ARROW ELECTRONICS, INC. quarterly report, Q1 FY2014

Arrow Electronics, Inc. — Q1 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 ECS. The unaudited quarter ended March 29, 2014, compared with March 30, 2013. Approximately 67% of sales came from Global Components and 33% from Global ECS.

Key financial metrics

Metric	Q1 2014	Q1 2013	Change
Sales	$5.082 billion	$4.850 billion	4.8% increase
Gross profit	$703.8 million	$642.1 million	9.6% increase
Gross margin	13.8%	13.2%	Up 60 basis points
Operating income	$177.7 million	$137.6 million	29.2% increase
Operating margin	3.5%	2.8%	Up 70 basis points
Net income attributable to shareholders	$107.1 million	$77.9 million	37.6% increase
Diluted EPS	$1.06	$0.72	47.2% increase
Operating cash flow	$124.0 million	$(179.4) million	Improved by $303.4 million

Adjusted operating income, excluding identifiable intangible amortization and restructuring, integration, and other charges, was approximately $200.3 million, or 3.9% of sales, versus $168.1 million, or 3.5%, in the prior-year quarter. Adjusted net income attributable to shareholders was approximately $124.0 million versus $103.1 million.

Global Components sales increased 7.2% to $3.421 billion; sales increased across Asia Pacific, EMEA, and the Americas.
Global ECS sales increased 0.2% to $1.661 billion as reported, but declined 11.4% after adjusting for acquisitions and foreign currency, primarily due to quarter-end timing and weaker storage and server demand.
SG&A increased 5.9% to $477.9 million, while depreciation and amortization increased 16.1% to $36.6 million, primarily due to acquisitions.
Income before taxes was $149.5 million and the effective tax rate was 28.3%, compared with 26.3% in the prior-year quarter.

Liquidity, debt, and capital resources

Cash and cash equivalents were $258.3 million at March 29, 2014, down from $390.6 million at December 31, 2013. Approximately $231.0 million was held outside the United States and intended to remain permanently reinvested abroad.
Total debt was approximately $2.159 billion, consisting of $16.5 million of short-term borrowings and $2.143 billion of long-term debt. Net debt was approximately $1.901 billion.
The company had no borrowings under its $1.5 billion revolving credit facility, which matures in December 2018.
The asset securitization program was amended in March 2014: borrowing capacity increased from $775 million to $900 million and maturity was extended to March 2017. Outstanding borrowings were $335 million, secured by approximately $1.441 billion of receivables.
Management stated that cash, available borrowing capacity, expected operating cash flow, and capital-market access should be sufficient for projected needs for the foreseeable future. The company was in compliance with applicable debt covenants.
Q1 financing cash outflows included $88.5 million of share repurchases, $85.0 million of net long-term bank debt repayments, and $7.3 million of reduced short-term borrowings.

Material changes versus the prior comparable period

Reported sales growth was 4.8%; after adjusting for acquisitions and currency, consolidated sales declined 1.4%. Currency translation contributed approximately $45 million of sales, while acquisitions contributed approximately $258 million to the prior-period comparison.
Profitability improved because of higher sales, improved gross margins, a favorable business mix, and lower restructuring charges. The increase was partially offset by higher operating expenses related to acquisitions.
Restructuring, integration, and other charges declined to $11.6 million from $21.6 million. Q1 2014 actions eliminated approximately 100 positions and involved six vacated facilities.
There was no Q1 2014 loss on debt prepayment; Q1 2013 included a $4.3 million loss related to redemption of senior notes.
Operating cash flow shifted from a $179.4 million use to a $124.0 million source, primarily reflecting favorable changes in accounts receivable and inventory. Accounts payable and accrued expenses were significant uses of cash in Q1 2014.
The company completed one acquisition in Q1 2014 for aggregate consideration of $66.3 million, including contingent consideration; its impact was not material to consolidated results.
Common-share repurchases totaled $88.5 million during the quarter. The company had approximately $76.4 million remaining under its $200 million repurchase authorization at March 29, 2014.

Outlook, commentary, risks, contingencies, and unusual items

The filing provides no formal quantitative sales or earnings guidance. Management noted that sales are generally made order-by-order rather than under long-term contracts, limiting visibility beyond a few months. Management’s objectives remain to grow sales faster than the market, expand markets and geographies, grow profit faster than sales, and improve return on invested capital.

Key operating risks include demand and pricing changes, product supply, supplier relationships, competition, margin pressure, global economic conditions, acquisition integration, cost-reduction actions, and implementation of the new enterprise resource planning system.
ERP implementation in selected Asia Pacific operations was completed April 1, 2014. Management reported no significant difficulties to date, but the implementation involves changes to internal controls and ongoing monitoring.
The company received a Federal Trade Commission Civil Investigative Demand concerning an industry database program. No proceedings had been instituted, and the potential impact could not yet be predicted.
Environmental obligations related to former Wyle facilities remain unresolved. Estimated additional costs were approximately $0.5 million to $0.75 million for investigation and $3 million to $4 million for certain Huntsville remediation measures, and $16.95 million to $24.5 million for identified Norco activities. Further costs cannot presently be estimated.
Restructuring and integration accruals totaled $32.4 million at quarter-end, principally for personnel and facility obligations expected to be paid over several years.
The company has foreign-exchange exposure; a hypothetical 10% decline in average foreign-exchange rates against the U.S. dollar would have reduced Q1 sales and operating income by approximately $165.3 million and $5.7 million, respectively.
Approximately 84% of debt was fixed-rate and 16% floating-rate. Management estimated that a one-percentage-point change in average interest rates would not materially affect Q1 net interest expense.
Accumulated other comprehensive income declined by $9.3 million during the quarter, primarily because of foreign-currency translation losses.

Important facts for investors to verify

Whether the reported sales growth is sustainable after removing acquisition and foreign-currency effects, particularly the adjusted decline in Global ECS sales.
Whether gross-margin improvement and operating leverage continue as product mix, demand, and pricing conditions change.
The cash-flow impact of working-capital movements, acquisitions, share repurchases, and debt repayments.
Debt maturities, asset-securitization availability, covenant compliance, and the company’s ability to access liquidity if international cash cannot be repatriated.
Progress, costs, and control implications of the phased ERP implementation.
Potential exposure from the FTC inquiry, environmental remediation, contingent acquisition consideration, and other legal or regulatory matters.
The reconciliation and continuing relevance of management’s non-GAAP adjusted results, including amortization and restructuring exclusions.