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spk00: Good afternoon and welcome to the Arrow Electronics second quarter 2022 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, press star 1 on your telephone keypad. If you'd like to withdraw your question, press star 1 again. Thank you. Rick, you may begin your conference.
spk05: Good day and welcome to the Arrow Electronics second quarter 2022 earnings conference call. With us on the call today are Shawn Cairns, President and Chief Executive Officer, and Emeric Seidlitz, Interim Principal Financial Officer. 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 the 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.com, along with the CFO commentary, the non-GAAP earnings recommendation, 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, Sean Cairns.
spk01: 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 Arrow. 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 ample 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, have led to improvements in profitability. We think this is proof positive that we are uniquely positioned to help our customers navigate today's market opportunities and challenges. In our global component segment, demand for electronic components and associated design, engineering, and supply chain services remain strong. In fact, demand continues to outpace supply. Our book-to-bill ratios remain 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 remain 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 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. In the enterprise computing solutions business, demand for more complex enterprise IT 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 EMEA region delivered record second quarter sales, and 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 about the future of Arrow, all underpinned by the talent, hard work, and dedication of all the Arrow 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 solutions driven by the electrification of everything, we believe in the power of innovation to make the world a better place. And I'm 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.
spk05: 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 $1.06 to 1 euro. Second quarter gross margin of 13.1% was up 140 basis points year over year, driven by higher margins and global components. Operating expenses as a percentage of sales were 7.4% down 20 basis points year over year. Interest and other expense totaled $39 million, 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 in the target long-term range of 23% to 25%. Turning to cash flow in the balance sheet, our second quarter operating cash flow was negative $83 million as a result of working capital investments to support continued growth. Our cash cycle of approximately 60 days was unchanged from the first quarter, but has increased to 10 days year over year. Although strong demand and supply chain issues have resulted in significant inventory price increases year over year, our calculated investments in inventory have positioned us to capitalize on this environment. Our return on invested capital and return on working capital reach 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, and total liquidity was $2.3 billion, including cash of $226 million. Our liquidity remains in one of the strongest positions 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 I've shared during the call today 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 that the CFO commentary includes information on our fiscal calendar closing dates. Turning to guidance. Midpoint sales and ETS guidance imply records for the third quarter. Our guidance reflects normal seasonality and a continuation of the current supply, demand, and balance. 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 enterprise computing solution profits will be relatively flat year-over-year. We estimate an approximately $350 million headwind to sales and $0.25 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.
spk00: Thank you. At this time, I would like to remind everyone, in order to ask a question, press star 1 on the telephone keypad. We'll pause for just a moment to call the Q&A roster. Your first question comes from Jim Suva from Citi. Please go ahead.
spk06: Thank you very much. Can you help us understand? You mentioned normal seasonality for September. You know, looking at it, it kind of looks like it's subnormal, but maybe there's FX in there. Maybe there's some items we need to be aware of. But can you help us reconcile your comment about FX? Then I have a question about your inventory level. Not a question 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.
spk01: Yeah. Hey, Jim. It's Shawn. 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.
spk05: Sure. So I think you hit it there when you talk about FX. There's normal seasonality, particularly in Europe, and that's also magnified with some of the FX segments that we spoke about.
spk01: Jim, also to remember, last year in Q3, it was really the start of the uptick in the cycle that we've been enjoying.
spk06: Right. And then what's the FX impact on the outlook quarter over quarter or year over year? Either way is fine.
spk05: Year over year, $350 million to sales and 25 cents to EPS.
spk06: 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?
spk01: You know, I'd like to think we're hitting equilibrium, Jim, but we're really not. You know, inventories did come up in Q2, but certainly less so than in Q1. You know, the increase was more about pricing than units, but there was also some timing and in transit, you know, activity as well that you're seeing in the number. Frankly, if we could have gotten, you know, more product last quarter, I would have taken it because it's what supported our growth. It's what really helped us deliver great returns, and it's also important to us you know, when it comes to customer SAP. So I'm not too concerned at all about, you know, the inventory build. I think, you know, we have every confidence that even as and when the market does soften, you know, our ability to sell through the inventory and generate future cash flow is highly reliable.
spk06: Thank you so much for the details and clarifications, and congratulations to you and your entire new management team. Thank you. Thanks, Jim.
spk00: Your next question comes from Nick from Longboat. Please go ahead.
spk07: Yeah, good afternoon, everyone, and congrats, Sean, on the first call. A question on guidance specifically for components. I was hoping you can kind of maybe bridge. We understand there's seasonality in Europe and there's a little bit of impact from FX, but maybe if you can try to bridge how much is the sequential FX impact that you're baking in. And also, if we look at your guidance relative to the suppliers, the semiconductors specifically, and even IP&E, 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?
spk01: Yeah, I'd be happy to. So if you step back a little bit, come up to 25,000 feet, in the aggregates, All the indicators that I talked about earlier tell us that the overall demand picture is still outstripping supply. That's a fundamental fact that we don't see that changing anytime soon. So from a top line perspective, you know, 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, you know, 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 you know from one quarter to the next you know either related to seasonality which drives the difference in regional mix uh differences in product mix you know sometimes we get more content for fulfillment versus more content for you know design win and demand creation and that's going to vary quarter to quarter as well and you're absolutely seeing you know fx play into the equation as well i think the you know the fx headwind alone more than accounts for the difference in you know what you might have expected you know, on a top line guide.
spk07: Okay, great. The second question is, obviously you talked about still continued supply and demand imbalance. I'm wondering if you're seeing any differences by end market. Obviously, I think there's been widely known that consumer electronics is experiencing some weakness in demand. But I think you called out that in China industrial demand and communication was also down with that type specifically to supply lack of availability or are you seeing any changes in order trends there. And also, if you're seeing any any changes from the level of expedite request, you're getting from customers.
spk01: So, Again, let me start with the market overall. Broadly speaking, demand remains pretty healthy based on what we see. It's healthy in industrial, automotive, aerospace and defense, network and 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 you know, the industrial mass market, a little bit different than some of our competitors. We are monitoring carefully, you know, to the extent that any of that leads into, you know, heavy industrial automotive and beyond, but so far, you know, we're not convinced of that.
spk07: Okay, got it. Thanks for the answers.
spk00: Your next question comes from Joe Quattrochi from Wells Fargo. Please go ahead.
spk03: Yeah, thanks for taking the question. I'm wondering if you could talk about the price increases you're seeing from your suppliers. Have you continued to see those in the June quarter, and do you expect that to continue in the second half of this year?
spk01: So if you look at the question about inventory, obviously, as I said, that was more about price increases than 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. Our suppliers are in the best position to answer that question going forward. But again, I would say that overall demand still in excess of supply would indicate that some of that might still be likely in pockets a little too early for us to speculate. Okay.
spk03: And then just You know, relative to maybe past quarters when you've received better supply than you'd expected in your guidance, you know, it kind of enabled some upside. How did this quarter play out just given the, you know, results were relatively in the range you provided?
spk01: Well, Joe, you know, I'd like to think that we're getting a little bit better at calling where we're going to land, you know, at the start of this quarter. this you know this cycle all based on a big disconnect between uh supply and demand um you know we probably weren't calling it as accurately as we we could have um and therefore you saw a couple quarters where we really came in you know comfortably passed our guide i think over time we've gotten you know better intel um and frankly learned more about how to make this call and you know you're not seeing any you know, 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. Hopeful. Thank you.
spk00: Your next question comes from William Steen from Trist Securities. Please go ahead.
spk04: Great. Thank you for taking my question. I'm wondering if you can help me understand the dynamic 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 have been on more of a year-over-year comparison basis. When we look at the sequential from March to June, how did the mix between hardware and software change, and are you seeing any greater availability or let's say more consistent fulfillment on the system side?
spk01: Sure, Will. So let me start in a couple different places and hopefully get 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 software services hardware from one quarter to the next, but you will see that on a year-over-year basis become a little more pronounced. The hardware supply constraints probably only got worse in Q2 as in our backlog continued to build. Lead times are still well past historical norms in all the hardware spaces in which we compete. 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 helped. But by and large, you know, remember our North American business leans more to hardware than software, cloud, and services, at least at this juncture, than does our business in Europe. And so they were, you know, disproportionately, you know, hurt by that. But as I said earlier, the backlog has continued to grow. And, you know, these fulfillment delays and product fulfillments are going to have to resolve themselves at some point.
spk04: A follow-up is that in the CFO commentary it noted that lead times were elevated but stable sequentially and that is a change. They had been rising for some time and the commentary noted that on a sequential basis lead times were stable. How have lead times tracked in the last 34 days or so since the quarter closed? Has there been any moderation? I know this It's very difficult to sort of call an average because there's a million different lead times. There's a massive range. But I know we ask you often to make these summary judgments. Have you seen any retraction in the lead times at all?
spk01: No, you will. I appreciate your empathy because you're absolutely right. You know, this is something our teams monitor daily, but by and large, since the, you know, the end of the quarter, we haven't seen really a change in lead times. And yes, while they didn't get any further elongated in Q2 versus Q1, they're already well past, you know, historical norms. You know, typically we'd 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. Thank you. Thank you.
spk00: Your next question comes from Rupu Bhattacharyya from Bank of America. Please go ahead.
spk08: Hi. Thank you for taking my questions. Sean, my first question is on the enterprise computing solution segment. The 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 macro or have you seen any share shifts there? So just trying to understand what happened in the Americas region.
spk01: Yes. So a couple different pieces to that. You know, first of all, I wouldn't necessarily cite anything of a macro nature. You know, there's a lot of good sort of trends overall around sort of enterprise level, you know, spending patterns starting to return to, you know, 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 good momentum we're seeing with software and certainly cloud as well. From a cybersecurity perspective, you're right, because we have pretty good exposure to that segment. Believe it or not, even though it's software, it's often delivered via an appliance. And security-based appliances are also part of what's been slowed by the hard work and strength to help deliver those solutions both on-premise and off. So that would be the wrinkle you're seeing there. By and large, we think the outlook for cyber remains pretty healthy.
spk08: Okay, thanks for that. Maybe for my follow-up, if I can ask, in the component segment, you posted strong operating margin of 7.1%, which is up 200 basis points year-on-year. How 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 should we expect that margins can normalize down in that segment? So just your thoughts on component operating margins going forward. Thank you.
spk01: Yeah. So as I said, 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 you know, the margin improvements we're enjoying, you know, one part, you know, regional mix, and that's going to vary from quarter to quarter. One part pricing, and then one part 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... you know, might not be right on target, but I think all three are helping. Certainly pricing is part of it. And I think even when, you know, supply and demand normalize, we believe that some portion of the, you know, the structural improvements we've been able to build into our model will remain.
spk08: Okay, thanks for all the details. Appreciate it.
spk00: Your next question comes from Melissa Fairbanks from Raymond James. Please go ahead.
spk02: 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 FX is a headwind, but was there any pull forward of demand in June or was it just better execution, better sourcing?
spk01: Thanks, Melissa. No, there was absolutely no pull forward business in our June number from the third quarter. This is all about supply and we're obviously 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're we've called this supply equation pretty accurately you know walking into the quarter so we don't we don't see any upside as of yet um but i think again you'll find that the the currency headwinds alone account for you know part of the part of the gap you're seeing versus maybe what you might have expected okay great and then um maybe just as a follow-up are you able to quantify
spk02: How much of your revenue today is related to demand creation or the engineering services? Maybe as a rough percentage.
spk01: You know, Melissa, we've never spelled that out. I can tell you that our design registration activity has continued to build over the last three quarters and this past quarter both sequentially and year on year. Certainly the history around that is part of what contributed to you know, the margin upside we saw in Q2. And remember what I said, you know, in this environment, especially, you know, the predictability 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 margin result and the build-in reg activity, you know, kind of helps us validate you know, those investments. And they bode well for the future. You know, 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, you know, multiple months and quarters.
spk02: Okay, great. Thanks very much.
spk01: Thank you.
spk00: And there are no further questions at this time. I will turn the call back over to the presenters for closing remarks.
spk05: Thank you for your interest in air electronics, and have a nice day.
spk00: This concludes today's conference call. You may now disconnect.
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