Arrow Electronics, Inc. — Form 10-Q Summary
Business context and reporting period
Arrow Electronics is a global distributor of electronic components and enterprise computing solutions. Its two reportable segments are Global Components and Global Enterprise Computing Solutions (ECS). The filing covers the quarter and nine months ended September 30, 2017, compared with periods ended October 1, 2016. The financial statements are unaudited.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Sales | $6.954 billion | $5.936 billion | $19.179 billion | $17.382 billion |
| Gross profit | $843.4 million | $773.2 million | $2.427 billion | $2.321 billion |
| Gross margin | 12.1% | 13.0% | 12.7% | 13.4% |
| Operating income | $236.0 million | $198.7 million | $657.5 million | $603.6 million |
| Operating margin | 3.4% | 3.3% | 3.4% | 3.5% |
| Net income attributable to shareholders | $134.6 million | $117.7 million | $348.1 million | $358.2 million |
| Diluted EPS | $1.50 | $1.28 | $3.87 | $3.87 |
- Q3 sales increased 17.1%; nine-month sales increased 10.3%. On a currency- and acquisition-adjusted basis, Q3 sales increased 15.5% and nine-month sales increased 10.3%.
- Global Components sales rose 24.6% in Q3 and 17.3% for the nine months, driven primarily by additional supplier-awarded business.
- Global ECS sales rose 2.8% in Q3 but declined 2.9% for the nine months, primarily reflecting lower demand in the Americas.
- Adjusted operating income was $264.5 million in Q3 and $751.3 million for the nine months, compared with $236.8 million and $706.1 million, respectively, in the prior-year periods. Adjusted operating margins declined to 3.8% and 3.9% from 4.0% and 4.1%.
- Adjusted net income attributable to shareholders was $162.9 million in Q3 and $455.3 million for the nine months, versus $143.1 million and $428.1 million, respectively.
- Q3 and nine-month effective tax rates were 25.4% and 24.7%, compared with 27.6% for both prior-year periods.
Cash flow, liquidity, debt, and capital allocation
- Cash and cash equivalents were $584.3 million at September 30, 2017, compared with $534.3 million at December 31, 2016; $319.5 million was held outside the United States.
- Nine-month operating cash flow was $1.8 million, down from $140.7 million, primarily because higher earnings were offset by working-capital investment. Accounts receivable and inventories increased to $7.071 billion and $3.169 billion, respectively.
- Investing cash flow was a use of $131.3 million, including $149.6 million of capital expenditures and $44.6 million for the global ERP initiative.
- Financing cash flow was $181.4 million, including $987.1 million of net note proceeds, $555.9 million of note redemptions, $149.1 million of share repurchases, and $23.4 million to acquire additional Data Modul shares.
- Short-term borrowings were $380.2 million and long-term debt was $2.803 billion at quarter-end, compared with $93.8 million and $2.696 billion, respectively, at year-end 2016.
- The company issued $500 million of 3.875% notes due 2028 and $500 million of 3.25% notes due 2024. Debt refinancing generated a $59.5 million loss on extinguishment of debt for the nine months.
- Arrow had $96.2 million outstanding under its $1.8 billion revolving credit facility and $255.0 million under its $910.0 million asset securitization program. No commercial paper was outstanding. The company was in compliance with applicable debt covenants.
- The board-approved repurchase programs had $383.9 million remaining at September 30, 2017.
Material changes versus the prior comparable period
- Strong sales growth, particularly in Global Components, increased reported operating income despite lower gross and adjusted operating margins.
- Reported nine-month net income declined 2.8%, primarily because 2017 included a $59.5 million debt-extinguishment loss and a $14.3 million investment loss. Excluding identified unusual items, adjusted nine-month net income increased to $455.3 million from $428.1 million.
- Restructuring, integration, and other charges decreased to $15.9 million in Q3 and $55.8 million for the nine months, from $24.3 million and $61.2 million, respectively.
- Operating cash generation deteriorated materially as receivables and inventories absorbed cash to support higher sales. Working capital as a percentage of sales increased to 17.4% from 16.3%.
- Debt balances and financing activity changed substantially because of the 2017 note offerings, redemptions, and refinancing transactions.
Guidance, outlook, commentary, risks, and unusual items
- The filing does not provide a specific quantitative revenue or earnings outlook. Management states that current cash, borrowing capacity, expected operating cash flow, and capital-market access are sufficient for projected needs for the foreseeable future.
- Sales are generally order-by-order rather than under long-term contracts, limiting visibility beyond a few months. Management cited supplier relationships, product supply, pricing, customer demand, competition, margin pressure, acquisitions, ERP implementation, foreign exchange, and global market conditions as key uncertainties.
- Gross-margin pressure was attributed primarily to growth in lower-margin distribution services. Management expects continued cost-reduction and operational-efficiency initiatives.
- Restructuring accruals totaled $29.4 million at September 30, 2017, primarily for personnel and facility costs, and are expected to be paid over multiple years.
- Arrow recorded a $15.0 million Q3 loss from the full impairment of a cost-method investment.
- Wyle environmental obligations remain uncertain. Estimated additional costs were $4.7 million to $10.6 million for the Huntsville site and $19.0 million to $29.8 million for Norco, with potential costs beyond these estimates not presently determinable.
- In October 2017, Arrow entered into a settlement for part of its Wyle defined benefit plan and expected to recognize a settlement expense in Q4 2017.
- The company stated that there were no material changes to previously disclosed risk factors, market risks, or internal controls.
Important facts for investors to verify
- Whether Global Components growth is sustained and whether lower-margin mix continues to pressure gross margins.
- Progress in converting higher sales into operating cash flow, particularly through inventory and receivables management.
- Debt maturities, refinancing requirements, variable-rate exposure, and compliance with revolving-credit and securitization covenants.
- The ultimate cost and timing of Wyle environmental remediation and the expected Q4 2017 pension-settlement expense.
- The effect of the ERP implementation, restructuring programs, acquisitions, foreign exchange, and forthcoming accounting standards, including revenue recognition and leases.
- The company’s continued ability to fund repurchases, capital expenditures, acquisitions, and working-capital needs while maintaining liquidity.