Arrow Electronics, Inc. — Q1 2012 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 ECS. The filing covers the quarter ended March 31, 2012, with comparison to the quarter ended April 2, 2011. Both periods contained 64 shipping days. The company adopted a quarterly calendar based on the Saturday closest to the end of the calendar quarter.
Financial performance and liquidity
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Sales | $4.890 billion | $5.223 billion | Down 6.4% |
| Gross profit | $680.6 million | $722.5 million | Down $41.9 million |
| Gross margin | Approximately 13.9% | Approximately 13.8% | Up approximately 10 basis points |
| Operating income | $187.4 million | $219.2 million | Down 14.5% |
| Operating margin | 3.8% | 4.2% | Down 40 basis points |
| Net income attributable to shareholders | $113.6 million | $136.3 million | Down 16.6% |
| Diluted EPS | $1.00 | $1.16 | Down 13.8% |
| Operating cash flow | $250.3 million | $(179.7) million | Improved by $430.0 million |
Global Components sales declined 13.8% to $3.350 billion, while Global ECS sales increased 15.2% to $1.540 billion. Excluding foreign currency and acquisitions, consolidated sales declined 7.9%. A stronger U.S. dollar reduced reported sales by $77.2 million and operating income by $3.9 million.
Cash and cash equivalents were $739.7 million at March 31, 2012, compared with $396.9 million at December 31, 2011. Accounts receivable were $4.208 billion and inventories were $2.011 billion. Total debt was approximately $2.281 billion, consisting of $30.6 million of short-term borrowings and $2.250 billion of long-term debt. The company had $233.7 million outstanding under its $1.2 billion revolving credit facility and $450.0 million outstanding under its $775.0 million asset securitization program.
Investing cash outflows were $182.8 million, including $160.5 million for acquisitions and $22.3 million of capital expenditures. Financing cash inflows were $278.0 million, including $329.7 million of net long-term bank borrowings, partly offset by $57.7 million of share repurchases. The company was in compliance with its debt covenants at quarter-end.
Material changes versus the prior comparable period
- Sales and earnings declined primarily because of weaker Global Components demand and lower corresponding gross profit.
- Global ECS grew, driven by higher demand for storage, services, and software in North America and EMEA.
- Reported gross margin improved modestly, although management stated that underlying gross margin declined approximately 30 basis points excluding currency effects and acquisitions, largely because of product and customer mix.
- SG&A declined 2.0% in dollars but increased to 9.3% of sales from 8.9%, reflecting the sales decline and the higher cost structure of certain acquired businesses.
- Depreciation and amortization increased 26.6% to $29.1 million, primarily due to the ERP initiative and acquisitions.
- Interest and other financing expense increased 5.3% to $27.1 million because of higher average debt, primarily used to fund acquisitions.
- Q1 2012 included $8.2 million of restructuring, integration, and other charges. Q1 2011 included $9.6 million of such charges, a $5.9 million legal settlement charge, and a $1.8 million bargain-purchase gain.
- The company completed four acquisitions in Q1 2012; management stated that their aggregate impact was not material. Goodwill increased to $1.615 billion from $1.473 billion at year-end 2011.
Guidance, outlook, commentary, risks, and unusual items
Management did not provide specific revenue or earnings guidance in the filing. It stated that customer and supplier visibility is limited because substantially all sales are made on an order-by-order basis rather than under long-term contracts.
The company expects its global ERP initiative to require approximately $50 million to $60 million of cash flow in 2012, with the impact expected to decrease by approximately $20 million in 2013. Implementation is expected to be phased in over several years and funded with operating cash flow.
Management believes available cash, borrowing capacity, expected operating cash flows, and access to capital markets are sufficient for foreseeable needs. Approximately $700.1 million of cash was held outside the United States and is intended to remain permanently reinvested abroad; repatriation could result in significant U.S. tax costs and may be subject to local restrictions.
Restructuring actions eliminated approximately 130 positions across the two segments and generated a $5.4 million current-period charge. The remaining restructuring and integration accrual was $13.4 million at quarter-end, principally expected to be paid within one year or over future facility lease periods.
Environmental and indemnification matters related to former Wyle facilities remain unresolved. The company estimates additional costs for the Huntsville and Norco sites within disclosed ranges but cannot estimate costs beyond those amounts because the ultimate scope of remediation is uncertain. The company believes contractual indemnifications and insurance recoveries are probable, including a $49.5 million receivable from E.ON AG, but collection timing may extend for several years.
Key risks include changes in customer demand and product supply, pricing and margin pressure, supplier relationships, foreign currency movements, competition, ERP implementation, acquisition integration, restructuring actions, liquidity and debt covenant requirements, and environmental and litigation contingencies. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether the Global Components sales decline and related margin pressure persist in subsequent quarters.
- Progress, cost, and operating disruption associated with the ERP implementation.
- Debt repayment and refinancing needs, particularly the $340.3 million carrying amount of senior notes due in 2013.
- Utilization and covenant capacity under the revolving credit facility and asset securitization program.
- Cash generation after acquisition spending, capital expenditures, ERP costs, and share repurchases.
- Integration performance and goodwill or intangible-asset impairment risk from acquisitions.
- Resolution and recoverability of the E.ON AG indemnification, insurance, legal, and environmental receivables.
- The effect of foreign currency movements on reported sales and operating income.