Arrow Electronics, Inc. — 2020 Q1 Form 10-Q Summary
Business Context and Reporting Period
Unaudited results cover the quarter ended March 28, 2020, compared with the quarter ended March 30, 2019. Arrow distributes electronic components to OEMs and contract manufacturers through Global Components and provides enterprise computing solutions to VARs and managed service providers through Global ECS. Approximately 71% of first-quarter sales came from Global Components and 29% from Global ECS.
Key Financial Metrics
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Sales | $6.381 billion | $7.156 billion | (10.8%) |
| Gross profit | $728.4 million | $861.7 million | (15.5%) |
| Gross margin | 11.4% | 12.0% | (60) bps |
| Operating income | $138.3 million | $245.6 million | (43.7%) |
| Operating margin | 2.2% | 3.4% | (120) bps |
| Net income attributable to shareholders | $49.5 million | $140.7 million | (64.8%) |
| Diluted EPS | $0.61 | $1.63 | (62.6%) |
| Operating cash flow | $466.9 million | $(329.0) million | Improved $795.9 million |
- Adjusted net income attributable to shareholders was $79.0 million versus $163.7 million in the prior-year quarter. Adjusted operating income was $156.5 million, or 2.5% of sales, versus $276.9 million, or 3.9%.
- Global Components sales declined 12.4% to $4.551 billion; Global ECS sales declined 6.8% to $1.831 billion.
- Cash and cash equivalents were $201.0 million at March 28, 2020, down from $300.1 million at year-end 2019. Accounts receivable were $7.817 billion and inventories were $3.334 billion.
- Total debt was approximately $2.600 billion, consisting of $377.2 million of short-term borrowings and $2.223 billion of long-term debt. The company had $122.5 million drawn on its $2.0 billion revolving credit facility, no commercial paper outstanding, and no borrowings under its $1.2 billion North American receivables securitization program.
- Capital expenditures were $28.0 million. Financing cash outflows included $288.6 million of net long-term debt repayments, $84.4 million of short-term borrowing repayments, and $159.0 million of share repurchases.
Material Changes Versus the Prior Comparable Period
- Sales weakened across both segments. Adjusted for currency, dispositions, and wind-down activities, consolidated sales declined 9.1%.
- COVID-19-related closures and supply-chain disruptions were the primary driver of lower Asia-Pacific Components sales. Softer demand affected the Americas and EMEA, while ECS also experienced delayed orders and weaker Network Security, Storage, and infrastructure-project demand.
- Gross margin declined due primarily to product and regional mix. Selling, general, and administrative expense decreased 4.0%, but increased to 8.4% of sales from 7.8%.
- Net income was affected by a $16.8 million net investment loss compared with a $5.3 million gain in the prior-year period, approximately $32.7 million of reserves and other adjustments primarily related to foreign tax and other contingencies, and a higher effective tax rate of 35.9% versus 27.5%.
- 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.
- The company launched an EMEA receivables securitization program. It sold approximately $528.5 million of receivables during the quarter, contributing approximately $382.1 million to operating cash flow; $171.0 million of collateralized receivables remained held by the related bankruptcy-remote entity.
Outlook, Commentary, Risks, and Unusual Items
The filing does not provide formal quarterly or annual sales, earnings, or margin guidance. Management stated that visibility is limited because substantially all sales are made on an order-by-order basis rather than under long-term contracts.
- Management expects the COVID-19 pandemic to remain a significant risk. Potential effects include reduced demand, supply-chain and shipping disruptions, workforce limitations, customer payment delays, higher credit losses, reduced access to capital, and recessionary pressures.
- Goodwill impairment testing for the Americas Components and eInfochips reporting units did not identify impairment, but estimated fair value exceeded carrying value by only approximately 4% and 2%, respectively. Management noted that further COVID-19-related deterioration could result in future impairment.
- The company believes cash, available borrowing capacity, and expected operating cash flow are sufficient for foreseeable needs, but acknowledges that COVID-19 could impair access to capital markets.
- During April 2020, the company repaid $209.4 million of 6.00% notes due April 2020 and entered into $300.0 million of forward-starting interest-rate swaps at an average swap rate of 0.97%.
- Restructuring, integration, and other charges were $9.1 million. Restructuring and integration accruals were $9.9 million at quarter-end, and the operating expense reduction program had a $20.6 million accrual.
- The company voluntarily reported historical shipments potentially involving violations of U.S. sanctions and export-control laws. OFAC and BIS reviews could result in penalties that the company cannot currently estimate.
- Environmental remediation liabilities remain associated with former Wyle facilities. Estimated additional costs were $3.5 million to $10.0 million for Huntsville and $7.4 million to $18.3 million for Norco, while the ultimate costs remain uncertain.
- The company reported compliance with debt, securitization, and EMEA program covenants as of March 28, 2020.
Important Facts for Investors to Verify
- Whether COVID-19 disruptions produce additional sales declines, margin compression, customer defaults, or supply-chain constraints in subsequent quarters.
- The sustainability of operating cash flow, particularly the extent to which it depended on the new EMEA receivables securitization program.
- Liquidity after the April debt repayment, ongoing working-capital needs, share repurchases, and any further borrowing.
- Potential goodwill impairment given the limited valuation headroom in the Americas Components and eInfochips reporting units.
- Exposure to foreign tax, export-control, environmental, litigation, and other contingencies, including penalties or remediation costs not yet estimable.
- The reconciliation and continuing relevance of management’s non-GAAP adjusted results, which exclude several material unusual items and should be considered alongside GAAP results.