Avnet, Inc. — Form 10-Q summary
Business context and reporting period: Avnet distributes electronic components through its Electronic Components (EC) and Farnell businesses. This report covers the first quarter of fiscal 2020, ended September 28, 2019; comparisons are with the first quarter ended September 29, 2018, unless otherwise noted. Amounts below are in U.S. dollars.
Key financial results
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Sales | $4.630 billion | $5.090 billion | Down 9.0% reported; down 7.8% in constant currency |
| Gross profit / margin | $543.8 million / 11.7% | $636.8 million / 12.5% | Profit down 14.6%; margin down 76 basis points |
| Operating income / margin | $62.7 million / 1.4% | $146.8 million / 2.9% | Down 57.3% |
| Adjusted operating income / margin | $107.4 million / 2.3% | $182.5 million / 3.6% | Down 41.2%; margin down 127 basis points |
| Net income | $41.8 million | $83.7 million | Down 50.1% |
| Diluted EPS | $0.40 | $0.72 | Down $0.32 |
| Operating cash flow | $195.6 million provided | $85.0 million used | Improved $280.6 million |
| Capital expenditures | $29.9 million | $41.0 million | Down $11.1 million |
Cash, debt and liquidity: Cash and equivalents were $664.1 million at quarter-end, up from $546.1 million at June 29, 2019; $592.6 million was held outside the United States. Total debt carrying value was $1.83 billion, compared with $1.72 billion at fiscal year-end. Short-term debt increased to $638.4 million, including $338.1 million drawn under the receivables securitization program and $300 million of notes due June 2020. Long-term debt was $1.192 billion. Avnet reported approximately $1.41 billion of available capacity under its $1.25 billion revolving credit facility and $500 million securitization program, and was in compliance with their covenants. The company expects to renew or replace the securitization program before its August 2020 maturity and expects to refinance or fund the June 2020 notes using new notes or available credit capacity.
Material changes and management commentary
- Management attributed the sales decline across both segments and all regions to a global, industry-wide slowdown in demand. EC sales declined 8.8% reported (7.7% in constant currency); Farnell sales declined 11.4% (9.0% in constant currency). EMEA was the weakest region, down 14.2% reported and 10.5% in constant currency.
- Gross margin weakened in both segments, particularly Farnell, reflecting product, customer and geographic mix and market conditions. Lower SG&A partly offset reduced sales and gross profit; SG&A fell 3.9% but rose to 83.9% of gross profit from 74.6%.
- Operating cash flow turned positive, with $82.2 million generated from working capital and other items, including a $189.7 million increase in accounts payable. The comparable quarter used $275.6 million in working capital and other. Trailing-four-quarter operating cash flow from continuing operations was $871.7 million.
- The effective tax rate was negative 22.7%, versus 27.3% a year earlier. The current-quarter tax benefit primarily reflected release of unrecognized tax benefit reserves and income mix in lower-tax jurisdictions; this helped support net income despite lower pretax income.
Outlook, risks and unusual items
- Texas Instruments distribution agreement: Avnet said it had received notice of termination. TI products represented approximately 10% of fiscal 2019 sales; management warned future sales and gross profit could be lower if strategic initiatives, margin improvements or other sales do not offset the impact.
- Restructuring: Q1 restructuring, integration and other expenses were $24.6 million, including $18.3 million of restructuring costs and a $6.7 million non-cash software impairment. The restructuring actions involved reducing or planning to reduce more than 200 positions and are expected to yield about $20 million of annual operating expense savings once complete. Most remaining severance and prior restructuring liabilities are expected to be paid by fiscal year-end.
- Capital returns: Avnet repurchased 2.6 million shares for $112.1 million and paid $21.5 million in dividends. The board increased the cumulative repurchase authorization to $2.95 billion; $593.3 million remained at quarter-end. Future repurchases and dividends are discretionary and subject to conditions and board approval.
- Contingencies: The company had $14.7 million of estimated liabilities for reasonably estimable compliance-related matters. Outcomes of certain legal and regulatory matters, including import/export and environmental matters, could not be estimated; management did not expect a material effect on financial position or liquidity but said a matter could be material to results in an individual period. Avnet also remains subject to certain indemnification obligations related to the 2017 sale of Technology Solutions.
- Other: Adoption of lease accounting standards resulted in recognition of $278.6 million in operating lease assets and $300.6 million in lease liabilities at quarter-end, without a material impact on operations or retained earnings. No formal revenue or earnings guidance is provided in the filing. Management cited expected future cash generation and borrowing capacity as sufficient for liquidity needs, subject to economic and other factors.
Important facts for investors to verify
- Progress and financial impact of the Texas Instruments agreement termination, including whether replacement sales or cost actions offset lost revenue and gross profit.
- Whether demand and margins recover from the industry slowdown, especially in Farnell and EMEA.
- Execution and realized savings from restructuring, and any further restructuring or integration costs.
- Renewal or replacement terms for the securitization program and funding plan for the $300 million notes due June 2020.
- Working-capital trends and sustainability of operating cash flow, given the large contribution from accounts payable in the quarter.
- Developments in compliance-related claims, indemnification matters and the remaining share repurchase authorization.