As Arrow Shifts From Hardware To Software, Sales Drag But Margins Climb

A product mix favoring infrastructure software, security and data analytics resulted in tepid technology sales but higher margins for Arrow Electronics in the most recent quarter.

Revenue for the Centennial, Colo.-based distributor in the quarter ended Sept. 26 declined 1 percent, to $5.7 billion, after adjusting for acquisitions and the impact of changes in foreign currencies, the company reported Wednesday. This fell short of Seeking Alpha's projection of $5.75 billion.

"We think [the growing presence of software] is healthy for us in the long term, but it does sometimes create downward pressure on sales," Sean Kerins, president of Arrow's Enterprise Computing Solutions (ECS) business, said during the earnings call Wednesday.

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Earnings per share climbed 5 percent on a constant-currency basis, to $1.40, or $133.4 million in net earnings, falling short of Seeking Alpha's estimate of $1.46 per share.

Earnings were released before the market opened Wednesday. Arrow's stock dropped 4.2 percent, to $55.74 per share, Wednesday afternoon.

Servers and storage have declined as a percentage of Arrow's business over the past decade, with storage sales falling in absolute terms from the earlier quarter, according to Michael Long, Arrow's chairman, president and CEO. This business has tended to be very seasonal, Long said, with a huge amount of spending associated with a couple of hardware vendors coming in the fourth quarter.

Software sales in security and data analytics, virtualization, middleware- and software-defined products have helped fill the gap, Kerins said. Software sales tend to be more stable over the entire year, Long said, prompting Arrow to scale back its projections for the next quarter.

"We're seeing fairly healthy billing, but the mix is different," Long said. "We don't think there's any issue in the computing business at all."

Even as software makes up a greater percentage of Arrow's revenue mix, Kerins emphasized that hardware sales and billings have grown year to date.

Arrow has seen strong demand in new architectures, converged infrastructure and flash storage as the distributor helps customers move to private and hybrid clouds, Kerins said. And traditional hardware isn't going away overnight, either, Kerins said, particularly in mission-critical areas or for more complicated workloads.

Still, Kerins emphasized that shifting the product mix to software is the right move in the long term.

Year-over-year sales for Arrow's ECS business climbed just 1 percent, to $2.01 billion, after adjusting for acquisitions and foreign currency movements.

Arrow's European ECS business grew for the third consecutive quarter, with sales leapfrogging 15.3 percent, to $599.1 million, after adjusting for currency and acquisitions, thanks to strength in the company's software, server, storage and networking practices. The European business has also evolved to meet marketplace needs around data analytics and hybrid cloud automation and orchestration, Long said.

The picture was far less rosy in the Americas, though, where revenue fell 3.6 percent, to $1.41 billion, after adjusting for acquisitions. The software-rich sales mix in the Americas depressed sales but drove record margins, according to Paul Reilly, Arrow's chief financial officer and executive vice president of finance and operations.

The perks of Arrow ECS's higher software mix were reflected in its operating income figures, which grew 21.6 percent on a year-over-year basis, to $91 million, after factoring out amortization expenses. Operating income is the amount of revenue left over after accounting for all of the expenses necessary to keep the business running.

Supplier mergers and acquisitions have typically been helpful for Arrow, and Long said he doesn't think Dell's acquisition of EMC will make any difference, especially since Arrow is close to both vendors.

"We have no reason at this point to believe anything will come of this but goodness and additional products down the road," Long said. "We haven't seen a scenario where we've gotten hurt by this."

Arrow works closely with EMC around storage and with both Dell and EMC around reverse logistics, Long said. Frank Vitagliano, Dell's vice president for global partner strategy and programs, has identified Ingram Micro, Synnex and Tech Data -- but not Arrow -- as Dell's primary product distributors in North America.

Arrow is also looking to cut $40 million of annual expenses by integrating recent acquisitions, increasing automation, utilizing greater purchasing leverage and reducing the company's real estate footprint, Reilly said. Most of those cuts will come from Arrow's components business, Long said, where the company is looking to reduce expenses 5 percent.

Arrow is projecting total sales of $6.15 billion to $6.55 billion in its next quarter, with ECS contributing revenue of between $2.7 billion and $2.9 billion. Diluted earnings per share are expected to come in at between $1.75 and $1.91 per share, the company said.

Thomson Reuters has projected overall sales of $6.67 billion in the next quarter on earnings of $2.02 per share.

PUBLISHED OCT. 28, 2015