Arrow Electronics, Inc. — Form 10-Q Summary
Reporting period: Quarter ended March 30, 2013; comparative quarter ended March 31, 2012. Financial statements are unaudited and prepared under U.S. GAAP. Arrow distributes electronic components through its Global Components segment and enterprise computing solutions through its Global ECS segment.
Business Context and Reporting Period
- Global Components represented approximately 66% of first-quarter 2013 sales; Global ECS represented approximately 34%.
- Arrow completed one acquisition during the quarter for aggregate consideration of $9.95 million, including $0.57 million of contingent consideration. The acquisition was not material.
- The company prospectively changed the presentation of certain fulfillment-contract revenue from gross sales to net agency fees. The change reduced reported first-quarter 2012 sales by approximately $131.5 million but did not affect gross profit, operating income, net income, earnings per share, balance sheet, or cash flow.
Financial Results and Key Metrics
| Metric | Q1 2013 | Q1 2012 | Change |
|---|
| Sales | $4.850 billion | $4.890 billion | Down 0.8% |
| Gross profit | $642.1 million | $680.6 million | Down $38.5 million |
| Operating income | $137.6 million | $187.4 million | Down $49.9 million |
| Operating margin | 2.8% | 3.8% | Down approximately 100 basis points |
| Net income attributable to shareholders | $77.9 million | $113.6 million | Down 31.5% |
| Diluted earnings per share | $0.72 | $1.00 | Down $0.28 |
| Net cash from operating activities | $(179.4) million | $250.3 million | Decrease of $429.7 million |
- Gross margin declined approximately 70 basis points, primarily from competitive pricing pressure in both segments and product mix. The revenue-presentation change increased reported gross margin by approximately 40 basis points in 2013.
- Selling, general, and administrative expense declined 1.0% to $451.4 million, while depreciation and amortization increased 8.5% to $31.5 million, principally because of the ERP initiative.
- The effective tax rate was 26.3%, compared with 30.0% in the prior-year quarter. Excluding restructuring, integration, other charges, and the debt-prepayment loss, management reported adjusted effective tax rates of 27.0% and 29.8%, respectively.
- Average diluted shares declined to 107.8 million from 114.1 million, reflecting share repurchases and other share activity.
Segment Performance
| Segment | Q1 2013 Sales | Year-over-Year Change | Q1 2013 Operating Income |
|---|
| Global Components | $3.193 billion | Down 4.7% | $128.3 million |
| Global ECS | $1.657 billion | Up 7.6% | $61.6 million |
- Global Components sales were affected by weaker demand in the Americas and EMEA, partly offset by Asia-Pacific demand, acquisitions, and currency translation. On an adjusted basis, sales declined 2.1%.
- Global ECS growth reflected higher demand in North America and EMEA, particularly for software, storage, industry-standard servers, and services, partly offset by lower proprietary-server sales. Adjusted sales increased 1.6%.
- Global Components operating income fell from $170.7 million to $128.3 million. Global ECS operating income increased from $55.5 million to $61.6 million.
Cash Flow, Debt, and Liquidity
- Cash and cash equivalents were $364.2 million at March 30, 2013, down from $409.7 million at December 31, 2012. Approximately $324.2 million was held outside the United States and was intended to remain permanently reinvested overseas.
- Operating cash use of $179.4 million primarily reflected working-capital investment, including a $467.8 million decrease in accounts payable and a $173.4 million decrease in accrued expenses, partly offset by a $389.0 million reduction in accounts receivable.
- Investing cash use was $39.1 million, including $26.8 million of capital expenditures and $9.4 million paid for the acquisition. ERP-related capital expenditures were $15.1 million.
- Financing activities provided $186.5 million. Sources included $591.2 million of net note-offering proceeds and $44.3 million of long-term bank borrowings. Uses included $338.2 million for senior-note redemption and $113.5 million for common-stock repurchases.
- Short-term borrowings were $37.0 million, compared with $364.4 million at year-end 2012. Long-term debt increased to $2.205 billion from $1.587 billion, primarily because of the new note issuance and increased asset-securitization borrowings.
- In February 2013, Arrow issued $300 million of 3.00% notes due 2018 and $300 million of 4.50% notes due 2023. In March, it redeemed $332.1 million principal amount of 6.875% senior notes due July 2013, generating a $4.3 million pretax loss.
- The company had $57.9 million outstanding under its $1.2 billion revolving credit facility and $335.0 million outstanding under its $775.0 million asset-securitization program. Both facilities include borrowing, repurchase, dividend, and financial-ratio covenants. Arrow was in compliance at March 30, 2013.
- Management stated that cash, borrowing capacity, expected operating cash flow, and access to capital markets should be sufficient for projected needs for the foreseeable future.
Material Changes, Outlook, Risks, and Unusual Items
- Restructuring, integration, and other charges increased to $21.6 million from $8.2 million. The 2013 amount included $18.6 million of restructuring charges, $2.8 million of acquisition-related expenses, and actions eliminating approximately 340 positions and exiting six facilities.
- Restructuring accruals totaled $27.0 million at quarter-end, expected to be paid in cash, primarily within one year for personnel costs and through 2017 for facilities costs.
- Management cited competitive pricing pressure, weaker demand in the components business, product mix, customer and supplier uncertainty, ERP implementation, acquisition integration, foreign exchange, and the ability to generate cash as key risks.
- Substantially all sales are made on an order-by-order basis rather than under long-term contracts, limiting visibility beyond a few months. The filing provides no specific full-year sales or earnings guidance.
- Foreign-currency translation increased first-quarter sales by approximately $9.1 million. A hypothetical 10% decline in international currencies against the U.S. dollar would reduce quarterly sales by approximately $144.5 million and operating income by approximately $3.2 million.
- Approximately 81% of debt was fixed-rate and 19% floating-rate at quarter-end. Management stated that a one-percentage-point change in average interest rates would not materially affect first-quarter net interest expense.
- Environmental remediation obligations related to former Wyle facilities remain uncertain. The filing identifies estimated additional costs for specified Huntsville and Norco activities but states that ultimate costs cannot currently be fully estimated.
- The company completed a phased ERP implementation in a European operation and reported no significant difficulties to date. Disclosure controls were deemed effective.
Important Facts for Investors to Verify
- Assess whether the decline in Global Components demand and gross margins is temporary or reflects sustained pricing and competitive pressure.
- Reconcile reported sales comparisons for the fulfillment-contract presentation change and evaluate adjusted versus GAAP trends.
- Monitor working-capital requirements and the reversal from positive operating cash flow in Q1 2012 to substantial operating cash use in Q1 2013.
- Review leverage, debt maturities, asset-securitization collateral, and compliance with revolving-credit and securitization covenants.
- Track the financial benefits and cash costs of the 2013 restructuring program, including the remaining $27.0 million accrual.
- Evaluate ERP implementation execution, acquisition integration, and potential environmental remediation costs.
- Verify the effect of share repurchases on diluted shares and per-share results; the company had repurchased approximately $200.0 million of stock under its programs by March 30, 2013.
