Arrow Electronics, Inc. — Q1 2015 Form 10-Q 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 original equipment manufacturers and contract manufacturers, and Global ECS, serving value-added resellers. The unaudited quarter ended March 28, 2015 is compared with the quarter ended March 29, 2014.
Financial performance and key metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Sales | $5.002 billion | $5.082 billion | Down 1.6% |
| Gross profit | $685.3 million | $703.8 million | Down 2.6% |
| Gross margin | 13.7% | 13.8% | Down 10 basis points |
| Operating income | $177.4 million | $177.7 million | Essentially flat |
| Operating margin | 3.5% | 3.5% | Flat |
| Net income attributable to shareholders | $106.1 million | $107.1 million | Down 1.0% |
| Diluted earnings per share | $1.09 | $1.06 | Up 2.8% |
| Cash used in operating activities | $241.6 million | Cash provided of $124.0 million | Unfavorable swing |
Adjusted for foreign-currency effects and acquisitions, sales increased 3.4%, gross profit increased 1.7%, and adjusted operating income increased to $204.7 million from $200.3 million. Adjusted diluted earnings information is not clearly provided, but adjusted net income attributable to shareholders was $127.8 million versus $124.0 million.
- Global Components sales declined 2.2% as reported but increased 1.8% on a currency- and acquisition-adjusted basis.
- Global ECS sales were flat as reported and increased 6.9% on an adjusted basis.
- SG&A decreased 4.9% to $454.5 million, and SG&A as a percentage of sales improved to 9.1% from 9.4%.
- Interest and other financing expense increased 4.1% to $30.9 million, primarily because of higher average debt.
- The effective tax rate was 27.8%, compared with 28.3% in the prior-year quarter.
Balance sheet, cash flow, debt, and liquidity
- Cash and cash equivalents were $305.3 million at March 28, 2015, down from $400.4 million at December 31, 2014; $253.2 million was held outside the United States.
- Accounts receivable were $4.874 billion and inventories were $2.255 billion. Working capital as a percentage of sales was 17.5%, compared with 16.3% in the prior-year quarter.
- Total debt was approximately $2.470 billion, consisting of $13.6 million of short-term borrowings and $2.457 billion of long-term debt, versus approximately $2.081 billion at year-end 2014.
- The company issued $700 million principal amount of notes, generating $688.2 million of net proceeds, and redeemed $250 million principal amount of 3.375% notes due November 2015.
- The company had $151.6 million outstanding under its $1.5 billion revolving credit facility and $75.0 million outstanding under its $900 million asset securitization program.
- Management stated that the company was in compliance with debt covenants and believed available cash, borrowing capacity, expected operating cash flow, and capital-market access were sufficient for foreseeable needs.
- Investing cash outflows included $133.1 million for acquisitions and $31.2 million for capital expenditures, including $10.9 million for the enterprise resource planning initiative.
- Financing cash inflows included the note offering; outflows included debt repayments, $78.6 million of share repurchases, and $3.0 million of contingent-consideration payments.
Material changes versus the prior comparable period
- Reported sales and gross profit declined, primarily because of the stronger U.S. dollar and lower reported sales; underlying sales growth was positive after currency and acquisition adjustments.
- Operating income was nearly unchanged despite lower sales, supported by lower SG&A and cost-management actions.
- Foreign-currency translation generated a $196.5 million other comprehensive loss, compared with a $9.3 million loss in Q1 2014. This reduced comprehensive income attributable to shareholders to a loss of $90.4 million.
- Operating cash flow deteriorated to a use of $241.6 million, primarily because of working-capital movements, including a $1.279 billion decrease in accounts payable.
- Restructuring, integration, and other charges increased to $16.2 million from $11.6 million, including $6.5 million of acquisition-related expenses.
- The company repurchased 1.064 million shares under publicly announced programs during the quarter for $64.1 million. Total quarterly share purchases, including employee tax-withholding shares, were 1.294 million.
Outlook, unusual items, risks, and contingencies
- No specific quantitative sales or earnings guidance is provided. Management noted that substantially all sales are order-by-order, limiting visibility beyond a few months.
- Management expects or planned to close two second-quarter acquisitions, immixGroup and ATM Electronic, for combined consideration of approximately $409 million. On April 16, 2015, Arrow acquired 53.7% of Data Modul AG for approximately $55 million.
- Restructuring initiatives focus on reducing costs and improving operating efficiency. Restructuring and integration accruals totaled $17.2 million at quarter-end, with most personnel-related amounts expected to be spent within one year.
- Environmental remediation liabilities related to former Wyle facilities remain uncertain. Estimated additional costs were $0.5 million to $0.75 million for Huntsville investigation and related work, $3 million to $4 million for certain Huntsville remediation measures, and $16.8 million to $24.5 million for Norco activities, excluding costs that cannot yet be estimated.
- An FTC Civil Investigative Demand concerning an industry sales-data database program remained unresolved. No proceedings had been instituted, and the potential impact could not be predicted.
- Key business risks include foreign-exchange volatility, pricing and margin pressure, product supply and customer-demand changes, competition, supplier relationships, ERP implementation, acquisition integration, legal and regulatory matters, and the ability to generate cash flow.
- The company’s estimated sensitivity indicated that a 10% decline in average foreign-exchange rates against the U.S. dollar would reduce quarterly sales by approximately $149.2 million and operating income by approximately $6.0 million.
- The company adopted the debt-issuance-cost presentation standard effective January 1, 2015 without a material impact. It was evaluating the future adoption of the new revenue-recognition standard.
Investor verification checklist
- Verify the sustainability of underlying 3.4% sales growth after excluding currency and acquisition effects.
- Monitor gross-margin pressure, particularly in Global ECS, and determine whether restructuring savings offset competitive pricing pressure.
- Reconcile the significant negative operating cash flow to working-capital trends, especially accounts payable and receivables.
- Assess leverage and refinancing needs following the note issuance, note redemption, acquisitions, and share repurchases.
- Track the closing, purchase accounting, financing, and integration performance of the announced acquisitions.
- Review the ultimate costs and timing of the Huntsville and Norco environmental matters and the status of the FTC inquiry.
- Evaluate the effect of continued currency movements on reported sales, operating income, comprehensive income, and equity.