Arrow Electronics, Inc. — Q2 2018 Form 10-Q Summary
Business context and reporting period
Unaudited quarterly report for the quarter and six months ended June 30, 2018. Arrow is a global distributor of electronic components and enterprise computing solutions, operating through Global Components and Global Enterprise Computing Solutions (ECS). Approximately 72% of first-half sales came from Global Components and 28% from ECS.
Financial performance and key metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Sales | $7.393 billion | $6.422 billion | $14.268 billion | $12.159 billion |
| Sales growth | 15.1% | — | 17.3% | — |
| Gross profit | $932.8 million | $824.0 million | $1.802 billion | $1.585 billion |
| Gross margin | 12.6% | 12.8% | 12.6% | 13.0% |
| Operating income | $286.8 million | $230.4 million | $522.8 million | $423.5 million |
| Operating margin | 3.9% | 3.6% | 3.7% | 3.5% |
| Net income attributable to shareholders | $169.9 million | $99.7 million | $309.0 million | $214.5 million |
| Diluted EPS | $1.92 | $1.11 | $3.48 | $2.38 |
- Adjusted sales growth excluding currency, acquisitions, and dispositions was 13.0% in Q2 and 13.7% for the first six months.
- Adjusted operating income was $318.0 million in Q2 and $590.2 million for the first six months, with adjusted margins of 4.3% and 4.1%, respectively.
- Adjusted net income attributable to shareholders was $194.9 million in Q2 and $362.7 million for the first six months, compared with $159.1 million and $291.2 million in the prior-year periods.
- Q2 segment sales increased 18.4% in Global Components and 7.6% in Global ECS. First-half increases were 19.9% and 11.4%, respectively.
- Q2 net interest and other financing expense increased to $60.8 million from $42.5 million; first-half expense increased to $106.0 million from $80.8 million, primarily due to higher average debt and variable interest rates.
Cash flow, balance sheet, debt, and liquidity
- Cash and cash equivalents were $330.5 million at June 30, 2018, down from $730.1 million at December 31, 2017; $268.6 million was held outside the United States.
- First-half operating cash flow was negative $484.8 million versus negative $133.1 million in the prior-year period, primarily because higher sales required additional receivables and inventory investment.
- First-half investing cash flow was negative $371.8 million, including $331.6 million for acquisitions and $66.6 million of capital expenditures.
- First-half financing cash flow was positive $452.2 million, including $759.3 million of long-term bank borrowings, partially offset by the $300.0 million redemption of notes and $72.6 million of share repurchases.
- Total debt, including current borrowings, was approximately $3.805 billion at June 30, 2018, compared with approximately $3.290 billion at year-end 2017. Long-term debt was $3.690 billion.
- The company had a $1.8 billion revolving credit facility maturing in December 2021, with $57.7 million outstanding, and a $1.2 billion asset securitization program, with $1.2 billion outstanding. The securitization program was amended to increase capacity and extend maturity to June 2021.
- The company reported compliance with applicable debt covenants and stated that available cash, borrowing capacity, and expected operating cash flows should meet foreseeable liquidity needs.
Material changes versus prior comparable periods
- Revenue, operating income, and reported net income increased substantially, supported by strong demand in industrial, transportation, aerospace and defense, storage, servers, and infrastructure software.
- Gross margin declined 20 basis points in Q2 and 40 basis points for the first six months, primarily due to lower ECS margins and product mix. Global Components margins were generally stable.
- Operating expense leverage improved: reported operating expenses as a percentage of sales declined to 8.5% in Q2 from 8.9% and to 8.7% for the first six months from 9.2%.
- Working capital as a percentage of sales increased to 18.1% in Q2 2018 from 16.7%, contributing to weaker operating cash flow.
- Arrow acquired eInfochips in January 2018 for $327.6 million, including $14.8 million of cash acquired, and completed one additional immaterial acquisition. The acquisition added $40.9 million of sales during the first six months.
- Restructuring, integration, and other charges were $19.2 million in Q2 and $40.4 million for the first six months, compared with $24.4 million and $39.9 million, respectively, in the prior-year periods.
- The prior-year period included a $58.8 million loss on extinguishment of debt; no comparable charge was recorded in 2018. Conversely, 2018 included a $1.6 million loss on disposition of businesses during the first six months.
Guidance, outlook, risks, and unusual items
- The filing does not provide specific quantitative revenue, earnings, or margin guidance. Management described strong demand and expects available liquidity and borrowing capacity to support foreseeable needs.
- Sales are primarily generated on an order-by-order basis rather than under long-term contracts, limiting visibility beyond a few months.
- Management identified risks from tariffs and potential retaliatory trade restrictions, including higher product costs, possible demand effects, and operating margin pressure.
- Other principal risks include product supply and pricing, customer demand, supplier relationships, competition, margin pressure, ERP implementation, acquisition integration, foreign currency and interest-rate exposure, and the ability to generate cash flow.
- Environmental remediation obligations at former Wyle facilities remain unresolved. Estimated additional costs were $4.3 million to $10.0 million for Huntsville and $16.0 million to $26.7 million for Norco, excluding costs that cannot yet be estimated.
- Arrow adopted the revenue recognition standard Topic 606 retrospectively and ASU 2016-01 prospectively in 2018. Prior-period figures were adjusted; the filing states that Topic 606 did not have a significant impact on prior-period revenue recognition.
Important facts for investors to verify
- Whether strong Components demand and ECS growth persist after adjusting for currency, acquisitions, and changing product mix.
- Whether gross-margin pressure in ECS and higher interest costs offset operating expense leverage.
- The sustainability of cash generation given the substantial first-half working capital investment and $3.8 billion of debt.
- Integration results and valuation assumptions related to the eInfochips acquisition, including goodwill and acquired intangible assets.
- Potential effects of tariffs, supply constraints, foreign exchange, and variable interest rates.
- Progress and ultimate cost of the Huntsville and Norco environmental remediation matters.
- Final effects of the Tax Act measurement process and future accounting standard adoptions, including leases and credit losses.