Arrow Electronics, Inc.: Form 10-Q for the period ended Jun 29, 2024

Information Relating to Forward-Looking Statements

This report includes “forward-looking statements,” as the term is defined under the federal securities laws. Forward-looking statements are those statements which are not statements of historical fact. These forward-looking statements can be identified by forward-looking words such as “expects,” “anticipates,” “intends,” “plans,” “may,” “will,” “believes,” “seeks,” “estimates,” and similar expressions. These forward-looking statements are subject to numerous assumptions, risks, and uncertainties, which could cause actual results or facts to differ materially from such statements for a variety of reasons, including, but not limited to: unfavorable economic conditions; disruptions or inefficiencies in the supply chain; political instability and changes; impacts of military conflict and sanctions; industry conditions; changes in product supply, pricing and customer demand; competition; other vagaries in the global components and the global ECS markets; deteriorating economic conditions, including economic recession, inflation, tax rates, foreign currency exchange rates, or the availability of capital; the effects of natural or man-made catastrophic events; changes in relationships with key suppliers; increased profit margin pressure; changes in legal and regulatory matters; non-compliance with certain regulations, such as export, antitrust, and anti-corruption laws; foreign tax and other loss contingencies; breaches of security or privacy of business information and information system failures, including related to current or future implementations, integrations and upgrades; outbreaks, epidemics, pandemics, or public health crises; and the company’s ability to generate positive cash flow. For a further discussion of these and other factors that could cause the company’s future results to differ materially from any forward-looking statements, see the section entitled “Risk Factors” in this Quarterly Report on Form 10-Q and the company’s most recent Annual Report on Form 10-K, as well as in other filings the company makes with the Securities and Exchange Commission. Shareholders and other readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. The company undertakes no obligation to update publicly or revise any of the forward-looking statements.

Certain Non-GAAP Financial Information

In addition to disclosing financial results that are determined in accordance with GAAP, the company also discloses certain non-GAAP financial information in the sections below captioned “Sales”, “Gross Profit”, “Operating Expenses”, “Operating Income”, “Income Tax”, and “Net Income Attributable to Shareholders”. Refer to these sections below for reconciliations of non-GAAP financial measures to the most directly comparable reported GAAP financial measures. Non-GAAP financial information includes the following:

• Non-GAAP sales (referred to as “sales on a constant currency basis”) exclude the impact of changes in foreign currencies by retranslating prior period results at current period foreign exchange rates.
• Non-GAAP gross profit excludes inventory write downs related to the wind down of a business within the global components reportable segment (“impact of wind down to inventory”) and impact of changes in foreign currencies.
• Non-GAAP operating expenses exclude identifiable intangible asset amortization, restructuring, integration, and other, and the impact of changes in foreign currencies.
• Non-GAAP operating income excludes identifiable intangible asset amortization, restructuring, integration, and other, and impact of wind down to inventory.
• Non-GAAP effective tax rate and non-GAAP net income attributable to shareholders exclude identifiable intangible asset amortization, restructuring, integration, and other, impact of wind down to inventory, loss on extinguishment of debt, gain (loss) on investments, net, and the impact of tax legislation changes.

Management believes that providing this additional information is useful to the reader to better assess and understand the company’s operating performance and future prospects in the same manner as management, especially when comparing results with previous periods. Management typically monitors the business as adjusted for these items, in addition to GAAP results, to understand and compare operating results across accounting periods, for internal budgeting purposes, for short-term and long-term operating plans, and to evaluate the company’s financial performance. However, analysis of results on a non-GAAP basis should be used as a complement to, and in conjunction with, data presented in accordance with GAAP. For a discussion of what is included within “Restructuring, integration, and other” and “(Loss) gain on investments, net” refer to the similarly captioned sections of this item below.

Overview

The company is a global provider of products, services, and solutions to industrial and commercial users of electronic components and enterprise computing solutions. The company has one of the world’s broadest portfolios of product offerings available from leading electronic components and enterprise computing solutions suppliers, coupled with a range of services, solutions and tools that enables its suppliers to distribute their technologies and help its industrial and commercial customers to source, build upon, and leverage these technologies to grow their businesses, reduce their time to market, and enhance their overall competitiveness. The company is a trusted partner in a complex value chain and is uniquely positioned through its electronics components and IT content portfolios to increase value for stakeholders. The company has two reportable segments, the global components reportable segment and the global ECS reportable segment. The company’s global components reportable segment, enabled by a comprehensive range of value-added capabilities and services, markets and distributes electronic components to OEMs and CMs. The company’s global ECS reportable segment is a leading value-added provider of comprehensive computing solutions and services. Its portfolio of computing solutions includes datacenter, cloud, security, and analytics solutions. Global ECS brings broad market access, extensive supplier relationships, scale, and resources to help its VARs and MSPs meet the needs of their end-users. For the second quarter of 2024, approximately 73% and 27% of the company’s sales were from the global components reportable segment and the global ECS reportable segment, respectively.

The company’s strategic initiatives include the following:

• Offering a variety of value-added services in the global components reportable segment, including demand creation, design, engineering, global marketing and integration services to promote the future sale of suppliers’ products, which generally lead to longer and more profitable relationships with its suppliers and customers.
• Providing global supply chain service offerings such as procurement, logistics, warehousing, and insights from data analytics within the global components reportable segment.
• Enabling customer cloud solutions through the global ECS reportable segments’ cloud marketplace and management platform, ArrowSphere, which helps VARs and MSPs to manage, differentiate, and scale their cloud businesses while providing the business intelligence that IT solution providers need to drive growth.

The company’s long-term financial objectives are to grow sales faster than the market, increase the markets served, grow profits faster than sales, generate earnings per share growth in excess of competitors’ earnings per share growth and market expectations, grow earnings per share at a rate that provides the capital necessary to support the company’s business strategy, allocate and deploy capital effectively so that return on invested capital exceeds the company’s cost of capital, and increase return on invested capital. To achieve its objectives, the company seeks to capture significant opportunities to grow across products, markets, and geographies. To supplement its organic growth strategy, the company continually evaluates strategic acquisitions to broaden its product and value-added service offerings, increase its market penetration, and expand its geographic reach. The company also continues to evaluate cost reduction initiatives to improve its profitability.

Executive Summary

(millions except per share data)

Business environment and other trends:

• During the second quarter and the first six months of 2024, the global components reportable segment continued to experience a cyclical downturn characterized by elevated customer inventory levels, and a challenging global macroeconomic environment, contributing to lower demand for the company’s products. These trends could continue throughout 2024 and while the duration and severity of the current downturn remain uncertain, management currently believes market conditions are improving and the downturn is stabilizing.
• Within the company’s global ECS reportable segment, in certain periods, changes in the mix of sales of IT solutions between more on-premises solutions, versus more “as a service” and cloud-based solutions can impact the proportion of the company's revenue that is recorded on a net basis compared to a gross basis. These changes can increase or decrease sales during a period without a corresponding change in gross profit. Refer to Note 1 “Summary of Significant Accounting Policies” in the company’s Annual Report on Form 10-K for the year ended December 31, 2023.

Results of Operations

Sales by reportable segment

Following is an analysis of the company’s sales by reportable segment:

The sum of the components for sales, as reported, and sales on a constant currency basis may not agree to totals, as presented, due to rounding.

Reportable segment sales by geographic region

Following is an analysis of the company’s reportable segment sales by geographic region:

The sum of the components for sales by geographic region and consolidated sales may not agree to totals, as presented, due to rounding.

During the second quarter and the first six months of 2024, global components sales decreased compared to the year-earlier periods primarily due to the following impacts:

• sales declines in the Americas region primarily due to decreased demand for most major verticals, particularly industrial and communications;
• sales declines in the EMEA region primarily due to decreased demand for industrial, communications, and transportation verticals;
• sales declines in the Asia/Pacific region primarily due to decreased demand for industrial and networking & communications verticals.

During the second quarter and the first six months of 2024, sales in the EMEA region of the global ECS business outperformed the Americas ECS region compared to the year-earlier periods primarily due to a challenging IT spending environment in the Americas region.

Substantially all of the company’s sales are made on an order-by-order basis, rather than through long-term sales contracts. As such, the nature of the company’s business does not provide for the visibility of material forward-looking information from its customers and suppliers beyond a few months.

Gross Profit

Following is an analysis of the company’s consolidated gross profit:

The sum of the components for non-GAAP gross profit may not agree to totals, as presented, due to rounding.

The decrease in gross profit related primarily to declining demand and gross profit margins for the second quarter and the first six months of 2024.

• Global components gross profit margins decreased during the second quarter and the first six months of 2024, compared with the year-earlier periods, due to product mix shifting toward lower margin products and regional mix shifting more towards the Asia/Pacific region. Global components supply chain services offerings continued to have a positive impact on gross margins.
• Global ECS gross profit margins decreased during the second quarter of 2024, compared with the year-earlier periods, due to softer margins in the Americas region as the company works to optimize the customer mix and supplier line card to better serve the mid-market and product mix shifting towards a higher proportion of revenue recognized on a gross basis in the current year. Global ECS gross profit margins during the first six months of 2024 remained flat.

Operating Expenses

Following is an analysis of the company’s consolidated operating expenses:

The sum of the components for non-GAAP operating expenses may not agree to totals, as presented, due to rounding.

The declines in operating expenses for the second quarter and the first six months of 2024, relative to the year-earlier periods, were related to lower variable costs, primarily sales incentives, in line with the decrease in sales discussed above, lower employee costs related to cost reduction initiatives, and a $20.0 million benefit related to the reversal of an allowance for credit losses due to the collection of certain aged receivables related to one customer in the ECS reportable segment. The declines were partially offset by an increase in restructuring, integration and other of $30.2 million and $74.5 million for the second quarter and first six months of 2024, respectively (see discussion below).

Restructuring, Integration, and Other

Restructuring initiatives and integration costs are due to the company’s continued efforts to lower costs, drive operational efficiency, integrate acquired businesses, and consolidate certain operations, as necessary. The company recorded restructuring, integration, and other charges as follows:

The following were included in other charges:

• charges of $22.8 million and $60.5 million for the second quarter and the first six months of 2024, respectively, related to the termination of personnel as a part of operating expense reduction initiatives not related to exit or disposal activities;
• consulting costs of $9.1 million and $14.1 million for the second quarter and the first six months of 2024, respectively, related to ongoing cost reduction initiatives; and
• charges of $3.2 million and $6.5 million related to early lease terminations and related asset impairments.

The company is continuing to evaluate and seek out opportunities to lower costs in order to improve profitability and reallocate resources to strategic investments. During the six months ended June 29, 2024, the company incurred $87.3 million in costs related to cost reduction initiatives and is likely to incur material costs related to these initiatives in the near term. The company cannot presently estimate the amount of these costs due to the variety of factors involved and the early stages of related projects.

Operating Income

Following is an analysis of the company’s consolidated operating income, and operating income for the company’s two reportable segments:

The sum of the components of consolidated operating income do not agree to totals, as presented, because unallocated corporate amounts are not included in the table above. Refer to Note M “Segment and Geographic Information” of the Notes to the Consolidated Financial Statements for further discussion.

The decrease in consolidated operating income as a percentage of sales for the second quarter and the first six months of 2024 relates primarily to the changes in sales, gross profit margins and operating expenses discussed above, partially offset by a $20.0 million benefit related to the reversal of an allowance for credit losses due to the collection of certain aged receivables.

The decrease in operating income as a percentage of sales in the global components reportable segment related primarily to lower sales and higher operating expenses as a percentage of sales.

The increase in operating income as a percentage of sales in the global ECS reportable segment related primarily to a $20.0 million benefit related to the reversal of an allowance for credit losses due to the collection of certain aged receivables related to one customer.

(Loss) Gain on Investments, Net

(Loss) gain on investments, net is primarily related to the changes in fair value of assets related to the Arrow SERP pension plan, which consist primarily of life insurance policies and mutual fund assets, as well as changes in the fair value of the company’s investment in Marubun Corporation, refer to Note H “Financial Instruments Measured at Fair Value” of the Notes to the Consolidated Financial Statements.

Interest and Other Financing Expense, Net

The company recorded net interest and other financing expense as follows:

The decreases in interest and other financing expenses, net for the second quarter and first six months of 2024 compared to the year-earlier periods were primarily related to lower average daily borrowings on floating rate credit facilities and lower interest costs within the company’s cash pooling arrangements, partially offset by slightly higher rates on credit facilities. Refer to the section below titled “Liquidity and Capital Resources” for more information on changes in borrowings.

Income Tax

Income taxes for the interim periods presented have been included in the accompanying consolidated financial statements on the basis of an estimated annual effective tax rate. The determination of the consolidated provision for income taxes requires management to make certain judgments and estimates. Changes in the estimated level of annual pre-tax earnings, tax laws, and changes resulting from tax audits can affect the overall effective income tax rate, which impacts the level of income tax expense and net income. Judgments and estimates related to the company’s projections and assumptions are inherently uncertain, therefore, actual results could differ from projections.

Following is an analysis of the company’s consolidated effective income tax rate:

The sum of the components for non-GAAP effective income tax rate may not agree to totals, as presented, due to rounding.

The company’s effective tax rate deviates from the statutory U.S. federal income tax rate mainly due to the mix of foreign taxing jurisdictions in which the company operates and where its foreign subsidiaries generate taxable income, among other things. The change in the effective tax rate for the second quarter and the first six months of 2024, compared to the year-earlier periods, is primarily due to the changes in the mix of tax jurisdictions where taxable income is generated, taxation of stock-based compensation, tax law changes, and utilization of tax credits in certain jurisdictions.

Net Income Attributable to Shareholders

Following is an analysis of the company’s consolidated net income attributable to shareholders:

The sum of the components for non-GAAP net income attributable to shareholders may not agree to totals, as presented, due to rounding.

* Identifiable intangible asset amortization excludes amortization attributable to the noncontrolling interest.

The decrease in net income attributable to shareholders in the second quarter and the first six months of 2024 compared to the year-earlier periods, relates primarily to changes in sales and gross margins as discussed above.

Liquidity and Capital Resources

Management believes that the company’s current cash availability, its current borrowing capacity under its revolving credit facility and asset securitization programs, and its expected ability to generate future operating cash flows are sufficient to meet its projected cash flow needs for the next 12 months and the foreseeable future. The company’s current committed and undrawn liquidity stands at over $2.6 billion in addition to $213.0 million of cash on hand at June 29, 2024. The company also may issue debt or equity securities in the future and management believes the company will have adequate access to the capital markets, if needed. The company continually evaluates its liquidity requirements and would seek to amend its existing borrowing capacity or access the financial markets as deemed necessary.

The company’s principal sources of liquidity are existing cash and cash equivalents, cash generated from operations and cash provided by its revolving credit facilities and debt. The company’s principal uses of liquidity include cash used in operations, investments to grow working capital, scheduled interest and principal payments on its borrowings, and the return of cash to shareholders through share repurchases.

The following table presents selected financial information related to liquidity:

Working Capital

The company maintains a significant investment in working capital which the company defines as accounts receivable, net, plus inventories less accounts payable. The change in working capital during the first six months of 2024, was primarily attributable to decreases in inventory.

Working capital as a percentage of sales, which is defined as working capital divided by annualized quarterly sales, increased to 24.6% for the second quarter of 2024, compared to 22.0% in the year-earlier period. The increase was primarily due to lower sales.

Cash and Cash Equivalents

Cash equivalents consist of highly liquid investments, which are readily convertible into cash, with original maturities of three months or less. At June 29, 2024 and December 31, 2023, the company had cash and cash equivalents of $213.0 million and $218.1 million, respectively, of which $152.5 million and $160.0 million, respectively, were held outside the United States.

The company has $5.3 billion of undistributed earnings of its foreign subsidiaries which it deems indefinitely reinvested, and recognizes that it may be subject to additional foreign taxes and U.S. state income taxes, if it reverses its indefinite reinvestment assertion on these foreign earnings. The company also has $2.1 billion of foreign earnings that are not deemed permanently reinvested and are available for distribution in future periods as of June 29, 2024.

Revolving Credit Facilities and Debt

The following tables summarize the company’s credit facilities by category:

(a) Amounts outstanding under the commercial paper program are backstopped by available commitments under the company’s revolving credit facility.

The company also has an EMEA asset securitization program under which it continuously sells its interest in designated pools of trade accounts receivable of certain of its subsidiaries in the EMEA region. Receivables sold under the program are excluded from “Accounts receivable, net” and no corresponding liability is recorded on the company’s consolidated balance sheets. During the first six months of 2024 and 2023, the average daily balance outstanding under the EMEA asset securitization program was $428.2 million and $644.8 million, respectively. Refer to Note E “Accounts Receivable” of the Notes to the Consolidated Financial Statements for further discussion.

The following table summarizes recent events impacting the company’s capital resources:

(a) Upon issuance of the 6.125% notes due March 2026, the company entered into an interest rate swap, which effectively converted the 6.125% notes to floating rate notes based on SOFR + 0.508%. In March 2024, the company received a notice from the swap counterparty to terminate the swap. The effective date of cancellation was April 1, 2024. See “Interest Rate Swaps” under Note H “Financial Instruments Measured at Fair Value” of the Notes to the Consolidated Financial Statements for further discussion.

Refer to Note G “Debt” of the Notes to the Consolidated Financial Statements for further discussion of the company’s short-term and long-term debt and available financing.

Cash Flows

The following table summarizes the company’s cash flows by category for the periods presented:

Cash Flows from Operating Activities

The net amount of cash provided by the company’s operating activities during the first six months of 2024 and 2023 was $723.4 million and $97.0 million, respectively. The change in cash provided by operating activities during 2024, compared to the year-earlier period, related primarily to the company’s historical counter-cyclical cash flow as the company generates cash flow in periods of lower demand due to reduced investments in working capital.

Cash Flows from Investing Activities

The net amount of cash used for investing activities during the first six months of 2024 and 2023 was $45.2 million and $26.1 million, respectively.

Cash Flows from Financing Activities

The net amount of cash used for financing activities was $634.9 million during the first six months of 2024 compared to $58.1 million used for financing activities in the year-earlier period. The change in cash used for financing activities related primarily to a decrease in short-term and other borrowings partially offset by higher proceeds from long-term bank borrowings and lower share repurchases.

Capital Expenditures

Capital expenditures for the second quarter of 2024 and 2023 were $51.6 million and $37.1 million, respectively. The company expects capital expenditures to be approximately $100.0 million for the fiscal year 2024.

Share-Repurchase Program

The company repurchased 1.2 million shares of its common stock for $150.0 million and 4.2 million shares of its common stock for $500.9 million in the first six months of 2024 and 2023, respectively, under its share-repurchase program, excluding excise taxes. During the first six months of 2024, the company accrued $1.1 million of excise tax, which is recorded within “Treasury stock” on the company’s consolidated balance sheets and reduces the share-repurchase authorization, as the excise tax is a part of the overall cost of acquiring treasury shares. As of June 29, 2024, approximately $425.0 million remained available for repurchase under the share-repurchase program. The share-repurchase authorization does not have an expiration date and the pace of the repurchase activity will depend on factors such as the company’s working capital needs, cash requirements for acquisitions, debt repayment obligations or repurchases of debt, share price, and economic and market conditions. The share-repurchase program may be accelerated, suspended, delayed, or discontinued at any time subject to the approval of the company’s Board of Directors.

Contractual Obligations

The company has contractual obligations for short-term and long-term debt, interest on short-term and long-term debt, purchase obligations, operating leases, and other sources and uses of capital that are summarized in the sections titled “Contractual Obligations” and “Additional Capital Requirements and Sources” in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in the company’s Annual Report on Form 10-K for the year ended December 31, 2023.

Refer to the section above titled “Revolving Credit Facilities and Debt” for updates to the company’s short-term and long-term debt obligations. Refer to Note H “Financial Instruments Measured at Fair Value” of the Notes to Consolidated Financial Statements for further discussion on hedging activities. As of June 29, 2024, there were no other material changes to the contractual obligations of the company.

Critical Accounting Estimates

The company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the company to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and related disclosure of contingent assets and liabilities. The company evaluates its estimates on an ongoing basis. The company bases its estimates on historical experience and on various other assumptions that are believed reasonable under the circumstances; the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

There have been no significant changes to the company’s critical accounting estimates during the six months ended June 29, 2024. Refer to the section titled “Critical Accounting Estimates” in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in the company’s Annual Report on Form 10-K for the year ended December 31, 2023.

Impact of Recently Issued Accounting Standards

See Note B “Impact of Recently Issued Accounting Standards” of the Notes to Consolidated Financial Statements for a full description of recent accounting pronouncements, including the anticipated dates of adoption and the effects on the company’s consolidated financial position and results of operations.

During the six months ended June 29, 2024, there were no material changes in market risk for changes in foreign currency exchange rates and interest rates from the information provided in Part II, Item 7A – Quantitative and Qualitative Disclosures About Market Risk in the company’s Annual Report on Form 10-K for the year ended December 31, 2023.

Evaluation of Disclosure Controls and Procedures

The company’s management, under the supervision and with the participation of the company’s Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of the company’s disclosure controls and procedures as of June 29, 2024 (the “Evaluation”). Based upon the Evaluation, the company’s Chief Executive Officer and Chief Financial Officer concluded that the company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934) were effective as of June 29, 2024.

Changes in Internal Control over Financial Reporting

There were no changes in the company’s internal control over financial reporting during the company’s most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting.

There have been no material changes to the company’s risk factors from those discussed in Part I, Item 1A - Risk Factors in the company’s Annual Report on Form 10-K for the year ended December 31, 2023.