SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-Q

 

 

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended April 1, 2006

 

 

 

 

Commission File #1-4224

 

AVNET, INC.

 

Incorporated in New York

 

 

 

 

IRS Employer Identification No. 11-1890605

 

2211 South 47^th Street, Phoenix, Arizona 85034

(480) 643-2000

 

 

 

 

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 þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

 

 

AVNET, INC. AND SUBSIDIARIES

 

INDEX

 

 

This Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, with respect to the financial condition, results of operations and business of Avnet, Inc. and subsidiaries (“Avnet” or the “Company”). You can find many of these statements by looking for words like “believes,” “expects,” “anticipates,” “should,” “will,” “may,” “estimates” or similar expressions in this Report or in documents incorporated by reference in this Report.

 

These forward-looking statements are subject to numerous assumptions, risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by the forward-looking statements include, but are not limited to, the following:

 

 

Although management believes that the plans and expectations reflected in or suggested by these forward-looking statements are reasonable, management cannot assure you that the Company will achieve or realize these plans and expectations. Because forward-looking statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by them. Management cautions you not to place undue reliance on these statements, which speak only as of the date of this Report.

 

Except as may be required by applicable law, Avnet assumes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

PART I

FINANCIAL INFORMATION

 

 

See notes to consolidated financial statements.

(Unaudited)

 

 

See notes to consolidated financial statements.

(Unaudited)

 

 

See notes to consolidated financial statements.

AVNET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.  In the opinion of management, the accompanying unaudited interim consolidated financial statements contain all adjustments necessary, all of which are of a normal recurring nature, except for the acquisition and purchase price allocation adjustments discussed in Note 4, the debt extinguishment costs discussed in Note 6 and the restructuring and other charges and integration costs discussed in Note 13, to present fairly the Company’s financial position, results of operations and cash flows. For further information, refer to the consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 2, 2005.

 

Certain reclassifications have been made to the prior period financial statements to conform to the current year presentation.

 

2.  The results of operations for the third quarter and nine months ended April 1, 2006 are not necessarily indicative of the results to be expected for the full year.

 

 

Effective in the first quarter of fiscal 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payments (“SFAS 123R”), which revises SFAS No. 123, Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees.  SFAS 123R requires all share-based payments to employees, including grants of employee stock options, be measured at fair value and expensed in the consolidated statement of operations over the service period (generally the vesting period). Upon adoption, the Company transitioned to SFAS 123R using the modified prospective application, whereby compensation cost is only recognized in the consolidated statements of operations beginning with the first period that SFAS 123R is effective and thereafter, with prior periods’ stock-based compensation for option and employee stock purchase plan activity still presented on a pro forma basis. The Company continues to use the Black-Scholes option valuation model to value stock options. As a result of the adoption of SFAS 123R, the Company recognized pre-tax charges of $2,279,000 and $8,304,000, respectively, in the three and nine months ended April 1, 2006, associated with the expensing of stock options and employee stock purchase plan activity. Additionally, the Company increased its grant activity under other stock-based compensation programs (while decreasing the number of stock options granted) that have always been expensed in the Company’s consolidated statements of operations, which yielded incremental expense under these other programs amounting to $1,133,000 and $2,910,000, respectively, when compared with the third quarter of fiscal 2005 and first nine months of fiscal 2005. In the third quarter of fiscal 2006, the combination of these two changes resulting from the adoption of SFAS 123R resulted in incremental expenses of $3,412,000 pre-tax (included in selling, general and administrative expenses), $2,260,000 after tax and $0.02 per share on a diluted basis. In the first nine months of fiscal 2006, the incremental expense was $11,214,000 pre-tax, $7,195,000 after tax and $0.05 per share on a diluted basis.

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Reported and pro forma net income and earnings per share are as follows:

 

 

 

 

The fair value of options granted is estimated on the date of grant using the Black-Scholes model based on the assumptions in the table below. The assumption for the expected life is based on evaluations of historical and expected future employee exercise behavior. The risk-free interest rate is based on the US Treasury rates at the date of grant with maturity dates approximately equal to the expected life at the grant date. The historical volatility of Avnet’s stock is used as the basis for the volatility assumption.

 

 

There were no stock options granted during the third quarter of fiscal 2006. At April 1, 2006, the Company had 14,174,127 shares of common stock reserved for stock option and stock incentive programs.

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Stock option plans

 

The Company has four stock option plans with shares available for grant at April 1, 2006 as follows:

 

 

Option grants under all four plans have a contractual life of ten years. Option grants vest 25% on each anniversary of the grant date, commencing with the first anniversary.

 

The following is a summary of the changes in outstanding options for the nine months ended April 1, 2006:

 

 

The weighted-average grant-date fair values of share options granted during the first nine months of fiscal 2006 and 2005, were $11.86 and $8.40, respectively. The total intrinsic values of share options exercised during the first nine months of fiscal 2006 and 2005, was $684,000 and $109,000, respectively.

 

The following is a summary of the changes in non-vested shares for the nine months ended April 1, 2006:

 

 

As of April 1, 2006, there was $18,038,000 of total unrecognized compensation cost related to non-vested awards granted under the option plans, which is expected to be recognized over a weighted-average period of

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

workforce reductions; (2) lease commitments of leased facilities that will no longer be used; (3) write-offs or write-downs in value of certain fixed assets and leasehold improvements that will have limited or no use in the combined business as a result of the facilities being exited; and (4) commitments related to other contractual obligations (see Preliminary acquisition-related exit activity accounted for in purchase accounting included in this Note 4). The allocations of purchase price discussed herein are preliminary as management completes its evaluation of the assets and liabilities acquired and finalizes the actions that will be taken and the charges associated with the integration of Memec into Avnet’s operations. The Company expects all adjustments will be completed within the purchase price allocation period, which is generally within one year of the acquisition date.

 

During the third quarter of fiscal 2006, the Company completed its valuation of identifiable intangible assets that resulted from the Memec acquisition. The Company allocated $22,600,000 of purchase price to intangible assets relating to customer relationships, which management estimates have a life of ten years, and $3,800,000 to intangible assets associated with the Memec tradename, which management estimates have a life of two years. In addition, the Company recorded $3,120,000 of amortization ($1,695,000 for customer relationships and $1,425,000 for tradename) during the third quarter of fiscal 2006, which represents nine months of intangible asset amortization from the date of acquisition. Amortization expense for the next five years is estimated to be $4,160,000 in fiscal 2007, and $2,260,000 in each of fiscal 2008 through 2011. These identifiable intangible assets other than goodwill are included in other long-term assets in the accompanying consolidated balance sheet at April 1, 2006.

 

A portion of the goodwill generated by the Memec acquisition is expected to be deductible for tax purposes, although the Company has not yet quantified the deductible portion.

 

 

The acquisition of Memec has expanded EM’s operations in each of the three major economic regions. The combination of Memec’s Asian operations with Avnet’s industry-leading position, based on sales, in the Asia region has provided Avnet with a stronger position in this key growth region. Memec’s already established position in Japan — the only U.S.-based distributor with such a presence in the Japanese market — also represents an opportunity by providing entry into this major electronic component marketplace. Because Memec’s operations and business model was similar to Avnet’s, management has been able to achieve significant operating expense synergies through the integration efforts which are substantially complete, with much of the synergies already realized by the end of the third quarter of fiscal 2006 and the remaining synergy benefits expected to be realized as

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

the remaining integration efforts are completed in the fourth quarter of fiscal 2006. The combination of these factors are the drivers behind the excess of purchase price paid over the value of assets and liabilities acquired.

 

Preliminary acquisition-related exit activity accounted for in purchase accounting

 

As a result of the acquisition, the Company established and approved plans to integrate the acquired operations into all three regions of the Company’s EM operations, for which the Company recorded $66,586,000 in preliminary exit-related purchase accounting adjustments during the nine months of fiscal 2006. These purchase accounting adjustments consist primarily of severance for Memec workforce reductions, non-cancelable lease commitments and lease termination charges for leased facilities, and other contract termination costs associated with the exit activities.

 

The following table summarizes the reserves related to exit activities that have been preliminarily established through purchase accounting and the related activity that has occurred during the nine months of fiscal 2006:

 

 

Total amounts utilized for exit-related activities during the first nine months of fiscal 2006 consisted of $38,676,000 in cash payments and $8,405,000 in non-cash write-downs.

 

The purchase accounting reserves established for severance are for reductions of workforce acquired from Memec relating to over 700 personnel primarily in the Americas and EMEA regions, including reductions in senior management, administrative, finance and certain operational functions. These reductions are based on management’s assessment of redundant Memec positions compared with existing Avnet positions and are driven primarily by completed and current consolidations of Memec facilities into Avnet facilities. Severance reserves, particularly those estimated to date for the EMEA region, may be adjusted during the purchase price allocation period because these costs are subject to local regulations and approvals.

 

The costs associated with the consolidation of over 60 Memec facilities are presented in Facility Exit Reserves/Write-downs in the table above and include estimated future payments for non-cancelable leases, early lease termination costs, and write-downs or write-offs of Memec owned assets in these facilities, including capitalized equipment and leasehold improvements. These actions relate primarily to facilities located in the Americas and EMEA. These reserves are subject to adjustment based on final analyses of the ultimate liabilities.

 

The other reserves in the table above relate primarily to remaining commitments and termination charges related to other contractual commitments of Memec that will no longer be of use in the combined business.

 

Estimated purchase accounting adjustments may change as the Company continues to execute its integration plan, particularly as it relates to EMEA severance and facility exit costs. However, the Company expects to complete all actions encompassed in the plan by the end of fiscal 2006. Cash payments for severance are expected to be substantially paid out before the end of fiscal 2007, whereas reserves for other contractual commitments, particularly for certain lease commitments, will extend into fiscal 2010.

 

Pro forma results

 

Unaudited pro forma financial information is presented below as if the acquisition of Memec occurred at the beginning of fiscal 2005. The pro forma information presented below does not purport to present what actual results

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

would have been had the acquisition in fact occurred at the beginning of fiscal 2005, nor does the information project results for any future period. Pro forma financial information is not presented for fiscal 2006 because the acquisition occurred on July 5, 2005, which was three days after the beginning of the Company’s fiscal year 2006. As a result, the accompanying consolidated statement of operations for the quarter and nine months ended April 1, 2006 effectively includes Memec’s results of operations for comparative purposes.

 

 

The combined results for Avnet and Memec for the third quarter and nine months ended April 2, 2005 were adjusted for the following in order to create the pro forma results in the table above:

 

 

Pro forma results above exclude any benefits that may result from the acquisition due to synergies that were derived from the elimination of any duplicative costs. In addition, the pro forma results have not been adjusted to remove the following Memec costs, which management considers to be non-recurring:

 

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Divestitures and investments

 

During the third quarter of fiscal 2006, the Company completed the divestiture of two end-user business lines in its TS Americas business. In January 2006, the Company sold its TS Americas end-user enterprise server and storage business line to a value-added reseller for approximately $12 million. This business line sold various products and services directly to end-users. The Company concurrently executed an exclusive distribution agreement whereby the acquiring company will procure certain enterprise computer products under customary terms from Avnet for a five-year contract period.

 

In February 2006, the Company contributed cash and certain operating assets and liabilities of its TS Americas end-user network solutions business line into a joint venture with Calence Inc. in exchange for an investment interest in the joint venture, called Calence LLC. This business line provided network and related products and services directly to customers and generated annual revenues of less than $200 million for Avnet. Avnet’s equity investment in Calence LLC of $22,908,000 is being accounted for under the equity method, with this investment included in other long-term assets on the accompanying consolidated balance sheet.

 

As a result of these divestitures, the Company recorded a pre-tax gain of $10,950,000 during the third quarter and nine months ended April 1, 2006.

 

 

The following table presents the carrying amount of goodwill, by reportable segment, for the nine months ended April 1, 2006:

 

 

The additions in EM primarily relate to the Memec acquisition and reflect purchase accounting adjustments recorded during the nine months ended April 1, 2006 (see Note 4). The additions in EM also relate to the purchase of shares formerly held by a minority interest holder in one of the Company’s Israeli subsidiaries. The additions in Technology Solutions (“TS”) relate primarily to a final earnout payment made in the first quarter of fiscal 2006 to the former owners of DNS Slovakia, which was acquired by Avnet in fiscal 2005.

 

 

Short-term debt consists of the following:

 

 

Bank credit facilities consist of various committed and uncommitted lines of credit with financial institutions utilized primarily to support the working capital requirements of foreign operations, including bank credit facilities in Japan assumed as part of the acquisition of Memec (see Note 4). The weighted average interest rates on the bank

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

credit facilities at April 1, 2006 and July  2, 2005 were 3.4% and 4.0%, respectively. Although interest rates generally rose during the nine month period ended April 1, 2006, the weighted average rate at April 1, 2006 is lower than at July 2, 2005 primarily due to the mix of outstanding borrowings amongst the Company’s different bank credit facilities. Specifically, at April 1, 2006, more than 30% of borrowings on bank credit facilities were drawn on the Japanese facility acquired with Memec in the first quarter of fiscal 2006. The interest rates for borrowings under on this facility average less than 1%.

 

As of July 2, 2005, the Company had an accounts receivable securitization program (the “Program”) with two financial institutions that allowed the Company to sell, on a revolving basis, an undivided interest of up to $350,000,000 in eligible U.S. receivables while retaining a subordinated interest in a portion of the receivables. At July 2, 2005, the Program qualified for sale treatment under Statement of Financial Accounting Standards No. 140. The Company had no drawings outstanding under the Program at July 2, 2005.

 

During the first quarter of fiscal 2006, the Company amended the Program to, among other things, increase the maximum amount available for borrowing from $350,000,000 to $450,000,000. In addition, the amended Program now provides that drawings under the Program no longer qualify as off-balance sheet financing. As a result, the receivables and related debt obligation will remain on the Company’s consolidated balance sheet when amounts are drawn on the Program. The Program, as amended, has a one year term which expires in August 2006. There were no drawings outstanding under the Program at April 1, 2006.

 

Long-term debt consists of the following:

 

 

As of July 2, 2005, the Company had an unsecured $350,000,000 credit facility with a syndicate of banks (the “Credit Facility”), expiring in June 2007. During the second quarter of fiscal 2006, the Company amended and restated the Credit Facility to, among other things, increase the borrowing capacity from $350,000,000 to $500,000,000, and increase the maximum amount of the total facility that can be used for letters of credit from $75,000,000 to $100,000,000 (the “Amended Credit Facility”). In addition, the Amended Credit Facility has a five-year term that matures in October 2010. The Company may still select from various interest rate options, currencies and maturities under the Amended Credit Facility. The Amended Credit Facility contains certain covenants, all of which the Company was in compliance with as of April 1, 2006. At April 1, 2006, there was $2,400,000 drawn under the Amended Credit Facility included in other long-term debt in the preceding table. There were no borrowings under the Credit Facility at July 2, 2005.

 

In August 2005, the Company issued $250,000,000 of 6.00% Notes due September 1, 2015 (the “6% Notes”). The proceeds from the offering, net of discount and underwriting fees, were $246,483,000. The Company used these proceeds, plus cash and cash equivalents on hand, to fund the tender and repurchase of $250,000,000 of the 8.00% Notes due November 15, 2006 (the “8% Notes”), at a price of $1,045 per $1,000 principal amount of Notes. In addition, the Company also repurchased $4,095,000 of the 8% Notes at a premium of approximately $1,038 per $1,000 principal amount of Notes. As a result of the tender and repurchases, the Company incurred debt

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

extinguishment costs of $11,665,000 pre-tax, $7,052,000 after tax or $0.05 per share on a diluted basis, relating primarily to premiums and other transaction costs. In December 2005, the Company repurchased an additional $2,230,000 of the 8% Notes at a premium of approximately $1,026 per $1,000 principal amount of Notes.

 

The Company’s $300,000,000 of 2% Convertible Senior Debentures due March 15, 2034 (the “Debentures”) are convertible into Avnet common stock at a rate of 29.5516 shares of common stock per $1,000 principal amount of Debentures. The Debentures are only convertible under certain circumstances, including if: (i) the closing price of the Company’s common stock reaches $45.68 per share (subject to adjustment in certain circumstances) for a specified period of time; (ii) the average trading price of the Debentures falls below a certain percentage of the conversion value per Debenture for a specified period of time; (iii) the Company calls the Debentures for redemption; or (iv) certain corporate transactions, as defined, occur. Upon conversion, the Company will deliver cash in lieu of common stock as the Company made an irrevocable election in December 2004 to satisfy the principal portion of the Debentures, if converted, in cash. The Company may redeem some or all of the Debentures for cash any time on or after March 20, 2009 at the Debentures’ full principal amount plus accrued and unpaid interest, if any. Holders of the Debentures may require the Company to purchase, in cash, all or a portion of the Debentures on March 15, 2009, 2014, 2019, 2024 and 2029, or upon a fundamental change, as defined, at the Debentures’ full principal amount plus accrued and unpaid interest, if any.

 

At July 2, 2005, the Company had two interest rate swaps with a total notional amount of $400,000,000 in order to hedge the change in fair value of the 8% Notes related to fluctuations in interest rates. These contracts were classified as fair value hedges with a November 2006 maturity date. The interest rate swaps modified the Company’s interest rate exposure by effectively converting the fixed rate on the 8% Notes to a floating rate (6.4% at July 2, 2005) based on three-month U.S. LIBOR plus a spread through their maturities. During the first quarter of fiscal 2006, the Company terminated the interest rate swaps which hedged the 8% Notes due to the repurchase of $254,095,000 of the $400,000,000 8% Notes, as previously discussed. The termination of the swaps resulted in net proceeds to the Company, of which, $1,273,000 was netted in debt extinguishment costs in the first quarter of fiscal 2006 based on the pro rata portion of the 8% Notes that were repurchased. The remaining proceeds of $764,000, which represent the pro rata portion of the 8% Notes that were not repurchased, have been capitalized in other long-term debt and are being amortized over the maturity of the remaining 8% Notes.

 

The Company has three additional interest rate swaps with a total notional amount of $300,000,000 in order to hedge the change in fair value of the 93/4% Notes due February 15, 2008 (the “93/4% Notes”) related to fluctuations in interest rates. These hedges are classified as fair value hedges and mature in February 2008. These interest rate swaps modify the Company’s interest rate exposure by effectively converting the fixed rate on the 93/4% Notes to a floating rate (11.2% at April 1, 2006) based on three-month U.S. LIBOR plus a spread through their maturities.

 

The hedged fixed rate debt and the interest rate swaps are adjusted to current market values through interest expense in the accompanying consolidated statements of operations. The Company accounts for the hedges using the shortcut method as defined under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by Statement of Financial Accounting Standards No. 138, Accounting for Certain Derivative Instruments and Hedging Activities. Due to the effectiveness of the hedges since inception, the market value adjustments for the hedged debt and the interest rate swaps directly offset one another. The fair value of the interest rate swaps at April 1, 2006 and July 2, 2005 was a liability of $10,332,000 and an asset of $910,000, respectively, and is included in other long-term liabilities and other long-term assets, respectively, in the accompanying consolidated balance sheets. Additionally, included in long-term debt is a comparable fair value adjustment decreasing long-term debt by $10,332,000 at April 1, 2006 and increasing long-term debt by $910,000 at July 2, 2005.

 

 

From time to time, the Company may become liable with respect to pending and threatened litigation, tax, environmental and other matters. The Company has been designated a potentially responsible party or has become

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

aware of other potential claims against it in connection with environmental clean-ups at several sites. Based upon the information known to date, the Company believes that it has appropriately reserved for its share of the costs of the clean-ups and management does not anticipate that any contingent matters will have a material adverse impact on the Company’s financial condition, liquidity or results of operations.

 

 

The Company’s noncontributory defined benefit pension plan (the “Plan”) covers substantially all domestic employees. Components of net periodic pension costs during the third quarter and first nine months of fiscal 2006 and 2005 were as follows:

 

 

During the first quarter of fiscal 2006, the Company made contributions to the Plan totaling $58,638,000. Management does not anticipate making any further contributions to the Plan during fiscal 2006.

 

 

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

The 4.5% Convertible Notes, which matured in September 2004, are excluded from the computation of earnings per share in the nine months ended April 2, 2005 as the effects were antidilutive. The Debentures, due March 2034, are also excluded from the computation of earnings per share for the quarter and nine months ended April 1, 2006 as a result of the Company’s election to satisfy the principal portion of the Debentures, if converted, in cash (see Note 6). Shares issuable upon conversion of the Debentures were also excluded from the computation of earnings per share in the third quarter and nine months ended April 2, 2005 because the contingent condition for their conversion had not been met.

 

The effects of certain stock options and unvested stock awards are also excluded from the determination of the weighted average common shares for diluted earnings per share in each of the periods presented as the effects were antidilutive because the exercise price for the outstanding options exceeded the average market price for the Company’s stock. Accordingly, in the third quarters of fiscal 2006 and 2005, the effects of 1,810,000 and 4,267,000 shares, respectively, are excluded from the computation above, all of which relate to options for which the exercise prices were greater than the average market price of the Company’s common stock. In the first nine months of fiscal 2006 and 2005, the effects of 2,091,000 and 5,948,000 shares, respectively, are excluded from the computation above, all of which relate to options for which the exercise prices were greater than the average market price of the Company’s common stock. In addition, the Performance Shares, which were issued during fiscal 2006, are accounted for as contingently issuable shares in determining the impact on diluted earnings per share. For the third quarter and nine months ended April 1, 2006, the Performance Shares have been excluded from the computation above because none of the necessary conditions for including contingently issuable shares in diluted earnings per share have been met.

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Other non-cash and other reconciling items consist of the following:

 

 

Other, net, cash flows from financing activities are comprised primarily of proceeds from the exercise of stock options (see Note 3), including tax effects relating to stock-based compensation costs with the corresponding offset in cash from operating activities.

 

Interest and income taxes paid in the nine months ended April 1, 2006 and April 2, 2005, respectively, were as follows:

 

 

Non-cash activity during the first nine months of fiscal 2006 that was a result of the Memec acquisition (see Note 4) consisted of $418,206,000 of common stock issued as part of the consideration, $439,945,000 of liabilities assumed and $27,343,000 of debt assumed.

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

 

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

 

Fiscal 2006

 

During the nine months ended April 1,2006, the Company has incurred certain restructuring and other charges and integration costs as a result of the acquisition of Memec on July 5, 2005 (see Note 4), which is discussed further under Memec-related restructuring and other charges and integration costs. In addition, the Company has incurred restructuring and other charges primarily relating to actions taken following the divestitures of certain TS business lines in the Americas region, certain cost reduction actions taken by TS in the EMEA region and other items, which are discussed further under Restructuring and other charges related to business divestitures and other actions.  The restructuring and other charges incurred for all of these activities totaled $12,385,000 pre-tax, $8,205,000 after-tax and $0.06 per share on a diluted basis for the third quarter of fiscal 2006, and $42,878,000 pre-tax, $28,784,000 after-tax and $0.20 per share on a diluted basis for the nine months ended April 1, 2006. The following table summarizes the restructuring and other charges incurred related to these broad groups of actions:

 

 

 

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Memec-related restructuring and other charges and integration costs

 

The acquired Memec business is being integrated into the Company’s existing EM operations in all three regions. As a result of the acquisition integration efforts, the Company established and approved plans to restructure certain of Avnet’s existing operations to accommodate the merger of Avnet and Memec.

 

The following table summarizes the activity associated with the fiscal 2006 restructuring and other charges related to Memec (excluding $8,977,000 recorded in cost of sales as discussed below):

 

 

The Memec-related restructuring and other charges incurred during the third quarter of fiscal 2006 totaled $5,455,000 pre-tax ($4,015,000 which are included in the restructuring and other charges in the accompanying consolidated statement of operations and $1,440,000 related primarily to terminated inventory lines, which was recorded in cost of sales as discussed below), $3,614,000 after-tax and $0.03 per share on a diluted basis. The third quarter pre-tax charge of $4,015,000 (included in restructuring and other charges) consisted of $3,433,000 for severance costs, $17,000 of facility exit costs (primarily non-cancelable lease commitments), $48,000 for the write-down of certain capitalized IT-related initiatives and $517,000 for other charges.

 

The restructuring and other charges incurred during the nine months ended April 1, 2006 totaled $31,887,000 pre-tax ($22,910,000 included in the preceding table and $8,977,000 recorded in cost of sales as discussed below), $21,467,000 after-tax and $0.15 per share on a diluted basis. The pre-tax charges included inventory write-downs for terminated lines amounting to $8,977,000. The remaining pre-tax charge of $22,910,000, which was included in restructuring and other charges in the accompanying consolidated statement of operations, included $16,172,000 for severance costs, $2,862,000 of facility exit costs related primarily to remaining lease reserves on exited facilities, $2,382,000 for the write-down of certain capitalized IT-related initiatives, primarily in the Americas, and $1,494,000 for other charges related primarily to other contractual obligations that will no longer be utilized in the combined Avnet and Memec business.

 

The charge for terminated inventory lines related to a strategic decision during the first half of fiscal 2006 to exit certain product lines within EM in the Americas. The charge in the third quarter of fiscal 2006 was a result of similar strategic decisions made in the EMEA region. The terminated lines were product lines that either Avnet management or Avnet’s suppliers elected not to continue with the combined Avnet and Memec business. As a result, management recorded a write-down of the related inventory on hand to fair market value due to the lack of contractual return privileges when a line is terminated. Severance charges incurred during the first nine months of fiscal 2006 related to work force reductions of over 250 personnel primarily in administrative and support functions in the EMEA and Americas regions. The positions eliminated were Avnet personnel that were deemed redundant by management with the merger of Memec into Avnet. The facility exit charges related to liabilities for remaining non-cancelable lease obligations and the write-down of leasehold improvements and other property, plant and equipment relating to the facilities being exited. The facilities, which supported administrative and support functions, and some sales functions, were identified for consolidation based upon the termination of certain personnel discussed above and the relocation of other personnel into other existing Avnet facilities. The IT-related charges resulted from management’s review of certain capitalized systems and hardware as part of the integration effort. A substantial portion of this write-off, which was recorded in the first quarter of fiscal 2006, relates to mainframe hardware that was scrapped due to the purchase of new, higher capacity hardware to handle the increased

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

capacity needs with the addition of Memec. Similarly, certain capitalized IT assets were written off when they became redundant either to other acquired systems or new systems under development in the first quarter of fiscal 2006 as a result of the acquisition of Memec. Other charges in the nine months ended April 1, 2006 related primarily to certain other contractual obligations and contract termination charges.

 

Of the total amounts recorded to expense for the Memec-related restructuring activity during the nine months ended April 1, 2006, $11,762,000 represented non-cash write-downs, which consisted primarily of the charge to cost of sales for inventory write-downs and the write-down of IT and other fixed assets. The remaining Memec-related charges in the nine months ended April 1, 2006 required or will require the use of cash, of which $12,157,000 was paid during the nine months ended April 1, 2006.

 

As of April 1, 2006, remaining Memec-related reserves related to the restructuring actions taken in the first nine months of fiscal 2006 total $8,105,000, of which $5,649,000 related to severance reserves, the majority of which management expects to utilize by the end of fiscal 2006, facility exit costs of $2,124,000, the majority of which management expects to utilize by fiscal 2010, and other costs of $332,000, the majority of which management expects to utilize by fiscal 2007.

 

Also resulting from the Memec acquisition and its subsequent integration into Avnet, the Company incurred certain costs during the third quarter of fiscal 2006, amounting to $4,584,000 pre-tax, $3,037,000 after tax or $0.02 per share on a diluted basis. Integration costs incurred during the nine months ended April 1, 2006 totaled $20,301,000 pre-tax, $13,824,000 after-tax and $0.09 per share on a diluted basis. The integration costs, particularly in the first six months of fiscal 2006, related to incremental salary costs, primarily of Memec personnel, who were retained by Avnet following the close of the acquisition, solely to assist in the integration of Memec’s IT systems, administrative and logistics operations into those of Avnet. Generally, these identified personnel were retained for nine months or less following the close of the acquisition. These personnel had no other meaningful day-to-day operational responsibilities outside of the integration effort. Also included in integration costs are certain professional fees, travel, meeting, marketing and communication costs that were incrementally incurred solely related to the Memec integration efforts. Professional fees include primarily consulting and legal advice associated with the efforts to merge the numerous legal entities that exist globally between the Avnet and Memec operations. Integration costs are presented separately from selling, general and administrative expenses on the consolidated statement of operations. All integration costs recorded in fiscal 2006 represent amounts incurred and paid during the third quarter and nine months ended April 1, 2006.

 

Restructuring and other charges related to business line divestitures and other actions

 

During the third quarter of fiscal 2006, the Company divested its end-user business lines in TS Americas (see Note 4). As a result, restructuring charges were incurred due to certain actions taken by the Company following these divestitures. The Company also incurred restructuring costs and other charges relating to certain cost-cutting measures and other actions taken by TS in the EMEA region in both the second and third quarters of fiscal 2006.

 

The following table summarizes the activity relating to the restructuring and other charges related to business line divestitures and other actions taken during fiscal 2006:

 

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The restructuring and other charges incurred during the third quarter of fiscal 2006 totaled $6,930,000 pre-tax, $4,591,000 after-tax and $0.03 per share on a diluted basis. The third quarter pre-tax charge of $6,930,000, which is included in restructuring and other charges in the accompanying consolidated statement of operations, consisted of $1,751,000 for severance costs in the TS operations in the Americas and EMEA regions, facility exit costs in the Americas and EMEA regions of TS totaling $1,923,000, and $3,256,000 for other charges relating primarily to the termination of a UK-based pension plan.

 

The restructuring and other charges incurred during the nine months ended April 1, 2006 totaled $10,991,000 pre-tax ($7,930,000 included in the preceding table, and $3,061,000 relating to other charges and reversals of previously recorded reserves discussed below), $7,317,000 after-tax and $0.05 per share on a diluted basis. The year-to-date pre-tax charges, which are included in restructuring and other charges in the accompanying consolidated statement of operations, consisted of severance costs of $2,893,000 related to TS operations in the Americas and EMEA regions, facility exit costs in the Americas and EMEA regions totaling $4,853,000, and $184,000 for other charges. Not included in the table above are other charges totaling $3,179,000 pre-tax, the majority of which relates to a curtailment charge resulting from a small UK-based pension plan that the Company elected to terminate. During the second quarter of fiscal 2006, the Company also recorded a reversal of $118,000 for charges recorded in prior fiscal years in TS EMEA (see Fiscal 2004 and 2003 reserve discussion in this Note 13).

 

The severance costs related primarily to severance and other termination benefit payments related to five personnel in the TS Americas’ operations who were rendered redundant in Avnet’s ongoing business following the divestiture of the end-user business lines during the third quarter of fiscal 2006. This included one management-level employee whose primary responsibilities previously included the management of the divested business lines. Severance charges in the first nine months of fiscal 2006 also include termination benefits for three personnel in the TS EMEA operations who were identified as redundant based upon the realignment of certain job functions in that region. The facility exit charges related to liabilities for remaining non-cancelable lease obligations and the write-down of facility-related property, plant and equipment. The impacted facilities were TS leased facilities in the Americas that were rendered redundant with the divestitures discussed above, as well as certain TS leased facilities in EMEA that were vacated as part of the realignments of personnel discussed above. Certain furniture, fixtures and equipment in these facilities were also written off as part of these charges. Other charges in the nine months ended April 1, 2006 related primarily to asset impairment charges recorded in the second quarter of fiscal 2006 totaling $2,671,000 for two owned but vacant facilities — one in EMEA and one in the Americas. The write-down to fair value was based upon management’s estimates of the current market values and possible selling price, net of selling costs, for these properties. Also included in other charges is the pension plan curtailment charge noted previously.

 

These restructuring and other charges related to business line divestitures and other actions, along with the Memec-related restructuring charges discussed previously, are presented separately from selling, general and administrative expenses in the consolidated statements of operations. Of the amounts recorded to expense for these restructuring and other charges during the nine months ended April 1, 2006, $2,845,000 represented non-cash write-downs, which consisted primarily of the write-down to fair value of the owned facilities in EMEA and the Americas and certain furniture, fixtures and equipment in leased facilities. The remaining charges in the nine months ended April 1, 2006 required or will require the use of cash, of which $878,000 was paid during the nine months ended April 1, 2006.

 

As of April 1, 2006, remaining reserves related to these restructuring and other actions taken in the first nine months of fiscal 2006 total $4,210,000, of which $2,215,000 relates to severance reserves, the majority of which management expects to utilize before the end of fiscal 2006, facility exit costs of $1,852,000, the majority of which management expects to utilize by fiscal 2010, and other costs of $143,000, the majority of which management expects to utilize by fiscal 2007.

 

AVNET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Fiscal 2004 and 2003

 

During fiscal 2004 and 2003, the Company recorded a number of restructuring charges which related to the reorganization of operations in each of the three major regions of the world in which the Company operates, generally taken in response to business conditions at the time of the charge and as part of the efforts of the Company to return to the profitability levels enjoyed by the business prior to the industry and economic downturn that commenced in fiscal 2001.

 

The following table summarizes the activity during the nine months ended April 1, 2006 in the remaining accrued liability and reserve accounts in these prior year restructuring reserves:

 

 

The Company expects to utilize the majority of the remaining reserves for severance costs by the end of fiscal 2006. The Company expects to utilize most of the remaining reserves for contractual lease commitments, shown under Facility Exit Costs above, by the end of fiscal 2007, although a small portion of the remaining reserves relate to lease payouts that extend as late as fiscal 2010. The other remaining reserves relate primarily to remaining contractual commitments, the majority of which the Company expects to utilize during fiscal 2006.

 

Adjustments recorded during the nine months ended April 1, 2006 accumulated to $24,000 and are a result of revised estimates of reserves recorded in prior fiscal years.

 

 

In April 2006, the Company entered into an agreement to sell the net assets of a small (approximately $140 million of annualized sales) EM distributor of specialty radio frequency and optoelectronic products and related services in EMEA. Avnet will retain a 16% investment in this business following the sale. Net proceeds received from the sale of the majority ownership in this business were $20,375,000. The Company will record a loss on the sale of this business in the fourth quarter of fiscal 2006. This loss has not yet been quantified.

 

For a description of the Company’s critical accounting policies and an understanding of the significant factors that influenced the Company’s performance during the quarters and nine months ended April 1, 2006 and April 2, 2005, this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the consolidated financial statements, including the related notes, appearing in Item 1 of this Report, as well as the Company’s Annual Report on Form 10-K for the year ended July 2, 2005.

 

There are numerous references to the impact of foreign currency translation in the discussion of the Company’s results of operations that follow. Over the past several years, the exchange rates between the US Dollar and many foreign currencies, especially the Euro, have fluctuated significantly. For example, the US Dollar has weakened only slightly against the Euro by approximately 1% when comparing the third quarter of fiscal 2006 to the second quarter of fiscal 2006. However, on a year-over-year basis (third quarter fiscal 2006 compared to third quarter fiscal 2005), the US Dollar has strengthened against the Euro by approximately 8%. When the stronger US Dollar exchange rates of the current year are used to translate the results of operations of Avnet’s subsidiaries denominated in foreign currencies, the resulting impact is a decrease, in US Dollars, of reported results. In the discussion that follows, this is referred to as the translation impact of changes in foreign currency exchange rates.

 

In addition to disclosing financial results that are determined in accordance with US generally accepted accounting principles (“GAAP”), the Company also discloses certain non-GAAP financial information such as income or expense items as adjusted for the impact of foreign currency exchange rate fluctuations, as discussed above. Management believes that providing this additional information is useful to the reader to better assess and understand operating performance, especially when comparing results with previous periods or forecasting performance for future periods, primarily because management typically monitors the business both including and excluding these adjustments to GAAP results. Management also uses these non-GAAP measures to establish operational goals and, in some cases, for measuring performance for compensation purposes.

 

As further discussed in the Overview below, during the first quarter of fiscal 2006, Avnet completed the acquisition of Memec Group Holdings Limited (“Memec”), a global distributor that markets and sells a portfolio of semiconductor devices from industry-leading suppliers, in addition to providing customers with engineering expertise and design services. Memec recorded sales of $2.28 billion in the twelve months prior to the July 5, 2005 close of the acquisition, which makes this Avnet’s largest acquisition to date based on sales. The consideration paid for the Memec acquisition consisted of stock and cash valued at approximately $506.6 million, including transaction costs, plus the assumption of $240.0 million of Memec’s net debt (debt less cash acquired). All but $27.3 million of this acquired net debt was repaid upon the closing of the acquisition. Under the terms of the purchase, Memec investors received 24.011 million shares of Avnet common stock plus $64.0 million of cash. The shares of Avnet common stock were valued at $17.42 per share, which represents the five-day average stock price beginning two days before the acquisition announcement on April 26, 2005.

 

Within this MD&A, management occasionally discusses certain prior year sales of Avnet combined with the historical results of Memec for the corresponding period. Although the Memec acquisition is accounted for as a purchase business combination and, therefore, the results of Memec are only included in Avnet’s results subsequent to the July 5, 2005 close of the acquisition, management believes that comparative analysis of financial results to historical periods, as if Memec were a part of Avnet’s operations, helps investors relate current year results to historical periods prior to the close of the acquisition. Management uses similar pro forma data to analyze performance for internal operational goal setting and performance management. Furthermore, the combined results of Avnet and Memec in prior periods provide one of the bases by which management evaluates its achievement of synergy targets resulting from the merger as discussed further herein. In the discussion that follows, mention of Avnet and Memec or Electronics Marketing and Memec combined data is referred to as pro forma combined results.

 

Analysis of results and outlook on a non-GAAP basis should be used as a complement to, and in conjunction with, data presented in accordance with GAAP.

OVERVIEW

 

Organization

 

Avnet, Inc. and its subsidiaries (the “Company” or “Avnet”) is the world’s largest industrial distributor, based on sales, of electronic components, enterprise computer products and embedded subsystems. Avnet creates a vital link in the technology supply chain that connects over 300 of the world’s leading electronic component and computer product manufacturers and software developers as a single source for multiple products for a global customer base of over 100,000 original equipment manufacturers (“OEMs”), contract manufacturers, original design manufacturers, value-added resellers (“VARs”) and end-users. Avnet distributes electronic components, computer products and software as received from its suppliers or with assembly or other value added by Avnet. Additionally, Avnet provides engineering design, materials management and logistics services, system integration and configuration, and supply chain advisory services.

 

The Company consists of two operating groups — Electronics Marketing (“EM”) and Technology Solutions (“TS”) — each with operations in the three major economic regions of the world: the Americas, EMEA (Europe, Middle East and Africa) and Asia/Pacific. A brief summary of each operating group is provided below: