ARW - NYSE

Good day, and welcome to Arrow Electronics Second Quarter 2025 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Rick Seidlitz, Arrow's Vice President of Investor Relations. Please go ahead.

Thank you. I'd like to welcome everyone to the Arrow Electronics Second Quarter 2025 Earnings Conference Call. Joining me on the call today is our President and Chief Executive Officer, Sean Kerins; and our Chief Financial Officer, Raj Agrawal; our President of Global Components, Rick Marano, and our President of Global Enterprise Computing Solutions; Eric Nowak. During this call, we'll make forward-looking statements, including statements about our business outlook, strategies, plans 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 due to the risk factors and other factors described in this quarter's associated earnings release in our most recent annual report on Form 10-K and other filings with the SEC. We undertake no obligation to update publicly or revise any of the forward-looking statements as a result of new information or future events. 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. You can access our earnings release at investor.arrow.com, along with a replay of this call. We've also posted a slide presentation on this website to accompany our prepared remarks and encourage you to reference these slides during this webcast. Following our prepared remarks today, Sean and Raj will be available to take your questions. I'll now hand the call over to our President and CEO, Sean Kerins.

Thank you, Rick, and thank you all for joining us. Today, I'd like to discuss our second quarter results, provide some commentary on the broader market environment and then close with some thoughts as we look to the balance of the year. I'll then turn things over to Raj for more detail on our financials as well as our outlook for the third quarter. For the second quarter, we delivered sales as well as earnings per share that exceeded the high end of our guidance ranges, with solid contributions from both of our operating segments. In Global Components, our momentum was punctuated by year-over-year growth for the first time since Q4 of '22 with strength in Asia and improving trends across our industrial and transportation market segments. And in enterprise computing solutions, we delivered year-over-year billings and gross profit dollar growth based on strength both on- premise and in the cloud as well as in both of our operating regions. Taking a closer look at our global components business the prolonged cyclical correction is yielding to early signs of a market recovery. All three of our operating regions again delivered sales in excess of typical seasonality. Demand trends were highlighted by broad strength in Asia, improving activity levels in our industrial and transportation markets on a global basis and healthy aerospace and defense patterns in Western markets. Additionally, our sales for IP&E components once again grew sequentially and but now also year-over-year, underscoring our continued commitment to specialization in this accretive and resilient market segment. Lastly, our value-added offerings, namely supply chain management, engineering and design and integration services contributed nicely to our operating margin stability. And for some color commentary on a regional basis, in the Americas, the industrial and aerospace and defense markets drove our results, supported by resilience in transportation. In Asia, our sequential growth was broad-based in nature, highlighted by strength in industrial, compute and consumer, along with continued EV momentum in the transportation sector. And finally, our sales in EMEA grew sequentially despite macroeconomic and geopolitical headwinds. Results were marked by strength in industrial, transportation and aerospace and defense markets. Now as we look at the market more broadly, our book-to-bill ratios are above parity in all three regions. While lead times still approximate pre-pandemic norms, our backlog further improved, growing for a second consecutive quarter. Throughout our large OEM customer base, inventory levels are normalizing, illustrated through more sustainable order patterns, providing us with visibility into their real demand. We also believe our mass market customers are still in the later stages of destocking, suggesting there's still runway for a broader market recovery, particularly in the West. And finally, as in prior cycles, we expect to follow the suppliers that we represent, many of whom are now calling for growth through the balance of the year and beyond. The shape and slope of this recovery remain difficult to predict, but we believe these leading indicators point to a modest recovery taking flight. Our Q3 guidance reflects the continuation of these trends highlighted by mid-single-digit sales growth and operating margin stability while still navigating headwinds related to regional and customer mix. In regard to tariffs, due to uncertainty around future trade policy, we saw modest order acceleration in Asia alongside less tariff uplift than anticipated in the U.S. These dynamics did not materially impact our second quarter results, nor have we contemplated any material impact in our third quarter guidance. While the current trade environment continues to evolve, I'd like to reiterate Arrow's focus on helping our customers navigate the associated complexity. We will continue to lean on our global footprint of supply chain assets as well as our portfolio of services to help them do so. Now turning to our global ECS business. In the second quarter, we delivered year-over-year double-digit growth in billings and gross profit as well as operating income when normalized. The results were highlighted by solid contributions from both of our operating regions. Our performance in EMEA was broad-based with year-over-year billings growth in cloud, infrastructure software and cybersecurity. And in North America, we saw continued acceleration in our cloud portfolio alongside strength in infrastructure software and data storage. Our efforts to align our go-to-market strategy in North America in a way that mirrors our success in EMEA is starting to pay dividends. Looking to the future, we again enjoyed backlog growth in excess of 50% year-over-year. We believe this reflects our alignment to some very promising demand trends, many of which are now served on an as-a-service basis. Examples include hybrid cloud solutions, the deployment of infrastructure software in areas such as virtualization and data protection and the early innings of AI in the traditional data center. In addition, our focus on the mid-market, enabled by the continued adoption of our digital platform, ArrowSphere positions us nicely for ongoing customer base expansion. With all of that in mind, our third quarter outlook again suggests healthy performance in both operating regions poised for year-over-year growth in billings, gross profit and operating income. In closing, despite various market and geopolitical uncertainties, we are optimistic as we look to the near future. In global components, the evidence of cyclical recovery suggests will enjoy better than seasonal sales patterns for the balance of the year. In enterprise computing solutions, it's clear to us that our momentum will continue to build across the full second half and for the company overall, our ongoing productivity initiatives will benefit us at more scale. As always, the credit for our progress belongs to all of the Arrow teams and employees throughout the world. I'm thankful for their dedication to our suppliers, our customers and each other. And with that, I'll hand the mic over to Raj.

Thanks, Sean. Consolidated sales for the second quarter were $7.6 billion, exceeding our guidance range and up 10% versus prior year or up 8% year-over-year on a constant currency basis. Global components sales were $5.3 billion, above our guidance range and up 11% versus prior quarter or up 8% sequentially in constant currency terms. You will recall that in our Q2 outlook that we provided last quarter, we highlighted a potential 2% to 4% incremental lift to global component sales from tariff billing impacts. In our second quarter results, we attribute around 1% of sales to these impacts. Additionally, as Sean mentioned, we saw modest order acceleration related to tariff expectations, particularly in Asia, and we believe the impact could be 1% to 2% on second quarter sales. Enterprise computing solutions sales were $2.3 billion, above our guidance range and 23% higher than prior year or 20% higher year-over-year in constant currency. ECS billings grew 15% in the second quarter compared to the same period last year. Moving to other financial metrics for the quarter. Second quarter consolidated non-GAAP gross margin of 11.2% was down approximately 110 basis points versus prior year driven primarily by regional and customer mix in global components and by product mix in ECS. Global components' non-GAAP gross margin was 11.2%, down 40 basis points sequentially due to regional and customer mix and enterprise computing solutions was 11.2% on a non-GAAP basis. Our second quarter non-GAAP operating expenses grew $38 million sequentially to $631 million due largely to variable costs to support top line sales growth as well as the impact of currency exchange rates. Also, although we have returned to growth, we remain committed to executing against our productivity initiatives, which will provide increasing benefits in the second half of this year. In the second quarter, we generated non-GAAP operating income of $215 million, which was 2.8% of sales with Global components operating margin at 3.6% and enterprise computing solutions at 4.3% and both on a non-GAAP basis. As a reminder, ECS operating income in the second quarter of 2024 included a $20 million benefit for the collection of certain aged receivables related to one customer. Interest and other expense was $60 million in the second quarter, and our non- GAAP effective tax rate was 17.6%, which is well below our typical range of 23% to 25% due to certain benefits which we are not expecting to recur in the third quarter. We expect both interest expense and taxes to be a drag on third quarter EPS when compared to the second quarter. And finally, non-GAAP diluted EPS for the second quarter was $2.43, which was above our guided range, mainly due to favorable sales results and a lower tax rate. Turning to working capital. Net working capital grew sequentially in the second quarter by $456 million, ending the quarter at $6.8 billion. However, our cash conversion cycle improved by 10 days in the second quarter to 68 days. Inventory at the end of the second quarter was $4.7 billion, down modestly quarter-over-quarter and our inventory turns improved to our highest rate in over 2 years. We will maintain our focus on matching our inventory to associated demand trends as the current cyclical recovery continues. Cash flow used for operating activities in the second quarter was $206 million. In conjunction with cash generated in the first quarter, on a year-to-date basis, cash flow from operations was $146 million. Gross balance sheet debt at the end of the second quarter was $2.8 billion or flat quarter-over-quarter. We repurchased $50 million of shares in the second quarter and our remaining repurchase authorization stands at approximately $225 million. In the short term, we are continuing to balance our capital priorities with managing our debt ratios. Now turning to Q3 guidance. We expect sales for the third quarter to be between $7.3 billion and $7.9 billion. We expect global component sales to be between $5.3 billion and $5.7 billion, which, at the midpoint, is up 4% from prior quarter. In enterprise computing solutions, we expect sales to be between $2 billion and $2.2 billion, which is up approximately 12% at the midpoint year- on-year. In our outlook, we have factored in the direct billing impact from tariffs. Based on tariffs already in place, we estimate that this impact on global component sales will be similar in magnitude when compared to the second quarter. We have not factored in our guidance any assumptions around evolving trade policies nor does our outlook assume any order acceleration from customers. We're assuming our tax rate to return to our typical range of approximately 23% to 25% and interest expense to increase to approximately $65 million as compared to $60 million in the second quarter and our non-GAAP diluted earnings per share is expected to be between $2.16 and $2.36. And finally, given weakness in the U.S. dollar, particularly relative to the euro, we estimate changes in foreign currencies to be a tailwind in the third quarter. The details of foreign currency impact can be found in our earnings release. With that, Sean and I are now ready to take your questions. Operator, please open the line.

[Operator Instructions] Your first question comes from the line of Joe Quatrochi with Wells Fargo.

Maybe just kind of trying to understand the demand dynamics relative to your inventory? How do you think about having the right inventory for maybe signs of a recovery here?

Sure, Joe. Well, as you know, because you've been following us for some time, our inventories are down well more than maybe $1 billion from the peak that we saw in late '23. And I think in Q2, they came down roughly $50 million or more, something in that range. And we know our turns definitely improved as well. So I would say in the aggregate, we feel like we've done a pretty good job managing inventory throughout this prolonged correction. There are still some pockets of excess, but we continue to eat away at them. We're not concerned about the aging profile of the inventory. We believe we'll sell through it over time. And certainly, we're adequately reserved for any risk that we would contemplate. But I think the bigger picture to your question is really all about the market. We pay real close attention to our customers and what they tell us and what they see going forward. We want to be leaning in as the market recovers, so we can best support them. And I think with some of the improving leading indicators, we continue to see, we don't intend to be caught flat-footed. So we can expect -- we will invest in working capital to support growth where and when it makes sense. And I think we're at that inflection point where we need to best support our customers.

That's helpful. And then maybe one for Raj. Just trying to kind of like the puts and takes of the margin -- implied margin guidance for the September quarter and then also kind of balancing that with the cost efforts that you guys have been undertaking over the last few quarters. Like I guess, is it right to think that the margins are slightly down I think sequentially in the September quarter?

That's probably not a right conclusion, Joe. We see margins being relatively stable, certainly at an Arrow Inc. level and also in components. ECS has its own cyclicality that we have to deal with. But the gross margin is likely to see continued mix shift given the APAC growth in components as well as the large customer mix that we have, but we are certainly offsetting that with some of our productivity and cost savings initiatives. So that is certainly going to mitigate that impact, but we see relatively stable margins quarter- over-quarter.

And Joe, I would just add in the Global Components business, the gross margin pressure that Raj alluded to is strictly a function of regional and customer mix. As you know, Asia typically leads the globe into recovery, and that's been the case now for a good couple 3 quarters, and they're performing well on the sales line. The West will come back, but it's also a function of customer mix. The larger OEMs are driving our sequential sales growth. We know the mass market will return at more scale. We're starting to see evidence of that in our backlog as it builds out in time into Q4 and even a little bit into Q1. When that happens, you'll see the gross margin line benefit and the operating leverage improve. So we feel good about the fact that the sales momentum has returned. We've always known that the operating leverage won't come until the scale comes back. So we think this is an encouraging sign.

Your next question comes from the line of William Stein with Truist Securities.

I'm hoping you can talk about your customer inventory level to the best of your ability. You talked a moment ago about when the broad-based end markets come back that, that should be more beneficial to margins. And I think it suggests that perhaps they still have some excess inventory or maybe just demand in those broader end markets is not as robust. Can you clarify and help us understand that a little bit?

Yes. Sure thing, Will, and thanks for joining. I think we made mention of it in the prepared remarks. But as you know, we're pretty disciplined about the leading indicators that we monitor and I would say we definitely are seeing customer level inventories normalize, especially in the larger OEM piece of the market, and that's been driving a level of replenishment activity and we're seeing normal booking patterns reemerge if you will. We do think the mass market customer base lacks the larger OEMs, to your point, with still some destocking playing out. Obviously, visibility will improve as either lead times extend or end market demand improves more sharply. But I think there's still some destocking going in -- going on in a broader piece of our customer base. And that's -- that will play out over time. And as it does, we'll see that piece of the market return to our mix at more scale, and that's where the gross margin line will benefit most. But there is a difference playing out, inventories normalizing in the high end, destocking still playing out in the lower end. And if you think about it, given the shortage market, the larger accounts got the inventory first and have certainly worked their way through good portions of it. The mass market got it later on and they're still digesting some of it as we speak.

That's very helpful for sort of more of a demand picture. So thank you for that. On the supply side, are you seeing still very short lead times, as I would expect from the supply base. I think they haven't seen a huge recovery that would lead to extended lead times, but are we still seeing many of your suppliers quote stock in terms of their lead times or has that begun to reach a more normalized level?

Yes. You're right, Will. The lead times basically are stable. We have not seen lead times come in any further, but we also haven't seen them go out. They've been quite level at roughly pre-pandemic rates. If you go back to late '19, early '20 and haven't moved much over the past 2 to 3 quarters at all.

Your next question comes from Ruplu Bhattacharya.

Maybe I'd like to dig a little bit deeper into the ECS segment margins. I mean ECS sales were up 23% year-on-year. but margins were down about 90 bps. I think, Sean, you said something had to be normalized for. So if you can just kind of explain that. And then how are you thinking about ECS segment margin for fiscal 3Q and beyond?

So Ruplu, let me just start with the basics on Q2 performance in ECS. On a sales basis, we show operating margins declining by maybe 20 basis points year-on-year. But as we've said on multiple occasions, the sales number will vary in some cases, quite significantly from one quarter to the next based on mix. And based on the rules of agency accounting, and that the best way to look at both gross and operating margins is really on a billings basis. And that's partly why we now disclose our billings activity. And if you look at the billings base operating margins in ECS year-on-year in Q2, they were stable. So we're very comfortable with the margin profile of the business. And as the transactional volume continues to scale, we see the operating leverage improving further. In fact, I think if you look at it in Q2, billings were roughly in the neighborhood of 15% year-on-year. OI grew by almost 18% year-on-year. So they drove a little bit of leverage in Q2. And I think our guide reflects even better leverage in Q3. So we're comfortable with the margin profile, and we do believe it will improve in the future. The team is driving the right things from a mix perspective. But again, try not to read too much into the sales-based margin profile because it can mislead you from time to time.

And Ruplu, the adjustment, you do have to make was from the second quarter of last year, we did receive a $20 million release from a bad debt reserve that we'd previously taken. And as Sean was explaining, if you make that adjustment, then you can see exactly what he was referring to.

Okay. Can I ask you on component sales, it looks like EMEA sales were down year-on-year. How do you see that region progressing? And Sean, overall, your guidance for fiscal 3Q components is pretty strong. It's like above seasonal growth. So what is giving you confidence that, that growth continues. I think you said there's no benefit from tariff-related prebuys. So I mean, can you -- is ArrowSphere, I think, is another thing you highlighted, is that -- does that come in, in Europe? And just your overall confidence in the guidance for components.

Sure thing. Well, Ruplu, as you might recall, ArrowSphere is a function of our ECS business, it's the digital go-to-market platform for that team. So it's not relevant in the components realm. But if you look at our components business, you're right, we were better than seasonal in Q2 in all three regions. Our forecast means better than seasonal again in Q3 in all three regions. And our backlog grew again in Q2. And this time, even more substantially than it did in Q1. And the important thing there, Ruplu, is when we look at our backlog is that it's not just growing in magnitude, it's growing out in time, meaning into Q4 and a little bit into Q1. But I also think we're seeing better vertical trends throughout the world, and those vertical trends vary a little bit. So I thought I might have Rick Marano, who is the architect of our go-to-market motion in global components, just give you a little more color on that front.

Yes. Thanks, Sean. And building off, Ruplu, what Sean had said is if you look at globally, what we're seeing is in the West, in both aerospace and defense and transportation in aggregate and some industrial in the larger markets, we're seeing [Audio Gap] market. And in Asia, we are in the cycle of recovery, we're seeing growth [Audio Gap] as well. But to Sean's point, key is the fundamentals of backlog and backlog growth, book-to-bill are giving us confidence in a recovery that is starting to take place.

And there are no further questions at this time. I will turn the call back over to Rick Seidlitz for closing remarks.

Thank you all again for joining today's call, and have a great day.