Arrow Electronics, Inc. — Q3 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 filing covers the quarter and nine months ended September 26, 2015, compared with September 27, 2014. The interim financial statements are unaudited.
Financial Performance and Key Metrics
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Sales | $5.698 billion | $5.613 billion | $16.531 billion | $16.372 billion |
| Gross profit | $742.4 million | $728.7 million | $2.196 billion | $2.180 billion |
| Gross margin | 13.0% | 13.0% | 13.3% | 13.3% |
| Operating income | $185.8 million | $199.8 million | $570.2 million | $585.8 million |
| Operating margin | 3.3% | 3.6% | 3.4% | 3.6% |
| Net income attributable to shareholders | $109.2 million | $146.9 million | $339.2 million | $381.9 million |
| Diluted EPS | $1.15 | $1.47 | $3.52 | $3.80 |
Adjusted operating income, excluding identifiable intangible amortization and restructuring, integration, and other charges, was $217.8 million, or 3.8% of sales, in Q3 and $660.6 million, or 4.0% of sales, for nine months. Adjusted net income attributable to shareholders was $133.4 million in Q3 and $410.1 million for nine months, compared with $140.2 million and $408.6 million, respectively, in the prior-year periods.
Net cash provided by operating activities was $110.9 million for the first nine months, versus $216.2 million in the prior-year period. Investing cash flow used $624.0 million, including $512.9 million for acquisitions and $113.1 million for capital expenditures. Financing activities provided $476.6 million, primarily reflecting $688.2 million of net note proceeds and $238.7 million of net long-term bank borrowings, partly offset by $254.3 million of note redemptions and $206.6 million of share repurchases.
Cash and cash equivalents were $336.7 million at September 26, 2015, down from $400.4 million at December 31, 2014. Total debt, including current borrowings, was approximately $2.834 billion, consisting of $85.8 million of short-term borrowings and $2.748 billion of long-term debt. The company had a $1.5 billion revolving credit facility, with $33.7 million outstanding, and a $900 million asset securitization program, with $480.0 million outstanding. Management stated that the company was in compliance with applicable debt covenants.
Material Changes Versus Prior Comparable Period
- Reported sales increased 1.5% in Q3 and 1.0% for nine months. Foreign currency translation reduced reported sales by approximately 5.0% and 5.8%, respectively.
- Global ECS sales increased 6.6% in Q3 and 2.5% for nine months, while Global Components sales decreased 1.1% in Q3 and increased 0.1% for nine months.
- After adjusting for currency and acquisitions, consolidated sales decreased 1.5% in Q3 but increased 1.6% for nine months.
- Operating income and reported earnings declined, primarily because restructuring, integration, and other charges rose to $17.8 million in Q3 and $51.1 million for nine months, compared with $3.9 million and $25.2 million, respectively.
- Interest and other financing expense increased to $35.4 million in Q3 and $101.0 million for nine months, primarily due to higher average debt used for refinancing and general corporate purposes.
- The prior-year Q3 included a $29.7 million gain on the sale of an investment, which reduced year-over-year comparability.
- Accounts receivable declined to $5.066 billion from $6.044 billion at year-end, while inventories increased to $2.479 billion from $2.335 billion. Accounts payable declined to $3.852 billion from $5.027 billion.
- The company completed seven acquisitions during the first nine months, including immixGroup and a controlling investment in Data Modul AG, for aggregate cash consideration of $512.9 million, net of cash acquired.
- The Board authorized an additional $400 million share-repurchase program in September 2015. Total repurchases under the programs reached 5.9 million shares with a market value of $330.6 million at repurchase dates.
Outlook, Commentary, Risks, and Unusual Items
Management stated that current cash, borrowing capacity, expected operating cash flow, and access to capital markets should be sufficient to meet projected liquidity needs for the foreseeable future. However, the company noted that sales are generally made on an order-by-order basis and provide limited visibility beyond a few months; the filing does not provide formal quantitative revenue or earnings guidance.
Management cited continued efforts to lower costs and improve operating efficiency. Restructuring and integration accruals totaled $18.4 million at September 26, 2015, with scheduled cash payments extending through 2018. The company did not anticipate material further adjustments related to the disclosed restructuring plans.
Key risks include foreign currency movements, demand and pricing pressure, product supply and supplier relationships, competition, integration of acquisitions, implementation of the enterprise resource planning system, margin pressure, regulatory and legal matters, and the ability to generate additional cash flow. A 10% decline in average foreign exchange rates against the U.S. dollar would have reduced estimated nine-month 2015 sales by approximately $476.9 million and operating income by approximately $20.0 million. Approximately 75% of debt was fixed-rate and 25% floating-rate at quarter-end.
Environmental remediation obligations related to former Wyle facilities remain unresolved. Estimated additional costs were approximately $600,000 to $750,000 for investigative work and $3.0 million to $4.0 million for certain potential Huntsville remediation measures, and approximately $15.9 million to $24.5 million for additional Norco activities. The ultimate costs remain uncertain and could exceed current estimates. The FTC antitrust inquiry described in the filing had sought information only, with no proceedings instituted as of the filing date.
The company adopted several accounting updates during 2015 without material impact and was evaluating the future impact and transition method for the new revenue recognition standard. Management concluded that disclosure controls were effective and reported no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Reconcile GAAP earnings declines with adjusted earnings, including the effects of restructuring charges, intangible amortization, debt-prepayment costs, investment gains or losses, and the prior-year investment-sale gain.
- Assess whether acquisition-driven growth and expected integration benefits justify the increase in goodwill, intangible assets, debt, and acquisition-related cash usage.
- Monitor operating cash conversion, working-capital requirements, inventory levels, and the decline in operating cash flow versus the prior year.
- Review debt maturities, refinancing needs, covenant compliance, floating-rate exposure, and the asset securitization program’s collateral restrictions.
- Evaluate the effect of continued U.S. dollar strength on international sales, operating income, and accumulated other comprehensive loss.
- Track restructuring cash payments, ERP implementation costs, environmental remediation estimates, and the status of the FTC inquiry and other contingencies.
- Confirm the remaining authorization and pace of share repurchases relative to leverage, liquidity, acquisitions, and capital expenditures.