Arrow Electronics, Inc. — Q3 2014 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). The filing covers the unaudited quarter and nine months ended September 27, 2014, compared with September 28, 2013. Approximately 65% of year-to-date sales came from Global Components and 35% from Global ECS.
Financial performance and key metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Sales | $5.613 billion | $5.048 billion | $16.372 billion | $15.204 billion |
| Gross profit | $728.7 million | $671.7 million | $2.180 billion | $2.003 billion |
| Gross margin | 13.0% | 13.3% | 13.3% | 13.2% |
| Operating income | $199.8 million | $162.7 million | $585.8 million | $456.2 million |
| Operating margin | 3.6% | 3.2% | 3.6% | 3.0% |
| Net income attributable to shareholders | $146.9 million | $96.8 million | $381.9 million | $264.6 million |
| Diluted EPS | $1.47 | $0.95 | $3.80 | $2.53 |
- Q3 sales increased 11.2%; nine-month sales increased 7.7%. Global Components increased 7.6% for the quarter and 6.6% year to date, while Global ECS increased 19.0% and 9.8%, respectively.
- Adjusted for acquisitions and currency, consolidated sales increased 5.8% in Q3 and 1.8% year to date. Adjusted Global ECS sales increased 6.7% in Q3 but declined 2.1% year to date.
- Adjusted operating income, excluding identifiable intangible amortization and restructuring, integration, and other charges, was $214.9 million in Q3 and $643.9 million year to date, representing margins of 3.8% and 3.9%.
- Net income attributable to shareholders increased 51.8% in Q3 and 44.3% year to date. Results included an $18.3 million after-tax gain from the sale of an investment in Q3 2014.
- Adjusted net income attributable to shareholders was $140.2 million in Q3 and $408.6 million year to date, compared with $119.9 million and $347.0 million in the comparable 2013 periods.
Cash flow, liquidity, and debt
- Year-to-date operating cash flow was $216.2 million, compared with $235.6 million in 2013. Investing cash flow used $176.9 million, including $129.5 million for acquisitions and $87.9 million for capital expenditures; $57.0 million of capital expenditures related to the ERP initiative.
- Financing activities used $180.9 million, principally reflecting $189.4 million of share repurchases. Cash decreased by $132.4 million to $258.2 million at September 27, 2014, from $390.6 million at December 31, 2013.
- Total debt was approximately $2.229 billion, consisting of $17.5 million of short-term borrowings and $2.211 billion of long-term debt. The company had $49.8 million outstanding under its $1.5 billion revolving credit facility and $360.0 million under its $900 million asset securitization program.
- The revolving credit facility matures in December 2018, and the asset securitization program matures in March 2017. The company was in compliance with applicable debt covenants at quarter end.
- Management believes cash, available borrowing capacity, expected operating cash flow, and capital-market access are sufficient for foreseeable needs. Of total cash, $221.5 million was held outside the United States and is intended to remain permanently reinvested abroad.
Material changes versus the prior comparable period
- Reported growth accelerated, particularly in Global ECS, although year-to-date organic ECS sales declined 2.1% after removing acquisition and currency effects.
- Q3 gross margin declined 30 basis points, primarily due to geographic mix, including a larger Asia-Pacific component-sales contribution, and lower ECS margins. Year-to-date gross margin increased 10 basis points.
- Operating margin improved by 40 basis points in Q3 and 60 basis points year to date, aided by lower restructuring charges and operating-cost discipline.
- Restructuring, integration, and other charges fell to $3.9 million in Q3 and $25.2 million year to date, from $22.6 million and $74.4 million, respectively, in 2013.
- The company completed three acquisitions during the first nine months for aggregate consideration of $135.6 million, and completed two additional acquisitions after quarter end for approximately $37 million in cash. Management stated that the acquisitions were not material individually or in aggregate.
- Share repurchases totaled $189.4 million year to date. The company repurchased 1.141 million additional shares for $55.4 million through October 24, 2014.
- Other comprehensive income was negatively affected by foreign-currency translation, producing a comprehensive loss attributable to shareholders of $21.1 million in Q3 despite positive net income.
Guidance, outlook, commentary, and risks
The filing does not provide explicit quantitative revenue or earnings guidance. Management stated that sales are generally made order-by-order rather than under long-term contracts, limiting visibility beyond a few months. Management continues to target sales growth above market growth, faster profit growth, broader markets, and improved return on invested capital.
- Key operating risks include product supply, pricing and customer demand, competition, supplier relationships, margin pressure, global economic conditions, ERP implementation, acquisition integration, foreign-currency movements, and the ability to generate cash.
- A 10% decline in average foreign exchange rates against the U.S. dollar would have reduced estimated first-nine-month 2014 sales by approximately $498.4 million and operating income by approximately $18.1 million.
- Approximately 77% of debt was fixed-rate and 23% floating-rate at quarter end; management stated that a one-percentage-point interest-rate change would not materially affect year-to-date net interest expense.
- Environmental remediation obligations related to former Wyle facilities remain unresolved. Estimated additional costs are $0.5 million to $0.75 million for investigation and related work at Huntsville, plus an estimated $3 million to $4 million for possible remediation; Norco additional costs are estimated at $16.8 million to $24.5 million. The company cannot estimate potential costs beyond these amounts.
- The FTC is investigating a trade-group database program in which Arrow participated. The company received a Civil Investigative Demand, supplied information, and stated that no proceedings had been instituted; the potential impact cannot yet be predicted.
- Restructuring and integration accruals totaled $13.1 million at quarter end and are expected to be paid in cash. The company does not anticipate material adjustments to the related plans.
Important facts for investors to verify
- Assess the sustainability of reported growth after excluding acquisitions, currency effects, and the one-time investment gain.
- Monitor Global ECS organic demand, particularly the year-to-date decline in adjusted sales and weaker server demand.
- Review gross-margin trends by segment and geography, especially Asia-Pacific mix and ECS profitability.
- Reconcile operating cash flow with earnings and monitor working-capital requirements, inventory, receivables, and cash held outside the United States.
- Evaluate debt maturities, asset-securitization dependence, covenant headroom, and the effect of continued share repurchases on liquidity.
- Track environmental remediation estimates, the FTC investigation, acquisition-related contingent consideration, and the integration and execution risks associated with the ERP initiative.