Business Context and Reporting Period
Arrow Electronics, Inc. filed its Form 10-K for the fiscal year ended December 31, 2019, with unaudited fourth-quarter information. Arrow distributes electronic components and enterprise computing solutions through two segments: global components, approximately 70% of 2019 sales, and global enterprise computing solutions (ECS), approximately 30%. The company serves more than 175,000 customers in over 90 countries.
Substantially all sales are order-by-order rather than under long-term contracts, limiting visibility beyond a few months. Approximately 60% of 2019 sales originated outside the United States.
Key Financial Metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Sales | $28.917 billion | $29.677 billion | Down 2.6% |
| Gross profit | $3.298 billion | $3.701 billion | Down 10.9% |
| Gross margin | 11.4% | 12.5% | Down 110 basis points |
| Operating income | $107.7 million | $1.148 billion | Down 90.6% |
| Operating margin | 0.4% | 3.9% | Down 350 basis points |
| Net income attributable to shareholders | $(204.1) million | $716.2 million | Loss versus profit |
| Diluted EPS | $(2.44) | $8.10 | Loss versus profit |
| Operating cash flow | $858.0 million | $272.7 million | Up $585.3 million |
| Capital expenditures | $143.2 million | $135.3 million | Up $7.9 million |
Adjusted for foreign exchange, dispositions, and the personal computer and mobility asset disposition business wind-down, consolidated sales were approximately flat. Adjusted operating income was approximately $1.057 billion, or 3.7% of sales, versus $1.259 billion, or 4.2%, in 2018. Adjusted net income attributable to shareholders was approximately $636.5 million versus $777.6 million.
Global components sales declined 2.9% to $20.251 billion, while adjusted sales declined 0.5%. Global ECS sales declined 1.7% to $8.666 billion, while adjusted sales increased 1.1%.
Fourth-Quarter Information
| Metric | Q4 2019 | Q4 2018 |
|---|---|---|
| Sales | $7.338 billion | $7.918 billion |
| Gross profit | $822.9 million | $975.4 million |
| Operating income | $238.1 million | $334.4 million |
| Net income attributable to shareholders | $112.0 million | $230.7 million |
| Diluted EPS | $1.36 | $2.63 |
Liquidity, Debt, and Balance Sheet
- Cash and cash equivalents were $300.1 million at December 31, 2019, compared with $509.3 million a year earlier; $277.7 million was held outside the United States.
- Total debt, including current borrowings, was approximately $2.972 billion, consisting of $331.4 million of current borrowings and $2.640 billion of long-term debt.
- Available committed liquidity included a $2.0 billion revolving credit facility and a $1.2 billion North America asset securitization program. Outstanding borrowings were $10.0 million and $400.0 million, respectively, at year-end.
- The company had $60.0 million outstanding under uncommitted lines of credit and no commercial paper outstanding.
- Management stated that available cash, borrowing capacity, and expected operating cash flow were sufficient for projected needs for the foreseeable future. The company was in compliance with applicable debt covenants at year-end.
- Share repurchases consumed $404.2 million of cash in 2019. The company had $338.5 million remaining under its repurchase authorization at year-end.
Material Changes Versus the Prior Comparable Period
- Sales declined 2.6%, primarily from lower global components and ECS reported sales, foreign-exchange effects, dispositions, and the personal computer and mobility asset disposition business wind-down.
- Gross margin fell 110 basis points on a reported basis and 70 basis points on an adjusted basis, primarily due to product and regional mix.
- Operating income was heavily reduced by $698.2 million of impairments, including $570.2 million of goodwill and $46.0 million of trade-name impairments, compared with no impairments reported in 2018.
- The company recorded $105.2 million of charges related to closing the personal computer and mobility asset disposition business, including $74.9 million of non-cash impairments and $21.3 million of disposition losses.
- Arrow recorded $22.3 million of digital inventory write-downs and an $18.0 million charge related to receivables and inventory in its Arrow Financing Solutions business, which it decided to exit.
- Restructuring, integration, and other charges increased to $89.8 million from $60.4 million, including $46.0 million of personnel charges related to an operating expense reduction program.
- Operating cash flow increased substantially as lower demand reduced working-capital requirements, including accounts receivable and inventory.
- Long-term debt declined by approximately $599.0 million, while cash declined by approximately $209.2 million, reflecting debt repayment, share repurchases, and operating and investing activity.
Guidance, Outlook, Risks, and Unusual Items
The filing does not provide formal quantitative revenue or earnings guidance. Management’s stated objectives are to grow sales faster than the market, grow profits faster than sales, expand markets and geographies, and improve return on invested capital. Management highlighted operating-efficiency initiatives, investment in digital and cloud capabilities, and continued evaluation of strategic acquisitions.
- Goodwill impairment sensitivity remains significant. At the latest test, fair value exceeded carrying value by approximately 3% for the Americas components reporting unit and 6% for eInfochips. A 100-basis-point decline in forecasted gross margin could result in full impairment of the remaining $603.5 million of Americas components goodwill or $197.2 million of eInfochips goodwill, assuming other inputs remain unchanged.
- Key operating risks include semiconductor and technology-sector cyclicality, pricing and margin pressure, rapid technological change, inventory obsolescence, customer credit losses, supplier concentration, tariffs, foreign-exchange movements, and limited forward order visibility.
- The company identified unauthorized shipments from 2015 to 2019 with aggregate invoiced value of approximately $4.8 million to resellers for re-export to sanctioned persons. Arrow voluntarily reported the matter to OFAC and BIS, investigated it, and terminated or disciplined involved employees. Potential penalties were not estimable at filing.
- Arrow remains responsible for environmental remediation at former Wyle sites in Huntsville, Alabama, and Norco, California. Estimated additional remediation costs were $3.6 million to $10.0 million for Huntsville and $7.7 million to $18.4 million for Norco, while ultimate costs remain uncertain.
- The filing identifies the coronavirus outbreak in China as a potential risk to supply chains, shipments, customer demand, and operations in China and other regions.
- In the first quarter of 2020, Arrow entered an EMEA receivables securitization program with capacity of up to €400.0 million and maturity in January 2023.
- The company adopted the new lease standard in 2019, recognizing $307.9 million of operating lease liabilities at year-end. The reported impact was not described as material to operating results or cash flow.
- Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. Critical audit matters included inventory valuation and goodwill impairment testing.
Important Facts for Investors to Verify
- Whether adjusted operating performance improves after the components restructuring, digital inventory actions, financing-business exit, and personal computer and mobility wind-down.
- Whether the thin remaining goodwill headroom in the Americas components and eInfochips reporting units leads to additional impairment charges.
- The refinancing or repayment plan for the $209.3 million of 6.00% notes due in 2020 and other scheduled debt maturities.
- Cash generation, working-capital requirements, inventory aging, and the sustainability of the strong 2019 operating cash flow.
- The outcome and potential penalties from the OFAC and BIS review of unauthorized shipments.
- Future costs and insurance recoveries related to the Huntsville and Norco environmental matters.
- The effects of coronavirus-related supply-chain disruption, tariffs, foreign exchange, semiconductor demand, and customer IT spending on revenue and margins.
- Execution of the EMEA receivables securitization program and its effect on reported accounts receivable and operating cash flow.