Q2 2021 Arrow Electronics Inc Earnings Call

Good day, and thank you for standing by welcome to the Arrow Electronics second quarter 2021earnings conference call. At this time all participants are in a listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question. During the session you will need the press star 1 on your telephone.

If you require any further assistance press star Zero I would now like to hand, the conference over to your speaker of today, Steve O'brien. Thank you. Please go ahead.

Thanks, Stephanie and welcome once again to Arrow Electronics second quarter 2021 earnings conference call with US on the call today are Michael long, Chairman, President and Chief Executive Officer, Sean Kerins, Chief Operating Officer, and Chris Stansbury, Senior Vice President and Chief Financial Officer. During this call we will make forward looking statements.

Including statements about our business outlook strategies in the future financial results, which are based on predictions and expectations as of today, our actual results could differ materially due to a number of risks and uncertainties, including the risks risk factors in our most recent 10-K and 10-Q filings with the SEC we under.

No obligation to update publicly or revise any of the forward looking statements. As a reminder of some of the figures. We will discuss on today's call are non-GAAP. We've reconciled those of the most recent directly comparable GAAP financial measures in our earnings release. These non-GAAP measures, our non intended to be a substitute for our GAAP results.

You can access our earnings release at the Investor Day, the Arrow Dot com along with the CFO commentary the non-GAAP earnings reconciliation and a replay 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 of our chairman President and CEO, Michael Thanks, Steve.

Thanks, all of you for joining us today.

Over the last few quarterly reports I've shared with you the growing momentum behind our business.

Even as we navigated the pandemic, we maintain staffing we continued to identify efficiencies to fund greater investments in design engineering and supply chain services I am pleased to report that this momentum of shielding results.

We achieved all time record sales gross profit and earnings per share not just for the second quarter, but for any quarter in arrow's history.

In our industry, maintaining a leadership position requires constant evolution at arrow, we strive to be our customers' trusted source for solution to their manufacturing and information technology challenges, we always seek new ways to help their businesses be more successful to do so.

We must consistently expand and enhance our service offerings in the areas of engineering design for manufacturing supply chain management and secure workload management and we've made great progress on these fronts.

Arrow is now operating from a position of strength the.

The opportunity for our business has never been greater in the current environment. It is rare to find the company or industry does not facing challenges from the supply chain perspective.

We are ideally positioned to help customers address those challenges by leveraging our unmatched database of the design of electronic components information from our media properties beyond the information we see the companies around the globe are rethinking their approaches to component procurement.

Just on time deliveries of become a high risk low return strategy.

Customers are seeking reliability and we can work with them to create a more stable and more secured stream of parts that benefits our suppliers as well.

As a result, we've expanded our customer base and are engaging with new companies who are in the past had not considered arrow services, we're providing solutions tailored to their specific challenges to achieve success.

The trajectory of our global components business with very positive during the second quarter.

Our global components business capitalized and continued strong demand in all regions.

With sales up 40% year over year sales were above the high end of our expectations for the fifth quarter in a row the up.

The side largely attributable to our ability to secure additional inventory to meet the strong demand.

We saw robust demand from key industries, such as transportation Industrial communications consumer electronics and data networking. We also saw growth in the aerospace and defense sector on a year over year basis as the commercial aviation industry continues to recover.

The result global component sales reached 6.6 billion, which is an all time record in the company's history.

Again this quarter, we achieved significant growth along with exceptional profit leverage on sales and.

Operating income from global components increased more than 2 times the rate of sales growth. We continue to provide customers with valuable supply chain services that utilize our global ERP capability and distinguishes our level of inventory insights from many of our competitors in this area.

Our digital platform is also helping customers manage component supply and safeguard their manufacturing the sales contribution from design and engineering activities, which were remarkably resilient through the pandemic is keeping pace with the market growth.

<unk> back to a multi year view of our industry. We see several key indicators of the smooth transition to normalized demand first based on our current orders in backlog, even with the heavy level of caution of skepticism, we see the urgent need for electronic components.

For production extending well into 2022.

We believe customers want to keep their places in line with lead times extending.

Lastly, and this isn't changing the increasing electronic content and everything around us is the tail.

<unk> for the business.

Turning to enterprise computing solutions sales were in line with our expectations and billings increased at a solid rate year over year.

We experienced growth in storage and.

In networking, which was helped by businesses and their workers returning to their offices, while the board turned out largely as we expected in the short run lower spending on work and learn from home is an offset the growth we saw supply chain issues limit our ability.

To capitalize on stronger demand.

While we're pleased with our enterprise computing solutions performance, we see strong potential for even better results.

It spending priorities of shifting towards more complex transformational projects that tend to be better aligned with our value added focus.

The growing threat of.

Landscape and the return to on site business have greatly increased activities for our business.

Increases in cyber threats, such as ransomware attacks continued to shine a light on the importance of being proactive towards the security protocols.

Arrow has proven itself to be an expert in this area and continues to be the trusted partner for bars, MSP and their end customers.

Finally, I'm happy to report that we increased our share repurchase authorization by an additional $600 million. This comes of approximately 1 year. After our last $600 million authorization and shows our continued commitment to returning cash to the shareholders at <unk>.

Its levels in our industry.

As our metrics show, we have never in our history been better positioned to balance working capital demand with robust growth.

This makes the increasing cash returns and easier decision.

With that I'll now hand, the call over to Chris to provide more details on our second quarter results and expectations for the third quarter.

Thanks, Mike the second quarter sales increased 25% year over year on a non-GAAP basis the.

The average Euro dollar exchange rate for the quarter was $1.21 to 1 euro compared to the rate of $1.18, we'd use for forecasting.

Slightly stronger euro benefited sales growth by approximately $69 million more than we anticipated.

Interest expense was slightly lower than we expected, but it is slightly higher than expected effective tax rate offset any impacts of the bottom line for.

For the full year 2021, we continue to expect our effective tax rate to be near the low end of our long term range of 23% to 25%.

Turning to the balance sheet and cash flow second quarter operating cash flow was $281 million. Despite substantial inventory demands to fund growth over the last 510, and 15 year periods cash.

Cash flow from operations has consistently averaged 90% of non-GAAP net income, but on a year to year basis cash flow has an inverse relationship to sales growth our cash cycle of approximately 50 days improved by 6 days compared to last year. This improvement significantly aided cash flow performance in the face of working capital demand.

Ann.

Our liquidity position is the best in the history of our company and continues to improve leverage as measured by debt to EBITDA is the lowest level in nearly 10 years.

We returned approximately $250 million to shareholders during the second quarter 2 of our share repurchase plan.

And this was the largest single quarter of share repurchases in our history and it was enabled by our strong profit and proactive working capital management.

We remain committed to returning cash to shareholders and recently expanded the operation by 600 million the.

The total authorization under our plan is approximately $663 million.

And we're confident that we're purchasing shares below their intrinsic value based on the increasing return on invested capital and return on working capital that we're showing in the business.

Please keep in mind that the information I've shared during this call is the 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.

<unk> sales and EPS guidance would be an all time third quarter record.

<unk> is implied in the third quarter profits would be slightly above the second quarter. Despite slightly lower sales of both businesses continue to face supply constraints that are limiting our ability to make the most of strong customer demand. Our guidance reflects continued strong profit leverage for global components on a year over year basis and for global enterprise compute.

The solutions profitability to remain consistent with last quarter and last year.

Finally, as we discussed last quarter. Please note. The CFO commentary includes information on our fiscal calendar closing dates for 2021.

In 2021, the fourth quarter starts on October 3rd Unlike in 2020, when it started on September 27.

This makes the fourth quarter shorter than prior year fourth quarters.

But year over year comparisons for the second and third quarters are not affected and our fiscal year ends on December 31 as always.

With that I'll turn the call over to the operator for Q&A.

At this time, if you would like to ask a question. Please press Star then the number 1 on your telephone keypad again. The Star then the number 1 to ask a question.

The first question comes from the line of Joe <unk> with Wells Fargo.

Yes, thanks for taking the question congrats on the results I was curious.

Last quarter, I think you've talked about being a hand to mouth in terms of anything that you could get in from an inventory perspective of the write off the door I was wondering if you can talk about.

The sequential increase we saw in inventory relative to the demand commentary you gave the backlog commentary.

Yes.

Thanks for the question I think you hit right at the core of.

What everybody is wondering clearly book to bills are still strong backlog has grown significantly again in the quarter.

Inventory, while you saw up.

I have the value with a moment of time.

If you would have seen the same inventory on Monday, it would've looked significantly different.

We are still.

A bit of hand to mouth, however, we've been able to try to manage our customers' expectations.

Along with our suppliers.

So everybody knows whats coming on.

The third quarter guidance is purely guidance based off of what we think we can get an inventory.

I can tell you right now it would be a very simple equation it could be of $1 billion bigger if I got the inventory. So the demand is not the issue.

At this point in time supply is the issue.

But I would say there is more visibility into supply now than there was last quarter or the quarter before and hopefully.

We will be able to keep everybody's expectations in check and hopefully we can get out of this sometime next year, but as I said in my remarks, I don't see it anytime sooner.

Thanks for that and then just as a follow up for Chris.

Just kind of curious on the gross smart kind of imply gross margin for the September quarter, how should we think about the mix and the pricing and it seems like that can be pretty strong.

Going into the September quarter.

Yes, I mean, I think again, we got to be careful about looking at points in time.

The way we're looking at it if we look at our Q2 performance.

Basically back to the gross margin level in the components business that we were at before we went into the cyclical downturn.

In late 2019, So Q2.19, the Q2 'twenty 1.

Both margins are pretty flat, so I think what you're really seeing in the business.

Is a return to those historical levels, but at much higher sales and gross gross profit dollar levels, which is driving operating leverage down through <unk>.

<unk> margin. So as you go to Q3, specifically answer your question, we just really see that trend continuing given the current environment and we will continue to drive strong leverage operating leverage as we go forward.

Thank you.

Your next question is from Matt Sheerin with Stifel.

Yes. Thank you good afternoon I just wanted to follow up on the previous question regarding the.

The gross margin.

Also just the pricing environment.

And it looks like the mix is certainly helped geographically with with Europe growing year over year and really strong sequential growth.

In North America.

But value weighted imagine that you're in a pretty beneficial position in terms of pricing.

Not battling your competitors for 4 orders so how much of that is helping and how sustainable do you see that.

Thanks, Matt I think.

If you remember the last couple of quarters, we had talked about the.

The design win business being off some of the.

Of the engineering business being of some.

And.

On the ancillary businesses in here, where customers were focused on just getting product not really.

Driving more designs.

We've had record design wins for.

For the quarter is.

It's hard to find a business in house.

That is not producing these days so that helps a lot.

The mix is the mix is sort of coming back as Chris said to pre declining levels.

And I think thats really what youre seeing that other than something special because of demand.

These contracts.

Sort of roll off and roll on over the course of the year. So there is not a lot of room for a huge uptick in pricing.

We do have suppliers that raised their prices that gives us more gross profit dollars, which is the benefit and we've seen that from a few of our suppliers, but it has not been.

Widely done at this point, although we do expect price increases over the balance of the next year and I don't think theres any way to stop that given the raw materials that are coming in so price increases are real therefore of real reason more than just the demand piece.

On the second side of this mad customers are being held more accountable for their forecasts than ever.

And I think that's going to be good for the industry going forward and the supply chain going forward. So I would say.

Most of it to stick.

And I'll leave it at that for right now.

Okay. Thank you.

And just on the semiconductor side, we've been hearing from several suppliers.

And customers that customers are we configuring boards and designs.

Accommodate the constrained say replace parts with others.

Are you involved in that at all what types of orders I would imagine youre at the ease of working with customers there and do you see that as the positive or negative for arrow.

I call it overtime right now which is a positive.

Any gi hire engineers of working overtime match, that's more money for arrow and we like that.

Not to be too flippant about it but our design services business is working.

At scale right now, helping customers find new products.

I will put of caution on that we see most of the work continuing to be new designs for the future.

Theres not a lot of mileage short term and trying to redesign of board to find another product because of the product Youre looking for is on allocation too and so I don't want.

You to think for a minute that that work is the primary driver of the engineering business because.

Frankly, it's not.

When you look at the components lead times.

There's not much that's available in 12 weeks right now.

Got it okay. That's very helpful. Thanks, a lot of height.

Yes.

Your next question comes from Boston.

About the Chara.

With bank of America.

Our questions and congrats on.

Instead of a way to quantify what the impact was of component shortages on your revenues.

How much more could you have shipped either on the components are in EPS. If you had all of the parts.

Yeah.

Well you know.

I thought you heard me before but.

Given the $1 billion will ship of $1 billion.

Give us the $1 billion of half will ship a billion of half after that I'd probably have to look at my notes and do some math to see a bit more but it is a lot of product that we could ship.

Okay. Okay. Thanks for that day I appreciate that.

And then maybe just on the margins on the component side, you had a strong 50 basis points of operating margin improvement.

And youre above 5% now.

I guess on the guide for the September quarter, Youre guiding for many of them.

The lower revenue at the midpoint.

Do you think you can maintain the.

The higher margins.

Is there a way to quantify how much of that 50 bps is mix of horses FX forces.

Higher volumes and how should we think of us margins going forward.

Yes.

I think youll see like.

Margins going forward Thats, what we were.

Sort of half an.

In our model.

And by the way I had a debt with the guys that no..1 would notice we were over 5% on the bottom line. So thank you for that.

It's.

As I said, we were getting back to the sort of the pre pandemic levels in the.

Pre downturn levels, where we did have the.

The company leverage both.

For us from a scale point of view to produce right around that 5% range and it's good to see even after going through a downturn and coming back up out of the downturn that we could get there, but we are expect them to stay right there for now.

Okay. Thanks for all of the details congrats on the quarter.

Thanks.

Yeah.

Your next question comes from Nikolay Todorov with Longbow Research.

Yes, thanks for taking the questions and congrats on from strong results I wanted to first clarify.

The comments around components supply.

You were able to get upside inventory in the second quarter, but driven based on your guidance. It sounds like you are in the face incremental constrains and getting inventory in the third quarter. So.

<unk> getting worst what are some of the drivers of that.

You also talked about improving visibility so it sounds like there's sort of a silver lining of getting better, but maybe thats more on the.

In the fourth quarter or beyond that so just a clarification on debt.

Well I think the qualification was I thought it would get better towards mid next year.

That was the qualification I didn't expect it to get better in the short term, but if you look at the guidance it would suggest.

We think we're going to get the same amount of product that we kind of ended up with last quarter.

It would be great if something else happened in the quarter and it very well could but our job here is to give you the very best that we see at the time that we're on this call.

And I think we did that.

I would hope we would get some upside but you have everything we think we're actually going to get right now.

Okay, and then on the on the on the on.

Operating margin on the component side getting to the 5% of obviously much earlier.

Dissipated can you talk about the structural versus cyclical components on impact on the operating margin and as we think about you mentioned.

Inc. Component of pricing if you can kind of on an uptrend for the at least in the medium term for the next couple of quarters should we anticipate for Youtube.

The incremental uptick in the.

And component margins as pricing flow through and drive the leverage.

Yes, if we see the growth as we see growth.

Yes, I think you'll see some of the business operates.

2 of certain level of the business, where all of your cost base.

Based upon your mix and if youre down on 1 area of your costs are a little higher you feel that once the corporation gets to a certain breakeven size everything becomes kind of of fixed cost after that.

And I can have Chris detail that for you.

Little more when when I finish, but when you have that fixed cost coupled with a little bit of margin improvement that is exactly what youre seeing in the leverage and we expect that the continued Chris do you want to add to that Nick.

Nick Junior debt.

To put it in perspective kind of going back to the comment I made earlier on.

Where we were pre the cyclical downturn of 19 and pre Covid on where we are today.

So on ROI margin has grown by 120 basis points, that's entirely opex as a percentage of sales it's entirely operating leverage the gross margin is effectively flat and so back to mikes point, there's a lot of puts and takes the go on in the mix of the business, but this is this isn't the operating leverage model.

And the more that we can drive in terms of sales and GP.

On.

The opex efficiently, that's what really drives the Oi margin, where it is so that's the <unk>.

Big picture.

Got it very helpful. If I can sneak 1 more.

Free cash flow generation very strong given the environment, Chris sounds like you've got the right format on for working capital management, maybe can you talk about the structure on nature of free cash flow of in a strong growing demand environment.

The new normal for for Arrow to have positive free cash flow Inc.

Yeah.

Yes, I wouldn't go so far as to say, it's the new normal I mean, the reality is back to mikes comments on if we had more we ship more ideally if you were to take the current baseline of sales we have a few $100 million more of inventory than we have today.

The amount of higher but we definitely have more inventory and typically in a window of like we're on growth like we're going through now you would see those additions coming in but because of the supply constraints, it's a little.

It's a little tougher so that'll normalize over time, but that said I think we can continue to manage.

Our collections and our payables very tightly as well as both of those inventory turns and we will and.

That has been of focus over the last 12 months, we generated over $700 million in cash and it will continue to be of focus.

Got it thanks, guys. Good luck.

Your next question comes from Jim Suva with Citigroup investments.

Thank you.

Lot of the commentary so far was focused on components, which is absolutely fair can you talk more about ECS. We're hearing about a lot of corporate enterprise demand yet it seemed like this quarter I'm not saying it was.

Bad, but it was a little bit softer than I think what some people were expecting or maybe it was just a lack of availability can you talk about ECS a little bit.

I'll give you an override what we're seeing.

Jim is sort of.

And our customer base of our retreat from work to home and.

Migration to more complex.

Data center issues that we add.

Prior to the downturn of prior to the pandemic, which clearly changed the trajectory of this business and every other business out there so.

So we do have some supply constraints that are are very real in that plus the change of how the businesses is moving.

Happening.

Pretty good clip and it takes longer to close those more complex deals or longer to service those deal than just <unk>.

Setting up work from home Somebody's home office.

So that's sort of the structural change we've seen I'll have sean add to that a little bit.

And tell you what you sort of expect Youll see over the next quarter or 2 which should catch up to this.

Yes, Jim.

So my point, if you look at kind of our performance in the second quarter on a relative basis, we actually saw pretty good strength.

Across the hardware portfolio.

The proprietary server storage networking I take that as a good sign of kind of renewed activity levels in the traditional data center I don't think.

That's all the way back yet I think we're still looking for that to get back to more predictable levels, but I would take that as a good sign.

I think we saw at least the pause as it relates to some of our work and learn from home offerings and then the associated security.

<unk>.

Transitory if you will I think security is still.

A really good market to be in I think it's the big piece of our.

Our mix.

And we're going to continue to invest in that space and that's going to be promising for some time to come.

I think that as we look to Q3 and beyond.

We are wrestling, a little bit with the the downstream impacts of the the chip shortage.

In our systems business I think we saw a rotation.

Out of Q2 into Q3, and I think we will see something of a similar magnitude.

Out of Q3 in the Q4.

But activity levels, we do fully expect to pick up.

Backlog is strong.

Now getting more visibility too.

More demand from end users to channel partners for bulk.

The multiple quarters, not just 60 to 90 days.

So that's a good sign so I think the overall direction of the market is as promising but steady and so on.

The mix I think where we're headed for better days.

Great and then my follow up question, maybe it's better for Chris.

I noticed your inventory went up Mike said, if he had another ex amount of revenues you could easily sold at an X plus Y you can of sold that too and maybe even more so when you mentioned the point in time for inventory was that literally like a truck showed up the day of your inventory count and you didn't have time to completely on packet and if it had been like 3 days earlier.

It would've been out the door or how should I think about those comments that's inc.

That's exactly right you've been doing this for too long Jim.

We did have some inventory show up.

In the last.

Day, 2 days of the quarter the immediately.

Immediately shipped out.

Q3, so the.

Definitely you do not want to read into a things are improving.

<unk> is starting to free up it was just a.

The big shipment that happened to land on the date of that landed.

Great. Thank you so much for the additional commentary it's greatly appreciate it and congratulations.

Thanks, Jeff Thanks Julien.

There are no additional questions at this time I would like to turn it back over to Steve O'brien for closing remarks.

Thanks, Stephanie Thank you all for joining US today, if you have any questions about the information presented feel free to reach out to me. Thank you for your interest in Arrow electronics and have the nice day.

Thank you this.

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

Okay.

[music].

Okay.