UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549
FORM 10-Q
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
For the transition period from to
Commission file number 1-4482
ARROW ELECTRONICS, INC.
(Exact name of Registrant as specified in its charter)
New York
11-1806155
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification Number)
25 Hub Drive, Melville, New York
11747
(Address of principal executive
(Zip Code)
Offices)
Registrant's telephone number,
including area code
(516) 391-1300
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes X
No
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Common stock, $1 par value: 100,433,678 shares outstanding at August 2, 2002.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
ARROW ELECTRONICS, INC.CONSOLIDATED STATEMENT OF OPERATIONS(In thousands except per share data)(Unaudited)
Six Months Ended
Three Months Ended
June 30,
2002
2001
Sales
$
3,687,856
5,452,364
1,843,317
2,355,745
Costs and expenses:
Cost of products sold
3,053,736
4,525,985
1,523,729
1,966,790
Selling, general and administrative
expenses
509,348
606,447
257,158
290,469
Depreciation and amortization
34,310
58,169
16,639
29,585
Severance costs
5,375
-
Integration charges
9,375
3,602,769
5,199,976
1,802,901
2,286,844
Operating income
85,087
252,388
40,416
68,901
Equity in earnings (losses) of affiliated
companies
966
(1,393
)
813
(997
Interest expense, net
82,072
120,072
40,830
54,479
Earnings before income taxes and minority
interest
3,981
130,923
399
13,425
Provision for income taxes
1,404
53,260
33
7,435
Earnings before minority interest
2,577
77,663
366
5,990
Minority interest
(84
(263
(210
(294
Earnings from continuing operations
2,661
77,926
576
6,284
Income (loss) from discontinued
operations, net of taxes (including
loss from disposal of $6,120, net of
tax benefit of $4,114, in 2002)
(5,911
707
(6,610
670
Earnings (loss) before cumulative effect
of change in accounting principle
(5,250
78,633
(6,034
6,954
Cumulative effect of change in accounting
principle
(603,709
Net income (loss)
(606,959
Net income (loss) per basic and diluted
share:
Income from continuing operations
.03
.79
.01
.06
Income (loss) from discontinued operations
(.06
(.07
(6.06
Net income (loss) per basic share
(6.09
.80
.07
.74
Net income (loss) per diluted share
.75
Average number of shares outstanding:
Basic
99,667
97,957
99,813
98,006
Diluted
113,017
99,580
See accompanying notes
ARROW ELECTRONICS, INC.CONSOLIDATED BALANCE SHEET(Dollars in thousands)
December 31
,
(Unaudited
ASSETS
Current assets:
Cash and short-term investments
909,102
556,861
Accounts receivable, net
1,403,031
1,389,882
Inventories
1,248,989
1,372,797
Prepaid expenses and other assets
65,104
52,892
Assets from discontinued operations
98,954
Total current assets
3,626,226
3,471,386
Property, plant and equipment at cost:
Land
42,648
42,288
Buildings and improvements
174,533
164,111
Machinery and equipment
366,625
347,170
583,806
553,569
Less accumulated depreciation and
amortization
(289,150
(252,374
294,656
301,195
Investments in affiliated companies
36,292
32,917
Cost in excess of net assets of
companies acquired, net of amortization
($190,940 in 2001)
757,255
1,224,283
Other assets
349,632
326,024
3,179
5,064,061
5,358,984
See accompanying notes.
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable
867,032
641,454
Accrued expenses
383,657
342,670
Short-term borrowings
10,475
37,289
Liabilities from discontinued operations
25,572
Total current liabilities
1,261,164
1,046,985
Long-term debt
2,458,574
2,441,983
Other liabilities
107,937
103,555
Shareholders' equity:
Common stock, par value $1:
Authorized - 160,000,000 shares
Issued - 103,868,002 shares in 2002
and 103,856,024 shares in 2001
103,868
103,856
Capital in excess of par value
523,392
524,299
Retained earnings
916,125
1,523,084
Foreign currency translation adjustment
(196,896
(259,694
1,346,489
1,891,545
Less: Treasury stock (3,445,650 shares in 2002
and 3,998,063 shares in 2001), at cost
(92,165
(106,921
Unamortized employee stock awards
(12,838
(12,363
Other
(5,100
(5,800
1,236,386
1,766,461
ARROW ELECTRONICS, INC.CONSOLIDATED STATEMENT OF CASH FLOWS(In thousands)(Unaudited)
Cash flows from operating activities:
Income (loss) from discontinued operations, net
Net income (loss) from continuing operations
(601,048
Adjustments to reconcile net income (loss) to net
cash provided by (used for) operations:
41,540
65,106
Accretion of discount on convertible debentures
14,278
9,782
Equity in (earnings) losses of affiliated companies
(966
1,393
Deferred income taxes
(6
(43,640
Severance costs, net of taxes
3,214
Integration charge, net of taxes
5,719
Cumulative effect of change in accounting principle
603,709
Change in assets and liabilities, net of effects of
acquired businesses:
Accounts receivable
85,689
681,130
174,423
688,625
(6,808
(4,902
195,523
(740,825
9,312
(55,818
(32,768
(8,567
Net cash provided by operating activities
486,008
675,666
Cash flows from investing activities:
Acquisition of property, plant and equipment, net
(21,440
(36,283
Proceeds from sale of discontinued operations
37,087
Cash consideration paid for acquired business
(110,335
Investments
(2,724
(15,509
Net cash used for investing activities
(97,412
(51,792
Cash flows from financing activities:
Change in short-term borrowings
(55,309
(496,154
Change in credit facilities
13,071
112,928
Change in long-term debt
(17,873
(894,468
Proceeds from convertible debentures
670,883
Proceeds from exercise of stock options
8,323
1,985
Sale of accounts receivable under securitization program
251,737
Repayment under securitization program
(252,865
Net cash used for financing activities
(51,788
(605,954
Effect of exchange rate changes on cash
15,433
(4,372
Net increase in cash and short-term investments
352,241
13,548
Cash and short-term investments at beginning of period
55,546
Cash and short-term investments at end of period
69,094
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Income taxes
31,633
46,753
Interest
72,787
112,999
ARROW ELECTRONICS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSJune 30, 2002(Unaudited)
Note C -- Goodwill and Other Intangible Assets
In June 2001, the FASB issued Statement No. 142, "Goodwill and Other Intangible Assets." This Statement, among other things, eliminates the amortization of goodwill and requires annual tests for determining impairment of goodwill. On January 1, 2002, the company adopted Statement No. 142, and accordingly, discontinued the amortization of goodwill.The following table provides a reconciliation of reported earnings from continuing operations and earnings per share to the adjusted earnings from continuing operations and earnings per share, which reflects the exclusion of goodwill amortization, net of the related tax effect (in thousands except per share data):
For the Six
For the Three
Months Ended
Earnings from continuing
operations, as reported
Add: Goodwill amortization from
continuing operations, net of tax
20,314
10,078
Adjusted earnings from continuing
operations
98,240
16,362
Basic earnings per share from
continuing operations, as reported
Add: Goodwill amortization, from
.21
.10
Adjusted basic earnings per share
from continuing operations
1.00
.16
Diluted earnings per share from
.18
Adjusted diluted earnings per share
.92
In addition, on a proforma basis adjusting for the amortization of goodwill, income before cumulative effect of change in accounting principle and net income would have been $98,947,000 ($1.01 per basic share and $.93 per diluted share) and $17,032,000 ($.17 per basic and diluted share) for the six and three months ended June 30, 2001, respectively.As required under the transitional accounting provisions of Statement No. 142, the company completed the two steps required to identify and measure goodwill impairment for each reporting unit as of January 1, 2002. The first step involved identifying all reporting units with carrying values (including goodwill) in excess of fair value. The identified reporting units from the first step were then measured for impairment by comparing the fair value of the reporting unit, determined by reference to comparable businesses using a weighted average EBITDA multiple, with the carrying amount of the goodwill. Those reporting units having a carrying value exceeding the fair value were identified as being fully impaired, and the company fully wrote down those assets. For reporting units with potential impairment, the company obtained an independent appraisal of the fair value of the assets and liabilities of the unit and wrote down the goodwill to its implied fair value accordingly. No other impairment indicators have a risen since January 1, 2002. In determining a reporting unit, the company looked to its current reporting structure at the date of adoption and allocated goodwill to the reporting units. In most cases, the goodwill was identifiable to specific acquisitions, so the allocation was direct. The following were determined to be the reporting units of the company: (i) North America Components, (ii) North America Computer Products, (iii) on an individual country basis for Europe Components, (iv) on an individual country basis for Europe Computer Products, (v) South America, and (vi) Asia.As a result of the evaluation process discussed above the company recorded an impairment charge of $603,709,000, which was recorded as a cumulative effect of a change in accounting principle at January 1, 2002. Accordingly, the first quarter's results have been modified to include this charge as required under the transitional rules of Statement No. 142. The following table presents the carrying amount of goodwill, allocated to reportable segments, for the periods presented (in thousands):
Electronic
Computer
Components
Products
Total
Carrying value at December 31, 2001
$902,093
$322,190
$1,224,283
Cumulative effect of change in
accounting principle
(281,519
(322,190
Additions
110,335
Other (principally foreign currency
translation)
26,346
Carrying value at June 30, 2002
$757,255
$ -
$ 757,255
The following table reflects the impact of the cumulative effect of change in accounting principle on the reported results for the company's first quarter ended March 31, 2002 (in thousands):
Net income from continuing operations
$ 2,085
Net income from discontinued operations
699
Net loss, as adjusted
$(600,925
Net loss per share, as adjusted:
$ (6.04
The company does not have any other intangibles subject to valuation under Statement No. 142.
Note D -- Discontinued Operations
In May 2002, the company sold substantially all of the assets of Gates/Arrow, a business unit within the company's North American Computer Product Group that sells commodity computer products such as printers, monitors, other peripherals, and software to value-added resellers in North America. On May 31, 2002, the company completed the sale of this business unit to Synnex Information Technologies, Inc. for estimated cash proceeds of $44,700,000, subject to price adjustments, of which $37,087,000 has been collected as of June 30, 2002. The remaining amount due is payable in two increments: 50 percent due 90 days after closing and the remaining 50 percent due 180 days after closing. The assets sold consisted primarily of accounts receivable, inventories, and property and equipment. The buyer also assumed certain liabilities.The disposition of the Gates/Arrow operations represents a disposal of a "component of an entity" as defined in Statement No. 144. Accordingly, the company's financial statements have been presented to reflect Gates/Arrow as a discontinued operation for all periods. Its assets and liabilities have been segregated from continuing operations in the accompanying consolidated balance sheet, and its operating results are segregated and reported as discontinued operations in the accompanying consolidated statement of operations, and related notes.In connection with the sale of Gates/Arrow, the company recorded a loss on disposal of $6,120,000, net of the related tax benefit of $4,114,000. The loss consists approximately of the following:
Personnel related
1,250,000
Facilities
3,144,000
Professional fees
599,000
Write-down of asset carrying value
3,000,000
2,241,000
10,234,000
The personnel costs are due to the termination of 88 people employed by the Gates/Arrow business and 57 warehouse personnel of the North American Computer Products Group due to reduced activity levels as a result of the sale of Gates/Arrow. The facilities costs are principally related to vacated warehouse space no longer required due to reduced activity levels as a result of the sale of Gates/Arrow. The write-down of assets was to adjust the carrying value of the assets sold to the value agreed to under the terms of the contract of sale.The utilization of these charges as of June 30, 2002 is as follows (in thousands):
Personnel
Professional
Asset
Costs
Fees
Write-down
Original accrual
$1,250
$3,144
$599
$3,000
$2,241
$10,234
2002 payments
257
2
70
92
421
2002 non-cash
2,000
June 2002 balance
$ 993
$3,142
$529
$1,000
$2,149
$ 7,813
Operating results of Gates/Arrow for the six and three months ended June 30, are as follows (in thousands):
Net sales
180,534
333,510
72,822
154,382
operations, net of taxes
(including loss from disposal of
$6,120, net of tax benefit of
$4,114, in 2002)
(a) Operating results for the six and three months ended June 30, 2002 includes five and two months of activity, respectively.
The following is a summary of the net assets as of December 31, 2001 (in thousands):
68,676
30,278
Property, plant and equipment, net
102,133
23,909
1,663
Note E -- Accounts Receivable
Accounts receivable consists of the following (in thousands):
790,897
744,864
Retained interest in securitized
accounts receivable
678,934
725,988
Allowance for doubtful accounts
(66,800
(80,970
In March 2002, the company renewed its one-year, $750,000,000 asset securitization program (the "program") under which it sells, on a revolving basis, an individual interest in a pool of its trade accounts receivable. Under the program, the company sells receivables and retains a subordinated interest and servicing rights to those receivables. At June 30, 2002 and December 31, 2001, there were no receivables sold to and held by third parties under the program, and, as such, the company had no indebtedness outstanding under this program. In the event that the company had sold receivables to third parties under the program at June 30, 2002 and December 31, 2001, those receivables would not have been recorded on the company's balance sheet and the related financing provided by the program would not be reflected as indebtedness on the company's balance sheet.During March 2001, the company sold $251,737,000 of outstanding trade accounts receivable, which was subsequently repurchased during the second quarter of 2001 for $252,865,000. Upon the initial sale, the company recognized a loss of $1,700,000 and removed the sold assets from the balance sheet, reduced previously established allowance for uncollectible accounts and recognized the present value of future net cash flow related to the assets sold. The present value amount was recorded in accounts receivable and represented the company's retained interests. The key assumptions used in measuring the fair value of the retained interests upon the initial sale were as follows:
Coupon rate of 5.19%
Estimated future uncollectible accounts 6.3%
Coverage life of trade accounts receivable of 48 days
Upon the repurchase, all costs related to the program were expensed as incurred in the quarter ended June 30, 2001. Those expenses included servicing, interest, uncollectible accounts, facility and program fees. Servicing fees received by the company approximated the market value of servicing and thus no servicing asset or liability was recorded.
During the second quarter of 2002, the company purchased additional shares in Marubun Corporation increasing its ownership interest from 5.4 percent to 8.4 percent, increased its holdings in IR Electronic, a distributor in Slovenia, to 100 percent, and acquired an additional 10.6 percent interest in Ally, Inc., increasing the company's ownership from 75 percent to 85.6 percent. The aggregate cost of these acquisitions was approximately $5,422,000.The company, in connection with certain acquisitions, may be required to make future payments that are contingent upon the acquired businesses' earnings and, in certain instances, the achievement of operating goals. During the second quarter of 2002, the company made such payments aggregating $108,470,000 in connection with three acquisitions, which have been capitalized as cost in excess of net assets of companies acquired. The company may be contractually required to make these types of payments in the future. Based on the performance of those businesses, for which contingent payments remain open as of June 30, 2002, the company currently estimates such payments to be approximately $15,000,000.In May 2002, the company sold its interest in VCE Virtual Chip Exchange, Inc. for $3,250,000.Note G -- Severance Costs
During the second quarter of 2002, the company's chief executive officer resigned. As a result, the company recorded severance costs totalling $3,214,000 (net of the related tax effect) principally based on the terms of his employment agreement. Included therein, are provisions principally related to salary continuation, retirement benefits and the vesting of restricted stock and options.Note H -- Integration and Restructuring Charges
During the first quarter of 2001, the company recorded an integration charge of $9,375,000 ($5,719,000 net of the related tax effect) associated with the acquisition of Wyle Electronics and Wyle Systems. In connection with this integration, approximately 240 positions, largely performing duplicate functions were eliminated.
The utilization of all of the company's integration, realignment, and restructuring reserves are as follows (in thousands):
Customer
IT
Termination
and Other
December 2000 balance
$16,922
$41,040
$19,290
$8,134
$85,386
19,989
9,749
38,800
23,093
151,692
243,323
Reversals
11,814
500
12,314
2001 payments
26,315
8,729
14,536
898
50,478
2001 non-cash usage
578
14,600
5,977
83,278
104,433
Foreign currency
translation
50
282
(377
101
56
December 2001 balance
10,646
29,950
24,200
20,993
75,751
161,540
6,603
2,105
5,812
217
14,737
2002 non-cash usage
14,132
48,324
62,456
(137
(255
(49
(78
(519
$ 3,906
$27,590
$10,068
$15,132
$27,132
$83,828
Included in the column "Asset Write-down" are valuation reserves of $53,000,000 related to the companies internet investments and $97,475,000 related to inventories.
Note I -- Earnings per Share
The following table sets forth the calculation of basic and diluted earnings per share (in thousands except per share data):
used for basic earnings per share
Interest on convertible debentures,
net of tax
5,761
83,687
operations, net of tax
Adjusted income (loss) before
cumulative effect of change in
(3,250
84,394
Adjusted net income (loss)
Weighted average shares outstanding
for basic earnings per share
Net effect of dilutive stock options
and restricted stock awards
2,119
1,574
Net effect of convertible debentures
12,941
for diluted earnings per share
Net income (loss) per basic and
diluted share:
Net income(loss) per basic share
Income(loss) from discontinued
Net income(loss) per diluted
share (c)
(a) Excluding the severance costs, net income and net income per share from continuing operations for the six and three months ended June 30, 2002, would have been $5,875,000 and $.06, and $3,790,000, and $.04, respectively.
(b) Excluding the integration charge, net income and net income per share from continuing operations on a basic and diluted basis would have been $83,645,000, $.85, and $.79, respectively, for the six months ended June 30, 2001.
(c) Earnings per share on a diluted basis for the six and three months ended June 30, 2002 exclude the effect of 18,242,000 shares related to convertible debentures. In addition, the effect of options to purchase 1,347,000 and 5,400,000 shares, respectively, of common stock were outstanding but excluded from the computation because the average exercise price of the options was greater than the average market price of the shares. The impact of such common stock equivalents are excluded from the calculation of earnings per share on a diluted basis as their effect is anti-dilutive.
Note J -- Comprehensive Income (Loss)
Comprehensive income (loss) is defined as the aggregate change in shareholders' equity excluding changes in ownership interests. The components of comprehensive income (loss) are as follows (in thousands):
Foreign currency translation
adjustments (a)
62,798
(45,021
64,021
10,907
Unrealized gain (loss) on
securities
700
(300
Comprehensive income (loss)(b)(c)
(543,461
33,612
57,687
17,861
(a) The foreign currency translation adjustments have not been tax effected as investments in foreign affiliates are deemed to be permanent.
(c) Excluding the integration charge of $9,375,000 ($5,719,000 net of the related tax effect), comprehensive income would have been $39,331,000 for the six months ended June 30, 2001.
Note K -- Segment and Geographic Information
The company is engaged in the distribution of electronic components to original equipment manufacturers and computer products to value-added resellers. As a result of the company's philosophy of maximizing operating efficiencies through the centralization of certain functions, selected fixed assets and related depreciation, as well as borrowings and prior to 2002, goodwill amortization, are not directly attributable to the individual operating segments. Computer products includes North American Computer Products together with UK Microtronica, Nordic Microtronica, ATD (in Iberia), and Arrow Computer Products (in France).
Revenue:
Electronic Components
2,689,646
4,275,460
1,340,379
1,787,687
Computer Products
998,210
1,176,904
502,938
568,058
Consolidated
Operating income (loss):
100,410
307,728
50,342
92,684
24,802
15,820
12,968
8,340
Corporate
(40,125
(71,160
(22,894
(32,123
(a) Excluding the severance costs of $5,375,000, operating income would have been $90,462,000 and $45,791,000 for the six and three months ended June 30, 2002, respectively.
(b) Excluding the integration charge of $9,375,000, operating income would have been $261,763,000 for the six months ended June 30, 2001.
Total assets, by segment, are as follows (in thousands):
3,064,742
3,767,595
483,270
929,240
1,516,049
662,149
Revenues, by geographic area, are as follows (in thousands):
Americas
2,149,187
3,247,520
1,096,099
1,385,441
Europe
1,211,525
1,717,810
585,840
737,986
Asia/Pacific
327,144
487,034
161,378
232,318
Total assets, by geographic area, are as follows (in thousands):
3,136,038
3,253,575
1,616,268
1,771,137
311,755
334,272
Note L -- Subsequent Event
On August 8, 2002, the company repurchased $250,000,000 of its 6.45% senior notes, due in November 2003, at a price of 104.65 percent of the principal amount. The premium paid and deferred financing costs written-off upon the repurchase of this debt, aggregated approximately $11,000,000, net of the related tax effect, will be recognized as an extraordinary loss in the company's consolidated statement of operations in the third quarter of 2002. As a result of this transaction net interest expense will be reduced by approximately $21,000,000 from the date of the repurchase through the original maturity date, if current interest rates remain the same.In August 2002, the company entered into a series of interest rate swaps (the "swaps"), with third parties, with an aggregate notional amount of $250,000,000 million in order to hedge the change in fair value of the company's 8.7% senior debentures, due 2005, related to fluctuations in interest rates. These contracts are classified as fair value hedges and mature in October 2005. The swaps modify the company's interest rate exposure by effectively converting the fixed 8.7% senior debentures issued in October 2000 to a floating rate based on the six-month U.S. dollar LIBOR plus a spread through their maturities.In July 2002, the company sold its investment in Mediagrif Interactive Technologies, Inc. for $3,714,000.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Consolidated sales for the first six months and second quarter of 2002 decreased 32.4 percent and 21.8 percent, respectively, compared with the year-earlier periods. This decline was principally due to a 37.1 percent and 25 percent decrease in sales of electronic components for the first six months and second quarter of 2002, respectively, principally as a result of continued lower volume from telecommunications and networking customers and the large contract manufacturers that serve them reflecting the continued low levels of business activity in those industries. Since the beginning of the economic downturn in our industry, the company's operating groups that service these customers have experienced the greatest absolute decline in sales levels. Sales have declined by 60.5 percent and 47.2 percent to such customers for the first six months and second quarter of 2002, respectively, compared with the year-earlier period. In addition, contributing to the decline is lower demand in the company's core OE M businesses due to the weakened, general economic conditions worldwide. Historically, in our industry, Europe has trailed the business cycles experienced in North America by six to nine months; however, the company believes, the decline in activity levels in Europe, should be less than in North America due to the fact that sales to telecommunication and networking customers and the contract manufacturers that serve them is a lower percentage of total business activity in Europe, than it is in North America. Computer product sales declined 15.2 percent and 11.5 percent for the first six months and second quarter of 2002, respectively, compared with the year-earlier periods. Beginning in mid-2001, the company's computer products businesses implemented a new strategy which focused less on sales volume and placed more emphasis on profitability. While sales of computer products declined compared with the first six months and second quarter of 2002, operating income increased by 56.8 percent and 55.5 percent for the first six months and second quarter of 2002 as compared with the year-earlier periods, respectively. In the first six months and second quarter of 2002, sales of low margin microprocessors (a product segment not considered a part of the company's core business) decreased by approximately 31.7 percent and 32.9 percent, respectively, compared with the year-earlier periods. Sales declined in Asia/Pac principally due to the termination of a single large customer engagement. Lastly, the translation of the financial statements of the company's international operations into U.S. dollars resulted in increased revenues of $2.4 million and $26.9 million for the first six months and second quarter of 2002, respectively, because of a weakening U.S. dollar compared with the year-earlier periods.Operating Income
The company recorded operating income of $85.1 million and $40.4 million in the first six months and second quarter of 2002, compared with operating income of $252.4 million and $68.9 million in the year-earlier periods. Included in operating income for the first six months of 2002 and second quarter is severance costs of $5.4 million associated with the resignation of the company's chief executive officer. Excluding these costs, operating income for the first six months and second quarter of 2002 would have been $90.5 million and $45.8 million. Included in operating income for the first six months of 2001 is an integration charge of $9.4 million associated with the acquisition of Wyle Electronics and Wyle Systems (collectively, "Wyle") and goodwill amortization of $23.5 million. Excluding the charge and goodwill amortization, operating income for the first six months and second quarter of 2001 would have been $285.2 and $80.5 million, respectively. The reduction in operating income is principally due to the decline in sales, offset, in part by a decrease in operating expenses.
Gross profit of $634.1 million and $319.6 million for the first six months and second quarter of 2002 decreased from $926.4 million and $389 million in the year-earlier periods principally due to the 32.4 percent and 21.8 percent declines in sales for the first six months and second quarter, respectively. The gross profit margins for the six months and quarter ended June 30, 2002 improved by 20 basis points and 80 basis points, respectively, when compared to the year-earlier periods. The increase in gross profit percentage is principally due to a change in the mix of sales, which is more heavily concentrated on the businesses serving core OEM customers that typically have higher margins and fewer sales to large accounts that typically have a lower gross profit percentage, and the computer products businesses' increasing focus on higher margin business. Interest Expense
Interest expense of $82.1 million and $40.8 million in the first six months and second quarter of 2002 decreased from $120.1 million and $54.5 million in the year-earlier periods as a result of lower debt balances. During the past twelve months, free cash flow has totaled $2 billion, thereby permitting the company to reduce debt by $838 million and increase cash by $840 million.Income Taxes
The company recorded an income tax provision at an effective tax rate of 35.3 percent and 8.3 percent for the first six months and second quarter of 2002, respectively, compared with a provision for taxes at an effective tax rate of 40.7 percent and 55.4 percent, respectively, in the comparable year-earlier periods. The company's effective tax rate is principally impacted by, among other factors, the statutory tax rates in the countries in which it operates and the related level of earnings generated by these operations.Net Income
The company recorded a net loss of $607 million and $6 million in the first six months and second quarter of 2002, respectively, compared with net income of $78.6 million and $7 million, respectively, in the year-earlier periods. Included in the 2002 net income is a goodwill impairment charge and the loss on disposal of the Gates/Arrow commodity computer products business as discussed below.
The company recorded earnings from continuing operations of $2.7 million and $.6 million in the first six months and second quarter of 2002, respectively, compared with earnings from continuing operations of $77.9 million and $6.3 million, respectively, in the year-earlier periods. Excluding the previously mentioned severance costs, earnings from continuing operations would have been $5.9 million ($.06 per share) and $ 3.8 million ($.04 per share) in the first six months and second quarter of 2002, respectively. Excluding the integration charge and goodwill amortization, earnings from continuing operations for the first six months and second quarter of 2001 would have been $104.0 million ($1.06 and $.97 on a basic and diluted basis, respectively) and $16.4 million ($.17 and $.16 on a basic and diluted basis), respectively. The decrease in income from continuing operations is due to the significant reduction in sales offset, in part, by a decrease in operating expenses and interest expense.
In May 2002, the company sold substantially all of the assets of Gates/Arrow, a business unit within the company's North American Computer Product Group that sells commodity computer products such as printers, monitors, other peripherals, and software to value-added resellers in North America. On May 31, 2002, the company completed the sale of this business unit to Synnex Information Technologies, Inc. for estimated cash proceeds of $44.7 million, subject to price adjustments, of which $37.1 million has been collected as of June 30, 2002. The remaining amount due is payable in two increments: 50 percent due 90 days after closing and the remaining 50 percent due 180 days after closing. The assets sold consisted primarily of accounts receivable, inventories, and property and equipment. The buyer also assumed certain liabilities.
The disposition of the Gates/Arrow operations represents a disposal of a "component of an entity" as defined in Statement No. 144. Accordingly, the company's financial statements have been presented to reflect Gates/Arrow as a discontinued operation for all periods. Its assets and liabilities have been segregated from continuing operations in the accompanying consolidated balance sheet, and its operating results are segregated and reported as discontinued operations in the accompanying consolidated statement of operations and related notes.
In connection with the sale of Gates/Arrow, the company recorded a loss on disposal of $6.1 million, net of the related tax benefit of $4.1 million. The loss consists of the following (in millions):
1.3
3.1
.6
3.0
2.2
10.2
The personnel costs are due to the termination of 88 people employed by the Gates/Arrow business and 57 warehouse personnel of the North American Computer Products Group due to reduced activity levels as a result of the sale of Gates/Arrow. The facilities costs are principally related to vacated warehouse space no longer required due to reduced activity levels as a result of the sale of Gates/Arrow. The write-down of assets was to adjust the carrying value of the assets sold to the value agreed to under the terms of the contract of sale.
In June 2001, the FASB issued Statement No. 142, "Goodwill and Other Intangible Assets." This Statement, among other things, eliminates the amortization of goodwill and requires annual tests for determining impairment of goodwill. On January 1, 2002, the company adopted Statement No. 142, and accordingly discontinued the amortization of goodwill. As required under the transitional accounting provisions of Statement No. 142, the company completed the two steps required to identify and measure goodwill impairment for each reporting unit as of January 1, 2002. The first step involved identifying all reporting units with carrying values (including goodwill) in excess of fair value. The identified reporting units from the first step were then measured for impairment by comparing the fair value of the reporting unit, determined by reference to comparable businesses using a weighted average EBITDA multiple, with the carrying amount of the goodwill. Those reporting units having a carrying value exceeding the fair value were identified as being fully impaired, and the company fully wrote down those assets. For reporting units with potential impairment, the company obtained an independent appraisal of the fair value of the assets and liabilities of the unit and wrote down the goodwill to its implied fair value accordingly. No other impairment indicators have arisen since January 1, 2002.
In determining a reporting unit, the company looked to its current reporting structure at the date of adoption and allocated goodwill to the reporting units. In most cases, the goodwill was identifiable to specific acquisitions, so the allocation was direct. The following were determined to be the reporting units of the company: (i) North America Components, (ii) North America Computer Products, (iii) on an individual country basis for Europe Components, (iv) on an individual country basis for Europe Computer Products, (v) South America, and (vi) Asia.
As a result of the evaluation process discussed above the company recorded an impairment charge of $603.7 million, which was recorded as a cumulative effect of a change in accounting principle at January 1, 2002. Accordingly, the first quarter's results have been modified to include this charge as required under the transitional rules of Statement No. 142. The company does not have any other intangibles subject to valuation under Statement No. 142. If last year's first six months and second quarter results were restated to reflect the elimination of goodwill amortization, earnings would have increased by approximately $.21 and $.10 per share.
Severance Costs
During the second quarter of 2002, the company's chief executive officer resigned. As a result, the company recorded severance costs totalling $3.2 million (net of the related tax effect) principally based on the terms of his employment agreement. Included therein, are provisions principally related to salary continuation, retirement benefits and the vesting of restricted stock and options.Integration Charge
During the first quarter of 2001, the company recorded an integration charge of $9.4 million ($5.7 net of the related tax effect) associated with the acquisition of Wyle. In connection with this integration, approximately 240 positions, largely performing duplicate functions, were eliminated. A summary of the integration charge is as follows (in millions):
4.1
1.5
Leasehold Improvements
1.1
MIS and miscellaneous
2.7
9.4
Of the expected $8.2 million to be spent in cash, approximately $7.4 million was spent as of June 30, 2002.Liquidity and Capital Resources
The company maintains a significant investment in accounts receivable and inventories. As a percentage of total assets, accounts receivable and inventories were approximately 52.4 percent and 51.6 percent at June 30, 2002 and December 31 2001, respectively. At June 30, 2002, cash and short-term investments increased to $909.1 million from $556.9 million at December 31, 2001.
One of the characteristics of the company's business is that in periods of revenue growth, investments in accounts receivable and inventories grow, and the company's need for financing increases. In the periods in which revenue declines, investments in accounts receivable and inventories generally decrease, generating cash.
The net amount of cash provided by the company's operating activities during the first six months of 2002 was $486 million, principally reflecting lower working capital requirements as a result of lower sales. In addition, the company was able to improve net working capital utilization during the period. The net amount of cash used for investing activities was $97.4 million, including $110.3 million for consideration paid to acquired businesses and $21.4 million for various capital expenditures offset, in part, by the $37.1 million of cash proceeds collected on the sale of Gates/Arrow. The net amount of cash used for financing activities was $51.8 million, primarily reflecting the repayment of short-term debt, offset, in part, by proceeds from the exercise of stock options.
The net amount of cash provided by the company's operating activities during the first six months of 2001 was $675.7 million, principally reflecting changes in working capital. The net amount of cash used for investing activities was $51.8 million, including $36.3 million for various capital expenditures. The net amount of cash used for financing activities was $606 million, primarily reflecting the repayment of short-term and long-term debt, offset, in part, by proceeds from the sale of convertible debentures.
The company's three-year revolving credit facility and the asset securitization program limit the incurrence of additional borrowings and require that working capital, net worth, and certain other financial ratios be maintained at designated levels. In addition, in the event that the company's credit rating is reduced to non-investment grade by either Standard & Poor's or Moody's Investors Service, Inc. the company would no longer be able to utilize its asset securitization program in its present form. At June 30, 2002, there were no amounts outstanding under the asset securitization program or the three-year revolving credit facility.
The company's credit rating is currently investment grade, though it has been notified by Standard & Poor's and Moody's Investors Service, Inc. that it has been placed on credit watch.
On August 8, 2002, the company repurchased $250 million of its 6.45% senior notes, due in November 2003, at a price of 104.65 percent of the principal amount. The premium paid and deferred financing costs written-off upon the repurchase of this debt, aggregated approximately $11 million, net of the related tax effect, will be recognized as an extraordinary loss in the company's consolidated statement of operations in the third quarter of 2002. As a result of this transaction net interest expense will be reduced by approximately $21 million from the date of the repurchase through the original maturity date, if current interest rates remain the same. After the affect of this transaction, the company will have in excess of $600 million in cash and unutilized credit facilities of $625 million and the asset securitization program of $750 million, aggregating available credit of $1.375 billion.
In August 2002, the company entered into a series of interest rate swaps (the "swaps"), with third parties, with an aggregate notional amount of $250 million in order to hedge the change in fair value of the company's 8.7% senior debentures, due 2005, related to fluctuations in interest rates. These contracts are classified as fair value hedges and mature in October 2005. The swaps modify the company's interest rate exposure by effectively converting the fixed 8.7% senior debentures issued in October 2000 to a floating rate based on the six-month U.S. dollar LIBOR plus a spread through their maturities.
The company, in connection with certain acquisitions, may be required to make future payments that are contingent upon the acquired businesses' earnings and, in certain instances, the achievement of operating goals. During the second quarter of 2002, the company made such payments aggregating $108.5 million in connection with three acquisitions, which have been capitalized as cost in excess of net assets of companies acquired. The company may be contractually required to make these types of payments in the future. Based on the performance of those businesses, for which contingent payments remain open as of June 30, 2002, the company currently estimates such payments to be approximately $15 million.Information Relating to Forward-Looking Statements
This report includes forward-looking statements that are subject to certain risks and uncertainties which could cause actual results or facts to differ materially from such statements for a variety of reasons, including, but not limited to: industry conditions, changes in product supply, pricing, and customer demand, competition, other vagaries in the electronic components and computer products markets, and changes in relationships with key suppliers. Shareholders and other readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. The company undertakes no obligation to update publicly or revise any of the forward-looking statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.The company is exposed to market risk from changes in foreign currency exchange rates and interest rates.
The company, as a large international organization, faces exposure to adverse movements in foreign currency exchange rates. These exposures may change over time as business practices evolve and could have a material impact on the company's financial results in the future. The company's primary exposure relates to transactions in which the currency collected from customers is different from the currency utilized to purchase the product sold in Europe, the Asia/Pacific region, and Latin and South America. At the present time, the company hedges only those currency exposures for which natural hedges do not exist. Natural hedges exist when purchases and sales within a specific country are both denominated in the same currency and therefore no exposure exists to hedge with a foreign exchange contract. In Asia, for example, sales and purchases are primarily denominated in U.S. dollars, resulting in a "natural hedge". Natural hedges exist in most countries in which the company operates, although the percentage o f natural offsets vs. offsets which need to be hedged by foreign exchange contracts will vary from country to country. The translation of the financial statements of the non-North American operations is impacted by fluctuations in foreign currency exchange rates. Had the various average foreign currency exchange rates remained the same during the first six months of 2002 as compared with December 31, 2001, 2002 sales and operating income would have been $6 million and $.4 million lower, respectively, than the reported results. Sales and operating income would have fluctuated by approximately $11 million and $1 million, respectively if average foreign exchange rates had changed by one percentage point in 2002. This amount was determined by considering the impact of a hypothetical foreign exchange rate on the sales and operating income of the company's international operations.
The company's interest expense, in part, is sensitive to the general level of interest rates in the Americas, Europe, and the Asia/Pacific region. The company historically has managed its exposure to interest rate risk through the proportion of fixed rate and variable rate debt in its total debt portfolio. At June 30, 2002, as a result of significant generation of operating cash flow, the company had paid down nearly all of its variable rate debt with the net result being that approximately 99 percent of the company's debt was subject to fixed rates and 1 percent of its debt was subject to variable rates. Interest expense, net of interest income, would have fluctuated by approximately $4 million if average interest rates had changed by one percentage point during the first six months of 2002. This amount was determined by considering the impact of a hypothetical interest rate on the company's average variable rate of investments and outstanding borrowings. This analysis does not consider the effect of the level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, management could likely take actions to further mitigate any potential negative exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no changes in the company's financial structure.PART II. OTHER INFORMATIONItem 4. Submission of Matters to a Vote of Security Holders. NoneItem 6. Exhibits and Reports on Form 8-K. (a) Exhibits 10(i) Consulting Agreement, dated as of June 3, 2002, between the company and Stephen R. Kaufman
10(ii) Amended and Restated Agreement, dated as of June 13, 2002, between the company and Francis M. Scricco (b) Reports on Form 8-K NoneA certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, accompanies this report.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ARROW ELECTRONICS, INC.
Date: August 12, 2002 By:/s/ Paul J. Reilly Paul J. Reilly Chief Financial Officer
Arrow Electronics, Inc.
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(18 U.S.C. Section 1350)
In connection with the Quarterly Report of Arrow Electronics, Inc (the "Company") on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Stephen P. Kaufman, Chief Executive Officer of the Company, certify, pursuant to the requirements of Section 906 of the Sarbanes-Oxley Act of 2002, (18 U.S.C. Sections 1350(a) and (b)), that, to the best of my knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act"); and
(2) The information in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: August 12, 2002
By: /s/ Stephen P. Kaufman Stephen P. Kaufman Chief Executive Officer
In connection with the Quarterly Report of Arrow Electronics, Inc (the "Company") on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Paul J. Reilly, Chief Financial Officer of the Company, certify, pursuant to the requirements of Section 906 of the Sarbanes-Oxley Act of 2002, (18 U.S.C. Sections 1350(a) and (b)), that, to the best of my knowledge:
By: /s/ Paul J. Reilly Paul J. Reilly Chief Financial Officer