UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

Commission file number 1-4224

Avnet, Inc.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code

(480) 643-2000

Securities registered pursuant to Section 12(b) of the Act:

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  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

 

The aggregate market value (approximate) of the registrant’s common equity held by non-affiliates based on the closing price of a share of the registrant’s common stock for New York Stock Exchange composite transactions on December 30, 2006 (the last business day of the registrant’s most recently completed second fiscal quarter) — $3,754,446,293

 

The number of shares of the registrant’s Common Stock (net of treasury shares) outstanding at July 27, 2007 — 149,874,689

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive proxy statement (to be filed pursuant to Reg. 14A) relating to the Annual Meeting of Shareholders anticipated to be held on November 8, 2007 are incorporated herein by reference in Part III of this Report.

 

 

TABLE OF CONTENTS

 

 

PART I

 

 

Avnet, Inc., incorporated in New York in 1955, together with its consolidated subsidiaries (the “Company” or “Avnet”), is one of the world’s largest industrial distributors, based on sales, of electronic components, enterprise computer and storage products and embedded subsystems. With sales of $15.68 billion in fiscal 2007, 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 value-added source for multiple products for a global customer base of over 100,000 original equipment manufacturers (“OEMs”), electronic manufacturing services (“EMS”) providers, original design manufacturers (“ODMs”), and value-added resellers (“VARs”). 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.

 

Organizational Structure

 

Avnet has two primary operating groups — Electronics Marketing (“EM”) and Technology Solutions (“TS”). Both operating groups have operations in each of the three major economic regions of the world: the Americas; Europe, the Middle East and Africa (“EMEA”); and Asia/Pacific, consisting of Asia, Australia and New Zealand (“Asia”). Each operating group has its own management team that is led by a group president and includes regional presidents and senior executives within the operating group that manage the various functions within the businesses. Each operating group also has distinct financial reporting that is evaluated at the corporate level and on which operating decisions and strategic planning for the Company as a whole are made. Divisions exist within each operating group that serve primarily as sales and marketing units to further streamline the sales and marketing efforts within each operating group and to enhance each operating group’s ability to work with its customers and suppliers, generally along more specific product lines or based upon geography. However, each division relies heavily on the support services that are provided centrally within each operating group and centralized support at the corporate level.

 

Avnet’s operating groups and their sales are as follows:

 

 

A description of each operating group and their businesses is presented below. Further financial information by operating group and geography is provided in Note 16 to the consolidated financial statements appearing in Item 15 of this Report.

 

Electronics Marketing

 

EM markets and sells semiconductors and interconnect, passive and electromechanical devices (“IP&E”) on behalf of over 300 of the world’s leading electronic component manufacturers. EM markets and sells its products and services to a diverse customer base spread across end-markets including automotive, communications,

computer hardware and peripheral, industrial and manufacturing, medical equipment, military and aerospace. EM also offers an array of value-added services that help customers evaluate, design-in and procure electronic components throughout the lifecycle of their technology products and systems. By working with EM from the design phase through new product introduction and through the product lifecycle, customers and suppliers can accelerate their time to market and realize cost efficiencies in both the design and manufacturing process.

 

EM Design Chain Services offers engineers a host of design chain services in support of the sales process. With access to a suite of design tools and engineering services from any point in the design cycle, customers can get product specifications along with evaluation kits and reference designs that enable a broad range of applications from concept through detailed design including new product introduction. EM also offers engineering and technical resources deployed globally to support product design, bill of materials development, design services and technical education and training. By utilizing EM’s design chain services, customers can optimize their component selection and improve their time to market.

 

EM Supply Chain Services provides end-to-end supply chain services to OEMs, EMS providers and electronic component manufacturers, enabling them to optimize supply chains on a local, regional or global basis. By combining internal competencies in global warehousing and logistics, finance, information technology, and asset management with its global footprint and extensive partner relationships, Avnet’s supply chain services develop a deeper level of engagement with the customers by allowing them to continuously manage their supply chains to meet the demands of a competitive environment globally without a commensurate investment in physical assets. With proprietary planning tools and a variety of inventory management solutions, EM can provide unique solutions that meet a customer’s just-in-time requirements in a variety of scenarios including lean manufacturing, demand flow and outsourcing.

 

Suppliers of components to EM include:

 

 

EM sells to multinational, regional and local OEMs and contract manufacturers including:

 

 

Each of EM’s regional operating groups has sales and marketing divisions that generally focus on a specific customer segment, particular product lines or on a specific geography. EM Americas addresses the needs of its customers and suppliers through focused channels to service small- to medium-sized customers, global customers, defense and aerospace customers, emerging customers and contract manufacturers. In EMEA, divisions which are organized by semiconductors, IP&E products and supply chain services address customers on both a pan-European and regional basis. EM EMEA does business in over 40 European countries, and over 10 countries in the Middle East and Africa. EM Asia goes to market in China with two focused sales and marketing divisions; it also has separate divisions focused on South Asia, Taiwan and Japan. Collectively, the divisions offer one of the industry’s broadest line cards and convenient one-stop shopping with an emphasis on responsiveness, engineering support, on-time delivery and quality. Certain specialty services are made available to the individual divisions through common support service units.

Technology Solutions

 

TS markets and sells mid- to high-end servers, data storage, software, and the services required to implement these products and solutions to the VAR channel. TS also focuses on the worldwide OEM market for computing technology, system integrators and non-PC OEMs that require embedded systems and solutions including engineering, product prototyping, integration and other value-added services.

 

TS is a leading partner for system vendors such as IBM, Hewlett-Packard and Sun Microsystems. Other key suppliers TS serves include:

 

 

TS markets and sells its products and services to the VAR channel and embedded computing customers, which include:

 

 

As a global technology sales and marketing organization, TS has dedicated sales and marketing divisions focused on specific customer segments including OEMs, independent software vendors, system builders, system integrators, and VARs. The TS select line card strategy enables an exceptional level of attention to the needs of its suppliers.

 

TS divisions fall within three primary product solutions groups:

 

Enterprise Solutions

 

With VARs as their customers, these businesses focus on the value-added distribution of enterprise computing systems, software, storage, services and complex solutions from the world’s foremost technology manufacturers, including IBM, Hewlett-Packard, Sun Microsystems, EMC, Network Appliance and other key suppliers. These businesses also provide complementary logistics, financial, marketing, sales and technical services, including engineering support, systems integration and configuration. Geographic markets: Australia, Austria, Belgium, Canada, Czech Republic, France, Germany, Hungary, Italy, Malaysia, Mexico, Netherlands, Poland, Portugal, Romania, Singapore, Slovakia, Spain, Switzerland, UK, US.

 

Embedded Solutions

 

These businesses provide technical design, integration and assembly to developers of application-specific computing solutions in the non-PC market, including OEMs targeting the medical, telecommunications, industrial and digital editing arenas. They also provide the latest microprocessor, motherboard and DRAM module technologies to manufacturers of general-purpose computers and system builders. Geographic markets: Americas, EMEA, Asia.

 

Avnet Visual and Data Solutions

 

Specializing in audio, video and display products, network products and storage solutions as well as wireless switch and wireless stand-alone solutions, these businesses target primarily VARs and system integrators. Geographic markets: EMEA.

 

Foreign Operations

 

As noted in the operating group discussions, Avnet has significant operations in all three major economic regions of the world: the Americas, EMEA, and Asia/Pacific. The percentage of Avnet’s consolidated sales by region is presented in the following table:

 

 

Historically, Avnet’s operations in the Americas region (primarily the United States) have contributed the largest percentage of consolidated sales. The Asia region has experienced more continuous rapid growth in recent years which is indicative of a worldwide industry trend and is a result of Avnet’s continued investment into this rapidly growing region, particularly in the Peoples’ Republic of China. Management expects the Asia region to continue to grow, both in volume of business and as a percentage of the Company’s global business in the future, although the rate of growth may not remain at the same robust percentages exhibited in the past three to four years. Avnet’s foreign operations are subject to a variety of risks. These risks are discussed further under Risk Factors in Item 1A and under Quantitative and Qualitative Disclosures About Market Risk in Item 7A of this Report. Additionally, the specific translation impacts of foreign currency fluctuations, most notably the Euro, on the Company’s consolidated financial statements are further discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of this Report.

 

Acquisitions

 

On December 31, 2006, the Company completed the acquisition of Access Distribution (“Access”), a leading value-added distributor of complex computing solutions, which recorded sales of $1.90 billion in calendar year 2006. As of the end of fiscal 2007, the Access business has been fully integrated into the TS Americas and EMEA operations. Management estimates that it achieved more than $15 million of annualized operating expense synergies as of the end of fiscal 2007; the benefit of which will largely impact fiscal 2008. The preliminary purchase price of $437.6 million, which is subject to adjustment based upon the audited closing net book value, was funded primarily with debt, plus cash on hand. In addition, during fiscal 2007, the Company acquired Azure Technology, an IT solutions provider in Asia that specializes in systems infrastructure and application solutions services. The acquired business operates in Singapore and Malaysia and is focused on the distribution of IBM systems and solutions with annual revenues of approximately $90 million. See Note 2 in the notes to consolidated financial statements in Item 15 of this Form 10-K for further discussion of the Access and other acquisitions.

 

Subsequent to June 30, 2007, the Company announced a definitive agreement to acquire the European Enterprise Infrastructure division of value-added distributor Magirus Group. The division to be acquired is a distributor of servers, storage systems, software and services of IBM and Hewlett-Packard to resellers in seven European countries and Dubai and has annual revenues of approximately $500 million. The acquisition is expected to close in October 2007, subject to regulatory approval, and is anticipated to be integrated into TS by the end of fiscal 2008. Also, subsequent to June 30, 2007, the Company acquired Flint Distribution, Ltd. a UK-based interconnect, passive and electromechanical distributor with annual revenues of approximately $40 million which will be integrated into EM.

On July 5, 2005, the Company completed the acquisition of Memec, a global distributor that marketed and sold a portfolio of semiconductor devices from industry-leading suppliers, and a provider of engineering expertise and design services. The acquisition of Memec is the Company’s largest acquisition to date, based on annual sales. Memec recorded sales of $2.28 billion in the twelve months prior to the July 5, 2005 close of the acquisition. The consideration for the Memec acquisition consisted of stock and cash valued at approximately $506.9 million, including transaction costs, plus the assumption of approximately $240.0 million of Memec’s net debt (debt less cash acquired). Under the terms of the purchase agreement, Memec investors received approximately 24.011 million shares of Avnet common stock plus approximately $64.0 million in 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.

 

Avnet has historically pursued a strategic acquisition program to grow its presence in world markets for electronic components and computer products. This program was a significant factor in Avnet becoming one of the largest industrial distributors of such products worldwide. Avnet will continue to pursue strategic acquisitions as part of its overall growth strategy, with its focus likely directed at smaller targets in markets where the Company is seeking to expand its global presence or to increase its scale and scope where an acquisition may be beneficial.

 

Major Products

 

One of Avnet’s competitive strengths is the breadth and quality of the suppliers whose products it distributes. During fiscal 2007, IBM products accounted for approximately 14% of the Company’s consolidated sales, and was the only supplier from which sales exceeded 10% of sales. Listed in the table below are the major product categories and the Company’s approximate sales of each during the past three fiscal years:

 

 

As of June 30, 2007, the Company had more than 300 locations worldwide, as well as a limited number of instances where Avnet-owned product is stored in customer facilities. Many of these locations contain sales, warehousing and administrative functions for multiple sales and marketing units. Avnet sells to customers in over 70 countries.

 

Competition & Markets

 

Avnet is one of the world’s largest industrial distributors, based on sales, of electronic components and computer products.

 

The electronic component and computer products industry continues to be extremely competitive and is subject to rapid technological advances. The Company’s major competitors include Arrow Electronics, Inc., Future Electronics and World Peace Group. There are also certain smaller, specialized competitors who focus upon one market or product or a particular sector. As a result of these factors, Avnet must remain competitive in its pricing of goods and services.

 

Another key competitive factor in the electronic component and computer product distribution industry as a whole is the need to carry a sufficient amount of inventory to meet rapid delivery requirements of customers. However, to minimize its exposure related to valuation of inventory on hand, the majority of the Company’s products are purchased pursuant to non-exclusive distributor agreements, which typically provide certain protections to the Company for product obsolescence and price erosion in the form of rights of return and price protection. Furthermore, these agreements are generally cancelable upon 30 to 180 days’ notice and, in most cases, provide for

inventory return privileges upon cancellation. In addition, the Company enhances its competitive position by offering a variety of value-added services which entail the performance of services and/or processes tailored to individual customer specifications and business needs such as point of use replenishment, testing, assembly, supply chain management and materials management.

 

A key strength of the Company is the breadth and quality of the suppliers whose products it distributes. Because of the number of Avnet’s suppliers, many customers can make all of their required purchases with Avnet, rather than purchasing from several different vendors.

 

Seasonality

 

Historically, Avnet’s business has not been materially impacted by seasonality, with the exception of a relatively minor impact on consolidated results from the growth in revenues in the Technology Solutions business during the December quarter. This may be impacted by the recently completed Access acquisition, which has a particularly strong June quarter coinciding with its largest supplier’s fiscal year end.

 

Number of Employees

 

At June 30, 2007, Avnet had approximately 11,700 employees.

 

Avnet Website

 

In addition to the information about Avnet contained in this Report, extensive information about the Company can be found through our website located at www.avnet.com, including information about our management team, products and services and our corporate governance practices.

 

The corporate governance information on our website includes the Company’s Corporate Governance Guidelines, the Code of Conduct and the charters for each of the committees of our Board of Directors. In addition, amendments to the Code of Conduct, committee charters and waivers granted to our directors and executive officers under the Code of Conduct, if any, will be posted in this area of our website. These documents can be accessed at www.avnet.com under the “Investor Relations — Governance” caption. Printed versions of our Corporate Governance Guidelines, our Code of Conduct and the charters of our Board committees can be obtained, free of charge, by writing to the Company at: Avnet, Inc., 2211 South 47th Street, Phoenix, AZ 85034; Attn: Corporate Secretary.

 

In addition, the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those Reports, if any, filed or furnished pursuant to Section 13(a) or 15(d) of Securities Exchange Act of 1934, as well as Section 16 filings made by any of the Company’s executive officers or directors with respect to Avnet common stock, are available on the Company’s website (www.avnet.com under the “Investor Relations — SEC Filings” caption) as soon as reasonably practicable after the report is electronically filed with, or furnished to, the Securities and Exchange Commission.

 

These details about Avnet’s website and its content are only for information. The contents of the Company’s website are not, nor shall they be deemed to be, incorporated by reference in this Report.

 

 

Forward-Looking Statements And Risk Factors

 

This Report contains forward-looking statements with respect to the financial condition, results of operations and business of Avnet. These statements are generally identified by words like “believes,” “expects,” “anticipates,” “should,” “will,” “may,” “estimates” or similar expressions. Forward-looking statements are subject to numerous assumptions, risks and uncertainties.

 

Avnet does not undertake any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

Factors that may cause actual results to differ materially from those contained in the forward-looking statements include the following:

 

An industry down-cycle in semiconductors could significantly affect the Company’s operating results as a large portion of our revenues comes from sales of semiconductors, which has been a highly cyclical industry.

 

The semiconductor industry historically has experienced periodic fluctuations in product supply and demand, often associated with changes in technology and manufacturing capacity, and is generally considered to be highly cyclical. During each of the last three fiscal years, sales of semiconductors represented over 50% of the Company’s consolidated sales, and the Company’s revenues, particularly those of EM, closely follow the strength or weakness of the semiconductor market. While the semiconductor industry has strengthened recently as compared with the downturn experienced in 2001 and 2002 and industry cycles appear less volatile, it is uncertain whether this trend will continue. Future downturns in the technology industry, particularly in the semiconductor sector, could negatively affect the Company’s operating results and negatively impact the Company’s ability to maintain its current profitability levels.

 

Failure to maintain its relationships with key suppliers could adversely affect the Company’s sales.

 

One of the Company’s competitive strengths is the breadth and quality of the suppliers whose products the Company distributes. However, sales of products and services from one of the Company’s suppliers, IBM, accounted for approximately 14% of the Company’s consolidated sales in fiscal year 2007. Management expects IBM products and services to continue to account for over 10% of the Company’s consolidated sales in fiscal year 2008. The Company’s contracts with its suppliers, including those with IBM, vary in duration and are generally terminable by either party at will upon notice. To the extent IBM or a group of other primary suppliers is not willing to do business with the Company in the future, the Company’s business and relationships with its customers could be materially, adversely affected because its customers depend on the Company’s distribution of electronic components and computer products from the industry’s leading suppliers. In addition, to the extent that any of the Company’s key suppliers modifies the terms of their contracts including, without limitation, the terms regarding price protection, rights of return, rebates or other terms that protect the Company’s gross margins, it could materially, adversely affect the Company’s results of operations, financial condition or liquidity.

 

The Company may not have adequate or cost-effective liquidity or capital resources.

 

The Company’s ability to satisfy its cash needs depends on its ability to generate cash from operations and to access the financial markets, both of which are subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond the Company’s control.

 

The Company may need to satisfy its cash needs through external financing. However, external financing may not be available on acceptable terms or at all. As of June 30, 2007, Avnet had total debt outstanding of $1.21 billion under various notes and committed and uncommitted lines of credit with financial institutions. The Company needs cash to make interest payments on, and to refinance, this indebtedness and for general corporate purposes, such as funding its ongoing working capital and capital expenditure needs. Under the terms of any external financing, the Company may incur higher than expected financing expenses and become subject to additional restrictions and covenants. Any material increase in the Company’s financing costs could have a material adverse effect on its profitability.

 

Under some of its various credit facilities, the Company is required to maintain certain specified financial ratios and meet certain tests. If the Company fails to meet these financial ratios and tests, it may be unable to continue to utilize these facilities. If the Company could not continue to utilize these facilities, it may not have sufficient cash available to make interest payments on and refinance indebtedness and for general corporate needs. Furthermore, disclosure of any such non-compliance may contribute to increased volatility of the Company’s share price and thereby exposing the Company to potential securities litigation.

The agreements governing some of the Company’s financings contain various covenants and restrictions that limit the discretion of management in operating its business and could prevent us from engaging in some activities that may be beneficial to the Company’s business.

 

The agreements governing the Company’s financing, including its five-year, $500 million credit facility and the indentures governing the Company’s outstanding notes, contain various covenants and restrictions that, in certain circumstances, limit the Company’s ability and the ability of certain subsidiaries to:

 

 

As a result of these covenants and restrictions, the Company may be limited in how it conducts its business and may be unable to raise additional debt, compete effectively or make investments.

 

Declines in the value of the Company’s inventory or unexpected order cancellations by the Company’s customers could materially, adversely affect its business, results of operations, financial condition or liquidity.

 

The electronic components and computer products industries are subject to rapid technological change, new and enhanced products and evolving industry standards, which can contribute to a decline in value or obsolescence of inventory. During an industry and/or economic downturn, it is possible that prices will decline due to an oversupply of products and, as a result of the price declines, there may be greater risk of declines in inventory value. Although it is the policy of many of the Company’s suppliers to offer distributors like Avnet certain protections from the loss in value of inventory (such as price protection, limited rights of return and rebates), the Company cannot be assured that such return policies and rebates will fully compensate us for the loss in value, or that the vendors will choose to, or be able to, honor such agreements, some of which are not documented and therefore subject to the discretion of the vendor. In addition, the Company’s sales are typically made pursuant to individual purchase orders, and the Company generally does not have long-term supply arrangements with its customers. Generally, the Company’s customers may cancel orders 30 days prior to shipment with minimal penalties. The Company cannot be assured that unforeseen new product developments, declines in the value of the Company’s inventory or unforeseen order cancellations by its customers will not materially, adversely affect the Company’s business, results of operations, financial condition or liquidity, or that the Company will successfully manage its existing and future inventories.

 

Substantial defaults by the Company’s customers on its accounts receivable or the loss of significant customers could have a significant negative impact on the Company’s business, results of operations, financial condition or liquidity.

 

A significant portion of the Company’s working capital consists of accounts receivable from customers. If customers responsible for a significant amount of accounts receivable were to become insolvent or otherwise unable to pay for products and services, or were to become unwilling or unable to make payments in a timely manner, the Company’s business, results of operations, financial condition or liquidity could be adversely affected. An economic or industry downturn could adversely and materially affect the servicing of these accounts receivable, which could result in longer payment cycles, increased collection costs and defaults in excess of management’s expectations. A significant deterioration in the Company’s ability to collect on accounts receivable could also impact the cost or availability of financing under its Securitization Program.

The electronics component and computer industries are highly competitive and if the Company cannot effectively compete, its revenues may decline.

 

The market for the Company’s products and services is very competitive and subject to rapid technological advances. Not only does the Company compete with other global distributors, it also competes for customers with regional distributors and some of the Company’s own suppliers. The Company’s failure to maintain and enhance its competitive position could adversely affect its business and prospects. Furthermore, the Company’s efforts to compete in the marketplace could cause deterioration of gross profit margins and, thus, overall profitability.

 

The sizes of the Company’s competitors vary across market sectors, as do the resources the Company has allocated to the sectors in which it does business. Therefore, some of the competitors may have greater financial, personnel, capacity and other resources or a more extensive customer base than the Company has in one or more of its market sectors.

 

The Company’s non-U.S. locations represent a significant and growing portion of its revenue, and consequently, the Company is increasingly exposed to risks associated with operating internationally.

 

During fiscal year 2007, 2006 and 2005, approximately 50%, 49% and 48%, respectively, of the Company’s sales came from its operations outside the United States. Most notable in this growth of non-U.S. sales is the increasing volume of sales activity in the Asia region, which accounted for approximately 19% of consolidated sales during fiscal year 2007. As a result of the Company’s foreign sales and locations, its operations are subject to a variety of risks that are specific to international operations, including, but not limited to, the following:

 

 

The Company has operations in several locations in emerging or developing economies that have a potential for higher risk. The risks associated with these economies include currency volatility and other economic or political risks. While the Company has and will continue to adopt measures to reduce the impact of losses resulting from volatile currencies and other risks of doing business abroad, the Company cannot be ensured that such measures will be adequate.

 

If the Company fails to maintain effective internal controls, it may not be able to report its financial results accurately or timely or detect fraud, which could have a material adverse effect on the Company’s business or stock price.

 

Effective internal controls are necessary for the Company to provide reasonable assurance with respect to its financial reports and to effectively prevent fraud. If the Company cannot provide reasonable assurance with respect to its financial reports and effectively prevent fraud, its brand and operating results could be harmed. Pursuant to the Sarbanes-Oxley Act of 2002, the Company is required to furnish a report by management on internal control over financial reporting, including management’s assessment of the effectiveness of such control. Internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Therefore, even effective internal controls cannot provide absolute assurance with respect to the preparation and fair presentation of financial statements. In addition, projections of any evaluation of effectiveness of internal control over financial reporting to future periods are subject to the risk that the

control may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. If the Company fails to maintain the adequacy of its internal controls, including any failure to implement required new or improved controls, or if the Company experiences difficulties in their implementation, the Company’s business and operating results could be harmed, and the Company could fail to meet its reporting obligations, which could have a material adverse effect on its business and the share price.

 

If the Company’s internal information systems fail to function properly, its business operations could suffer.

 

The Company’s expanding operations put increasing reliance on the Company’s internal information systems in producing timely, accurate and reliable reports on financial and operational results. Currently, the Company’s global operations are tracked with multiple internal information systems. The Company recently implemented a new financial system for its North America operations. There is no guarantee that the Company will be successful at all times or that there will not be integration difficulties that will adversely affect the Company’s operations or the accurate recording and reporting of financial data. In addition, these systems are subject to computer hacking or other general system failure. Maintaining and operating these systems requires continuous investments. Failure of any of these internal information systems or material difficulties in upgrading these information systems could have material adverse effects on the Company’s business and its compliance with securities laws.

 

 

Not applicable.

 

 

At June 30, 2007, the Company owned and leased approximately 839,000 and 3,918,000 square feet of space, respectively, of which approximately 44% is located in the United States. The following table summarizes certain of the Company’s key facilities as of June 30, 2007. In addition, the Company has numerous facilities that were added as a result of acquisitions, including Access warehouse facilities, certain of which are expected to be exited within the next twelve months.

 

 

 

As a result primarily of certain former manufacturing operations, Avnet may have liability under various federal, state and local environmental laws and regulations, including those governing pollution and exposure to, and the handling, storage and disposal of, hazardous substances. For example, under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (“CERCLA”) and similar state laws, Avnet may be liable for the costs of cleaning up environmental contamination on or from its current or former properties, and at off-site locations where the Company disposed of wastes in the past. Such laws may impose joint and several liability. Typically, however, the costs for cleanup at such sites are allocated among potentially responsible parties (“PRPs”) based upon each party’s relative contribution to the contamination, and other factors.

In May 1993, the Company and the former owners of a Company-owned site in Oxford, North Carolina entered into a Settlement Agreement in which the former owners agreed to bear 100% of all costs associated with investigation and cleanup of soils and sludges remaining on the site and 70% of all costs associated with investigation and cleanup of groundwater. The Company agreed to be responsible for 30% of the groundwater investigation and cleanup costs. In October 1993, the Company and the former owners entered into a Consent Decree and Court Order with the Environmental Protection Agency (the “EPA”) for the environmental clean up of the site, the cost of which, according to the EPA’s remedial investigation and feasibility study, was estimated to be approximately $6.3 million, exclusive of the approximately $1.5 million in EPA past costs paid by the PRPs. Based on current information, the Company does not anticipate its liability in the matter will be material to its financial position, cash flow or results of operations.

 

The Company is a PRP at a manufacturing site in Huguenot, New York, currently under investigation by the New York State Department of Environmental Conservation (“NYSDEC”), which site the Company owned from the mid-1960s until the early 1970s. The Company has reached a settlement in litigation to apportion the estimated clean-up costs among it and the current and former owners and operators of the site. Pursuant to the settlement, the Company has paid a portion of past costs incurred by NYSDEC and the current owner of the site, and will also pay a percentage of the cost of the environmental clean up of the site (the first phase of which has been estimated to cost a total of $2.4 million for all parties to remediate contaminated soils). The remediation plan is still subject to final approval by NYSDEC. Based on the settlement arrangement and the expected costs of the remediation efforts, the Company does not anticipate its liability in the matter will be material to its financial position, cash flow or results of operations.

 

Based on the information known to date, management believes that the Company has appropriately accrued in its consolidated financial statements for its share of the costs associated with these and other environmental clean up sites.

 

The Company and/or its subsidiaries are also parties to various other legal proceedings arising from time to time in the normal course of business. While litigation is subject to inherent uncertainties, management currently believes that the ultimate outcome of these proceedings, individually and in the aggregate, will not have a material adverse effect on the Company’s financial position, cash flow or results of operations.

 

 

Not applicable.

 

PART II

 

 

Market price per share

 

The Company’s common stock is listed on the New York Stock Exchange under the symbol AVT. Quarterly high and low sales prices (as reported for the New York Stock Exchange composite transactions) for the last two fiscal years were:

 

 

The Company has not paid dividends since fiscal 2002 and does not currently contemplate any future dividend payments.

 

Record Holders

 

As of July 27, 2007, there were approximately 3,402 holders of record of Avnet’s common stock.

 

 

 

Stock Performance Graphs and Cumulative Total Returns

 

The two graphs below compare Avnet, Inc.’s cumulative 5-year and 4-year total shareholder return on common stock with the cumulative total returns of the S&P 500 index and a peer group. The Peer Group includes seven companies which are Agilysys Inc, Arrow Electronics Inc, Bell Microproducts Inc, Ingram Micro Inc, Jaco Electronics, Nu Horizons Electronics Corp. and Tech Data Corp. The graph tracks the performance of a $100 investment in our common stock, the peer group, and the index (with the reinvestment of all dividends) from June 28, 2002 to June 30, 2007 and June 27, 2003 to June 30, 2007, respectively.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Avnet, Inc., The S&P 500 Index And A Peer Group

 

 

 

* $100 invested on 6/28/02 in stock or index-including reinvestment of dividends.

 

Index calculated on month-end basis.

 

Copyright ^© 2007, Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved. www.researchdatagroup.com/S&P.htm

 

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

 

COMPARISON OF 4 YEAR CUMULATIVE TOTAL RETURN*
Among Avnet, Inc., The S&P 500 Index And A Peer Group

 

 

 

* $100 invested on 6/27/03 in stock or on 6/30/03 in index-including reinvestment of dividends.

 

Index calculated on month-end basis.

 

Copyright ^© 2007, Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved. www.researchdatagroup.com/S&P.htm

 

 

Issuer Purchases of Equity Securities

 

The following table includes the Company’s monthly purchases of common stock during the fourth quarter ended June 30, 2007:

 

 

The purchases of Avnet common stock noted above were made on the open market to obtain shares for purchase under the Company’s Employee Stock Purchase Plan. None of these purchases were made pursuant to a publicly announced repurchase plan and the Company does not currently have a stock repurchase plan in place.

 

 

 

 

 

 

For an understanding of Avnet and the significant factors that influenced the Company’s performance during the past three fiscal years, the following discussion should be read in conjunction with the description of the business appearing in Item 1 of this Report and the consolidated financial statements, including the related notes, and other information appearing in Item 15 of this Report. The Company operates on a “52/53-week” fiscal year. The fiscal years ended June 30, 2007, July 1, 2006 and July 2, 2005 all contained 52 weeks.

 

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 against the Euro by approximately 7% when comparing fiscal 2007 to fiscal 2006, but strengthened against the Euro by approximately 4% from fiscal 2006 to fiscal 2005. When the weaker 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 an increase, in US Dollars, of reported results. When the stronger US Dollar exchange rates are used to translate the results, 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.” When this “translation impact of changes in foreign currency exchange rates” is excluded from the reported results on a pro forma basis, it is referred to as “constant dollars.” Results as reported in the financial statements which include this translation impact are referred to as “delivered dollars” or “reported dollars.”

 

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 translation impact of changes in foreign currency exchange rates, as discussed above, or adjusted for the impact of acquisitions (by adjusting Avnet’s prior periods to include the sales of businesses acquired prior to the date of acquisition) and divestitures (by adjusting Avnet’s prior periods to exclude the sales of businesses divested). 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. However, 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.

 

Results of Operations

 

Executive Summary

 

Several items impacted the financial results for Avnet as a whole when comparing fiscal 2007 results with fiscal 2006. The acquisitions of Access Distribution (“Access”) and Azure Technology (“Azure”) (both discussed further below), which occurred in the third and fourth quarter of fiscal 2007, respectively, positively impacts the comparison of results to prior period results of Avnet and TS as prior periods do not include the acquired business’ results before the date of acquisition. Also, in conjunction with the acquisition of Access and reflecting recent industry trends, the Company reviewed its method of recording revenue related to the sales of supplier service contracts and determined that such sales will now be classified on a net revenue basis rather than on a gross basis beginning the third quarter of fiscal 2007 (referred to as “the change to net revenue reporting” in this MD&A). Although this change reduces sales and cost of sales for the Technology Solutions operating group and on a consolidated basis, it has no impact on operating income, net income, cash flow or the balance sheet. The Company divested of several small non-core businesses during fiscal 2006 affecting both EM and TS which also negatively impacts fiscal 2007 sales comparisons with fiscal 2006 as the prior periods include the sales of the divested businesses. These items, when aggregated, have a net positive impact on fiscal 2007 sales comparisons to prior periods and are presented in tables under Sales.

 

As mentioned above, on December 31, 2006, Avnet completed the acquisition of Access Distribution, a leading value-added distributor of complex computing solutions which recorded sales of $1.90 billion in calendar year 2006. The purchase price of approximately $437.6 million, subject to adjustment based upon the audited closing net book value, was funded primarily with debt plus cash on hand. The integration of the Access business into the TS Americas and EMEA operations was complete as of the end of fiscal 2007 and, as a result, the Company estimates it achieved more than $15 million of annualized synergies; the benefit of which will largely impact fiscal 2008. In addition, during fourth quarter of fiscal 2007, the Company acquired Azure, an IT solutions provider in Asia that specializes in systems infrastructure and application solutions services with annualized sales of approximately $90 million.

 

Avnet’s consolidated sales for fiscal 2007 were a record $15.68 billion, up $1.43 billion or 10.0%, over fiscal 2006 of $14.25 billion, with approximately $340 million of the increase resulting from the translation impact of foreign currency exchange rates. The TS operating group was the driver of the year-over-year growth primarily as a result of the Access and Azure acquisitions, which contributed over $950 million in sales since they were acquired. TS sales were up 20.2% year over year and EM sales were up 4.5%. As presented in the tables under Sales,

consolidated sales were impacted by the Access and Azure acquisitions, the businesses divested in fiscal 2006 and the change to net revenue reporting.

 

Avnet’s ongoing focus on the management of operating costs and returns on capital has resulted in its highest level of operating income, operating income margin and returns on capital since before the multi-year economic and industry downturn that began in 2001. On a consolidated basis, operating income grew 56.6% to a record $678.3 million as compared with fiscal 2006 operating income of $433.1 million. Operating profit margin also increased year over year to 4.3%, up 129 basis points from 3.0% in the prior fiscal year. Both operating groups contributed to the year-over-year increase in operating profit margin, with EM and TS reporting operating profit margins of 5.5% (an increase of 95 basis points) and 3.9% (an increase of 55 basis points), respectively, for fiscal 2007. For EM, the fourth quarter of fiscal 2007 marks the sixth quarter in a row that operating income margin is over 5.0%. For TS, the fourth quarter of fiscal 2007 marks the sixteenth consecutive quarter of year-over-year improvement in both operating income dollars and margin. The consolidated current and prior year results included certain restructuring, integration and other items discussed further in this MD&A, which amounted to $7.4 million for fiscal 2007 and $69.9 million ($9.0 million of which was included in “cost of sales”) for the prior year. Despite these charges, the year-over-year operating income improved primarily as a result of continued focus on profitable growth, cost efficiencies and the effect of the realization of a full year of synergies after the successful integration of the Memec acquisition.

 

Operating efficiency and working capital management will remain a key focus of Avnet’s overall value-based management initiatives to increase return on capital and its efforts to continue to grow profitability at a faster rate than its growth in revenues.

 

It is difficult for the Company, as a distributor, to forecast the material trends of the electronic component and computer products industry, aside from some of the normal seasonality discussed herein, because Avnet does not typically have material forward-looking information available from its customers and suppliers beyond a few months of forecast information by way of incoming order rates. As such, management relies on the publicly available information published by certain industry groups and other related analyses in evaluating its business plans in the longer term.

 

Sales

 

The table below provides a year-over-year summary of sales for the Company and its operating groups:

 

Three-Year Analysis of Sales: By Operating Group and Geography

 

Items Impacting Fiscal 2007 Sales

 

As discussed in Executive Summary, sales for fiscal 2007 as compared with fiscal 2006 were impacted by the aggregate of (i) the sales of Access and Azure since the close of the acquisitions, (ii) sales of the divested EM and TS businesses included in prior periods, and (iii) the change in classification of sales of supplier service contracts to a net revenue basis. Comparative financial information is presented for acquisitions, divestitures and other items in order to better assess and understand the Company’s revenue performance. The following tables present the sales of acquisitions prior to their date of close; revenue from divestitures prior to their date of sale and the effect of the change to net revenue reporting for periods prior to the implementation thereof for each quarter of fiscal 2007 and 2006.

 

 

 

Avnet’s consolidated sales in fiscal 2007 were a record $15.68 billion, up $1.43 billion, or 10.0%, over fiscal 2006 consolidated sales of $14.25 billion. The year-over-year growth occurred in all three geographic regions and in both operating groups. Of the $1.43 billion year-over-year increase, approximately $340 million is a result of the translation impact of changes in foreign currency exchange rates. More than half of the reported sales growth is attributable to the Access and Azure acquisitions. As presented in the tables above, the comparison of sales to prior year were also impacted by current year acquisitions, prior year divestitures and the change to net revenue reporting. When the impacts of these items are considered in both the current and prior fiscal year, consolidated sales growth would have been 5.7%. Both EM and TS contributed to the year-over-year improvement in sales. Specifically, fiscal 2007 sales for EM were $9.68 billion, up $417.4 million, or 4.5% over fiscal 2006. Fiscal 2007 sales for TS were $6.00 billion, up $1.01 billion, or 20.2%, as compared with sales of $4.99 billion for fiscal 2006. Including Access and Azure in the periods prior to the acquisition dates and including the change to net revenue reporting for periods prior to third quarter of fiscal 2007, TS year-over-year sales growth would have been 5.5%.

 

EM sales of $9.68 billion were up 4.5% over fiscal 2006. Excluding the translation impact of changes in foreign currency exchange rates (which management estimates increased current year sales by approximately $221 million) and the impact of divestitures (which had sales of approximately $123 million in fiscal 2006), EM sales grew 3.5% year over year. Although the rate of EM sales growth slowed to the low single digits at the end of fiscal 2007, continued focus on operating efficiencies and profitable revenue enabled EM to grow operating income more than five times faster than sales. Geographically, sales in the EM Americas were $3.72 billion, a decline of 1.5% from fiscal 2006 sales of $3.78 billion. The fiscal 2007 sales in the EM Americas region were significantly impacted by a slow down in purchases from large EMS customers primarily due to softer demand in the communications infrastructure end markets. Sales in the EM EMEA region increased 7.9% to $3.31 billion in fiscal 2007 and increased 4.7% excluding the impact of divestitures and the changes in foreign currency exchange rates. The comparative results for the EM EMEA were positively impacted by the changes in foreign currency

exchange rates, as discussed above, but were negatively impacted as prior year sales for the EM EMEA region included revenues of approximately $123 million of two small specialty businesses that were divested in the fourth quarter of fiscal 2006. EM Asia sales were $2.65 billion, up 9.6% over fiscal 2006 sales of $2.42 billion as Asia continues to experience the highest growth rate among the three regions.

 

TS reported sales of $6.00 billion for fiscal 2007, up $1.01 billion, or 20.2%, when compared with fiscal 2006 sales of $4.99 billion. Approximately $118 million of the growth is due to the translation impact of changes in foreign currency exchange rates. More than half of the year-over-year growth was due to the acquisition of Access. Conversely, the comparative year-over-year growth for TS was negatively impacted by the change to net revenue reporting for supplier service contracts and by the divestiture of its Enterprise Solutions business during the third quarter of fiscal 2006, which generated sales of approximately $112 million in fiscal 2006. Excluding the effect of current year acquisitions, prior year divestitures and the change to net revenue reporting as presented in the preceding table, TS sales growth would have been 5.5% which was impacted by weakness in microprocessor sales. On a regional basis, all three regions experienced sales growth with the Americas contributing the majority of the increase which grew $658.1 million, or 19.1%, year over year. The EMEA region reported sales growth of 20.6%, or 3.3% excluding the translation impact of changes in foreign currency exchange rates of approximately $117 million, the change to net revenue reporting and the impact of the Access acquisition. The Asia region, which was not impacted by the Access acquisition, grew sales 34.7%, with more than half of the growth due to the positive impact of the Azure acquisition. For the Americas and EMEA regions, comparisons to prior year were positively impacted by the Access acquisition and negatively impacted by the change to net revenue reporting and the business divested in fiscal 2006 in the Americas.

 

Avnet’s consolidated sales in fiscal 2006 were $14.25 billion, up $3.19 billion, or 28.8%, over fiscal 2005 consolidated sales of $11.07 billion. Year over year growth was driven primarily by the acquisition of Memec. Including Memec’s sales in fiscal 2005 on a pro forma basis, Avnet’s consolidated sales grew 6.8% on a delivered U.S. dollar basis and an estimated 8.3% excluding the translation impact of changes in foreign currency exchange rates. EM recorded sales of $9.26 billion in fiscal 2006, up $3.00 billion, or 48.0%, over EM’s fiscal 2005 sales of $6.26 billion. Including Memec’s sales in fiscal 2005 on a pro forma basis, EM’s fiscal 2006 sales grew 8.4% as compared with the prior year in delivered U.S. dollars and by approximately 10.2% excluding the translation impact of changes in foreign currency exchange rates, which management estimates reduced EM’s year-over-year sales growth by approximately $151 million. TS sales in fiscal 2006 were a record $4.99 billion, up $183 million, or 3.8%, over fiscal 2005 sales of $4.81 billion. Excluding the impact of changes in foreign currency exchange rates, TS fiscal 2006 sales grew approximately 4.9% over the prior year.

 

Gross Profit and Gross Profit Margins

 

Consolidated gross profit was $2.05 billion in fiscal 2007, up $209.6 million, or 11.4%, as compared with fiscal 2006. The gross profit in fiscal 2006 included a charge totaling $9.0 million to write down inventory due primarily to supplier terminations in connection with the Memec acquisition in fiscal 2006. See Restructuring, Integration and Other Items for further discussion. Gross profit margin of 13.1% was up 16 basis points as compared with fiscal 2006 profit margin of 12.9%. Both operating groups contributed to the improvement in gross profit margins with an increase of 33 basis points at EM and 17 basis points at TS. The impact to gross margins resulted from the change in the mix of business between EM and TS over the prior year as a result of the Access acquisition as well as the change from gross revenue to net revenue reporting for supplier service contracts. For EM, the mix of revenues among small-to-medium businesses and large customers, particularly large EMS customers discussed previously, positively impacted EM’s gross profit margins. With the addition of Access sales in fiscal 2007, TS sales grew to 38% of consolidated sales compared to 35% of consolidated sales in fiscal 2006 which impacted consolidated gross margins. The TS business is typically a higher asset velocity business than EM, but is also a lower gross profit margin business compared with EM.

 

Consolidated gross profit in fiscal 2006 was $1.84 billion as compared with $1.46 billion in fiscal 2005. Gross profit margin in fiscal 2006 was 12.9%, down from 13.2% in fiscal 2005. The increase in gross profit dollars was due primarily to the increase in sales as a result of the acquisition of Memec. As mentioned above, the gross profit in fiscal 2006 included charges totaling $9.0 million to write down certain inventory due primarily to supplier

terminations. In fiscal 2006, the Company’s gross margin was impacted by the mix of business between Avnet’s two operating groups and mix of sales by region.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative (SG&A) expenses in fiscal 2007 were $1.36 billion, an increase of $18.1 million, or 1.3%, as compared with fiscal 2006. Excluding the translation impact of changes in foreign currency exchange rates, SG&A expenses were down 1.2%. The year-over-year comparison of expenses was positively impacted by the divestitures of businesses in the second half of fiscal 2006, further cost-reduction initiatives during fiscal 2007 (see Restructuring, Integration and Other Items for further discussion) and the synergy benefits associated with the Memec integration during fiscal 2006. During fiscal 2006, the Company was in the process of integrating the Memec business into the existing operations of Avnet, with that integration completed by the end of fiscal 2006. As a result, fiscal 2007 operating expenses reflect the full benefit of the synergies achieved, whereas fiscal 2006 results reflect only a portion of the synergies as the integration was not completed until the end of fiscal 2006. In addition, during the second half of fiscal 2007, the Access acquisition was being integrated into Avnet’s business which was completed as of the end of fiscal 2007. Management estimates that as of the end of fiscal 2007 it has achieved over $15 million of annualized operating expense synergies as a result of the completed integration, which are expected to be fully realized beginning fiscal 2008.

 

Two additional metrics which management monitors are SG&A expenses as a percentage of sales and as a percentage of gross profit. SG&A as a percentage of sales was 8.7% in fiscal 2007, down 75 basis points, as compared with 9.4% in fiscal 2006. SG&A as a percentage of gross profit was 66.5% in fiscal 2007, down 660 basis points, as compared with 73.1% in fiscal 2007; however, this metric for fiscal 2006 was negatively impacted by the $9.0 million line termination charge in prior year (see Restructuring, Integration and Other Items for further discussion). The year-over-year improvement in both of these metrics is primarily due to the Company’s realization of operating expense synergies following the acquisition and integration of Memec. The metrics were also positively impacted by the Company’s ongoing focus on managing levels of operating costs through its various operational excellence initiatives.

 

Consolidated SG&A expenses were $1.34 billion, or 9.4% of sales, in fiscal 2006 as compared with $1.14 billion, or 10.3% of sales, in fiscal 2005. The increase in SG&A dollars over the prior year is a direct result of the expansion of the overall business following the acquisition of Memec at the beginning of fiscal 2006. Despite this increase in SG&A expenses, the ratio of SG&A expenses as a percentage of sales improved 84 basis points over fiscal 2005. The primary driver in the ratio improvement was the realization of synergies as a result of restructuring and integration actions taken in fiscal 2006. As of the end of fiscal 2006, the Company had taken actions to remove approximately $150 million of annualized operating expenses from the combined Avnet and Memec businesses. SG&A expenses as compared to fiscal 2005 were also negatively impacted by incremental stock-based compensation expense as a result of the adoption of a new accounting pronouncement and the initial recognition and subsequent amortization of intangible assets associated with the Memec acquisition.

 

Restructuring, Integration and Other Items

 

The Company recorded a number of restructuring, integration and other items during fiscal 2007 and 2006. There were no restructuring charges recorded in fiscal 2005. The fiscal 2007 restructuring, integration and other items related primarily to cost-reduction initiatives and the acquisition and subsequent integration of Access. The fiscal 2006 restructuring, integration and other items relate primarily to actions taken to integrate Memec into the existing Avnet business as well as actions taken in connection with recent divestitures, and other actions. See Note 17 to the consolidated financial statements in Item 15 of this Report for a summary of activity within the restructuring, integration and other charges accounts during the past three years.

 

Fiscal 2007

 

During fiscal 2007, the Company incurred certain restructuring, integration and other items as a result of cost-reduction initiatives in all three regions, the acquisition of Access on December 31, 2006 and other items. The Company established and approved plans for cost-reduction initiatives across the Company and approved plans to

integrate the acquired Access business into Avnet’s existing TS operations, which was complete as of the end of fiscal 2007.

 

Restructuring expenses recorded as a result of the exit-plans implemented during fiscal 2007 as discussed above were $13.6 million and included severance costs of $10.8 million, facility exit-costs of $1.0 million, and other contract termination costs of $1.8 million. In addition, in connection with the Access acquisition, the Company recorded integration costs of $7.3 million. The Company also recorded in “restructuring, integration and other items” the write-down of $0.7 million related to an Avnet owned building in EMEA, and the reversal of $1.7 million related primarily to excess severance and lease reserves, certain of which were previously established through “restructuring, integration and other items” in prior fiscal periods. Partially offsetting these charges was a pre-tax benefit of $12.5 million which resulted from the favorable outcome of a contingent liability acquired in connection with an acquisition completed in a prior year. The combined impact of the restructuring, integration and other charges and the acquisition-related benefit recorded during fiscal 2007 was a charge of $7.4 million pre-tax, $5.3 million after tax and $0.03 per share on a diluted basis.

 

Severance charges related to Avnet personnel reductions of 96 employees in all three regions of EM and 42 employees in TS Americas and EMEA (a total of 138 employees) in administrative, finance and sales functions associated with the cost reduction initiatives implemented during the third and fourth quarter of fiscal 2007 as part of the Company’s continuing focus on operational efficiency, and Avnet employees who were deemed redundant as a result of the Access integration. The facility exit charges related to vacated Avnet facilities in the Americas and Japan. Other charges consisted primarily of Avnet IT-related and other asset write-downs and other contract termination costs. Included in the asset write-downs were Avnet software in the Americas that was made redundant as a result of the acquisition, Avnet system hardware in EMEA that was replaced with higher capacity hardware to handle increased capacity due to the addition of Access, and the write-down of certain capitalized construction costs abandoned as a result of the acquisition. Other charges incurred included contractual obligations related to abandoned activities, the write-down of an Avnet-owned building in EMEA and Access integration costs. The write-down of the building was based on management’s estimate of the current market value and possible selling price, net of selling costs, for the property. The integration costs related to incremental salary costs, primarily of Access personnel, who were retained following the close of the acquisition solely to assist in the integration of Access’ IT systems, administrative and logistics operations into those of Avnet. These personnel had no other meaningful day-to-day operational responsibilities outside of the integration efforts. Also included in integration costs are certain professional fees, travel, meeting, marketing and communication costs that were incrementally incurred solely related to the Access integration efforts.

 

Of the $13.6 million recorded to expense related to the cost-reduction activities and exit-related activity associated with the Access integration, $0.7 million represented non-cash write-downs. As of June 30, 2007, the remaining reserves totaled $7.9 million which included severance reserves of $6.7 million, facility exit reserves for lease of $0.8 million and other contract termination costs of $0.4 million. Management expects the majority of the reserves to be utilized by the end of fiscal 2008.

 

While the above charges related to Avnet personnel, facilities and operations, and are therefore recorded through Avnet’s consolidated statements of operations as “restructuring, integration and other items”, the Company also recorded certain purchase accounting adjustments during fiscal 2007 related to the acquired personnel and operations of Access. These adjustments were generally recorded as part of the allocation of purchase price and, therefore, were not recorded in the Company’s consolidated statement of operations. During fiscal 2007, the Company established and approved plans to integrate the acquired operations of Access into the Americas and EMEA regions of the Company’s TS operations, for which the Company recorded $5.0 million in exit-related purchase accounting adjustments. These purchase accounting adjustments consisted primarily of $3.0 million for severance for Access workforce reductions of 80 personnel (primarily administrative, finance and other operational functions); $1.8 million for lease and other contract termination costs; and $0.2 million for remaining commitments and termination charges related to other contractual commitments of Access that will no longer be of use in the combined business. Of these exit-related purchase accounting adjustments recorded in the fiscal 2007, $0.7 million was paid out in cash during fiscal 2007, leaving $4.3 million of remaining reserves related to severance, which are expected to be substantially paid out by the end of fiscal 2008, and lease and other contractual commitment reserves, for which payments will extend into fiscal 2013.

Fiscal 2006

 

During the fiscal year 2006, the Company incurred certain restructuring, integration and other items as a result of the acquisition of Memec on July 5, 2005, which is discussed further under Memec-related restructuring, integration and other items. In addition, the Company has incurred restructuring and other charges primarily relating to actions taken following the divestitures of two TS end-user 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 line divestitures and other actions. The restructuring, integration and other items incurred for all of these activities totaled $69.9 million pre-tax (including $9.0 million recorded in cost of sales), $49.9 million after-tax and $0.34 per share on a diluted basis for fiscal 2006.

 

Memec-related restructuring, integration and other items

 

During fiscal 2006, the acquired Memec business was 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 integration of Memec into Avnet.

 

The restructuring and other charges (excluding integration charges discussed below) incurred during fiscal 2006 related to the integration of Memec totaled $31.6 million pre-tax, $24.2 million after-tax and $0.16 per share on a diluted basis. The pre-tax charges included inventory write-downs for terminated lines amounting to $9.0 million recorded in “cost of sales” as discussed below. The remaining pre-tax charge of $22.6 million, which was included in “restructuring, integration and other items” in the accompanying consolidated statement of operations, included $16.4 million for severance costs, $2.6 million of facility exit costs related primarily to remaining lease obligations on exited facilities, $2.4 million for the write-down of certain capitalized IT-related initiatives, primarily in the Americas, and $1.2 million 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 as a result of the Memec acquisition. 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 Avnet management 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 by Avnet. Severance charges incurred during 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 as a result of the integration 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 due to the integration of Memec. 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 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 fiscal 2006 related primarily to certain other contractual obligations and contract termination charges.

 

Of the $31.6 million recorded to expense for the Memec-related restructuring activity during fiscal 2006, $11.6 million represented non-cash asset 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. In addition, certain severance and lease liabilities in the amount of $1.3 million were assumed by the buyer of the net assets of a small, non-core EM business in the EMEA region (see Gain (Loss) on Sale of Business Lines in this MD&A for further discussion). The

remaining Memec-related charges in fiscal 2006 of $18.7 million required or will require the use of cash, of which $15.4 million was paid during fiscal 2006.

 

As of June 30, 2007, remaining Memec-related reserves related to the restructuring actions taken in fiscal 2006 totaled $0.6 million, of which $0.2 million related to severance reserves, which management expects to utilize by the end of fiscal 2008, facility exit costs of $0.4 million, the majority of which management expects to utilize by fiscal 2009.

 

As a result of the Memec acquisition and its subsequent integration into Avnet, the Company incurred integration costs during fiscal 2006, which totaled $21.9 million pre-tax, $14.6 million after-tax and $0.10 per share on a diluted basis. The integration costs, particularly in the first nine months of fiscal 2006, related to incremental salary costs, primarily of Memec personnel, who were retained 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 efforts. 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 included 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, along with restructuring and other charges, are presented separately from selling, general and administrative expenses. All integration costs recorded in fiscal 2006 represent amounts incurred and paid during fiscal 2006.

 

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

 

During the third quarter of fiscal 2006, the Company divested two of its end-user business lines in TS Americas (see Gain (Loss) on Sales of Business Lines in this MD&A for further discussion). 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 and certain actions at corporate in fiscal 2006. The restructuring and other charges incurred during the fiscal 2006 related to these actions totaled $16.5 million pre-tax, $11.0 million after-tax and $0.08 per share on a diluted basis. The pre-tax charges, which are included in “restructuring, integration and other items” in the accompanying consolidated statement of operations, consisted of severance costs of $5.9 million related to TS operations in the Americas and EMEA regions, facility exit costs in the Americas and EMEA regions totaling $6.5 million, and $4.1 million for other charges. Other charges included $3.2 million pre-tax, which related primarily to a curtailment charge resulting from a small UK-based pension plan that the Company elected to terminate, $1.8 million related to the reassessment of an existing environmental liability, $0.4 million of other charges, and a reversal of $1.3 million for charges recorded through restructuring charges in prior fiscal years primarily in TS EMEA.

 

The severance costs related primarily to severance and other termination benefit payments related to 20 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 two management-level employees whose primary responsibilities previously included the management of the divested business lines. Severance charges in fiscal 2006 also included termination benefits for over 10 personnel in the TS EMEA operations who were identified as redundant based upon the realignment of certain job functions in that region and two corporate management-level employees. 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 fiscal 2006 related primarily to asset impairment charges recorded in the second quarter and fourth quarter of fiscal 2006 totaling $3.6 million for two owned but vacant facilities and certain related fixed assets — 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 and environmental liability charge noted previously.

 

Of the $16.5 million recorded to expense for these restructuring and other charges during fiscal 2006, $3.3 million represented non-cash asset 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 fiscal 2006, amounting to $13.2 million, required or will require the use of cash, of which $5.1 million was paid during fiscal 2006.

 

As of June 30, 2007, remaining reserves related to the non-Memec related restructuring activities taken in fiscal 2006 totaled $2.1 million, of which $0.7 million related to severance reserves, the majority of which management expects to utilize by the end of fiscal 2008, facility exit costs of $1.3 million, the majority of which management expects to utilize by fiscal 2013, and other costs of $0.1 million, the majority of which management expects to utilize before the end of fiscal 2008.

 

While the above charges related to Avnet personnel, facilities and operations, and are therefore recorded through Avnet’s consolidated statements of operations as “restructuring, integration and other items”, the Company also recorded numerous purchase accounting adjustments during fiscal 2006 related to the acquired personnel and operations of Memec. These adjustments were generally recorded as part of the allocation of purchase price and, therefore, were not recorded in the Company’s consolidated statement of operations. During fiscal 2006, 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 $73.3 million in exit-related purchase accounting adjustments. These purchase accounting adjustments consist primarily of $32.5 million for severance for Memec workforce reductions of over 700 personnel (including senior management, administrative, finance and certain operational functions) primarily in the Americas and EMEA; $36.2 million for lease and other contract termination costs; and $4.6 million for remaining commitments and termination charges related to other contractual commitments of Memec that will no longer be of use in the combined business. Of these exit-related purchase accounting adjustments recorded in the fiscal 2006, $43.1 million was paid out in cash during fiscal 2006 and $7.7 million were non-cash write-downs.

 

As of June 30, 2007, remaining reserves related to these purchase accounting reserves totaled $14.4 million, of which $0.4 million related to severance reserves, the majority of which management expects to utilize by the end of fiscal 2008, facility exit costs of $12.0 million and other costs of $2.0 million, the majority of which management expects to utilize by the end of fiscal 2013. During fiscal 2007, $0.6 million of the reserves initially recorded through purchase accounting were deemed excessive and were reversed through goodwill.

 

Fiscal 2005

 

Although there were no restructuring charges recorded in fiscal 2005, the Company recorded certain adjustments to reserves totaling $1.3 million during fiscal 2005, which were recorded through “selling, general and administrative expenses”. The adjustments related primarily to the reversal of certain excess legal expense reserves associated with finalization of termination payments and reversal of excess severance reserves, offset in part by additional severance costs recorded based upon revised estimates of required payouts. The Company also reduced certain lease reserves due to modification to sublease and termination assumptions based upon ongoing market conditions.

 

Operating Income

 

Operating income for fiscal 2007 was $678.3 million, or 4.3% of consolidated sales, as compared with operating income of $433.1 million, or 3.0% of consolidated sales, in fiscal 2006. The gross margin and operating expense trends discussed previously in this MD&A contributed to the 129 basis point improvement in operating income margin year over year. The operating income margin in fiscal 2007 benefited by 10 basis points as a result of the change to net revenue reporting for supplier service contracts and was negatively impacted by 5 basis points from the restructuring, integration and other items in connection with the cost reduction initiatives and the Access integration activity as well as other items previously discussed, which amounted to $7.4 million pre-tax. In comparison, operating income for fiscal 2006 was negatively impacted by a total of $69.9 million (0.5% of

consolidated sales) for restructuring charges previously described. See Restructuring, Integration and Other Items for further discussion. The overall improvement in operating income margin without these charges was driven by the increased sales volume, gross profit margin growth, continued focus on cost management and the full benefit of the synergies achieved subsequent to the successful Memec integration completed at the end of fiscal 2006, as discussed previously in this MD&A.

 

EM reported operating income of $529.9 million (5.5% of EM sales) in fiscal 2007 as compared with operating income of $419.1 million (4.5% of EM sales) in fiscal 2006. The fourth quarter of fiscal 2007 is the sixth consecutive quarter that EM has generated operating income margin in excess of 5.0%. This year-over-year improvement is a direct result of the full benefit of the synergies realized from the Memec integration and continued focus on profitable top line growth. TS increased operating income to $232.2 million, or 3.9% of TS sales, as compared with $165.7 million, or 3.3% of TS sales, in the prior year, which is a 55 basis point increase in operating profit margin over fiscal 2006. The fourth quarter of fiscal 2007 represents the sixteenth consecutive quarter of year-over-year improvement in both operating income dollars and margin for TS.

 

Operating income for fiscal 2006 was $433.1 million, or 3.0% of consolidated sales, as compared with operating income of $321.3 million, or 2.9% of consolidated sales, in fiscal 2005. Operating income dollars increased over the prior year largely as a result of the Memec acquisition. The margin and operating expense trends discussed previously in this MD&A contributed to the operating income performance improvement over prior year. Operating income in fiscal 2006 was negatively impacted by a total of $69.9 million (0.5% of consolidated sales) for charges previously described. (See Restructuring, Integration and Other Items). Operating income for fiscal 2006 as compared to fiscal 2005 was also negatively impacted by incremental stock-based compensation expense as a result of the adoption of a new accounting pronouncement and the initial recognition and subsequent amortization of intangible assets associated with the Memec acquisition. EM reported operating income of $419.1 million (4.5% of EM sales) in fiscal 2006 as compared with operating income of $233.1 million (3.7% of EM sales) in fiscal 2005. The 80 basis point year-over-year improvement in operating income margin reflects increased volume resulting from the Memec acquisition and the partial realization of synergies created from the successful integration of the combined businesses. Operating income at TS was $165.7 million (3.3% of TS sales) as compared with operating income of $147.7 million (3.1% of TS sales) in fiscal 2005. The improvement in TS operating profitability in fiscal 2006 was driven by continued focus on profitable relationships and managing ongoing operating costs.

 

Interest Expense and Other Income

 

Interest expense was $77.2 million in fiscal 2007, down $19.3 million, or 20.0%, from interest expense of $96.5 million in fiscal 2006. The decrease in interest expense is attributable to the reduction in the average debt balance year over year and a lower effective interest rate on debt outstanding during fiscal 2007. The lower effective interest rate is a direct result of the refinancing activities that occurred in fiscal 2006 and fiscal 2007, whereby higher interest rate debt was repaid or replaced with lower interest rate debt. Specifically, during the fourth quarter of fiscal 2006, the Company repurchased $113.6 million of its 93/4% Notes due February 15, 2008 with available liquidity. During fiscal 2007, the Company issued $300.0 million principal amount of 6.625% Notes due 2016 in September 2006, and used the proceeds and available liquidity to fund the repurchase of $361.4 million of the 93/4% Notes, which was completed in October 2006. The Company also repaid the remaining $143.7 million of the 8.00% Notes that matured on November 15, 2006 and, in March 2007, the Company issued $300.0 million principal amount of 5.875% Notes due 2014 and used the proceeds to repay amounts outstanding under the Credit Facility and the Securitization Program. See Financing Transactions for further discussion of the Company’s outstanding debt.

 

Interest expense was $96.5 million in fiscal 2006, up $11.4 million, or 13.5%, from interest expense of $85.1 million in fiscal 2005. The increase in interest expense was a result of rising short-term interest rates and higher borrowings on the Company’s various bank credit facilities. As a result of rising short-term interest rates during fiscal 2006, the Company incurred a higher rate of interest on its fair value hedges. The increased borrowings were a direct result of certain cash expended for the acquisition of Memec in the first quarter of fiscal 2006, cash payments for other charges in fiscal 2006 and working capital needs (see Liquidity and Capital Resources — Cash Flow for further discussion). The factors driving interest expense up were offset partially by the favorable impact of

the Company’s issuance of $250.0 million of 6.00% Notes due September 1, 2015 and repurchase of $254.1 million of the Company’s higher rate 8.00% Notes due November 15, 2006 during the first quarter of fiscal 2006.

 

Other income, net, in fiscal 2007 was $9.9 million as compared with $4.8 million in fiscal 2006 and $3.5 million in fiscal 2005. The increase in fiscal 2007 other income, net, compared with fiscal 2006 was primarily the result of higher short-term interest rates in combination with higher cash balances as well as foreign currency exchange gains. In addition, during fiscal 2007, the Company recorded a benefit in other income due to the recovery of a non-trade receivable during the first quarter, however, this benefit was offset by equity method investment losses.

 

Fiscal 2006 results included higher rate interest income earned on cash balances partially offset by foreign currency losses. The interest income in fiscal 2006 also included approximately $0.4 million earned on the investment of the net proceeds from the issuance of the 6.00% Notes during the four week tender period for the 8.00% Notes discussed above. Fiscal 2005 contained foreign currency losses which offset a portion of the interest income earned on the Company’s cash and cash equivalent balances.

 

Gain (Loss) on Sale of Business Lines

 

During fiscal 2007, the Company recorded a gain related to the receipt of contingent purchase price proceeds from the fiscal 2006 sale of a TS end-user business discussed below. The gain amounted to $3.0 million pre-tax, $1.8 million after tax and $0.01 per share on a diluted basis. During fiscal 2006, the Company divested two TS end-user business lines in the Americas and two EM specialty business lines in EMEA. In TS, the Company sold its Americas end-user server and storage business line to a value-added reseller. As a result of these divestitures, a gain of $10.9 million pre-tax, $7.3 million after tax and $0.05 per share on a diluted basis was recorded in the third quarter of fiscal 2006. The Company also contributed cash and certain operating assets and liabilities of its TS Americas end-user network solutions business into a joint venture with Calence, Inc. in exchange for an investment interest in the joint venture, called Calence, LLC. In EM, the Company sold two small, non-core business lines in its EMEA region during the fourth quarter of fiscal 2006 for which no tax benefit was available and, as a result, recorded a loss of $13.6 million pre-tax, $14.3 million after tax and $0.10 per share on a diluted basis. The total impact of these divestitures in fiscal 2006 was a net loss of $2.6 million pre-tax, $7.1 million after tax and $0.05 per share on a diluted basis.

 

Debt Extinguishment Costs

 

As discussed further under Liquidity and Capital Resources — Financing Transactions, the Company incurred debt extinguishment costs in fiscal 2007 and 2006 associated with the tender and early repurchase of a portion of its outstanding publicly traded debt. In completing these transactions, the Company incurred debt extinguishment costs, related primarily to premiums and other transaction costs associated with these tenders and early repurchases, which totaled $27.4 million pre-tax, $16.5 million after tax and $0.11 per share on a diluted basis in fiscal 2007 and $22.6 million pre-tax, $13.6 million after-tax and $0.09 per share on a diluted basis in fiscal 2006.

 

Income Tax Provision

 

Avnet’s effective tax rate on its income before taxes for fiscal 2007 was 33.0% as compared with an effective tax rate of 35.3% in fiscal 2006 and 29.8% in fiscal 2005. The decrease in the fiscal 2007 effective tax rate over prior year is attributable to: (i) the mix of pre-tax income towards the lower statutory tax rate jurisdictions; (ii) a similar dollar amount of net contingency reserves applied against significantly higher pre-tax income; and (iii) the negative impact increasing prior year’s effective tax rate related to the loss on the sale of an EM business for which no tax benefit was available.

 

The increase in the effective rate in fiscal 2006 compared with fiscal 2005 was primarily due to the negative tax impact of the EM divestiture as discussed above and additional contingency reserves due to the recognition of tax exposures in the EMEA and Asia regions, partially offset by a favorable settlement of a European audit. Excluding these items, the effective tax rate would have been lower than the 35% U.S. federal tax rate for fiscal 2006 as a result of varying statutory tax rates across the jurisdictions in which the Company operates.

Net Income

 

As a result of the factors described in the preceding sections of this MD&A, the Company’s net income was $393.1 million, or $2.63 per share on a diluted basis, in fiscal 2007 as compared with net income of $204.5 million, or $1.39 per share on a diluted basis, in fiscal 2006 as compared with net income of $168.2 million, or $1.39 per share on a diluted basis, in fiscal 2005. Fiscal 2007 results were negatively impacted by a total of $20.0 million after tax, or $0.13 per share on a diluted basis, as detailed in the following table.

 

 

In comparison with fiscal 2007, the fiscal 2006 results were negatively impacted by a total of $70.6 after tax, or $0.48 share on a diluted basis, as detailed in the following table.

 

 

Critical Accounting Policies

 

The Company’s consolidated financial statements have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during the reporting period. These estimates and assumptions are based upon the Company’s continuous evaluation of historical results and anticipated future events. Actual results may differ from these estimates under different assumptions or conditions.

 

The Securities and Exchange Commission defines critical accounting polices as those that are, in management’s view, most important to the portrayal of the Company’s financial condition and results of operations and that require significant judgments and estimates. Management believes the Company’s most critical accounting policies relate to:

 

Valuation of Receivables

 

The Company maintains an allowance for doubtful accounts for estimated losses resulting from customer defaults. Bad debt reserves are recorded based upon historic default averages as well as the Company’s regular assessment of the financial condition of its customers. Therefore, if collection experience or the financial condition of specific customers were to deteriorate, management would evaluate whether additional allowances and corresponding charges to the consolidated statement of operations are required.

 

Valuation of Inventories

 

Inventories are recorded at the lower of cost (first in — first out) or estimated market value. The Company’s inventories include high-technology components, embedded systems and computing technologies sold into rapidly changing, cyclical and competitive markets whereby such inventories may be subject to early technological obsolescence.

The Company regularly evaluates inventories for excess, obsolescence or other factors that may render inventories less marketable. Write-downs are recorded so that inventories reflect the approximate net realizable value and take into account the Company’s contractual provisions with its suppliers, which may provide certain protections to the Company for product obsolescence and price erosion in the form of rights of return and price protection. Because of the large number of transactions and the complexity of managing the process around price protections and stock rotations, estimates are made regarding adjustments to the carrying amount of inventories. Additionally, assumptions about future demand, market conditions and decisions to discontinue certain product lines can impact the decision to write down inventories. If assumptions about future demand change or actual market conditions are less favorable than those projected by management, management would evaluate whether additional write-downs of inventories are required. In any case, actual values could be different from those estimated.

 

Accounting for Income Taxes

 

Management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and the valuation allowance recorded against net deferred tax assets. The carrying value of the Company’s net operating loss carry-forwards is dependent upon its ability to generate sufficient future taxable income in certain tax jurisdictions. In addition, the Company considers historic levels of income, expectations and risk associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing a tax valuation allowance. Should the Company determine that it is not able to realize all or part of its deferred tax assets in the future, an additional valuation allowance may be recorded against the deferred tax assets with a corresponding charge to income in the period such determination is made.

 

The Company establishes reserves for potentially unfavorable outcomes of positions taken on certain tax matters. These reserves are based on management’s judgments and estimates of probable future tax liabilities. As these estimates are highly judgmental, there may be differences between the anticipated and actual outcomes of these matters that may result in reversals of reserves or additional tax liabilities in excess of the reserved amounts. To the extent such adjustments are warranted, the Company’s effective tax rate may potentially fluctuate as a result.

 

Restructuring, Integration and Impairment Charges

 

The Company has been subject to the financial impact of integrating acquired businesses and charges related to business reorganizations. In connection with such events, management is required to make estimates about the financial impact of such matters that are inherently uncertain. Accrued liabilities and reserves are established to cover the cost of severance, facility consolidation and closure, lease termination fees, inventory adjustments based upon acquisition-related termination of supplier agreements and/or the re-evaluation of the acquired working capital assets (inventory and accounts receivable), and write-down of other acquired assets including goodwill. Actual amounts incurred could be different from those estimated.

 

Additionally, in assessing the Company’s goodwill for impairment in accordance with the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards No. 142 (“SFAS 142”), Goodwill and Other Intangible Assets, the Company is required to make significant assumptions about the future cash flows and overall performance of its reporting units. Should these assumptions or the structure of the reporting units change in the future based upon market conditions or changes in business strategy, the Company may be required to record impairment charges to goodwill.

 

Contingencies and Litigation

 

The Company is involved in various legal proceedings and other claims related to environmental, labor, product and other matters, all of which arise in the normal course of business. The Company is required to assess the likelihood of any adverse judgment or outcome to these matters, as well as the range of potential losses. A determination of the reserves required, if any, is made after careful analysis by management and internal and, when necessary, external counsel. The required reserves may change in the future due to developments or a change in circumstances. Changes to reserves could increase or decrease earnings in the period the changes are effective.

The Company does not consider revenue recognition to be a critical accounting policy due to the nature of its business in which revenues are generally recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the sales price is fixed or determinable and collectibility is reasonably assured. Generally, these criteria are met upon the actual shipment of product to the customer. Accordingly, other than for estimates related to possible returns of products from customers, discounts or rebates, the recording of revenue does not require significant judgments or estimates. Provisions for returns are estimated based on historical sales returns, credit memo analysis and other known factors. Provisions are made for discounts and rebates, which are primarily volume-based, and are generally based on historical trends and anticipated customer buying patterns. Finally, revenues from maintenance contracts, which are deferred and recognized in income over the life of the agreement, are not material to the consolidated results of operations of the Company.

 

Recently Issued Accounting Pronouncements

 

In December 2006, the FASB issued Staff Position No. EITF 00-19-2, Accounting for Registration Payment Arrangements (“FSP EITF 00-19-2”). FSP EITF 00-19-2 specifics that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate arrangement or included as a provision of a financial instrument or other arrangement, should be separately recognized and measured in accordance with FASB Statement No. 5, Accounting for Contingencies. FSP EITF 00-19-2 also requires additional disclosure regarding the nature of any registration payment arrangements, alternative settlement methods, the maximum potential amount of consideration and the current carrying amount of the liability, if any. FSP EITF 00-19-2 is effective beginning fiscal 2008. The adoption of FSP EITF 00-19-2 will not have a material effect on the Company’s consolidated financial statements.

 

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Current Year Misstatements (“SAB 108”). SAB 108 requires analysis of misstatements using both an income statement (rollover) approach and a balance sheet (iron curtain) approach in assessing materiality and provides for a one-time cumulative effect transition adjustment. SAB 108 is effective for fiscal year end 2007. The adoption of SAB 108 did not have a material impact on the Company’s consolidated financial statements.

 

In September 2006, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (“SFAS 158”). SFAS 158 requires the recognition in the balance sheet of the overfunded or underfunded positions of defined benefit pension and other postretirement plans, along with a corresponding non-cash after-tax adjustment to stockholders’ equity. SFAS 158 is effective for fiscal year end 2007. Other than enhanced disclosure, the adoption of SFAS 158 did not have a material impact on the Company’s consolidated financial statements. See Note 10 in the notes to the consolidated financial statements appearing in Item 15 of this Report for further discussion.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. SFAS 157 is effective for fiscal year 2009. The Company is evaluating the potential impact on its consolidated financial statements upon adoption of SFAS 157.

 

In July 2006, the FASB issued Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (“SFAS 109”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS 109 and prescribes that a company should use a more-likely-than-not recognition threshold based on the technical merits of the tax position taken or expected to be taken. Tax positions that meet the more-likely-than-not recognition threshold should be measured in order to determine the tax benefit to be recognized in the financial statements. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company will adopt FIN 48 (as amended by FASB Staff Position No. FIN 48-1, Definition of Settlement in FASB Interpretation No. 48) beginning fiscal 2008. The adoption of FIN 48 will not have a material impact on the Company’s consolidated financial statements.

In March 2006, FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets — an Amendment of FASB Statement No. 140” (“SFAS 156”). SFAS 156 provides guidance on the accounting for servicing assets and liabilities when an entity undertakes an obligation to service a financial asset by entering into a servicing contract. This statement is effective for all transactions at the beginning of fiscal 2008. The adoption of SFAS 156 will not have a material impact on the Company’s consolidated financial condition or results of operations.

 

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments — an Amendment of FASB Statements No. 133 and 140 (“SFAS 155”). SFAS 155 allows financial instruments that contain an embedded derivative and that otherwise would require bifurcation to be accounted for as a whole on a fair value basis, at the holders’ election. SFAS 155 also clarifies and amends certain other provisions of SFAS 133 and SFAS 140. SFAS 155 is effective beginning fiscal 2008. The adoption of SFAS 155 will not have a material effect on the Company’s consolidated financial statements.

 

Liquidity and Capital Resources

 

Cash Flows

 

The following table summarizes the Company’s cash flow activities for fiscal 2007, 2006 and 2005, including the Company’s computation of free cash flow and a reconciliation of this metric to the nearest GAAP measures of net income and net cash flow from operations. Management’s computation of free cash flow consists of net cash flow from operations plus cash flows generated from or used for purchases and sales of property, plant and equipment, acquisitions and divestitures of operations, effects of exchange rates on cash and cash equivalents and other financing activities. Management believes that the non-GAAP metric of free cash flow is a useful measure to help management and investors better assess and understand the Company’s operating performance and sources and uses of cash. Management also believes the analysis of free cash flow assists in identifying underlying trends in the business. Computations of free cash flow may differ from company to company. Therefore, the analysis of free cash flow should be used as a complement to, and in conjunction with, the Company’s consolidated statements of cash flows presented in the accompanying financial statements appearing in Item 15 of this Report.

 

Management also analyzes cash flow from operations based upon its three primary components noted in the table below: net income, non-cash and other reconciling items and cash flow generated from or used for working capital. Similar to free cash flow, management believes that this breakout is an important measure to help management and investors better understand the trends in the Company’s cash flows, including the impact of management’s focus on asset utilization and efficiency through its management of the net balance of receivables, inventories and accounts payable.

 

 

 

During fiscal 2007, the Company generated $724.6 million of cash and cash equivalents from its operating activities as compared with a utilization of $19.1 million in the fiscal 2006. These results are comprised of: (1) the cash flow generated from net income excluding non-cash and other reconciling items, which consist of the add-back of depreciation and amortization, deferred income taxes, stock-based compensation, non-cash restructuring and other charges, and other non-cash items (primarily the provision for doubtful accounts and periodic pension costs) and (2) the cash flows generated from (used for) working capital, excluding cash and cash equivalents. The working capital inflow in fiscal 2007 consisted of an increase in receivables ($129.4 million), decrease in inventories ($53.7 million), increase in accounts payable ($262.2 million) and cash outflow for other items ($60.3 million). The growth in receivables as well as payables was primarily attributable to TS and was driven, in part, by the acquisition of the Access business for which the largest supplier is Sun Microsystems whose strongest quarter is typically its June fiscal year end. The decrease in inventory was a net result of EM’s decrease of $74 million partially offset by a small increase in inventory at TS. In addition, during fiscal 2007, the Company paid $29.7 million associated with the restructuring, integration and other charges and exit-related costs accrued through purchase accounting. See Results of Operations — Restructuring, Integration and Other Items discussed elsewhere in this MD&A.

 

For fiscal 2007, the Company’s cash flows associated with investing activities included capital expenditures related to system development costs, computer hardware and software expenditures as well as certain leasehold improvement costs. Also included in cash flows from investing activities is cash used for the acquisition of Access, Azure and a small distributor business in Italy (see Note 2 in the accompanying consolidated financial statements appearing in Item 15 of this Report), net of contingent purchase price proceeds received (see Results of Operations — Gain (Loss) on Sale of Business Lines discussed elsewhere in this MD&A). Other financing activities, net, in fiscal 2007 are primarily a result of cash from the exercise of stock options and the excess tax benefits associated with stock option exercises.

 

As a result of the factors discussed above, the Company generated free cash flow of $316.3 million and used a net $35.6 million to repay debt during fiscal 2007. During fiscal 2007, the Company redeemed the 93/4% Notes outstanding balance of $361.4 million using proceeds from the issuance of $300.0 million of 6.625% Notes in September 2006 and repaid $143.7 million of the 8.00% Notes that matured in November 2006. In March 2007, the Company issued $300.0 million of 5.875% Notes due 2014 and used proceeds to repay certain amounts outstanding under its Credit Facility and the Securitization Program that were used to fund the Access acquisition (see Financing Transactions for further discussion).

 

In fiscal 2006, the Company utilized $423.4 million of cash and cash equivalents for working capital needs. The working capital outflows consist of growth in receivables ($254.7 million), growth in inventory ($142.6 million), net cash inflow from accounts payable ($99.7 million) and outflow for other working capital items ($125.8 million). The driver of the change in working capital includes organic sales growth and a small investment in inventory at TS in preparation for the seasonally stronger September quarter that TS typically experiences. In addition, the Company paid $92.9 million during fiscal 2006 relating to restructuring, integration and payments of amounts accrued in purchase accounting associated with the Memec acquisition, and restructuring and other costs as a result of the sale of two TS business lines and other actions taken during fiscal 2006. See Results of Operations — Restructuring, Integration and Other Items discussed elsewhere in this MD&A. The Company also made an accelerated contribution to the Company’s pension plan during the first quarter of fiscal 2006, totaling $58.6 million and used $27.0 million primarily for premiums, transaction costs and other costs associated with the refinancing and repurchasing of its Notes and credit facilities (see Financing Transactions).

The cash flows associated with investing activities included capital expenditures during fiscal 2006, primarily related to certain information technology hardware and software purchases, a new mainframe purchase and the ongoing development of one additional operating system to replace one of the systems that was disposed of as part of the restructuring, integration and other items (see Results of Operations — Restructuring, Integration and Other Items for further discussion). Also included in cash flows used in investing activities for fiscal 2006 is $294.3 million for acquisitions and investments net of divestitures which relate primarily to the following: (1) $297.5 million associated with the Company’s acquisition of Memec, including the retirement of substantially all of Memec’s debt at the time of the acquisition (see Note 2 to the accompanying Consolidated Financial Statements for further discussion); (2) $13.9 million cash contribution to the Calence, LLC joint venture; and (3) $5.7 million for the purchase of shares held by a minority interest holder in one of the Company’s Israeli subsidiaries, an additional earn-out payment associated with a small acquisition completed in fiscal 2005 and other items; net of (4) cash inflow of $22.8 million relating to the divestiture of the TS end-user business lines during the third quarter and EM business lines during the fourth quarter of fiscal 2006. Finally, the cash inflows from other net financing activities related primarily to cash received for stock option exercises. As a result of the items discussed above, the Company utilized free cash flow of $326.5 million in fiscal 2006 along with $34.6 million related to net debt repurchases.

 

Avnet generated $461.8 million of net cash flows from operations during fiscal 2005. This positive cash flow was largely driven by the Company’s improved profitability in fiscal 2005, as further discussed in Results of Operations in this MD&A, and the generation of cash from its working capital, excluding cash and cash equivalents. Management has continued to focus on improving asset utilization and efficiency since the economic and industry downturn that began in fiscal 2001. This focus was enhanced again in fiscal 2005 as the Company weathered the mid-cycle inventory correction in the electronic components sector. The Company’s efforts to manage the combined balance of accounts receivable and inventories, net of accounts payable, allowed the Company to generate positive cash flows from these working capital components of $166.4 million in fiscal 2005. A significant catalyst for this cash flow was the Company’s ability to effectively manage inventory levels throughout its business. Cash expenditures for acquisitions of operations relate to the first quarter fiscal 2005 acquisition of DNS Slovakia, a small computer product distributor, as well as certain legal and other costs incurred in fiscal 2005 related to the acquisition of Memec, which did not close until after fiscal 2005. Trends in foreign currency exchange rates shifted in fiscal 2005 to generate a net cash outflow as most foreign currencies, particularly the Euro, weakened slightly against the U.S. Dollar in the second half of fiscal 2005. This negative cash flow results from the translation of Avnet’s cash and cash equivalents held in foreign currencies, which were generally higher throughout the second half of fiscal 2005 resulting largely from the combination of the Company’s higher profitability and working capital management as it emerged from the mid-cycle inventory correction. The combination of these factors yielded net free cash flow in fiscal 2005 of $425.7 million, of which the Company utilized $100.5 million for repayment of debt.

 

Capital Structure

 

The Company uses a variety of financing arrangements, both short-term and long-term, to fund its operations. The Company also uses diversified sources of funding so that it does not become overly dependent on one source and to achieve lower cost of funding through these different alternatives. These financing arrangements include public bonds, short-term and long-term bank loans and a Securitization Program. For a detailed description of the Company’s external financing arrangements outstanding at June 30, 2007, please refer to Note 7 to the consolidated financial statements appearing in Item 15 of this Report.

The following table summarizes the Company’s capital structure as of the end of fiscal 2007 with a comparison with the end of fiscal 2006:

 

 

At July 1, 2006, long-term debt in the above table includes a fair value adjustment decreasing total debt and capitalization by $7.5 million in fiscal 2006. The fair value adjustment relates to the interest rate hedges on the Company’s 93/4% Notes in fiscal 2006, which were subsequently terminated during fiscal 2007 as discussed in Financing Transactions below.

 

Financing Transactions

 

The Company has an unsecured $500.0 million credit facility with a syndicate of banks (the “Credit Facility”), expiring in October 2010. The Company may select from various interest rate options, currencies and maturities under the Credit Facility. The Credit Facility contains certain covenants, all of which the Company was in compliance with as of June 30, 2007. At June 30, 2007, there were no borrowings outstanding under the Credit Facility and $21.2 million of letters of credit issued under the Credit Facility, which represents a utilization of the Credit Facility capacity but are not recorded in the consolidated balance sheet as the letters of credit are not debt. As of July 1, 2006, there was $6.0 million drawn under the Credit Facility included in “long-term debt” in the consolidated financial statements and $22.9 million in letters of credit issued under the Credit Facility.

 

The Company has a Securitization Program with a group of financial institutions that allows the Company to sell, on a revolving basis, an undivided interest of up to $450.0 million in eligible receivables while retaining a subordinated interest in a portion of the receivables. The Securitization Program does not qualify for sale accounting and has a one year term that expires in August 2007 which has been renewed on comparable terms for another year. There were no borrowings outstanding under the Securitization Program at June 30, 2007.

 

In March 2007, the Company issued $300.0 million of 5.875% Notes due March 15, 2014 (the “5.875% Notes”). The proceeds of $297.1 million from the offering, net of discount and underwriting fees, were used to repay amounts outstanding under the Company’s Credit Facility and the Securitization Program. The borrowings under the Credit Facility and the Securitization Program were used to fund the Access acquisition.

 

During October 2006, the Company redeemed all of its outstanding ($361.4 million) 93/4% Notes due February 15, 2008 (the “93/4% Notes”). The Company used the net proceeds of $296.1 million from the issuance in the first quarter of $300.0 million principal amount of 6.625% Notes due September 15, 2016 plus available liquidity, to repurchase the 93/4% Notes. In connection with the repurchase, the Company terminated two interest rate swaps with a total notional amount of $200.0 million that hedged a portion of the 93/4% Notes. Debt extinguishment costs incurred during the first quarter of fiscal 2007 as a result of the redemption totaled $27.4 million pre-tax, $16.5 million after tax, or $0.11 per share on a diluted basis, and consisted of $20.3 million for a make-whole redemption premium, $5.0 million associated with the two interest rate swap terminations, and $2.1 million to write-off certain deferred financing costs.

 

In June 2006, the Company repurchased $113.6 million of the $475.0 million 93/4% Notes and, in connection with this repurchase, the Company terminated one of the interest rate swaps with a notional amount of $100.0 million that hedged a portion of the $475.0 million 93/4% Notes. The termination of this swap and repurchase of the related hedged debt resulted in debt extinguishment costs of $10.9 million pre-tax, $6.6 million after tax or $0.04 per share on a diluted basis. As a result of the tender and total repurchases in fiscal 2006, as previously described, and the termination of interest rate swaps noted above, the Company incurred total debt

extinguishment costs of $22.6 million pre-tax, $13.6 million after tax or $0.09 per share on a diluted basis, relating primarily to premiums and other transaction costs.

 

In August 2005, the Company issued $250.0 million of 6.00% Notes due September 1, 2015. The proceeds from the offering, net of discount and underwriting fees, were $246.5 million. The Company used these proceeds, plus cash and cash equivalents on hand, to fund the tender and repurchase during the first quarter of fiscal 2006 of $254.1 million of the 8.00% Notes due November 15, 2006. As a result of the tender and repurchases, the Company incurred debt extinguishment costs of $11.7 million pre-tax, $7.1 million after tax, or $0.05 per share on a diluted basis, relating primarily to premiums and other transaction costs.

 

The Company’s $300.0 million 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.

 

The hedged fixed rate debt and the interest rate swaps outstanding at the end of fiscal 2006 were adjusted to current market values through interest expense in the accompanying consolidated statements of operations. The Company accounts for 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 July 1, 2006 was a liability of $7.5 million which is included in “other long-term liabilities” and a corresponding fair value adjustment of the hedged debt decreased long-term debt by the same amount. As discussed above, the Company terminated all remaining interest rate swaps during the first quarter of fiscal 2007 in connection with the redemption of the 93/4% Notes.

 

In addition to its primary financing arrangements, the Company has several small lines of credit in various locations to fund the short-term working capital, foreign exchange, overdraft and letter of credit needs of its wholly owned subsidiaries in Europe, Asia and Canada. Avnet generally guarantees its subsidiaries’ debt under these facilities.

 

Covenants and Conditions

 

The Securitization Program discussed previously requires the Company to maintain certain minimum interest coverage and leverage ratios as defined in the Credit Facility (see discussion below) in order to continue utilizing the Securitization Program. The Securitization Program agreement also contains certain covenants relating to the quality of the receivables sold. If these conditions are not met, the Company may not be able to borrow any additional funds and the financial institutions may consider this an amortization event, as defined in the Securitization Program agreement, which would permit the financial institutions to liquidate the accounts receivable sold to cover any outstanding borrowings. Circumstances that could affect the Company’s ability to meet the required covenants and conditions under the Securitization Program agreement include the Company’s ongoing profitability and various other economic, market and industry factors. Management does not believe that the covenants under the Securitization Program limit the Company’s ability to pursue its intended business strategy or future financing needs. The Company was in compliance with all covenants of the Securitization Program agreement at June 30, 2007.

The Credit Facility discussed in Financing Transactions contain certain covenants with various limitations on debt incurrence, dividends, investments and capital expenditures and also includes financial covenants requiring the Company to maintain minimum interest coverage and leverage ratios, as defined. Management does not believe that the covenants in the Credit Facility limit the Company’s ability to pursue its intended business strategy or future financing needs. The Company was in compliance with all covenants of the Credit Facility as of June 30, 2007.

 

See Liquidity for further discussion of the Company’s availability under these various facilities.

 

Liquidity

 

The Company had total borrowing capacity of $950.0 million at June 30, 2007 under the Credit Facility and the Securitization Program, against which $21.2 million in letters of credit were issued under the Credit Facility, which resulted in $928.8 million of net availability at the end of fiscal 2007. The Company also had $557.4 million of cash and cash equivalents at June 30, 2007. During fiscal 2007, the Company utilized $410.4 million of debt plus cash on hand to fund the Access acquisition (including the estimated amount due to the sellers and transaction costs, the gross purchase price was $437.6 million. See Note 2 to the accompanying consolidated financial statements). The Company has no other significant financial commitments outside of normal debt and lease maturities discussed in Capital Structure and Contractual Obligations. Management believes that Avnet’s borrowing capacity, its current cash availability and the Company’s expected ability to generate operating cash flows are sufficient to meet its projected financing needs. Generally, the Company is more likely to utilize operating cash flows for working capital requirements in a growing electronic component and computer products industry. However, additional cash requirements for working capital are generally expected to be offset by the operating cash flows generated by the Company’s enhanced profitability resulting from the Company’s cost reductions achieved in recent years and its focus on profitable growth. During fiscal 2007, the Company repaid the remaining $143.7 million of the 8.00% Notes that matured in November 15, 2006 and redeemed all of the $361.4 million outstanding 93/4% Notes, as previously discussed. During March 2007, the Company issued $300.0 million principal amount of 5.875% Notes dues 2014 and used the proceeds to repay amounts outstanding under the Credit Facility and Securitization Program. The 5.875% Notes are the next significant public debt maturity due to mature in 2014. In addition, the holders of the 2% Convertible Senior Debentures due 2034 may require the Company to redeem the Debentures for cash in March 2009 if the share price of the Company’s stock reaches $45.68 (see Financing Transactions for further discussion).

 

The following table highlights the Company’s liquidity and related ratios for the past two years:

 

COMPARATIVE ANALYSIS — LIQUIDITY

 

 

The Company’s quick assets (consisting of cash and cash equivalents and receivables) increased 32.9% from July 1, 2006 to June 30, 2007 primarily as a result of the Access acquisition and the increase in cash and cash equivalents. Quick and current assets were both impacted by the increase in cash and cash equivalents since fiscal 2006. Current liabilities grew 13.9% due to the Access acquisition offset by the reduction in outstanding bank credit facilities, primarily in Asia, and the repayment of the 8.00% Notes that matured in November 2006. As a result of

the factors noted above, total working capital increased by approximately 33.6% during fiscal 2007. Total debt decreased 2.1% due to the net result of refinancing activities during the fiscal 2007. Specifically, the Company issued $300.0 million of 6.625% Notes in September 2006, the proceeds of which were used to fund the redemption of the 93/4% Notes outstanding balance of $361.4 million. The Company also repaid $143.7 million of the 8.00% Notes that matured in November 2006. In March 2007, the Company issued $300.0 million in 5.875% Notes due 2014 and used the proceeds to repay amounts outstanding under the Credit Facility and Securitization Program, the borrowings from which were used to acquire Access. Total capital grew primarily due to net income for fiscal 2007 of $393.1 million, the increase in common shares outstanding, and the decrease in outstanding debt. Finally, the debt to capital ratio decreased to 26.2% at June 30, 2007 from 30.4% at July 1, 2006 primary due to the net result of the refinancing activities discussed previously.

 

Long-Term Contractual Obligations

 

The Company has the following contractual obligations outstanding as of June 30, 2007 (in millions):

 

 

 

 

The Company does not currently have any material commitments for capital expenditures.

 

 

The Company seeks to reduce earnings and cash flow volatility associated with changes in interest rates and foreign currency exchange rates by entering into financial arrangements intended to provide a hedge against all or a portion of the risks associated with such volatility. The Company continues to have exposure to such risks to the extent they are not hedged.

 

The Company has used interest rate swaps that convert certain fixed rate debt to variable rate debt, effectively hedging the change in fair value of the fixed rate debt resulting from fluctuations in interest rates. During fiscal year 2007, the Company terminated its remaining swaps in connection with the redemption of its 93/4% Notes (see Financing Transactions). The following table sets forth the scheduled maturities of the Company’s debt outstanding at June 30, 2007 (dollars in millions):

 

 

 

 

The following table sets forth the carrying value and fair value of the Company’s debt at June 30, 2007 (dollars in millions):

 

 

 

 

Many of the Company’s subsidiaries, from time to time, purchase and sell products in currencies other than their functional currencies. This subjects the Company to the risks associated with the fluctuations of foreign currency exchange rates. The Company reduces this risk by utilizing natural hedging (offsetting receivables and payables) as well as by creating offsetting positions through the use of derivative financial instruments, primarily forward foreign exchange contracts with maturities of less than sixty days. The Company adjusts all foreign denominated balances and any outstanding foreign exchange contracts to fair market value through the consolidated statements of operations. Therefore, the market risk related to foreign exchange contracts is offset by changes in valuation of the underlying items being hedged. The asset or liability representing the fair value of foreign exchange contracts is classified in the captions “other current assets” or “accrued expenses and other,” as applicable, in the accompanying consolidated balance sheets. A hypothetical 10% change in currency exchange rates under the contracts outstanding at June 30, 2007 would result in an increase or decrease of approximately $12.9 million to the fair value of the forward foreign exchange contracts, which would generally be offset by an opposite effect on the related hedged positions.

 

 

The financial statements and supplementary data are listed under Item 15 of this Report.

 

 

None.

 

 

Disclosure Controls and Procedures

 

The Company’s management, including its Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the reporting period covered by this Annual Report on Form 10-K. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this Annual Report on Form 10-K, the Company’s disclosure controls and procedures are effective such that material information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified by the Securities and Exchange Commission’s rules and forms relating to the Company.

During the last quarter of fiscal 2007, there have been no changes to the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

Management’s Report on Internal Control Over Financial Reporting

 

The Company’s management, including its Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15(d)-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Management conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of June 30, 2007. In making this assessment, management used the framework established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and concluded that the Company maintained effective internal control over financial reporting as of June 30, 2007.

 

The Company’s independent registered public accounting firm, KPMG LLP, has audited the effectiveness of the Company’s internal controls over financial reporting as of June 30, 2007, as stated in its audit report which is included herein.

 

On December 31, 2006, the Company acquired substantially all of the assets and operations of Access Distribution, a leading value-added distributor of complex computing solutions (the “Access acquisition”). Management has excluded the Access acquisition from its evaluation of the effectiveness of the Company’s internal control over financial reporting as of June 30, 2007. Assets acquired from, and the revenues associated with, the Access acquisition accounted for approximately 11% of Avnet’s consolidated assets as of June 30, 2007 and approximately 6% of Avnet’s total revenue for the fiscal year ended June 30, 2007.

 

 

Not applicable.

 

PART III

 

 

The information called for by Item 10 is incorporated in this Report by reference to the Company’s definitive proxy statement relating to the Annual Meeting of Stockholders anticipated to be held on November 8, 2007.

 

 

The information called for by Item 11 is incorporated in this Report by reference to the Company’s definitive proxy statement relating to the Annual Meeting of Stockholders anticipated to be held on November 8, 2007.

 

 

The information called for by Item 12 is incorporated in this Report by reference to the Company’s definitive proxy statement relating to the Annual Meeting of Stockholders anticipated to be held on November 8, 2007.

 

 

The information called for by Item 13 is incorporated in this Report by reference to the Company’s definitive proxy statement relating to the Annual Meeting of Stockholders anticipated to be held on November 8, 2007.

 

 

The information called for by Item 14 is incorporated in this Report by reference to the Company’s definitive proxy statement relating to the Annual Meeting of Stockholders anticipated to be held on November 8, 2007.

 

PART IV

 

 

a. The following documents are filed as part of this Report:

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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.

 

AVNET, INC.

(Registrant)

 

Roy Vallee,

Chairman of the Board, Chief Executive

Officer and Director

 

Date: August 29, 2007

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on August 29, 2007.

 

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Shareholders

Avnet, Inc:

 

We have audited the accompanying consolidated balance sheets of Avnet, Inc. and subsidiaries (the Company) as of June 30, 2007 and July 1, 2006, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended June 30, 2007. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule for each of the years in the three-year period ended June 30, 2007, as listed in the accompanying index. We also have audited the Company’s internal control over financial reporting as of June 30, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Avnet, Inc. and subsidiaries as of June 30, 2007 and July 1, 2006, and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 2007, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule for each of the years in the three-year period ended June 30, 2007, when considered in relation to the basic consolidated financial statement taken as a whole, presents fairly, in all material respects, the information set forth therein. Furthermore, in our opinion, Avnet, Inc. maintained, in all material respects, effective internal control over financial reporting as of June 30, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

On December 31, 2006, the Company acquired substantially all of the assets and operations of Access Distribution (Access acquisition). Management has excluded the Access acquisition from its assessment of the effectiveness of the Company’s internal control over financial reporting as of June 30, 2007. Assets acquired from, and the revenues associated with the Access acquisition accounted for approximately 11% of Avnet, Inc.’s consolidated assets as of June 30, 2007 and approximately 6% of the Company’s total revenue for the fiscal year ended June 30, 2007. Our audit of internal control over financial reporting of Avnet, Inc. also excluded an evaluation of the internal control over financial reporting of Access Distribution.

 

As discussed in Note 1 to the consolidated financial statements, effective July 3, 2005, the Company adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment. As discussed in Note 1 to the consolidated financial statements, effective June 30, 2007, the Company adopted Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB No. 87, 88, 106 and 132(R).

 

Phoenix, Arizona
August 27, 2007

AVNET, INC. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS