艾睿電子 (ARW) 2003 Q3 法說會逐字稿

Good afternoon, and welcome to Arrow Electronics third quarter Earnings Conference Call. At this time all lines have been placed on a listen-only mode. And the floor will be open for questions, following the presentation. At this time it is my pleasure to turn it over to your host, Mr. Robert Klatell. Sir, you may begin.

Thank you very much, operator, and good afternoon, everyone. Welcome to the Arrow Electronics third quarter conference call. I will be serving as the moderator of today's call. With us today in their usual speaking roles are Bill Mitchell, President and chief executive officer of the company, Mike Long, President of our North American computer product group, Jan Salsgiver, president of our North American components group and Paul Reilly, our Chief Financial Officer. Also with us today are Harriet Green, Vice President of worldwide marketing, Peter Brown, Senior Vice President and General Council, Ira Burns, Vice President and Treasurer of the company, and Eileen O'Connor, Vice President of Investor Relations.

As usual, let's review some housekeeping matters. By now you all should have received a copy of the earnings release that was issued this morning. If not, please contact either my office or Eileen O'Connor, and we'll make sure to get you a copy. 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 call may contain forward-looking statements. Those statements are, of course, subject to risks and uncertainties as described in our S.E.C. filings. Rather than read the entire disclaimer contained in those filings, just let me state that, as always, they do apply to the call. We will begin with several minutes of prepared remarks, which will then be followed by a question and answer period. At this time I'd like to introduce Bill Mitchell, our President and CEO. Bill?

Thanks, Rob, and thanks to all of you for joining us on this call. I'm very pleased to report that our third quarter net income on an operating basis, excluding the impact of previously announced restructuring charges, the loss on the prepayment of debt and the indemnification charge from an acquisition made in 2000, all of which we'll discuss in further detail shortly, was $15.1 million, or 15 cents a share. As we also discussed on our last call, our third quarter results were negatively impacted by approximately 3 cents a share because of the timing of our successful refinancing of a debt issue that matured in early October, and the timing of other bond repurchases. We borrowed funds at the ends of June at very attractive rates and could not repay the maturing bonds until October. If you exclude the one-time impact of the refinancing, our earnings were $18 million, or 18 cents a share. And that's a penny above our quarter 2 earnings of 17 cents a share, excluding restructuring charges. I'm really pleased with our solid performance in what is traditionally a seasonally weak quarter.

Let me comment on some of the highlights of the third quarter before asking Paul, Jan and Mike to get into the details. Consolidated sales were 2.1 billion in the third quarter and were essentially flat after eliminating the impact of our previously announced divestiture of our Nordic computer products business. And they were up 16% over last year's third quarter. As we said on last quarter's call, the third quarter is typically weaker than the second quarter in both our computer products business, as well as in various parts of Europe, given the extended summer vacation periods. This quarter was no different. Despite this, we were pleased with the solid operational performance in our computer products business as well as our European and Asian business. And we were particularly encouraged by the uptick in sales in the significantly improved operating efficiencies we saw in our North American components business, which Jan will discuss later. Operating income dollars were 56.3 million, up 2% from last quarter, which is especially encouraging, as the third quarter is traditionally weaker than the second quarter. And they were up 49% over last year. Operating income as a percentage of sales at 2.7% was up 10 basis points from last quarter and up 60 basis points from last year.

We're encouraged by both the impact of the efficiency initiatives that we have already implemented and by the ability of the organization to capitalize upon our operating leverage. Worldwide component revenues were $1.6 billion, flat with the second quarter, but up 20% over last year. Operating income as a percentage of sales increased by 40 basis points from the second quarter and by 50 basis points from last year. Sales in our North American components group, which Jan will discuss in detail later, were up 6% compared to our second quarter and up 26% over last year. Operating income dollars were up 28% sequentially and up over a hundred percent from last year's level.

This increase in operating income dollars is the third consecutive quarterly increase and the highest the North American components group has seen in nine quarters. We see this as confirmation that our strategies are delivering results, the acquisition of Pioneer standards IED business has been accretive to earnings and we continue to make good progress towards putting a cost structure in place that meets today's business realities without sacrificing our future. Worldwide computer product revenues were $516 million, down 6% sequentially, but up 4% over last year.

Excluding the impact of the computer-related businesses we divested in northern Europe, sales declined by 3% from the second quarter. This sequential decline was not unexpected due to the seasonality traditionally experienced in this business. Excluding both the disposal of the Nordic computer products business and foreign exchange, sales advanced 6% over the second quarter. Operating income as a percentage of sales decreased by 80 basis points sequentially, but increased by 50 basis points from last year's. Sales in our North American computer products group experienced year-over-year sales growth for the third sequential quarter, though they were impacted by the traditional seasonal sales decline from the second quarter. Notably, the group experienced year-over-year growth in operating income dollars, as well as operating margin for the ninth sequential quarter. This means that the strategy we implemented in the second quarter of last year by disposing of the Gates Arrow commodity computer products business, and focusing on other, more profitable areas, was the right decision.

On a macroeconomic basis, the European economy continues to be generally weak. Our sales of 642 million were down 5% sequentially, but up 9% over last year in reported dollars. However, excluding foreign exchange, sales were essentially flat with last year. Despite this general economic weakness as well as the impact of extended summer holiday periods, our European businesses continue to post-operating margins well ahead of our European competitors. In a promising development, our northern European business, which at the end of August divested its distribution business, serving hardware integrators and resellers in Norway, Sweden, Denmark and Finland, saw its operating income margin rise more than tenfold sequentially as they continue to focus on operational improvement. This excludes the impact of the divested business.

Following double-digit sales growth in the second quarter, our sales in Asia decreased by 2% sequentially to $196 million, and our operating performance was at the same level as our second quarter. On a year to year basis, however, our core sales in Asia increased by over 32%, which we find very encouraging. Have I mentioned before this is an area where we are focusing a significant amount of time and effort to ensure that we can effectively and efficiently meet the developing needs of suppliers and customers? Now I'd like to ask Paul Reilly, our Chief Financial Officer, to review our financials in greater detail. Paul?

Thanks, Bill. As you have seen in our press release, there is a number of items that impact the comparability of our results with those in the trailing quarter and Q3 of last year. I'll start by reviewing our results, excluding these items, and then at the end of my comments I will go through them in detail. Sales for the third quarter were $2.1 billion. That's essentially flat with the second quarter and up 16% from Q3 of last year. Sales, excluding the impact of foreign exchange, were flat again sequentially and up 12% over last year.

As Bill mentioned, sales in our worldwide components business were $1.6 billion, flat with the second quarter. Sales advanced in our North American components business, offsetting the seasonal impact of the traditional extended holiday period in Europe. Year-over-year, worldwide component sales increased 20% with each region around the world posting strong sales gains. Our gross profit margin of 16.4% was 30 basis points below the second quarter, principally due to pricing pressure in certain product sets around the world.

Compared with last year, our gross profit margin was 60 basis points lower, principally as a result of margin pressures in our components businesses around the world. Operating expenses as a percentage of sales were 13.7%, down 40 basis points from Q2 and 120 basis points from last year. The decrease in operating expenses versus Q2 was a result of our continued focus on operating efficiency and our ability to better size our structure to meet the needs of our business model. In addition to our focus on operating efficiency, a strong decrease from last year's third quarter validates what we've said many times regarding our business model. And that is we have a considerable operating leverage that will enable us to capitalize on even modest increases in sales activity. Operating income as a percentage of sales was 2.7%. That's up 10 basis points over Q2 and over 60 basis points ahead of last year. That's a 29% increase in operating income percent over last year. More importantly, operating income dollars were up 49% over last year. Interest expense was $36.2 million, up from 31.9 million in the second quarter and down from 38.4 million last year. Remember that, in late June, we issued $350 million of ten-year senior notes with a coupon of 6 and 7/8ths%. Almost $200 million of this amount was utilized to pay off the 8.2% senior notes due after the end of Q3. We did purchase $154 million of our zeros during Q3, so our interest was up in Q3 and should be near Q2 levels in Q4.

Cash flow from operations for the quarter was over $113 million. That's following an increase in $72.8 million in the second quarter. Our effective tax rate for the quarter was 32% versus 36.3% for all of 2002. We expect it to be 32% in the fourth quarter, as well. The principal drivers in the rate decline are change in geographical mix of our earnings, a tax reorganization we completed at the end of 2002, which better matched certain costs with the profits they generate. That income for the quarter was $15.1 million compared with $16.8 million last quarter and $500,000 last year. The principal driver for the decline in net income when compared to Q2 is the extra interest we carry during Q3 on the debt refinancing. Excluding this interest, net income would have increased by $1 million over Q2 and EPS for the quarter, which was 15 cents, would have increased to 18 cents if the duplicates of interest was ignored. That's versus 17 cents last quarter and one penny last year. Depreciation and amortization for the quarter was $15.5 million and non-cash interest expense related to the zero coupon convertible debentures was $6.9 million. And the number of actual shares outstanding was 100 million, 150 thousand.

As I mentioned earlier, for comparability purposes, and more importantly to give you a better sense of our operating results, I've excluded a number of one-off items from my remarks. The difference between our reported GAAP basis numbers and the numbers I have been discussing are due to the following items: First, as you saw in our press release [inaudible], a company we acquired in 2000, is alleged to have been a party to fraudulent activities in an attempt to avoid the payment of value added taxes for periods prior to our acquisition. As part of our acquisition, we obtained indemnities from the selling shareholder. Because of the factors noted in our press release, we have accrued a reserve of approximately $13 million for this potential liability. As I stated, these activities occurred prior to our acquisition of the company. The company has since been audited by the tax authorities for the period from our acquisition date in April 2000 through the end of 2001, and that audit resulted in no significant tax assessment.

As you remember from our last call, we announced a series of initiatives to further enhance operating efficiencies. It is estimated that these actions will reduce our operating costs by $75 million annually. During the third quarter we recorded $9.1 million in restructuring costs related to these actions. During the quarter we paid $154 million for our zero coupon bonds that may first be put through the company in 2006. On October 1st we repaid the $192 million still outstanding on the 8.2% senior notes. So, you won't see that last repayment in our balance sheet at September 30.

Going forward, we will continue to be opportunistic with regard to repurchasing our debt. In connection with the repurchasing of bonds in this year's third quarter, we incurred a $2 million loss after taxes, or two cents per share. In last year's third quarter we incurred a loss of $11.6 million after taxes, or 11 cents per share on the repurchase of bonds. Last year the loss was recorded as an extraordinary loss. The gain or loss on the retirement of bonds is no longer considered an extraordinary item under new accounting rules, so we restated last year's result. Again, the operating information we provide to you, to be used as a complement to, and not a substitute for, our GAAP numbers. Rob?

Thanks, Paul. Let's turn now to a discussion of our global components businesses. Let's start first with Jan Salsgiver, President of the North American Components Business.

Thanks, Rob. In the third quarter, our North American components business generated sales of over $800 million, up 6% from Q2 and up about 26% versus Q3 of last year. As Bill mentioned in his opening remarks, we are encouraged by the fact that our operating income dollars, as well as the operating margin, are at the highest level since the first quarter of 2001. Turning to trends in the customer base, sales to our core small to medium sized OEM and contract manufacturing customers, were up sequentially in the single digits. These customers represent a wide range of end markets, with the sales increase being very broad-based. The large tier 1 contract manufacturers were up sequentially more than 15 percent. But remember, this is the sector that declined the most. So, it's a high percentage off a lower base. Sales to large OEMs were up just over 10%. Order patterns remained pretty consistent with prior quarters with the majority of the business being book shift.

Moving on to price and availability, most product categories in both semiconductor and passive electromechanical and connector technologies continue to be readily available, though we are starting to see some differentiation. For semiconductors, our units were up 5 to 10% sequentially for nearly every technology. Average selling prices for ASPs, for analog, discreet and non-volatile memory were down in the low to mid single digits. Commodity logic ASPs declined by about 10%. ASPs for the higher technology, more differentiated products, such as embedded processors, were essentially flat. Most products remained readily available, but lead times had stretched to the more normal 8 to 10 weeks instead of two to four weeks.

The longest lead times we're seeing are with NAND flash devices and some parts that are made with very leading edge process technology. In passives, ASPs continue to be under pressure. We saw another sequential decline in the mid single digits, while units increased by more than 10%. This is the fourth consecutive quarter of increasing units with steadily decreasing ASPs. Connector ASPs were stable and units were up in the mid single digits.

Thank you, Jan. Bill Mitchell will now discuss our businesses in Europe and Asia. Bill?

Thanks, Rob. Europe continues to be a difficult market because of weak economic environments, though our European operations continue to perform well. Sales reflected this in the third quarter, declining 5% from the second quarter to 642 million. Excluding the impact of foreign exchange, sales were down 4% sequentially. I would point out that this rate of decline is consistent with what we experienced last year, and year-over-year sales increased by nearly 10% driven entirely by the stronger Euro. Excluding this impact, sales were essentially flat. Despite this softness, we continued to deliver solid operational performance.

As you know, the third quarter is traditionally the weakest in Europe due to extended holiday periods in southern Europe. Sales in northern Europe, which consist of the United Kingdom and the nordic area, increased by over 2% versus the 2n quarter, excluding the divested computer products business; and sales in central Europe were up 1% over the second quarter. Sales in southern Europe declined by 10% from the second quarter in line with the seasonal weakness. While we are generally pleased with our performance, we still see no long-term change in order patterns from our customers. Sales in the core components business in Europe, excluding the impact of foreign exchange, were down 9% from the second quarter and down 5% from last year. For us, core components exclude sales of microprocessors and our microtronic business.

Turning to Asia-Pacific, our 3rd quarter sales were approximately 196 million, down about 2% from the 2nd quarter, but up 35% in our core business over last year. Operating income as a percentage of sales for the third income was as the same level as second quarter, well ahead of last year. As for lead times and ASPs, what we saw in Asia as well as in Europe is basically the same as Jan described in the North America components business. Of course, as Asia is a major production center for hand sets and consumer-related products, we, like everyone else, are seeing certain product categories stretch out with the correlating increase in ASPs. This is not widespread, and product is generally available. In our core components business in Asia-Pacific we have the number one position in China, including Hong Kong, and in Australia and New Zealand. If we include our shared sales of our Maribund Arrow joint venture, we also have the number one position in Southeast Asia, commonly called the Asian region, and we are the number one global distributor in Korea.

As I've mentioned in the past, this entire region is a whole area of focus for us, and we plan to increase the investment in people, facilities and capabilities going forward. We're very focused on the opportunities present in the region, particularly in Taiwan, and we're evaluating how they and the investments necessary to make them realities, fit the strategy we are building to take us forward to a clear leadership position in Asia. Mike Long, President of North American computer products, will discuss the group's performance. Mike?

Thanks, Bill. In the third quarter, sales of our North American computer products businesses were $420 million, down 8% sequentially, but up 5% over last year. As we've always said, the seasonal decline from Q2 to Q3 is expected and an 8% decline is not out of line with prior years. But the real story here is our operating performance. And that becomes clear when you look at our year-over-year performance. Operating income, as a percentage of sales, was up 70 basis points over last year, and operating income dollars were up 33% over last year.

Sales in our enterprise computing group were down 10% sequentially driven principally by seasonality, but up 9% year on year, notably our Sun sales showed the strongest year-over-year increase as they continue to demonstrate their commitment to the channel. Our OEM sales were up sequentially by 1% and up 12% from last year, as the customer base for this business is principally in the telecom and networking sectors, which as you know, continue to be under pressure. We're very pleased to sequential growth for the third consecutive quarter.

Arrow's enterprise storage sales increased by 65% sequentially, and by 75% from last year, as the MC and network appliances business are growing as expected. If you remember, this is the group that opened the first storage solution centers in Atlanta and Minneapolis about a year and a half ago. We expect sales within our enterprise storage solutions group to increase going forward. Overall we think we had a solid quarter, attributable to the strength of both Enterprise and Computing, and our OEM group. Rob?

Thanks, Mike. Bill, would you like to make a few closing remarks?

Yes, I would. Thanks Rob. The third quarter was a good, solid quarter for us from an operational point of view. And let me highlight a couple of items that, I hope, you'll take away with you from this call. Over the last year we've made some tough decisions and implemented a number of restructuring initiatives, designed to enhance the operational efficiencies of the corporation. These are working. And we will continue to look for additional opportunities to increase operating efficiencies.

As some examples of what we have done, last year the Gates Arrow commodity computer products division was sold, enabling the computer products group to focus on its mid range business and look to enhance its offerings to customers in other areas. The operating income margin for that group reached a new third quarter high and operating income dollars are up 33% over last year. During the course of this year we announced restructuring plans focused on the North American components business that were designed to do the same thing, and that is to maximize efficiencies. Jan's group reported its highest operating income in dollars and as a percentage of sales since the first quarter of 2001. The operating income dollars of the group were up over a hundred percent from the third quarter of last year. As everyone knows, the European economy continues to be under pressure. Germany and Italy, which represent nearly 40% of the GDP of the European Union, are technically in recession, having reported two consecutive quarters of negative growth. Moreover, the third quarter is always weak for southern Europe, due to the extended holiday period. In the face of this our European businesses were able to maintain their strong operating performance despite a decline in sales.

Earlier I referred to our northern European business, which in the third quarter divested its Nordic computer products business after carefully evaluating its fit within our overall strategy. Our northern European business increased its operating margin by more than tenfold. We continue to make progress in Asia, and that will continue to be one of my primary areas of focus. From a balance sheet perspective, we generated another $113 million in free cash flow. We've again retired debt prior to its scheduled maturity, solidifying our already strong balance sheet. And we'll continue to be opportunistic in this area.

How does a company produce these results in an environment that is sluggish, at best? It's through clear focus and sharp execution. The decisions that we've made were proactive ones, and I'm very pleased with the results to date. We make decisions on how to run our business every single day, not just when sales are slow and not just when visibility is limited. Continuous improvement is one attribute that makes a company great, and it's one facet of what makes an investment a premier investment. And as I've said in the past, we will continue to make decisions such as these as we see fit and as they are necessary.

Looking forward, visibility remains limited at best and customer ordering patterns remain largely consistent with prior quarters. That means few long scheduled orders and a high percentage of book ship business. Just as many of you are doing, we're waiting to see if there is a true, sustainable uptick in end demand, or if we experience a holiday build-up. We are not prepared to call a turn in the technology business yet. What we are prepared to do is to tell you that we remain committed to maximizing efficiencies and maximizing returns. We do this for our shareholders. We do this for our customers, for our suppliers, and for the people of Arrow.

We are operating well in tough markets. We are doing everything in our power to ensure that our structure enables us to quickly capitalize on the inevitable cyclical upturn. Our operating results in the third quarter, even with a modest decline in sales, confirm the amount of leverage we have in our model. And because of that I can tell you for sure that when sales pick up, and they will, they'll fall to the right; profits will fall to the bottom line. Why don't we open it up for questions now, Rob.

Thanks Bill. Mauritia, would you open the call to questions from the participants, please.

Thank you. The floor is now open for questions. If you have a question, please press the number 1, followed by 4 on your touch tone phone. Once again, that's 1 followed by 4 for any questions at this time . Once again, please remain on the line. Your conference call will resume shortly. Once again, please remain on the line. Your conference call will resume shortly. Thank you. Our first question is coming from Steve Savas of Goldman Sachs. You line is live.

Thank you. Bill, I guess I have a macro question. You've been at the helm for a while and I know you've been quite focused on Asia. I was wondering on your thoughts, maybe just on the whole business, particularly from a financial standpoint, your thoughts considering the trend on things in Asia. Clearly you're growing your business quite well there and rapidly. In part you need to because of shifting manufacturing to Asia. There is a lower margin profile in Asia. It's certainly a very different market, either because of local regulations as well as, you know, a much more fragmented market. But it might be harder to consolidate than America and Europe once was. Just wondering on your thoughts on what does this mean longer term, over kind of a two-year basis on the financial profile of Arrow as we move into hopefully a recovery?

Steve, it's a great question, and I think that as we have begun to really develop a deeper understanding of the dynamics going on in Asia; 1, we get ever more excited by the opportunities we see, that the macro trends are real, they will stay, and we expect the demand to be there.

The business model is challenging, but what we're finding is we do believe that we can make returns that are at very acceptable levels and that we will not dilute the overall profitability of the company by doing so. What we are seeing is in fact a market that is in the early stages of its maturity, that is beginning to develop the attributes of the more developed marketplaces; that is, in-depth vertical segments, local demand, multiple end product segments, etc. And what that market is starting to demand is the things that we do best, which is to be a broad line distributor.

And so, what we are very excited with is that we're seeing more and more that that market will develop towards the kinds of capabilities that we have, that the complexities that we see that the press so rightly is pointing out, that the complexities and logistics and legal structure and all of the other aspects of it, in fact play to our strengths of a broad line distributor, that our broad line card is something that helps, that our financial strengths helps. And so, we're very excited not only by the opportunities, but we believe that in fact the returns are going to be there. And we're going to continue to invest.

And then that makes plenty of sense in the medium term, then, while there's kind of this transition taking place there as it matures and becomes a more reasonable market for you. Any concern that the shift in manufacturing to a market where you're less penetrated and it's more fragmented, that that just slows down the upside that you would see in typical cycles?

I don't think so. In fact, I think we're particularly well-poised to take advantage of the upcycle because we will be the people that have the best set of capabilities to handle the increases in demand, to handle the increased requirements for additional services, to take on that additional business. And so, we think that in fact the uptick will accelerate our growth rates, because we're the best positioned to take advantage of it.

Okay. Thank you.

You're welcome.

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

Hi. Good afternoon. Could you talk about the fourth quarter from the sense that, were there any pull-ins or push-outs that were prevented from beein at least seeing normal seasonal trends in each of your businesses?

There was nothing significant.

Okay. And then second question, with regard to your inventories, they keep coming down. Given that you're seeing some improvement on the component side, would you expect to be investing in inventory starting in this quarter or not yet?

This is Jan. On the inventory side, yes, we have been working our inventories to stay in line with our business. One of the things that is very important to our business, though, is in fact inventory. Inventory is one of the functions that we provide for both customers and suppliers, making sure that it's readily available. So, we are constantly adjusting, looking to profile our inventory, to make sure that we're there to handle the upside.

So, we have the opportunity to be profiling inventory and keeping our pipelines in order with our suppliers, and we have our pipelines in line with what we think the growth is going to be. So, the couple of good things for us are really working on quality of inventory. The higher the quality of the inventory, the better it turns. And therefore, we're able to reduce inventories and still grow sales. And the other thing is that we pipeline our order patterns with our own suppliers, based on where we anticipate demand to be. So, we bring in inventory in line with where those increases will be.

Thank you. And Jan, just from a standpoint of shortages, are you concerned at all that you could see shortages develop over the next couple quarters, or even if --

Shortages are a nice thing because they drive increased ASPs. As you know, we've been talking about the tact that units have been going up and ASPs go down. If we see shortages, the good news about that, with the ASPs increasing is that you very quickly see sales fall to the bottom line because you don't have the related line item. We did say that we saw lead time stretching a little bit from the six weeks out to the normal 10 to 12 weeks. And we are looking at specific technologies. And the way we're handling that is working closely with both our customers and suppliers with as much, you know, as we can to make sure we're ready. But I would welcome some lead times going out.

Thank you very much.

Thank you.

Thank you. Our next question is coming from Matthew Sheerin of Thomas Weisel Partners.

Yes, thank you. Good afternoon. Just on the gross margin, which was down, you explained about the pricing pressures and competitive pressures. Just trying to get a sense, Jan, if one reason is because you're starting to see a pickup in demand from the larger OEM and EMS customers, and whether your sequential growth in the quarter also had to do with perhaps market share gains due to the competitive pricing?

Okay. Let me take them one at a time. Your first question was, has the mix of our business changed, and is that part of what's happening with margins?

Correct.

The large customers, as I did say, grew in double digits, versus the small to medium-sized. But if you remember, I also said that they were the ones that had been down the most over the last couple quarters. Therefore, overall for us, our mix did not change that much. So, I wouldn't say that from the North American standpoint the margin decline had much to do with a mix in customer base.

I would say that with products being readily available that we are seeing some pressure on pricing, which does translate into some tougher margins. But in fact what we've been able to do is outgrow with our gross profit dollars, even with some lower margin percent, and that's how you saw that our operating income was up so much quarter on quarter.

As it relates to growing market share, we believe that we're doing a good job penetrating our customers and we continue to be very comfortable that we, that the Pioneer merger was a very solid one. It gave us access to new customers and sales, and we've continued to grow those.

Hey, Matt, it's Paul Reilly. Just to take your question to around the world, we actually do track on a macro basis our mix, and we saw virtually no change in our mix of our -- the percentage of our business to large accounts, or to our core accounts around the world. So, not a real significant change overall for the business.

Okay. Great, and then, ah, just regarding Asia, I was just a little surprised that the sales were down sequentially, given that most of your suppliers have talked about strength in Asia. I know their customer concentration is a little bit different. But if you could just elaborate on your customer mix in Asia, and then also update us on the number of authorized semiconductor lines you have in Asia, and as a percentage of your overall franchise lines and what the plans are going forward for adding those lines?

Yeah. Much of the activity that's going on in Asia is in fact in handsets, PCs and consumer products. And these sectors tend to go direct since they're the very low mix, high volume. And those are segments that we typically don't play in as heavily as we do in some of the other ones.

Our modest decline was not out of line with our expectations. We're continuing to grow year-over-year, and we're continuing to grow in a broader base where we grow throughout a number of different technology verticals, as well as beginning to penetrate into a quite large and rapidly growing local market that's developing, particularly in China. And so, those were not unexpected for us. We continue to be very bullish on our outlook and think we had a pretty good quarter in Asia.

Okay. And just on your authorization for selling products over there?

We have a good line of products. We in fact believe we have the broadest line of products. We don't have every line in every place, but we're working to fill that in and to make sure that we are seamlessly able to supply all our customers. But as we have looked across the competitive landscape, we do believe that we have the broadest line and the broadest capability. And that in fact matches with what we're seeing in a number of the marketplaces that in fact are looking for a broad line distributor. And that's very much the trend that's going in there. So, we think we're well-positioned to pick up business, as the capabilities that we bring to the market in fact are the ones that the market needs.

Okay. Thank you.

Thank you. Our next question is coming from John Horvath of Lehman Brothers. Your line is live, sir.

Thank you. First question is just you mentioned interest expense going into Q4. Can you also just talk about the quarter on quarter impact of some of the restructuring actions that you talked about last quarter on your SG&A line?

Sure. That's a good question, John. So, what we've talked about, and we've been very clear, is that we have targeted $75 million of annual cost savings.

And we right now have achieved about 68 or 69 million dollars of those cost savings, the only difference being the closing of some warehouses which we had announced would be scheduled for late this year and the beginning of next year. So, we've already hit our targeted goal of $75 million. If you're comparing Q2 to Q3, we actually picked up about somewhere right around $6 million of improvement in our cost savings effort. So, that's from our initiatives that we've kicked off and that we've targeted for cost savings.

Okay. Sorry. 6 million incremental to what you announced or there was an absolute 6 million --

What we achieved in the second quarter. So, right now, if you take our 68 to 69 million dollars that we've achieved annually, divide that by 4, that gives us about a $17 million quarterly achievement so far in the third quarter.

Okay. And then -- so, from Q3 to Q4, what's the expectation?

Q3 to Q4 should be minimal because most of the warehouse activity takes place in 2004.

Okay. Great. And then just a question for Mike about North American computer products. Last quarter the enterprise computing grew 22% sequentially, and I think it was down 10 percent. And I think that Sun is one of your big vendors, and their seasonality was actually worse on the downtick. And I'm just trying to understand how you grew so much in Q2 and then the decline was only about half the growth? Was it share gains or was it the storage business that was outgrowing the systems business? Can you give me a little bit more color on that?

Yeah. We had share gain in the primary suppliers, Sun, IBM and Hewlett-Packard along with share gains in storage from the Q1 to Q2 time frame, if you recall, and also maintaining and continuing to grow a little share in Q3 minimized the downturn for us.

Okay. So, the explanation is not that your business inherently has much more seasonality than Sun; it's more of a share gain explanation?

And to be honest with you, if you recall, we have talked about Sun increasing its support on the channel this year along with IBM. So, the two vendors have really been supporting the channel, and that has helped the channel business overall stay up.

Okay. And then just in terms of the gross margins, was there any kind of pricing -- you talked about price pressure in different products around the world. Was pricing pressure in computer products a large contributor to that gross margin sequential downtick?

Very small. The Q2 to Q3 business, as you know, is sequentially down. Therefore, every year, year after year, you have margin pressures in servers, storage in particular. Software and services stayed flat to up over the quarter. So, the quarter on quarter impact on the overall business was minimal.

Okay. Great. Thanks. Just one final question for Jan. I'm just wondering about -- you know, I was very encouraged by the growth in the components in the U.S. business, and I'm wondering if you could talk a little bit about the linearity in terms of if the business improved later on in the quarter or not, and just a little bit more color on the end markets?

You talked about concerns about it being a holiday build. And that would make me think that it's consumer. And maybe you could got into a little bit about networking and com-markets and if you're seeing encouraging signs much stabilization there, please?

Okay. I'll start with your first question, and that was did we see strength throughout the quarter. And the answer is yes, we saw continuing improvement, month by month, throughout the quarter. As you know, we always look at this as a quarterly gain, though, and find it very hard even when things looked good in July, to say we're gonna call a quarter that way. You always wait till the quarter's over. But in this case it did feel pretty good throughout the quarter.

My comment on the breadth of the customer base is that what we saw was every one of our selling group, from our dedicated military operation to our small to medium sized OEM group to large customers to -- you know, as we said before, more than two third of our sales to the contract manufacturers come from our small to medium size, not the big top five. Every one of our groups showed sequential growth. To me that means that we're seeing a very -- a good, solid, broad-based, whether it's, you know, medical electronics, military or, you know, broad industrial base. There wasn't any one end market that stood out as driving the growth.

So, we felt that, you know, there isn't really a specific end market. I believe that the -- Bill is the one who made the comment at the end about is it or is it not a -- you know, is this a real growth or is there something about a holiday build-up? But I wouldn't say that that has anything to do with specifically our being high provider for the PCs or hand-held type markets, which is where you see that holiday build-up. So, I don't have a real differentiation for you in terms of the customer bases because our broad customer base strategy really worked this quarter and we saw growth across the way.

Yeah, one of the things I might just kick in with is that some of the comments about whether it's a holiday one very much relate to Asia where there clearly is a drive. And some of the shortages that we do see that appear to be appearing in Asia are related to the consumer products, flat panel displays, DVDs, PDAs, et cetera. But as Jan said, in North America, it was pretty broadly based. And that's very good news for us.

Great, thanks, that's very helpful.

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

Good afternoon. If we could go back to the inventory question, your suppliers are also trying to figure out what's happening in demand. And one of the things that they point out is that they haven't seen the normal pickup in distribution demand that they would like to see to confirm that things are real.

The reasons that you're not picking up inventories, controlling inventories so well, is that because of caution, or are you waiting to see more confirmation, or has something happened in all the cost cutting and organizational changes that you've made that will allow you going forward to continue to run on better inventory and higher turns than we've seen in the past?

Okay. This is Jan. First of all, I wouldn't say that our-- I'd say our inventory performance, in terms of being able to keep our inventories in line while we grew sales, was really not a sense of caution, but a sense of really continuing to work the team to make sure that we've got the best quality of inventory that matches our customer needs. So, it's not related to any sense of caution. I will tell you, and it's always been true, every call, we're never satisfied that our inventory performance is good enough. We always believe we should be working on improving the turns performance. But at the same time, we balance that with inventory is one of the most valuable things we provide to our customers and suppliers, so we'll continue to try and improve it. And that's basically --

Yeah, Mark. I'd like to chip in on that one, too, because clearly we've had a real focus on the balance sheet and to try to make sure that we get the right levels of inventory and get the right levels of control on our balance sheet. And I'm very pleased with the progress we're making there.

But as Jan said, our job is to make sure we have the right part at the right place at the right time at the right price. And we are not being cautious in doing that. So, I think what you're saying is we did a better job of managing our inventory last quarter. And I'm very pleased with what I'm seeing. And we're going to continue to work on that.

We continue to believe that we can, as Jan says, continuously improve, do better, utilize some of the tools we've been investing in to continue to both provide increased service as demand begins to pick up, and yet not end up having to spend a huge amount on inventory, but still service our customers to the level that they require.

Just one other comment. In past cycles, we used to see a bit more speculation on the part of distributors than maybe we're seeing this time in terms of trying to take advantage of some pricing and pick up inventories at lower prices on the expectation that there will be some profit involved in doing that. Is there more caution and discipline on that this cycle than you've seen in the past?

Mark, this is rob. I guess I'm the longest tenured one in the room at the moment, so let me just jump in on that.

We both knew each other when we were young, Rob.

Yeah, when we were young, I know. But I would quarrel with the initial premise. I don't believe that this company has ever made a serious practice of speculating in inventory, in anticipation of an up or of a down cycle going back 30 years. We try, as Jan described earlier, to match our inventory position with the input we get from our suppliers and our customers, and that's how we position the inventory.

So, I would quarrel with the beginning part of your assessment. And I don't think it has anything to do with caution or anything else. Jan, you run the inventories.

Yeah, I would agree with you that, Rob, our primary driver is trying to anticipate what we think is going on in the marketplace. I do think that we have tried to be smart at using volume when it makes sense to be able to buy at the right prices. But you're always making a tradeoff between price and holding inventory, and we continue to try and work on getting smarter at that.

Great.

Thank you very much. Very nice quarter.

Thank you. Our next question is coming from Patrick Parr of UBS.

Good afternoon, guys. A question on the restructuring. I guess, you said in the press release you've got another $8 million to take in the next several quarters. I was wondering if you could remind us exactly how that might be used in terms of head count reductions, warehouse closures, et cetera?

Sure, Pat. First off, that 8 million, it's about 5 million in cash, and 3 million in facility costs will be non-cash. The vast majority of the cost savings will come out of elimination of leases as well as the reduction of head count. But keep in mind it's principally focused in logistics centers, distribution centers. And those are employees that on an hourly basis are not necessarily highly paid employees.

Paul, could you give us any sense of the order of magnitude, or do we have to calculate it?

You know what? It's -- are you talking about when the $8 million will be spent, or are you talking about the actual cost savings?

Well, the actual cost savings and the total head count.

I don't have the actual head count handy at this point in time. And the spending will be principally in the first half of next year.

Okay. All right. Then a question for Jan on the components business. A number of the passives manufacturers have talked about pricing for passives improving during the September quarter. I was wondering if you had noted any similar-type trend?

You know, as I said in my remarks, we saw on the passive side that in fact pricing in North America continued to see pressure. I believe we saw less pressure, if you think about Bill's comments, in Asia. I think we had less pressure in Asia. And then at the very end of the quarter, we did start to see some firming, more so than we had seen earlier in the quarter. And we'll hope that when we talk to you again at the end of this quarter that maybe we see some more firming.

Okay. And then, regarding your lead time comment, having extended from 6 to 8 weeks to 10 to 12, did that happen during the quarter, or are you referencing the 6 to 8 weeks from a much earlier time period?

Yeah, I think most of the last callsthat we've had, we've been saying products are readily available in the four to six week time frames. And, what we're now saying, is the lead times throughout this quarter - it feels like the lead times on most products are now the more typical eight to 12 weeks. So, that was just kind of throughout this quarter. Most of them have stretched back out to the eight to 12-week time period, which again increases the value of our inventory.

Okay, and then I guess to tie back to maybe another question about inventory. Would I assume that as your confidence grows in the recovery that there would be an inclination to build some inventory to service the customers better?

Only if we think we need more inventory in order to drive the sales. If you can get smarter about how you manage inventory, you can continue to improve your turns velocity while you're driving increased sales. And one of the major focuses that we've had is making sure that we're making - having the right quality of inventory, so we can make that happen.

Okay. So, then, thinking ahead with the kind of outlook you're seeing right now, I would probably model inventory to be tracking in line with my sales at this point?

Yeah, that's fine.

Pat, if you look at our inventory turns over the last four quarters, they've been pretty consistent in that 5.1, 5.2, 5.3 category. Which is up from where they were last year, and the year before that. That's probably right around our targeted area. So, there may be some planning differences, and we are, as Bill mentioned, and Jan mentioned, looking for incremental improvement, but the bottom line is that our inventory is spinning pretty well right now, and we'll probably match that going forward, depending on the sales.

Thank you. Our next question is coming from Mark [inaudible] of CSFB. Your line is live, sir.

Thank you. Good afternoon. Two questions. One is the balance sheet. The repurchase of the zeros, was that just because you had borrowed money, or will we likely see more drawdown on cash to buy back more debt going forward?

Mark, what we've said all along throughout this downcycle, where we generate significant amount of cash -- that we'll be opportunistic in utilizing it in driving the business success, and that's part of it. So, we saw an opportunity to deliver the balance sheet a bit and we utilized the cash at that point to be opportunistic. So, I think we've been pretty clear that we'll continue to be opportunistic in how we manage our balance sheet and manage our business.

I guess, maybe I'll ask another way. How much cash do you feel you're comfortable with, absent a strong increase in the business?

Well, we've talked about in the past that our sales drive about a 25-cent increase in working capital requirements for every dollar of increased sales. So, that's what we've looked at. You see that we've been very cash positive for the whole down cycle and will continue to be so. So, if you're asking us about our cash balance, we've not historically run having a $687 million cash balance. We'd like to have it around 100, 125, 150 million and have it invested either in working capital supporting higher sales or delivering the company.

Okay. And then on sales at the moment, did we enter the quarter at sort of that two to four-week lead time, and we're exiting now in, what you're saying a more normal eight to 12. And if that was the case, was there a change in the ASTs coming down more strongly in the beginning and exiting more towards the flat level?

There was nothing that was that obvious in terms of which week. I would say that, you know, throughout -- so the answer is I can't really give you that it started one day and moved another day.

But I guess at your more normal lead times, which I guess would suggest greater factory utilization on the other side, are you seeing a smaller decline in ASPs than the average?

Yeah. If you remember the question that we had on passives, we did answer that in fact we saw that there was a -- we saw a little bit less appreciate sure on passive at the end of the quarter. And, you know, so we'll -- but I can't tell you that across the board, that I've seen a real big change. As you know, the customers, as the lead times start to go out, it takes a little while for the customers to come around, to recognize, that in fact, the lead times are going out and parts may be harder to get and, therefore, ASPs will go up. So, I'm hoping that we'll see more of that in the upcoming weeks.

So, you're not seeing in semis what you're seeing right now in passives, to ask the same question in semis as passives?

No, nothing that I would tell you that is that notable.

Okay. Thank you.

Thank you. Our next question is coming from Scott Craig of Morgan Stanley. Your line is live, sir.

Thank you. Good afternoon. Could you just provide a little more flavor on the computer side of the business with regards to operating margins, you know, on an apples to apples basis, when you get rid of the Nordic business, how is that going to impact things related to what happened last quarter with the 80 basis point decline? Thanks.

Yes, Scott, these a good question. I think what we announced on our last call was that we would be divesting of the business in the Nordic area, computer products business. And it was on a run rate of generating about a $5 million operating loss at that point in time. So, that will obviously improve our performance in the computer products world. The rest of our computer products performance is really driven by the North American computer products business. And we've talked in the past about the seasonality there. So, that drives some of the performance. I think the take away would be that we've seen nine consecutive quarters of year over year improvement in the North American computer products business, and that's a pretty good performance.

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

Thanks. Good afternoon. Just to go back to the gross margin change sequentially down about 30 basis points, and I think, Paul, you said earlier pricing pressure across general product categories. Mike said it didn't happen in the computer business, so it sounds like most of that margin pressure is on the components side. And I'm just wondering why would that be if, you know, lead times are stretching, albeit modestly, why are we seeing a little more margin pressure on the component side than we have been? Or maybe I'm not interpreting that correctly.

First let me start by trying to get a point of clarity about both my comment and Mike's comment. What I said was that on a sequential basis, gross profits were down because of pricing pressure in certain product sets. And I believe what Mike said was not that there was no impact in computer products, but that there was a small impact in computer products. So, that's just a point of clarity to go with your question. I'll let Jan answer vis-a-vis the components business.

Sure. On the components side I'll go back to what we just talked about. And that is that we have not yet trained the customers to respond the day that lead times start to stretch, to recognize that prices should also go up. And so, what we're seeing is that, in fact, the customer behavior lags the change in lead times, and they're not yet completely convinced that they need to pay more for product. So, we're working on that, and we'll continue to work that. But it does lag a little bit.

Brian, this is Bill. I just chime in on that one - that's really true. And I can tell you that from my old experience, that it takes a good long time for those end customers to -- having been one of those not so very long ago, to recognize that there's anything else going out there. So, they are pounding away, as ever, to have lower costs and lower prices and the fact that things are getting a little tighter is falling on deaf ears. But ,ultimately, marketplaces work, and this will all come through over a period of time. We're just seeing the inevitable lag as the markets start to tighten up on the supply side. There is that lag as it gets into the customer side. And if it continues to tighten, we will see prices beginning to turn.

As we say, we are not ready to call the turn yet, but we do believe that the signs are that if the shortages continue, if capacity continues to get utilized, then in fact ultimately customers have to recognize that supply and demands works.

And I guess in a typical cycle how long is that lag time?

It's three to six months - would be the most logical kind of thing. And so, we're beginning to see the tightening that's started to happen in this quarter. If it continues - if it continues past the Christmas season, then we might be expecting to see something in the early part of next year.

And Bill, to go back to your comments about Europe, we're starting to get a little bit more, I guess, positive data points coming out of companies in Europe with respect to the environment. But it doesn't sound from your perspective that that's something that Arrow is experiencing. So, I'm just trying to understand your comments in the context of the environment over there. Would you say that you're basically experiencing normal seasonality in Europe? Or is it a little bit worse than that, or, are you seeing any signs of hope at all about Europe, perhaps, getting a little bit better?

What we're seeing is, I believe, normal seasonality coupled with some real structural weaknesses in some of the key enigens of Europe, particularly Germany and Italy. And France has been precious close to zero growth for some period of time. We also believe that Europe is probably a few quarters behind North America normally, that as North America starts to pull out of it, Europe will pull out a couple of quarters after that. So, some of the earlier signs that may be coming in Europe, or that we're seeing in North America, if that trends holds, then we would expect to see that a couple of quarters afterwards coming on in our European business.

And one final question for Paul. I think you mentioned on the SG&A line you had about 16 or 17 million dollars of quarterly savings. If I were to back that off the last quarter, that would put your SG&A at a run rate of about $265 million or so. But you ended up at about 272. So, and sales were essentially flat or down a little bit sequentially. What am I missing in that picture and why didn't SG&A go down a little bit more?

Yeah, I think, Brian, that what we're looking at is -- let me just make sure I get the right numbers so we're all dealing with them. And I actually have a little cheat sheet here that I could point to.

When we look at our SG&A in pure dollars, it went from -- let's use rounds numbers. $300 million at the end of the June quarter to 287. In fact, the incremental increase in our cost savings coming out of our announced actions was about $6 million. So, if you take 300 minus 600, would put it around 297. The decrease from 297 to 287 is really driven by a variable cost structure, sales being down marginally, those types of things. And just as a pure accountant, keep in mind that when people go on holiday during summer, there is no payroll charge for us. It reduces the accrued vacation number. So, that has a bit of an impact, also.

Okay, thanks. That's helpful. One last one. In terms of the charges this quarter, when I look at the segmented operating income data, I assume that none of the charges -- they're all allocated to the corporate side and not to the individual segments, is that right?

That's absolutely correct, Brian. It's our policy to take the non-recurring one-off items as charges in corporate, and that's why you would see a substantial increase in the corporate expenses in the segment disclosure.

Thank you. Our next question comes from Douglas Armand of Aristia Capital. Your line is live.

Thank you. Congrats, guys, on the quarter. Two questions: One, can you comment on the rationale for not repurchasing the shorter dated higher coupon 870s rather than the convertible notes? And then, I guess, on the cash flow, I may have missed it if you mentioned it, could you talk about what you spent on cap ex for the quarter and the cash flow from operations contribution from working capital? Thank you.

Okay. So, I can tell you that for the quarter we spent a little over $8 million in capital expenditures. And I can tell you that the three components of working capital that we look very closely to, which is accounts receivable, inventory and accounts payable, contributed around, I'd say, 65 to 70 million dollars of the free cash flow for the quarter.

Your first question around the repurchases, if the pricing's right, we'll be more than happy to take off the table any of the shorter tenured tender offerings that are out there. So, it's really a matter of what the market will bear at this point in time.

Thanks, Paul.

Thank you. Once again, that's 1 followed by 4 for any questions at this time. Mr. Klatell, I'm showing no further questions at this time.

Thank you. And thank you all for taking the time to participate in the call today. If you have any additional questions, please don't hesitate to call Eileen O'Connor or me here at the office. And we will see you next quarter. Thank you all.

Thank you. That does conclude this evening's teleconference. Please disconnect your lines and have a wonderful day.