艾睿電子 (ARW) 2002 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Arrow Electronics, Incorporated, New York Stock Exchange ticker ARW, third quarter 2002 earnings call. At this time all parties are in a listen only mode. And later, we will conduct a question and answer session and instructions will follow at that time. As a reminder, this conference will be recorded. It is now my pleasure to introduce our host for today, Mr. Robert Klatell. Sir, the floor is yours.

Thank you, Enrique. Good afternoon, everyone. And welcome to the Arrow third quarter conference call. I will be serving as the Moderator of today's call. With us on the call is Dan Duval, Chairman and CEO of the company, Paul Reilly, our Chief Financial Officer, Mike Long, President of our North American computer products businesses, Jan M. Salsgiver, President of the North American components businesses and Eileen O'Connor, our Vice President of Investor Relations. As usual, let's get rid of a few of the house keeping matters. By now, you all should have received a copy of our earnings release as it was issued this morning. If you have not, please contact either my office or Eileen, and we'll make sure to get you copies. Alternatively of course, you can access the release on our website, which as you know is www.Arrow.com. Let me remind everyone that some of the comments made on today's conference call may contain forward-looking statements. Those statements are of course subject to risks and uncertainties as described in the company's SEC filings, and rather than read the entire disclaimer contained in those SEC filings, let me just remind everyone that as always they do apply to this call. As a reminder to the members of the press, you are in a listen only mode on this call, but please do not hesitate to contact us afterwards and we can try and set up some time to answer any questions that you may have. We'll begin with several minutes of prepared remarks related to the third quarter and an update on our operations and that will then be followed by a Q&A discussion. Let's lead with Paul Reilly our Chief Financial Officer. Paul, will you review our financials?

Thanks, Rob. There are a number of wrote-off or unusual items affecting the comparability of our numbers that I wanted to review with you before we get into our results. Earlier in Q3 we announced the repurchase of bonds that was scheduled to mature in the fourth quarter of 2003. The premium along with the write-off of the related deferred issuance costs resulted in our recording an extraordinary charge of $11.6 million, or 12 cents per share during the quarter. Our return on this repurchase is well in excess of the return we were earning on our cash investments. In Q3 this repurchase increased EPS by a penny and after giving effect for a full quarter, beginning in Q4 it will be two cents accretive.

We adopted FAS 142, that's the new rules around good will accounting, effective January 1st of this year. Accordingly, we no longer amortize good will. In the third quarter of 2001, good will amortization was $11.8 million pre-tax, or $10.3 million after taxes. As we previously announced during the second quarter, we sold the Gates Arrow commodity computer products business. As we have exited this business, Gates Arrow must be accounted for as a discontinued operation and that we restated our prior year results to exclude the individual components of the Gates Arrow business. That's sales, gross profit, operating expenses, et cetera. Instead, Gates Arrow's results are now shown as a single line item in our income statement. For those of you trying to keep your model straight, sales of Gates Arrow in Q3 of last year were $168.5 million. You may remember this year's second quarter included $5.4 million pretax and that's $3.2 million after taxes of severance costs related to former CEO. And finally, last year's third quarter included restructuring costs and other special charges of $227.6 million pretax to cover the cost of reducing head count, consolidating and closing facilities, valuation adjustments related to inventory and internet investments, and a termination of certain customer engagements.

For comparative purposes will I exclude these items from my remarks. Sales for the seasonally weak third quarter were $1.81 billion down 1.7% when compared with sales from continuing operations in the second quarter, that is, same store sales. Excluding the impact of strengthening European currencies, sales declined 3.8% compared with the second quarter. Q3 sales were down ten percent from last year's third quarter excluding Gates. Gross profit was 17 percent compared with Q2's 17.3 and 15.9% in Q3 of last year. The decrease in Q3 versus Q2 is driven principally by a change in mix, with sales of lower margin computer products being a greater percentage of total sales. The increase in gross profit percent compared with last year is due to increase in the mix of core components as we continue to limit our exposure to the CPU business and as a result of the decline in large telecom and networking accounts, and the contract manufacturers that service them.

Operating expenses were down by $3 million or $1.1 percent versus Q2, however as a percentage of sales this was a ten basis point increase. When compared to last year's third quarter, operating expenses declined nearly five percent, however as a percentage of sales this was a 90 basis point increase. Operating income as a percentage of sales was 2.1 percent, down basis 40 points from the prior quarter, but up 30 points compared to last year. Interest expense was $38.4 million, that's down from 40.8 million in Q2 and $48.7 million last year. The third quarter was our seventh consecutive quarter of positive cash flow, and that's since the downturn began. We generated $90 million in free cash flow this quarter bringing the total for the past seven quarters to nearly $2.2 billion.

Our effective tax rate for the quarter was 38.1 percent and net income was $500,000. EPS for the quarter was one penny versus a profit of four cents in Q2 but up compared to a loss five cents in last year's third quarter. And here's a couple of other statistics to help you with your analysis and model. Depreciation and amortization was for the quarter $16.2 million. Rent expense was $15 million. And non-cash interest expense in the quarter related to our zero coupon convertible debentures was $7.2 million. Lastly, the number of actual shares outstanding at the end of the quarter was 99,884,000.

Thanks, Paul. And now I'd like to ask Jan M. Salsgiver, President of our North American components operation, to discuss her group's performance in the quarter.

Thanks, Rob. Our North American components business generated sales of $635 million in the third quarter, down marginally when compared to the second quarter. Sales in our core components businesses, the ones that serve small and medium sized industrial and military customer base increased, somewhat. For this core segment, this is our third consecutive quarter of improving sales after two quarters of flat sales. The area within our North American components group that continues to be most impacted is the business that serves large complex engagements. This customer base is heavily weighted towards the large telecomm and networking companies and the contract manufacturers that serve them. Since the beginning of the downturn this group has experienced the greatest absolute decline in sales given the nature of their customer base.

Since Q1 of 2001, sales have declined by more than 70 percent in that particular business. Overall, semiconductor prices continue to be competitive and we know that they can change on a dime, but for now, they've stabilized. All product categories in both semiconductors and passive electromechanical and connectors continue to be readily available with short stable lead times.

Thanks, Jan. I'd like to turn to Mike Long, President of our North American computer products business. Mike, will you discuss your group's performance?

Thanks, Rob. Sales of our North American computer products group were approximately $402 million, down nearly 4 percent sequentially from the June quarter. Remember that, we've adjusted Q2 to reflect the disposal of the gates Arrow commodity business, which we sold in May. North American computer products operating income as a percentage of sales remains a very strong at 2.8%. This is well in excess of the operating margin traditionally seen in the third quarter. Sales of the mid-range businesses were virtually flat versus the prior quarter. As you know, the second quarter is the end of the fiscal year for some, so during that quarter we saw a traditional seasonal sales surge in that line. Our Sun business continues to improve year over year reflecting Sun's renewed commitment to the distribution channel.

With that said, we would have expected a greater sales drop-off in Q3 but our other mid range businesses, Hewlett-Packard and IBM had strong performance. In the interprice phase we continue to see a general softness with respect to new capital budgets. With activity focused mainly on up grades and enhancements and storages growing slower than anticipated, as Fortune 1000 customers continue to maintain existing storage systems rather than replace them with new ones. The OEM market continues to be impacted by large complex telecomm and networking companies. As a result of this, our OEM sales were down in the low single digits from the second quarter primarily due to CPUs. Rob?

Thanks, Mike. Let's turn it over to Dan Duval now. Dan, welcome to the first speaking role you've had at our conference calls. And why you talk about our European and Asian businesses?

Okay, Rob, thanks, and good afternoon, everyone. I've just spent about two weeks meeting with our teams in Europe and in Asia Pacific. And for the third quarter, sales in Europe were virtually flat at about $587 million versus Q2. However, excluding the impact of foreign exchange, sales declined approximately 6 percent. Keep in mind that many parts of Europe have extended vacation periods during the summer months and business activities virtually cease in some countries for the entire month of August. Sales in the core component business excluding foreign exchange again, declined approximately 8 percent. The sales decline in the core business was primarily in our southern European region which, as you know, is significantly impacted by the extended summer holiday period. Overall sales in Asia-Pacific experienced a modest decline of about 3 percent from the second quarter to $157 million and with just a small operating loss.

Now let me touch on a few of the issues before we move on to the Q&A section. We've generated a significant amount of free cash flow, nearly $2.2 billion as Paul has mentioned since the downturn began. And we built up a significant cash balance over the past several quarters. Plus we haven't had to utilize our credit facilities since July of 2001, over a year ago. So in August, we made a decision to utilize some of the cash to repurchase selected outstanding bonds that were due in the fourth quarter of 2003. Our cash investments are earning less than 2 percent, well below the interest rate on the bonds. So this is an effective use of our excess cash. As Paul mentioned earlier, this added a penny into Q3 and the transaction should add about two cents per share into our earnings in Q4. Liquidity remains an important factor during these difficult times, so let me summarize where we stand. Our cash balances are in excess of $700 million. We have a $625 million revolving credit facility that is virtually zero at the present time, that is, zero outstanding. And we have a $750 million accounts receivable assets securitization that also has zero outstanding. In fact, we haven't had any had meaningful borrowings under this facility since June of '01. And the only maturity we have coming due in 2003 is approximately $355 million of 8.2 percent bonds, which are due in the fourth quarter of '03. So it goes without saying that we have plenty of liquidity and unless there's a dramatic change in our business, we'd not expect a change in our investment grade ratings from S&P 500 and Moody's. You've heard us discuss this before on working capital. On average, each incremental sales dollar requires about 25 cents of working capital. So we can support a dramatic increase in our sales level with our significant cash balances alone and without touching our credit lines.

In summary, we've had a fairly respectable performance in another difficult quarter. Expenses remain well controlled and we continue to generate cash. Sales declined marginally and that's a bit disappointing, but not unexpected in light of the traditional summer holiday period. As you know, I stepped in as Arrow's Chairman in June of this year and as planned assumed the additional role of CEO when Steve Kaufman returned to the Harvard Business School on September 15th. So let me answer the question that I'm sure you're all going to ask and that is how's the search going?

Well, our search is going very well, in fact, and we're pleased with the caliber of candidates that we're seeing and while we have not and will not put a drop dead date on when we're going to bring in a new CEO I do think it's fair to say we'll have some comments to make on this within the next couple of months. Now let me tell you what else I've been doing. Over the past four-and-a-half months I've traveled to many of Arrow's locations throughout the United States, Europe and Asia, becoming more intimately familiar with the business and getting to know the Arrow family. Though I've been a member of the Board of Directors of Arrow for over 15 years, I think the transition period that I spent with Steve Kaufman this summer was beneficial for me personally and for our global network. So I would like to personally thank Steve for helping us through this difficult time and for easing my transition into the business as the full-time CEO. We've always said that we are fortunate to have a strong and deep management team and after spending more than four months in the business, I can confirm that this is indeed true. I'm confident that Arrow has made the right decisions throughout this prolonged downturn. We've generated a significant amount of cash, reduced costs broadly while making selective investments in the business. And in spite of a sales decline of nearly 50 percent since the fourth quarter of 2000, we remain profitable on an operating basis. I'm equally confident that Arrow will, as always, emerge from this depressed economic environment that our industry is immersed in and emerge a stronger more profitable company, ready to provide customers and suppliers with the best supply chain solutions available, ready to provide our employees with the best work environment possible, and ready to provide shareholders with an attractive investment opportunity. And with those comments, I'll turn it back to Rob.

Thanks, Dan. Enrique, let's open it up to question and answers now.

Thank you, the floor is now open for questions. If you do have a question or comment, please press one followed by four on your touch tone phones. If you're on a speakerphone we ask you pick up your hand sets to minimize any background noise. And if at any point your question has been answered you may remove yourself from the cue by pressing the pound key. Our first question is coming from Brian Alexander of Raymond James.

Thanks and good afternoon. Given your comments earlier about, you know, how different end markets are performing, you know, worse than others, i.e. telecomm on the component side of your business, can you just give us a rough estimate of your end market exposure in terms of telecomm, industrial, military?

Hi, Brian. It's Rob, why don't we let Jan take the first crack at that.

Okay. I can give you from a North American perspective what that breakdown, you know, a sense of what the breakdown is, but it is not the same around the world. So it won't give you the whole picture for Arrow and the components business. Our business is divided into military, industrial OEMs and the contract manufacturers. The contract manufacturers represent about a quarter of our business in the North American components business, and the military business is about 10 percent and the rest is spread among the OEM customer base. Given what we talked about, the fact that the telecomm and networking customers have dropped so significantly, most, you know, a large proportion of our OEM business is from the broad industrial customer base and what we've always talked about is it's an important part of our strategy to be serving the broadest possible customer base. And so that gives you a little color on the segment.

Brian, it's Rob. Remember that our customer segmentation here in North America is focused on how customers present themselves to us, what level of service and engagement they want from us, what type of products they're buying from us, it's not necessarily by the industry that they serve themselves. And also keep in mind that our customer base is very diverse with approximately 200,000 customers globally so that any one sector has a limited impact on our results. Does that help you?

It does. Thanks, Rob. And quick follow up for Mike. I guess reading a little bit about HP's new channel initiatives and read somewhere that after May 1st, they were only going to use two distributors on their enterprise products. I'm wondering if that's consistent with your understanding and if so, confident that Arrow will be one of those two distributors?

Yes. Let me remind you that they only have two distributors today in the PDM model. And they have announced that they are going to continue with two distributors on a go forward basis. I am very confident that the business will continue as it is today.

Thanks a lot.

Thank you. Our next question is coming from Steven Fox of Merrill Lynch.

Hi. Good afternoon. My first question is for Mike. I was wondering, you know, normally the fourth quarter, the December of the calendar year sees a very good lift for your products. Given what your comments earlier, do you expect more of a subdued lift this quarter? And what type of outlook do you provide there and why? And then, if you could just expand on your comments about HP? It seems like Arrow, Advent and Pioneer are all very confident about their ability to remain within the HP-Compaq family. Is there anything that you can point to that would give us a clear idea of why you have such an advantage?

Well, that's two questions; I'll take them one at a time. First off, it's pretty early in the quarter to see what the traditional fourth quarter lift would be. And as you guys know, it has always ranged somewhere between 11 and 20 percent during the quarter. Wouldn't be able to give any kind of guidance until we're several weeks into the quarter as that moves on. In terms of advantage, of the three distributors that you said and why do I think we have an advantage? I wasn't insinuating that there was a huge advantage. Pioneer is primarily an end user type business with respect to Hewlett-Packard and Advent and Arrow are distributors. So there's a little bit about channel definition that I think could play in what you're looking at. I do believe there's a place for all three of us. I do believe we all three are going to continue to play with the product line.

Mike, that clarification is really helpful. And then Paul, just one quick question, on the interest expense line for this quarter, how do you see it falling out?

Well, we should see a decline because we'll have the bond retirement for the full quarter compared to only half the quarter in Q3. Plus we do have a little bit more in the way of cash balances, cash generated during the quarter which will give us a little bit of a reduction in overall interest expense.

Although it's fair to say, Paul, we're not earning a great return on our cash at this point in time.

That's true.

Thanks, guys.

Thank you our next question is coming from Patrick Parr from UBS Warburg.

Good afternoon, guys. Question regarding your inventory. Can you give us a sense of the composition in terms of enterprise systems versus components and then what the trend was from the June quarter to the September quarter?

Paul, why don't you lead that?

Sure. So, on a worldwide basis, our components inventory is approximately between 75 and 80 percent it changes daily depending upon sales mix as well as what we received that day. So that's an overall view. Our inventory actually came down during the quarter a little bit more than we thought and it's more of a timing issue. We had a very strong sales month in September as well as the fact that we had strong receipts in the October time period. So our inventory has bounced back up from where it was at the end of the quarter to a more normalized level.

Jan, do you want to comment on your components inventories here in North America?

Sure. I think you know that holding inventory is a very important part of the value proposition that we provide for our customers. And we are holding pretty stable at the levels of inventory that we've got on components in North America. And we are very focused on making sure we've got the right products on the shelf and the quality of the inventory there to drive sales. So we are not in a mode of declining the inventory in North America.

Thanks, Jan.

Okay, and then a quick follow-up to that. You talk about having generated over $2 billion in free cash since the downturn began. If we assume the business picks up at least a little bit at some point, can you still generate free cash?

I think our ability to generate free cash is dependent upon the rate at which the sales increase comes. So Dan mentioned that on average we need a 25-cent investment of working capital for each incremental dollar of sales. But factually, depending on where you are in the cycle, and as I say, the pace of the recovery it could be less than that or more than that. So we just look at the average. So it depends on what the pace of recovery is.

Okay. And then one quick final question. Can you give any sense within the components base how IP&E product trended in the quarter versus semiconductors?

Let's turn to Jan for that one, Pat.

Okay. Sure. Let's start with semiconductors. And again, these are North American statistics. In North America, our sales were essentially flat quarter on quarter in semiconductors across most of the technologies. I'm pleased though that we saw strength in analog and discrete. They were up for three quarters in a row and the significance there is those are the parts that are sold to the broadest customer base to the core industrial, they have a very broad customer base and as I said before that fits with the fact that our core businesses were also up. On the PEMPCO side, our sales were down 3 percent quarter on quarter. But it's interesting when you dig into it a little deeper; the units were actually up 5 percent quarter on quarter, but pricing pressures of a decline of 8 percent actually saw the fact that's what drove the sales down 3 percent. If you look at it a little bit deeper levels, passes, our sales were flat and for connectors our sales were flat. And in both cases units were actually up, but they were offset equally by ASP decline. It was really in electromechanical where the units were flat, but the pricing pressure was enough that really drove our sales down. So hopefully that helps.

Interesting. That's very helpful. Thank you.

Thank you. Our next question is coming from Matt Sharon from Thomas Weisel partners.

Hi, Matt. Yes. Thank you. You talked about continuing sort of declining demand from your big contract manufacturing and telecomm customers in North America. How much of that is related to just the sort of dismal end market demand versus shift of vendor direct to the OEM customer and also the shift of manufacturing to Asia and then sort of on those same lines, how is the Asian business going? It sounded like sales were down a little bit on the quarter. If you can just talk a little more detail in terms of demand there. Thanks.

Why don't we let Jan take that one.

Okay the first question was how much of the decline in the big contract manufacturers has to do with the end market versus potentially business going direct. I would say that the decline in the large contract manufacturers does in fact have to do with the fact that those, the end market business for those customers is actually down. I think you probably hear the same thing from the suppliers who do, you know, their business is done direct as well as done through distribution and I think we are both experiencing a decline. I don't believe that there's a change in the mix of how much is being done through distribution. So I don't think we're getting any harder than anybody else on that one.

Are there certain big engagements based on your return on capital requirements and other things that you have or that you walked away from or will continue to walk away from?

We have not walked away from customer engagements. We have found in fact, I would say some of our large complex engagements are actually; we're not walking away from them. We have found ways to be creative and work with our suppliers and customers to be able to hold on to that business. It's just the business itself is down.

Remember, we've been engaged in a process of helping customers understand the value that we deliver for them and that's really what's been helping us.

Great. And then on Asia?

This is Dan Duval. We have set up a global transfer group to measure and manage the business that's being transferred from the U.S., either into Eastern Europe or into Asia. So we're beginning to get our arms around what business is moving, whether it's moving into a direct environment or a distribution environment, and working with our suppliers to be able to service that on the other end. But this is not a one or two quarter phenomenon. This is a kind of a long-term trend. It's not the kind of thing that's going to impact our business on a quarterly basis.

Okay. Thank you.

Thank you. Our next question is coming from Rob Damron of SWS securities.

Hi. Most of my questions have been answered. But I do have one question for Paul in terms of the equity earnings as well as the minority interest. Could you just give us some detail into today's time frame what those numbers are being generated from?

Sure. So we have a couple of investments that we do not own a majority interest in. So our share of those earnings are recorded as equity earnings of affiliated companies.

Which investments are those?

Well, the biggest and most critical one that impacts that line would be our investment in South Africa. And then there are a few very small right now number of companies that we own, less than 100% of but more than a majority. And that's the reason why we have some of that there, and those are principally in South America and in Israel.

Okay. And the minority interest line?

That's the minority interest.

Okay. Okay that helps. Thank you.

Thank you our next question is coming from Julie Santariello of Morgan Stanley.

Thanks, good afternoon.

Hi Julie.

Hi, Rob. I'm wondering if this depressed climate that we're in should linger for several more quarters are there further cost reduction actions that you've identified or that you would at least consider? Things such as closing more facilities or exiting certain lines of business or certain supplier relationships?

Hey Julie, it's Paul. That's a good question. Back at the end of the second quarter, we told you that we anticipated no further significant cost cutting in our business because we really want to be poised to be able to take full advantage of the upswing in the economy and we know it's going to happen eventually, it's a matter of at what point in time. So we're not going to have any broad cost cutting efforts at this point in time. We are continually though looking for process improvement, and that's one area where we're focusing a lot of time and effort on right now. How can we do things better, more effectively? What things have we done in the past that we don't need do to do? So I wouldn't see expect to see any dramatic change in our SG&A level. You may see it bumped down a little bit you may see it bumped up a little bit depending upon timing. But long-term we believe this business has some very strong opportunity and we want to be well positioned to participate in the up cycle.

Okay. Thanks, Paul.

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

Good afternoon, on the last conference call, Steve was a little more optimistic about, you know, the outlook going into the second half of the year. He had been by far the most conservative in the industry and correct about the downturn, but he was feeling a bit better. Looking at what's happened in the last three months and, you know, everybody is still struggling to see the upturn, what points were you looking for that have been disappointing that hadn't built the way you thought they might?

Mark, it's Rob. Because I also remembered Steve's comments, it's easier to look back than it is to look forward. We certainly have more clarity. Actually the third quarter came out pretty much the way people -- the way we were expecting. Remember Steve talked about a seasonally weak quarter. And without any data points and relying on his 20-some odd years of experience in the industry and his gut. He made a suggestion that he thought things would be getting better in the fourth quarter and then into the continued into next year. That's just putting his comment into some context. Dan, you want to talk about that?

Yeah, I was sitting here when Steve made that comment that he thought the fourth quarter would be stronger than the second quarter. And it made me smile at the time knowing that he wouldn't be here to report on it and that he would hand that off to me to take care of. And I was still hopeful that he's right. However, as is the case early in the quarter, it's still pretty early to be able to see any change in trends from the third quarter.

I certainly wasn't being critical of Steve. I mean he had --.

You had a lot of fun with him over there.

Well, he had been very conservative while many of us were more optimistic and that's why his being more optimistic about the fourth quarter held some importance. If things, I mean everybody is still struggling; yet prices seem to have stopped going down at the rate that they were before. There seems to be some sort of stabilization here. One, how do you explain that? And two, do you think that as demand starts to improve, that we'll actually see better pricing or do you think that as the orders get bigger the competition will get greater?

On the pricing side, I think you're absolutely right that things have stabilized. Certainly on the semiconductor side, it feels and the data says that pricing has stabilized and why and how it's holding. The suppliers continue to launch new technologies and they are getting, you know, they continue to drive to have higher percentages of their sales coming from those new technologies and the new technologies, I think, are helping hold the prices up. And that's good for them and it's good for our business. As I said on the passive electromechanical side, the price has been declining and felt more pressure than they are due on the semi side, but even there the decline is less than what it had been before. So same thing, we're seeing stable prices there.

Okay, thank you.

Thank you. Our next question is coming Sasment DiVetti, of Goldman Sachs.

Good afternoon, everyone. First question for Jan, I'm just trying to get a better handle on the operating margins runs you saw in the components business overall. And by the way, thanks for you the color you gave on the pricing and so forth. So if you were to summarize in terms of overall what happened in the third quarter, it looks like pricing in electromechanical was the main culprit, but in your mind does that kind of explain almost the entire 30-40 basis points swing in operating margin that you saw in the decline from second quarter to third quarter?

I would say that as we've talked about for a couple of quarters now, you know, we're basically a fixed cost business today. So when you miss a couple of dollars of sales, it has a dramatic impact upon your ratios. So I would say that's the biggest driving factor we're seeing right now as well as a little bit of a change in the mix this quarter were where we had some more sales of lower margin computer products than we had in the second quarter. More so than anything around pricing pressure, those types of things.

Okay. That's fair. I guess I just want to get back one more time, Paul. I know you already talked about it, to the SG&A comments. If you kind of look back the last three quarters, basically give and take a few dollars here and there, you're kind of at a flat sales level and also, you know, a few million dollars up or down on the SG&A line. So-I mean, does that kind of indicate that all along over the last six or nine months you kind of felt like you were appropriately sized or is this more an indication that you think that an opportunity is coming and that you just want to be better positioned for it? We can go back some years and see your SG&A line being significantly smaller than where it is today for comparable lines. I'm just trying to get a better handle on that.

Let me give you a stat to try to frame that. If you look at our North American components sales compared to Q3 of last year, we're down probably somewhere between 10 and 12 percent in sales. When you look at the line item shift, we're up 3 percent. So we're working harder today to get fewer sales. So one of the things that's impacting our SG&A and how we can really reduce costs is the fact that our work level has gone up. So we think we're the right size today for the sales that we have going through, sales, you know, are bouncing around a little bit, one percent, two percent, impacts our operating income for sure in the short term. But in the long term, we think we want to be prepared for the upturn and we think we're well positioned for that now.

Okay, and one last question, Paul, on the free cash flow. It looks like if you kind of look at the net working capital line, pretty much the entire free cash flow came from the working capital declines plus or minus a few million dollars. Does that kind of indicate that you see a flattish to modestly up fourth quarter, that you would not expect any more kind of working capital, you know improvements and therefore too much more free cash flow. Are we going to add inventory and receivables else elsewhere for example, where that it would need a significant swing on the top line to change your cash flow from neutral?

If you look at really the last seven quarters, the vast majority of our free cash flow has in fact been generated by working capital reductions. Obviously, mix has a bit of an impact whether it's computer products, which has higher asset turnover than components. So we would expect in the normal period to have a marginal improvement in cash flow, but it could also be down just based upon timing. So I would not expect to see and I think we've said this consistently, substantial increases in the amount of free cash flow we generate on a quarterly basis and it could be down a bit compared to Q3 for sure.

Okay. Thanks, Paul.

Thank you. Our next question is coming from Pat English of SMI.

Hi, guys. Hi, Jan. I think the previous questioner was trying to get at this SG&A issue I want to tackle one more time. If we go back to the '97 period when we had about this level of revenue, SG&A was about $75 million less. Can you just try to explain, you know, how much of this incremental SG&A is tied up in new offices and you know just try to put a little bit more information in terms of that $75 million incremental increase.

I think there's a couple of things to take a look at. For sure, the services we provide today are much more varied and richer than what we provided in 1997 and that comes at a cost. You've heard us talk about justifying our value and unbundling services and that's all part of the process that we have going on right now, negotiating the customers. I think you also go back to 1997 probably our gross profit margins are higher than they were at that point in time, too. So we're getting a little bit of an impact there, where we're providing more services, we're able to recoup some of those costs from our customers. Our job is to try to do more of that.

And if we look at the unit activity levels, I would venture to say they were significantly higher than they were in 1997, which goes to the issue again of the cost structure.

In the North American components business, I know for certain that our strategy of making sure we're serving the broadest customer base has a trade off with it. We get higher margins, but our operating SG & A is higher as well. But the higher margins obviously offset the higher SG&A.

Okay. Thank you.

Thank you. Our next question is coming from Alan Mitroney from Cooper Beach Capital.

Thank you. Can you elaborate a bit in terms of which areas of passives and connectors you said units were up but ASP's were down? Can you talk about - can you break it down to some components?

Yeah. I actually don't have a lot of granular detail, but I would be happy to have a discussion offline on that.

Sure. Okay. Thank you.

Thank you. Our next question is coming from Tom Leech of Bennett Lorings Management.

Yes, you had made a comment in your prepared remarks about storage being softer. Give me a little education here. Do you just sell disk drives or do you sell fiber channel kits or storage arrays and tell me what you saw and what you expected?

Let's turn that over to Mike Long for that one. Go ahead, Mike.

Yeah, the storage, we sell everything from the sharp boxes enterprise storage, storage networking, it is not a disk drive business. The disk drive business itself falls within our OEM and disk drives are primarily used in our integration center. So our storage business is enterprise.

And what did you see there? You said it was -- could you tell me where it was softer? Was it price or what?

If you read all of the estimates over the last two years, this was supposed to be a high growth storage year. And as the economy came down, many of the enterprise storage units that were out there, the workload on those also came down so the need to upgrade or change became less than what was anticipated early on. Having said that, we are still seeing a couple percent growth a quarter in that business. But we were hoping and expecting more over the course of the year.

And what about pricing, whether it be in per installation or per server or per whatever? Is that a problem or hang in will a little better?

Price on the enterprise space is hanging in there. The hinge on the pricing is no longer the hardware because that's where everyone has traditionally beat each other up. The pricing Deltas are now on the complete solution and what the end user getting in consulting and services and software. But it is all about the solution today versus the hardware.

Thank you.

Thank you our next question is coming from Cherriane Matthews of Pangea.

This is Alec Bowman from Matthews. A couple of things. Why do you think Asia revenues were down sequentially given that I think for most people that's been the strongest area of their business in general? And Obviously there's transference going on, too.It's the trend, I think , you know, all else equal would be up. I know obviously visibility is tricky these days, but given sort of guidance that a number of semiconductor companies have already given for their Q4s, it's really curious to see what kind of trends you're seeing in October and is it sort of fair to say this won't be a typical Q4, I mean you probably have visibility to half the quarter by now, just PI to TLD guys have given guidance on Intel. I just thought you might have a better sense?

Actually, outside of the industry, we don't have a great deal of visibility this early in a quarter and frankly, we wouldn't be able to give you any guidance even for the first half based upon the first number of days that we've actually shipped. Much of our business is a book shipped businesses these days without long scheduled orders. So visibility is very limited at this point in time. And so we're actually -- we're not in a position to give any guidance at all. You want to talk to that?

I think the other thing you have to understand about our business in Asia and the distribution business in Asia is that it's a very different model than it is in North America and you're. In North America and Europe, where we've gone through a consolidation where there's just a few major distributors and a few small distributors. In Asia, it's a highly fragmented market. You have hundreds of small distributors. Business moves around quite a bit. We have less than ten percent market share in Asia. We only have about 25 percent of the line card in Asia that we have in the U.S. So there's a lot of moving parts in the Asia business and it can move from quarter to quarter without really indicating a significant trend one-way or the other.

Okay. Thank you.

Thank you. Our next question will be coming from Craig Gilbert from Bank of America Securities.

Good afternoon. You mentioned that zero is outstanding on the revolving credit facility and accounts receivable facility. I just wanted to make sure there was $625 million of availability under the RC and $750 million of availability under the accounts receivable facility.

Right. Well, the credit line that you're referring to, the revolver is 625 and the total size of the asset securitization is the 750. Based upon today's level of activity, we'd be able to borrow about $300 million under the securitization itself. Now then obviously if sales went up receivables would go up and we would be able to borrow more underneath it.

But you can borrow the whole 625 under the revolver?

yes.

Okay. Thank you.

Thank you our next question will be coming from Derek Winger of Jeffrey's.

Yes. What were the capital expenditures in the third quarter and could you give guidance for the fourth quarter in the years going forward?

Yeah, our capital expenditure rate was right around the $8-$10 million number around the third quarter. I expect to see capital expenditures in that range for the fourth quarter. We haven't really completed our whole planning process for 2003 so it's a bit early for us to give you a full guess on the capital expenditures at this point in time for next year.

Okay. Thank you.

Thank you, our next question will be coming from Noah Freedman of Brookside Capital.

Hey guys, thank you for taking my call. One question I've had is how does your ability to extend payables and have inventory, how much of that is a competitive advantage for you? And if you or if one of the other people in your space were to start managing that very aggressively, how much would that effect for a given gross margin, things like long-term market share?

Jan, do you want to talk about that?

So is the question do we use credit and extend payment terms to grow? I'm a little confused.

Repeat the question please.

If you stopped offering them or if you were to stop offering them, would that affect your ability to grow or ability to get new revenues?

So, I guess your question is the way we're hearing it and correct me if I'm wrong, is that if we were to tighten down on our credit terms with customers, would that impact our ability to grow? In fact we believe that distribution plays a critical role even as a financial institution for our customers, so we use our balance sheet to gain as much market share and sales growth as we can. So if we were in position where we needed to reduce credit lines, then that would impact our ability to grow.

Why don't you talk about the process we use for evaluating and establishing credit lines for customers around the world.

So let's focus on North America. We actually have two distinct businesses here. One is the components business and the other is the computer products business. They each have their own separate credit team and these credit teams have people that traditionally have a financial background, maybe have come through banking training programs and they're doing financial statement analysis that you might see at a brokerage house an analyst doing on the customers, we spend a lot of time visiting customers, trying to understand their capital structure, their liquidity, their reliance upon any one customer or their customer base, what they're manufacturing, market acceptance, that type of thing. So we have a pretty active credit team here. As I say we use credit as a tool to gain more sales.

In Europe, we have smaller credit teams, but they're supplemented by credit insurance and what's kind of unique to Europe is that the amount of available financial data on customers just isn't there like it is in North America, yet the insurance, the credit insurance companies, are able to get that data and that's the reason why they do a lot of the analytical work around what type of credit lines the customer should have and other type of credit insurance they'll give us. Of course, there are other instances where we do go over the credit limits, but we have teams in place out doing and their own credit analysis of those customers. And once again they have the same type of motion we do here. They look at financials, they visit customers, they understand the capital structure, that type of thing. Asia package is very similar to North America, but we do use credit insurance in Asia Pac to supplement their efforts.

Great. Thank you very much.

Thank you our next question will be coming from Jim Pasone of Delphi Management.

Good afternoon. Earlier in the call you mentioned Europe was flat at 587 million but excluding foreign exchange it was down how much because I missed that number?

I'll give that to you in a second here.

Excluding foreign exchange we were down 3.8 percent.

Okay. And in terms of pricing, is -- I mean albeit pricing seems to be stabilizing in the semiconductors and everything else the decline has decreased, but let's be blunt about it it's still difficult out there I'm assuming?

Absolutely. It's a very competitive environment as it always will be if the market is tough, people are going to be fighting for business and our initiatives of both trying to be in the small to medium sized customers as well as the largest customers can help us there, but it is a very tough you know, it's a tough business.

On the number I just quoted for you, I gave the impact on consolidated sales of 3.8%. The impact in Europe was 6 percent.

6 percent, okay. And I guess one other question. Do you see any signs of life out there any place?

Well, as you heard, our unit activity levels are doing fine.

Okay. But I mean --.

Well there is activity out there; it's all on a turns basis.

That's what I mean, do you see stuff firming up overall or is it may be too soon to tell and you don't want to go out on that one there.

That's good.

That's the right answer.

Thanks a lot.

Thank you. Our next question will be coming from Mike Lanier of AAG.

Yeah, thanks. In Seagate's recent discussion of its quarter, it seemed that you know their units went way up despite the fact that PC sales from the people we know are you know pretty flat and it was ultimately explained that the white box manufacturers are garnering a greater and greater share of the world wide market. Can you comment on what percentage of your sales would go to what is classified as a white box manufacturer? And what trends you're seeing there?

Mike, why don't you take that.

Yeah. As you know, when we sold the gates Arrow business that virtually eliminated the sales we had to white box manufacturers. So our position within that industry really no longer exists as a vast percentage of sales for us.

I think Mike is saying we're not the right guys to ask that question of.

I understand. Thanks.

Okay.

Once again for any further questions or comments please press one followed by four on your touch tone phones at this time. There appears to be no further questions or comments at this time.

Thank you, Enrique and thank you all for take the time to be on the call with us. If you do have further questions please call Eileen O'Connor or me this is Rob. Eileen will then get new touch if you have a specific question for one of our operating executives, she will be the one to get you in touch with that executive and help coordinate that process. Thank you all, we'll talk to you folks during the quarter and after the fourth quarter.

Thank you ladies and gentlemen for your participation. This does conclude this afternoon's conference call. You may disconnect your lines at this time and have a wonderful day.