Arrow Electronics, Inc. (NYSE:ARW) Q3 2023 Earnings Call Transcript

Arrow Electronics, Inc. (NYSE:ARW) Q3 2023 Earnings Call Transcript November 2, 2023

Arrow Electronics, Inc. beats earnings expectations. Reported EPS is $4.14, expectations were $3.48.

Operator: Good day, and welcome to the Arrow Electronics Third Quarter 2023 Earnings Call. Today's conference is being recorded. And at this time, I would like to turn the conference over to Anthony Bencivenga, Vice President of Investor Relations. Please go ahead.

Anthony Bencivenga: Thank you, operator. I'd like to welcome everyone to the Arrow Electronics Third Quarter 2023 Earnings Conference Call. Joining me on the call today is our President and Chief Executive Sean Kerins; and our Chief Financial Officer, Raj Agrawal. During this call, we'll 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 described in our most recent 10-K and 10-Q filings with the SEC. We undertake no obligation to update or publicly revise any of the forward-looking statements as a result of new information or future events.

An assembly line of electronics components in a factory operated by the company.

As a reminder, some of the figures we will discuss on today's call are non-GAAP measures, which are not intended to be a substitute for our GAAP results. We've reconciled these non-GAAP measures to the most directly comparable GAAP financial measures in this quarter's associated earnings release or Form 10-Q, you can access our earnings release at investor.arrow.com, along with the CFO commentary, the non-GAAP earnings reconciliation and a replay of this call. We've also posted a slide presentation to accompany our prepared remarks and encourage you to reference these slides during this webcast. Following our prepared remarks today, we'll be available to take your questions. I'll now hand the call over to our President and CEO, Sean Kerins.

Sean Kerins: Thanks, Anthony, and thank you all for joining us and for your interest in Arrow Electronics. Today, I'd like to discuss our Q3 performance provide some color regarding the market overall, and then close with a couple of thoughts as we look to the future. I'll then turn things over to Raj for more detail on our financials as well as our outlook for the fourth quarter. Despite continued market softness, I'm pleased to announce that we delivered sales results for the third quarter, in line with our expectations and earnings per share well above them. Now Included in our results are two items worth noting: one of benefit and one of charge to our P&L. Raj will describe these in more detail, but even when normalizing for these items, our non-GAAP earnings per share were at the high end of our guidance.

As I discussed last quarter, we're experiencing a cyclical correction in our global components business and a very mixed IT spending environment in our enterprise computing solutions business. But as I also mentioned, we've seen corrections like this before, are confident in our resilience and ability to successfully navigate them, and remain optimistic regarding the longer-term outlooks, both in electronics and information technology. In the meantime, we continue to stay very close to our suppliers and customers and are taking all the right steps to emerge even stronger as market conditions improve. In our global components business, market conditions remain challenging evident through softer demand across several verticals and elevated inventory levels throughout the ecosystem.

Having said that, we again see signs that point to the underlying health of the business. Lead times have now largely normalized and will contribute to the service of our delinquent backlog and improved visibility to future demand signals, book-to-bill ratios, though below parity -- a steady and the pricing environment remains relatively stable. In addition, given what we can control, we remain steadfast in our focus on the initiatives that continue to benefit our structural margin health. Demand creation activity was strong in Q3, demonstrating our continued commitment to the role and value of our engineering investments. We made steady progress in the market for interconnect, passive and electromechanical technologies, and accretive segment proving a little more resilient through the cycle, and we saw continued adoption of our supply chain services offering.

As a proof point, our results and guidance for Global Components indicate operating margins roughly 100 basis points better than what we experienced during the cyclical downturn in 2019. Now from a regional perspective, sales were soft across the board. However, we did see some pockets of relative strength. In the Americas, we were pleased with the increased traction in design-related activity as we continue to help our customers design in components for their next-generation products. Over in Europe, our focus on interconnect, passive, and electromechanical components appears to be paying off as we saw some improvement in IP&E booking activity during the quarter and in Asia, while it's too soon to call for a broader recovery, we were encouraged by relative momentum in transportation, networking and communications, and, to a lesser degree, computing.

As we look to the near term and global components, we're confident in the stability of our supplier technology portfolio, the strength of our customer relationships, and our ability to generate cash as we continue to navigate correction territory. Now turning to our global ECS business. We were pleased with the relative strength we saw in infrastructure software, cybersecurity, and cloud adoption, all consistent with our strategy. This contributed to overall gross billings growth on a year-over-year basis. On the other hand, large enterprise IT spending remain lumpy as customers proceed cautiously given a more uncertain macro environment, creating headwinds for our high-end compute and storage offerings. In EMEA, we benefited from our broad exposure to the mid-market, the strength of our software and cloud portfolio and the consistent execution of our European team.

And in North America, we saw strength in the public sector and yet are still in transition to a model that better resembles both our line card and customer mix in EMEA given only modest investment to support this transition and an improving demand environment, we expect to see better performance in 2024. Despite the volume shortfall, operating margins were solid. And given typical seasonality, we expect them to be quite healthy again in Q4. Before I turn things over to Raj, just a couple of thoughts. First, I'd like to reinforce that we remain optimistic regarding our long-term growth prospects and are taking this opportunity to further align around them. I have every confidence in our strategy and ability to execute and believe that we will be well positioned for a better market environment as demand conditions improve.

And then I'd also like to take a moment and recognize our Arrow employees around the globe. Despite the challenges of an uncertain and sometimes chaotic world, they continue to serve our suppliers and customers with perseverance and dedication. Their wellbeing will always be paramount to our success, and I thank them for their continued commitment to Arrow and all of its stakeholders. With that, I'll hand things over to Raj.

Raj Agrawal: Thanks, Sean. Consolidated revenue for the third quarter was $8 billion, down 14% versus last year or down 15% in constant currency. Global components sales were $6.2 billion, above the midpoint of our guidance range and down 14% versus last year or down 16% in constant currency. The primary drivers of the decline were softness in the Asia market and reduced shortage market activity in the Americas. Now that the shortage market is normalized, it had an immaterial effect on sequential results of the company. Enterprise computing solutions sales were $1.8 billion, down 10% versus last year or down 13% in constant currency. This was partly a function of product mix and partly a function of softness in North America.

Moving to other financial metrics for the quarter. Consolidated gross margin of 12.2% was down 30 basis points sequentially and 60 basis points versus last year. The primary driver of the sequential decline was softness in the business and unfavorable mix in Asia. The year-on-year decline was principally due to reduced volumes in the component shortage market in the Americas, partially offset by improved mix in the European enterprise computing solutions business where we continue to see strong demand for software and cloud solutions. Non-GAAP operating expenses were down $55 million from last quarter to $600 million and included a legal settlement benefit of $62 million in our Global Components business and a partially offsetting $22 million charge in our ECS business to increase our accounts receivable reserve related to one customer.

Even when adjusting for the legal settlement and AR reserve items, our OpEx declined quarter-over-quarter as a function of both the decline in variable expenses and our continued efforts to control spending. Non-GAAP operating income was $379 million or 4.7% of sales with Global components operating margin coming in at 6.2% and enterprise computing solutions coming in at 3.2%. Global Components operating margin benefited 100 basis points from the legal settlement and enterprise computing solutions operating margin incurred a loss of 120 basis points from the AR reserve item. Interest and other expense was $82, which was better than guided due to lower-than-expected average daily borrowings in the quarter. Our effective tax rate of 21% was below our guided range as a result of utilizing certain domestic and foreign tax credits.

Diluted EPS on a non-GAAP basis for the third quarter was $4.14 which was well above the high end of our guided range and based on a 56.3 million share count. Both GAAP and non-GAAP EPS included an $0.87 benefit from the legal settlement and a $0.31 negative impact from the AR reserve item as described. As such, non-GAAP EPS, taking these items into account was at the high end of our guidance range. Moving on to working capital. Net working capital was down from Q2 at $7.4 billion. Accounts receivable decreased from Q2 to $10.7 billion with days of sales outstanding increasing to 121 from 118 last quarter. Accounts payable increased to $9.1 billion, with days of payables increasing to 112 from 111 last quarter. Inventory increased in the quarter due to an attractive and working capital neutral opportunity that we capitalized on as part of our supply chain services offering.

As we've not entered into this opportunity, our inventory position would have declined quarter-over-quarter, similar to the inventory decline we saw in Q2. We remain confident in the quality of our inventory and our business model as it relates to inventory reduction in a down market. We expect to continue to reduce inventory in the coming quarter as we convert our backlog. Our cash flow from operations was a robust $322 million in the quarter based on our operating results and a reduction in working capital. Net debt for the third quarter was flat to Q2 at $3.9 billion. Total liquidity stands at approximately $2.3 billion, including our cash balance of $333 million. Our balance sheet remains strong and provides us with financial flexibility to handle our working capital and other needs.

In the quarter, we repurchased shares in the amount of approximately $200 million. At the end of the third quarter, our remaining stock repurchase authorization stands at approximately $622 million. Please keep in mind that the information I've shared during this call is a high-level summary of our financial results. For more details regarding the business segment results please refer to the CFO commentary in the earnings presentation published in our web this morning. Now turning to Q4 guidance. We expect sales for the fourth quarter to be between $7.5 billion and $8.1 billion. We expect Global Components sales to be between $5.4 billion and $5.8 billion, which at the midpoint is down 10% from prior quarter. We expect enterprise computing solutions sales to be between $2.1 billion and $2.3 billion which, at the midpoint, is up 25% to prior quarter due to seasonality and represents a 12% decline year-on-year.

We are assuming a tax rate in the range of approximately 23% to 25% and interest expense of approximately $90 million. Our non-GAAP diluted earnings per share is expected to be between $3.61 and $3.81 on an average diluted share count of 55 million shares. We estimate changes in foreign currencies will benefit sales in Q4 by approximately $54 million and benefit EPS by approximately $0.02 compared to the prior year. Compared to the prior quarter, we estimate changes in foreign currencies will negatively impact sales in Q4 by approximately $82 million and EPS by $0.07. I will now turn the call over to the operator for Q&A.

Operator: [Operator Instructions]. Your first question comes from the line of Matt Sheerin with Stifel. Your line is open.

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