艾睿電子 (ARW) 2004 Q3 法說會逐字稿

Good morning, ladies and gentlemen. And welcome to the Arrow Electronics Quarterly Earnings Release Conference Call. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions following today's presentation.

It is now my pleasure to hand the floor over to your host, Ira Birns. Sir, the floor is yours.

Thank you, Matt. Good morning, everyone. And welcome to the Arrow Electronics third-quarter conference call. I'm Ira Birns, Vice President and Treasurer and I will be serving as the moderator on today's call.

With us on the call today are Bill Mitchell, President and Chief Executive Officer; Paul Reilly, Vice President and Chief Financial Officer; Brian McNally, President North American Components; Germano Fanelli, President of Arrow Europe, Middle East, Africa and South America; Harriet Green, President of Arrow Asia Pacific; Mike Long, President North American Computer Products; Jan Salsgiver, Vice President Global Strategy and Operations; and Peter Brown, Senior Vice President and General Counsel.

By now you should all have received a copy of our earnings release, if not, you could access our release on the Investor Relations section of our website, which is www.arrow.com.

Before we get started, I would like to review Arrow's Safe Harbor statement. Comments to be made on today's call contain certain forward-looking statements, including statements addressing future financial results of Arrow. These statements are based upon the Company's current expectations and are subject to risks and uncertainties, which could cause actual results to vary materially from the expectations contained in the forward-looking statements. Detailed information about these risks is included in Arrow's SEC filings.

We will begin with several minutes of prepared remarks, which will then be followed by a question-and-answer period.

At this time, I would like to introduce Bill Mitchell, our President and CEO.

Thank you, Ira. And thanks to all of you for taking the time to hear about our quarter. We delivered a very solid third quarter in the midst of a choppy market with consolidated sales of $2.67 billion and net income of $55.8 million, which excludes certain charges, credits and losses. This represents a 27% year-over-year increase in sales and a 270% increase in net income. We achieved these results despite the fact that we experienced the traditional seasonal weakness, as well as an element of cautiousness and uncertainty throughout the component related supply chain. Our continued focus on operational efficiencies is paying off, as evidenced by these solid results. Sequentially, sales were down 3% and net income was down 19% inline with the guidance we provided in July.

Let me give you a brief overview of the third quarter at the business unit level. Our North American computer products business delivered record third-quarter results for sales, operating income - as a percentage of sales, and they doubled operating income over last year's third-quarter level. We continued to do an exceptional job in this highly competitive market, driving profitable growth and increasing sales of products including storage, software, and services. Congratulations to the team for once again delivering another quarter of stellar performance.

Our components business around the world posted relatively strong sales performance in what is traditionally a weak quarter due to the summer holiday period. Worldwide component sales were $1.99 billion, down 3% sequentially, but up 26% from last year's third quarter, with operating income as a percentage of sales at 4.9%. What our components business has experienced in the third quarter is reflective of what you had heard from some of our suppliers and customers.

Business activity was generally softer in July and August than it was in the first two months of either the first or second quarters. And while we saw modest recovery in daily run rates in September, it was neither at the level we anticipated nor at the level we experienced in prior quarters. With that said, regardless of whether current market conditions represent a pause in the overall technology market recovery or a weaker than normal seasonal period, I'm very pleased with this group's performance. They collectively posted healthy year-over-year increases in sales, operating income and returns on asset utilization.

On a regional basis, North American sales in the component region were $950 million, down 4% compared to our second quarter, but up 17% over last year. Operating income was down 19% from the second quarter, but up 74% over the third quarter of last year. In Europe, primarily as a result of their extended holiday period, component sales were down 9% sequentially, but were up 18% over last year, excluding the impact of acquisitions and divestitures. Operating income was down 28% from the second quarter, but up 32% over the third quarter of last year.

Our Asia Pacific regions performance remains strong, and sales continue to grow at a significant pace. They achieved $300 million of component sales for the first time, with total third-quarter sales of $302 million, up 4% sequentially and 54% over last year. In China, activity levels rebounded in September after softness in July and August, due to a combination of energy shortages, an imbalance of inventory levels and to a lesser extent the tightening of credit by the Chinese government. We made very good progress in expanding our sales base in Taiwan and Korea, though this was at the low end of the market where gross profit levels are generally lower. Congratulations to the team for once again outperforming the market.

Operating income was down 69% sequentially, but up 16% over last year and our year-to-date profit now exceeds that of the last two years combined. Overall, our revenue levels continued to be well above the levels of a year ago and we continued to grow earnings faster than sales. This was a solid quarter for us in the midst of a market that continues to offer very mixed signals.

Paul Reilly will now give you more detailed review of the third quarter and then Mike, Brian, Germano and Harriet will discuss their business performance in greater detail.

Thanks, Bill. As you have seen in our press release, there are a number of items that impact the comparability of our results with those in the trailing quarter in 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 the excluded items. Sales for the third quarter were $2.67 billion, that's down 3% from the second quarter, but up 27.4% from Q3 of last year. Excluding the impact of foreign exchange, the change in our business model associated with our HP business and acquisitions and divestitures, sales were up 22% over last year's third quarter.

Sales in our worldwide components business were 1.99 billion, that's down approximately 2.5% over Q2 and up 26.1% over Q3 of 2003. Each business around the world posted year-over-year sales growth of more than 17%. Operating income as a percentage of sales was 4.9%, down 100 basis points from last quarter, but up 100 basis points over last year. Worldwide computer product sales were $677 million, down 4.2% sequentially, but up 31.1% year-over-year.

Operating income as a percentage of sales was 4.6%, which was up 10 basis points from last quarter and up 200 basis points from last year. Our consolidated gross profit margin of 15.7% was down 70 basis points from the second quarter, principally due to pricing pressures in the marketplace. Compared with last year, our gross profit margin was also down 70 basis points, due principally to the change in our business model with HP. Operating expenses as a percentage of sales were 11.8%, down 190 basis points from last year. This continued decrease in our operating expenses is a result of our continued focus on operational efficiency, our ability to continue to better size our structure to meet the needs of our business model, and our ability to lever our cost structure to meet growing sales volumes.

Operating income was $105.8 million, down almost 17% sequentially, but up 88% over last year's third quarter. And operating income as a percentage of sales was down 60 basis points from Q2, but up 130 basis points over last year. Net interest expense was $24.4 million, down marginally from $24.5 million in the second quarter and down nearly 33% from last year's $36.2 million in the third quarter, principally reflecting the impact of over $700 million in debt repayments over the past year. Our effective tax rate for the quarter remained unchanged from Q2 at 32.5%.

Net income was $55.8 million, down 19% from Q2's $69.2 million, but up 270% from last year's $15.1 million. Earnings per share at 48 cents and 46 cents on a basic and diluted basis respectively, were within the expected range we announced on our Q2 earnings call. EPS was 60 cents and 57 cents on a basic and diluted basis respectively in Q2 and 15 cents in last year's third quarter. We generated $52 million of cash from operations in the third quarter. We expect to be cash positive for the fourth quarter as well.

Our balance sheet remained strong, with net debt to total cap at 39.5%, an improvement of 26% over last year. In addition, we have $1 billion in available liquidity under our banking facility and asset securitization program. Depreciation and amortization for the quarter were $13.1 million, and non-cash interest expense related to the zero coupon convertible debentures was $3.6 million. And finally, our number of actual shares outstanding at the end of the quarter was 115,616,612.

As I mentioned earlier, for comparability purposes, and more importantly, to give you a better sense of our operating results, I have excluded some one-off items from my remarks. The differences between our reported GAAP basis numbers and the numbers I have been discussing are due to the following items; as disclosed earlier in the third quarter of this year, we have settled a claim against our French subsidiary, Tekelec SA, in respect of French value added taxes relating to periods before Arrow owned Tekelec. The settlement amount was for 3.4 million Euros. The original claim of 11.3 million Euros was fully reserved during the third quarter of 2003. And that was $13 million at the then current exchange rate. Accordingly, we recorded an acquisition indemnification credit of $9.7 million. That's 9 cents and 8 cents per share on a basic and diluted basis respectively. This amount represents a difference between the amount previously reserved for the claim and the settlement amount.

During the third quarter, the company in which we have a 5.6% ownership interest decided to raise additional capital in order to sustain its business model. We chose not to participate in this round of financing and, as a result, our ownership interests will be diluted and subordinated to the new investment. We wrote down our investment in this company as unlikely, we will be able to recover our current net investment of $1.3 million or a penny per share. During the third quarter of this year, we repurchased an additional $19.8 million of accreted value of our zero coupon convertible debentures due in 2021, which could have been initially put to us in February of 2006. The related loss on the repurchase, including the premium paid and the write-off of the related deferred finance cost was approximately $900,000 pre-tax, or $500,000 net-of-tax, a rounded penny per share.

We also during the third quarter of 2004, in connection with previously announced restructurings, recorded additional restructuring charges of $400,000 or $200,000 net-of-taxes. As always, the operating information we provide to you should be used as a complement to our GAAP numbers. Our earnings release includes a reconciliation of the GAAP numbers to the numbers I have been quoting. Each of our business presidents will discuss their results for the third quarter. We'll start with Mike Long, who will review the results and the performance of our North American computer products business.

Thanks, Paul. Sales in North America and computer products were 592 million. Down 5% sequentially and up 30% from last year on an adjusted basis. Our operating income was down 4% sequentially, but more than doubled from last year. And this is our 13th consecutive quarter of year-over-year earnings growth. Our strong performance was the result of our continued strong execution across our broad customer and product bases.

Sales in our enterprise-computing group were down 6% sequentially from the June quarter and up 34% from last year on an adjusted basis. Our Sun business was down 25% from a phenomenal quarter in Q2 when Sun's yearend occurred. Year-over-year Sun sales were up 28%. More of Sun's product is being sold through distribution and we continue to out grow the market. Our IBM business was down 2% sequentially and up 7% year-over-year. The sequential decline was influenced by IBM's product announcements in Q2 and Q3. Our HP business was up 40% sequentially and 125% year-over-year on an adjusted basis. Resulting in its strongest quarter since 2000.

Storage sales remain strong, driven in part by regulatory compliance and infrastructure upgrades. Storage sales were flat from June and up 54% from last year. And we maintained our number one position with EMC, Hitachi, and Network Appliances. Service sales decreased by 32% from the second quarter and increased 29% from last year. Software sales were up 37% from second quarter and up 65% from last year. Remember, we said that these three areas, storage software and services were going to be areas of focus for us going-forward. So we are very pleased with their improvement in performance year-over-year.

Sales in our OEM computing group were down 4% sequentially and up 15% from last year. Our virtual factory program continues to generate interest from OEM customers. Our ability to manage their supply chain from Borden system designs integration and through direct shipments to our OEM customers eliminates redundancy in the supply chain and allows our customers to focus on their core business.

In conclusion, we had a very strong quarter, posting our 13th consecutive quarterly year-over-year increase in sales and operating income. We continue to out grow the market, expand our product offering, and grow operating income at a faster pace than our sales growth.

Thanks, Mike, and congratulations to you and your team for another great quarter. Brian McNally will now discuss our North America components business.

Thanks, Bill. Sales in the North American group were down 4% sequentially to 950 million and up 17% over last year. Operating income decreased by 19% from Q2, but increased by 74% over the third quarter of last year. We believe we continue to out pace the market and operating income was at its highest third quarter level since 2000. Third quarter results were clearly impacted by the cautiousness in the market that Bill referred to earlier. With the exception of our military business, which was up 1% sequentially, sales were down between 2 and 4% in both our large complex and small and mid-sized customer segments.

Our daily run rate for the quarter was down 2% versus Q2, while this is the first daily run rate decline in five quarters, we are still experiencing a rational and disciplined cycle, with cancellation rates relatively flat with Q2 and with no real shortages across our product segments. Moving on to ASP trends, we will start with semiconductors. In Q3 blended ASPs were up slightly, with increases in analog, embedded processors and programmables. Decreases in volatile memory and in the communication segment. This increase is principally mix driven more than anything else.

Passive prices were also up slightly as some suppliers selectively raised prices during the quarter. Connector ASPs were up slightly from the second quarter, impacted by supplier increases announced during Q2, largely driven by increases in the raw materials that make up these products. Connector lead times remain stable with no material shortages to report. Electromechanical ASPs were down slightly, driven by the mix of our product sales.

Customers continue to closely manage their own inventory levels as they remain cautious about end market demand, this translates into less backlog visibility and more book shipped business as they look to position themselves to take advantage of imbalances in supplier inventory levels to achieve better pricing.

Thanks, Brian. I would like to now ask Germano Fanelli to comment on our European business.

Thank you, Bill. The environment, the economic environment in Europe remains sluggish. And the weak US dollar (indiscernible) the energy and commodity costs are continued to have negative effects on the manufacturers of product usually exported. Sales in Europe of 800 million were down 4% sequentially, approximately the same as last year, reflecting the normal impact of the extended summer holiday period. Year-on-year sales were up 15%. Excluding the impact of acquisitions and divestitures, sales were down 7% sequentially, but up 14% over last year's third quarter in local currencies. Despite a tough macroeconomic environment and the impact of the seasonal slow down in Europe, we increased operating income as a percentage of sales by 100 basis points year-over-year. While that is more readily available with lead times back to normal levels. Pricing, though generally stable, is under pressure in certain customers and product groups. We continue to believe that we outperform our European competitors. We also close the Disway acquisition during the third quarter and we're excited to welcome them to our European team. This way, we further strengthen our business in central and southern Europe.

Thanks, Germano. And now I would like to ask Harriet Green to discuss our Asia Pacific business.

Thanks, Bill. Second quarter sales were $302 million, up 4% sequentially and 54% over last year. The growth we experienced in the third quarter was led by strong demand for broad basis segments and for analog high performance LCD Displays as well as growth in the programmable logic segment across a wide range of customers. Our year-on-year growth was again broad based across the region with Asian leading a strong pack. North Asia countries have continued to record strong year-on-year sales growth with Korea and Taiwan recording the most significant increases. Additionally, our customer-focused initiatives in China, India and the Australia/New Zealand region are showing great progress. The Chinese government began easing its monetary -- its tighter monetary stance late in the third quarter, with business picking up in the markets that we serve. Supply chain engagements continue to increase, and supplier support is very critical and strong in this area. We continue to outperform the market in China. The situation regarding pricing and availability was similar to the North American and the European regions. Semiconductor ASPs were down slightly with pricing in the analog and programmable segment increasing. But lead times have also come down in Asia. They remain with in normal ranges with no meaningful shortages.

Thanks, Harriet. And congratulations to you and your team for another great quarter. Reflecting on the quarter, we're proud of our achievements. We posted solid sales results throughout the company and most noteworthy is that of our computer products business, who achieved a record third quarter.

In each of our components business around the world, we continued to outperform the market. The components business in North America generated strong operating performance with significant year-over-year improvement in sales and operating income. In Europe, operating income dollars and operating income as a percentage of sales showed healthy improvement year-on-year. And Asia continues to show strong growth and underlying demand while less than the frantic pace we saw in 2000 and early 2003 and early 2004 remains strong. And we've made solid improvements in Taiwan and Korea, where we have traditionally been weak. We were cash positive in the third quarter and expect to remain cash positive for the balance of the year. We continued to maintain $1 billion of untapped credit facilities.

We continue to implement the four pillars of our strategy, to grow sales organically at a faster rate than the overall growth in the markets, we serve. We have a very relentless commitment to operational excellence and continuous process improvement. We are committed to greater financial stability to ensure we drive enhanced shareholder value. And finally, we remain committed to our philosophy of shared leadership, ensuring that our high performance teams around the world share the same values and vision and are working collectively toward our success.

As we look to the fourth quarter, based upon the information known to us today, we expect customers to remain cautious and products to continue to be readily available. We expect to see fewer scheduled orders and more booked shipped business. We expect our North American and European components business combined to be essentially flat with the third quarter. In Asia, sales should show a slight increase over the third quarter and in our computer products business, we expect to see the traditional seasonal strength in the fourth quarter. With that said, we believe that sales in the fourth quarter will be between 2.75 and $2.85 billion, an increase of 10% to 14% over last year's fourth quarter. And we expect earnings per share on a diluted basis, excluding charges, to be in the range of 48 to 53 cents per share, an increase of 48% to 71% from last year. We had a solid quarter. We continue to operate well. But the market remains cautious. As we move into the fourth quarter, we are committed to driving and expanding the breadth and depth of our relationships with our suppliers and customers. We will continue to raise the bar on operational excellence and look for ways to improve our processes and provide value-added services to both our customers and suppliers. All of these activities support our relentless focus on delivering a premium investment return to our shareholders.

Thank you, Bill. Matt, why don't we open up the call to questions now?

Thank you. The floor is now open for questions. If you would like to ask a question, please press "*" followed by "1" on the telephone keypad at this time. If at any point your question has been answered, you may remove yourself from the queue, by pressing the "#" key. We do ask you that while you pose your question, please pickup your handset to ensure the best possible sound quality. Once again if you do have a question, that is "*" followed by "1" on your touch tone phone at this time. Our first question is coming from Steven Fox with Merrill Lynch.

Hi, good morning. First question, regarding HP, can you quantify the amount of sales dollars that was driven in from the new HP model in the quarter, so we could sort of look at that further?

Yes, Steve, it's Paul. It's tough to get an exact number. But I would say, that if you use somewhere between 35 and $40 million, that would be a good guess estimate at this point in time.

Great. And then similar question for the European acquisition, how much should that contribute in the quarter?

Yes, we had that business for two months. So we had about a $25 million impact on sales because of the acquisition of Disway.

And D&A coming down this quarter, why was that? And what should we be looking for in a quarterly run rate the next couple of quarters?

Yes, I think, D&A – the depreciation and amortization dipped down this quarter. In fact, we had some software and PCs that were coming off depreciation. I think it will bounce back up in the next quarter, probably around the 13.5 to $14 million number as we replace some of that.

Okay. And then one final question, if I might -- just Bill, on the bigger picture with the components business, it looks like there is some pressure on the profitability side. I guess, is it fair to say you expect that to continue into Q4? How would you describe profitability potential, I guess, for the rest of the year?

Well, I think, you can almost argue it in both directions. What we saw was that clearly during the third quarter, lead times came back. No meaningful shortages. And as a result, our customers became a bit cautious. And as they felt the product was readily available. And that put some pressure on pricing. Offsetting that is what we have seen is that among most of our suppliers, there was some inventory that was built in the third quarter. And you can look across virtually all of our key suppliers and there was inventory that was built. That would tend to mitigate some of the pressures that we might see. So, we'll take it case-by-case and be very cautious going forward. But in terms overall, we're going to continue to focus on trying to maintain our margins in this very choppy market.

Thank you.

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

Thanks. Just to, I guess piggyback on that last question. The operating income was down about 17% sequentially in your components business. Revenue was only down about 2.5%. So, within that 100 basis point decline, can you give us a better feel for how much of that was perhaps geography mix or customer mix versus pricing? Because it sounded like the commentary on pricing, at least in North America and Asia, I couldn't hear Europe so well, was that it was up or down slightly depending on what the component was.

Yes Brian, that's a good question. When you think about the businesses, and we've talked about this in the past, each one has very different dynamics. Keeping in mind that we've been able to really drive strong gross profit performance in Europe on a historical basis. And in fact when you get the seasonal slow down there, it does change our mix. So, what you see is that we lose some of the higher margin sales in the third quarter there. Also had a very strong quarter in the fourth quarter, I'm sorry, in the third quarter in Asia-Pac where we saw very strong growth from there also. That changes the mix. And also we saw some sales increases in Taiwan and Korea where we've historically been weak. It's the lower technology, low margin business there. So, when I look at it, the vast majority of the change in our performance from a profitability standpoint has really been driven by a change in the mix of our sales. And we'll see a change in that as we go forward as the mix goes back to more normal levels.

Thanks, Paul, that's helpful. So should we assume implicit in your guidance for Q4, which I think assumes operating margins will be up in the range of 10 to 20 basis points, should we assume that that entire increase is going to come out of the seasonally strong computer products business and that you'll see further operating margin declines in your components business?

No. Look, we're trying to manage the business no matter where we are in the cycle, whether it's a pause, whether we’re up, whether we're down or sideways for that matter. So, we are continually driving to improve the business, whether it's components or computer products. So, we expect to see a very strong performance in the computer products business. They've done it for 13 consecutive quarters year-on-year. Our expectations are for improved performance also around the world in the components business.

Okay and then just one last question on the computer products business for Mike. You've obviously, had very strong growth for the last several quarters. On a year-over-year basis your growth is well ahead of your major OEM partners. And I'm just wondering if you could just help us think about how much of that relative performance is due to your vendors really shifting more of their business into the channel versus maybe how much share you're gaining from other competitors.

I think there's a couple of parts to that. The first part, as you know, Hewlett Packard and Sun have both commented that they are moving business into the channel. We do believe that we are gaining share in both of those lines, on top of what's coming into the channel. Also our growth is driven by software storage and services, which we have said for the last eight or so quarters that that was going to be a strong area of focus for us. And we do expect to see continued growth in all three of those areas. But do expect to outpace the market in every area we're in.

Well, just on the HP because the growth was so dramatic and they've had some well-publicized issues with some of their systems and they've talked about shifting some of their business into the channel that they were not able to fulfill. So is any of your HP growth that you've seen over the last couple of quarters a function of that or is it completely independent of that? And along those lines, if that is an issue, where are they in the process of getting that fixed?

Okay, I think you are talking about their SAP conversion problems.

Correct.

I think there's more to it than that. As you know, they have a new group in place. John Thompson, who is now heading US Enterprise Sales, Jack Novia, who came over from the services piece. They were just at a meeting with us, but they have a renewed commitment and plan where they are actually working with the field better than I have seen in years. They are supporting the resellers at a pace that I do expect the channel to continue to grow, despite the fact of the SAP initiatives that you're talking about. They will get that fixed. I don't believe it's a blip. I believe that the sales will continue to grow at this point for the channel in HP.

Okay. Thank you.

Thank you. Our next question is coming from Stephen Savas with Goldman Sachs.

Thanks, good morning. Or I guess good afternoon. I guess first, Bill, last quarter I think you had indicated that most of your inventory increase you had, kind of, selectively bought some inventory on speculation given ASP trends that evolved over the last quarter. I was wondering if that ended up helping or hurting you during the quarter?

It helped us. We were actually able to make some selected inventory buys and that helped us in the areas in which we made them. So, we're pleased that we did that.

Okay. And then while the headline figure is here roughly flat for inventory for this quarter, did you continue to selectively buy in certain places?

The bulk of the inventory that we added this quarter, the huge majority of it was from the Disway acquisition.

Okay. Did you already say on the call how much that added in terms of inventory?

No, we didn't say that, Steve, but it added about $27 million to our June 30 inventory balance.

Okay. And then do you have any concerns given that most of the semi suppliers have been very clear that they are trying to flush out some inventory that is sitting in the distribution channels? Any expectation for what 4Q might have in store for you on that basis?

That's another good question. We look at this as an opportunity. We are going to be selective of where we invest. But, we've talked about over the last several quarters that the supply chain is much more sophisticated now and with a reasonable end demand from our customers, you know, our expectation is that we will be selective in investing where we want to invest and in other places we'll look to manage it a little bit more tighter.

Okay, great and just a last quick question for you, Paul, on diluted shares out, it dropped a bit. Was that because of the convert?

It was because of the convert, yes. And then your know when you do the common stock equivalent calculation for stock options it moves around based upon our stock price.

Okay. Great. Thank you very much.

Thank you. Our next question is coming from Matt Sheerin with Thomas Weisel Partners.

Yes, thank you. Let's talk about pricing. You talk about pricing pressure on the components business. Would you expect pricing to continue to decline, given the inventory out there and given some capacity coming online? And have you baked that into your guidance for the fourth quarter?

Matt, I'm going to ask Jan Salsgiver, who heads up our global marketing, to answer that one for you.

Jan.

Hi, Matt. As you did hear from all of our regional leaders, prices were relatively stable. But there were some ups and downs. Prices for the high-tech differentiated products, like high performance analog, programmables, embedded processors and connectors, held firm. And we see those high-tech differentiated product trends continuing while commodity prices are the ones that were under a lot more pressure. And we also see that continuing. And have built that into the plans that we've shared with you. Lead times, products continue to be readily available. No real exceptions and we also expect that to continue.

And what was there the book-to-bill for the electronics business in September?

Yes, Matt, around the world our book-to-bill was marginally below one-to-one. We are not necessarily troubled by that, in light of the fact -- so that's for the quarter, by the way. And we are not, particularly troubled by that because products are readily available and customers don't need to be giving us scheduled orders at this point in time. So we saw a slight uptick in our book ship business this quarter also. So it didn't surprise us by any means that we saw it as being slightly below the one level.

Okay. And then when you said that you, Paul, expected components to improve, are you talking about your revenue should be up sequentially or is it on the operating margin line?

Yes, that the question I thought was driven towards our operating income performance in components. And that's what I was specifically addressing. When we look at what we think is going to happen, as Bill mentioned in his remarks, we think Asia-Pac in components will be up and we think combined Europe and North America will be relatively flat with the third quarter.

OK. So net, net flattish?

We will be up a little bit.

OK. Thanks very much.

Thank you. Our next question is coming from Bernie Mahon with Morgan Stanley.

Hi good morning, follow-up on the inventory question, it seems like even if you exclude the inventory that Disway added, inventory was probably still flattish, but it seems like you had a cautious outlook pretty much through the quarter. I'm just wondering why you didn't bring inventory down a little bit on the component side. Was that kind of a surprise? Or had you planned to do that?

Bernie, it's Bill. No, we had actually planned that. Remember, inventory is our lifeblood. This is what we do and so we managed this very carefully. And I think we -- as Jan mentioned, I think ours and many others, the tools for managing that have gotten some more sophisticated. So what we try to do is manage that inventory and match that with what we see going forward. And we in fact have done that. That's what we've tried to do. So we are obviously trying to manage that carefully, but we are okay where we are.

Bernie just as a point of reference also, you will see our inventory turns are up about 10% compared to the third quarter of last year. So we have been talking about making progress in that particular area. We have been doing that each and every quarter. So we are looking at it as real positive that we made a 10% improvement on performance year-over-year.

OK. And then I guess just kind of building on that, when you look through the December quarter, would you expect to bring them down or are you kind of satisfied at this level of days? Or how do you think of inventory in terms of the next few months?

Well, that's hard for us to predict. And we are not looking forward -- we don't have a whole lot of visibility, given where the market is today, into 2005 and the early parts of it. So we will manage that carefully during the quarter and we will see where we come out. I think you do know that we do have, as part of our overall performance improvement we do want to focus on our working capital. We are always looking at ways to make that better. We've shown improvement in those measures over the last year and we will continue to hope to make those improvements as we go forward in the face of -- at a pretty cautious market right now.

OK. Thanks a lot.

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

Good afternoon, guys. It looks like the next quarter might be the first in awhile where you don't have any restructuring or one-time items. Is that a correct statement at this point?

Pat, as we do have some more costs that will come out in the way of restructuring charges. It's a small amount. It's, you know, $1 million or $2 million at this point in time. You know, the accounting rules changed about a year and a half to two years ago where at one point in time you used to be able to take the big charge at once. Now the accounting rules have changed and you have got to take it over time. So we might have 1 to $2 million in charges right now. Also do not forget we have been opportunistic in the buy back of bonds. So if the pricing is right and it's a good return for us, we may continue to do some of that also.

OK. But just as I look at you now, you are looking kind of flat for the fourth quarter, sales earnings flattish. Are you relatively comfortable with the way the cost structure stands right now? And I know you've never done taking costs out. But or as -- and I guess what -- where do we go in terms of earnings? Is it just going to be more sales driving, you know, continued leverage? Or at what point do you maybe get a little bit more aggressive on costs if sales don't continue to improve next year?

That's a good question, Pat. We're looking at on a sequential basis EPS being up in a range that we’ve disclosed anywhere from 4% to 15%. So, we feel good about where we're going. You heard us talk about our continuous process improvement, a philosophy that we are building into the company. We are pushing forward on that. We are making progress there. You know, that's really a lot of blocking and tackling. And we have initiatives underway in each part of our business, whether it's geographically or by function, to really try to drive for best in class performance around expense structure. We look at it each and every day; we are driving hard. And by the way when we look at the expense structure, we don't just look at operating expenses, we look at interest expense and our tax expense also. If you see we've driven down interest expense nicely and we have driven down our tax rate nicely also. And we are not stopping in those areas. So we look at all parts of the P&L. We are driving hard there. Like you know visibility is limited. We got to keep looking at manage the business the best way possible. As things develop during the quarter and we have more insight into what is going to happen in the future, we may adjust how we are operating at that point in time.

OK. And one final question on -- I guess this is more of a question for Mike Long. In the computer business you talk about driving growth, in services software and storage. At least two of those I would imagine have a much different margin profile than hardware. Is that something that could begin to materially impact the operating margin in your computer products business going forward?

Well, I think it's a balance. And at this point, I would say -- the pending mix is not expected to change much. Right now going forward. As you know, software is less than services. They are growing in the same range. So there is a balance that we're seeing and until we hit the top end of the market, which is quite a ways away, I think we're going to be fine.

OK. Great. Thanks.

Thank you. Our next question is coming from Carter Shoop with Deutsche Bank.

Hi, guys. A couple of questions on pricing. I was a little bit disappointed with profitability levels in the Americas and European components business. I was wondering if we can get a little bit more clarity in regards to the operating income drop there. How much of that was from fixed cost utilization versus pricing declines in the commodity goods.

I'll ask Brian McNally to comment on the North American.

Hi, Carter. We saw --- as we mentioned in the pricing -- we saw some pricing movement in the commodities that we mentioned. We also had a 4% decline in revenue, quarter on quarter. The combined impact of those two had the impact on our overall profitability with the strong operational efficiencies driving the 74% improvement from quarter three. So we really feel like we've got the business positioned in much better shape for what has turned out to be a fairly choppy market.

So, you would say it's roughly even then between fixed cost absorption and pricing pressure?

Yes, Carter, it's Paul. I would say that's about right. It's interesting to note that when you look at operating income, as a percentage in our North American components business, there actually was a 50% improvement year-on-year. So that's, we've talked about trying to push our business forward, no matter where we are in the cycle. And in fact, that's the highest quarterly performance for any third quarter, since 2000. And in fact, when we looked at Europe, we see almost a 25% improvement year-over-year in operating income. So you're right, what we saw is some slippage compared to the last quarter. But part of that is driven by the seasonality in Europe. And it’s really not that unusual compared to prior quarters.

I'm just trying to understand the outlook for kind of flat operating margin in the European and American components business, when that seasonality reverses on kind of flat revenue. I guess I'd expect that to bounce back a little bit.

Maybe I wasn't clear enough, Carter, I apologize.

That's alright.

When I talk about what we expect in Q4 for the Americas and for Europe in the components world, we are expecting the sales to be flattish with Q3. Our expectation is that operating income will be up.

OK. Sorry about that. And then if we look at the inventory you guys have on hand right now, and it sounds like you have a little bit more price risk with commodity goods versus more proprietary goods. When you look at your inventory, how would you break that out on the component side? How much of that is commodity versus proprietary -- where you guys don't have as much price risk.

Once again, it's interesting. Recall that ,contractually, we have protection from the suppliers. So that as prices move, we are really protected against having to sell product at a lower price or less GP, trying to make up for the fact that we have been holding it or purchased it at a higher price. Such less of an issue for us as we move forward, as far as, impacting our gross profit percent.

OK. I thought we were talking about the ASP drops though in 3Q and hurting profitability because actually ASPs were up, but as commodity prices went down, it sounds like that was hurting overall profitability.

Again, this is Bill. It may or it may not. Declining prices on the part of suppliers may in fact help us, as we may be able to generate more margin in the marketplace. And again, you have to look across a lot of segments and a lot of our regions. So it's not just a simple answer, that says if prices are under pressure, that our margins necessarily go down or we get less profitable.

OK.

We do manage that very, very carefully.

OK. Great. Maybe one last question on the outlook in '05 in regards to pricing for commodity goods. Do you guys have a stance on that right now?

We really don't. You know, the market -- we can explain what we are seeing in the marketplace, as a pause. Many of the metrics that we look at, book-to-bill ratios, book ship ratios, cancellations all of those kinds of things in fact are running in pretty normal levels. Lead times have come down. We would have expected to see what we did see in things like book-to-bills because of lead times coming down. So we certainly can view this as a market that has gotten more cautious, and it has. It can also be explained by being a normal part of the cycle. Having said that, our visibility has come down, from where we were a couple of quarters ago. And as a result, we don't have a great deal of visibility in terms of what the market is going to look like for 2005. We do see the same forecast as all the rest of you see. For example, for semiconductors, we've seen forecasts ranging from 5% down to 28% up. So you can sort of pick it. And that's what we will continue to monitor carefully.

OK. Great. Just with a follow-up there. Like hypothetically, if you guys get to the point where you look at '05 and you get concerned about inventory levels at the semiconductor companies and the capacity coming online for the semiconductor companies and you get concerned about pricing, would we expect to see inventory come down at Arrow as a result of that or would you be comfortable with existing levels?

Again it depends. We might or we might not. It would depend on what we are seeing in the end markets. Demands we're seeing from our customers. The mix of products, a whole series of factors that don't lend themselves particularly well, to a one size fits all. And so we'll monitor it very carefully. Clearly, as Paul said, we do have -- built in some very nice protections against price movements and large inventory movements. Most of our suppliers are, don't get credit for their sales until we sell it. So it doesn't do them any good particularly, to put it out to us. So we manage that carefully. And again, I don't want to give the impression of anything other than, we will continue to manage our business and manage our business carefully and closely going forward. And inventory is a very key portion of that.

Great. Thanks a lot, guys.

Thank you. Our next question is coming from Shawn Conner (ph) or with Aragon Global.

I was wondering if you could maybe give us a little bit of guidance on the gross margin line. It was down a little bit this quarter. Do you expect it to stay at this level or start to increase a little bit?

We were down year-over-year principally because of the impact of the HP business, where we went from an agency basis to a true distribution model. That was the majority of the decrease year-over-year. The marketplace is very competitive. And it depends on where the sales come from. As I mentioned, also faster sales growth in Asia-Pac, we talked about our model is built around lower GP, but lower cost to serve and lower asset requirements, lower tax rate which gives us a higher return. If we go to Europe, if it grows faster there, we will see a margin increase because of a mix issue. So, we have to see each business we are managing differently, to recognize the unique nature of the business and even the businesses are different. When we manage our computer products business, which has a different GP structure, different expense structure and a much lower investment in working capital, which is gives us very high return. So, we are managing each one individually to drive for the best success that we can have.

Thank you. Our next question is coming from Mark Edelstone with Morgan Stanley.

Good afternoon. I, certainly, understand the comments you're making about inventories. But, if we listen to what we are hearing from some of the bigger distribution oriented semi-conductor companies like TI, ST, National, Fairchild, and so on, they are describing their inventories and distribution as being a couple of weeks higher than they would like them to be, mostly referring to that being an Asian based phenomenon. So I wonder if you could give us a view as to what you think is going on out there in the marketplace as a whole, maybe outside of your own business? Do you see your competitors out there, especially in Asia, with inventories that still need to be brought down meaningfully?

Mark, it's Bill. We don't have a particularly good view by supplier of what exists at our competitors. We certainly like to try to think about that, and to manage accordingly. We certainly have not heard any of that from our own suppliers in terms of any particular concerns that they have evidenced to us, in terms of, we're holding too much of a particular inventories in Asia. As Harriet described, the inventory or the situation in Asia is very, very dynamic. And the business models are quite different, depending on where you are in Asia. What we saw was a July and August that was reasonably slow in China, came back in September. And end market demand seems quite reasonable in the area. And we are trying to maintain our inventory levels to meet the level of demand that we see. In terms of what the others are seeing, that's not something that we really have much in sight into.

Thank you very much.

Thank you. Our next question is coming from James Parchman (ph) with Banca Antessa (ph).

Good afternoon, gentlemen. Can you hear me? Looking at your net debt balance and it looks like your total debt, including short-term maturities, decreased by about 4 million quarter over quarter, but the net debt balance decreased by that 20 million. I'm just wondering, with respect to comments, in your earlier answer regarding to opportunistic buy backs, what the split between debt buy-backs and shareholder actions might be?

Yes, most of our -- not most, all of our efforts have been focused on being opportunistic in the debt marketplace. That's where we focused all of our attention. You know, we took the opportunity back earlier in the year to strengthen our equity base by doing an equity raise. So there are no near term plans for us to do any type of equity buyback. We are constantly reviewing our capital structure at each and every board meeting, looking for guidance and counsel from our board. And they have been very helpful and supportive of the actions we've taken, so far. So we're going to stay probably focused on that with our board and continue to be opportunistic in the debt marketplace.

Thank you. Our next question is coming from Gary Nackenson with Variant Research.

Yes, hi. That's Variant Research. I don't know Arrow that well. So this is a -- I'm just wondering, you are flat in revenues in the North American distribution and yet your revenues were down 4% sequentially overall. Could you kind of go into how those things differ generally?

Yes. I think, if you were looking at our overall segment information that's included on the earnings release, which is all geographically -- will be geographically driven. We have seasonality that impacts our business in Europe more than anywhere else. There is the extended summer holiday period in southern Europe, France, Spain, Portugal, and Italy. We also have extended holiday periods in the rest of Europe. And as a result, there's just less shipping activity during the months of July and August. So it's not unusual for us to see a decline in revenues compared to the second quarter. It's just less shipping days.

And the second question would be, what sequential revenue would you normally see in North American distribution given -- assuming your guidance is correct?

So I guess, are you asking the question, what would we expect to see as a seasonal uptick in the fourth quarter in North America?

No. What would the sequential revenue be in North America, if you did the 3 or 4%, if I'm not mistaken, topline revenue growth in Q4?

Well, we've got to be careful about it if we’re combining the computer products business and the components business. They are both very, very different. In fact, the components business, we do have fewer shipping days in the fourth quarter. Number one. The other thing is, it depends where we are in the cycle. So if there's a dramatic up cycle, it would be growing dramatically. If there's a dramatic down cycle, it could be slipping dramatically. So it really depends on the dynamics that we are faced with there. In the computer products business, the fourth quarter is traditionally a strong quarter, it's seasonally driven by people trying to spend all of their approved capital expenditures before they get into a new budgeting year. It's a very strong quarter, as one of our suppliers looks to finish their year strongly. And it depends on where we're also around refresh on IT spending. You know, we saw -- you go back to late '90s, a tremendous boom in spending in the fourth quarter around Y-2K. And it wasn't fourth quarter of 1999, we show it in 1998. And a lot of that equipment is-- first off used much longer. It's used to be only three years, now it's used for five years. And it depends on when people made the investments and there's a refresh around that also.

Let me try to ask the question one more way. When you did your forecast for Q4 that led to your guidance, what sequential revenue growth did you expect for component distribution?

Well, again, what we said was that we expected it to be essentially flat in North America and Europe combined, to be slightly up in our components in Asia and to have a seasonal uptick that we would expect in our computer products business. And that was what we factored in and used to develop our guidance to you.

OK. Thanks. That's great. Thank you.

Great.

And your next question is coming from Rob Harris with Credit Suisse First Boston.

Yes, good afternoon, gentlemen. So I just want to pursue the point of the gentleman just asked before, going back to your comment about what would you maybe -- what would you maybe normally expect in terms of a slight sequential uptick fourth quarter in North America, European components? And would you normally I mean, I know you've mentioned a couple less shipping days. But nonetheless, is flat sequentially Q4 and Q3 a reasonably weakish steer?

Hey, Robert. This is Bill again. And again, I'm sorry for if we're not being clear. What -- again we're seeing is that virtually everything that we're seeing is tracking within normal ranges and within normal variability. In terms of book-to-bills, orders and shipments, backlogs, cancellation rates, book ships, all of the things that we track on a normal basis, we don't see anything that's outside of our normal range. What we have seen is that lead times have come down. And that typically would in fact cause our customer set to say I'm going to wait and buy. And the way we see that as our book ship ratio goes up. So in terms of what we would expect, that's always a range of things depending on where we are in the business. And as we have said, what we are seeing is within normal variances that we would see.

OK. Can I ask just one more question? And what was your sequential growth in North America, European components, Q4 '03, on Q3 '03 and what is your sequentially flat guidance for this year (indiscernible) in terms of your year-on-year run rate?

Well, again, you've got to be careful, that was different parts of the cycle. That's when the cycle was just beginning to take off in both North America and Europe. And so I don't have the numbers in front of me right now. Paul is – (multiple speakers).

Yes, usually, what we see is anywhere from 7 to 10%, depending upon where we are in the cycle, above. So if you recall, at this point in time last year...

Is that sequential or year-over-year?

I'm sorry, that was sequentially.

Right.

And if you recall, at this time last year, we were two to three quarters into the up cycle in North America. And we were just beginning an up cycle in the European marketplace. You have got to also factor in where we are in the cycle and on a broad business conditions.

Well, I'm still unclear, where you think we are in the cycle?

We're basically where we think it's a normal cycle. Cycles tend to last anywhere from 18 to 36 months. And what we've tried to say is that we think we are at a normal part of a cycle. The cycle started turning up in North America in the third quarter of 2003. It started turning up in Europe in the first quarter of 2004. It's been up for quite some time in Asia. We don't see the cyclicality in the components business. And we think we are probably at a normal part of the cycle right now. And we see nothing out of the normal range right now. So the cycle has been going on for a while in North America. It's been going on not quite so long in Europe. But we think we're at normal parts of it.

Thank you very much.

Thank you. Our next question is coming Alan Mitrani with Copper Beech Capital.

Hi. Thank you very much. I'm not sure if this was asked before, but your depreciation was down sequentially from call it 17 to 13, it looks it added a couple of pennies. Is there something extraordinary this quarter or somewhere should we be modeling now 13 million in D&A. Can you talk us through that a little bit?

Yes, sure. Remodeling going-forward is 13.5 to $14 million.

Okay.

In fact, we had some equipment principally around technology that depreciation ended during the quarter. And we are adding new IT type items into the fourth quarter. So, that will kick the depreciation number back up.

Okay. And then secondly, I'm sure this has been asked. It sounds like it has been asked a zillion different ways. I am going to try it differently. I track, as do everybody else tracks, a number of passive component companies and semi companies. Most of the guidance out of them has been less than stellar, even if the stocks perform differently. From an ASP perspective, both from a volume and ASP perspective, you guys seem to be guiding to a little bit better than that in your fourth-quarter guidance. What gives you the confidence that you are going to out perform some of your end-markets?

Well, again, in terms of the way we try to manage the business, we look across a broad variety of end-markets and look to our customer demands that we see coming in to us. It's the rollup of all of those that leads us to our guidance. And we think based on the business that we see and the market conditions across those end market segments and across all of the regions of the world, that in fact this is a reasonable forecast for us. In addition, we continue to perform much better than market in our computer products business. It's the fourth quarter is historically a very strong quarter for the computer products business and we expect that to continue. That's what we are projecting for you.

Okay. Thank you.

Matt, I think we have time for one more question.

Thank you. Our final question is coming from Tom Dinges with JP Morgan.

Hi, guys. This is Jason Grewsky (ph) for Tom. Three quick questions. Inventory this quarter was up slightly, even backing out this way. I was wondering if you had a sense of where the inventory growth might have been?

Yes, you asked all three -- you want to have me answer them as you go along?

Okay. So, there's inventory then expectation on share count for the next quarter and then if you could talk briefly about ASPs in the computer business.

So the rest of the inventory build was principally in the North American computer products business. Mike, do you want to give us a comment on what you saw in the inventory build there?

Yes. What we saw was minimal inventory build. However, by certain product type. For example, X series type products, net servers. That product is growing at a faster rate. So, we saw inventory go up there. Some storage inventory increase. And obviously some increases in our Sun business because of the continued growth we are seeing in that area. As far as computer product ASPs go, we have seen consistent pricing in servers. Storage products have continued to remain competitive as well as software products. And service products have remained stable. Does that help you with what you were looking for?

Yes, I think that's fair enough.

Yes, basically what Mike and his business is doing is profiling inventory for their traditionally strong fourth quarter. And we'd expect to see the same very strong inventory turns that they posted for the last 12 or 13 quarters. So, they are just getting ready for a strong fourth quarter. On the share count issue, it's obviously dependent upon what happens around our stock price and how we calculate common stock equivalents. I think you can safely assume for the fourth quarter we will have as diluted shares outstanding, I would say 125 million shares.

OK. Great. Thank you, gentlemen.

Okay. I'd like to thank everyone for taking the time to participate in our call today. If you have any questions, please feel free to contact Paul or me after the call. Thank you.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.

CONFERENCE CALL CONCLUDED