Arrow Electronics, Inc. — 2020 Q3 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 unaudited quarter and nine months ended September 26, 2020, compared with September 28, 2019. Approximately 73% of third-quarter sales came from Global Components and 27% from Global ECS.
Key Financial Metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Sales | $7.231 billion | $7.078 billion | $20.219 billion | $21.579 billion |
| Gross profit | $788.6 million | $798.8 million | $2.267 billion | $2.475 billion |
| Gross margin | 10.9% | 11.3% | 11.2% | 11.5% |
| Operating income (loss) | $238.2 million | $173.2 million | $573.1 million | $(130.4) million |
| Operating margin | 3.3% | 2.4% | 2.8% | (0.6)% |
| Net income (loss) attributable to shareholders | $166.1 million | $92.1 million | $348.4 million | $(316.1) million |
| Diluted EPS | $2.13 | $1.10 | $4.39 | $(3.75) |
For the nine months, net income included approximately $32.7 million of charges, primarily related to foreign tax and other loss contingencies in Global ECS. Management reported non-GAAP net income attributable to shareholders of $162.1 million for the quarter and $367.2 million for the nine months, compared with $154.8 million and $455.1 million, respectively, in the prior-year periods.
- Segment sales: Q3 Global Components sales rose 5.1% to $5.308 billion, while Global ECS sales declined 5.2% to $1.924 billion. Nine-month sales declined 6.0% and 7.0%, respectively.
- Cash flow: Nine-month operating cash flow was $1.160 billion, compared with $363.2 million in 2019. Capital expenditures were $89.6 million, resulting in approximate free cash flow of $1.070 billion before other investing items.
- Cash and working capital: Cash and equivalents were $227.0 million at September 26, 2020, versus $300.1 million at December 31, 2019. Accounts receivable were $7.959 billion and inventories were $3.236 billion. Working capital as a percentage of sales was 15.0%, compared with 18.2% in Q3 2019.
- Debt: Short-term borrowings and current maturities were $166.1 million, and long-term debt was $2.098 billion, for total reported debt of approximately $2.264 billion. The company repaid $209.4 million of 6.00% notes due April 2020 and had no borrowings under its $2.0 billion revolving facility, $1.2 billion commercial paper program, or North American asset securitization program at quarter-end.
- Liquidity: Management reported more than $3.2 billion of committed and undrawn liquidity, in addition to $227.0 million of cash. The company stated that available liquidity and expected operating cash flow should meet projected needs for the foreseeable future.
Material Changes Versus the Prior Comparable Period
- Q3 sales increased 2.2%, but gross profit declined 1.3% and gross margin contracted 40 basis points. The margin decline primarily reflected geographic mix, with APAC representing 49% of Global Components sales versus 40% in the prior-year quarter.
- Operating income increased 37.5% in Q3, benefiting from substantially lower restructuring and other charges, lower selling, general and administrative expenses, and the absence of significant 2019 wind-down losses. Nine-month operating income improved from a $130.4 million loss to $573.1 million of income, largely because 2019 included approximately $623.8 million of goodwill and other impairments.
- Q3 selling, general and administrative expense declined 3.5%, and nine-month expense declined 8.2%, reflecting cost-reduction actions and lower travel costs.
- Net interest and other financing expense declined to $30.5 million in Q3 and $105.6 million for nine months, from $49.9 million and $153.4 million, respectively, due primarily to lower borrowings and interest rates.
- Financing activities used $1.134 billion of cash during the first nine months, including $411.4 million of long-term debt repayments, the $209.4 million note repayment, $48.4 million to settle interest-rate swaps, and $384.8 million of share repurchases.
- The company adopted the expected-credit-loss standard on January 1, 2020, increasing the allowance for credit losses by $47.0 million and reducing opening retained earnings by $35.9 million after tax.
Outlook, Commentary, Risks, and Unusual Items
No formal numerical sales or earnings guidance is provided in the filing. Management stated that demand remained strong for business-continuity and work-from-home solutions and that it continued to manage supply-chain requirements despite COVID-19-related restrictions. However, sales visibility is limited because substantially all sales are made on an order-by-order basis rather than under long-term contracts.
- COVID-19: The severity and duration of the pandemic, potential operational restrictions, recessionary conditions, customer defaults, credit losses, supply-chain disruption, and reduced access to capital markets could materially affect results and liquidity.
- Goodwill sensitivity: No interim goodwill impairment test was required at September 26, 2020. However, the Americas Components and eInfochips reporting units had less than 10% excess fair value over carrying value as of March 28, 2020, making future impairment sensitive to revenue, margin, cash-flow, growth-rate, and discount-rate assumptions.
- Receivables securitization: The EMEA program permits sales of up to €400 million and generated $1.425 billion of receivable sales during the first nine months. Approximately $570.7 million of collateralized receivables were held by the bankruptcy-remote entity at quarter-end and may not be available to other creditors in insolvency proceedings.
- Contingencies: Environmental remediation liabilities related to former Wyle facilities remain subject to uncertainty. Estimated additional costs were $3.4 million to $10.0 million for Huntsville and $6.5 million to $17.7 million for Norco, excluding costs that cannot currently be estimated.
- Regulatory matter: Arrow disclosed prior unauthorized shipments involving persons covered by U.S. sanctions and export-control laws. BIS issued a warning letter without penalties; the OFAC review remained open, and potential penalties could not be estimated.
- Other unusual items: The first nine months included $7.2 million of impairment charges, $6.9 million of restructuring, integration, and other charges, a $3.2 million net investment loss, and approximately $32.7 million of foreign tax and other loss-contingency reserves.
Important Facts for Investors to Verify
- Whether COVID-19-related demand, supply-chain conditions, customer credit quality, and regional sales mix support or pressure future revenue and gross margins.
- The sustainability of unusually strong operating cash flow, including the impact of working-capital reductions and EMEA receivable securitization.
- Future goodwill impairment risk for the Americas Components and eInfochips reporting units.
- Debt maturities, covenant compliance, access to the revolving facility, and the continued availability of receivable-based liquidity.
- The ultimate cost and timing of Wyle environmental remediation and the outcome of the pending OFAC review.
- The effect of discretionary share repurchases, with $563.5 million remaining under the approved repurchase programs at quarter-end.