Avnet, Inc. — Q2 FY2017 Form 10-Q
Reporting period: Quarter ended December 31, 2016; six-month period ended the same date. Avnet’s fiscal 2017 first half comprised 26 weeks, versus 27 weeks in the prior-year period. The Technology Solutions (TS) business is presented as discontinued operations; continuing operations principally comprise Electronics Marketing (EM), including Premier Farnell (PF), acquired October 17, 2016.
Financial performance
| Metric | Q2 FY2017 | Q2 FY2016 | Six months FY2017 | Six months FY2016 |
|---|---|---|---|---|
| Continuing-operations sales | $4,273.6m | $4,161.1m | $8,391.7m | $8,689.7m |
| Gross profit | $586.2m | $505.1m | $1,108.8m | $1,061.2m |
| Operating income | $124.2m | $136.1m | $253.7m | $302.7m |
| Continuing-operations income | $32.5m | $102.1m | $100.2m | $211.1m |
| Net income | $103.2m | $156.0m | $172.1m | $286.3m |
| Diluted EPS | $0.79 | $1.16 | $1.32 | $2.11 |
Reported Q2 continuing sales rose about 2.7%, but organic sales declined 3.6% (2.9% in constant currency). Q2 gross margin improved to 13.7% from 12.1%; operating margin fell to 2.9% from 3.3%. Adjusted operating income, excluding restructuring, integration and other expenses and acquired-intangible amortization, was $164.5m, up 7.9%; adjusted operating margin was 3.8% versus 3.7%. First-half gross margin was 13.2% versus 12.2%; operating margin was 3.0% versus 3.5%.
Q2 continuing-operations income declined amid higher SG&A, financing and acquisition-related costs, and a higher tax rate. The effective tax rate was 46.7% for the quarter and 33.0% for the first half, versus 9.7% and 18.4%, respectively, a year earlier. Net income included TS discontinued-operations income of $70.8m in Q2 and $71.9m in the first half.
Cash flow, debt and liquidity
- First-half operating cash flow was $240.1m, versus $84.2m a year earlier; continuing operations generated $303.2m, partly offset by $63.1m used by discontinued operations. Working-capital cash generation included inventory reduction of $139.7m and increased payables of $133.7m, partly offset by receivables growth of $127.2m.
- First-half investing cash outflow was $864.1m, including $798.4m net cash paid for acquisitions and $70.4m of capital expenditures. Financing cash inflow was $889.7m, including new borrowings; dividends paid were $43.4m.
- At December 31, cash and equivalents were $1.27bn, of which $1.18bn was held outside the U.S. Continuing-operations short- and long-term debt totaled approximately $3.63bn, compared with $2.49bn at July 2, 2016. The filing reports total debt fair value of $3.66bn.
- Combined borrowing capacity under the revolving credit facility and receivables program was $2.05bn; approximately $653m remained available at quarter-end. Avnet reported compliance with applicable debt covenants. Management stated available cash, borrowing capacity and expected operating cash generation should meet liquidity needs.
Material changes, outlook and risks
- PF acquisition: Completed October 17 for $839.7m cash consideration; Avnet also assumed debt. PF contributed $269m of sales and approximately $9m of continuing-operations income after acquisition during Q2. Purchase-price allocations remained preliminary. Acquisition financing, bridge fees and currency hedging contributed to elevated other expense; first-half acquisition-related foreign-currency hedge losses were approximately $35m.
- TS sale: Avnet agreed to sell TS to Tech Data for approximately $2.60bn, comprising $2.40bn cash and 2.8m Tech Data shares, subject to closing adjustments and conditions. Completion was expected by fiscal year-end 2017; Avnet expected a gain because the sale price exceeded carrying value. Closing, regulatory approvals, transaction execution and expected benefits remain uncertain. The company anticipated using some after-tax proceeds to repay debt, return capital, fund acquisitions or for general purposes.
- Operating trends: EM organic sales were weaker overall, including a 13.5% constant-currency decline in Asia, which management attributed primarily to exiting lower-margin, high-volume supply-chain business. EMEA organic sales grew 11.6% in constant currency. Management cited PF and the lower-margin business exits as drivers of improved gross margin. TS Q2 sales fell 8.7%; its organic sales declined 7.1% in constant currency, primarily due to weaker demand in the Americas and Asia.
- Costs and unusual items: Q2 continuing-operations restructuring, integration and other expenses were $30.4m; first-half expense was $59.9m. First-half restructuring actions included reductions or planned reductions affecting over 200 employees. Management estimated approximately $5.4m in incremental annualized savings upon completion. The Q2 tax rate was adversely affected by deferred-tax valuation allowances and nondeductible acquisition expenses. Foreign-currency translation and other reduced Q2 comprehensive income by $182.7m, resulting in a total comprehensive loss of $76.3m.
- Other risks and commitments: Foreign cash is expected to remain permanently reinvested abroad; repatriation could incur significant taxes. The company disclosed pending compliance and legal matters, with $11.7m of estimated compliance-related liabilities; some potential exposures could not be reasonably estimated. A 1 percentage-point interest-rate increase was estimated to reduce Q2 continuing-operations pretax income by $4.1m.
- No specific earnings or sales guidance was provided in the supplied filing text. The company noted results are subject to demand, economic and industry cycles, supplier relationships, foreign exchange, acquisition and divestiture execution, liquidity and other risks.
Investor verification priorities
- Confirm TS sale closing, final proceeds and adjustments, taxes, gain recognition, and post-sale financing arrangements.
- Track PF integration, final purchase-price allocation, realized synergies, and the effect of acquisition debt and costs on earnings and cash flow.
- Assess whether organic sales trends, especially in Asia, and improved gross margin are sustainable after lower-margin business exits.
- Monitor debt reduction, covenant headroom, available facility capacity, and the location and accessibility of foreign-held cash.
- Evaluate the persistence of elevated tax expense, deferred-tax valuation allowances, restructuring costs, and expected savings.