Arrow Electronics, Inc. (ARW) Earnings

Management highlights

Key themes include leading indicators improving with book-to-bill ratios above parity in all regions and backlog building; market recovery unit volume driven by customer demand; recovery broad-based with mass market customers' backlog building; value-added services, especially supply chain services, contributing meaningfully to operating income; achieving more profitable growth due to better mix, value-added services accretion, and efficient cost structure. Four key pillars of investment thesis: leading position in large and growing markets; differentiated capabilities driving profitable growth with increased mix of higher margin value-added services; diversified business model providing financial flexibility; focused capital allocation strategy to maximize shareholder value. Priorities include continuing to execute with discipline, drive operational momentum, expand high margin value-added offerings, and align leadership compensation with relative total shareholder return. Board's search for permanent CEO is ongoing.

Guidance

Expect sales for the second quarter to be between $9.15 and $9.75 billion, up 25% year-over-year at midpoint. Global component sales expected between $6.8 and $7.2 billion, up 5% at midpoint sequentially. Enterprise Computing Solutions expected between $2.35 and $2.55 billion, up 7% at midpoint year-over-year. Estimating tax rate in range of 23% to 25% and interest expense of approximately $60 million. Non-GAAP diluted earnings per share expected between $4.32 and $4.52. Global components expected to perform at or above seasonal trends in all regions for remainder of year, but Asia seasonally strong in Q2. Supply chain services expected to return to more normal profit level in Q2. ECS expected to have healthy hardware sales driven by ongoing AI data center build out. Organizational annual compensation increases to impact operating expenses beginning in Q2.

Segment performance

Total revenue was $9.5 billion, up 39% year-over-year. Operating margin expanded 160 basis points to 4.2%. Non-GAAP EPS was $5.22, up 190% year-over-year. Global components sales increased $758 million sequentially to $6.6 billion, non-GAAP operating income increased $146 million sequentially to $365 million, non-GAAP operating margins increased 180 basis points sequentially to 5.5%. Global ECS sales increased approximately $800 million year over year to $2.8 billion. Total ECS billings were $6.4 billion up 39% year over year. First quarter non-GAAP operating margins for ECS declined modestly by 10 basis points year over year due to factors like hardware sales momentum and a charge related to an underperforming contract. Networking capital declined sequentially by approximately $490 million, ending the quarter at $6.9 billion. Inventory grew sequentially by approximately $640 million, ending the first quarter at $5.7 billion. Return on working capital increased 11.8 percentage points year-over-year to 23.1%. Return on invested capital increased 7 percentage points year-over-year to 13.4%. Working capital as a percent of sales declined in the first quarter through approximately 18%, and cash conversion decreased year-over-year by 16 days. Gross balance sheet debt at the end of the first quarter declined sequentially by $619 million to $2.5 billion. Repurchased $25 million in shares in the first quarter.

Analyst Q&A

• Q: Touch on what drove the ECS strength in Q1, how much of that may have been one time, and then also what's driving the Q2 guide. And then secondly, if I could, If you could quantify the contribution from value-added services maybe to hyperscalers specifically.

  A: Eric said trends in ECS are same as several quarters with high growth in cloud, AI, software, and infrastructure business. Q1 had extra growth due to memory shortage and four days at end of quarter. Q2, Q3 expected to be more normal quarters. Rick said on hyperscaler side, experiencing same growth as market, serviced through supply chain services and normal channels. Raj added one hyperscaler accelerated data center build in Q1 leading to higher revenues in supply chain service business. Value added services was about 30% of operating income last year, ticked down a little in Q1 but still significant contributor.

• Q: Ask for more detail on margin performance between fiscal 4Q, fiscal 1Q, and components, contribution of extra four days on revenues as well as on EBIT, and on value-added services part, whether level of demand will continue.

  A: Bill said business in Q1 had strong leading indicators, regional mix change with mass market coming back, value-added services push, growth in mass market. Raj said growth in West, mass market customer coming back, value-added services, not pulling in demand for value-added services but extra growth, four extra days in ECS business worth several hundred million dollars of billings in Q1, not benefiting in Q2.

• Q: Ask about judging pull ahead, risk of component costs including memory costs going up, chance of customers pre-ordering, risk of lower demand in second half.

  A: Raj said monitor order flows, don't see double ordering currently. Rick said lead times gradually increasing, customers looking at buffer inventories and demand planning based on lead times in line with market. Also, revenue growth in components business driven by unit volume growth not pricing, memory exposure in mid single digit range.

• Q: Ask if resell GPUs and percent of product line that is, and if ECS is meaningful contributor this year.

  A: Rick said don't resell CPUs or GPUs. Eric said hardware business in ECS is 25% of revenue, impact of memory on ECS weak, but ECS heavily exposed to AI and data center build with good long-term opportunity.