Arrow Electronics, Inc. — 2018 Third-Quarter Form 10-Q
Business Context and Reporting Period
Unaudited results for the quarter and nine months ended September 29, 2018, compared with adjusted comparable periods ended September 30, 2017. Arrow distributes electronic components through Global Components and provides enterprise computing solutions through Global ECS. For the first nine months, approximately 72% of sales came from Global Components and 28% from Global ECS.
Financial Performance and Position
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Sales | $7.490 billion | $6.856 billion | $21.759 billion | $19.015 billion |
| Gross profit | $923.8 million | $842.6 million | $2.726 billion | $2.428 billion |
| Gross margin | 12.3% | 12.3% | 12.5% | 12.8% |
| Operating income | $290.3 million | $235.4 million | $813.1 million | $658.9 million |
| Operating margin | 3.9% | 3.4% | 3.7% | 3.5% |
| Net income attributable to shareholders | $176.5 million | $134.1 million | $485.5 million | $348.5 million |
| Diluted EPS | $1.99 | $1.50 | $5.47 | $3.88 |
- Reported sales increased 9.3% in the quarter and 14.4% year to date. On a basis adjusted for foreign currency, acquisitions, and dispositions, sales growth was 10.4% and 12.5%, respectively.
- Global Components sales increased 10.6% in the quarter and 16.5% year to date; Global ECS sales increased 5.9% and 9.5%, respectively.
- Adjusted operating income increased 19.0% in the quarter to $314.1 million and 20.2% year to date to $904.3 million. Adjusted operating margin was 4.2% in both periods.
- Interest and other financing expense increased to $54.2 million in the quarter and $160.2 million year to date, primarily because of higher average debt and variable interest rates.
- Cash provided by operating activities was only $9.6 million year to date, compared with $1.8 million in the prior-year period. Working-capital investment included $254.4 million of additional accounts receivable and $456.1 million of additional inventory uses of cash.
- Investing cash outflow was $415.4 million, including $331.6 million for acquisitions and $104.9 million for capital expenditures. Financing cash inflow was $138.5 million.
- Cash and cash equivalents declined to $474.2 million from $730.1 million at December 31, 2017. Approximately $377.1 million was held outside the United States.
- At September 29, 2018, short-term borrowings were $158.2 million and long-term debt was $3.352 billion. Total debt was approximately $3.510 billion. The company had $92.5 million outstanding under its $1.8 billion revolving facility, $830.0 million under its asset securitization program, and $90.0 million under uncommitted lines of credit.
- The company reported compliance with applicable debt covenants and stated that current cash, borrowing capacity, and expected operating cash flows should satisfy foreseeable needs.
Material Changes Versus the Prior Comparable Period
- Profitability improved substantially despite essentially flat quarterly gross margin. Year-to-date gross margin declined 30 basis points, primarily due to lower ECS margins, product mix, and a higher proportion of sales recognized on a gross basis.
- Global Components margins improved in both periods, while ECS operating margins were pressured by product mix, a $6 million sales-tax adjustment in the quarter, and greater hardware exposure.
- Restructuring, integration, and other charges declined to $10.1 million in the quarter and $50.5 million year to date, compared with $15.9 million and $55.8 million, respectively.
- Net income benefited from a $1.1 million investment gain in the quarter, compared with a $13.0 million investment loss in the prior-year quarter. The prior-year nine-month period also included a $59.5 million loss on extinguishment of debt.
- Arrow acquired eInfochips in January 2018 for a purchase price of $327.6 million, including $14.8 million of cash acquired. The acquisition contributed $64.9 million of sales after closing and increased goodwill.
- Debt increased from $3.290 billion at December 31, 2017 to approximately $3.510 billion, while the company redeemed $300 million of 3.00% notes in March 2018.
- Share repurchases totaled $93.2 million during the first nine months. Approximately $278.6 million remained available under the repurchase authorization at quarter-end.
Guidance, Outlook, Risks, and Unusual Items
- The filing does not provide a clear quantitative full-year sales or earnings guidance figure. Management expects liquidity from cash, available facilities, and future operating cash flows to be adequate for foreseeable needs.
- Management cited strong demand from industrial and manufacturing customers in Global Components and demand for storage, infrastructure software, virtualization, security, and industry-standard servers in Global ECS.
- Sales are substantially order-by-order rather than under long-term contracts, limiting visibility beyond a few months. Risks include supplier relationships, product supply and pricing, customer demand, competition, margin pressure, ERP implementation, acquisition integration, foreign exchange, and global market conditions.
- New U.S. tariffs and potential retaliatory tariffs could increase product and operating costs, reduce customer demand, and pressure operating profits. Management intends to pass price increases to customers, but the ultimate effect remains uncertain.
- Environmental remediation obligations related to former Wyle facilities remain uncertain. Estimated additional costs were $4.3 million to $10.0 million for Huntsville and $14.3 million to $25.0 million for Norco, excluding potential costs that cannot yet be estimated.
- Arrow adopted revenue recognition Topic 606 retrospectively and ASU 2016-01 prospectively in 2018. The company expects to adopt the new lease standard in the first quarter of 2019 and expects total assets to increase by less than 3%.
- The company recorded a $124.7 million provisional tax impact of the 2017 Tax Act in the fourth quarter of 2017 and made no adjustment during the first nine months of 2018.
Investor Verification Checklist
- Verify whether strong component demand and improved component margins offset continued ECS margin pressure.
- Monitor operating cash conversion, inventory and receivables growth, and working-capital requirements.
- Review debt maturities, variable-rate exposure, asset securitization collateral, and covenant headroom.
- Assess the integration and financial contribution of eInfochips and other acquisitions.
- Track tariff developments and the company’s ability to pass increased costs to customers.
- Reassess the potential range and timing of Wyle environmental remediation costs.
- Distinguish GAAP results from management’s adjusted non-GAAP measures, particularly the effects of amortization, restructuring, investment gains or losses, and disposition losses.