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, operating through Global Components and Global Enterprise Computing Solutions (ECS). The filing covers the quarter and six months ended June 29, 2019; comparative periods ended June 30, 2018. The financial statements are unaudited.
Financial Performance and Position
| Metric | Q2 2019 | Q2 2018 | Six Months 2019 | Six Months 2018 |
|---|---|---|---|---|
| Sales | $7.345 billion | $7.393 billion | $14.501 billion | $14.268 billion |
| Gross profit | $814.9 million | $932.8 million | $1.677 billion | $1.802 billion |
| Gross margin | 11.1% | 12.6% | 11.6% | 12.6% |
| Operating income (loss) | $(549.2) million | $286.8 million | $(303.6) million | $522.8 million |
| Operating margin | (7.5)% | 3.9% | (2.1)% | 3.7% |
| Net income (loss) attributable to shareholders | $(549.0) million | $169.9 million | $(408.2) million | $309.0 million |
| Diluted EPS | $(6.48) | $1.92 | $(4.80) | $3.48 |
- Adjusted operating income was $242.7 million in Q2 and $519.5 million for the six months, compared with $317.1 million and $587.6 million, respectively, in the prior-year periods. Adjusted operating margins were 3.3% and 3.6%, down 100 and 50 basis points.
- Adjusted net income attributable to shareholders was $136.6 million in Q2 and $300.3 million for the six months, compared with $194.1 million and $360.1 million, respectively.
- Q2 Global Components sales declined 0.3% to $5.271 billion; ECS sales declined 1.6% to $2.074 billion. On an adjusted basis for currency, dispositions, and wind-down effects, consolidated sales increased 1.9% in Q2 and 4.9% for the six months.
- Six-month operating cash flow was $76.4 million, compared with cash used of $484.8 million in the prior-year period. Investing cash use was $69.2 million, including $81.6 million of capital expenditures. Financing cash use was $245.8 million, including $200.9 million of share repurchases.
- Cash and cash equivalents were $270.0 million at June 29, 2019, down from $509.3 million at December 31, 2018. Accounts receivable were $8.0 billion and inventories were $3.6 billion.
- Debt comprised $279.2 million of short-term borrowings and $3.157 billion of long-term debt. The company had no borrowings under its $2.0 billion revolving credit facility or $1.2 billion commercial paper capacity, and $930.0 million outstanding under its asset securitization program.
- The company reported compliance with applicable debt covenants and stated that available cash, borrowing capacity, and expected operating cash flows should satisfy foreseeable liquidity needs.
Material Changes Versus the Prior Comparable Period
- Results were materially affected by $623.1 million of goodwill and other impairments, including $509.0 million in the Americas Components reporting unit, $61.2 million in the Asia-Pacific reporting unit, $74.9 million of long-lived-asset impairments, and a $46.0 million trade-name impairment.
- The company recorded $104.2 million of Q2 losses associated with winding down its personal computer and mobility asset disposition business, including the $74.9 million long-lived-asset impairment. Total expected wind-down charges are approximately $115 million, with operations expected to cease substantially by year-end 2019.
- Additional Q2 charges included a $20.1 million digital inventory reserve and a $15.9 million reserve for Arrow Financing Solutions notes receivable and related inventory. The company will narrow its digital inventory offerings and no longer provide notes to components customers.
- Reported gross margin declined 150 basis points in Q2 and 100 basis points for the six months, primarily due to customer mix. Adjusted gross margin declined 90 and 70 basis points, respectively.
- SG&A increased 3.2% in Q2 and 1.0% for the six months, while net interest expense declined to $51.6 million in Q2 and $103.5 million for the six months.
- Cash flow improved primarily because of lower inventory purchases, timing of payments, and working-capital movements, including reductions in accounts receivable and inventory.
Guidance, Outlook, Risks, and Unusual Items
- Management announced cost-reduction actions expected to produce approximately $130 million of annualized savings. Substantially all actions are expected to be completed by year-end 2019, with approximately $45 million of cash severance, $4 million of non-cash asset impairments, and $10 million of cash contract-termination costs expected, primarily in Q3 2019.
- The remaining goodwill of $601.3 million in the Americas Components reporting unit is highly sensitive to forecast assumptions and has no excess fair value over carrying value. Management stated that a 100-basis-point decline in forecasted gross margin could result in full impairment of the remaining goodwill, absent offsetting improvements.
- Sales are primarily order-by-order rather than under long-term contracts, limiting visibility beyond a few months. Principal operating risks include demand and pricing pressure, product supply, supplier relationships, customer concentration and credit, foreign exchange, interest rates, acquisitions and integrations, restructuring execution, and global economic and geopolitical conditions.
- Environmental remediation obligations remain at former Wyle sites. Estimated additional costs are $3.8 million to $10.0 million for Huntsville and $8.5 million to $19.2 million for Norco, while the ultimate costs cannot yet be fully estimated.
- The company adopted the new lease standard and recognized $313.0 million of operating lease right-of-use assets and $363.9 million of lease liabilities at quarter-end.
- In May 2019, the company entered into $300 million of forward-starting interest-rate swaps to hedge anticipated debt issuance to refinance the 6% notes due in April 2020.
Most Important Facts to Verify
- Whether the personal computer and mobility wind-down is completed on schedule and within the estimated $115 million total charge.
- Progress toward the $130 million annualized cost-savings target and the timing and final amount of restructuring costs.
- Performance of the Americas Components reporting unit and the risk of further goodwill impairment.
- Underlying gross-margin trends, particularly the reported customer-mix pressure and adjusted margin decline.
- Liquidity, working-capital requirements, and refinancing of the $209.2 million of 6% notes due in 2020.
- Recoverability of AFS receivables and related inventory and the financial impact of narrowing digital offerings.
- Potential variability in environmental remediation costs and other contingencies not presently estimable.