Arrow Electronics, Inc. — 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 Enterprise Computing Solutions (ECS), serving value-added resellers. This unaudited report covers the quarter and nine months ended September 28, 2013, compared with the periods ended September 29, 2012.
Key Financial Metrics
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Sales | $5.048 billion | $4.962 billion | $15.204 billion | $15.002 billion |
| Gross profit | $671.7 million | $662.7 million | Approximately $2.00 billion | Approximately $2.03 billion |
| Operating income | $162.7 million | $163.8 million | $456.2 million | $540.0 million |
| Operating margin | 3.2% | 3.3% | 3.0% | 3.6% |
| Net income attributable to shareholders | $96.8 million | $103.6 million | $264.6 million | $331.6 million |
| Diluted EPS | $0.95 | $0.94 | $2.53 | $2.96 |
- Q3 sales increased 1.7%; nine-month sales increased 1.3%. Global Components sales increased 2.8% in Q3 but declined 1.1% for nine months. Global ECS sales declined 0.6% in Q3 but increased 6.6% for nine months.
- Gross profit margin declined nearly 10 basis points in Q3 and 40 basis points for the first nine months, primarily because of competitive pricing pressure and product mix.
- Net interest and other financing expense increased 13.4% in Q3 to $27.2 million and 9.1% for nine months to $86.9 million, mainly due to higher average debt outstanding.
- The nine-month effective tax rate was 28.4%, including a $5.4 million increase in tax expense related to ongoing international tax audits. Excluding specified items, management reported an adjusted nine-month effective tax rate of 27.6%.
- Cash provided by operating activities was $235.6 million for the first nine months, compared with $487.3 million in the prior-year period. Investing cash outflow was $131.9 million, and financing cash outflow was $287.5 million.
- Capital expenditures were $85.5 million, including $43.0 million related to the enterprise resource planning initiative. Cash paid for acquisitions was $43.4 million.
- At September 28, 2013, cash and cash equivalents were $251.8 million, accounts receivable were $4.569 billion, inventories were $2.166 billion, total assets were $10.366 billion, and total equity was $4.033 billion.
- Total debt was approximately $1.945 billion, consisting of $31.0 million of short-term borrowings and $1.914 billion of long-term debt. The company had $35.7 million outstanding under its $1.2 billion revolving credit facility and $70.0 million outstanding under its $775.0 million asset securitization program.
Material Changes Versus the Prior Comparable Period
- Reported net income attributable to shareholders declined 6.6% in Q3 and 20.2% for the first nine months. Excluding disclosed unusual items, management stated that Q3 earnings increased slightly, while nine-month earnings decreased because of weaker sales in more profitable Global Components markets, competitive pricing pressure, and higher interest expense.
- Restructuring, integration, and other charges increased to $22.6 million in Q3 from $14.6 million and to $74.4 million for nine months from $36.2 million. The 2013 restructuring program eliminated approximately 1,020 positions and involved 31 vacated facilities worldwide.
- Operating income declined despite higher sales, reflecting lower gross margins and substantially higher restructuring charges. Nine-month operating income also reflected a $4.3 million loss on the redemption of senior notes.
- The company issued $600.0 million principal amount of new notes in February 2013, generating $591.2 million of net proceeds, and redeemed $332.1 million principal amount of 6.875% senior notes in March 2013.
- Share repurchases totaled approximately $198.6 million under 2013 programs through September 28, 2013, representing 5.1 million shares. The company had approximately $201.4 million remaining under the publicly announced programs at quarter-end.
- Accounts receivable declined from $4.924 billion at December 31, 2012, while inventories increased from $2.053 billion. Cash declined from $409.7 million to $251.8 million.
- The company prospectively changed the presentation of certain fulfillment-contract sales to an agency basis. The change reduced reported nine-month 2012 sales by approximately $280.6 million but did not affect gross profit dollars, operating income, net income, EPS, balance sheet amounts, or cash flow.
Guidance, Outlook, Commentary, Risks, and Unusual Items
- No specific numerical earnings or sales guidance is provided. Management stated that substantially all sales are order-by-order rather than under long-term contracts, limiting visibility beyond a few months.
- Management believes cash availability, borrowing capacity, expected operating cash flow, and access to capital markets are sufficient for projected needs for the foreseeable future. The company was in compliance with debt covenants at September 28, 2013.
- On October 28, 2013, after the reporting date, Arrow acquired ComputerLinks AG for approximately €230 million, or $317 million, in cash. The acquisition expands value-added enterprise computing distribution across Europe, North America, the Middle East, and Asia.
- Key risks include global economic conditions, product supply and customer demand, competitive pricing and margin pressure, supplier relationships, ERP implementation, acquisition integration, foreign exchange, legal and regulatory matters, and the ability to generate sufficient cash flow.
- Foreign currency translation increased nine-month sales by approximately $103.3 million and operating income by $3.7 million. A hypothetical 10% decline in average foreign exchange rates against the U.S. dollar would have reduced nine-month sales by approximately $431.9 million and operating income by approximately $8.8 million.
- Approximately 93% of debt was fixed-rate and 7% floating-rate at quarter-end. Management stated that a one-percentage-point change in average interest rates would not materially affect nine-month net interest expense.
- Environmental liabilities related to former Wyle facilities remain uncertain. Estimated additional costs were $0.5 million to $0.75 million for Huntsville investigation and $3.0 million to $4.0 million for certain remediation measures, with further costs potentially material and not yet estimable. Norco activities were estimated to require an additional $18.0 million to $24.9 million.
- Restructuring accruals totaled $37.2 million at quarter-end, primarily expected to be paid in cash, with most personnel-related amounts expected to be spent within one year.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. No material changes were reported to previously disclosed risk factors.
Important Facts for Investors to Verify
- Whether restructuring actions produce the expected cost savings and whether additional restructuring charges arise.
- Underlying sales and margin trends excluding foreign exchange, acquisitions, and the fulfillment-contract presentation change.
- Working-capital requirements, particularly inventory growth and the substantial accounts-receivable balance, and their effect on operating cash flow.
- Debt maturities, refinancing needs, covenant compliance, and the impact of higher average debt on interest expense.
- Integration, purchase accounting, and performance of the post-quarter-end ComputerLinks acquisition.
- Potential costs and timing of the Huntsville and Norco environmental matters, including uncertain insurance recoveries.
- Execution risks and capital spending associated with the ERP initiative.