Arrow Electronics, Inc. — Q3 2012 Form 10-Q Summary
Business Context and Reporting Period
Arrow Electronics is a global distributor of electronic components and enterprise computing solutions, operating through Global Components and Global Enterprise Computing Solutions (ECS). The filing covers the unaudited quarter and nine months ended September 29, 2012, compared with October 1, 2011. Each period included 63 shipping days in the quarter and 191 shipping days in the nine months.
During the first nine months of 2012, the company completed seven acquisitions. Management stated that their individual and aggregate effects were not material to consolidated results.
Financial Performance and Position
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Sales | $4.962 billion | $5.187 billion | $15.002 billion | $15.950 billion |
| Gross profit | $662.7 million | $711.1 million | $2.030 billion | $2.204 billion |
| Operating income | $163.8 million | $209.2 million | $540.0 million | $676.7 million |
| Operating margin | 3.3% | 4.0% | 3.6% | 4.2% |
| Net income attributable to shareholders | $103.6 million | $132.2 million | $331.6 million | $424.7 million |
| Diluted EPS | $0.94 | $1.15 | $2.96 | $3.64 |
- Q3 gross profit margin was approximately 13.4%; nine-month gross profit margin was approximately 13.5%. Management reported year-over-year declines of approximately 40 basis points and 30 basis points, respectively.
- Global Components sales declined 7.6% in Q3 and 10.8% for the nine months. Global ECS sales increased 3.4% and 6.3%, respectively.
- SG&A declined 2.3% in Q3 and 3.8% for the nine months, although SG&A as a percentage of sales increased to 9.2% and 9.1%, respectively.
- Net interest and other financing expense was $24.0 million in Q3, down 5.0%, but $79.6 million for the nine months, up 2.7%, primarily reflecting higher average debt used to fund acquisitions.
- The effective tax rate was 27.0% in Q3 and 28.8% for the nine months, compared with 28.9% and 29.8% in the comparable 2011 periods.
Cash Flow, Debt, and Liquidity
- Nine-month operating cash flow was $487.3 million, compared with an operating cash use of $25.6 million in 2011, primarily reflecting working-capital benefits from lower sales.
- Investing cash use was $281.8 million, including $191.3 million for acquisitions, $75.6 million for capital expenditures, and $15.0 million for a cost-method investment.
- Financing cash use was $223.4 million, including $222.8 million of share repurchases and $25.0 million of net long-term bank-debt repayments.
- Cash and cash equivalents were $358.6 million at September 29, 2012, down from $396.9 million at December 31, 2011. Approximately $317.9 million was held outside the United States and was intended to remain permanently reinvested offshore.
- Total debt, including current and long-term borrowings, was approximately $1.94 billion at quarter-end, compared with approximately $1.96 billion at December 31, 2011. Current borrowings increased to $379.5 million, primarily because $337.0 million of 6.875% senior notes due 2013 was classified as short-term.
- The company had a $1.2 billion revolving credit facility maturing in August 2016, with $94.0 million outstanding, and a $775.0 million asset securitization program maturing in December 2014, with $235.0 million outstanding.
- Management stated that the company was in compliance with debt covenants and believed available cash, borrowing capacity, operating cash flow, and capital-market access were sufficient for foreseeable needs.
Material Changes Versus the Prior Comparable Period
- Reported sales decreased 4.3% in Q3 and 5.9% for the nine months. Excluding acquisitions, foreign exchange, and the sales-presentation change, sales were flat in Q3 and declined 3.4% for the nine months.
- A stronger U.S. dollar reduced reported sales by approximately 3.1% in Q3 and 2.7% for the nine months; management estimated a nine-month translation impact of $436.9 million on sales and $16.7 million on operating income.
- Management attributed weaker profitability primarily to lower sales, competitive pricing pressure, and product mix. Cost reductions partially offset the decline.
- During Q3, certain fulfillment-contract revenues were prospectively presented on a net agency basis rather than gross. On a gross basis, these contracts would have contributed approximately $176.5 million of Q3 sales and the presentation change reduced reported year-over-year sales growth by approximately 3.4%. The change did not affect gross profit dollars, operating income, net income, EPS, balance sheet, or cash flow.
- Restructuring, integration, and other charges increased to $14.6 million in Q3 and $36.2 million for the nine months, compared with $8.8 million and $23.7 million, respectively, in 2011. The 2012 actions included approximately 750 position eliminations across the two segments, facility exits, and asset write-downs.
- Compared with 2011, the nine-month period did not include the prior-year $5.9 million legal-settlement charge or $1.8 million bargain-purchase gain.
- The company repurchased $222.8 million of common stock during the first nine months and had repurchased 6.2 million shares under its programs as of September 29, 2012.
Outlook, Commentary, Risks, and Unusual Items
The filing does not provide formal revenue or earnings guidance. Management noted limited forward visibility because substantially all sales are made order-by-order rather than under long-term contracts. Management expected continued focus on operational efficiency, restructuring, acquisitions, and implementation of a global ERP system.
- The ERP initiative was expected to require $50 million to $60 million of cash spending in 2012, with the impact expected to remain relatively flat in 2013.
- Key operating risks include global economic weakness, customer demand, supplier relationships and product availability, competitive pricing and margin pressure, foreign-exchange movements, acquisition integration, ERP implementation, and the ability to generate cash flow.
- Approximately 80% of debt was fixed-rate and 20% floating-rate at quarter-end. The company’s $175.0 million forward-starting interest-rate swap had a negative fair value of $11.2 million.
- Environmental and indemnification matters related to former Wyle facilities remained unresolved. The company recognized a $41.9 million receivable from E.ON AG for environmental and related matters and believed recovery was probable, but collection timing depended on mediation, litigation, and insurer matters that could take several years.
- Estimated additional environmental costs disclosed included approximately $3.5 million to $4.75 million for Huntsville investigative and remediation activities and approximately $13.0 million to $24.4 million for Norco activities, while additional costs beyond those estimates could not be determined.
- The company reported effective disclosure controls and no material changes to internal control over financial reporting or its previously disclosed risk factors.
Important Facts for Investors to Verify
- Whether weakness in Global Components demand and pricing pressure persists and whether ECS growth continues to offset it.
- The underlying sales and margin trends after adjusting for foreign exchange, acquisitions, and the fulfillment-contract presentation change.
- The timing and refinancing plan for the $337.0 million of senior notes due in 2013 and compliance with debt covenants.
- Actual cash costs and savings from the restructuring program and the global ERP implementation.
- The collectability and timing of the $41.9 million E.ON AG receivable and the ultimate exposure from environmental matters and related litigation.
- The sustainability of share repurchases given debt maturities, acquisition spending, and international cash restrictions.