Arrow Electronics, Inc. 2016 Form 10-K Summary
Business Context and Reporting Period
Arrow Electronics is a global distributor of electronic components and enterprise computing solutions, serving more than 125,000 customers in over 90 countries. The fiscal year ended December 31, 2016. The company reports two segments: Global Components, representing approximately 65% of sales, and Global Enterprise Computing Solutions (ECS), representing approximately 35%.
Global Components distributes semiconductors, passive, electromechanical and interconnect products, computing and memory products, and related services. Global ECS provides datacenter, cloud, security, analytics, hardware, software, and integration solutions to value-added resellers.
Key Financial Metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Sales | $23.825 billion | $23.282 billion | +2.3% |
| Gross profit | $3.144 billion | $3.035 billion | +3.6% |
| Gross margin | 13.2% | 13.0% | +20 bps |
| Operating income | $858.5 million | $824.5 million | +4.1% |
| Operating margin | 3.6% | 3.5% | +10 bps |
| Adjusted operating income | $987.0 million | $944.3 million | +4.5% |
| Net income attributable to shareholders | $522.8 million | $497.7 million | +5.0% |
| Adjusted net income | $609.8 million | $592.3 million | +3.0% |
| Diluted EPS | $5.68 | $5.20 | +9.2% |
| Cash flow from operations | $355.8 million | $655.1 million | Down $299.3 million |
Global Components sales increased 7.0% to $15.409 billion, or 5.1% excluding currency effects and acquisitions. Global ECS sales decreased 5.2% to $8.416 billion, or 7.0% excluding currency effects and acquisitions. Components operating income increased to $686.5 million from $649.4 million, while ECS operating income increased to $441.8 million from $424.1 million.
Cash and cash equivalents were $534.3 million at year-end, compared with $273.1 million in 2015. Accounts receivable and inventories totaled $9.602 billion, equal to approximately 67.6% of total assets. Working capital as a percentage of sales increased to 16.1% from 14.8%, contributing to lower operating cash flow.
Investing activities used $241.4 million, including $164.7 million of capital expenditures, $64.8 million for three acquisitions, and $12.0 million for an equity-method investment. Financing activities provided $166.1 million, including $313.0 million of net long-term bank borrowings, partly offset by $216.4 million of share repurchases.
Long-term debt was $2.696 billion, compared with $2.381 billion in 2015; short-term borrowings and the current portion of long-term debt were $93.8 million. The company had $460.0 million outstanding under its asset securitization program, no borrowings under its revolving credit facility, and no commercial paper outstanding. The revolving facility was increased to $1.8 billion and extended to December 2021. Management stated that available cash, borrowing capacity, expected operating cash flow, and capital-market access should meet foreseeable needs.
Material Changes Versus the Prior Comparable Period
- Consolidated sales growth was driven by Global Components, while Global ECS declined because of lower hardware sales, partly offset by higher software sales.
- Gross margin improved primarily because of a more favorable ECS product mix.
- Operating expenses increased 3.3%, faster than reported sales, and operating expenses as a percentage of sales increased to 9.3% from 9.2%.
- Restructuring, integration, and other charges increased to $73.6 million from $68.8 million. The 2016 amount included $32.9 million of restructuring and integration costs, a $12.2 million pension settlement charge, an $11.8 million increase in the Wyle environmental accrual, $8.7 million of acquisition-related charges, and a $4.3 million net fraud loss.
- Interest and other financing expense increased 11.3% to $150.7 million because of higher average debt and variable interest rates.
- Operating cash flow declined substantially because accounts receivable increased by $636.9 million and inventories increased by $404.0 million.
- Share repurchases declined to $216.4 million from $356.4 million. The company authorized an additional $400 million repurchase program in December 2016.
- Weighted-average diluted shares declined to 92.0 million from 95.7 million, supporting diluted EPS growth.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
The filing does not provide specific financial guidance for 2017. Management’s stated objectives are to grow sales faster than the market, grow profits faster than sales, expand markets and geographies, and increase return on invested capital. The company expects to complete implementation of its global components ERP system in the Americas in 2017; the EMEA and Asia/Pacific conversions were substantially complete at year-end.
- The business has limited forward visibility because substantially all sales are order-by-order and generally lack long-term contracts.
- Key risks include semiconductor and technology-cycle volatility, pricing pressure, competition, rapid product obsolescence, customer defaults, supplier concentration, and reliance on generally cancelable distribution agreements.
- International operations represented approximately 56% of sales and expose the company to currency, political, regulatory, tax, export-control, Brexit, and geopolitical risks. A hypothetical 10% decline in average foreign exchange rates against the U.S. dollar would have reduced 2016 sales by approximately $678.3 million and operating income by approximately $32.2 million.
- The company experienced executive-impersonation fraud in January 2016 that caused unauthorized cash transfers in Europe to Asia. The net loss was $4.3 million. Management identified and remediated a related material weakness in controls over unauthorized cash disbursements by December 31, 2016. The CEO, CFO, and auditor concluded that internal control over financial reporting was effective at year-end.
- Wyle-related environmental matters remain unresolved at sites in Huntsville, Alabama, and Norco, California. Estimated additional costs were approximately $3.3 million to $4.7 million at Huntsville and $21.0 million to $31.7 million at Norco, excluding costs that cannot yet be estimated. The company recorded an additional $11.8 million environmental accrual in 2016.
- The FTC antitrust matter remained at the investigative-information stage, with no proceedings instituted as of the filing date. The company stated that the potential impact could not be predicted.
- Goodwill was $2.392 billion and represented a significant balance-sheet concentration. Annual 2016 impairment testing indicated that fair value exceeded carrying value for all reporting units, although the smallest cushion was approximately 12% for the Asia/Pacific Components reporting unit.
- The company had $31.5 million of unrecognized tax benefits and related interest, most of which had no reliably estimable settlement timing.
- The company had contractual obligations totaling approximately $7.580 billion, including $2.785 billion of debt principal, $3.830 billion of purchase obligations, $327.5 million of operating leases, and $585.0 million of interest on long-term debt.
Most Important Facts for Investors to Verify
- Whether Global ECS stabilizes after its 2016 sales decline and whether Global Components growth remains strong without acquisition or currency support.
- The sustainability of margin expansion given competitive pricing pressure and the lower margins of Asia/Pacific Components.
- Working-capital discipline, particularly the substantial growth in receivables and inventories and the resulting decline in operating cash flow.
- Debt maturities, asset-securitization borrowings, interest-rate exposure, and compliance with financing covenants.
- Progress and cost of the Americas ERP implementation and its potential effect on operations or acquisition integration.
- Resolution and ultimate cost of the Wyle environmental obligations and any related insurance recoveries.
- Effectiveness of the remediated cash-disbursement controls and exposure to future fraud or cybersecurity events.
- Potential impairment sensitivity of the $2.392 billion goodwill balance, especially in Asia/Pacific Components.
- The company’s ability to convert earnings into cash while continuing acquisitions, capital expenditures, and share repurchases.