Q2 2022 Arrow Electronics Inc Earnings Call
Please wait the conference will begin shortly.
[music].
Good afternoon, and welcome to the Arrow Electronics second quarter 2022 earnings Conference call.
Lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you'd like to ask a question. During this time press star one on your telephone keypad. If you like to withdraw your question Press Star One again. Thank you Rick you May begin your conference.
Okay.
Good day and welcome to the Arrow Electronics second quarter 2022 earnings Conference call.
With us on the call today are Sean Kerins, President and Chief Executive Officer, and Emmerich side, Let's interim principal financial officer.
During this call we will make forward looking statements, including statements about our business outlook strategy 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 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 to 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 Arrow Dot Com, along with the CFO commentary the non-GAAP earnings reconciliation.
And a replay of this call.
Following our prepared remarks today, we will be available to take your questions I will now hand, the call to our president and CEO John Kearns.
Thanks, Rick and thanks to all of you for joining US today I'm excited to join all of you in my first earnings call as the CEO of available I'm also very pleased to report record results for the second quarter as we continue to build upon our record performance over the past several while market conditions are challenging they also provide amp.
Opportunities to showcase our commitment to the success of our suppliers and customers the dedication and focused execution by our team helped us deliver all time record quarterly sales gross profit operating income and earnings per share, while facing an ongoing imbalance between supply and demand past investments.
To enhance our capabilities, especially in the areas of engineering and supply chain.
Led to improvements in profitability.
Thanks. This is proof positive that we are uniquely positioned to help our customers navigate todays market opportunities and challenges.
In our global components segment demand for electronic components and associated design engineering and supply chain services remained strong.
In fact demand continues to outpace supply our book to Bill ratios remained well above parity backlog is at a record level and continues to grow lead times are still much longer than historical norms and supplier and customer delinquencies remained at all time highs given long lead times and production delays we continue.
To work closely with our customers to help them satisfy their most urgent backlog priorities a favorable mix of higher margin products value added content and regional performance led to record quarterly operating income and margins for the business as a whole the.
The Americas and EMEA regions experienced robust demand across most end markets and industries.
Both regions produced year over year growth rates in excess of 20%.
And despite the adverse effects of Covid related shutdowns in China, Our Asia region still delivered record quarterly sales.
And the enterprise computing solutions business demand for more complex enterprise content was healthy in both regions and while supply constraints represented a headwind to hardware sales, we saw strength in our software and cloud portfolios.
The region delivered record second quarter sales in the Americas region sales were down slightly year over year due mainly to supply chain constraints related to hardware initiatives, we expect to see upside in those categories when fulfillment improves and project postponements are resolved.
Operating profit grew year over year and reported sales came in near the high end of our guidance. Despite currency headwinds, we believe prospects for this business will continue to improve across the balance of 2022.
Before handing over the call I do want to express how excited and confident I am.
That's the future of Arrow, all underpinned by the talent hard work and dedication of all of the Aero colleagues around the world. We believe our strength comes from enabling technology solutions that make a difference in People's lives, whether it's our work in semi autonomous technology intelligence at the edge or clean energy solution is driven by the electrification.
<unk> of everything we believe in the power of innovation to make the world a better place and I am grateful for the privilege to lead this great company.
With that I will now hand, the call over to Rick to provide more details on our results and our expectations.
Thanks, Sean.
Second quarter sales increased 14% year over year on a non-GAAP basis adjusted for currency.
Changes in foreign currencies had a negative impact on sales growth of $291 million year over year, which was slightly better than our expectation of $300 million.
The average Euro dollar exchange rate for the quarter was $1 <unk> to one Europe .
Second quarter gross margin of 13, 1% was up 140 basis points year over year, driven by higher margins in global components.
Operating expenses as a percentage of sales or seven 4% down 20 basis points year over year.
Interest and other expense totaled $39 million <unk>.
Slightly above our prior expectation of $36 million due to higher rates on floating rate debt.
The effective tax rate for the quarter was 23, 5% in line with prior expectation and the target long term range of 23% to 25%.
Turning to cash flow and the balance sheet, our second quarter operating cash flow was negative $83 million as a result of working capital investments to support continued growth in our cash cycle of approximately 60 days was unchanged from the first quarter, but has increased to 10 days year over year.
Strong demand and supply chain issues have resulted in significant inventory price increases year over year our COO.
Calculated investments in inventory have positioned us to capitalize on this environment.
Our return on invested capital and return on working capital reached New records for any second quarter and are not far from the all time highs achieved in the fourth quarter of 2021. These returns are the result of record profits in the quarter and continued focus on management of working capital.
At the end of the quarter net debt totaled $3 3 billion.
Total liquidity was $2 3 billion, including cash of $226 million.
Our liquidity remains one of the strongest position in the history of our company.
Our free cash flow and flexible balance sheet position us to maintain our commitment to returning cash to shareholders through the purchase of approximately $225 million of.
Shares during the quarter.
At the end of the second quarter, our remaining repurchase authorization stands at approximately $288 million.
Please keep in mind that the information is shared during the call.
<unk> is a high level summary of our financial results for more detail regarding the business segment results. Please refer to the CFO commentary, which we published on our website. This morning also note CFO commentary included information on our fiscal calendar closing dates.
Turning to guidance midpoint sales and EPS guidance imply records for the third quarter, our guidance reflects normal seasonality and a continuation of the current supply demand imbalance.
Midpoint global component sales guidance would be a third quarter record and reflects continued operating leverage for global components on a year over year basis with profit growing several times faster than sales our forecast suggests and enterprise computing solutions profits will be relatively flat year over year.
We estimate an approximately $350 million headwind to sales and 25% headwind to EPS growth due to the strengthening of the U S dollar compared principally to the euro.
I will now turn the call over to the operator for Q&A.
Thank you at this time I would like to remind everyone in order to ask a question press star one on your telephone keypad webcast participants compile the Q&A roster.
Your first question comes from Jim Suva from Citi. Please go ahead.
Thank you very much.
Can you help us understand you mentioned normal seasonality for September .
Looking at it kind of looks like its subnormal, but maybe there's FX in there maybe there are some items, we need to be aware of but can you help us reconcile your comment about FX and then I have a question about your inventory level.
Not so much about FX can you help us understand your comment about the normal seasonality, which actually looks a little bit below and then I have a question on inventory.
Yeah, Hey, Jim it's Sean good to us.
Good to hear your voice again, I'll, let Rick take the first part of the question and then we'll talk more about inventory.
Sure. So I think I think you hit it there when you talk about FX, there's normal seasonality, particularly in Europe .
That's also magnified with MIT.
With some of the FX headwinds that we spoke about.
Jim also to remember last year in Q3, it was really the start of the uptick in the cycle that we've been enjoying.
Right and then what's the FX impact on the outlook quarter over quarter or year over year, either way is fine.
A year over year $350 million to sales and 25.
Yes.
Okay that bridges it and then my question on inventory it looks like sales is going down next quarter, maybe due to FX, but inventory went up this quarter are you still seeing a lot of shortages and everything that comes in being shipped out are we starting to hit equilibrium here in many things.
I'd like to think we're hitting equilibrium, Jim, but we're really not inventory did come up in Q2, but certainly less so than in Q1.
The increase was more about pricing then units, but there was also some timing.
And in transit.
Activity as well that youre seeing in the number frankly, if we could have gotten more product last quarter I would have taken it because it's what supported our growth is what really helped us deliver great returns and it's also important to us.
When it comes to customer SaaS.
So I'm not I'm not too concerned at all about the inventory build I think we.
Have every confidence that even as and when the market does soften our ability to sell through the inventory and generate future cash flow is highly reliable.
Thank you so much for the details and clarifications and congratulations to you and your entire new management team. Thank you.
Thanks, Jim.
Your next question comes from Nick Todorov from Longbow. Please go ahead.
Yeah, good afternoon, everyone and congrats shown on the first call.
A question on guidance typically for components I was hoping you can kind of maybe bridge.
We understand there is seasonality in Europe , and there is a little bit of impact from FX, but maybe if you can try to bridge how much of the sequential FX impact that you are baking in and also if we look at your guidance relative to the suppliers on the semiconductor specifically and even IPO.
Most of them are guiding to sales up sequentially. While your guidance is down maybe can you talk about the puts and takes impacting that.
Yes, I'd be happy too. So if you step back a little bit come up to 25000 feet in the aggregate all the indicators that I talked about earlier tell us that the overall demand picture is still outstripping supply.
That's the fundamental fact that we don't see that changing anytime soon so from a top line perspective, the limiting factor is really all about supply and we think we know our suppliers and customers really well and this is our best view of what they told US we're going to get.
At this point in the quarter I think if you look at it from a sequential perspective, you got to remember in this environment, there's always going to be puts and takes.
From one quarter to the next either related to seasonality, which drives the difference in regional mix.
Differences in product mix, sometimes we get.
More content for fulfillment versus more content for design win in demand creation, and thats going to vary quarter to quarter as well and you are absolutely seeing FX play into the equation as well I think the.
The FX headwind alone more than accounts for the difference in what you might have expected.
On the top line guide.
Okay.
Great second question is.
Obviously, you talked about still continue a supply imbalance of supply and demand imbalance I'm wondering if you're seeing any differences by end market. Obviously, I think theres been widely known that consumer electronics has experienced some weakness in demand, but I think you called out that in China industrial demand and communication was also down.
Was that tied specifically to supply.
Lack of availability or are you seeing any changes in order trends there and also if youre seeing any changes from the level of expedite requests you're getting from customers.
Yeah.
So again, let me start with the market overall broadly speaking demand remains pretty healthy based on what we see is healthy and industrial automotive aerospace and defense net.
Networking communications infrastructure, obviously, there are some consumer sector related headwinds in China, we've all read about that.
That's probably not news to you.
We don't Fortunately have a lot of exposure to that piece of the market. Our focus has always been on the yeah.
The industrial and mass market, a little bit different than some of our competitors. We are monitoring carefully to the extent that any of that bleeds into.
Heavy industrial automotive and beyond but so far we're not we're not convinced of that.
Okay got it thanks for the answers.
Your next question comes from Joe <unk> from Wells Fargo. Please go ahead.
Yes, thanks for taking the question.
I'm wondering if you could talk about the price increase that youre seeing from your suppliers and we continue to see those in the June quarter and do you expect that to continue in the second half of this year.
So if you look at the you know the question about inventory, obviously as I said that was more about price increases in units.
We're not getting units at the rate, we would like to continue to deliver the growth and returns that we have in the past, but what I would say is we have seen a substantial level of price increase activity up to this point.
Sure.
Our suppliers are in the best position to answer that question going forward, but again I would say that overall demand is still in excess of supply would indicate that that some of that might still be likely in pockets.
Too early for us to speculate.
Okay, and then just relative to maybe past quarters, when you receive better supply than you'd expected and your guidance it.
Kind of enabled some upside how did this quarter play out just given the results were relatively in the range you provided.
Well, Joe I would like to think that we're getting a little bit better at calling where we're going to land at the start of this this this cycle all based on a big disconnect between.
Supply and demand.
We probably werent, calling it as accurately as we could of and therefore, you saw a couple of quarters, where we really came in.
Comfortably passed our guide I think over time, we've gotten better Intel and frankly learn more about how to make this call.
Youre not seeing any.
Any increase in supply in the forecast for Q3, and so it would be way too early for me to call upside, we think that as I said earlier. This reflects a pretty accurate read on what we think we're going to get.
Helpful. Thank you.
Your next question comes from William Stein from Trust Securities. Please go ahead.
Great. Thank you for taking my question.
I'm wondering if you can help me understand the dynamic in the in the systems part of your business in that segment.
The CFO commentary noted that there was a shift to more software because of supply availability, but I think that comment might've been on more of a year over year comparison basis. When we look at the sequential from March to June .
How did the.
The mix between hardware and software change and are you seeing.
Any greater availability.
Or.
Lets say more consistent fulfillment on the system side.
Sure will so let me let me start in a couple of different places that hopefully gets you what you need first of all this business is much more.
It's much better to look at this business on a year over year basis versus sequentially.
You won't see dramatic mix shifts in our overall portfolio of software services hardware from one quarter to the next but you will see that on.
On a year over year basis become a little more pronounced.
<unk>.
Supply constraints.
Probably only got worse in Q2 is in our backlog continued to build.
Lead times are still well past historical norms and all the hardware spaces in which we compete and we're not really in a position to say when that will resolve itself. It's obviously an extension of.
What's happening upstream in the broader semiconductor and electronic components market.
But we did benefit by.
More software more cloud and there were pockets in Europe , where we were able to get some hardware supply that certainly helps but by and large you remember our north American business.
It means more to hardware than software cloud and services at least at this juncture than does our business in Europe and so they were.
Proportionately hurt by that but as I said earlier, the backlogs have continued to grow in.
These these fulfillment delays in project fulfillment are going to have to resolve themselves at some point.
Great and a follow up is in the CFO commentary noted that lead times.
Elevated but stable sequentially and that is a change they had been rising for some time.
The commentary noted that some of the.
Sequential basically countries people.
How have lead times tracked in the last I don't know 34 days or so since the quarter closed.
<unk> been any moderation I know this is very difficult.
To sort of call. It average because there's a million different lead times is a massive range but.
Okay.
But I know, we ask you often to make the summary judgments have you seen any.
We're attraction in the lead times at all.
No.
I appreciate your empathy because youre absolutely right. This is something our teams monitor daily, but by and large since the <unk>.
End of the quarter, we havent seen really a change in lead times and yes, while they didn't get any further elongated in Q2 versus Q1, they were already well past.
Historical norms typically we would expect overall for the business.
Something on the order of 12 to 15 weeks and we're we are well north of that probably 35, 40 days or more there's a little bit of a mix, but even if they flatten they're still highly extended yes.
Yes.
<unk>.
Thank you.
Your next question comes from Rob clue that touch Arya from Bank of America. Please go ahead hi.
Thank you for taking my questions.
Sean My first question is on the enterprise computing solutions segment.
CFO commentary says that in the Americas region, you saw decreased demand for security infrastructure applications and networking year over year, that's a little bit counterintuitive from what we're hearing about demand for security. So just wanted to see if you could delve a little bit deeper into that was that because of the macro.
Have you seen any share shifts there so just trying to understand what happened in the Americas region.
Yes, so a couple of different pieces to that first of all I wouldn't necessarily say anything of a macro nature. There is a lot of good trends overall around sort of enterprise level.
Spending patterns starting to return to.
More pre pandemic levels, if you will or patterns.
And there's lots of reasons for that but that's showing up in the backlog we see for hardware, it's showing up in the the good momentum, we're seeing with software and certainly <unk>.
Cloud as well from a cyber security perspective, Youre right, because we have pretty good exposure to that that segment.
Believe it or not even though its software it's often delivered via an appliance and security based appliances are also part of what's been.
Load by the hardware constraints to help deliver those solutions both on premise and off so that would be the wrinkle youre seeing there by and large we think.
The outlook for Ciber remains pretty healthy.
Okay. Thanks for that maybe for my follow up if I can ask in the components segment, you posted strong operating margin of seven 1%, which is up 200 basis points year on year.
Much of that is because of the price increases that you've seen.
And do you expect to be able to sustain this level of margins or how should we expect that margins can normalize down in that segment. So just your thoughts on component operating margins going forward. Thank you.
Yes, so as I said as you heard me talk about the fact that in this environment, you're going to see some ebb and flow from one quarter to the next but I think we've been pretty consistent since this cycle started in describing the.
Margin improvements were enjoying one part regional mix.
And that's going to vary from quarter to quarter, one of our pricing.
And then one for a structural remember we've talked about the investments we've made in engineering supply chain and digital capabilities over time, and we think that's contributing as well.
If I were explicitly going to tell you how much we're getting from each.
Might not be.
Might not be right on target, but I think all three are helping certainly pricing is part of it and I think EBIT when supply and demand normalizes, we believe that some portion of the.
The structural improvements, we have been able to build into our model.
We will remain.
Okay. Thanks for all the details appreciate it.
Your next question comes from Melissa Fairbanks from Raymond James. Please go ahead.
Hi, guys, thanks very much.
I was just wondering to the extent that you delivered upside to the midpoint of your guidance in June , but maybe a little bit lower than consensus for September .
I understand opex as a headwind, but was there any pull forward of demand in June or was it just better execution better sourcing.
Thanks, Melissa no there was absolutely no pull forward pull forward business in our June number from the from the third quarter. This is all about supply.
And we're absolutely doing the best we can to get as much as we can to satisfy our customers, but there was no pull forward and as I said earlier, we think we've called the supply equation pretty accurately walking into the quarter. So we don't we don't see any upside as of yet, but I think again youll find that the the curve.
The headwinds alone account for.
Part of the part of the gap, you're seeing versus maybe what you might have expected.
Okay, Great and then maybe just as a follow up are you able to quantify how much of your revenue today is related to demand creation or the engineering services.
Maybe as a rough percentage.
Got it.
Okay.
Melissa we've never we've never spelled that out.
Can tell you that our our design registration activity has continued to build over the last three quarters.
And in this past quarter, both sequentially and year on year, certainly the history around that.
As part of what contributed to that.
The margin upside we saw in Q2 and remember what I said in this environment, especially the predictability of around what we're going to get for things that I would call fulfillment versus things that I would call related to design win and demand creation tends to vary a bit as well.
But I'm absolutely confident that our engineering investments are contributing to part of the the margin results and the build in Reg activity kind of helps us validate.
Those investments so they bode well for the future. These are long cycles, you don't engage in a design activity on Monday get the Reg on Tuesday, and see the revenue by Friday, They typically play out over multiple months and quarters.
Okay, great. Thanks very much.
Thank you.
And there are no further question at this time I will turn the call back over to the presenters for closing remarks.
Thank you for your interest in Arrow electronics and have a nice day.
This concludes today's conference call you may now disconnect.
Yes.
Please wait the conference will begin shortly.
[music].
Okay.
Yes.
Yes.
[music].
Yes.
Okay.
Yes.
Okay.
Yes.
[music].