ARROW ELECTRONICS, INC. quarterly report, Q1 FY2018

Arrow Electronics, Inc. — Q1 2018 Form 10-Q Summary

Business context and reporting period

Arrow Electronics is a global distributor of electronic components and enterprise computing solutions. Its two segments are Global Components and Global Enterprise Computing Solutions (ECS). The filing covers the quarter ended March 31, 2018, compared with the adjusted quarter ended April 1, 2017. Approximately 72% of Q1 2018 sales came from Global Components and 28% from Global ECS.

Financial performance and liquidity

Metric	Q1 2018	Q1 2017 adjusted	Change
Sales	$6.876 billion	$5.737 billion	19.9%
Gross profit	$868.9 million	$761.2 million	14.2%
Gross margin	12.6%	13.3%	Down 70 bps
Operating income	$236.0 million	$193.0 million	22.3%
Operating margin	3.4%	3.4%	Flat
Net income attributable to shareholders	$139.1 million	$114.7 million	21.2%
Diluted EPS	$1.56	$1.27	22.8%

Reported sales growth reflected increases of 21.5% in Global Components and 16.0% in Global ECS. On a basis adjusted for foreign currency, acquisitions, and dispositions, consolidated sales increased 14.4%.
Adjusted operating income, excluding intangible amortization, restructuring and other charges, and disposition losses, was $272.2 million, or 4.0% of sales, versus $221.4 million, or 3.9%, in Q1 2017.
Adjusted net income attributable to shareholders was $167.7 million versus $132.1 million in the prior-year period.
Net cash used in operating activities was $75.1 million, compared with $20.9 million used in Q1 2017. Working capital absorbed cash as the company supported higher sales.
Net cash used in investing activities was $336.4 million, including $331.5 million for acquisitions and $34.7 million of capital expenditures.
Net cash provided by financing activities was $235.5 million, including $601.4 million of long-term bank borrowings, partially offset by the $300.0 million redemption of notes and $52.5 million of share repurchases.
Cash and cash equivalents were $548.6 million at March 31, 2018, down from $730.1 million at December 31, 2017. Approximately $261.1 million was held outside the United States.
Total debt was approximately $3.571 billion, comprising $38.2 million of short-term borrowings and $3.533 billion of long-term debt. The company had $281.5 million outstanding under its $1.8 billion revolving credit facility and $810.0 million under its $910.0 million asset securitization program.
Management stated that the company was in compliance with debt covenants and believed available cash, borrowing capacity, expected operating cash flow, and capital-market access were sufficient for foreseeable needs.

Material changes versus the prior comparable period

Revenue growth was broad-based, with double-digit growth across all Global Components regions. Management cited supplier-awarded business, transportation, aerospace and defense demand, and growth in the Digital business.
Global ECS growth was attributed to new customer wins and demand in cloud, infrastructure software, storage, and industry-standard servers.
Gross margin declined 70 basis points, primarily because of increased sales of lower-margin products and services. ECS sales growth was dilutive to operating margins due to new reseller onboarding and a shift toward hardware.
SG&A increased 9.2%, slower than sales growth, and declined to 8.2% of sales from 9.0%. Depreciation and amortization increased 27.2%, including $6.0 million of depreciation on a new ERP system placed into service.
Interest and other financing expense increased to $45.2 million from $38.2 million, primarily because of higher average debt and higher variable interest rates.
Arrow acquired eInfochips on January 8, 2018, for a purchase price of $327.5 million, including $14.8 million of cash acquired. The acquisition contributed $19.6 million of Q1 sales and added approximately $202.3 million of goodwill and $71.7 million of identifiable intangible assets on a preliminary basis. The company also completed a smaller acquisition for approximately $18.7 million.
Restructuring, integration, and other charges increased to $21.2 million from $15.5 million. The Q1 2018 amount included $11.4 million of current restructuring and integration charges and $6.2 million of acquisition-related charges.
The company recorded a $1.6 million net loss on the disposition of two non-strategic businesses and a $2.5 million net investment loss, compared with a $2.0 million investment gain in Q1 2017.
The company adopted ASC Topic 606 using the full retrospective method, with impacts primarily involving gross-versus-net presentation, distinct goods and services, and the timing of control transfer. Prior-period figures were adjusted for this and other accounting changes.

Guidance, outlook, management commentary, risks, and unusual items

The filing does not provide specific quantitative full-year or next-quarter revenue or earnings guidance.
Management stated that substantially all sales are order-by-order rather than under long-term contracts, limiting visibility beyond a few months.
Management expects the remaining $34.5 million restructuring and integration accrual at March 31, 2018 to be spent in cash over 2018 and later years; it did not anticipate material adjustments to the related plans.
The company completed implementation of a new ERP system in select Americas Components operations during Q1 2018. Management reported no significant implementation difficulties to date but identified execution of the ERP system as a forward-looking risk.
Key risks include product supply and pricing changes, customer demand, supplier relationships, competition, margin pressure, acquisition integration, foreign currency and interest-rate exposure, legal and regulatory matters, environmental remediation, and the ability to generate cash flow.
Environmental obligations inherited through the Wyle acquisition remain uncertain. Estimated additional costs were $4.7 million to $10.6 million for the Huntsville site and $18.0 million to $28.7 million for the Norco site, excluding potentially additional costs whose scope cannot yet be estimated.
A delinquent customer had approximately $24.2 million of combined notes and accounts receivable outstanding at March 31, 2018. Management believed the reserve was adequate but acknowledged that losses could exceed the reserve.
The company had not finalized the impact of the 2017 Tax Act and continued to evaluate its previously recorded provisional tax provision of $124.7 million under SEC SAB 118.

Important facts for investors to verify

Whether sales growth and adjusted operating leverage persist after separating foreign-exchange, acquisition, and disposition effects.
Whether gross-margin pressure from lower-margin products and ECS hardware mix continues.
The cash conversion impact of rising receivables and inventories, including working-capital requirements.
Post-acquisition performance and final purchase-price accounting for eInfochips and the other 2018 acquisition.
Debt levels, variable-rate exposure, asset-securitization collateral, covenant headroom, and refinancing requirements.
Execution and control effectiveness following the new ERP implementation.
Ultimate costs and timing of Wyle-related environmental remediation and other contingencies.
Final tax effects of the Tax Act and the continuing use of non-GAAP adjusted results alongside GAAP measures.