Arrow Electronics, Inc. ($ARW)

We're honored to have Arrow Electronics here. And representing Arrow, we have Bill Austen, who is with the Board of Directors. He's been on the Board since May of 2020, and he's the current interim CEO as well. Bill, thanks for joining us today. Prior to this -- prior to joining Arrow, he was with the Bemis Company, and that is a manufacturer of flexible packaging products. So Bill, thanks. We are hoping to have a great discussion today. Thanks for joining us today.

Thanks for having us, Ruplu. I'm glad to be here.

Great. For those of us who are new to the story, can you just kind of talk about overall, what does Arrow Electronics do? What are the different parts of the business and give us a lay of the land on what are the different types of services that you provide?

Sure. So for those of you that don't know the story, Arrow Electronics has been in the business for 90 years. We have a very long history. We are an electronic component and enterprise-wide software distributor. We're in 96 countries around the world. We have 23,000 employees, and we have an extremely broad and very diversified and differentiated business model. We feel that we're positioned extremely well today. We're undervalued. And if you want to play in the AI space, you could look to Arrow as somewhat of a mutual fund. If you think about all that goes into AI today, all that goes into data centers today, both on the hardware side, the component side and the software side, we are that business that distributes those products around the globe. We have 2 businesses, Global Components and ECS, Electronic Computing Solutions, which is the software side of the house. They're both big distributors. And inside the core of that is very large engines that distribute either components or software, enterprise software. And we'll -- $30 billion to $35 billion of revenue. Last couple of quarters, we -- Q4, we hit it out of the park. Q1, we absolutely to use my CFO's term. We crushed it in Q1 with 39% year-on-year growth in both components and in ECS, and we exceeded our EPS by 190%, $5.22 a year ago, we did $1.80. So we are -- we attribute that to a lot of things that have been going on in the business, a lot over the last few years, there's been a lot of hard work to take cost out and create leverage in the P&L. If you look at our operating expense as a percent of gross profit, it's 63%. And if you look at others in the space, they're in the low 70s and 70% from some of our competitors' percent of OpEx as a percent of GP dollars would be a good number. We're at 63%. So when we drive revenue growth, which the cycle has turned and it's moving up, we create profit because it falls through the P&L. So we've had a tremendous run over the last 2 quarters, and we just -- we see that we're just getting started. Long answer to a short question.

No, that's a great overview. Thanks for that. So as you said, this is a cyclical business, right? So where do you think we are in this cycle? And how do you see the remainder of 2026? And what are some of the things that are giving you confidence that this is maybe a more structural acceleration versus are we at the peak?

Well, I think if you look back, let's look back a couple of quarters, 3, 4, 5 quarters, and you looked at our leading indicators of book-to-bill ratios across the business, you look at what kind of visibility we had in our backlog, how far our backlog stretched out, what lead times were, they were nowhere near the levels they are today. So if you just step forward 2, 3 quarters or back a couple of quarters, quarters, we were below 1 book-to-bill ratios. We had very little visibility into our backlog. And when I say little, I'm talking within the quarter. So 90-day visibility is the backlog. As we went through the third quarter last year and the fourth quarter, that visibility started to extend a little bit. Book-to-bill ratios as we exited 2025, we're just about at parity, a little over. And then as we got into the second week, let's call it, second, third week of February 2026, our book-to-bill ratios jumped significantly above parity across all 3 geographic regions, across many of the verticals in our space and then all of a sudden backlog starts filling in. Q1 was full. Q2 was full. We're filling in Q3 and Q4. And in some cases, we now have visibility into Q1 2027. And there's always this debate in this conversation around is it real? People want to -- their nearest point of memory is COVID and all that happened in COVID with double ordering, triple ordering. That's not -- we don't see that happening today, okay? We see very solid backlogs. We see good visibility. And we think that we're in -- to answer your question, early stages of this recovery.

Got it. I want to touch on both parts of the business, but let's start with Global Components. Can you talk about what you're seeing from a demand standpoint, both from a geography -- from a regional standpoint as well as from a product standpoint, how is demand trending in different verticals and different product categories?

Well, you asked a lot of questions.

Yes, I combined 3 or 4 into one.

My memory, I'm getting old. No, but if you just -- let's walk across the regions, right? If you go back a couple of quarters, Asia was very -- was significant, right? And Asia for us and others, that's where you have -- you got good growth, but you have low margins. So everybody bets on the West coming back at some point. We started to see that late mid-Q4 last year. We started to see that Asia was continuing to grow. A lot of that was driven from electric vehicle and the fact that the Chinese government had incentivized the car industry -- incentivized consumers to buy more electric vehicles, so there was a spike in EVs toward the end of fourth quarter last year. Then we started to see the West coming back. And when I say starting to see the West coming back. Europe, a couple of green shoots in the Americas market, we saw more than green shoots. We saw many of the verticals across aerospace and defense, both in Europe and in North America. We see industrial and what we call our mass market. Those are our industrial markets. Those are customers that are going to buy anywhere mid million dollars, $3 million, $4 million, $5 million or less of components coming back strong. Now to us, that's really positive because that's where you make money, okay? You make money in the West, in the mid-market, in the mass market, rather, industrial, transportation, aerospace and defense, we saw those 3 verticals starting to place more orders as we went through Q4 into Q1. And that's continuing that strength today. Obviously, compute has been strong for a while, and compute has been strong. That's been a driver in Asia. Obviously, a lot of AI data center builds taking place in Asia. So we saw compute in Asia. We see compute in North, South America, we see compute in Europe. But the real strength is now that the industrial markets are coming back in both Europe and in North America. And we attribute that to industrial companies that are building their product that are going to attach to AI at the edge. So there's -- that's going to drive a tremendous amount of component growth as we go through the next many quarters.

Okay. Maybe I'll delve a little bit deeper into that in a bit. But one thing I want to touch on is supplier price increases. And just explain to us how that impacts your revenues and margins, and it didn't seem like it impacted the first quarter all that much. So is there a timing element here as well?

Ruplu, we've gotten this question because our first quarter was driven by volume, and that's a very positive thing. I would much rather have a volume-based recovery than a price-based recovery. And we see it in units. We had little to no impact from price in our result in Q1. It was virtually all unit volume. The way that pricing impacts us, supplier raises its price, we pass it through, okay? So we're going to see it in dollars. We're not going to see it in rate. But if you look at our operating income rate in Q1, it was 5.5%, which is far in excess of what people were anticipating. And that again goes to the fact that it's a volume-based recovery. We get units, we get volume. We've created a tremendous amount of leverage in the P&L and that falls through to operating income. And that's the model that we've built, and we're going to continue to push on that. We're not going to get crazy and add this cost, add that cost just because we can add cost. We're doing a really good job of making the right decisions within the business units. If you think through this, if you go back you've been in the space a lot longer than I have. But if you go back a few years, I've been on the Board for 5 years. The plan was always, hey, there's growth coming. We need to hire 80 people. We need to hire 70 people. We need more feet on the street because if we have more feet on the street, we can sell more. We said, time out, what are we doing? Do you -- why do we need to add 70 people? Why do you need to add 80 people? Why can't we do this a different way? What tools are out there that we can deploy. What processes can we put in place. So we don't need to add those 70 or 80 people. We've created a tremendous amount of momentum in our business, and I'm an engineer, and just real quick, momentum is a function of mass times velocity in a business like ours, mass comes down to the people. Velocity is how quick do you make decisions. We've reduced the mass. We've sped up the decision making and the right decision-making around what business do we really want because it has higher market versus let's take on this inventory at 2 and 3 points of margin because it's a good thing to do because we can go sell that. Well, wait a second. If we can take on inventory that's 14 points of margin. I want to make sure that we have the right balance and how are we going to drive the margin. So that's what we've done. We've created a tremendous amount of momentum. We're not managing -- we're not running the business the way we used to run the business, add heads, you get more sales. It's not necessarily that more sales are good. Are they the right sales? And I would argue that we're on that track of making the right decisions, make the right sales so that we can drive margin. And that's what we did in Q1.

Got it. One thing that's gone up significantly in price is memory. Can you talk to us like how big is memory in terms of your product line? And how do you see memory prices trending and impacting your results?

We see it as everybody else on the price side. And memory price is going to go up -- it's going to be memory capacity to manufacturer, is going to be tight. It's going to be managed that way from the manufacturers of that memory. And we're going to always be in that band of mid-single-digit memory as a percent of our revenue in Global Components. And it's 6% to 8% on any given quarter, it's somewhere -- it's in that band of 6% to 8%. And when we get the price increase, we pass it through.

Got it. Talk to us about value-added services and how that impacts the margins? And is that a margin lever that you can employ.

It is absolutely a margin lever. So if you look at our 2 businesses, right, Global Components and ECS, the core of those businesses are really big distributors. And when we look -- when we talk about value-added services, we talk about using that engine of the core and spinning out value-added services to support those big customers and/or suppliers that create that engine. So supply chain service is a front and center portion of our value-added services. If you go back a couple of years, value-added services was about 20% of our operating income. If you looked at last year, value-added services generated 30% of our operating income in the business. And we're going to continue to drive it in that direction. But value-added services on supply chain, we manage the supply chains of about, let's call it, a dozen and a half large companies that are heavily embedded in either global -- in global components. So for instance, hyperscalers. We manage the supply chain for about 5 of the top hyperscalers. And what that means is that if they want to build a data center in Hungary, we get notice of that. They ask us, can you help us and the answer is usually yes. What do you need? Well, we need to house all of this material. We need to procure, deploy, ship, receive, do all this work around $5 billion plus of material. We'll build them a warehouse. We'll build a warehouse in Hungary. And they will -- we will then step into the center of the relationship between the suppliers and the building of the data center and handle that material and handle the AR and the AP. It's not our inventory, it's the hyperscalers inventory. So it's a very inventory-light model, and we get paid a fee to manage that for them. We also manage the ARAP, so they pay us in advance we might carry that float of a lot of money for some period of time that we use within our business to pay down debt or do other things, and then we pay the receivables when they come in. So it is a really cool model. It is -- we manage complexity. We've done that for years. And now we've taken it from the core distributions, and we set it up on its own. We stood it up. We reorganized the components business earlier this year into 3 pieces: Semiconductor; IP&E; and value-added services. So we've got a leader that's -- we call him a Chief Growth Officer for value-added services, and that includes supply chain, demand creation, engineering services. And Murdoch manages that piece of the business. And what we do is we work with the core of the distribution model to pull business out and sticking into value-added services that creates a whole lot more margin than it would say in a semiconductor sale, which is at low single-digit margins. We still get the semiconductor sale, low single digit, but we're working with those suppliers at a much different level to create value for us and create ease of business for them. And it works really well, and we're going to continue to push on that.

That's helpful. As you look out into the next 6 months as demand is improving in various end markets, do you see any parts becoming in shortage? And in the past, Avnet -- sorry, Arrow has talked about shortage market business where you can help procure some parts. Is that a business that you see happening? Or do you see any parts going into short supply?

No. again, folks want to go back and relate today to COVID, we're nowhere near what was going on in COVID, okay? And don't let anybody kid you, all right? It's not there. During COVID, memory lead times were 54 weeks. Okay? Today, memory is at like 33 weeks. It's not -- it hasn't extended so far that it's in this huge shortage, it's constrained. We look at it as constrained. We get the memory we need and we're able to move it to this customer base. But we don't see a shortage market happening, and we don't -- we're not -- there's nothing in our P&L or our guide that says there's just going to be this massive shortage market and prices are going to go through the roof and it's going to be back to the golden screw mentality that existed during COVID.

Got it. Okay. Let's move on to the ECS business I mean, talk to us about that. What is that business? And how does that relate to the Components business?

Yes. So first off, part of our business model and any business, and any strategy that is that I believe is successful is when you have diversification and differentiation, okay? If you're a one-stop shop, I mean everybody can replicate a one-stop shop and compete with you. But we've got this diversified model and differentiated model between ECS and components. Global Components is the bigger of the 2 at about $20 billion or so, ECS in the $10 billion range. But ECS deals with enterprise-wide software. 25% of what we do in that space is hardware sales, and it's high-end hardware. It's not consumers, not mouse pads, it's not laptops, it's storage, it's compute. But the other 75% is enterprise-wide software. And I'm talking technology side of software, not application side of software. I'm talking cyber, virtualization, financial ops, things like that. That's what we distribute, and one of the things that differentiates us from others is a platform called ArrowSphere. ArrowSphere is a platform that suppliers and customers can attach to get access to product. And in ArrowSphere, we have ArrowSphere AI assistance. So it's an Agentic AI model that allows customers to attach to suppliers so that the customer can hold product from that supplier. ArrowSphere AI assistant won us 2025's Microsoft Distributor of the Year Award because what we do for Microsoft via the ArrowSphere platform. It differentiates us from others. And what I'm coming back to here is the balance between ECS and global components is such that components in a growth cycle that we're in today is going to consume working capital, right? You got to have the inventory, you got to -- you bring in more working capital. ECS is a low working capital model, but it generates great cash flow. So it allows us to take -- it helps us balance our balance sheet because we're bringing in cash flow from the ECS side, and we're using it to fund, if you will, some of the things we do in components. It balances out, it levels out. It gives us more financial stability across the cycles. ECS is also perfectly parked dead center of the AI explosion that's taking place on the software side. As more and more companies push their workloads to the cloud, AI workloads to the cloud, we're positioned right there to sell the products that they need to do that. It is a unique model that we have and we like it that way. We want it to be that way because we want differentiation and diversification versus our competitors. It gives us a leg up. Again, it goes back to this comment I started with earlier that if you look to Arrow, we are in a -- somebody is going to shoot me in the back, Raj or Michael. We are a -- I was going to say, extremely cheap at this point, mutual fund that plays in the AI space, both on the component side and the software side. And there isn't another company that has that ability. If you look at our line card, we are perfectly matched with all of the electronic components that go into making data center or attaching to the edge of AI, which is what all these guys are doing. And then on the software side, we're perfectly positioned for these companies to extend their network and communications, cyber, virtualization, fin ops in the cloud through ECS. Nobody else can do that. That's why we like the 2 business pieces. Does that makes sense.

No, that makes sense. I want to talk some numbers now. If I look at the guidance for fiscal 2Q, it looks like component revenues are going up, but ECS revenues are actually sequentially down. What is driving that? And what I'm getting to is, as component costs are going up, do you see any demand destruction happening in any of the verticals? And is that a factor in this at all?

No, I don't see demand destruction taking place at all really. I see that the value prop that we have to our supply base, they're extending it further. The value prop that we have with value-added services, whether it's demand creation or engineering services, but more importantly, supply chain, we have got large customers coming to us to talk about supply chain services every week. And it's somewhat holding them back from the standpoint of we can only take on so much at a time. And so that's why we separated it. We stood it up by itself. We're putting more resources into it so we can bring on more of those supply chain customers going forward because -- again, it's working capital light, it doesn't show on the revenue line, but what does it add horsepower and to the bottom line.

Got it. I want to talk about operating margins, and you mentioned this earlier, I was surprised and I know a lot of clients were surprised by the operating margin good performance in the first quarter. I think component margins were 5.5%, something like that. So talk to us like as to what gives you confidence that this is sustainable? What are the levers that you have on the operating margin side? And should investors look for further growth in operating margins either in the components business or in the ECS business?

Yes. Let me just go, first, go back to the surprise piece. I know there were 2 people that weren't that surprised at that operating profit margin. Raj and myself. We were not. We could see it coming. As soon as we saw the volume tick up and the leverage that we have in the P&L, we're like, okay, it's going to happen. And we see that, that's going to continue. All right. I'd be foolish to say that would we get to a 6 or we get to over 6. But 5 handle on the front end, that's Raj's term using the term 5 handle. I think that's sustainable. The business is really positioned well and the decisions that the business team is making, the business teams are making in each of the regions, it's just a reset, and it's a reset of how they think. And I think at this point, it's -- we're being successful with it.

Okay. Another thing I want to ask is on working capital and inventory management. How do you see this trending? I mean, do you think Arrow's inventory increases over time? Or do you see that decreasing? And is that a good thing or a bad thing?

Yes, I think -- so when I got there, if we talk about inventory, and I told the team what my definition of inventory was, and it was the stuff that doesn't sell, okay? Inventory is the stuff that doesn't sell. If you're moving it. That's great. Let's bring it in. But let's make the conscious decision to bring in the right stuff at the right spot, put it in the right distribution center, so it attacks the market and it turns. I think if you look at our metrics, ROIC, ROWC, have all improved. Our days cash to cash have all improved. So we're making the right decisions again around inventory and the inventory that moves versus the stuff that doesn't itself.

Got it. Maybe talk to us about capital allocation. I think you just had a big buyback authorization, given where the stock is trading today, how do you see the trade-off of buybacks versus any M&A, versus any more financial leverage. How are you thinking about capital allocation?

Yes. So our capital allocation strategy is no different than others. Number one, organic growth. Organic growth. Number 2 would be M&A, strategic M&A. And I want to talk about M&A for a moment in the sense of we're not going to buy stuff to get bigger. It just makes no sense. We're going to buy stuff that again, this unique ability to set us apart from others. That's where you would see us make acquisitions. And that would be in a service since some service area. IP&E is an ideal space for us to make an acquisition. If you look at our first quarter results, it's the first time in our history that we exceeded $1 billion in revenue in IP&E and completely attribute that to the fact that we stood it up on its own. We have a focus on it. We have a team on it. We got the right amount of mass on it. They're making quick decisions, and we exceeded $1 billion in revenue Q1 in IP&E. IP&E carries a whole lot more margin than the semiconductor. It's not as high as value-added services, but it's a lot higher than semiconductor. So you would see us being pushing in M&A on IP&E. The other would be a share buyback. And if you go back the last 5 years, I think the number is something like we bought back $3.6 billion worth of shares at an average price of about $98 a share. So we've created a tremendous amount of shareholder value just through buyback. We had $1 billion authorization. It was running out. We're down to maybe $150 million left on that. Our Board just reauthorized another $1 billion. We don't put a time frame on it because we'll do it strategically as we go across the next several years. But share buyback is always going to be a part of it, acquisitions two, number one, organic growth. And lastly, all of that is with an eye toward making sure we maintain our investment grade rating, extremely important for us. Not to be constrained because we don't have an investment-grade rating.

Can you talk to us about the CEO transition? Is there a timeline? And what capabilities matter the most for the next stage of Arrow's strategy and what needs to be true operationally for the transition to be seamless.

Yes. Well, it's still going on because I'm still here.

You're doing a great job.

Thank you. The -- we're trying to be extremely thoughtful and we're trying to thread the needle. We want someone that -- this is a huge company. It's got a lot of scale. It's got a lot of people. It's global. It's big. There's a lot of mass to it. There's a tremendous amount of competing priorities within the business. And you just don't find somebody that has that in their background. And we're a great commercial engine. We have fantastic -- we have, I call them commercial wizards. They know how to deal in the marketplace. What we're really trying to over-rotate on to is operating experience. Somebody that has got some operating chops, somebody that knows how to make money in a low-margin business, somebody that can squeeze pennies out. That's the kind of person we're trying to find, just not coming out of the woodwork just yet. But we're still on it. We're going to find somebody and stay tuned. And when we're ready, we'll make the proper announcement.

Got it. So we've got about 1.5 minutes left. Bill, I want you to talk to the clients. What are we missing about the Arrow story? Is there still things that you want to highlight that investors should focus on? And how do you see the next leg of growth for this company?

Yes. I've touched on it throughout our conversation Ruplu, and that I think you really have to understand the business, okay? We're not -- yes, we are a distributor, I get that, okay? But that's at the core. What we've built around the core is value-added services, both on the ECS side and on the component side. But if you put those 2 things together and you look at where the cycle sits today, we're the perfect play. We play on the software side, everything is going to the cloud. We distribute that. All the components. If you look at our line card, all these companies you hear about on CNBC and all that are driving growth we are a cheap -- if you look at our multiple versus theirs, we are a really cheap play to play across that entire spectrum of companies, whether it's in software or whether it's in components. We're a really cheap play.

Okay. Great. We've covered a lot of details. So Bill, thank you for coming today. Really appreciate it. Thanks.

Thanks for having me.