yes. Thanks Mike. Yes, you're bang on. I'd rather answer that question by saying which are the ones that are down the most or the ones that are most exposed because every vertical is being impacted through this cycle. And the backdrop is the answer we gave earlier is we're not overexposed to any one particular vertical or any one particular segment, so we're able to pivot our resources and our focus from segments that have relative and I use the word relative health quite and quite nimbly. But really, automotive is the area that is really well documented as being problematic right now with auto manufacturer shutdowns and Tier 1s and 2s follow suit. Commercial aviation is in the same place. As I say, while we sell into those marketplace we're not overexposed. The general industrial base, relative to that, is better buoyed by medical. But to be honest with you, Steve, it's pretty much down across the board as we look at those individual verticals and we play the portfolio. Okay?

Great. Thank you for all that. Very helpful.

No problem.

Thank you. Your next question is from William Stein of SunTrust.

Great. Thanks for taking my questions. Mike, I wonder, when you look at this elevated backlog that you have today which is a little bit counterintuitive relative to sort of what's going on. I wouldn't even say in the macro, just sort of look out the window. And I think, does it make sense for backlog to be up in this environment. I wonder if you have any comments about your relative confidence in the backlog's stability? And maybe more specifically, are you seeing any increased volatility of customer pushes and pulls and adjustments to their backlog to respond to either shortages or not getting parts or getting parts faster than they expected? Any clarification there would be helpful. Thank you.

Yes, certainly. First off, backlog, I would say, steady as she goes. I wouldn't put the term as aggressive as you do, but it's looking pretty good. And part of that reason is then the consistent or the past five quarters where customers -- if you look at the customer base that we service, have been getting their inventories in order. So I'll start with, we've seen that. The second thing is, we have not seen an uptick in cancellations from customers. So it's sort of an interesting dilemma. What we have seen is customers giving us the orders to make sure they're going to get the product when they want it, and so far they have been, which is why I'm not sure that everybody is on this over-ordering pattern. The market was already in decline. COVID it pushed down. So the real question in my mind that I believe needs to be answered is, how much is the impact of COVID over an economy that was already weak. We were five quarters into what had traditionally been a six quarter downturn historically, and you can go back to the last two, that pretty much has held true. And the fact that we're just sort of taking a pause here and holding for one quarter I think is good news, and we'll see how the quarter materializes out from there. But so far everything has been steady here. Our backlogs are steady. We are not seeing a huge ramp of those. And obviously, you have a decline of 12% year-over-year in your numbers. And of course, book-to-bill is going to look better because book-to-bill indicates the future, it doesn't indicate the past. So when you have a drop like that of year-over-year sales, just be cautious, the book-to-bill is less meaningful because customers are positioning their inventories to match what their MRP requirements are. So hopefully that gives you a little bit about how we're thinking of it and how it's looking right now.

Appreciate that. Thank you. One other if I can. Mike, you mentioned in the prepared remarks you intend to emerge from this current situation as a stronger business. We know that or we think that you're gaining some share at what is I think your largest supplier. It seems pretty clear. And I wonder if -- and you're also going through this divestiture of the IT asset disposal business. Any other things that were maybe stimulated by the current situation that could cause a change in the business, either one that you're practically taking or one that you're sort of pushed into by the environment that would make the Company stronger either in sort of an absolute way in a relative way versus your competitors?

Well, as far as it goes toward the competitors, that's hard to see exactly what they're doing in this downturn. But for us, remember, we spoke a little bit early on about the increase of our services business, which were staying and ties customers closer to us, makes us more sticky, has us more involved in their business, more involved with their products going in and out, more involved from the design point of view. So we're seeing the number of those customers going up, and we think that that is great for the business because that really was the vision. Remember, that was our strategy that engineering becomes a bigger and bigger piece of our business, and it's interesting that we're seeing that despite COVID, despite the downturn, that most of our engineering dynamics are still going up, so customers are viewing us as a trusted source for their future designs. So that is one area that I do believe we'll come out much stronger as this turns around. We have been able to gain some efficiencies through our ERP system, and the downturn has really shown us how valuable that is in helping us use data to our benefit as information. Before some of the data, because we had multiple systems, we could never ask the same question everywhere in the world and then come up with the same answer, use the same metrics to have those answers help us around efficiency of our business. So the ERP system now is becoming a tool that we believe is important. And I told you why before because we can see what products are increasing like, for example, sensors, and allows us to go in and take a position on sensors early on that will support not only the customers we have but the new customers asking for those products. And that was really important when everybody figured out they want to build ventilators in the first quarter and I don't know how many of those ventilators actually got off the engineering pages to get built, but there was a lot of products that went out for that, and it allows us to capture current trends. So those are going to be things that are going to be very important in the future that we stick with and continually improve our situation, continually improve where our people go. We think the Company will get much more efficient because of it and allow us to grow faster and preserve working capital in a way that we're not investing in things that maybe aren't so good anymore.

That helps. Thank you, Mike.

You bet.

Thank you. Your next question is from Joe Quatrochi of Wells Fargo.

Yes. Thanks for taking the question. Kind of building on your last answer there on the ERP system, that's really interesting. Do you think that given kind of where your book to bill sitting today, you need to make some working capital investments this quarter? Just trying to think about how to think about inventory.

No. I think you look at the inventory, the inventory is relatively stable where it is. It could end up going down a little bit, I think is our plan. So, we do plan on generating cash flow and working capital for our benefit. These inventories that we hold for customers presume that they take them at a certain period of time and if they don't take them, then they lose that inventory. And I think customers right now are trying to figure out how to gear their factories back up and make a living. So I'm not so sure they're willing to get out of place when it comes to getting their products. So all in all, right now I think we're stable and steady as she goes. We don't have any huge working capital requirements for the second quarter. As I said, we have things that are buttoned down. We still do have the investments in a couple of our logistics centers, which will make them better for the future and more efficient and we'll continue with those. But pretty much everything else, if it's moving, it's getting shut down.

Thanks. That's helpful. And then on the ECS side, I was wondering is there any update you can give us on the size of your cloud business. I would think that it would have accelerated this quarter. And I think in the past couple of years ago, you said that was around $1 billion.

Yes, sure thing, Joe. I think the last time we talked about it, we probably mentioned that we were on a run rate approaching $1 billion. I can say it's now well north of $1 billion. And more importantly, if you get underneath that and you look at the annualized recurring revenue piece of that, while it's a little bit too early for us to call a number, I can tell you that that's growing by double digits pretty consistently and it grew again by double digits in Q1. So we continue to build that portfolio both in terms of cloud offerings across the supplier base, but also in terms of our go-to-market capabilities with our ArrowSphere platform which is really helping us change the way we sell and change the kind of selling partners we engage and in turn make us more and more sticky as we help our partners manage cloud subscription. So we're happy with the progress so far, but we certainly have more to do.

Thank you.

Your next question is from Adam Tindle of Raymond James.

Thanks. Good afternoon. I just wanted to circle back to some of the commentary that seemed to allude to TI. And Mike, you mentioned not expecting some big windfall we'd have to disclose it if it was material I think were some of the things that you were saying. But if we look at some of the competitor revenue, it is material. So I guess the question would be, where do those billions in revenue go? Is that to say that that revenue is potentially not coming to Arrow? And secondly, that competitor actually grew sequentially with them in an environment where everything is declining. So I'm just overly confused is why customer would want to go with them at this point? And just any color around that would be helpful.

I mean, you're asking quite the same questions we have. I don't know the answer to that last question you answered. But what I can tell you is, yes, there are some customers coming. I think there was a relook look at exactly work TI said they were going to do, if you go back to the original letter of what TI said, that's exactly what they're doing. And we have no reason to believe that that will be a negative impact on us and would there be some benefit or some customers that want to come to us, yes, I think that's true. But the program hasn't changed. So all I'm cautioning you guys is don't make this into something it's not. The questions just keep coming. God, I wish I could tell you it was $10 billion, and we're going to have a windfall. It'd be great, wouldn't it? But it's not that. And I think everybody has been a little over-exuberant about it. And it's not the reason for our performance.

Okay. That's fair. And then also I wanted to dig into the approximately $30 million in charges. Could you maybe break that down further into what portion is foreign tax versus loss on investments, what does loss on investments mean, and what are the guiding factors to see that come back into operating profit dollars for ECS? Or should we be thinking about just a permanent $30 million reduction to the run rate?

No, it's definitely not a $30 million reduction to the run rate. So let's start there. As Mike mentioned and I mentioned, this took place over five years. The bulk of it really surrounds taxes that impact OI, so sales taxes, bad taxes those kinds of things. When we say other contingencies, there was a few things that we caught from a reconciliation standpoint that we felt needed to be cleaned up. But from an ongoing run rate standpoint, I would argue that it, even if you took the number and you divided it by five years, that's not the concern because there's penalties and interest in that that we're having to deal with as well. So we're on it, and we're addressing the issues, and we'll move forward from here.

Okay. I guess...

I'll just clarify one thing, if I could, Adam. The $16 million loss on investment you see in the income statement is a mark-to-market on some other investments due to the stock market performance during the quarter and had nothing to do with the charges.

Okay. Thank you.

Thank you. Your next question is from Ruplu Bhattacharya of Bank of America.

Hi. Thanks for taking my questions and congrats on the quarter. Chris, I just wanted to talk a little bit about the book value per share. It's about $57. One of your competitors took a goodwill and intangible asset write-off. How should investors think about the goodwill on your balance sheet? Have you guys taken a look at that and any danger of any write-offs in the near term?

We look at that on a regular basis and pretty much quarterly, and we're good for now. The way you have to evaluate that in terms of where there is impair in part anyways based off how the market views Arrow. And currently with the stock above book right now, we're in good shape. So, the bulk of the goodwill that exists obviously relates to acquisitions that we've done years ago, but we did do a rigorous tests as we close Q1 and we are good.

Okay. Thanks for that. Just on inorganic growth, I mean, valuations for companies have pulled back. I know you need to conserve cash at this point. But at some point, are you going to start relooking at M&A? And how should we think about that going forward?

Yes, I think the -- again -- remember, we told you the uses of our cash. Obviously, internal growth was the most important. And then we look at sort of M&A and then return to the shareholder. There is, right now, there is probably another one that you would put in there that you would never have had to put in there had it not been for COVID, and that was to make sure you preserve enough liquidity to run your business in case of a catastrophe. And I think at this point, we've demonstrated we have the liquidity to run the business. And at this point, our main concern is that the business emerges stronger than it did before. So that would be our first use of cash whatever that means. And if this point in time, I'm not looking at any big acquisitions that are going to make changes here, I think we just want to see the market get back stable, get back a little more normal. We've got enough to do to keep our business healthy and efficient than to lay something else on top of it that's not efficient or has a bunch of problems that frankly I don't want to deal with. I got enough problems right now, and I think we're doing a pretty good job managing them. I just don't want to add to the stack of problems if that helps you.

Yes, no, that makes sense. And for my last question, Chris, I think you talked about strong book-to-bill, 1.12. As we stand here, April 30, can you talk about the relative strength across in components across all three regions, which one is trending stronger, which one is weaker?

Ruplu, it's Andy. We've seen the positive trends continue through April, as Mike pointed out, and we're seeing our businesses play out pretty much as we expected. And most noticeable was the expected bounce back in China. And that is indeed what we're seeing. So nothing abnormal to the way we guided in the regional makeup so far.

Okay. Thanks for taking my questions. And, guys, congrats again on the strong quarter and also for giving guidance which is impressive in this environment. Thank you.

Thanks, Ruplu.

Thank you.

Thank you. Your next question is from Tim Yang of Citi.

Hi. Thanks for taking the question. You mentioned design activity has actually increased overall on a year-over-year basis. Can you talk about which end markets are driving that design activities? You mentioned I think ventilators and also home monitoring devices. Is that a major driver?

I think what we're going to do is, as far as design goes, we're going to have Andy talk to you about it because it's actually been a good investment by us over the years that we think is going to pay off and there is a lot going on now. So, Andy, why don't you go ahead and talk about it?

Yes, Tim, we're seeing design activity hold up pretty well obviously regionally across the world. So that's an encouragement. We put a lot of investment into Asia in our demand creation facilities and that's playing out well. In terms of end market segments, as I said earlier on, we're pretty well diversified across those segments. Broad industrial base is obviously a big part of our heartland, and that's really the heartland of our engineering efforts, and we're seeing that continue to play out. But don't forget, we continue to do design work in automotive segments, in aerospace and defense, etc., etc. So it's the kind of breadth of customers that we touch, the engineering investment that we've made, which is really enabling us to continue to do this through this current market cycle. So hopefully that gives you a little color about where we're seeing it.

Sure. Yes. That's very helpful. And then if I use this midpoint of your guidance, and I think it implies operating margins at roughly 3.1%. And I assume that your Q2 SG&A will be very similar to Q1 level given that there is extra cost to run the warehouse with this virus. So that means your gross margin will be at roughly -- which means that's a 40 basis point year-over-year growth -- I mean, 40 basis point increase on a year-over-year basis. So can you maybe just talk about, is that the right way to think about your gross margin for June quarter? And then if so, what's driving this gross margin improvement? I think the design activity is definitely one. But I think, look, you had a lower volume, but the gross margin improved. How sustainable this margin performance could be? Thank you.

You've got an awful lot in there and I'm going to answer, kind of, yes, all of it because, as you know, margin is not a one quarter windfall. The other thing to keep in mind is, the relative mix of our sales right now is changing very quickly, and that's something that we have not had to deal with before where you have a China shutdown and then a month later China coming back up. And so a complete shutdown of sales changes your mix a little bit. So don't underestimate that impact on margin or on gross margins. The same thing you have in the warehouses with freight. Depending on where we have to ship from because you might have something down in one portion of the world that is a more efficient warehouse to ship to that region of the world all of a sudden comes from somewhere else, and our big goal is to service our customers with what they need when they need it. And then the third thing is -- or the third and the fourth thing is, our engineering business has stayed stable, which helps the margins, and our services business has increased, which increases the margin. And so and it's really very hard to bring that down to one item. But this has been our strategy all along and so our strategy is playing out that, A, we can operate anywhere in the world at any time under any circumstance. I think the first quarter has shown that we could do that. By the way, at the same time, we said more than 10,000 people to work from home. Don't take that number out of your mind. That's a ton of people that were in the office one day and then in one day they were home. And there is cost to that. But they have been maintaining their sales orders and the profits on those sales orders. So that has been beneficial too. So I wanted to give you a little color before Chris adding to it, just what we were dealing with in this quarter. So is it lasting? It's hard to say.

Yes. And Tim, a couple of quick points, WE are expecting SG&A to go down. So in spite of headwinds on transportation and some of the warehousing challenges that we face, we've gone on lockdown on anything discretionary. We're protecting our key strategic areas, as Mike mentioned, like around design that's critical to us, that's going to serve us well in the future. I think the other thing is just kind of moving away from operating income margin relates to the question that was asked a little bit earlier. We did have some other operating losses of about $16 million in Q1 that relate to mark-to-market adjustments in some pensions and then also in some other stock investments that we hold in joint ventures. And so that is not expected to reoccur again in Q2, and so that's a tailwind to EPS as well.

Super-helpful. Thank you.

Thank you. Your next question is from Nick Todorov of Longbow Research.

Thanks. Good afternoon, guys. Can you talk, if you have seen supply chain disruptions and changes in the lead times for the hardware portion of your ESS [ph] business? And if so, have you seen an impact on demand from that? And just related, I think I heard as you noted the strength in orders for storage. I just want to make sure that's for the software part of storage and not to the typical hardware portion.

Yes, Sean, go ahead.

Sure, Nick. Let me start with your second question first. So my comment about storage was the hardware storage in the first quarter. We do understand that traditional on-prem infrastructure is somewhat challenged in this environment, although I would say over the long term I am highly doubtful that it goes away and it still remains a significant piece of our business. In terms of the supply chain overall, with the very significant backlog, we have seen that drain somewhat in the month of April. That certainly gives us some confidence relative to our Q2 outlook. I would say the supply chain challenges have not completely abated since the Chinese capacity has opened up to some degree. We've seen some of the component level challenges moderate. On the other hand, there are still bottlenecks at different points in the process, be at assembly integration and test, etc. And we just continue to work with each of our suppliers on a case-by-case basis to make sure we can meet customer expectations. But in general, lead times haven't extended much further than where they were before this all started. And with the exception of some things that are prioritized for healthcare and government agencies, we seem to be making progress on it at the moment.

Okay. And if I can just follow up, I think it took some restricting and cost of last year. Is there any savings that are left to roll on into this year and do you see the need for additional cost cuts other than just discretionary that you're taking, near-term?

So, in Q2 we will lap -- effectively will have a full year impact from last year's actions under our belt. In terms of what we're doing right now, it really is cutting discretionary. Our goal is to make sure that we maintain our strategy because that strategy has served us very well over the last couple of years, and that will be what differentiates us coming out of this. So we're doing everything we can to protect that, and we think the actions that we've taken to date are serving us well.

Thank you. We have no further questions at this time. I will turn the call back over to Steve O'Brien for any additional or closing remarks. Steve O’Brien: Thank you. In closing, I will review Arrow's Safe Harbor statement. Some of the comments made on today's call have included 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.

Thank you. This does conclude today's conference call. You may now disconnect.