Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

For the quarterly period ended October 2, 2004

Commission File #1-4224

Avnet, Inc.

IRS Employer Identification No. 11-1890605

2211 South 47th Street, Phoenix, Arizona 85034

      Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.     Yes þ          No o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes þ          No o

      The total number of shares outstanding of the registrant’s Common Stock (net of treasury shares)

as of October 30, 2004 — 120,501,165 shares.

AVNET, INC. AND SUBSIDIARIES

INDEX

1

Table of Contents

FORWARD-LOOKING STATEMENTS

      This Report contains forward-looking statements with respect to the financial condition, results of operations and business of Avnet, Inc. and subsidiaries (“Avnet” or the “Company”). You can find many of these statements by looking for words like “believes,” “expects,” “anticipates,” “estimates” or similar expressions in this Report or in documents incorporated by reference in this Report.

      These forward-looking statements are subject to numerous assumptions, risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by the forward-looking statements include the following:

	•	A technology industry down-cycle, particularly in the semiconductor sector, would adversely affect Avnet’s expected operating results.
	•	Competitive pressures among distributors of electronic components and computer products may increase significantly through entry of new competitors or otherwise.
	•	General economic or business conditions, domestic and foreign, may be less favorable than management expected, resulting in lower sales and declining profitability which can, in turn, impact the Company’s credit ratings, debt covenant compliance and liquidity, as well as the Company’s ability to maintain existing unsecured financing or to obtain new financing.
	•	Legislative or regulatory changes may adversely affect the businesses in which Avnet is engaged.
	•	Adverse changes may occur in the securities markets.
	•	Changes in interest rates and currency fluctuations may reduce Avnet’s profit margins.
	•	Avnet may be adversely affected by the allocation of products by suppliers.

      Because forward-looking statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by them. Management cautions you not to place undue reliance on these statements, which speak only as of the date of this Report.

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

2

Table of Contents

PART I

AVNET, INC. AND SUBSIDIARIES

See notes to consolidated financial statements

3

Table of Contents

AVNET, INC. AND SUBSIDIARIES

See notes to consolidated financial statements

4

Table of Contents

AVNET, INC. AND SUBSIDIARIES

See notes to consolidated financial statements

5

Table of Contents

AVNET, INC. AND SUBSIDIARIES

1. In the opinion of management, the accompanying unaudited interim consolidated financial statements contain all adjustments necessary, all of which are of a normal recurring nature, except for the restructuring and other charges discussed in Note 12, to present fairly the Company’s financial position, results of operations and cash flows. For further information, refer to the consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 3, 2004.

2. The results of operations for the first quarter ended October 2, 2004 are not necessarily indicative of the results to be expected for the full year. The Company operates on a “52/53 week” fiscal year and, as a result, the quarter ended October 2, 2004 contained thirteen weeks while the quarter ended October 4, 2003 contained fourteen weeks.

3. Stock-based Compensation

      The Company follows Accounting Principles Board Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees, in accounting for its stock-based compensation plans. In applying APB 25, no expense was recognized for options granted under the various stock option plans as the options granted during the periods presented had exercise prices equal to the market value of the underlying stock on the date of the grants. Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure — An Amendment of FASB Statement No. 123, requires certain disclosure of the pro forma impact on net income (loss) and earnings (loss) per share as if a fair value-based method of measuring stock-based compensation, as defined by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, had been applied.

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

6

Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

4. Goodwill:

      The following table presents the carrying amount of goodwill, by reportable segment, for the quarter ending October 2, 2004:

5. External financing:

      Short-term debt consists of the following:

      Bank credit facilities consist of various committed and uncommitted lines of credit with financial institutions utilized primarily to support the working capital requirements of foreign operations. The weighted average interest rates on the bank credit facilities at October 2, 2004 and July 3, 2004 were 2.8% and 2.5%, respectively.

      Long-term debt consists of the following:

      In March 2004, the Company issued $300,000,000 of 2% Convertible Senior Debentures due March 15, 2034 (the “Debentures”). 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

7

Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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 has the right to deliver cash or a combination of cash and common stock, in lieu of solely common stock. 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 Company has an unsecured, three-year $350,000,000 credit facility with a syndicate of banks (the “Credit Facility”), which expires in June 2007. 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 October 2, 2004. There were no borrowings under the Credit Facility at October 2, 2004 or July 3, 2004.

      The Company has two interest rate swaps with a total notional amount of $400,000,000 in order to hedge the change in fair value of the 8.00% Notes due November 2006 (the “8% Notes”) related to fluctuations in interest rates. These contracts are classified as fair value hedges and mature in November 2006. The interest rate swaps modify the Company’s interest rate exposure by effectively converting the fixed rate on the 8% Notes to a floating rate (4.9% at October 2, 2004) based on three-month U.S. LIBOR plus a spread through their maturities. The Company has three additional interest rate swaps with a total notional amount of $300,000,000 in order to hedge the change in fair value of the 9 3/4% Notes due February 15, 2008 (the “9 3/4% Notes”) related to fluctuations in interest rates. These hedges are also classified as fair value hedges and mature in February 2008. These interest rate swaps modify the Company’s interest rate exposure by effectively converting the fixed rate on the 9 3/4% Notes to a floating rate (8.2% at October 2, 2004) based on three-month U.S. LIBOR plus a spread through their maturities. The hedged fixed rate debt and the interest rate swaps are adjusted to current market values through interest expense in the accompanying consolidated statements of operations. The Company accounts for the hedges using the shortcut method as defined under Statement of Financial Accounting Standards No. 133 Accounting for Derivative Instruments and Hedging Activities, as amended by Statement of Financial Accounting Standards No. 138, Accounting for Certain Derivative Instruments and Hedging Activities. Due to the effectiveness of the hedges since inception, the market value adjustments for the hedged debt and the interest rate swaps directly offset one another. The fair value of the interest rate swaps at October 2, 2004 and July 3, 2004 was $20,086,000 and $13,563,000, respectively, and is included in other long-term assets in the accompanying consolidated balance sheets. Additionally, included in long-term debt is a comparable fair value adjustment increasing the total liability by these same amounts.

6. Commitments and Contingencies:

      From time to time, the Company may become liable with respect to pending and threatened litigation, tax, environmental and other matters. The Company has been designated a potentially responsible party or has become aware of other potential claims against it in connection with environmental clean-ups at several sites. Based upon the information known to date, the Company believes that it has appropriately reserved for its share of the costs of the clean-ups and it is not anticipated that any contingent matters will have a material adverse impact on the Company’s financial condition, liquidity or results of operations.

8

Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

7. Pension Plan:

      The Company’s noncontributory defined benefit pension plan (the “Plan”) covers substantially all domestic employees. Components of net periodic pension costs during the quarters ended October 2, 2004 and October 4, 2003 were as follows:

      The Company expects to make contributions to the Plan of approximately $13,330,000 during fiscal 2005, of which contributions of $5,459,000 have been made through October 2, 2004. The Company may make additional voluntary contributions to the Plan during fiscal 2005.

8. Comprehensive income:

9. Earnings (loss) per share:

      The 4.5% convertible notes are excluded from the computation of earnings (loss) per share in each quarter presented as the effects were antidilutive. Shares issuable upon conversion of the 2% Convertible

9

Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Debentures are also excluded from the computation of earnings per share in the quarter ended October 2, 2004 because the contingent conditions for their conversion have not been met (see Note 5).

      The effects of certain stock options and restricted stock awards are also excluded from the determination of the weighted average common shares for diluted earnings (loss) per share in each of the quarters presented as the effects were antidilutive. Accordingly, in the quarter ended October 2, 2004 the effects of approximately 7,184,000 shares related to stock options are excluded from the computation above, all of which relate to options for which the exercise prices were greater than the average market price of the Company’s common stock. In the quarter ended October 4, 2003 the effects of approximately 11,438,000 shares related to stock options and restricted stock awards are excluded from the computation above, of which approximately 9,509,000 related to options for which the exercise prices were greater than the average market price of the Company’s common stock.

10. Additional cash flow information:

      Other non-cash and other reconciling items primarily include the provision for doubtful accounts and net periodic pension costs (see Note 7).

      Interest and income taxes paid in the first quarters were as follows:

11. Segment information:

10

Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The Company manages its business based upon the operating results of its two operating groups before restructuring and other charges (see Note 12). During the first quarter of fiscal 2004, the approximate unallocated pre-tax restructuring and other charges related to Avnet Electronics Marketing (“EM”) and Avnet Technology Solutions (“TS”) were $16,171,000 and $9,936,000, respectively. The remaining restructuring and other charges recorded during the first quarter of fiscal 2004 relate to corporate activities.

12. Restructuring and other charges:

      During the first quarter of fiscal 2004, the Company executed certain restructuring and cost-cutting initiatives in order to improve profitability. These actions can generally be broken into three categories: (1) the combination of the Company’s Computer Marketing and Applied Computing operating groups into one computer products and services business called Avnet Technology Solutions; (2) the reorganization of the Company’s global IT resources, which had previously been administered generally on a separate basis within each of the Company’s operating groups; and (3) various other reductions within EM and certain centralized support functions.

      As a result of actions completed through the end of the first quarter of fiscal 2004, the Company recorded restructuring and other charges totaling $32,153,000 pre-tax, $22,186,000 after tax, or $0.18 per diluted share. The pre-tax charge consisted of severance costs ($9,393,000), charges related to consolidation of selected facilities ($10,848,000), write-downs of certain capitalized IT-related initiatives ($6,909,000) and other items, consisting primarily of the write-off of the remaining unamortized deferred loan costs associated with the Company’s former multi-year credit facility which was terminated in September 2003 ($5,003,000).

      Severance costs resulted from workforce reductions of approximately 400 personnel completed during the first quarter of fiscal 2004, primarily in executive, support and other non customer-facing functions in the Americas and EMEA regions. Management also identified a number of facilities for consolidation primarily in the Americas and EMEA regions. These facilities generally related to certain logistics and warehousing operations as well as certain administrative facilities across both operating groups and at the corporate level. The charges related to reserves for remaining non-cancelable lease obligations and write-downs to fair market value of owned assets located in these facilities that have been vacated. Management also evaluated and elected to discontinue a number of IT-related initiatives that, in light of recent business restructurings, no longer met the Company’s return on investment standards for continued use or development. These charges related to the write-off of capitalized hardware and software.

11

Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The following table summarizes the Company’s restructuring and other charge activity during the first quarter of fiscal 2005, during which there has been no material activity within the reserves other than payment activity as detailed in “amounts utilized” in the table below:

      The Company expects to utilize the majority of the remaining reserves for severance costs by the end of the first quarter of fiscal 2006. The Company expects to utilize substantially all of the remaining reserves for contractual lease commitments by the end of fiscal 2007. The IT-related and other reserves relate primarily to remaining contractual commitments, the majority of which the Company expects to utilize by the end of fiscal 2005.

      As part of management’s ongoing analysis of its restructuring reserves, the Company recorded certain adjustments during the first quarter of fiscal 2005. These adjustments were recorded through selling, general and administrative expenses in the quarter ended October 2, 2004. The adjustments related to recording additional severance costs based upon revised estimates of required payouts and legal costs associated with the payouts as well as reductions to certain lease reserves due to modifications to sublease and termination assumptions based upon ongoing market conditions.

12

Table of Contents

      For a description of the Company’s critical accounting policies and an understanding of the significant factors that influenced the Company’s performance during the quarters ended October 2, 2004 and October 4, 2003, this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the consolidated financial statements, including the related notes, appearing in Item 1 of this Report as well as the Company’s Annual Report on Form 10-K for the year ended July 3, 2004. The Company operates on a “52/53-week” fiscal year and, as a result, the quarter ended October 2, 2004 contained thirteen weeks while the quarter ended October 4, 2003 contained fourteen weeks. This extra week in the first quarter of fiscal 2004 impacts many of the following discussions in this MD&A.

      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 US Dollar has continued to significantly weaken in comparison to most foreign currencies, especially the Euro (which strengthened against the US Dollar by roughly 8% from the first quarter of fiscal 2004 to the first quarter of 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.

      In addition to disclosing financial results that are determined in accordance with U.S. generally accepted accounting principles (“GAAP”), the Company also discloses pro forma or non-GAAP measures that may exclude certain items. 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. Management believes the pro forma measures also help indicate underlying trends in the business. Management also uses pro forma information to establish operational goals and, in some cases, for measuring performance for compensation purposes. However, analysis of results and outlook on a pro forma or non-GAAP basis should be used as a complement to, and in conjunction with, data presented in accordance with GAAP.

OVERVIEW

      Avnet, Inc. and its subsidiaries (the “Company” or “Avnet”) is one of the world’s largest industrial distributors, based on sales, of electronic components, enterprise network and computer equipment and embedded subsystems. Avnet creates a vital link in the technology supply chain that connects over 250 of the world’s leading electronic component and computer product manufacturers and software developers as a single source for multiple products for a global customer base of over 100,000 original equipment manufacturers (“OEMs”), contract manufacturers, original design manufacturers, value-added resellers (“VARs”) and end-users. Avnet distributes electronic components, computer products and software as received from its suppliers or with assembly or other value added by Avnet. Additionally, Avnet provides engineering design, materials management and logistics services, system integration and configuration, and supply chain advisory services.

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

	•	EM markets and sells semiconductors and interconnect, passive and electromechanical devices. EM markets and sells its products to customers spread across end-markets including communications, computer hardware and peripheral, industrial and manufacturing, medical equipment, and military and aerospace. EM also offers an array of value-added design chain, supply chain and product enhancement services to its customers.

13

Table of Contents

	•	TS markets and sells mid- to high-end servers, data storage, software and networking solutions, and the services required to implement these solutions, to the VAR channel and enterprise computing customers. 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.

Results of Operations

      Avnet’s consolidated sales in the first quarter of fiscal 2005 were up 8.0% over the first quarter of fiscal 2004, even with the prior year first quarter containing an extra week as discussed above, representing the seventh consecutive quarter of year-over-year consolidated sales growth for Avnet. These results continue to show an electronic components and computer product industry that has emerged from the industry and economic downturn that began in fiscal 2001 and extended into fiscal 2004. The electronic components market is the more cyclical of the two businesses in which Avnet operates. As a result, the emergence from the industry downturn is most evident in EM where sales growth of 15.2% year-over-year drove the Company’s consolidated growth in sales in the same period. The Company recorded year-over-year increases in sales in each of the three regions in which it does business (the Americas; Europe, the Middle East and Africa, hereafter referred to as “EMEA”; and Asia). Approximately one-third of the Company’s consolidated growth in sales is a result of the impact of changes in foreign currency exchange rates.

      Sequentially, Avnet’s consolidated sales declined slightly, as expected, from the fourth quarter of fiscal 2004, driven primarily by a normally slow summer season in both groups and some reductions in inventory at certain EM customers that caused a softening in the electronic components market after several quarters of strong growth. While customer inventory reductions impacted the current quarter, and may continue to impact Avnet’s results slightly in the upcoming quarter or two, management does not view this phenomenon as one that will have a lasting impact on Avnet’s business. Even with the seasonal slowdown, TS maintained revenues essentially flat with the fourth quarter of fiscal 2004. Additionally, the negative impacts of customer inventory reductions in EM are expected to be much more than offset by the typically strong second quarter performance of the computer products business, driven primarily by the calendar year-end budgeting cycle of many of TS’s customers.

      The operating efficiencies that the Company has derived from its value-based management initiatives and focus on operating costs over the past several years allowed the Company to continue to record year-over-year improvements in operating income dollars and operating profit margin. Operating profit margin in the first quarter of fiscal 2005 was 2.8% and represents the Company’s highest operating profit margin for a first fiscal quarter since fiscal 2001. Comparatively, first quarter of fiscal 2004 operating profit margin was 0.3%. However, these prior year results included certain restructuring and other charges discussed further in this MD&A that totaled $32.2 million, or 1.3% of sales. Even without these restructuring and other charges, the increase in profitability year-over-year is significant. Sequentially, operating income and operating profit margin declined slightly driven by the small decline in sales on a consolidated basis and the customer inventory reductions in EM that are discussed above.

14

Table of Contents

      The table below provides period sales for the Company and its operating groups:

      Consolidated sales for the first quarter of fiscal 2005 were $2.60 billion, up $192.4 million, or 8.0%, from the prior year first quarter consolidated sales of $2.41 billion with approximately $68 million of this year-over-year increase resulting from the impact of foreign currency exchange rates. In light of Avnet’s fiscal calendar, which resulted in an extra week in the first quarter of fiscal 2004, sales on a per week basis are an important metric that management has utilized to analyze its sales results on a year-over-year basis in the first quarter. Sales per week increased by more than 16% in the first quarter of fiscal 2005 compared to the prior year first quarter. After four quarters of sequential sales growth, the Company’s top line declined slightly on a sequential basis, posting a decrease of $43.0 million, or 1.6%, due to the impacts of the slow summer season and some softness in the electronic components market as described further herein.

      EM reported sales of $1.56 billion in the first quarter of fiscal 2005, up $206.3 million, or 15.2%, over the prior year first quarter sales of $1.36 billion but down by $43.9 million, or 2.7%, from sales of $1.61 billion in the fourth quarter of fiscal 2004. The increase in EM represents the fourth consecutive quarter of year-over-year sales increases in excess of 10%. On a per-week basis, EM’s sales increased by approximately 24% over the prior year first quarter. As discussed above, EM’s sequential results were impacted by a normal seasonal slowdown in the summer quarter coupled with the targeted reduction of inventory by certain electronic component customers. However, management believes that the inventory reductions at EM’s customers are the result a short-term trend that will likely recede over the next three to six months.

      EM grew sales in all three regions with EMEA posting the strongest gains of 27.7% year-over-year (nearly 38% on a sales-per-week basis). Slightly more than one-third of this growth in EM EMEA was a result of foreign currency exchange rates. Despite the factors discussed above, EMEA also grew sales on a sequential basis by 1.2% (sales were essentially flat on a sequential basis excluding the impact of changes in foreign currency exchange rates between quarters). The Americas and Asia regions also posted year-over-year sales increases of 8.9% and 8.1%, respectively (17% and 16%, respectively, on a per-week basis) although both showed slight declines sequentially. The year-over-year improvement is a result of increasing customer demand coupled with steady improvement in all regions in capital spending throughout Avnet’s customer base. Furthermore, the year-over-year growth in the Asia/ Pacific region is indicative of a trend for the past several years whereby technology manufacturing, especially electronic components, continues to shift to this region

15

Table of Contents

      TS reported sales of $1.04 billion, down $13.9 million, or 1.3%, from sales in the first quarter of fiscal 2004 of $1.05 billion. However, on a per week basis, TS’s sales increased year-over-year by over 6%. Notwithstanding the normally slow summer season discussed above, TS maintained sales in the first quarter relatively flat sequentially when compared to the fourth quarter of fiscal 2004. TS Americas’ sales of $703.2 million stayed essentially flat with the prior year first quarter but were up over 7% on a per week basis. TS Americas’ sales fell $22.0 million, or 3.0%, on a sequential basis due primarily to strong growth in industry standard servers and microprocessors that was offset by a decline in sales of proprietary hardware products. TS EMEA’s sales of $278.8 million were down $26.3 million from the prior year first quarter, representing an 8.6% decline (15.7% decline year-over-year excluding the impact of foreign currency exchange rates) but a drop of less than 2% on a per-week basis. Sequentially, TS EMEA grew sales by 2.3%. TS Asia sales of $53.7 million were up 37.3% year-over-year (48% on a per-week basis) and 44.3% sequentially. Similar to the Americas, the sequential growth in EMEA and Asia is fueled by the strength of worldwide microprocessor demand, which management expects will become even more significant as the Company moves into its typically strong second fiscal quarter for the computer products group.

      On an overall regional basis, the EMEA region has exhibited the largest growth as a percentage of consolidated sales. This region represented 32.0% of consolidated sales in the first quarter of fiscal 2004 versus 33.6% in the current quarter. This increase is a result of the strong performance in the first quarter of fiscal 2005, with both of Avnet’s operating groups exhibiting sales growth in EMEA sequentially despite the normally slow summer season. The growth in reported sales for EMEA in the first quarter of fiscal 2005 was also enhanced by the impact of foreign currency exchange rates as discussed above. Although the year-over-year growth in the Asia region is not as significant as it has been in the past, management expects Asia will continue to be a significant growth opportunity. With its established position throughout the Asia region, most notably in markets in the Peoples’ Republic of China, management believes Avnet is well positioned to continue to capitalize on the region’s growth.

Gross Profit and Gross Profit Margins

      Consolidated gross profit for the first quarter of fiscal 2005 was $349.6 million, up $40.5 million, or 13.1%, over the first quarter of fiscal 2004. Similarly, gross profit margins of 13.4% in the first quarter of fiscal 2005 were up 61 basis points over gross margin of 12.8% in the prior year first quarter. The consolidated improvement in gross profit margins is driven primarily by two factors. First, TS is typically a higher asset velocity but lower gross profit margin business than EM. With the electronic component industry continuing on an up-cycle year-over-year, EM constituted a larger percentage of Avnet’s consolidated sales in the current quarter (60.2% in the first quarter of fiscal 2005 as compared with 56.4% in the prior year first quarter). Second, TS’s continued focus on value-added solutions and more profitable sales continued to enhance the computer products group’s gross margin performance resulting in more substantial basis point increases in gross profit margin within TS than with EM. However, even with the impact of EM customer inventory reductions on sales volume and gross profit margins in the first fiscal quarter, EM also posted modest gross profit margin improvement on a year-over-year basis.

      Although both operating groups continue to focus on enhancing profitability, TS’s strong second quarter driven by the calendar year-end budgeting cycles of many of its customers is likely to result in TS constituting a higher percentage of Avnet’s consolidated sales in the second fiscal quarter. However, management expects the mix of business between operating groups will return to roughly the same ratio as the current quarter mix after the end of the calendar year.

Selling, General and Administrative Expenses

      Selling, general and administrative expenses were $276.5 million in the first quarter of fiscal 2005, up $8.0 million, or 3.0%, over the prior year first quarter. This increase is driven in large part by the substantial increase in sales year-over-year as discussed above. Additionally, the effects of foreign currency translation

16

Table of Contents

      Metrics that management monitors with respect to its operating expenses are selling, general and administrative expenses as a percentage of sales and as a percentage of gross profit. In the first quarter of fiscal 2005, selling, general and administrative expenses were 10.6% of sales and 79.1% of gross profit as compared with 11.2% and 86.9%, respectively, in the first quarter of fiscal 2004. This significant year-over-year improvement is primarily a result of the Company’s ongoing cost reduction initiatives of recent years. Specifically, cost reduction efforts that resulted in restructuring and other charges in the first and second quarters of fiscal 2004 had not yet begun to significantly impact the operating results in the prior year first quarter but were completely in effect by the first quarter of fiscal 2005.

Restructuring and Other Charges

      During the first quarter of fiscal 2004, the Company executed certain restructuring and cost-cutting initiatives in order to improve profitability. These actions can generally be broken into three categories: (1) the combination of the Company’s Computer Marketing and Applied Computing operating groups into one computer products and services business called Avnet Technology Solutions; (2) the reorganization of the Company’s global IT resources, which had previously been administered generally on a separate basis within each of the Company’s operating groups; and (3) various other reductions within EM and certain centralized support functions.

      As a result of actions completed through the end of the first quarter of fiscal 2004, the Company recorded restructuring and other charges totaling $32.2 million pre-tax, $22.2 million after tax, or $0.18 per diluted share. The pre-tax charge consisted of severance costs ($9.4 million), charges related to consolidation of selected facilities ($10.9 million), write-downs of certain capitalized IT-related initiatives ($6.9 million) and other items, consisting primarily of the write-off of the remaining unamortized deferred loan costs associated with the Company’s former multi-year credit facility which was terminated in September 2003 ($5.0 million).

      Severance costs resulted from workforce reductions of approximately 400 personnel completed during the first quarter of fiscal 2004, primarily in executive, support and other non customer-facing functions in the Americas and EMEA regions. Management also identified a number of facilities for consolidation primarily in the Americas and EMEA regions. These facilities generally related to certain logistics and warehousing operations as well as certain administrative facilities across both operating groups and at the corporate level. The charges related to reserves for remaining non-cancelable lease obligations and write-downs to fair market value of owned assets located in these facilities that have been vacated. Management also evaluated and elected to discontinue a number of IT-related initiatives that, in light of recent business restructurings, no longer met the Company’s return on investment standards for continued use or development. These charges related to the write-off of capitalized hardware and software.

      As of October 2, 2004, the Company’s remaining reserves for restructuring and other related activities totaled $23.0 million. Of this balance, $2.8 million relates to remaining severance reserves, the majority of which management expects to utilize by the end of the first quarter of fiscal 2006. Reserves for $19.1 million relate to contractual lease commitments, substantially all of which the Company expects to utilize by the end of fiscal 2007. Lastly, the Company’s IT-related and other reserves, which total $1.1 million, relate primarily to remaining contractual commitments, the majority of which the Company expects to utilize by the end of fiscal 2005.

Operating Income

      As a result of the factors discussed in this MD&A, operating income in the first quarter of fiscal 2005 was $73.1 million (2.8% of sales) as compared with $8.4 million (0.3% of sales) in the prior year first quarter. The prior year results were negatively impacted by certain restructuring and other charges recorded in the first quarter of fiscal 2004 (see Restructuring and Other Charges), which totaled $32.2 million, or 1.3% of sales. EM improved its operating profit margin by 130 basis points, to 3.8% of sales in the first quarter of fiscal 2005

17

Table of Contents

Interest Expense and Other Income, Net

      Interest expense was $20.9 million in the first quarter of fiscal 2005, down $6.3 million, or 23%, from interest expense of $27.2 million in the first quarter of fiscal 2004. While a portion of this decrease is a result of a decrease in total debt outstanding ($1.32 billion at October 2, 2004 as compared with $1.43 billion at October 4, 2003) the primary driver of the lower interest expense is the Company’s effective interest rates on the current composition of its debt balances. Since the first quarter of fiscal 2004, the Company has repaid $29.9 million of 8.20% Notes due October 17, 2003, $100.0 million of 6 7/8% Notes due March 15, 2004 and $273.4 million of 7 7/8% Notes due February 15, 2005. The only significant debt added since the prior year first quarter are the Company’s Convertible Debentures due March 15, 2034, which bear interest at only 2.0% per annum.

      Other income, net, was $0.3 million in the first quarter of fiscal 2005 as compared with $2.3 million in the first quarter of fiscal 2004. The higher other income in the prior year first quarter was driven primarily by higher interest and investment income on the Company’s higher cash balances, including certain funds held in escrow from prior year debt offerings to fund the debt repayments discussed above, during that quarter.

Income Tax Provision (Benefit)

      The Company’s effective tax rate on its income before income taxes was 30.8% in the first quarter of fiscal 2005 as compared with an effective rate of 31.0% applied to the Company’s loss before income taxes in fiscal 2004. The mix of Avnet’s profits amongst its various international subsidiaries with varying statutory tax rates, including the projected mix of profits for the remainder of the fiscal year, impacts the Company’s effective tax rate.

Net Income (Loss)

      As a result of the operational performance and other factors described in the preceding sections of this MD&A, the Company’s consolidated net income for the first quarter of fiscal 2005 was $36.3 million, or $0.30 per share on a diluted basis as compared to a net loss of $11.4 million, or $0.09 per share on a diluted basis, in the first quarter of fiscal 2004. The first quarter of fiscal 2004 results include certain charges discussed in Restructuring and Other Charges which yielded a negative after-tax impact in that quarter of $22.2 million or $0.18 per share on a diluted basis.

18

Table of Contents

LIQUIDITY AND CAPITAL RESOURCES

Cash Flow

      The following table summarizes the Company’s cash flow activity for the first quarters ended October 2, 2004 and October 4, 2003 including the Company’s computation of free cash flow. Management believes that the non-GAAP metric of free cash flow is a useful measure to help management and investors to 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.

      During the first quarter of fiscal 2005, the Company used $7.2 million of cash and cash equivalents for its operating activities as compared with a generation of cash and cash equivalents of $57.1 million from operating activities in the first quarter of fiscal 2004. These results are comprised of: (1) the cash flow generated from net income excluding non-cash and other reconciling items, which includes the add-back of depreciation and amortization, deferred income taxes and other non-cash items (primarily the provision for doubtful accounts) as well as non-cash restructuring and other charges in the prior year first quarter (see Results of Operations — Restructuring and Other Charges for further discussion) and (2) the cash flows (used for) generated from working capital, excluding cash and cash equivalents. Although the first quarter of fiscal 2005 was significantly more profitable than the first quarter of fiscal 2004, the Company utilized cash and cash equivalents of $77.4 million for working capital as opposed to the generation of $26.3 million in cash and cash equivalents from working capital in fiscal 2004. Such trends in working capital are typical of an up-cycle in the electronic components industry as growth in receivables, inventory and payables is driven by higher sales and purchasing volumes. The cash outflow related to working capital in fiscal 2005 is driven primarily by the increase in inventories to support increased sales volumes. The majority of this increase resides in TS where the Company has made certain quarter-end purchases in support of the upcoming seasonally strong December quarter. While asset velocity metrics such as inventory turns have slowed from their recent record levels due to the slight softness in the electronic components business as discussed elsewhere in this MD&A, management continues to focus on its working capital and overall asset utilization and expects these metrics to again begin to improve in the second quarter of fiscal 2005.

      The Company’s cash flows associated with its investing activities such as purchases of property, plant and equipment and acquisitions remained relatively low in the first quarters of both fiscal 2005 and 2004. The Company completed a small acquisition of a computer product distributor in Slovakia during the first quarter of fiscal 2005 whereas the outflow of cash for acquisitions in the prior year first quarter was associated

19

Table of Contents

Capital Structure and Contractual Obligations

      The following table summarizes the Company’s capital structure as of the end of the first quarter of fiscal 2005 with a comparison to fiscal 2004 year-end: