Arrow Electronics, Inc. — 2010 Q2 Form 10-Q
Reporting period: Quarter and six months ended July 3, 2010, compared with July 4, 2009; balance sheet compared with December 31, 2009. The financial statements are unaudited. Arrow distributes electronic components to OEMs and contract manufacturers through Global Components and provides enterprise computing solutions to value-added resellers through Global ECS.
Financial performance and position
| Metric | Q2 2010 | Q2 2009 | 6M 2010 | 6M 2009 |
|---|---|---|---|---|
| Sales | $4.613 billion | $3.392 billion | $8.849 billion | $6.809 billion |
| Gross profit | $588.5 million | $402.2 million | $1.126 billion | $833.2 million |
| Gross margin | 12.8% | 11.9% | 12.7% | 12.2% |
| Operating income | $189.2 million | $51.2 million | $334.5 million | $112.4 million |
| Operating margin | 4.1% | 1.5% | 3.8% | 1.7% |
| Net income attributable to shareholders | $116.2 million | $21.1 million | $203.2 million | $47.8 million |
| Diluted EPS | $0.96 | $0.18 | $1.68 | $0.40 |
- Sales increased 36.0% in Q2 and 30.0% for the first six months. Global Components sales rose 43.5% and 38.3%, respectively; Global ECS sales rose 20.9% and 12.3%.
- Excluding foreign-currency effects, consolidated sales increased 38.2% in Q2 and 29.5% for the six months. Currency translation reduced Q2 sales by $54.1 million but increased six-month sales by $21.3 million.
- SG&A increased in dollars but declined as a percentage of sales to 8.1% in Q2 from 9.3% and to 8.4% for the six months from 9.5%.
- Income taxes were $53.9 million in Q2 and $94.1 million for the six months, with a 31.7% reported effective tax rate in both periods.
- Cash and cash equivalents were $576.7 million at July 3, 2010, down from $1.137 billion at year-end 2009. Accounts receivable were $3.373 billion and inventories were $1.806 billion.
- Operating cash flow was negative $217.5 million for the first six months, versus positive $537.0 million in the prior-year period, primarily because of increases in receivables and inventories.
- Investing cash flow was negative $212.0 million, including $172.4 million for acquisitions and $56.6 million of capital expenditures. Financing cash flow was negative $80.8 million, including $81.2 million of share repurchases.
- Total debt was approximately $1.340 billion, consisting of $77.3 million of current borrowings and $1.263 billion of long-term debt. The company had no borrowings under its $800 million revolving facility or $300 million asset securitization program.
Material changes versus the prior comparable period
- Profitability improved substantially as sales recovered, gross margins expanded by approximately 90 basis points in Q2 and 50 basis points for the six months, and SG&A leverage improved.
- Restructuring, integration, and other charges declined to $5.6 million in Q2 and $13.1 million for the six months, compared with $19.3 million and $43.3 million, respectively, in 2009.
- Arrow recognized a $1.6 million loss on debt prepayment in 2010; the related after-tax impact was approximately $1.0 million.
- Cash generation deteriorated year over year because working capital absorbed cash, while acquisition spending and repurchases increased uses of cash.
- Arrow acquired Converge on June 1, 2010 for a purchase price of $138.4 million, and also acquired Verical and Sphinx. Converge contributed $27.2 million of Q2 sales. The acquisitions increased goodwill and other intangible assets.
- Arrow terminated cross-currency swaps during Q2 for $2.3 million plus accrued interest. Foreign-currency translation reduced shareholders’ equity by $131.4 million during the first six months.
Guidance, outlook, commentary, risks, and unusual items
- The filing does not provide explicit quarterly or full-year revenue or earnings guidance. Management expects current cash, borrowing capacity, future operating cash flows, and capital-markets access to meet projected needs for the foreseeable future.
- Management’s strategy is to grow sales faster than the market, grow profits faster than sales, improve return on invested capital, and supplement organic growth through acquisitions.
- Management 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.
- Restructuring actions eliminated approximately 90 Global ECS positions and 80 Global Components positions and included the exit of four European facilities. Restructuring and integration accruals totaled $21.0 million at July 3, 2010, of which $20.6 million was expected to be spent in cash.
- The global ERP rollout is expected to continue over several years. Estimated 2010 cash costs were $40 million to $60 million, with the impact expected to decline by approximately $10 million in 2011. A European implementation was completed July 6, 2010; management reported no significant implementation difficulties to date.
- Key risks include economic and industry conditions, product supply and pricing, customer demand, supplier relationships, margin pressure, foreign exchange, ERP execution, acquisition integration, and the ability to generate cash flow. A new risk factor concerns acquisitions or investments outside the traditional distribution business, including potentially greater product or service warranty exposure.
- Environmental matters remain unresolved. Additional estimated costs include approximately $3.0 million to $5.0 million at Huntsville and at least $10.5 million to $19.9 million for identified Norco activities, while the ultimate Norco scope remains uncertain. Arrow recorded a $42.8 million receivable for indemnified amounts due from E.ON AG and is involved in related litigation and mediation.
- The company was in compliance with debt covenants. Committed credit-line access declined from $1.4 billion disclosed at year-end 2009 to $1.1 billion.
Investor verification checklist
- Verify whether the sharp sales and margin improvement is sustainable after acquisition effects, currency movements, and cyclical recovery factors.
- Reconcile negative operating cash flow with reported net income and monitor receivables, inventories, and working-capital requirements.
- Review Converge, Verical, and Sphinx integration performance, goodwill balances, and potential impairment indicators.
- Assess debt maturities, the January 2012 revolving-facility maturity, the March 2011 asset-securitization expiration, and covenant headroom.
- Monitor ERP implementation costs and any related internal-control or operating disruptions.
- Track environmental remediation estimates, E.ON AG indemnification recoveries, and the approximately $16 million counterclaim.
- Evaluate the impact of the additional $100 million share-repurchase authorization on liquidity and share count.