Arrow Electronics, Inc. — Q1 2019 Form 10-Q Summary
Business Context and Reporting Period
Unaudited results for the quarter ended March 30, 2019, compared with the quarter ended March 31, 2018. Arrow distributes electronic components to OEMs and contract manufacturers through its Global Components segment and provides enterprise computing solutions to VARs and MSPs through Global ECS. Approximately 73% of Q1 2019 sales came from Global Components and 27% from Global ECS.
Key Financial Metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Sales | $7.156 billion | $6.876 billion | 4.1% increase |
| Gross profit | $861.7 million | $868.9 million | 0.8% decrease |
| Gross margin | 12.0% | 12.6% | Down 60 bps |
| Operating income | $245.6 million | $236.0 million | 4.1% increase |
| Operating margin | 3.4% | 3.4% | Flat |
| Net income attributable to shareholders | $140.7 million | $139.1 million | 1.2% increase |
| Diluted EPS | $1.63 | $1.56 | 4.5% increase |
| Cash flow from operations | $(329.0) million | $(75.1) million | Higher use of cash |
Reported sales increased 5.3% in Global Components and 0.9% in Global ECS. Adjusted for foreign currency and dispositions, consolidated sales increased 7.6%. Adjusted operating income declined 0.8% to approximately $270.0 million, and adjusted operating margin declined to 3.8% from 4.0%. Adjusted net income attributable to shareholders declined to $158.5 million from $167.7 million; these are non-GAAP measures.
Interest and other financing expense increased to $52.0 million from $45.2 million, primarily because of higher average debt and variable interest rates. Income tax expense was $53.9 million, with a 27.5% effective tax rate versus 25.0% in the prior-year quarter.
Balance Sheet, Debt, and Liquidity
- Cash and cash equivalents were $351.9 million at March 30, 2019, down from $509.3 million at December 31, 2018; $336.2 million was held outside the United States.
- Accounts receivable were $7.903 billion and inventories were $3.735 billion. Working capital as a percentage of sales was 19.6%, compared with 17.6% in Q1 2018.
- Short-term borrowings were $138.7 million and long-term debt was $3.576 billion, for total reported debt of approximately $3.715 billion.
- Long-term debt included $1.090 billion outstanding under the asset securitization program and $55.0 million under the revolving credit facility. The company also had $74.8 million of commercial paper outstanding.
- The company had a $2.0 billion revolving credit facility maturing in December 2023, a $1.2 billion asset securitization capacity maturing in June 2021, and $200.0 million of uncommitted credit lines. Management stated that liquidity and borrowing capacity were sufficient for projected needs.
- The company was in compliance with applicable debt covenants at March 30, 2019.
Material Changes Versus the Prior Comparable Period
- Sales growth was led by Global Components, while Global ECS growth was modest on a reported basis.
- Gross profit declined despite higher sales, primarily due to unfavorable product mix; gross margin fell 60 basis points.
- SG&A declined 1.2% while sales increased 4.1%, and SG&A as a percentage of sales improved to 7.8% from 8.2%.
- Restructuring, integration, and other charges declined to $11.7 million from $21.2 million. Identifiable intangible amortization declined to $11.9 million from $13.5 million.
- The company recorded a $5.3 million net investment gain versus a $2.5 million net loss in Q1 2018, partially offsetting higher financing expense and tax expense.
- Operating cash flow deteriorated primarily because of inventory purchases early in the quarter, lower demand levels, and slower customer payments later in the quarter.
- Investing cash use fell to $30.9 million from $336.4 million because Q1 2018 included $331.5 million for acquisitions. Q1 2019 capital expenditures were $33.8 million.
- The company repurchased $53.9 million of common stock during the quarter and had approximately $688.6 million remaining under approved repurchase programs at March 30, 2019.
Accounting, Outlook, Risks, and Unusual Items
- Arrow adopted the new lease standard, Topic 842, on January 1, 2019, recognizing a $349.1 million operating lease right-of-use asset and $370.9 million of operating lease liabilities at March 30, 2019.
- No specific financial guidance was provided in the filing. Because substantially all sales are made on an order-by-order basis, management stated that customer and supplier visibility generally extends only a few months.
- Management cited risks from industry conditions, product supply and pricing, customer demand, competition, supplier relationships, margin pressure, efficiency initiatives, acquisition integration, legal and regulatory matters, foreign exchange, interest rates, and the ability to generate cash flow.
- Environmental contingencies remain at former Wyle facilities. Estimated additional costs were $4.1 million to $10.0 million for Huntsville and $10.8 million to $21.5 million for Norco, excluding potential costs whose scope cannot yet be determined. Management stated that costs exceeding current accruals could materially affect results.
- Restructuring and integration accruals were $10.8 million at quarter-end, substantially related to personnel terminations and expected to be paid within one year.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. The filing reported no material changes to previously disclosed risk factors.
Important Facts for Investors to Verify
- Whether the decline in gross margin and adjusted operating margin reflects temporary product mix effects or a sustained increase in margin pressure.
- Whether operating cash flow normalizes as inventory purchases, customer collections, and working capital improve.
- The effect of higher debt balances, variable interest rates, and the asset securitization program on future financing expense and liquidity.
- Progress against the $1.0 billion share-repurchase authorization and the effect of repurchases on diluted share count.
- The ultimate cost and timing of the Huntsville and Norco environmental remediation obligations.
- The effect of foreign currency movements, supplier awards, demand for electronic components, and enterprise infrastructure products on future sales.