Arrow Electronics, Inc. — Q3 2019 Form 10-Q Summary
Business Context and Reporting Period
Arrow Electronics distributes electronic components to OEMs and contract manufacturers through its Global Components segment and provides enterprise computing solutions to value-added resellers and managed service providers through Global ECS. The filing covers the quarter ended September 28, 2019, and the nine months then ended. Results are unaudited and use a quarterly calendar ending on the Saturday closest to quarter-end.
Financial Performance and Position
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Sales | $7.078 billion | $7.490 billion | $21.579 billion | $21.759 billion |
| Gross profit | $798.8 million | $923.8 million | $2.475 billion | $2.726 billion |
| Gross margin | 11.3% | 12.3% | 11.5% | 12.5% |
| Operating income (loss) | $173.2 million | $290.3 million | $(130.4) million | $813.1 million |
| Operating margin | 2.4% | 3.9% | (0.6)% | 3.7% |
| Net income (loss) attributable to shareholders | $92.1 million | $176.5 million | $(316.1) million | $485.5 million |
| Diluted EPS | $1.10 | $1.99 | $(3.75) | $5.47 |
| Net cash provided by operating activities | Not provided for quarter | Not provided for quarter | $363.2 million | $9.6 million |
Q3 sales declined 5.5% year over year, while nine-month sales declined 0.8%. Global Components sales declined 6.2% in Q3 and 0.5% for nine months; Global ECS sales declined 3.8% and 1.6%, respectively. Adjusted for foreign currency, dispositions, and the wind-down, consolidated sales declined 3.5% in Q3 but increased 2.0% for nine months.
Adjusted operating income was $252.6 million, or 3.6% of sales, in Q3 and $772.1 million, or 3.6%, for nine months, compared with 4.2% and 4.1%, respectively, in the prior-year periods. Management attributed the margin pressure primarily to product and regional mix, including a shift toward lower-margin products and away from engineering and design services.
At September 28, 2019, cash and cash equivalents were $262.3 million, down from $509.3 million at December 31, 2018. Current assets were $11.840 billion and current liabilities were $7.372 billion. Accounts receivable were $7.842 billion and inventories were $3.503 billion.
Total debt consisted of $356.8 million of short-term borrowings, including the current portion of long-term debt, and $2.942 billion of long-term debt. The company had $35.0 million outstanding under its $2.0 billion revolving credit facility, $680.0 million outstanding under its $1.2 billion asset securitization program, and $75.0 million under uncommitted lines of credit. The company reported compliance with applicable debt covenants.
Cash Flow, Capital Allocation, and Liquidity
- Nine-month operating cash flow was $363.2 million, compared with $9.6 million in the prior-year period, primarily reflecting lower demand and reduced working capital investment.
- Investing cash outflows were $120.0 million, including $113.1 million of capital expenditures. No acquisitions were completed during the period, compared with $331.6 million of acquisition spending in the prior-year period.
- Financing cash outflows were $482.7 million, including $304.2 million of share repurchases and net debt repayments of approximately $190.1 million.
- The company repurchased $161.5 million under the December 2018 program during the period and had approximately $438.5 million remaining under approved programs at September 28, 2019.
- Management stated that available cash, borrowing capacity, and expected operating cash flow should be sufficient for foreseeable needs.
Material Changes and Unusual Items
- The company is winding down its personal computer and mobility asset disposition business. It expects substantially to complete the wind-down by the end of 2019 and expects approximately $3.5 million of additional non-recurring charges through the first half of 2020.
- Wind-down-related charges were $26.1 million in Q3 and $101.6 million for the first nine months, including asset impairments, personnel costs, and disposal costs. The company also recognized a $14.6 million Q3 loss on disposition of related foreign subsidiaries.
- Nine-month results included $509.0 million of partial goodwill impairment in the Americas Components reporting unit, $61.2 million of goodwill impairment in Asia-Pacific Components, and a $46.0 million impairment of trade names. Remaining Americas Components goodwill of approximately $600 million was at heightened risk of further impairment; management stated that a 100-basis-point decline in forecasted gross margin could result in full impairment of that remaining amount, absent offsetting improvements.
- Digital inventory write-downs were $1.1 million in Q3 and $21.2 million for nine months. The company narrowed its digital inventory offerings and does not expect to fully realize the carrying value of the affected inventory.
- AFS-related receivable reserves and inventory write-downs were $15.2 million for nine months. The company will no longer provide notes to components customers and expects this decision to adversely affect repayment of certain notes and trade receivables.
- Restructuring, integration, and other charges were $43.1 million in Q3 and $74.7 million for nine months. The company expects an additional $24.1 million of cash personnel and contract-termination charges through the first half of 2020.
Outlook, Risks, and Contingencies
The filing does not provide specific consolidated revenue or earnings guidance. Management noted limited forward visibility because substantially all sales are made order-by-order rather than under long-term contracts. Key operating risks include customer demand, product supply and pricing, supplier relationships, margin pressure, global economic and geopolitical conditions, competition, acquisition integration, and the ability to generate cash flow.
The company disclosed unauthorized shipments involving sanctioned or restricted destinations. It voluntarily reported the matters to OFAC and BIS, investigated internally, and terminated or disciplined involved employees. Potential penalties cannot currently be estimated. A separate disclosure covered 15 unauthorized shipments to Iran during 2017–2018, with approximately $66 thousand of revenue and $4 thousand of gross profit.
Environmental obligations related to former Wyle facilities remain unresolved. Estimated additional costs were $3.8 million to $10.0 million for Huntsville and $8.0 million to $18.75 million for Norco, but the company cannot estimate potential costs beyond those amounts because the full remediation scope is not known. The company also identified ordinary-course litigation, regulatory, labor, product, and tax matters.
Important Facts for Investors to Verify
- Progress and final costs of the personal computer and mobility asset disposition business wind-down.
- Whether the remaining approximately $600 million of Americas Components goodwill is impaired in future periods.
- Underlying demand, product mix, and margin trends after excluding restructuring, impairment, wind-down, inventory, and AFS-related items.
- Cash conversion and working-capital requirements, particularly accounts receivable, inventory, and accounts payable.
- Debt refinancing plans for the $209.3 million of 6.00% notes due in 2020 and continued compliance with credit facility covenants.
- Potential OFAC/BIS penalties and the effectiveness of enhanced export-control procedures.
- Ultimate environmental remediation costs and the timing of any insurance recoveries.