Arrow Electronics, Inc. (ARW) Earnings Call Transcript & Summary

Good day, and welcome to the Arrow Electronics Second Quarter 2026 Earnings Call. Today's conference is being recorded. And at this time, I would like to turn the conference over to Michael Nelson, Arrow's Vice President of Investor Relations. Please go ahead.

Thank you, operator. I'd like to welcome everyone to the Arrow Electronics Second Quarter 2026 Earnings Conference Call. Joining me on the call today is our Interim President and Chief Executive Officer, Bill Austen; 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 projections regarding 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 and 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, Bill, Raj, Rick and Eric will be available to take your questions. I'll now hand the call over to our Interim President and CEO, Bill Austen.

Thank you, Michael, and good afternoon, everyone. We appreciate you joining us for a discussion of our second quarter 2026 results. Before turning to our results, I want to thank our team across the globe. Their commitment to serving our suppliers and customers is a key reason why Arrow delivered another strong quarter. Starting on Slide 3. We delivered excellent results in the second quarter. Total revenue of $10 billion increased 32% year-over-year and operating margin expanded 120 basis points year-over-year to 4%, each of which exceeded expectations. The combination of broad-based demand, disciplined execution and positive operating leverage resulted in non-GAAP EPS of $5.45, representing a significant increase of 124% year-over-year. Our strong results this quarter were underpinned by 4 primary drivers: one, sustained unit volume growth with incremental benefits from price inflation; two, disciplined execution as we managed expenses and working capital against the backdrop of solid customer demand; three, positive operating leverage resulting in year-over-year margin expansion; and four, favorable mix of higher-margin value-added services. Global Components once again performed exceptionally well with strength across geographies, industry verticals and customer mix. Similarly, within ECS, we continue to benefit from long-term secular demand trends around cloud, cybersecurity, infrastructure software and AI-driven workloads, while continuing to execute our strategy around higher-value software and services. Raj will share more details on our financial performance in a moment. But first, I would like to spend a few minutes discussing several key themes from the quarter that reinforce our confidence in the sustainability of the business and growth strategy. First, our leading indicators continue to give us enhanced visibility and conviction in our operating model. Book-to-bill ratios improved further and remain well above parity, while our backlog continues to build into 2027. Importantly, these leading indicators further strengthen our confidence in the durability of demand and sustainability of our growth trajectory. Second, our growth remains largely customer demand-driven. While we have seen incremental benefits from inflation, the primary driver of growth has been increased unit volume. Not only are we benefiting from ongoing AI investment trends, but we are also experiencing strength in industrial, aerospace and defense and the reemergence of transportation. Third, growth is broad-based, and we are still in the early stages of a mass market upturn as backlog from our mass market customers continues to slowly ramp. Fourth, value-added services remained a differentiator with supply chain services once again contributing significantly to overall profitability. Encouragingly, these favorable demand signals are interconnected with each contributing to a broader opportunity set across our portfolio. As we have highlighted previously, Arrow remains well positioned at the intersection of several attractive secular growth markets, allowing us to benefit from their continued expansion. Finally, the quality of our growth continues to improve, supported by a more favorable mix of customers and geographies, contribution from value-added services and ongoing productivity gains across the business. Combined with the structural changes we have made to reset our business model and our disciplined expense management, these factors are enabling us to deliver meaningful operating leverage and generate strong incremental returns. Turning to Slide 4. I would like to briefly revisit 4 pillars of our investment thesis and why we believe Arrow remains uniquely positioned for long-term growth and an attractive investment opportunity. I have discussed these pillars over the past several quarters, and you are starting to see the true strength of the business come through in our results. First, Arrow maintains a strong position in large and growing markets and plays a critical role in our 6 core markets of industrial, transportation, aerospace and defense, medical, consumer electronics and data center. These end markets are supported by favorable secular trends that continue to create growth opportunities. Second, Arrow has differentiated capabilities driving profitable growth. We are benefiting from a richer mix of higher-value service offerings, including supply chain services, engineering and design services and integration services. Notably, these offerings build upon our long-standing strengths in our core distribution franchise and represent a natural extension of the capabilities that have long differentiated Arrow in the marketplace. We continue to expand our suite of differentiated capabilities that deepen customer engagement and further differentiate Arrow. We recently introduced Digital Test Drive a new remote AI-driven engineering platform that allows customers to evaluate hardware, benchmark performance and accelerate product development without the logistics and delays associated with physical evaluation of equipment. This expands our ability to support customers globally, while increasing the efficiency and scalability of our engineering services. Additionally, our eInfochips business continues to strengthen its position as a leader in engineering services. It's differentiated silicon-to-cloud capabilities help customers navigate increasingly complex product life cycles. During the quarter, eInfochips was recognized in Gartner's Emerging Market Quadrant for physical AI services, reinforcing the strength of our technical capabilities in this rapidly evolving market. We also recently expanded our ECS Experience Centers, providing partners access to more than 100 prebuilt hybrid infrastructure, cybersecurity and AI solutions alongside our engineering expertise to accelerate solution development and deployment. Historically, these engagements have resulted in a proposal-close rates of approximately 90%. I'm proud to share that Arrow recently earned 3 key Microsoft distinctions for our ECS business, Frontier Distributor status, specializations in CoPilot and Azure Virtual Desktop. Together, they validate our scale and expertise across AI, cloud and the modern workplace, strengthening our ability to help channel partners deploy scalable solutions through ArrowSphere, and supporting continued growth in recurring cloud consumption. Third, Arrow has a diversified business model that provides financial flexibility supported by strong balance sheet and consistent free cash flow generation. The combination of our global components and ECS businesses is a strategic advantage, allowing us to participate across the full technology life cycle. And fourth, our focused capital allocation strategy is designed to maximize shareholder value by deploying capital where we expect the highest long-term risk-adjusted returns. We will continue to reinvest in the business to drive organic growth, evaluate disciplined M&A opportunities and return excess capital to shareholders while maintaining an investment-grade credit rating. Turning to Slide 5. We are very pleased with the strong results we delivered during the second quarter, which reflect our team's disciplined execution and the progress we have made over the past several years. We continue to build on our traditional distribution DNA, all while expanding our higher-margin value-added services across both Global Components and ECS, creating a broader portfolio of solutions that strengthen customer relationships and improve the quality of our earnings. We believe Arrow is uniquely positioned across both the hardware and software technology ecosystems giving us the opportunity to participate broadly as our customers continue investing across the full technology life cycle. As we enter the second half of the year, our focus remains on improving the quality of our growth through strong execution and disciplined financial management. We continue to make targeted investments in opportunities supported by customer demand and attractive long-term returns while maintaining a highly efficient business model which we expect will drive additional positive operating leverage. We are confident in the direction of the business, encouraged by the opportunities ahead and remain focused on creating sustainable long-term shareholder value. With that, I'll turn it over to Raj to discuss our financial performance in more detail.

Thanks, Bill. On Slide 6, sales for the second quarter increased $2.4 billion year-over-year to $10 billion, exceeding our guidance range and up 32% versus the prior year or up 30% versus the prior year on a constant currency basis. Second quarter consolidated non-GAAP gross margin as a percent of sales of 11.2% was flat versus the prior year. Our second quarter non-GAAP operating expenses increased $88 million year-over-year to $719 million, primarily driven by variable costs and FX. Importantly, non-GAAP OpEx as a percent of gross profit declined 10.5 percentage points year-over-year to 64.1%. We continue to focus on disciplined, profitable growth and our efforts around operational efficiency are driving substantial operating leverage in the business model. In the second quarter, non-GAAP operating income increased $188 million year-over-year to $403 million, non-GAAP operating margin rate expanded 120 basis points year-over-year to 4% of sales. Interest and other expenses was $37 million in the second quarter as we benefited from lower average debt levels throughout the quarter, and our non-GAAP effective tax rate was 23%. Finally, non-GAAP diluted EPS for the second quarter increased 124% year-over-year to $5.45, which was above our guidance range driven by a number of factors, including favorable sales volume continued strength of our value-added services, operational leverage from productivity initiatives and lower interest expense. Turning to Slide 7. Let's take a closer look at our Global Components business. Global Components sales increased $726 million sequentially to $7.4 billion in the second quarter, above our guidance range and up 11% versus prior quarter. Global Components' non-GAAP operating income increased $32 million sequentially to $397 million, up 9% from the prior quarter. Non-GAAP operating margins modestly declined 10 basis points sequentially to 5.4% and were up 180 basis points versus the prior year and well ahead of expectations. The growth that we experienced in the second quarter was once again broad-based across geographies, industry verticals and customer segments, underpinned by healthy trends in our leading indicators. Book-to-bill ratios continue to increase and remained well above 1 in all 3 regions. Overall, lead times continue to extend for certain technologies, but they remain lower than a pervasive shortage environment. Customer order patterns broadly are normal in size and pace, reflecting a rational market environment. Our backlog construct continues to grow and is building out into the first half of 2027, giving us visibility and confidence in the sustainability of the business's momentum. Encouragingly, the growth that we are seeing continues to be led by customer unit demand with some incremental lift from price inflation. Price inflation contributed roughly 1/3 of the sequential revenue growth in our Global Components business. Memory now represents a low double-digit percentage of total segment revenue. Our strategy remains focused on profitable growth, and our execution is driving a healthier business mix. First, while we continue to benefit from secular growth trends related to AI and data center, we are experiencing broad-based demand across our portfolio rather than concentrated in a single market, strength in aerospace and defense, industrial and the reemergence of transportation, particularly in the West, are presenting tailwinds to our Global Components business. These are our 3 largest verticals globally. Second, book-to-bill ratios and backlog across our mass market segment continues to improve, and we believe there is still healthy runway. Third, interconnect passive and electromechanical components or IP&E continue to grow, surpassing $1 billion in sales for the second consecutive quarter. Fourth, our value-added services, primarily supply chain services, made another meaningful contribution to our overall second quarter operating income. These capabilities expand our addressable market, deepen customer engagement and increase the durability of our earnings. Lastly, we have remained disciplined with our cost structure and have added positive operating leverage to our model. This discipline is expected to drive continued flow-through as the broader market grows and expands. Taking a closer look at each of the regions. In the Americas, sales growth was broad-based highlighted by strength in aerospace and defense, industrial and transportation. In EMEA, the market was underpinned by strength in transportation and aerospace and defense. And finally, in Asia, sequential growth was driven by industrial, transportation and demand for data center computing power. Turning to Slide 8 and our Global ECS business. In the second quarter, Global ECS sales increased $332 million year-over-year to $2.6 billion, above our guidance range and up 14% versus the prior year or up 13% year-over-year on a constant currency basis. Total ECS billings were $5.9 billion, up 14% year-over-year. Our Global ECS business is strategically positioned at the complex spend of the IT stack where hybrid cloud and AI demand is driving healthy backlog growth of over 75% year-over-year, finishing the second quarter at another all-time high. We are experiencing strength across our portfolio of cloud, cybersecurity, data protection, data intelligence and infrastructure software. Today, hardware solutions for on-premise storage and compute remain constrained by thin supply mostly due to memory and SSD shortages. However, our role in the middle of technology makers and channel partners allows us to source, provision, manage and scale alternatives that lean more on the software and public cloud solutions that we offer. And our single integrated ArrowSphere platform continues to help drive these efforts, unlocking deeper engagement and recurring revenue volumes. In the second quarter, we took a charge on certain underperforming multiyear contracts with one of our partners. As a result, second quarter ECS non-GAAP operating margins declined 100 basis points year-over-year due to the charge. As we have noted in prior quarters, we have been working through discussions with one of our strategic partners, with whom we also have these beyond distribution relationships. This is a highly valued relationship, and we wanted to ensure we reach the right outcome. We have now terminated one key element of our beyond distribution agreement with this partner and continue to work towards restructuring and other. We believe these actions will help to get this part of the business on the right track. Both of us remain committed to achieving success going forward. Turning to the balance sheet on Slide 9. Net working capital declined sequentially in the second quarter by approximately $100 million, ending the quarter at $6.8 billion. Inventory grew sequentially by $217 million, ending the second quarter at $5.9 billion. Importantly, the financial metrics that we monitor continue to significantly improve. Return on working capital increased 10.9 percentage points year-over-year, finishing the second quarter at 23.6%. Likewise, return on invested capital increased 5.8 percentage points year-over-year, finishing at of 13.9%. Working capital as a percent of sales declined in the second quarter to approximately 17% and our cash conversion decreased year-over-year by 23 days. Cash flow from operating activities in the second quarter was $318 million, taking us to over $1 billion of operating cash flow year-to-date. The strong cash generation is driven in part by timing effects from our supply chain services offering, which may partially unwind as the year progresses. This offering is largely working capital light because the inventory is typically consigned but they are an [ AP ] cash flows with an existing customer supplier relationships can create quarter-end swings. In general, the countercyclical cash flow dynamics of our business model have not changed. Gross balance sheet debt at the end of the second quarter declined sequentially by approximately $300 million and declined year-over-year by approximately $650 million, finishing at $2.2 billion. Our lower debt levels, along with increased profitability has improved our adjusted leverage ratio by over 1 turn for the past 12 months to 1.75x, which provides us with increased financial flexibility. Finally, we repurchased $43 million in shares in the second quarter. Now turning to Q3 guidance on Slide 10. We expect sales for the third quarter to be between $9.6 billion and $10.2 billion, representing an increase of 28% year-over-year at the midpoint of the range. We expect Global Component sales to be between $7.5 billion and $7.9 billion, representing sequential growth of 5% at the midpoint. In Enterprise Computing Solutions, we expect sales to be between $2.1 billion and $2.3 billion, which is up 2% year-over-year at the midpoint and reflects growing over a large partner addition last year. We're estimating a tax rate in the range of 23% to 25% and interest expense of approximately $50 million. Our non-GAAP diluted earnings per share is expected to be between $4.83 and $5.03. Details about the impact of changes in foreign currencies can be found in our earnings release. As we look to the balance of the year, we remain confident in the momentum we are seeing across the business and our ability to execute our strategy. At the same time, we recognize that a number of factors can influence the timing and linearity of results from quarter-to-quarter. We expect Global Components to perform at or above seasonal trends in all of our regions for the remainder of the year. However, consistent with historical patterns in Q3, Asia is expected to be seasonally strong, while EMEA is typically seasonally weaker. Additionally, our supply chain services is expected to return to more normal profit levels in the third quarter. Overall, we are confident that our healthier business mix, diversified business model and financial discipline will enable Arrow to deliver additional operating leverage and drive significant earnings power. With that, I'll now turn the call back over to Bill for some closing thoughts.

Turning to Slide 11. As we look ahead, we remain focused on disciplined execution, building on the operational momentum we have established and further improving the quality of our growth. Leading indicators continue to reinforce our conviction that underlying demand is strong. Combined with the actions we have taken to enhance efficiency and optimize our operating model, we believe we are well positioned to realize increasing levels of operating leverage. Our strategy is producing tangible results and strengthening our competitive position across our markets. As a result, we believe we are well positioned to capitalize on emerging opportunities and convert them into sustainable, profitable growth. We will continue investing in innovation and customer enablement to deepen relationships and expand our value proposition with a disciplined focus on allocating capital to the highest return on investment opportunities. In parallel, we will strive to continue growing our portfolio of higher-margin value-added services across both Global Components and ECS, deepening customer engagement and supporting more durable higher quality earnings over time. Everyone at Arrow is proud of the progress we have made, confident in the direction of the business and remains committed to creating long-term value for all of our stakeholders. Finally, I'm excited to welcome [ Dean Meriwether ] as Arrow's new President and Chief Operating Officer. These extensive distribution experience and successful leadership of commercial, operational and financial teams will further strengthen our organization. Just as importantly, she brings the humility transparency and purpose-driven leadership that aligns with our culture and commitment to delivering value for all of our stakeholders. These additions strengthens our succession planning and I will continue to serve as Arrow's Interim CEO until a permanent CEO is named. With that, Raj, Rick, Eric and I would be happy to take your questions. Operator, please open the call for questions.

[Operator Instructions] Your first question comes from the line of Will Stein with Truist Securities.

Congrats on the good overall results and outlook. I have a couple -- just a couple of quick questions. First, I go about 5 quarters into the component cycle in terms of expressing year-over-year growth. It's a very robust growth level now. I think it's 2 quarters of 39%, pushing 40% year-over-year growth. What inning would you say we're in, in terms of that dynamic? Are you seeing things that make you concerned that we're in the sort of the last couple of innings of that cycle? Do you think we're at the beginning still or perhaps somewhere in the middle?

Will, thanks for the question. It's Bill. The starting picture is still in the game, all right? We haven't gone to the release picture yet. So it's the early innings of the game. I would say we're in the second inning, somewhere in that range, but Rick is sitting here and he's living it every day. So I'm going to turn it over to Rick.

Yes. Thanks, Will, and thanks for the question. And I'll build on Bill's response. When we look at this recovery, it's really 3 different positions in the recovery cycle, if you want to call it that. You have AI, which is not a recovery. AI is a market that's evolving and will continue to evolve. You have what's happening in [indiscernible] and then you have what's happening in the core business, which is fundamentally the growth drivers to which we've always seen recoveries happen in the business. And as we said before, I kind of look at it and say it from this perspective. The growth in the core business is steady. All the indicators are strong. Backlog continues to build. And there's plenty of time left in the game from my perspective as it builds.

Yes, that's really helpful. Next, I want to highlight sort of a question mark in the guidance. Your ECS guidance is below typical seasonality. I was a bit surprised by that. And related -- perhaps related to this, there was a report mid-quarter noting that there was a departure of a supplier relationship. I think this called out a $1.4 billion revenue level of business, but I think that might not have been perfectly accurate. And so I'd like you to maybe set the record straight in terms of whether there was a loss, the timing of it, the sizing of it and whether that's perhaps what we're seeing in in the Q3 guide? If it wasn't that, maybe elaborate on that? .

Yes. Well, great question, and thanks for bringing that up. It was a misreport on the $1.4 billion. It's roughly half that at $700 million on the revenue line to us, but Eric is here, and I'll let Eric dive into that deeper, if you'd like.

Yes. There will be no impact in terms of revenue, margin and profits for ECS with this loss of the contract, it's in fact -- it's a mutual agreement. Sometimes the strategy between the vendors and the distributors are diverging. And this was the case here. And basically, we are not a volume distributor, a laptop or PC distributor. We are an infrastructure software-hardware distributor in cloud, and we are focusing on this. And so basically, this particular vendor wanted to have distributors that can do both, and this is not our case. So we will focus on alternative solutions and our partners will buy from us alternative solutions, and we do not expect any change at all in terms of the growth or whatsoever.

And then, Will, just the other part of your question was the below-seasonal guide that you referred to. The growth rate in the quarter on a year-over-year basis is primarily the result of growing over a large partner addition last year. There is no change in trajectory of the overall business. We still expect to get to low double-digit billings growth during the course of this full year. So it's really a grow-over issue for this particular time frame.

Yes. I'll just add to that, Raj, for a moment. The ECS business, the base business, the core business is quite strong. Our backlog is up 75%, as Raj noted in his script. And if you look at the product segment, the performance within the product segments on a year-over-year basis, security is up 21%, compute is up 51%, business application is up 26%. So there's a really strong healthy demand out there, and we're parked, as we've always said, kind of right in the center of that ecosystem. So the business is doing very well.

Your next question comes from the line of Melissa Fairbanks with Raymond James.