Q3 2021 Arrow Electronics Inc Earnings Call

November 4, 2021

Okay.

Good day, and thank you for standing by welcome to the Arrow Electronics third quarter 2021 earnings conference call.

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At this time all participants are in a listen-only mode. After the speakers' presentation that will be a question and answer session. To ask a question during the session you will need to press star one on your telephone.

After the Speakers' presentation that will be a question and answer session.

Question during the session you will need to press star one on your telephone.

Please be advised that today's conference is being recorded. If you require any further assistance. Please press star zero. I would now like to hand, the conference call over to your speaker today, Mr. Steven O'Brien. Please go ahead, Sir.

Thank you and good day and welcome to Arrow Electronics third quarter earnings conference call. With us on the call today are Mike 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 and future financial results, which are based on our predictions and expectations as of today. Our actual results could differ materially due to a number of risks and uncertainties, including the risk factors in our most recent 10-K and 10-Q filings with the SEC.

Statements, including statements about our business outlook strategies and future financial results, which are based on our predictions and expectations as of today, our actual results could differ materially due to a number of risks and uncertainties, including the risk factors in our most recent 10-K and 10-Q filings with the SEC we undertake no.

We undertake no obligation to update publicly or revise any of the forward-looking statements. As a reminder, some of the figures we will discuss on today's call are non-GAAP, we have reconciled those with the most directly comparable GAAP financial measures in our earnings release. These non-GAAP measures are not intended to be a substitute for our GAAP results. You can access our earnings release at Investor Day at arrow.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 to our chairman President and CEO, Mike Long.

Our earnings release at Investor Day at 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 to our chairman President and CEO, Mike long.

Thank you, Steve and thanks to all of you for joining us today. Before I touch on the supply chain topic, specifically, the current imbalance between supply and demand in the electronics component market.

Before I touch on the supply chain topic, specifically, the current imbalance between supply and demand in the electronics component market.

I'd like to focus on the theme we've been discussing over the last few years Arrow's ability to create even in challenging market conditions.

Our customers and suppliers recognize the value we bring as our team achieved all-time records in gross profit, operating income and earnings per share during the third quarter. Arrow's investment in design engineering and supply chain solutions have delivered the unmatched performance that makes us a leader in our industry.

<unk> investment in design engineering and supply chain solutions have delivered the unmatched performance that makes us a leader in our industry.

Those investments we have established a continuous cycle of growth that enables more customers to manage manufacturing and bring compelling new products to market sooner.

It also helps our suppliers embed their design and the next generation of electronically rich products. This continuous cycle ultimately leads to new product innovation closer ties with customers and suppliers and better outcomes for all.

Our emphasis on inventory and working capital investments as well as our key competitive differentiators of industry knowledge, media properties and experience have made us well-positioned to help customers drive their business advantages.

These low risk near term investments are helping our customers secure manufacturing continually and increasingly unpredictable conditions. Moving to the financials.

Moving to the financials.

The trajectory of the global components business was positive during the third quarter. Our global components business capitalized on continued strong demand in all regions with sales up 25% year over year. Sales were above the midpoint of our expectation for the six quarters in a row.

Like last quarter, we've struggled to secure additional inventory to meet strong demand. Based on the data we collect and our market intelligence. It's increasingly clear that supply will remain short of demand through the better part of 2022.

Based on the data, we collect and our market intelligence.

It's increasingly clear that supply will remain short of demand through the better part of 2022.

Instances of severe supply chain bottlenecks have increased leading to widely reported production slowdowns in certain industries.

During the quarter, we saw robust demand from such sectors of transportation, industrial communication, computing and data networking.

Our demand strength across all regions in multiple end markets more than offset any one customers or set of customers' challenges and as a result, our global component sales of $6.6 billion set an all-time record for Arrow and we were slightly ahead of last quarter.

In terms of profitability, we achieved significant growth along with exceptional operating leverage during the quarter. Notably, operating income from global components increased by more than three times the rate of sales. We continue to provide customers with value-added supply chain services that utilize our global ERP capability and unique level of inventory insights.

Notably operating income from global global components increased by more than three times the rate of sales. We continue to provide customers with value added supply chain services that utilize our global ERP capability and unique level of inventory insights.

Our digital platform is also helping customers manage components supply and safeguard their manufacturing processes. As a result, the revenue contribution from design and engineering activities increased within our mix during the third quarter.

Turning to enterprise computing solutions. Sales were within the range of our expectations, however, supply chain issues limited our ability to capitalize on strong demand.

<unk> were within the range of our expectation however supply chain issues limited our ability to capitalize on strong demand.

We saw projects postponed and pushed out during the third quarter due to an inability to secure IT hardware product. This also led to a miss software sales that would have been associated with those specific hardware refreshes.

This also led to a miss software sales that would have been associated with those specific hardware refreshes.

It's not surprising that the same component shortages that are impacting global components and global ETFs right now, it's a supply, not a demand issue. It is important to note that near term postponements due to product availability may not result in a one for one catch up in future quarters.

And customers have immediate needs to run mission-critical applications and workloads in a secure manner. And limited ability to stretch existing infrastructure. Any bottlenecks are therefore accelerating the utilization of cloud-based compute and storage. That's good news for Arrow, is that we have the leading cloud enablement tool aerosphere.

And limit limited ability to stretch existing infrastructure any bottlenecks are therefore accelerating the utilization of cloud based compute and storage. That's good news for Arrow is that we have the leading cloud enablement tool aerospace.

Ready enable to help our var and MSP customers meter monitor and bill cloud right away. In closing, I'd like to acknowledge our team for consistently delivering our customers and suppliers admidst some of the most acute and protracted product shortages and shortfalls we've ever seen.

In closing I'd like to acknowledge.

Our team for consistently delivering our customers and suppliers admit some of the most acute and protracted product shortages and shortfalls we've ever seen.

We earn our customers' trust and business during the tough times and that certainly includes time, where demand outstrips supply by a wide margin. By delivering for customers right now, we're securing strong mutually beneficial multi-year relationships for the future.

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

Thanks, Mike. 3rd quarter sales increased 17% year over year on a non-GAAP basis, and the average Euro dollar exchange rate for the quarter was $1.18 to one euro which was roughly in line with our forecasted expectations.

Quarter sales increased 17% year over year on a non-GAAP basis, and the average Euro dollar exchange rate for the quarter was $1 18 to one euro which was roughly in line with our forecast and expectations.

Changes in foreign currency benefited sales growth by approximately $55 million year over year. Third-quarter gross margin of 12.6% returned to its highest level since Q2 2018.

Third quarter gross margin of 12, 6% returned to its highest level since Q2 2018.

Gross margin improved year over year in global components in each of our operating regions.

Operating expenses increased slightly as a percentage of sales during the third quarter, but decreased as a percentage of gross profit.

As a reminder, many of our value added services and solutions can be independent of the sale of electronic components, and therefore contribute more meaningfully to profit and sales.

Interest expense was in line with our prior expectation. The third-quarter tax rate was slightly below our expectation that was due primarily to the timing of a discrete tax item.

Third quarter tax rate was slightly below our expectation that was due primarily to the timing of a discrete tax item.

We also saw some favorability in regional profit mix. As we have been saying on prior calls for the full year 2021, we expect our effective tax rate to be near the low end of our long term range of 23% to 25%.

As we have been saying on prior calls for the full year 2021, we 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, third-quarter operating cash flow was $114 million. Compared to the second quarter, DSOs and inventory days lengthened.

Compared to the second quarter, Dsos and inventory days lengthened, but.

But we're naturally offset by an increase in our payable days. As a result, our cash cycle of approximately 51 days. Effectively the same as last quarter.

Effectively the same as last quarter.

Our liquidity position is the best in the history of our company and continues to improve. Leverage as measured by total or net debt to EBITDA is at its lowest level in over 10 years. We returned approximately $250 million to shareholders during the third quarter through our share repurchase plan.

We returned approximately $250 million to shareholders during the third quarter through our share repurchase plan.

This matched last quarter as being the largest single quarter of share repurchases in Arrow's history enabled by our strong profits and proactive working capital management.

We remain committed to returning cash to shareholders with approximately $413 million remaining under our share repurchase authorization plan.

We're confident that we're repurchasing shares below their intrinsic value based on increasing return on invested capital and return on working capital.

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 that we published on our website this morning.

Now turning to guidance, the midpoint of sales and EPS guidance imply all-time full-year records for 2021. Our forecast implies a strong seasonal increase in enterprise computing solutions sales and profits.

However, both businesses continue to face supply constraints that are limiting our ability to make the most of strong customer demand. Our guidance continued strong performance in operating leverage for global components on a year over year basis, and for global Enterprise computing solutions profitability levels to be substantially accretive to consolidated financial performance.

Our guidance reflects.

Continued strong performance in operating leverage for global components on a year over year basis, and for global Enterprise computing solutions profitability levels to be substantially accretive to consolidated financial performance.

Finally, as we discussed last quarter, please note the CFO commentary includes information on our fiscal calendar closing dates for 2021. In 2021 in the fourth quarter began on October 3rd compared to September 27th in 2020.

This makes this year's fourth quarter about one week shorter than prior years fourth quarters. Full-year comparisons are not affected as 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 one on your telephone keypad. Again that's star one. Your first question comes from Matt Sheerin with Stifel.

Again Thats star one.

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Your first question comes from Matt Sheerin with Stifel.

Well.

Yes. Thank you and good afternoon. Thanks for all the details so far. I just wanted to just ask about the nice margin upside that you saw in components I think that was the highest number I can remember in quite some time that 5.9%.

I just wanted to just ask about the the nice margin upside that you saw.

In components I think that was the highest number I can remember in quite some time that five 9%.

How much of that was driven by favorable pricing versus that mix? Obviously, you saw strength in Europe and in North America, so mix versus pricing versus the pickup in design and in-demand creation that you talked about, Mike.

In North America, so mix versus pricing versus the pickup in design and in demand creation that you talked about Mike.

Yes, Matt. Thanks. By the way thanks for noticing. Didn't have to bring up to 5% thing again this quarter. What we're seeing right now is probably about half of that profit increase. A half to a third somewhere in there. Being structural. In other words, driven by services some of the supply chain activities those types of things design group that we've been selling for some time. As the mix goes to North America, and Europe, that's largely where those services have been. The good news with that is they were growing before COVID-19. They grew during COVID-19 and they continue to grow right now so that's more customers for us.

By the way thanks for noticing.

Didn't have to bring up to 5% thing again this quarter.

What we're seeing right now is probably about half of that profit increase.

Half to a third somewhere in there.

Being structural and.

In other words, driven by services some of the supply chain activities those types of things design group that.

Ed we've been.

Selling for some time as the mix goes to North America, and Europe, that's largely where those services have been the good news with that is they were growing before COVID-19. They grew during COVID-19 and they continue to grow right now so that's more customers for us.

The other two pieces are really mixed as you suggested. And then secondly, pricing increases that we're seeing from the manufacturers, which some of that price increase is also why you see increased inventory, not necessarily more units, but increased price on the inventory that we have. By the way, the price increases are just really coming through.

On the inventory that we have.

By the way the price increases are just really coming through there.

They are not done by any stretch of the imagination at this point in time. So we fully expect that to go on all the way through 2022, and possibly beyond but right now I am prepared to say that it looks like next year is going to be healthy in all cases.

Fair to say that it looks like next year is going to be healthy in all cases.

And possibly help out with a softer landing.

Okay. Thanks for that, and then on the computing side, you talked about some of the challenges especially the component constraints.

Specially the component.

Constraints.

But it looks like your growth rate. If you look at some of the large vars in the infrastructure market in other areas. They looked like they are growing faster than your business. I know, there's some netted down revenue and some moving parts there. But how do you think you're positioned to maybe start growing and we are accelerating growth in that business again?

But how do you think youre positioned.

Maybe start growing and we are accelerating growth in that business again.

Yes. So let me give you a little more clarity on that obviously, we saw growth in Europe, which was as expected. The other thing is we saw growth really in the core businesses. The bar is everything you saw in North America, where with notably soft with more in the public sector business.

Sector business.

And those deals came up shorter term. As a result, they are harder to supply product too. And that's really where the vast majority of the shortages were. And then if you remember computing in the fourth quarter is usually the governmental budget flush. So part of our guidance is based on what we think we will get for supply and it's clearly not a demand problem. So the good news is the sort of the core customer base is growing. The notable slowdown for us within the public sector and by the way back with the majority of it.

Product too and Thats really where the vast majority of the shortages were and then if you remember.

<unk> in the fourth quarter is usually the governmental budget flush so part of our guidance is based off of what we think we will get for supply and it's clearly not a demand problem. So the good news is the.

Sort of the core customer base is growing.

The notable slowdown for us within public sector and by the way back with the majority of it.

Okay. That's great could you just remind us what percentage of your revenue in the ECS is the public sector? And I'd love to Matt, but I don't think today's the today.

And I'd love to Matt, but I don't think today's today.

Okay, fair enough, thanks very much.

Thank you, your next response Stifel Nicholas of Choi Securities. Please go ahead.

Choi Securities. Please go ahead.

Yes.

Hi, can you hear me?

Yes, hi, great. Thanks for taking my question. Mike, I'm wondering if you can talk to us about the effect of things like the preferred supply program that one of your suppliers has installed. We learned last night that there's another vaguely similar supplier that's put one of these programs and where they are demanding very long noncancelable non reschedule orders. What sort of visibility is that dynamic introducing into your business? And maybe you can touch on book to bill and lead times while you're at it. Thank you.

Mike I'm wondering if you can talk to us about the effect of.

Things like the preferred supply program that one of your suppliers is installed we learned last night that theres another.

Basically similar supplier that's put one of these programs and where they are demanding very long.

Noncancelable non reschedule orders, what what sort of visibility is that dynamic introducing into your business and maybe you can touch on book to Bill and lead times, while youre at it. Thank you.

I mean. Any time, a customer will give you more visibility. I'll start with that, it's a good thing. Given the long term nature of the supply-demand imbalance here. The more information we have from a customer, the better we can help them. So I'll put those two things out there first. This sort of contractual arrangement says to the supplier that you are serious about getting supply over the next three years, let's say.

Any time, a customer will give you more visibility I'll start with that it's a good thing.

Given the long term nature of the supply demand imbalance here the more information we have from a customer the better we can help them.

So I'll put those two things out there first.

This.

Sort of contractual arrangement says to the supplier that you are serious of getting supply over the next three years, let's say.

And that you're going to share your forecast. And the supplier is going to commit to a percentage of your production capacity that you think you need. They're not going to allow you to stock it and put it on the shelves and not ship it, or not manufacture with it. But it opens a different type of dialogue. So personally I like these arrangements for that reason.

The supplier is going to commit to.

To a percentage of your production capacity.

You need.

We're not going to allow you to stock it and put it on the shelves and not ship it or not manufactured with it but it opens a different type of dialogue. So personally I like these arrangements for that reason.

If you are sort of an old-line customer that you've used to getting your shortage is fixed by pounding your fist on the table or calling up and asking somebody for a favor. And yelling at them. Those customers they are not likely to get their products.

And it's really come down to if you want to fix the supply chain. It has to be better visibility, it has to be long term commitment. And you can't just continue to whipsaw the supply chain and think you are going to get product and you have seen that there is no real one industry anymore.

And.

You can't just continue to whipsaw the supply chain and think you are going to get product and you have seen that there is no real one industry anymore.

That wields the power to come in and really push anybody around given the marketplace and electronics and so many different items today.

So. It really is going to have to be this more information, more visibility. And as a result, there will be rather results for everybody over the next couple of years, because this isn't really going to go away soon.

It really is going to have to be this more information more visibility.

And as a result, there will be rather results for everybody over the next couple of years, because this isn't really going to go away soon.

Yes, it seems clear, I appreciate that. One other if I can. The pricing dynamics that you can deploy to perhaps enhance your margin are sometimes a bit mysterious because we know there's a big part of your business that's done on these ship and debit dynamics that are sort of built for a deflationary. ASP sort of industry, which it's not today.

The pricing dynamics that.

You can deploy.

You too.

To perhaps enhance your margin are sometimes a bit mysterious because we know theres a big part of your business. That's done on these ship and debit dynamics that are sort of built for a deflationary.

Asps.

Sort of industry, which it's not today.

So when prices are rising, are you able to pass along more than the price increases or is that only in a relatively narrow set of cases, where you're more purchasing components at arm's length transactions? Maybe you can help explain this dynamic to help us understand the that part of the enhanced margins. Thank you.

Purchasing components at arm's length transactions, maybe you can help explain this dynamic tests to understand the that part of the enhanced margins. Thank you yes.

There is I believe a structural change going on in the industry. In the old days, when you had what we used to call allocation because there was a temporary shortage of products and therefore you could raise your prices, but then when the market changed they would come right back to where they were.

In the old days, when you had what we used to call allocation because there was a temporary shortage of products and therefore.

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You could raise your prices, but then when the market changed they would come right back to where they were.

There is no more year over year cost reduction on parts like there used to be. Raw materials are up for the suppliers, transportation is up for not only for the suppliers but for us too.

Like there used to be raw materials are up for the suppliers transportation is up for not only for the suppliers, but for us too.

Handling and labor costs are up as you have seen those types of things. So there is a structural change in the business that really hasn't had an inflationary impact on it for probably 10 years maybe a little longer. So these costs are real. These costs are permanent and these costs will be charged for and that's I think a little different than what we've seen in the past. So I don't expect the pricing to reduce in fact, we've got some suppliers are telling us right now prices are yet to go up another 20%.

Structural change in the business that really hasn't had an inflationary impact on it for probably 10 years maybe.

A little longer. So these costs are real these costs are permanent and these costs will be charged for and that's.

Think a little different than what we've seen in the past so I don't expect.

The pricing to reduce in fact, we've got some suppliers are telling US right now prices are yet to go up another 20%.

And if that's the case deal you'll see things happen again, so it's very important for us at Arrow to have our back-office systems in order, have our low cost for the customer every transportation routes being the quickest the fastest that they can be. And frankly, the shortage for the customers and that will help them keep the prices down but as far as the pricing going away now that there's a big change in technology. That's not going to come back.

You have our back office systems in order Hasnt been low cost for the customer every transportation routes being the quickest the fastest that they can be and frankly, the shortage for the customers and that will help them keep the prices down but as far as the pricing going away now that theres, a big change in technology.

That's not going to come back.

Thanks, Mike.

Thank you. Your next response is from the line of Toshiya Hari of Goldman Sachs. Please go ahead.

Hari of Goldman Sachs. Please go ahead.

Hi, guys. Thank you so much for taking the question and congrats on the strong execution. I have two as well. My first question is on customer behavior in the marketplace, one of your one of the bigger analog companies on their earnings call talked about customers being a little bit more selective with their expedites this quarter versus three months ago six months ago. Three months ago six months ago customers were pulling really hard across a very broad number of device types, but more recently they've become a little bit more selective. Are you seeing similar behavior from your customers or is it pretty much pulling hard across everything at this point?

Two as well my first question is on on.

Customer behavior in the marketplace one of your one of your one of the bigger analog companies on their earnings call talked about custom.

Customers being a little bit more selective with their expedited expedites this quarter versus three months ago six months ago, three months ago six months ago customers were pulling really hard across.

Very broad number of device types, but but more recently they've become a little bit more selective are you seeing similar behavior from your customers or is it pretty much pulling hard across everything at this point.

Yes. I'm not going to eliminate analog because analog is only a portion of the market. And it doesn't tell the story. The truth is I had five brands a year ago and I've got about 20000 now. People I didn't even know of calling into the office. Now where we're seeing an increased number of expedites, but the truth is those expedites are being used more and how can we help the customer over the longer term than just the one month shortage that occurs. And how can we help them layout our manufacturing schedule that can make sense for all the parts on their bill of material? So these expedite calls or not for one part, there are really for all the parts that we're supplying that customer. So they can get into manufacturing so they each take longer. There is better information of flows, but as I said, we probably saw more significant or what I would say emergency shortages over this quarter than we've seen since this started.

Im not going to eliminate to analog because analog is only a portion of the market and it doesn't doesn't tell the story.

The truth is.

I had five brands a year ago and Ive got about 20000 now.

People I didn't even know of.

Calling into the office now where we're seeing increased number of expedites, but the truth is those expedites are being used.

More and how can we help the customer over the longer term than just the one month shortage that occurs and how can we help them lay out our manufacturing schedule that can make sense for all the parts on their bill of material. So these expedite calls or not for one part there really for all the parts that we're in.

Applying that customer so they can.

Getting into a manufacturing so they each take longer there is better information.

Formation of flows, but as I said, we probably saw more.

Significant or what I would say emergency shortages over this quarter than we've seen since this started.

Interesting. And then as my quick follow up. Wanted to ask about market share and components. If we take sort of the midpoint of your December quarter revenue guide, I think your components business is going to be up 27, 28% year over year in calendar 2021. You are clearly outperforming your nearest peer.

And then as my quick follow up.

Wanted to ask about market share and components.

If we take sort of the midpoint of your December quarter.

Revenue Guide I think your components business is going to be up 27, 28%.

Year over year in calendar 2021, you.

You are clearly outperforming your nearest peer.

Obviously, they had some unique idiosyncratic headwinds this year, but even ex that I feel like you guys are outperforming against them and also the broader a broader industry. You've got idiosyncratic tailwind in sort of the Adi and Maxim dynamic going forward. And just being you know the company you are you probably have better access to supply visiting some of your smaller peers. So I guess the question is how should we think about your ability to continue to outperform from a growth standpoint enter into '22 and beyond, thank you.

Against them and also the broader a broader industry.

<unk> got idiosyncratic tailwind in sort of the Adi and Maxim.

<unk> going forward and just being you know the company you are you probably have better access to supply visiting some of your smaller peers. So I guess the question is how should we think about your ability to continue to outperform from a growth standpoint enter into 'twenty two and beyond thank you.

Well, thanks for that. Those are nice accolades, but we still have to get up. And fight the battle every single day that we're here and show the customers that it's worth it for them to place their orders with Arrow.

Those are those are nice accolades, but we still have to get up.

And fight the Battle every single day that we're here and show the customers that it's worth it for them to place their orders with Arrow.

I would say that our ability will increase as customers continue to come to our engineering services and utilizes for some of the supply chain services that exist other than just the parts today. Selling parts is very important to Arrow, but you are expected to be low cost and get the part for me and be on time all of that those are table stakes today.

Continue to come to our engineering services and utilizes for some of the supply chain services that exist other than just the parts today.

Selling parts as.

As a.

It is very important to arrow, but you are expected to be low cost and get the part for me and be.

On time all of that those are table Stakes today.

But the ability to affect the customer and help a customer with their design to make sure they're getting their products out and that they are low cost. And they are actually things that can manufacturer is becoming increasingly important to us and our profit levels. So as long as we continue to push that and stay in that end of the business. This cycle will be repetitive for us. And we believe we've been fortunate and we believe our strategy has worked. It's taken a long time to get here, but now we just have to continue to drive these new businesses that we brought in or built inside the company.

Getting their products out and that they are low cost and they are actually things that can manufacturer is becoming increasingly important to us and our profit levels. So as long as we continue to push that and stay in that end of the business. This cycle will be repetitive for us and we believe we've been fortunate and we believe our.

<unk> has worked it's taken a long time to get here, but now we just have to continue to drive these.

new businesses that we brought in or built inside the company.

Great. Thank you so much.

Thank you. Your next response is from Jim Suva of Citigroup. Please go ahead.

Thank you, and I would be remiss if I simply don't congratulate you on a great profitability and that's just really remarkable. With that compliment though, you know some people will say is this the new norm.

With that complement though as you know some people will say is this the new norm.

Or are you getting some extra boost from some of the shortages and how should we think about that? Because the profitability is truly remarkable and I know you've put a lot of effort into it. So maybe if you can just kind of talk about the sustainability of the profit margins. Thank you.

truly remarkable and I know you've put a lot of effort into it. So maybe if you can just kind of talk about the sustainability of the profit margins. Thank you.

Margins. Thank you.

Yes. Thanks, Jim. It did not come out and raise our longer-term targets, yet. We're still sorting through the benefits of our services sales that have a higher profit level at the bottom of each sale. And also our supply chain solutions business, which has a higher profit level at the bottom than components parts do. And then of course are our long term engineering where we actually do engineering for customers. That continues to grow.

It did not come out and raise our.

Longer term targets, yet, we're still sorting through the benefits of our services sales that have a higher.

Profit level at the bottom of each sale and also our supply chain solutions business, which has a higher profit level at the bottom then components parts do and then of course are our long term engineering, where we actually do engineering for customers that.

Continues to grow.

What we're seeing is our what we believe is those will continue to grow into the future, even if products sort of abates. So we're becoming increasingly positive that we will pass the long term bottom line number we gave you guys the 5% in the components business in the future. But we're still doing the math because I would like to see it continue throughout 2022 and see what the growth looks like there.

Our what we believe is those will continue to grow into the future, even if products sort of abates, So we're becoming increasingly positive.

That we will pass the long term.

Bottom line number we gave you guys the 5%.

In the components business in the future, but we're still doing the math because I.

I would like to see it continue throughout 2022 and see what the growth looks like there.

But certainly, I can tell you right now 2022 is looking a lot like today. Hopefully, that gives you enough information and we'll be looking at the rest of the business over the year and just staying where the growth rates are panning out before we make that commitment.

Hopefully that gives you enough information and we'll be looking at the rest of the business over the year and just staying where it is.

The growth rates are panning out before we make that commitment.

Thank you. Your next response is from Will Slabaugh with Bank of America. Please go ahead.

Alright.Thank you for taking my questions. My first question is on inventory some component companies have talked about some inventory some level of inventory build. Maybe in automotive at the OEMs and in industrial.

My first question is on inventory some component companies have talked about some inventory some level of inventory build.

Maybe in automotive at the Oems and in industrial.

And in the distribution channel. So when you look at the supply chain are you seeing any level of inventory built? And specifically with respect to your inventory. It looks like it was up 5% sequentially. So Chris, do you think that this is a good level of inventory or would you like to do you think you need to build more inventory as you go forward and how would that impact our free cash flow?

Inventory as you go forward and how would that impact our free cash flow.

Yes. It is. This is Mike. I'm gonna take this and then let Chris have it. A portion of our inventory this quarter is from price increases, which is makes the inventory a little bit more valuable so that has the piece to it. Secondly, I think you brought up transportation or automotive. That would be fantastic if they could build some inventory because then they can build some cards.

This is Mike.

Take this and then.

Chris habit, a portion of our inventory this quarter is from price increases, which is makes the inventory a little bit more valuable so that.

Has the piece to it.

Lee I think you brought up transportation or automotive.

That would be fantastic if they could build some inventory because then they can build some cards.

They are trying the automotive manufacturers are trying to build 10 million more cars next year than this year, so clearly they need inventory to do that.

They're not going to build pull the trigger and start building the cars until they can get to sort of have an assured supply chain activity to where they know they're going to get the product. So that's what you're sort of dealing with today.

Activity to where they know they're going to get the product. So that's what you're sort of dealing with today.

And the good news of that in my opinion is whatever they get they're going to manufacture. So that's going to help. We're largely seeing that in most sectors that are growing this year. And if the industry is only supplying 80% of what the market wants there's 20% extra growth rate in there that can be utilized today, how sustainable those growth rates are over time. So I don't think that just looking at inventory is a viable indicator for what the future is going to hold because there's a lot of moving parts. And even with our inventory some of that is when the inventory hit at the end of the quarter and it couldn't get out the door.

And.

If the industry is only supplying 80% of what the market wants theres, 20% extra growth rate in there that can be utilized today, how sustainable those growth rates are over time. So I don't think they are just looking at inventory.

is a viable indicator for what the future is going to hold because there's a lot of moving parts. And even with our inventory some of that is when the inventory hit at the end of the quarter and it couldn't get out the door.

So that is a trigger that should cause some questions to be asked. But it is right now no means an indicator that the market is slowing because I can tell you our book to bill for the quarter was still off the charts, still high demand and we are still being constrained by supply and expect that all the way through 2022.

That is a trigger that should cause for some questions to be asked but it is right now no means an indicator that the market is slowing because I can tell you our book to Bill for the quarter was still off the charts still high demand and we are still being.

By supply and expect that all the way through 2022.

And I would just weigh in and say to the question on our inventory levels.

Again, I wouldn't spend a lot of time looking at the dollar value of inventory. I'd really encourage you to focus on the cash conversion cycle. Inventory levels will rise as the business grows, working capital levels will rise as the business grows the key for us is being able to manage the days it takes to convert that convert that into cash.

Encourage you to focus on the cash conversion cycle inventory levels.

will rise as the business grows, working capital levels will rise as the business grows the key for us is being able to manage the days it takes to convert that convert that into cash.

The other thing is that you'll see this quarter is we do have some positive margin gains because of the geographic mix.

And we know that inventory turns a little slower in the west than it does in Asia, and that's got a margin benefit to it as well. So you got to take all of those variables into play, but our key focus here in terms of how we're running the business day to day is laser focus on the cash conversion cycle.

It turns a little slower in the west than it does in Asia, and that's got a margin benefit to it as well. So you got to take all of those all those variables into play, but our key focus here in terms of how we're running the business day to day is laser focus on the cash conversion cycle.

Got it, thanks for the details there, I appreciate that. Just for my follow up Chris. If I can ask you can you remind us of your capital allocation priorities in this environment? Is this are you looking at any potential M&A? And how should we think about debt reduction versus share buybacks? Thanks. Yeah. This is Mike. I'll answer it just though there is no question of anybody here or for you guys. Remember are our number one priority was to invest in our business to grow. Our number two was M&A at our number three was to return to shareholders. And as you can see right now we're doing a fair amount of returning to shareholders through our buybacks and we would expect that to continue for a while.

In this environment is this are you looking at any potential M&A.

And how should we think about.

<unk> debt reduction versus.

Versus share buybacks. Thanks, Yeah. This is Mike I'll answer it just though there is no question.

Anybody here or for you guys remember are our number one priority was to invest in our business to grow.

Number two was M&A at our number three was to return to shareholders and as you can see right now we're doing a fair amount of returning to shareholders through our buybacks and we would expect that to continue for a while.

Okay, great. Thanks for the details.

Mhm.

Thank you. Your next response is from Joe [inaudible] of Wells Fargo. Please go ahead.

Yes, thanks for taking the question. I was curious as you look into 2022 and I take your comments, Mike. Thinking about the components margin.

I was curious as you look into 2022 and I take your comments Mike.

Thinking about the components margin.

And the strong pricing that I guess expected to continue next year. Is there any reason that we should view this quarter's results from an operating margin perspective as an upper limit or could we continue to kind of increase that given the mix dynamic on a quarterly basis?

Given the mix dynamic.

Dynamic on a quarterly basis.

Or is there some level of fixed maybe investment you need to make at a certain run rate?

Yeah. Let me answer it sort of a way that I answered that internal. Whatever it is, it's not enough for me so I'll start there.

Whatever it is is not enough for me so ill start there.

And this is sort of one quarter, we're still sorting out remember we had some mix changes. So mix does have an impact on it. Now not only mixed by region has an impact but sort of mixed by our services sales those types of things have an impact on it.

Now not only mixed by region has an impact but sort of mixed.

<unk> buy our services sales those types of things have an impact on it.

So if all things stayed equal, I would tell you would be equal, but we're one quarter in this and what I can tell you is I'm very positive about what the future looks like. But I'm not ready to tell you that we're going to be going way north of this number going into next year.

<unk> way north of this number going into next year.

Got it that's helpful. And then just as a follow up on the ECS side, when you talked about supply availability impacting hardware and maybe driving some incremental cloud adoption. Can you just remind us what's the difference in terms of the economics for Arrow there in terms of like a revenue opportunity in margin?

Availability impacting hardware, maybe driving some incremental cloud adoption can you just remind us what's the difference in terms of the economics for arrow there in terms of like a revenue opportunity in.

Margin.

Sean, do you want to take that? Yes, Joe, I think if you look at our business historically and I think it's still pretty true. It's about a third hardware, about a third software and about a third services and that kind of bounces around a little bit quarter to quarter, but year by year is it kind of holds constant so we make a whole variety of returns across the portfolio.

Hardware or about a third software and about a third services and that kind of bounces around a little bit quarter to quarter, but year by year is it kind of holds constant so we make a a whole variety of returns across the portfolio.

I'd like to say not all hardware is bad and not all software is good. And as we pivot to all things cloud and all things IT as a service you're going to see our mix change.

And as we pivot to all things cloud and all things. It is a service youre going to see our mix change.

pandemic levelsBut the supply chain constraints, we're seeing right now are probably double the lead times that we saw at the start of the year, so that will be a headwind for a little bit of a time. And obviously, that will create some downward pressure on the top line, but just to give you another way to think about that I mean, I don't think the market has returned to pre-pandemic levels, when you think about enterprise, but I can say we are seeing signs of renewed activity in the data center. And the proof points for that are the strength of our storage business year to date, it's up into the high single digits. And the second thing I would say is we've now seen our backlog at record levels.

Probably double the lead times that we saw at the start of the year, so that will be a headwind for a little bit of a time and obviously that will create some downward pressure on the topline, but just to give you. Another way to think about that I mean, I don't think the market has returned to.

Print epic levels, when you think about enterprise, but I can say, we are seeing signs of renewed activity in the data center and the proof points for that are the strength of our storage business year to date, it's up into the high single digits in the second thing I would say is we've now seen our our backlog at record levels.

And a good piece of that is all associated with things that will land in the traditional data centres, so while the hardware will be a bit of a challenge in the short run, I don't think it will persist indefinitely.

The traditional data centers, so while the hardware will be a bit of a challenge in the short run.

I don't think it will persist indefinitely.

Got it that's helpful. Thank you.

Thank you. Your next response is from Nick [inaudible] with Longbow Research. Please go ahead.

Nick.

<unk> with Longbow Research. Please go ahead.

Yes. Thanks, and congrats from me as well on the results. Mike, you talked about half of the component margin increase this quarter being structural.

Mike you talked about half of the component margin increase this quarter being structural.

My question is first versus what anchor of margin is that upside structural is it based on the 5% that you're targeting? You kind of laid out a quarter or two ago.

You kind of laid out a quarter or two ago.

And also related to that how much of the component margin upside is from the supply chain services agreement that you talked about that they are earning higher margin than the core bank?

Earning higher margin than the core bank.

I'm not going to break out the differences between the services in the supply chain services, but what I can tell you is yes, the upside, over 5% has been impacted significantly by those sales.

The services in the supply chain services, but what I can tell you is yes, the upside over 5% has been impacted significantly by those sales.

Okay.

And as a follow-up question. You touched the ball on price increases were similar living now works have heard about acceleration in price increases, particularly in high-end semi.

As a follow up question you.

You touched the ball on our price increases were similar living now works have heard about acceleration in price increases, particularly in high end semi.

Can you talk about how much of your portfolio is experiencing price increases? And what is the magnitude of realized price increases? I'm assuming you're referencing list price is also going up by 20%, which I think could be different from what the realized prices are.

Yeah, actually I'm going to have the guy answer that lives. So I'm going to have David West give you an answer on that because he's been shepherding these price increases through the system. You didn't have much hair to start with you've got less now so.

Give you an answer on that because he's been shepherding these price increases through the system.

You didn't have much hair to start with you've got less now so.

You'll get to hear it, thanks, Mike. We've seen price increases from more than 100 suppliers and we expect that to continue through 2022.

Okay, maybe one last question for Chris, do you continue to post positive free cash flow, how should investors think about the sustainability of the buyback pace from the last two quarters? Assuming the environment allows you to post positive free cash flow as the cycle continues.

Continued to post positive free cash flow, how should investors think about the sustainability of the buyback pace from the last two quarters, assuming the environment allows you to to post positive free cash flow as the cycle continues.

Yes. The key thing that impacts our view on buying back stock obviously, the starting point is its value and if you look at the way we are trading today I think we're roughly eight times forward. So the stock's cheap on that basis, and so it's a good buy versus the intrinsic value. So that's point one. Point two is kept more cash flows and an important variable there so as our leverage and unquestionably, we're getting to a point where the cash generation moderate somewhat because of the need to invest in working capital for growth.

The key thing that impacts.

Our view on buying back stock obviously, the starting point is its value and if you look at the way we are trading today I think we're roughly eight times.

Forward, so the stock's cheap on that basis, and so it's a goodbye versus the intrinsic value. So that's 0.1 0.2 is kept more cash flows and an important variable there so as our leverage and.

Unquestionably, we're getting to a point, where the cash generation moderate somewhat because of the need to invest in working capital for growth.

But given the state of the balance sheet. We got a lot of room, while maintaining our commitment to investment grade two to buy back stock so to Mike's point earlier. I think that's what you should expect from us.

We got a lot of room, while maintaining our commitment to investment grade two to buyback stock so to Mike's point earlier.

I think thats, what you should expect from us.

Got it thanks, guys. Good luck.

Thank you.

There are no further questions in the queue at this time. Thank you for joining us today, if you have any questions feel free to reach out to me. This is Steve O'Brien and thank you for your interest in Arrow Electronics. Have a nice day.

Thank you for joining us today, if you have any questions feel free to reach out to me. This is Steve O'brien and thank you for your interest in Arrow electronics have a nice day.

This concludes today's teleconference. Thank you for participating. You may now disconnect.

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