ARROW ELECTRONICS, INC. annual report, FY2010

Arrow Electronics, Inc. 2010 Form 10-K Summary

Business context and reporting period

Arrow Electronics is a global distributor of electronic components and enterprise computing solutions. Its two reportable segments are Global Components, serving OEMs and contract manufacturers, and Global Enterprise Computing Solutions (ECS), serving value-added resellers. The filing covers the fiscal year ended December 31, 2010; fourth-quarter information is also provided because the request references 2010 Q4.

Approximately 70% of 2010 sales came from Global Components and 30% from Global ECS.
Approximately 56% of sales were generated outside the United States.
The company served more than 115,000 customers and 1,200 suppliers through operations in 52 countries.

Financial performance and key metrics

Metric	2010	2009	Change
Sales	$18.745 billion	$14.684 billion	27.7% increase
Gross profit	$2.42 billion	$1.75 billion	Approximately 100-basis-point margin expansion
Operating income	$750.8 million	$272.8 million	174.9% increase
Net income attributable to shareholders	$479.6 million	$123.5 million	288.3% increase
Diluted earnings per share	$4.01	$1.03	Increase of $2.98
Operating cash flow	$220.8 million	$849.9 million	Decrease of $629.1 million

Reported gross margin was approximately 12.9%, operating margin approximately 4.0%, and net margin approximately 2.6%.
Global Components sales increased 35.0% to $13.168 billion; Global ECS sales increased 13.0% to $5.576 billion.
Segment operating income was $715.3 million for Global Components and $191.5 million for Global ECS; corporate costs were $156.0 million.
Interest and other financing expense declined to $76.6 million from $83.3 million. The reported 2010 effective tax rate was 29.4%, compared with 34.6% in 2009.
Accounts receivable and inventories totaled $6.012 billion at year-end, representing approximately 62.6% of total assets.
Cash and cash equivalents were $926.3 million, compared with $1.137 billion at December 31, 2009. Total assets were $9.601 billion and shareholders’ equity was $3.251 billion.
Long-term debt was $1.761 billion, and total debt including current borrowings was approximately $1.822 billion. The company had no borrowings outstanding under its $800 million revolving credit facility or $600 million asset securitization program.
Cash used in investing activities was $682.4 million, including $587.1 million for acquisitions and $112.3 million for capital expenditures. ERP-related capital expenditures were $58.0 million.
Cash provided by financing activities was $270.9 million, including $494.3 million of net note proceeds and $173.7 million of common-stock repurchases.

Fourth-quarter 2010 results

Fourth-quarter sales were $5.238 billion, compared with $4.203 billion in fourth-quarter 2009.
Fourth-quarter gross profit was $683.4 million, compared with $496.6 million in the prior-year quarter.
Fourth-quarter net income attributable to shareholders was $157.9 million, or $1.37 diluted earnings per share, compared with $63.1 million, or $0.52 per diluted share, in fourth-quarter 2009.
Fourth-quarter results included $5.5 million of after-tax restructuring, integration, and other charges, a $9.4 million tax provision reduction, and a $2.3 million after-tax reduction in interest expense related primarily to multi-year tax settlements.

Material changes versus prior comparable periods

The 2010 recovery followed a recession-driven decline in 2009. Sales fell 12.4% in 2009 but rebounded 27.7% in 2010 as economic conditions and demand improved.
Gross-margin performance improved as pricing pressure in Global Components eased and the sales mix shifted toward the higher-margin Americas and EMEA components businesses. Global ECS gross margin was approximately flat.
Selling, general, and administrative expense increased in dollars but declined to 8.3% of sales from 8.9%, reflecting operating leverage and process simplification.
Restructuring, integration, and other charges declined to $33.5 million from $105.5 million. The 2010 restructuring actions eliminated approximately 280 positions and involved seven vacated facilities.
2010 included significant acquisition activity, including Converge, Shared, Intechra, Verical, Sphinx, Transim, ETG, and Diasa. Aggregate cash consideration for acquired businesses was approximately $587.1 million.
Goodwill increased to $1.336 billion from $926.3 million, primarily due to acquisitions. Annual impairment testing in 2010 did not indicate impairment; however, 2008 included a non-cash goodwill impairment charge of $1.019 billion.
Operating cash flow declined substantially because increased earnings were more than offset by higher accounts receivable and inventory balances associated with sales growth.

Outlook, commentary, risks, contingencies, and unusual items

Management described 2010 operating results as evidence of a recovery in the electronics distribution markets but cautioned that the recovery might not continue. The company’s objectives are to grow sales faster than the market, grow profits faster than sales, expand geographically and by product, and improve return on invested capital. The filing does not provide specific earnings or revenue guidance.

Customer orders are generally placed on an order-by-order basis rather than under long-term contracts, limiting visibility beyond a few months.
Key risks include cyclical semiconductor demand, inventory obsolescence, pricing pressure, supplier concentration and cancellable distribution agreements, customer defaults, international operations and currency movements, and technology changes.
The company is implementing a global ERP system. Estimated 2011 cash-flow impact was $40 million to $60 million, with the impact expected to decrease by approximately $10 million in 2012. Implementation could cause cost overruns, delays, or business interruptions.
The company expects to finance ERP costs with operating cash flow and stated that cash, borrowing capacity, expected operating cash flow, and capital-market access should meet foreseeable needs.
The $800 million revolving credit facility matures in January 2012, and the $600 million asset securitization program expires in April 2012. Both contain financial and other restrictive covenants; the company reported compliance at year-end.
Environmental matters associated with the former Wyle operations remain unresolved. The company has spent approximately $41 million on the Norco and Huntsville sites and recorded a $44.2 million receivable from E.ON AG for expected indemnification recoveries. Additional remediation costs remain uncertain.
E.ON AG has asserted a counterclaim of approximately $16.0 million, while mediation concerning indemnification remains ongoing. Insurance recoveries of approximately $13.0 million had been received.
At year-end, the company had $78.5 million of liabilities for unrecognized tax benefits and related interest, including approximately $12.3 million expected to be paid within one year.
Subsequent events included the January 3, 2011 acquisition of Nu Horizons for approximately $161.1 million and a planned acquisition of Richardson RFPD for approximately $210.0 million, subject to regulatory approvals.
The company paid no cash dividends in 2010 or 2009. Future dividends remain subject to earnings, financial condition, and debt covenants.
Management and Ernst & Young concluded that disclosure controls and internal control over financial reporting were effective. Controls at eight acquired entities, representing 8.8% of total assets, 1.7% of sales, and 1.8% of net income, were excluded from the annual assessment.

Most important facts for investors to verify

Confirm whether sales recovery and improved component pricing remain durable after the 2010 rebound.
Review working-capital requirements, particularly the increase in accounts receivable and inventories and the resulting decline in operating cash flow.
Assess acquisition integration, goodwill balances, acquired intangible assets, and the risk of future impairment charges.
Review debt maturities, refinancing requirements around 2012, covenant restrictions, and liquidity after acquisitions and share repurchases.
Monitor ERP implementation costs, timing, and any operational disruption.
Track the E.ON AG indemnification litigation, insurance recoveries, environmental remediation estimates, and potential uninsured exposure.
Evaluate the effect of semiconductor cycles, supplier agreements, inventory protections, currency movements, and international market exposure.
Reconcile reported earnings with restructuring charges, tax settlements, debt-prepayment losses, acquisition-related expenses, and other unusual items.