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). This unaudited report covers the quarter and nine months ended October 1, 2016, compared with September 26, 2015. Approximately 66% of nine-month sales came from Global Components and 34% from Global ECS.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Sales | $5.936 billion | $5.698 billion | $17.382 billion | $16.531 billion |
| Gross profit | $773.2 million | $742.4 million | $2.321 billion | $2.196 billion |
| Gross margin | 13.0% | 13.0% | 13.4% | 13.3% |
| Operating income | $198.7 million | $185.8 million | $603.6 million | $570.2 million |
| Operating margin | 3.3% | 3.3% | 3.5% | 3.4% |
| Net income attributable to shareholders | $117.7 million | $109.2 million | $358.2 million | $339.2 million |
| Diluted EPS | $1.28 | $1.15 | $3.87 | $3.52 |
Adjusted net income, excluding identifiable intangible amortization and restructuring, integration, and other charges, was $143.1 million in the quarter and $428.1 million for the nine months, compared with $133.4 million and $410.1 million, respectively, in the prior-year periods. Adjusted operating income was $236.8 million in the quarter and $706.1 million for the nine months.
Cash provided by operating activities was $135.8 million for the first nine months, compared with $110.9 million in the prior-year period. Investing activities used $207.3 million, including $68.9 million for acquisitions and $126.3 million for capital expenditures. Financing activities provided $203.4 million, including $320.0 million of long-term bank borrowings and $167.2 million of share repurchases.
Cash and cash equivalents were $384.4 million at October 1, 2016, compared with $273.1 million at December 31, 2015. Total debt was approximately $2.782 billion, consisting of $77.3 million of short-term borrowings and $2.705 billion of long-term debt. Shareholders’ equity was $4.426 billion.
Material changes versus the prior comparable period
- Quarterly sales increased 4.2%; nine-month sales increased 5.2%.
- Global Components sales increased 5.8% in the quarter and 6.3% for the nine months. Global ECS sales increased 1.3% and 3.0%, respectively.
- Excluding foreign-currency effects and acquisitions, consolidated sales increased 3.5% in the quarter and 2.3% for the nine months. On the same basis, ECS sales declined 0.6% in the quarter and 0.1% for the nine months.
- Gross margin was flat in the quarter and improved approximately 10 basis points for the nine months.
- Interest and other financing expense increased to $37.2 million in the quarter and $111.8 million for the nine months, primarily due to higher average debt outstanding.
- Weighted-average diluted shares declined to 91.9 million in the quarter and 92.5 million for the nine months, versus 95.4 million and 96.3 million, respectively, reflecting share repurchases.
- The company completed three acquisitions in the first nine months for $68.1 million, net of cash acquired; management stated their impact was not material.
Guidance, outlook, risks, contingencies, and unusual items
The filing does not provide specific quantitative quarterly or full-year revenue or earnings guidance. Management stated that sales visibility is limited because substantially all sales are made on an order-by-order basis rather than under long-term contracts.
- Management expects current cash, borrowing capacity, operating cash generation, and capital-market access to be sufficient for projected needs for the foreseeable future.
- The revolving credit facility has $1.5 billion of capacity and matures in December 2018; no amounts were outstanding at October 1, 2016. The asset securitization program was amended to increase capacity to $910.0 million and extend maturity to September 2019; $467.0 million was outstanding.
- The company was in compliance with debt covenants at October 1, 2016.
- Restructuring, integration, and other charges were $24.3 million in the quarter and $61.2 million for the nine months, compared with $17.8 million and $51.1 million in the prior-year periods.
- 2016 unusual items included a $4.4 million fraud loss net of insurance recoveries, a $12.2 million pension settlement charge, $7.6 million of acquisition-related expenses, an $11.7 million increase in the Wyle environmental accrual, and a $2.4 million release of the Tekelec legal reserve. Approximately $29 million of cash related to the fraud remained frozen in outside accounts and was considered probable of recovery.
- Environmental liabilities associated with former Wyle facilities remain uncertain. Estimated additional costs were $0.3 million to $0.75 million for Huntsville investigations, plus an estimated $3 million to $4 million for certain remediation measures; Norco activities were estimated at an additional $22.3 million to $33.0 million. The company stated that ultimate costs could exceed current accruals and be material.
- A Federal Trade Commission antitrust investigation remains pending at the information-gathering stage; the filing states that no proceedings had been instituted and that the potential impact could not be predicted.
- Management identified a continuing material weakness in internal control over financial reporting related to preventing or timely detecting unauthorized cash disbursements. Remediation actions were implemented and testing began in the second quarter, but the weakness had not been remediated as of October 1, 2016.
- Principal forward-looking risks include demand and pricing changes, product supply, supplier relationships, competition, margin pressure, ERP implementation, acquisition integration, legal and regulatory matters, foreign currency exposure, and cash-flow generation.
Investor verification checklist
- Verify the sustainability of organic growth, particularly the modest performance of Global ECS excluding acquisitions and currency effects.
- Reconcile GAAP results to management’s adjusted measures and assess the recurring versus nonrecurring nature of the $61.2 million of nine-month charges.
- Monitor debt levels, the increase in asset-securitization borrowings, covenant compliance, and refinancing needs beginning in 2018.
- Review remediation progress for the material weakness and controls over cash disbursements following the fraud loss.
- Assess potential exposure from Wyle environmental obligations, insurance recoveries, and the FTC investigation.
- Evaluate working-capital requirements, including $5.912 billion of receivables and $2.605 billion of inventory at October 1, 2016.
- Consider the effect of ongoing share repurchases, acquisitions, ERP spending, and foreign-currency movements on future earnings and cash flow.