ARROW ELECTRONICS, INC. (ARW) FY 2022 MD&A

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

This section of the Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in “Management's Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2021.

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, including any potential adverse effects of the ongoing global COVID-19 pandemic; political instability; impacts of military conflict, including the conflict in Ukraine; industry conditions; changes in product supply, pricing and customer demand; competition; other vagaries in the global components and the global enterprise computing solutions (“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; and the company's ability to generate 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 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 accounting principles generally accepted in the United States (“GAAP”), the company also discloses certain non-GAAP financial information, including:

•Non-GAAP sales and non-GAAP gross profit (referred to as "sales on a constant currency basis" and "gross profit on a constant currency basis") excludes the impact of changes in foreign currencies by re-translating prior period results at current period foreign exchange rates.

•Non-GAAP operating expenses excludes restructuring, integration, and other charges, identifiable intangible asset amortization and the impact of changes in foreign currencies.

•Non-GAAP operating income excludes identifiable intangible asset amortization, and restructuring, integration, and other charges.

•Non-GAAP effective tax rate and non-GAAP net income attributable to shareholders exclude identifiable intangible asset amortization, restructuring, integration, and other charges, pension settlement loss, and net gains and losses on investments.

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. Reconciliations of non-GAAP financial measures to the most directly comparable reported GAAP financial measures are included within this MD&A.

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 help industrial and commercial customers introduce innovative products, reduce their time to market, and enhance their overall competitiveness. The company has two business segments, the global components business segment and the global enterprise computing solutions (“ECS”) business segment. The company's global components business segment

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markets and distributes electronic components enabled by a comprehensive range of value-added capabilities and services. The company's global ECS business segment is a leading value-added provider of comprehensive computing solutions and services. Global ECS' 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 value-added resellers (“VARs”) and managed service providers (“MSPs”) meet the needs of their end-users. The company distributes electronic components to original equipment manufacturers (“OEMs”) and contract manufacturers (“CMs”) through its global components business segment and provides enterprise computing solutions to VARs and MSPs through its global ECS business segment. For 2022, approximately 78% and 22% of the company's sales were from the global components business and the global ECS business, respectively.

The company's strategic initiatives include the following:

•Offering a variety of value-added demand creation services in the global components business, including 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.

•Continuing to develop global supply chain service offerings such as procurement, logistics, warehousing, and insights from data analytics.

•Enabling customer cloud solutions through the global ECS business' 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 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.

Executive Summary

Consolidated sales for 2022 increased by 7.7% compared with the year-earlier period. The increase for 2022 was driven by a 9.2% increase in the global components business segment sales and a 2.7% increase in global ECS business segment sales. Consolidated sales on a constant currency basis increased 11.5% in 2022 compared with the year-earlier period.

The company reported net income attributable to shareholders of $1.4 billion in 2022 compared with a net income of $1.1 billion in the year-earlier period. Non-GAAP net income attributable to shareholders for 2022 was $1.5 billion compared with $1.1 billion in the year-earlier period. Non-GAAP net income attributable to shareholders is adjusted for the following items:

•restructuring, integration, and other charges of $13.7 million in 2022 and $15.4 million in 2021;

•identifiable intangible asset amortization of $34.7 million in 2022 and $36.9 million in 2021;

•net gain (loss) on investments of $(2.9) million in 2022 and $13.0 million in 2021.

During 2022, changes in foreign currencies reduced growth by approximately $1.2 billion on sales, $58.8 million on operating income and $0.53 on earnings per share on a diluted basis compared to the year-earlier period.

Significant trends impacting the business:

Below is a discussion of significant trends impacting the business. See discussion regarding the impacts of these and other risks included in Item 1A, Risk Factors within this Form 10-K.

Supply chain constraints and components shortages

Supply chain constraints are being caused by shortages in electronics components markets and supply chain logistical issues resulting in extended lead times and unpredictability, which has impacted the company’s global operations. Despite these challenges, the company believes it has efficiently managed the global supply chain requirements of customers and suppliers to date.

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The global components business has benefited from rising demand and higher prices for certain products leading to higher sales revenues and improved profit margins globally. Accordingly, current results and financial condition discussed herein may not be indicative of future operating results and trends. See further discussion below under the caption "Gross Profit".

Management is actively monitoring the impact of changes in supply and demand, as well as supply chain logistical issues, on its financial condition, liquidity, operations, suppliers, customer, industry, and workforce. Prices remained elevated during 2022 as supply constraints continued. Gross profit margins in the global components business expanded in 2022, relative to the year-earlier period. In addition, while prices remain elevated, the company has experienced improved supply in certain products, causing higher levels of inventory on the company's consolidated balance sheet, which increased by $1.1 billion as of December 31, 2022, relative to December 31, 2021. The extent to which these issues will continue to impact the company’s results will depend primarily on future developments, including the severity and duration of the current conditions, and the impact of actions taken and that will be taken to address supply chain constraints and continued customer demand, among others. These future developments are highly uncertain and cannot be predicted with confidence.

Impacts of changing foreign currency exchange rates

As a large global organization, the company’s consolidated results of operations and financial position are impacted by changes in foreign currency exchange rates through the translation of the company's international financial statements into U.S. dollars. The company's non-U.S. dollar results of operations are negatively impacted during periods when the U.S. dollar strengthens and positively impacted during periods when the U.S. dollar weakens. During 2022, the U.S. dollar strengthened substantially against most other currencies, and as a result, during 2022, changes in foreign currencies reduced earnings per share growth by $0.53 on a diluted basis compared to the year-earlier period. During 2022, the impact of changes in foreign currencies related mainly to the Euro. These exposures may change over time and changes in foreign currency exchange rates could materially impact the company’s financial results in the future.

COVID-19 Pandemic Update

As the ongoing COVID-19 pandemic has evolved, the company continues to monitor and evaluate the impact on its business operations on a regional, national and global basis. The COVID-19 pandemic continues to create macroeconomic uncertainty, volatility and disruption, including supply constraints, extended lead times, and unpredictability across many markets.

During 2022, certain of its distribution centers and customers' facilities located in the Asia/Pacific region experienced COVID-19 related lockdowns. As a result, the global components business in the Asia/Pacific region experienced some delays in fulfilling orders, receiving inventory and exacerbated supply chain constraints. Similar disruptions could occur in the future.

Sales

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.

Following is an analysis of net sales by reportable segment for the years ended December 31:

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

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Consolidated sales in 2022 increased by 7.7% due to an increase in global components business segment sales of $2.4 billion, or 9.2%, and an increase in global ECS business segment sales of $216.9 million, or 2.7%, compared with the year-earlier period. Consolidated sales on a constant currency basis in 2022 increased by 11.5%.

Global components sales growth in 2022, compared to the year-earlier period was primarily due to a mix of stronger demand and improved supply, driving greater than 20% sales growth in both the Americas and EMEA regions, with increases in most major verticals. Sales growth was partially offset by a 6% decrease in Asia/Pacific sales due to slowing market conditions and the impact of changes in foreign exchange rates primarily in the EMEA region.

Sales from the global ECS business benefited from a healthy IT demand environment in 2022 relative to the year-earlier period. The EMEA region saw strength across the region in all technologies; however, sales were reduced by changes in foreign exchange rates. Sales in the Americas region declined slightly due to a decline in storage and networking partially offset by growth in software applications, compute, and data intelligence.

Gross Profit

Following is an analysis of gross profit for the years ended December 31:

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

The increase in gross profit margins during 2022 related primarily to improvements in margins in the Asia/Pacific and Americas regions of the global components business, due to product mix shifting towards higher margin products, and increased prices and other global supply chain impacts discussed above. Margins in the EMEA region somewhat softened due to product mix shifting towards lower margin products. Global supply chain services offerings continued to have a positive impact on gross margins. Gross profit margins from the global ECS business also increased compared to the year-earlier period primarily due to strong growth in demand in the EMEA region as well as beneficial product mix, partially offset by the impact of changes in foreign currency.

During 2022, the company experienced benefits to gross margins in the global components business due to the factors discussed above related to supply chain shortages, which may not be representative of future trends or conditions. As such, the current gross margins may not be sustainable. During the fourth quarter of 2022, the company's gross margins declined 40 basis points compared to the fourth quarter of 2021, driven mostly by the normalization of shortage market conditions within our global components business. This normalization began during the third quarter of 2022. The company's gross margins improved 10 basis points in the fourth quarter of 2022 compared to the third quarter of 2022, due to favorable product mix in the global ECS business.

Operating Expenses

Following is an analysis of operating expenses for the years ended December 31:

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

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The decrease in operating expense as a percentage of sales in 2022 relates primarily to operating leverage the company generates when sales are growing. The decreases were also related to certain investments to grow the company's sales during the third quarter of 2021, partially offset by $12.5 million in settlement funds received in 2021 in connection with certain class action claims (Refer to Note 14), which were recorded as a reduction of selling, general, and administrative expenses.

Restructuring initiatives and integration costs are due to the company's continued efforts to lower costs, drive operational efficiency, integrate acquired businesses, and the consolidation of certain operations, as necessary. The company recorded restructuring, integration, and other charges of $13.7 million and $15.4 million for 2022 and 2021, respectively. The other charges include $4.5 million in impairment charge related to various long lived assets recorded in 2021. As of December 31, 2022, the company does not anticipate there will be any material adjustments relating to the aforementioned restructuring and integration plans. Refer to Note 8, “Restructuring, Integration, and Other Charges” of the Notes to the Consolidated Financial Statements for further discussion of the company's restructuring and integration activities.

Operating Income

Following is an analysis of operating income for the years ended December 31:

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

The increase in operating income as a percentage of sales in 2022 relates primarily to increases in gross profit margins and operating leverage the company generates when sales are growing, in addition to the other factors discussed above. During 2022, changes in foreign currencies reduced operating income growth by $58.8 million when compared to the year-earlier period.

Gain (Loss) on Investments, Net

During 2022 and 2021, the company recorded a gain (loss) of $(2.9) million and $13.0 million respectively, which are primarily related to changes in fair value of assets related to the Arrow SERP pension plan, which consist primarily of life insurance policies and mutual fund assets.

Interest and Other Financing Expense, Net

The company recorded net interest and other financing expense of $185.6 million for 2022, compared with $131.7 million in the year-earlier period. The increase in 2022 primarily relates to higher interest rates on credit facilities and higher borrowings.

Income Tax

The company records a provision for income taxes for the anticipated tax consequences of the reported financial results of operations using the asset and liability method. The following table presents the company's effective income tax rate deviation from the non-GAAP effective tax rate for the years ended December 31:

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

The change in the effective tax rate to 23.8% for 2022 from 22.7% for 2021 was primarily driven by the mix of income in jurisdictions with higher tax.

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Net Income Attributable to Shareholders

Following is an analysis of net income attributable to shareholders for the years ended December 31:

* Identifiable intangible asset amortization also excludes amortization related to the noncontrolling interest.

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

The increase in net income attributable to shareholders in 2022 relates primarily to increased sales and other factors discussed above. During 2022, changes in foreign currencies reduced net income growth by approximately $38.9 million when compared to the year-earlier period.

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 $2.1 billion in addition to $176.9 million of cash on hand at December 31, 2022. 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 at December 31:

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 2022, compared to the year-earlier period was primarily attributable to higher sales and increases in inventories. The company continues to invest in inventories to help mitigate the impact of supply shortages and support growth. Inflationary pressures along with improved supply, have contributed to higher inventory levels on the company’s consolidated balance sheet, which increased by $1.1 billion as of December 31, 2022, relative to December 31, 2021.

Working capital, as a percentage of sales, which is defined as working capital divided by annualized quarterly sales, increased to 19.3% at December 31, 2022 compared to 15.8% at December 31, 2021. The increase was primarily due to higher inventory related to the factors discussed above. Sales for the fourth quarter of 2022 and 2021 were $9.3 billion and $9.0 billion, respectively.

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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 December 31, 2022 and 2021, the company had cash and cash equivalents of $176.9 million and $222.2 million, respectively, of which $160.8 million and $211.6 million, respectively, were held outside the United States. Liquidity is affected by many factors, some of which are based on normal ongoing operations of the company's business and some of which arise from fluctuations related to global economics and markets.

The company has $3.3 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 has $2.1 billion of foreign earnings that are not deemed permanently reinvested and are available for distribution in future periods as of December 31, 2022.

Revolving Credit Facilities and Debt

The following table summarizes the company’s credit facilities by category at December 31:

(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 receivables 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 2022 and 2021, the average daily balance outstanding under the EMEA asset securitization program was $472.7 million and $458.5 million, respectively. Refer to Note 4 “Accounts Receivables” of the Notes to the Consolidated Financial Statements for further discussion.

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

Refer to Note 5, “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:

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Cash Flows from Operating Activities

The net amount of cash used for the company's operating activities during 2022 was $33.1 million and the net amount of cash provided by the company's operating activities during 2021 was $419.0 million. The change in cash used for operating activities during 2022, compared to the year-earlier period, related primarily to increases in inventories and the timing of payments received from customers, offset partially by increased sales and net income and the initial sales of accounts receivables under the increased capacity of the EMEA asset securitization program (see Note 4), which increased operating cash flows by approximately $175.6 million in 2022.

Cash Flows from Investing Activities

The net amount of cash used for investing activities during 2022 and 2021 was $57.7 million and $60.1 million, respectively. The change in cash used for investing activities related primarily to proceeds from the sale of property plant and equipment during 2021, offset largely by proceeds from collection of notes receivable during 2022.

Cash Flows from Financing Activities

The net amount of cash provided by financing activities during 2022 was $109.8 million and the net amount of cash used for the company's financing activities during 2021 was $463.3 million. The change in cash provided by financing activities related primarily to a $1.0 billion overall increase in borrowings during 2022 relative to 2021. The increases were partially offset by increased share repurchases and redemption of notes outstanding.

Capital Expenditures

Capital expenditures were $78.8 million and $83.1 million in 2022 and 2021, respectively. The company expects capital expenditures to be approximately $80.0 million for fiscal year 2023.

Share-Repurchase Program

The company repurchased 9.3 million shares of common stock for $1.0 billion and 7.7 million shares of common stock for $900.0 million in 2022 and 2021, respectively. On September 14, 2022, the company's Board of Directors approved a $600.0 million increase to the company's share-repurchase program. As of December 31, 2022, approximately $328.7 million remained available for repurchase. On January 31, 2023, the company's Board of Directors approved a $1.0 billion increase to the company's share-repurchase program. The stock-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, stock price, and economic and market conditions. The stock-repurchase program may be accelerated, suspended, delayed or discontinued at any time subject to the approval by the company’s Board of Directors.

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Contractual Obligations

The company has contractual obligations for short-term and long-term debt, interest on short-term and long-term debt, purchase obligations, and operating leases.

•At December 31, 2022, the company had $3.8 billion of total debt outstanding, $589.9 million of which matures in the next twelve months. The remaining debt has maturity dates in 2024 through 2032. During February 2022, the company repaid $350.0 million principal amount of its 3.50% notes due April 2022. Refer to Note 5.

•Amounts related to total interest on long-term debt at December 31, 2022 totaled $346.9 million, with $84.4 million expected to be paid within the next 12 months. Refer to Note 5.

•Purchase obligations of $13.4 billion represent an estimate of non-cancellable inventory purchase orders and other contractual obligations related to information technology and facilities as of December 31, 2022 with $11.0 billion expected to be paid within the next 12 months and $2.0 billion in 2024.

•Non-cancellable inventory purchase orders were in line with the year-earlier period, and remain elevated above historic levels, primarily due to significant increases in prices and lead times for orders during both 2021 and 2022. Additionally, many vendors continue to limit cancellations, although many of the company's non-cancellable purchase orders are backed by customer purchase orders with Arrow, that are also non-cancellable. Some of the inventory purchases above relate to sales where the company assumes an agency relationship in the transaction. Refer to discussion of the company's revenue recognition policy in Note 1.

•Amounts related to future lease payments for operating lease obligations at December 31, 2022 totaled $348.5 million, with $80.3 million expected to be paid within the next 12 months. Refer to Note 13.

Additional Capital Requirements and Sources

Recent and expected other capital requirements and sources, in addition to the above matters, also include the items described below:

•Employee Benefit Plans: The company maintains an unfunded executive pension plan under which the company will pay supplemental pension benefits to certain employees upon retirement. As of December 31, 2022, the company had designated $108.6 million in assets to cover the ongoing costs of SERP payouts for both current and former executives. The projected benefit obligation at December 31, 2022 and 2021, was $84.1 million and $105.5 million, respectively. Refer to Note 12.

•Environmental liabilities: The company is involved in certain ongoing environmental cleanup activities and legal proceedings, which are inherently uncertain with respect to outcomes, estimates and assumptions that it makes as of each reporting period, are inherently unpredictable. Refer to Note 14.

•Hedging activities: The company has entered into certain forward-starting interest rate swaps derivatives which are designated hedges of future debt issuances as well as certain foreign exchange forward contracts designated as net investment hedges. As of December 31, 2022 and 2021, all such contracts were in an asset position in the amount of $116.9 million and $62.4 million, respectively. Refer to Note 6.

•Sales of trade receivables: In the normal course of business, certain of the company’s subsidiaries have agreements to sell, without recourse, selected trade receivables to financial institutions. The company does not retain financial or legal interests in these receivables, and, accordingly, they are accounted for as sales of the related receivables and the receivables are removed from the company’s consolidated balance sheets.

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 consolidated 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.

The company believes the following critical accounting policies involve the more significant judgments and estimates used in the preparation of its consolidated financial statements:

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Revenue Recognition

The company recognizes revenue as control of products is transferred to customers, which generally happens at the point of shipment. Sales are recorded net of discounts, rebates, and returns, which historically have not been material. The company allows its customers to return product for exchange or credit in limited circumstances. A liability is recorded at the time of sale for estimated product returns based upon historical experience. The company also provides volume rebates and other discounts to certain customers which are considered a variable consideration. A provision for customer rebates and other discounts is recorded as a reduction of revenue at the time of sale based on an evaluation of the contract terms and historical experience. Tariffs are included in sales as the company has enforceable rights to additional consideration to cover the cost of tariffs. Other taxes imposed by governmental authorities on the company's revenue producing activities with customers, such as sales taxes and value-added taxes, are excluded from net sales.

Products sold by the company are generally delivered via shipment from the company's facilities, drop shipment directly from the vendor, or by electronic delivery of keys for software products. A portion of the company’s business involves shipments directly from its suppliers to its customers, in these transactions, the company is generally responsible for negotiating price both with the supplier and customer, payment to the supplier, establishing payment terms with the customer, product returns, and has risk of loss if the customer does not make payment. As the principal with the customer, the company recognizes revenue upon receiving notification from the supplier that the product was shipped.

The company has contracts with certain customers where the company’s performance obligation is to arrange for the products or services to be provided by another party. In these arrangements, as the company assumes an agency relationship in the transaction, revenue is recognized in the amount of the net fee associated with serving as an agent. These arrangements relate to the sale of supplier service contracts to customers where the company has no future obligation to perform under these contracts or the rendering of logistic services for the delivery of inventory for which the company does not assume the risks and rewards of ownership.

No single customer accounted for more than 2% of the company’s 2022 consolidated sales. One supplier accounted for approximately 13% of the company's consolidated sales in 2022. No other single supplier accounted for more than 7% of the company's consolidated sales in 2022. The company believes that many of the products it sells are available from other sources at competitive prices. However, certain parts of the company's business, such as the company's global ECS business segment, rely on a limited number of suppliers with the strategy of providing focused support, extensive product knowledge, and customized service to suppliers, MSPs, and VARs. Most of the company's purchases are pursuant to distributor agreements, which are typically non-exclusive and cancellable by either party at any time or on short notice.

Trade Accounts and Notes Receivable

Trade accounts and notes receivable are reported at amortized cost, net of the allowance for credit losses in the consolidated balance sheets. The allowance for credit losses is a valuation account that is deducted from the receivables’ amortized cost basis to present the net amount expected to be collected. Receivables are written off against the allowance when management believes the receivable balance is confirmed to be uncollectible. Refer to Notes 1 and 4.

Management estimates the allowance for credit losses using relevant available information about expected credit losses and an age-based reserve model. Inputs to the model include information about historical credit losses, customer credit ratings, past events, current conditions, and reasonable and supportable forecasts. Adjustments to historical loss information are made for differences in current receivable-specific risk characteristics such as changes in the economic and industry environment, or other relevant factors.

Expected credit losses are estimated on a collective (pool) basis, when similar risk characteristics exist, based on customer credit ratings, which include both externally acquired as well as internally determined credit ratings. Receivables that do not share risk characteristics are evaluated on an individual basis.

Inventories

Inventories are stated at the lower of cost or net realizable value. Write-downs of inventories to market value are based upon contractual provisions governing price protection, stock rotation rights, and obsolescence, as well as assumptions about future demand and market conditions. If assumptions about future demand change and/or actual market conditions are less favorable than those projected by the company, additional write-downs of inventories may be required. Due to the large number of transactions and the complexity of managing the process around price protections and stock rotations, estimates are made regarding adjustments to the book cost of inventories. Actual amounts could be different from those estimated.

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Income Taxes

Income taxes are accounted for under the liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements. Under this method, deferred tax assets and liabilities are determined on the basis of differences between the tax bases of assets and liabilities and their financial reporting amounts using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

The carrying value of the company’s deferred tax assets is dependent upon the company's ability to generate sufficient future taxable income in certain tax jurisdictions. Should the company determine that it is more likely than not that some portion or all of its deferred tax assets will not be realized, a valuation allowance to reduce the deferred tax assets is established in the period such determination is made. The assessment of the need for a valuation allowance requires considerable judgment on the part of management with respect to the benefits that could be realized from future taxable income, as well as other positive and negative factors.

It is also the company’s policy to provide for uncertain tax positions and the related interest and penalties based upon management’s assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. To the extent the company prevails in matters for which a liability for an unrecognized tax benefit is established, or is required to pay amounts in excess of the liability, or when other facts and circumstances change, the company's effective tax rate in a given financial statement period may be materially affected.

Contingencies and Litigation

From time to time, the company is subject to proceedings, lawsuits, and other claims related to environmental, regulatory, labor, product, tax, and other matters and assesses the likelihood of an adverse judgment or outcome for these matters, as well as the range of potential losses. A determination of the reserves required, if any, is made after careful analysis. The reserves may change in the future due to new developments impacting the probability of a loss, the estimate of such loss, and the probability of recovery of such loss from third parties.

Goodwill

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. The company tests goodwill for impairment annually as of the first day of the fourth quarter and/or when an event occurs or circumstances change such that it is more likely than not that an impairment may exist. Examples of such events and circumstances that the company would consider include the following:

•macroeconomic conditions such as deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets;

•industry and market considerations such as a deterioration in the environment in which the company operates, an increased competitive environment, a decline in market-dependent multiples or metrics (considered in both absolute terms and relative to peers), a change in the market for the company’s products or services, or a regulatory or political development;

•cost factors such as increases in inventory, labor, or other costs that have a negative effect on earnings and cash flows;

•overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods;

•other relevant entity-specific events such as changes in management, key personnel, strategy, or customers, contemplation of bankruptcy, or litigation;

•events affecting a reporting unit such as a change in the composition or carrying amount of its net assets, a more likely than not expectation of selling or disposing all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit; and

•a sustained decrease in share price (considered in both absolute terms and relative to peers).

Goodwill is tested at a level of reporting referred to as “the reporting unit.” The company's reporting units are defined as:

•each of the three regional businesses within the global components business segment:

◦Americas Components;

◦Europe, the Middle East, and Africa (“EMEA”) Components;

◦Asia/Pacific Components;

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•eInfochips, which is part of the global components business segment. and;

•each of the two regional businesses within the global ECS business segment:

◦ECS Americas;

◦ECS EMEA

Within the global components business segment, the Asia/Pacific reporting unit's goodwill was previously fully impaired.

An entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not (that is, a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the quantitative goodwill impairment test is unnecessary. The company elected not to perform the qualitative assessment and performed the quantitative goodwill impairment test. The quantitative goodwill impairment test, used to identify both the existence of impairment and the amount of impairment loss, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of the reporting unit is less than its fair value, no impairment exists. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit.

The company estimates the fair value of a reporting unit using the income approach. For the purposes of the income approach, fair value is determined based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate. The assumptions included in the income approach include forecasted revenues, gross profit margins, operating income margins, working capital cash flow, perpetual growth rates, income tax rates, and long-term discount rates, among others, all of which require significant judgments by management. Actual results may differ from those assumed in the company’s forecasts. The company also reconciles its discounted cash flow analysis to its current market capitalization allowing for a reasonable control premium. As of the first day of the fourth quarters of 2022, 2021, and 2020, the company's annual impairment testing did not indicate impairment at any of the company's reporting units.

As of the date of the company's 2022 annual impairment test, the fair value of all reporting units exceeded their carrying values by more than 20%. (See Note 2). Discount rates are one of the more significant assumptions used in the income approach, and given the rise in interest rates during 2022, the company increased its risk-adjusted discount rates for all reporting units. If the company increased the discount rates used by 100 basis points, the fair value of all reporting units would still exceeded their carrying values by more than 10%.

A decline in general economic conditions or global equity valuations could impact the judgments and assumptions about the fair value of the company’s businesses, and the company could be required to record an impairment charge in the future, which could impact the company’s consolidated balance sheets, as well as the company’s consolidated statements of operations. If the company was required to recognize an impairment charge in the future, the charge would not impact the company’s consolidated cash flows, current liquidity, capital resources, and covenants under its existing revolving credit facility, North American asset securitization program, other outstanding borrowings, and EMEA asset securitization program.

As of December 31, 2022, the company has $2.0 billion of goodwill, of which approximately $569.0 million and $107.0 million was allocated to the Americas and EMEA reporting units within the global components business segment, respectively, $782.2 million and $372.4 million was allocated to the North America and EMEA reporting units within the global ECS business segment, respectively, and $197.0 million was allocated to the eInfochips reporting unit.

Impact of Recently Issued Accounting Standards

In September 2022, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2022-04, Liabilities—Supplier Finance Programs (Subtopic 405-50) Disclosure of Supplier Finance Program Obligations ("ASU No. 2022-04"). ASU No. 2022-04 requires that a buyer in a supplier finance program disclose sufficient information about the program to allow a user of financial statements to understand the program’s nature, activity during the period, and potential magnitude. The amendments in this ASU will be applied retrospectively to each period in which a balance sheet is presented, with the exception of a new requirement to disclose a rollforward of program activity, which will be applied prospectively. The amendments in the ASU are effective for fiscal years beginning after December 15, 2022, with early adoption permitted. The disclosures required by this ASU would be required in the company's consolidated financial statements beginning in the first quarter of 2023. The company is currently evaluating the potential effects of adopting the provisions of ASU No. 2022-04.

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