艾睿電子 (ARW) 2002 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Arrow Electronics, Incorporated, New York Stock Exchange ticker ARW, second quarter 2002 earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. As a reminder, this conference is being recorded.

I would now like to introduce your host for today's call, Mr. Robert Clatell [phonetic]. Mr. Clatell, you may begin.

Thank you, Enrique. And good morning, everyone, welcome to our second quarter earnings conference call. I will be serving as the moderator on the call today. With us are Dan Duval, chairman of the board, Steve Kaufman, president and CEO of the company, Paul Reilly, our chief financial officer, Mike long is president of our North American computer product operations, Jan Salzgiver [phonetic], president of North American components operations, and Eileen O'Connor, vice-president of investor relations.

Let's get some of the traditional housekeeping matters out of the way. By now you all should have received a copy of our earnings release. If you did not, please contact either my office or Irene O'Connor and we'll make sure to get you a copy. Alternatively, you can always access the release on our web site which as you know is www.Arrow.com.

Let me remind everyone that some of the comments made on today's call may contain forward looking statements. Those statements are, of course, subject to risks and uncertainties as described in the company as SEC filings. [company's] and rather than read the entire disclaimer contained in those filings, let me just state that as always they do apply to this call. As a reminder to the members of the press [Reminder [Is this you are in a list not only mode on this call. But please feel free to contact us afterwards and we'll set up some^time to answer any questions you may have.

We'll begin with several minutes of prepared remarks related to the second quarter results and an update on operations. And that will then be followed by a Q and A discussion period.

First let's turn to Paul Reilly, our chief financial officer, to review the financial results. Paul?

Thanks, Rob. Before we begin, let me point out, there are a number of [Inaudible] items occurring this quarter. I thought it would be helpful if I summarize them for you. The adopted FAZ 142 effective January 1st of this year, accordingly we no longer amortize good will. The second quarter of 2001 good will amortization was $12 million pretax and $10 million after tax. In this quarter we have also completed the initial evaluation of the impairment of our good will. Writeoff total 600 $4 million. On a second basis, $348 million of the write^off related to the computer products business, with the remaining $256 million related to the components business. As required by the new accounting rules, this change is effective as of January 1st, 2002. Accordingly, you will not see the writeoff in Q2, but you will see that as required we have shown the impact of this charge in our year to date results. We previously announced during the second quarter we sold the gates Arrow commodity computer products business. As we have now exited this business, this transaction must be treated or accounted for as a sale of distanned operation. Accordingly, the individual components of the gates Arrow business, that's sales, gross profits, operating expenses, etc., have been excluded from our reported results. Instead, the net income or loss from gate is required to be shown as a single line item in our income statement, and we have restated all prior periods on a consistent basis. For those of you trying to keep your model straight, sales of Gate's Arrow in Q1 were $108 million. Lastly in this quarter is $5.4 million pretax, that's $3.2 million after tax, of CEO severance costs. Steve will discuss this in greater detail shortly.

For comparative purposes, I will exclude the aforementioned items from our discussions. Sales for the quarter were $1.84 billion, virtually flat with sales from continuing operations in the first quarter. That is, same store sales or sales excluding gates. Q2 sales were down 22 percent from last year's adjusted second quarter sales X Gate's. Gross profit was 17.3 percent compared to Q1 17.1 percent and 16. 5 percent in Q2 of last year. The increase in Q2 versus Q1 is driven entirely by a change in mix with sales of core components being a greater percentage of our total sales. As we continue to reduce our exposure to the CPU business, and we continue to see a decline in the large telecom and networking customer base. Operating expense dollars were up slightly over the first quarter. The primary drive is here was the increase [Drivers] in foreign exchange in Europe, and the end of our furlough program in North America. Operating income as a percentage of sales was 2.5 percent, up 7 basis points from the prior quarter, but down 90 basis points from last year. Interest expense was 40.8 million dollars, down from 41.2 million in Q1, and 54.5 million in last year's second quarter. In the second quarter, our six consecutive quarter of positive cash flow from operations, we generated over $213 million in free cash flow. That brings the total for the past 18 months to more than $2 billion. Our effective tax rate for the quarter was 38 percent and net profit was $3.8 million. GPS for the quarter was 4 cents per share versus a profit two cents in Q1 and 6 cents in last year's second quarter. Here are a couple stat to help with the analysis in model building. The depreciation aches amortization for the quarter was $16.8 million. Just to be clear the amortization I'm referring to here is amortization of leasehold improvement and not good will. Rent expense for the quarter was 15.$3 million. Noncash interest expense in the quarter related to the zero coupon convertible debentures with $7 million. And lastly, the actual numbers shares outstanding at the end of the quarter were 99 million, 857,000.

Thanks, Paul. Now we'll turn the meeting over to Steve Kaufman to discuss our operating performance in a little more detail. Steve?

Good morning, everyone.

Overall, we are quite pleased by the performance of each of our operating groups in what continues to be a very, very difficult market. But let me take you through some of our major operating businesses to give you a little flavor for this, starting with North American computer products. Sales in this North American computer products group were just over $400 million for the quarter, which is up nearly 10 percent sequentially from the March quarter. And please remember that we have adjusted Q1 to reflect the disposal of the Gate's hour commodity business which was sold in late May.

Sales in our mid range business, the principal thrust of our North American computer products business, sales in that mid range business were up over 12 percent. Now, this quarter, the June quarter is the end of the fiscal year for one of our major mid range suppliers, so we did see the traditional seasonal surge in that line. Interestingly, one of our other lines has a December fiscal year, and we see a similar surge in December each year. North America computer products operating income as a percentage of sales remains very strong in excess of 3 percent. On the North American component side, we generated sales of just over 650 million in the quarter, which is a slight increase, 1 to 2 percent over Q1. Operating income as a percentage of sales climbed again, and this is for the fourth consecutive quarter we've seen modest up ticks in our operating income in this business. Cutting it a little finer, sales in our core components business, that is, excluding those very large telecom and global accounts, sales in that core business, the traditional meat and potatoes component business increased three-and-a-half percent over the first quarter, and that's two quarters - that's after two quarters of flat sales. So we've finally seen a little tick upwards in that core business. And sales in our business that serves contract manufacturers increased, again which is the second sequentially quarter increase since the downturn began six quarters ago. So in both our core business and in our contract manufacturing business, we've seen slight up ticks which gives us some hope which I'll talk about in just a bit.

On the other side, the area within the North American components group that continues to be the most troubled is the business that serves large complex engagements. And the customer base here is very heavily weighted towards the large telecom and networking companies. Since the beginning of the downturn, sales to the customers of this group have experienced the greatest absolute decline than we've seen anywhere. Again, principally because, as you know and is well chronicled, the nature of the customer base means that there's been just a dramatic decline. And we, too, have seen the dramatic decline in serving them just as you've seen the dramatic decline in our outbound sales.

Moving over to Europe, sales in Europe were down about 6 percent sequentially to just a shade under $600 million. Excluding the impact of foreign exchange, sales declined about 11 percent. However, sales in the core component business, excluding the impact of foreign exchange, declined only 6 percent, less than the overall decline of 11. And that's because sales in the computer products arena in Europe which we call Microtronica [phonetic], and which focuses on CPU's, D-Ram's and disk drives, to dealers and white box PC builders. Sales to that segment declined almost 25 percent. As we have discussed in previous calls, Europe cycles traditionally trail North America by about six months. In addition in the second quarter of the calendar year, there are fewer business days in the major European countries than in Q1 due to various banking, national and religious holidays that occur beginning with April 1st.

And finally, June marks the beginning of the summer holiday period in Europe which usually produces a softening. So we were not surprised by the lower sales in the component business in Europe. But frankly, we don't know if this represents a continuing softening in the underlying market or just the normal seasonal pattern that frequently occurs. In any event, despite the sales decline, our European operations remain solidly profitable.

Over in Asia Pacific, we experienced a modest decline of about 3 percent in sales from the first quarter, and we're running at about 150 to $160 million sales level. However, operating income improved sequentially from Q1.

Component sales, that is, sales excluding CPU's, were up 14 percent sequentially, and that is what is driving the improvement in our operating income.

Now, before we turn to Q and A, let me touch on a couple of issues I suspect are on your minds. It goes without saying that Fran Ceraso's resignation was a surprise to the organization, but I'm very pleased that the entire team did a great job in quickly putting this behind them and continuing to focus on our day-to-day business. Our CEO search is moving along with the pace of screening candidates at about where we thought it would be at this point, six weeks after Fran's resignation. We have a deep and strong operating management team throughout many levels of the organization and in all the countries where we're active, and we're well prepared to operate the business effectively until a permanent successor is found. We are also fortunate to have Dan Duval, a board member of over 15 years experience with Arrow, and of course, as you know, a dozen years very successful experience as a public company CEO in his own right, prepared to step into CEO role in September should we not have the permanent successor in place by then.

As you know, Dan has been on board as an Arrow employee since early June and has spent his time first driving the CEO search on behalf of the board and then visiting our major facilities and suppliers in order to get up to speed while I have been focusing on running the business day to day. As Paul mentioned, our Q2 results were negatively impacted by severance costs totaling approximately $5.4 million for Fran. The great majority of this amount was consistent with his employment agreement.

Third, let me say that we feel quite good about our position in our marketplace, although, of course, no one is very happy about the condition of the marketplace itself. Our core component business in North America at had its first sequential increase in sales following two flat quarters, and we continue to make selective investments in our businesses around the world so as to be better prepared for the acceleration in business activities that will inevitably come, although I can't give you the precise date that will mark the visible upturn.

The last point I'll just reemphasize is the operating income in our North American computer business, which as I commented, remains at a very solid 3 plus percent. Profitability has increased in Asia Pacific. Our European components businesses are operating at the sales levels we would anticipate for this time of year, and of course they remain quite profitable. And as Paul emphasized, we had another very strong quarter in cash flow generation.

I know someone will ask the question about Q3, so let me answer it now. Q3 is always difficult, if not impossible, to forecast. The traditional seasonal cycle would say that we will see some drop in business activity in North America, while in Europe, of course, we all know that business activities slow down dramatically by the extended seasonal summer holidays, particularly through the Mediterranean countries. However, for us as for most companies in the technology sector, visibility remains very limited, at best. So I'm afraid I can give you even less guidance than I might normally have done in past years, and I would say, as I have said in past years, that we never really know how the summer quarter will be until we see September, until we see what happens when people come back from the summer holiday period, look at their own backlogs, look at their own inventory levels, and then decide how aggressively to go forward with their purchasing. And we just won't see much until we get to the third or fourth week of September.

Having said all of that, however, I will go a little bit out on the limb and say that I think we are bouncing along the bottom, not declining any further. And if past cycles are a barometer of the future, I would expect that we'll see another quarter bouncing on that bottom. I would then expect to see a slow gradual pick up for three quarters or so before we move into another more pronounced and aggressive up swing which regrettably will then result 7 or 8 quarters beyond that in another catastrophe as the cycles hit us once more and we cycle back down. But overall based on my 20 years in the business, I do believe that Q4 will be better than Q2.

Thank you, Steve. Enrique, let's open it up to questions and answers, now, please. 00:21:00

Thank you, sir. The floor is now open for questions. If you do have a question, please press 1 followed by 4 on your touch tone phone. Fur on a speakerphone, we do ask that you pick up your handset to minimize any background noise and if at any point your question has been answered, may remove yourself from the queue by pressing the pound key. Our first question is coming from Steven fox of Merrill Lynch.

Yes, good morning. A couple of questions. Can you talk a little bit about anything you can do independently of the market in the summer quarter to protect profitability? Is there some more cost savings coming through, or is it more driven really by the top line at this point? And then secondly I'm just a little confused. If you look at the balance sheet, the costs in excess of net access decline by 467 million, but in the press release you said the write down was $600 million. Where is the difference?

I'll have Paul Reilly answer the second question since it's numeric and I'll answer the first.

So we did have the 600 $4 million writeoff. Two other events occurred, one is the strengthening of the you're owe, means that any good will that we had in Europe would also become more dollars. So that impacts it, as well as we made some payments during the first six months of the year under our previous acquisition agreements to some of the shares that we purchased. And we disclosed it actually in our first quarter 10(k) at a subsequent event. So the details are already disclosed in that.

Great.

Your first question, Steve. We do not expect to see any significant additional cost reductions at this point. We believe we are at the place we should be with our staffing, which is of course our principal controllable cost. So the quarter will really float along based on the top line and on the gross margin yield from sales of various segments.

One last minor question, the tax rate for the rest of the year. Paul, what are we looking at?

I think it would be consistent from where we are for the first six months.

Thanks a lot. I have thank you. Our next question is coming from Matt Sharon of Thomas Wiesel Partners.

Yes, thanks and good morning. Just a couple questions. Regarding the - we talked about the declining microprocessor sales and PC components. Steve, maybe you can talk sort of philosophically about your role in that market. I know you've sort of deemphasized that going forward. Is that something you're just going to continue to sort of stay away from because you're just not profitable any more?

Hi, Matt. I would say that you're correct in stating that we have consciously de-emphasize sales in all of the commodity PC oriented products, whether it's CPU's or D-Ram's or the low end disk drives. That's the reason that we decided to exit and sell Gate's Arrow business because they were operating in that same space, and we're taking the same approach to the business on the component side of CPU's and D-Rams. It's not necessarily the lower profitability. That's part of it. It's just a marketplace where we're not sure we have the kind of expertise and value added that brings anything special to the market. We become just one of a whole bunch of guys out there hawking CPU's and D-Rams and disk drives at whatever today's worldwide market price is. We prefer to operate in segments where we can add some value either physical value or intellectual value, or value through kitting or value through service. and it's just hard to do that in the CPU and D-Ram businesses. Plus, there are the risks in those marketplaces that come from dealing with customers that arrive and depart suddenly, sometimes leaving you holding your baggage still on the platform of the train, or worse, I should say the analogy is you put your bag on the train, the train left and you're still on the train without your baggage. Those happen with enough regularity that the whole market just for us doesn't feel comfortable.

Okay, great. And then a question concerning inventories, they did come down again a little bit. Could you just give us a sense of were there areas where you're building inventory or were there still some excess and what that level might look like in the next quarter or so?

Well, as always, both of your comments are true. At any time in the cycle there is stuff we'd like more of and there's stuff we have excess of. In a broad sense, we're trying to flatten out the inventory dollar decline, so to use the mathematician's phrase, we've acetonically [phonetic] approaching the bottom of where we'd like to be. And because we see the market bottoming out and we expect it to increase, there are some areas where we're prepared to open our checkbooks and begin to add some inventories. And I'll let Jan talk a little bit about the areas where we see either market strength within particular segments, or where we would expect to see the leading areas as the business comes into an up cycle.

Okay. Thanks, Steve. Yes, our inventory in North America did decline about 10 percent quarter on quarter, but as Steve suggested, we are not aggressively in an inventory reduction mode. It's much more important to us to be focused on having the right technologies on the shelf to drive sales. And if I give you a sense of what happened in the quarter by technology, we basically had sequential single digit growth in our semiconductor segment, passive electromechanical and connector sales. Most of the growth, the high growth - highest growth areas were driven from embedded processors including DSP's, programables, discretes, connectors and analog products. Those were all the highest growth areas. We do continue to experience some pricing pressure in commodity products, particularly logic and commodity analog and some of the passer products. But we are positioning inventory to be able to drive sales, particularly in the areas I talked about where we're seeing the highest growth.

That's great. Thank you.

Thank you. Our next question is coming from Philip Olson of UBS Warburg.

Just a couple quick questions with respect to the balance sheet. First, in terms of the ratings triggers, have you had any chance of having those removed from your AR securitization program given the fact that you now have S and P placed on review for downgrade? And with respect to the S and P rating action, have they given you an indication whether or not they are contemplating on one or two notch downgrade?

Well, let me say that first off we've had no indication as to whether there will be a downgrade. What they've given us indication is they would like us to come in and meet with them and give them an update on what we think is going to happen for the business going forward. We're pretty comfortable with the fact we have $900 million carbon our balance sheet and nothing borrowed on either the revolver or the asset securitization. So the triggers that you're referring to would only come into effect if he we would have a two-notch downgrade and we have no indication at this point in time what the ultimate decision will be with the credit rating agencies once we meet with them. So right now we feel pretty good about our liquidity.

I guess as a follow-up, then, at some point in time would it make sense to proactively have those triggers removed just - just to really plan for a worst case scenario? And secondly, what would be the company's appetite to use some of that cash to go into the open market and repurchase some of your debt that's currently trading at a pretty steep discount?

Well, let me first address your question around the specific of puts and that type of thing. First off, that's a negotiation. That goes on when you enter into the agreement. So that's how we negotiate at this point in time, and if circumstance changes, both us and the potential lenders would take a look at it. As it relates to our balance sheet, we always discuss our strength with our board of directors and discuss various alternatives for the cash. So we're having those types of discussions always.

Thank you.

And just as a point of reference, we have over the last six months bought back some of the bonds that are out there as they're offered to us if we think it's a good economic decision for us.

It's interesting, there's not much float, so while there's, you know, as you call it deep discount on the pricing, whenever anyone goes in to buy one, the deep discount disappears. But as Paul said, occasionally we'll get a call from someone that would like to move quickly and sell at a price where when we run the internal rates of return it's advantageous to us and with $900 million of cash, Paul has the authority to do that whenever the numbers say it's the right thing to do.

Great. Thanks a lot.

Thank you. Our next is coming from Rob Dameron [phonetic] of SWS Securities.

Hi, good morning.

Hi, Rob.

Just a question about the gross margin. It was pretty impressive the margin improvement sequentially and year over year. Could you just talk about are we kind of peaking out in terms of where the gross margin can go and once business does start to come back with some of the larger customers, would you anticipate the gross margin to start eroding a bit based on the larger volume, larger volume mix?

Rob, there are always two sets of actions going on in the margins. One is the mix which you did appropriately refer to. The second - and so as those customers came back, yes, we would expect to see the margin increase reverse a little bit. However, because of the cyclical nature of the business, as the business starts to come back, we would also expect to see the margin in each segment begin to creep up. The passers margin, for example, came down and we would expect to see that, resisters caps and the like. We would expect to see that recover. So it could well be that when the recovery occurs we see telecom coming back in with lower margins, but we see the upward pressure on the product segments that start to get tight. And it could wash out to be even with where we are today, could be a dip of a few basis points, and then a recovery, or it could be a slight increase from the overall where we are today. You know, it's just so dependent on both factors.

And is it true the gross margin on the computer systems side of the business stays relatively constant throughout this cycle?

Mike, if you haven't fallen asleep with all this talk about components, maybe you can tell us what sense you have regarding mid range margins as the cycles go up and down.

Sure, Steve. Thanks a lot. On the mid range side, because the customers do negotiate with us to handle all their business, the margins do remain more constant. The ancillary products such as mid range storage, that does fluctuate a little bit with supply and demand, and we would expect these levels right now to hold.

Okay. Thank you.

Thank you. Our next question is coming from Julie Santorillio [phonetic] of Morgan Stanley.

Thanks. Good morning. Steve I was wondering if you could comment on Arrow's positioning in Asia, specifically how the ongoing shift in production to Asia is impacting Arrow and how you're addressing the shift from a strategic standpoint.

Very good question, and I'll give you what we know and then I'll tell you what we're thinking about it. But I'll start by saying, it is one of two or three of the current strategic issues that occupies our time, and we do not yet have a complete 100 percent bullet proof answer. the market is evolving. We're seeing an increase in business moving to Asia and in particular into China. For a long time the movement was to Southeast Asia, Malaysia, Singapore, places like that. We're now seeing it shift into China. The contract manufacturers who are a major customer base of ours seem to be in the process of exiting the factories they have in North America and Europe and either buying or building factories in Asia, moving production there, and more OEM customers are shifting production in their own facilities to China. So we do see, if you will, a flight to Asia.

We feel very good about our positioning as a distributor as this shift occurs. You will recall we were the first of the major distributors to get into Southeast Asia with our acquisitions in Hong Kong almost ten years ago. And then have grown that from a very modest level up into the, as I described the mid $600 million range. So we think we've got a good platform. We'd like to see it developing more rapidly. There is a clear issue that as the business moves into China itself, which is less developed and less structured from a market point of view, that we don't have as easy a time as we had when business was moving to Hong Kong or Singapore or Malaysia which has a more - a longer term infrastructure that's more stabilized and more accustomed to dealing with our kind of distributor. The infrastructure in China is less developed and it's also less understandable to the west, both in terms of practice as well as regulations and laws. The entry of China into the W T O means that all of the old regulations and laws are changing. They change in ways that are sometimes hard to decipher and understand, and the actual practices change a little more slowly. So it is more of a challenge for us, and that's why I say it is one of the two or three issues that consume the time of the strategic thinking time that we have. But all in all, the question, to be candid, is how does distribution as a group fair in Southeast Asia or Asia. We will fair very well within distribution given our strong positioning. We have to make sure that distribution as an industry finds a way to operate successfully in China as the world evolves.

So I don't have a real answer for you, but that's the background question.

Okay. Can I have a quick follow-up on that. Are there acquisition opportunities in China at this point or would it be more of a [inaudible]?

Now, Julie, you're relatively new, so this is the first time you and I have dealt together. I left before you got into our segment. We never, never comment on acquisitions. We find that nothing good ever comes of that. There may be opportunities there. They're difficult because it is a country with a different set of commercial laws than we're used to dealing with, and with different accounting traditions. And therefore, when one looks at acquisitions, it's hard to know exactly what's in the count and what isn't in the count. But as always, we're opportunistic and if the right thing came along with the right background and a comfort factor, we wouldn't shy away from it. But we do not have an aggressive program at this point as we did ten years ago, out searching for acquisitions to be made.

Okay. Thank you.

Thank you. Our next question is coming from Mark Hassenberg [phonetic] of Nottingham Capital.

Good morning.

Hi, Mark. How are you?

A number of the electronic component companies on their conference calls have pointed to a pickup in demand from distribution, and the comments that you made earlier make it sound like, you know, it's more than inventories being under better control. Steve, you were certainly the most cautious executive in the downturn, and I wonder if you could expand a little bit on what you're seeing in the marketplace that makes you a little more comfortable about your inventory level.

Sure, Mark. First, on the mechanics of the numbers, you're absolutely correct. If we're buying more but our inventories are still falling, both of which are facts, then we must be selling a little bit more, which is a fact. And you're also right to recall that I have always been the most conservative and don't crawl out on a limb without a real belief that the limb will hold me. And I would say to that that we just see lots of little signs, no big huge signs, but lots of little signs that we're past the bottom and that we're going to start seeing a gradual up tick. In particular, we look at the product segments that Jan mentioned, the micro controllers, embedded particularly, the programables, the specialized analog, are all areas that go into what we call our core customer base, not the huge telecoms, but the every day 100, 200, $500 million electronic equipment manufacturers that make stuff day in and day out. They didn't fall that much, although the headlines were pretty square scary and pretty painful on the telecom side. That core customer base kept bouncing along. The fact that Arrow has positioned itself relatively strongly at this midsize customer base with our acquisition of bell and Ritchie and then our investing in those companies, means that as those guys keep ticking along, we're getting the benefit of it. So we just see signs that suggest that the worst really is behind us, and I've seen enough of those signs that I'm starting to crawl out a little bit on that limb.

Thank you.

Now thank you. Our next question is coming from Bill Heffron [phonetic] of Regiment.

Yes, hi. Can you just let us know what the March telecom customers accounted for this quarter last year as well as this counter quarter? Just trying to get a feel for how much [inaudible] and what it means, the total.

We don't have those numbers by that kind of fairly fine slicing right in front of us. You know, I can say that sales to that customer base is down by more than 50 percent from the beginning of the downturn to now.

All right. That's fine. Thank you.

Thank you. Our next question is coming from Danielle Shoenbaum [phonetic] of Highland Capital Management.

Yes, I mostly wanted to ask about your ratings, but you already answered that. Can you just tell me how much, what your bank lines are one more time?

Hello. Our revolver is 625 and the -

Six $25 million.

Yes. And the securitization $750 million.

And that 625 is good until when?

February of '04.

Okay. Thank you.

Thank you. Our next question is coming from Sashmeed Sweveedi [phonetic] of Goldman Sachs.

Good afternoon, everyone. First a quick classification for Paul. Paul, I think you mentioned a couple factors in the T and A line including the end of the furlough period in North America and some impacting Europe. Can you qualify that so we can get a feeling for what normalized levels look like going forward?

I can tell you the foreign exchange impact was to add about $3.5 million of operating expenses compared to the first quarter.

Okay. And then the other five, I think the end of the furlough period that you mentioned, Paul?

Yeah, we'd have to scrub out some calculations to figure out exact [Pause in the call]

Steve, maybe you can address this one. I know that you mentioned the third quarter is typically a rate of 1, [inaudible] difficult to predict. Maybe looking out even into the fourth quarter, and just thinking more on the computer side of the world and your comments about seeing some strength from the end of the fiscal year for one large supplier this quarter, maybe the same phenomenon December where I guess IBM is the large supplier. Computing] what is your sense for how things might trend in terms of seasonality this year versus, you know, what you're used to seeing in a normal year?

Well, on the overall side, I did comment at the end of my prepared remarks that I expected Q4 to be ahead of Q2. That's in a perfectly flat year, that would be unusual because Q4 is truncated by in the states Thanksgiving and around the world by the Christmas new year shut down. So a year when Q4 is over Q2 would suggest sort of in the up part of the cycle, and that's where I am.

On the computer product side, you're correct that IBM has a year-end fiscal and you therefore get their year-end push, which always drives the Q4 number to be the highest number in the year for the computer products arena. And Mike, I guess, how do you see the Q3 and Q4 seasonality in your marketplace?

We see the Q3 being traditional, the traditional soft quarter, and we do see Q4 coming back stronger as we have always seen it. We don't really see any change of mix this year other than possibly a little more.

Okay. Thank you.

Thank you. Our next question is coming from Dan Cooper of Morgan Keegan.

It's actually Sam Cooper. Quick question, actually three quick questions. Could you talk a lit bit about your outlook for continued precash flow generation, particularly since this quarter had according to my math, came through the liability lines of accounts payable and accrued expenses. Secondly, could you just briefly comment about how you stand with your bank covenant? And I know you've addressed the S and P situation, but according to my read, I guess their review was prompted just this downturn with a little bit deeper and longer than they expected. Could you maybe comment about where your expectations were and their expectations were when they initially assigned a triple B rating and how different that compares to reality?

On the free cash flow question, the math would suggest that we will not generate free cash flow to any great extent going forward in the next couple of quarters. Our inventory reductions are over. The sales decline is over, so therefore the cash being generated from receivables and inventory will not be there. We will start buying again, and that's what causes the accounts payable to start to tick up since that always reflects the most recent 30 to 45 days worth of buying and we are starting to increase. However, we're operating at relatively meager profit levels, and so there won't be much cash flow from that beyond the depreciation amortization chunk, offset to a small amount by new cap expending, but we're not doing much capex. So all in all, there might be, you know, 10, 15, $20 million of cash generation on a quarterly basis, or it might even be down to nothing if the sales increase starts to move along and we start to see inventories and receivables pick up a little bit. I think the 2 billion of cash generation in the last 18 months, that's probably over, and eventually we'll start using that cash. Our cyclicality of the business means that in the downturn we throw off a lot of cash and as the up turn occurs, we begin to use that.

Paul, you want to respond to the other two questions?

Sure. Let me first address covenant issues. We are in compliance with our bank covenants and we respect to be in compliance for the rest of the year. So no issues there. To comment about most of our improvement coming out of liabilities is for the most part correct. We did get a fast return in inventory this quarter. Our DSO's were flat so we did see some improvement on the asset side also.

As it relates to the modeling question, we were pretty much dead on our own forecast for the first half of the year with some of the discussions that we had with S and P from a P and L point of view, the balance sheet came in better, stronger cash flow was more positive. But like everybody else, our suppliers, our customers, our competitors, Wall Street community, we all thought that there would be a faster and steeper recovery in business levels in the semiconductor area, and we're not just seeing that right now so we need to sit back, give some thought to what we think is going to happen in the second half of the year and get together with S and P and see what their thoughts are and come to a conclusion at that point in time.

Great. Thanks a lot.

Thank you. Our next question is coming from Diana Monteith [phonetic] of Loomis Sales.

Yes. Sorry to keep hammering on a couple of these points, but they are a concern. On your ratings triggers, my understanding is you have two very separate sets of rating trigger. One is our your securitization program and the other is on your bank loans. Would it be easier to renegotiate your bank loans?

I'm sorry, we lost you there for a minute. Could you pick it up after the securitization?

Sure. Are you taking any action to try to renew, renegotiate your bank loan triggers with the rating trigger? Because it looks like you're in technical default if you're down^graded to noninvestment grade there.

Well, once again, let me first say there's been no indication that we're going to be downgraded two steps to noninvestment grade at this point in time. All we've been put on is credit watch. We're going to be meeting with S and P. We have tremendous amount of liquidity with $900 million of carbon our balance sheet, we can meet any and all commitments we have in the near term to fund a substantial growth of our business without even going to our bank, revolver or to our asset securitization. So where we stand right now is pretty comfortable. Obviously as we go through the process with S and P we're always in communication with our both with the facility, with the bank supporting the revolver as well as the asset securitization. So as we move forward we'll talk to them about it.

Okay. How much is outstanding right now under your securitization program?

Nothing.

Zero?

Zero. In fact, we've had nothing outstanding under it since the first quarter of last year. For the last 18 - 15 months. So - and we have nothing outstanding under our revolver either. So from our point of view, while we're always glad to have lunch with the banks, whenever we have lunch with the banks, they want us to pay. And we just don't see the need to go in at this point and negotiate, have them hit us with a negotiation fee, a lunch fee and then a writing fee when we haven't been borrowing anything for over a year and with our liquidity such that it's going to take a number of quarters, maybe even to the natural end of the bank revolver, before we would need anything. So we don't want to sound cocky or too smug, but we have some aversion just to writing checks with access to something that we don't see something that we have a need for.

Sure. I certainly appreciate that. I think my concern is coming from the fact that we see the rating agencies moving sometimes and probably pretty irrational ways.

We agree with that, but our point of view is even if they were to move in a way, you know, my colleagues would all go whacky when I say this, but if something happened, we'd just let the line expire, because we don't need it.

And you just wouldn't secure ties any receivables?

We haven't for 15 months. [secure ties]

Okay.

That would be probably the first one to go. We'd say fine, here, take it back. All we're paying now is commitment fees and what do you call those fees? The unutilization fee? The lack of utilization fee.

Right. Just my last question. When I look at your 10(q) for the first quarter it says as of March 31st, 2002 you had a subordinated interest in outstanding receivables of 740 million so that is not - those are not receivables that have been secure advertised?

That's the size of the facility that we could utilize, it also talks about the fact we have nothing borrowed under the facility. So you talk about the mechanics of how to securitization works but there is nothing outstanding.

Okay. Thank you very much.

Thank you. Our next question is coming from Brian Alexander of Raymond James.

Thanks. Just a couple quick questions. First on the September quarter, what would you expect to be a normal, a normal linear quarter? In other words, what percentage would come from each of the months in the a quarter on a normal environment? And is the September quarter more back end loaded than other quarters? First question. Second question relates to SG and A and assuming there is a gradual improvement over the next few quarters, how quickly do you think you can get expenses below 14 percent do you have a target operating margin and if so, can you let us know what that is and how quickly you think you can get there?

To your first question, yes, the third quarter is more on linear than other quarters. It's also driven by our accounting calendar which for us these days is a five-week first month of the quarter, four weeks second month and four weeks third month. In most quarters, although the first month is five weeks and the last month is four weeks, the two months would be about equal because there's always the nonlinearity of pay plans which gets everyone working harder as the deadline looms.

In Q3 I would expect that to be unbalanced much more with a much bigger September. If I had to put a number on it, I'd probably guess 40 percent of the quarter would come in September, but that's purely off the top of my head and I could go look at numbers if you wanted to call me and get a better number.

Okay.

To your question on our expense levels, I can see you're trying to trap me into giving you a sales number, and I'm going to avoid going there. I think you're correct that our SG and A is about bottomed out. There will be slight increases in it naturally as sales pick up because some of the expenses are variable like shipping and a portion of the sales commissions. But by and large, the SG and A will remain pretty much at the level of that, and therefore the SG and A percent to sales will be a function solely of sales, and I'm really reluctant to try and predict where and when we get enough sales to drive the SG and A number down below any particular point.

Okay. That's fair. Can I just ask a quick follow-up for Mike? Have you seen any additional competition from the broad line distributors increment tact data in the enterprise base? They've been talking more about pushing into enterprise and I'm wondering if you would perceive that to be more talk at this point or if you actually are seeing the lines blurring between what you do and what they have done traditionally?

To this point we've seen the manufacturers stay very firm with their close distribution model. The amount of tech support required to successfully service enterprise sales is much different than commodity sales. And you have seen in the past one distributor go into this business and then get out two times. So my guess at this point is the manufacturers are going to stay firm, and we won't see those lines blurring for quite a while yet.

Thank you.

Thank you. Our next question is coming from William Quinn of CBM Specialists.

Actually, thank you, my question has been answered.

Thank you. Our next question is coming from dare I can lunger of Jeffries.

Yes. Could you just briefly describe the 350 million of other assets on the June balance sheet?

Yes. We have a couple different pieces in there. We have a note receivable that we utilize in connection with an acquisition. We have deferred taxes. We have deferred financing fees. Those are the principal items that are in there.

How much of that would be the notes receivable and who is that from or who is it - give me a feel for it?

The note receivable is about $55 million at this point in time. The deferred financing fees are in the 45 to $50,000,000 range. Deferred taxes are probably around 175 to $200 million, and the rest of it is just little dribs and drabs of long term assets.

But the receivables are from ?

It's something that we did in conjunction with an acquisition. It's not customer receivables that we've had to convert into notes or anything like that.

But it's receivables? And what's the time frame of that?

I'm sorry, we didn't hear the question. Would you repeat that, please?

The nature of the notes receivable, what's the time frame on that, who is it, what entity is it from ? Is it accruing interest?

It's accruing interest, yes. We're very comfortable that it is a safe asset to hold and one which we will realize the value on. We would expect to realize the value over the next 12 to 24 months, and there's probably some of that will be realized relatively soon.

Okay. And that was with respect to a divestiture?

No, it was with respect to an acquisition. We think it's been disclosed. In conjunction with the transaction where we and two other entities acquired pieces of the [inaudible] electronic distribution business, 18, almost two years ago. We took a piece of paper worth about $50,000,000.

Okay. So none of that has been paid down yet, but the time frame is to be paid down over the next 12 to 24 months?

Yes, that's our expectation expectation. It's structured without firm dates, but the nature and the interest rates are such that at this point in time 18 months having past, it's greatly in the interest of the other side to begin paying it off and we've had indications from them recently that that will start to occur.

Okay. Thank you very much.

Thank you. Our next question is coming from Eugene Shoy [phonetic] of Elliott and Page.

Hi. How are you doing? I just want to ask a question about, could you comment on your debt to capitalization as it stands right now -

I'm sorry, you faded for a minute.

Hi, can you hear me now.

Yes.

I just want you to provide some comment on where you guys are in terms of debt to capitalization and what the outlook looks like for the end of the year for you to be?

Our debt is all fixed debt at this point and nothing is coming due before the end of the year. So there is every likelihood the debt number will stay where it is. Our equity number, you know, only grows through profits or through F X changes. And our cash number is what it is, so if you do a raw debt to equity, you'll get $750 million of equity against -

Admit that to total cap factoring in the cash after the writeoff the .5621. That's net debt.

Right. All right. That's fine.

Thank you. Our next question is coming from Chet Lee of PDV Financial.

My question has been answered. Thank you.

Okay. Thank you.

Once again, ladies and gentlemen, for any further questions, please press 1 followed by 4 on your touch-tone phones. And if your question has been answered, you may remove yourself from the queue by pressing the pound key.

[Pause.]

Sir, there appears to be no further questions at this time.

Thank you, Enrique. And thank you all for taking the time to participate in the call today. If you have any additional questions [In the], please feel free to contact Eileen O'Connor or me. We will be here in the office today. So feel free to call us, and we'll talk to you all next quarter. Good-bye, everyone.

Ladies and gentlemen, that concludes today's teleconference. Thank you for your participation. You may disconnect your lines at 01:04:50 this time.