Proprietary Machines Prop Up Avnet, Arrow Server Sales

August 15, 2011 Timothy Prickett Morgan

The hardware refresh cycle in the wake of the Great Recession and acquisitions have been good for the two master resellers of IT gear, Avnet and Arrow Electronics. Both companies did well in their most recent quarters, but also expressed some concern about downstream customers made jumpy and cautious about a jittery global economy.

Avnet finished up its fiscal 2011 year in the first week of July, and in the fourth quarter the company had $6.91 billion in sales, up 32.6 percent compared to the year ago period, and brought $238.8 million to the bottom line, an increase of 69.2 percent. For the full fiscal 2011 year, Avnet posted $26.5 billion in revenues and brought $669.1 million to the bottom line. Avnet has a large electronic component distribution business and also makes a tidy living reselling servers, storage, networking, and software for IBM, Hewlett-Packard, Cisco Systems, and many others.

In the fourth quarter, Avnet had $2.95 billion in sales in its Technology Solutions distribution business, which peddles IT gear and software, up 41.2 percent. Sales in the Americas region rose by 25.3 percent, to $1.61 billion. Sales of IT products to downstream resellers rose 64 percent in EMEA, to $876.8 million, and in Asia, sales rose by 72.3 percent, to $460.6 million. Industry standard servers (by which everyone means X64-based machinery), storage, and software all rose by more than 60 percent in the quarter, said Rick Hamada, chief executive officer at Avnet, in a call with Wall Street analysts going over the figures. Margins were under pressure in the Technology Solutions business, however, with operating income of $67.5 million, up only 5.3 percent.

Given all the craziness in the global stock and bond markets, the last thing any CEO wants to do is spook anyone. But Hamada, like other CEOs, conceded that IT shops were a bit wary. “There is some caution based on the current outlook in the global economic growth sectors here with all the various things around the world,” explained Hamada. “It’s a cautious customer base out there. They are keeping an eye on things like everybody else. But outside of that I would say normal caution here–there is no other major change that we’ve sensed at this particular point.”

With margins under pressure on the Technology Solutions business unit, Wall Street wanted to know if anything funky was going on there. “Nothing really overly significant in the enterprise space,” said Phil Gallagher, president of the Technology Solutions unit, on the call. “The market is naturally competitive, but there’s nothing that really has changed that much in the past several quarters or even year-on-year.”

Gallagher added that because of the high growth in storage, networking, and proprietary servers, the percent of the total Technology Solutions business represented by X64 machinery actually went down in the quarter. Gallagher did not elaborate on proprietary server sales, which includes Power Systems iron running the IBM i operating system and a smattering of entry mainframes and various Unix boxes. He noted that the margins on all of this gear were higher than on X64 servers, so it was a net good for Avnet.

Looking ahead, Avnet said that it expected for sales in the first quarter of fiscal 2012 ending in September to be somewhere between $6.25 billion and $6.85 billion, with Technology Solutions being somewhere between $2.5 billion and $2.8 billion. Given the drubbing that all stocks have gotten on Wall Street, Avnet’s board authorized management to do $500 million in share buybacks. The company exited the quarter with $675.3 million in cash and equivalents and $1.52 billion in debt, so it is safe to say that unless a really attractive acquisition prospect comes along, Avnet is done eating for a while.

Over at Arrow, Michael Long, who is president, CEO, and chairman of the electronic component and IT gear distributor, said in his call with Wall Street analysts (which took place before the stock market crashed last week) that proprietary servers, industry standard servers, and software all grew at more than 25 percent in the second quarter ended in June and that Arrow’s Enterprise Computing Solutions (ECS) unit, which peddles the IT gear, beat the company’s expectations for growth in the second quarter. Software sales were up 29 percent in the quarter, and ECS services rose nearly 50 percent.

Arrow had record revenues and profits in the second quarter (ended on July 2), with sales up 20.1 percent, to $5.54 billion, and net income up 34.4 percent, to $156.2 million. The ECS unit had $1.66 billion in sales, up 22.9 percent, and posted an operating income of $63.7 million, up 48 percent. (The ECS unit doesn’t have its own net earnings number, but if you assume that you allocate corporate overhead proportionately, then it doesn’t make a lot of money. No distribution business other than Wal-Mart does.)

Arrow had finished up its $250 million in share buybacks with $50 million blown in Q2, and the Arrow board of directors authorized another $100 million to be walked down to Wall Street to buy shares back on the cheap.

In the third quarter, Arrow figures it will have revenues of between $5.15 billion and $5.55 billion, with ECS contributing somewhere between $1.39 billion and $1.59 billion of that, and undergoing the normal seasonality decline you get into comparing Q3 to Q2.

Andrew Bryant, who is president of the ECS unit at Arrow, said in the call that the company believed that business and profit margins could hold in the second half, thanks in part to an uptick in proprietary server sales.

“We have seen a very nice pickup in demand in enterprise spending and our business strategically has stayed very focused on the data center,” explained Bryant. “So with the rebound in proprietary servers and the way that we’ve grown software and services to become a bigger percentage of our business, I believe gives us optimism that we can maintain margins. Certainly, there’s always pressure on hardware margins, but I think the way our strategy is playing out and the way we’re driving the mix gives us the confidence that the second half will hold.”

Let’s hope so.

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