艾睿電子 (ARW) 2005 Q2 法說會逐字稿

Good morning. Welcome to the Arrow Electronics second quarter 2005 earnings conference call. At this time all participants have been placed on a listen-only mode and the floor will be open for questions following the presentation. It is now my pleasure to turn the floor over to your host, Ira Birns. Sir, you may begin.

Thank you. Good morning, everyone, and welcome to the Arrow Electronics second quarter earnings call. I am Ira Birns, Vice President and Treasurer and I will be serving as the moderator on this mornings this call. This call is also available via webcast. To access the webcast or future webcasts, please visit our Investor Relations web site at www.arrow.com/investor and click on the webcast icon.

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

By now you all should have received a copy of our earnings release. If not, you can access it on the Investor Relations section of the website is the www.arrow.com. Before we get started I would like to review Arrow's Safe Harbor statement.

Some of the comments to be made on this morning's call may include forward-looking statements including statements addressing future financial results that are subject to a number of risks and uncertainties that could cause actual results or facts to deliver materially from such statements for a variety of reasons. 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. As to reminder to members of the press you are in a listen-only mode mode on the call, but please feel free to contact us after today's call with any questions you may have. At this time I would like to introduce our President and CEO, Bill Mitchell.

Thanks, Ira. Thanks to all of you for taking the tame to join us this morning. In our second we delivered excellent results across all of our businesses. Our consolidated sales were $2.77 billion and net income was $65.4 million excluding certain charges. We posted our 10th consecutive quarter of year-over-year sales growth. Overall our view is that the market appears to have strengthened.

Our components business experienced sequential increases in daily run rates in North America and Asia, and our European business experienced normal seasonality. As we have talked about in our past calls, we have been focusing on operating excellence and our efficiency initiatives are continuing to pay off with our North American components business achieving its lowest level of operating expenses as a percentage of sales in four years as well as achieving its highest return on working capital in five years.

Performance in Asia continued to improve with China rebounding nicely from the first quarter while operating income advanced in Europe in a seasonally weak quarter. Our computer products business again performed exceptionally well as we leverage our operating structure to continue to grow earnings faster than sales.

On the next slide I would like to review some second quarter highlights with you. Sales came in at the higher end of our guidance at $2.77 billion, while diluted earnings per share exceeded the high end of our range at $0.54 per share excluding certain charges. We continue to grow profits at a faster pace than sales. Despite modest sales growth operating income increased by 11% sequentially, again, excluding certain charges.

We reduced the amount of working capital required to support a dollar of sales to another record level with no negative impact on our superior levels of service. As a matter of fact, we were named the 2005 Most Preferred Distributor in North America by our customers in the Electronics Supply and Manufacturing Annual Distributor Preference study. And the most preferred distributor in 5 of 8 categories in their survey in China.

We also continued to receive a substantial number of outstanding performance awards from our suppliers. We generated $63 million of cash flow from operations bringing our year-to-date cash flow to $216 million which exceeds the amount of cash we generated for the full year in 2004. We again reduced our debt position, driving it to our lowest level in 8 years. And for the 6th consecutive quarter we generated a return on invested capital in excess of our cost of capital.

So in summary, we had a solid quarter and continue to post stronger financial results than our competitors. Paul will now give you a more detailed review of the second quarter, and then Brian, Germano, Harriet and Mike will discuss their businesses performances in greater detail.

Thanks Bill. As reflected in our earnings release there are a number of items that impact the comparability of our results with those in the trailing quarter and the second quarter of last year. I will review our results excluding these items to give you a better sense of our operating performance.

As always, the operating income we provide to you should be used as a complement to our GAAP numbers. For a complete reconciliation between our GAAP and non-GAAP results, please refer to our earnings release which can be viewed on our website.

Sales for the second quarter were $2.77 billion, up 1.5% sequentially and up 3% year-over-year. Excluding the impact of changes in foreign exchange rates sales were up 3% sequentially and excluding the impact of foreign exchange rate changes and the Disway acquisition which we closed in the third quarter of 2004, sales were flat year-over-year. Please be reminded that last year's second quarter is a difficult comparison due to the widely reported large inventory build at the customer level in that period.

Sales in our worldwide components businesses were $2.08 billion, which is essentially flat sequentially and up 2% year-over-year. Our components business in North America increased 3% sequentially with sales gains across our broad customer base it was down 2% year-over-year.

Europe declined 5% sequentially, excluding the impact of changes in foreign exchange rates, and declined 7% year-over-year excluding the impact of foreign exchange rate changes and the Disway acquisition. The sequential decline is consistent with normal seasonal patterns seen in prior years.

Component sales in Asia-Pac advanced 7% sequentially, and up 12% year-over-year to record sales levels. Each of our businesses in Asia-Pac posted improvements in sales with fundamentals in China seeing improvement as well. Operating income as a percentage of sales in our worldwide components businesses is 5.1% which was up 50 basis points from last quarter and down 80 basis points from last year.

Worldwide computer products had record sales of $691 million, up 9% both sequentially and year-over-year. Operating income as a percentage of sales was 5.9%, which was up 30 basis points from last quarter, and up 90 basis points from last year as we continue to exhibit both good expense control and the ability to leverage our cost structure to handle increased levels of sales.

While pricing remains competitive our consolidated gross profit margin of 15.9% was flat with the first quarter. Each of our components businesses posted improvements in gross profit margins in their core customer base. Our gross profit margin was down 90 basis points year-over-year due to both increased competitive pricing pressure principally seen in the last half of 2004, and the change in mix.

Operating expenses as a percentage of sales were 11.5%, down 30 basis points from the first quarter, and down 60 basis points from last year. That represents a year-over-year decrease of $18 million or more than 5% when you exclude Disway and the impact of changes in foreign exchange rates. This was our 10th consecutive quarter of year-over-year declines in operating expenses as a percentage of sales.

Year-to-date we have achieved $16 million of the $50 million of annual cost savings we announced in the first quarter. We are on track to achieve the additional $24 million during the balance of this year and will achieve the full goal of $50 million in 2006. Operating income was $123.6 million, an increase of 11% sequentially, demonstrating our continued success in leveraging sales while focusing on cost containment.

Operating income was down 2% from last year's second quarter. Operating income as a percentage of sales was up 40 basis points in the first quarter and down 20 basis points from last year.

Our effective tax rate for the quarter was% 34.3% impacted by the very strong performance in both of our North American businesses. As you are probably aware our combined U.S. federal and state tax rates are the highest of any region we operate in. For modelling purposes you should assume that our tax rate for the remainder of 2005 should approximate 34%.

Net income was $65.4 million, that is up 12% from the first quarter and down 5% from last year. Earnings per share excluding certain charges were $0.56 and $0.54 on a basic and diluted basis respectively, compared to earnings per share of $0.50 and $0.49 on a basic and diluted basis respectively in the first quarter, and $0.67 and $0.57 on a basic and diluted basis respectively in last year's second quarter.

Our strong operating performance in terms of operating income, earnings per share, return on invested capital, continues to outpace the competition. Improved working capital management in each of our businesses contributed to our 6th consecutive quarter which our return on invested capital exceeded our cost to capital. And we reduced the amount of working capital required to support a dollar of sales to another record level at $0.18.3.

Year-to-date we have generated $216 million of cash flow from operations compared to a use of $160 million of cash in the first 6 months of last year. We have already generated more cash in the first half of 2005 than we did in all of 2004. We expect to be cash positive for the remainder of the year.

We continue to make significant progress in strengthening our balance sheet. Net debt to capital was down to 26%. That's an improvement of 34% over last year with net debt at its lower left in 8 years. In addition, we now maintain over $1.1 billion in available liquidity under our banking facility and asset securitization program after recently increasing the size of our bank facility and extending its term through 2010.

Each of our business units will now discuss their results for the second quarter. First, Brian McNally will discuss our North American Components business.

Thanks, Paul. We delivered a solid quarter with the sales in the North American components group up 3% sequentially to $965 million. And down 2% from last year's extremely strong second quarter. Our gross profit margin was flat with last quarter, and operating income increased by 7% over the first quarter yet decreased by 5% from last year's second quarter.

Our efficiency initiative has continued to pay off and when combined with our ability to lever our cost structure to support incremental sales, operating expenses decreased to their lowest level in four years. Streamlining our operation and managing our working capital more efficiently while maintaining service levels resulted in our highest returns on working capital in five years. Our focus on managing our balance sheet more efficiently once again, resulted in positive cash flow generation during the second quarter.

While we are focused on making continued improvement in working capital management, please be reminded that we remain committed to having the appropriate level of inventory available for our customers at all times.

In May, we were again named the 2005 Most Preferred Distributor in the Electronic Supply and Manufacturing Annual Distributor Preference survey. We ranked number one in both semiconductors and PEMCO products, as well as number one by total customer preference and total customer spend. This is evidence that our intense focus on customer satisfaction has differentiated Arrow in the North American marketplace.

We also received a significant number of outstanding performance awards from our suppliers throughout the quarter. Our continued focus on driving increased market share, without sacrificing profitability, was successful this quarter as we increased profitability and see strong signs of increased market share.

Pricing was generally stable and there have been no significant changes to lead times or customer order patterns over the past quarter. Our book-to-bill ratio remained positive for the quarter and cancellation rates were low. This quarter we surveyed a cross section of our customer base. The majority of our customers continue to feel that their inventory is at an appropriate level.

Thanks, Brian. We would like to turn to Europe now. We've had a little bit of a technical difficulty and Germano Fanelli, who was going to join us from Europe, will not be able to do so and so I will fill in for Germano and give the European overview.

While market conditions in Europe remain challenging our intense focus on driving our business, combined with benefits from our efficiency initiatives, led to the improved profitability in the second quarter. Sales in the second quarter were $831 million, operating income was up 5% sequentially, despite a sequential decline of 5% in sales in local currencies. The sales decline we saw was consistent with normal seasonal trends seen in prior years.

While competitive pressures in Europe continue, the market's stable, product remains readily available, and there has been no significant movement in pricing or in lead times. We remain focused on strengthening our organization and pursuing our initiatives to profitably grow our business, target new customer segments, and expand our focus into the developing markets in eastern Europe.

We also successfully completed the integration of Disway into our Germany and Italian businesses into the second quarter resulting in further operating efficiencies and the opportunity to further grow our leadership position in these regions. These activities combined with our drive for continued operating efficiencies resulted in a 50 basis point sequential improvement in our operating margins. While we have been successful in improving efficiencies in our business, we continue to provide the highest level of service to our customers. Suppliers showed their approval by awarding us with numerous awards for outstanding performance this quarter. Our initiatives to improve working capital performance continue to pay off as we again contributed to the Company's positive cash flow for the quarter.

I would like to turn it over to Harriet Green. Harriet, welcome, glad that you're here today. Usually you are in China at some unGodly hour, and it's nice to have you here in person.

Thank you, Bill. Second quarter sales were a record $325 million, that's up 7% sequentially and up 12% from last year. Each of our businesses in the region posted sequential increases in sales. We outgrew the market in Asia and particularly China whilst improving our overall operating performance. Our intense focus on working capital management resulted in positive cash flow despite a 7% increase in sales.

Driven by our successful strategies in Asia-Pac, we have experienced year-over-year growth in most regions. Early indicators are that the market was flat to slightly up in Q2 over Q1. Arrow's 7% growth clearly outpaced the market and we believe will result in another quarter of share gain.

Additionally, our continued focus on PEMCO product has resulted in a 31% increase in PEMCO sales over last year's second quarter. In the [INAUDIBLE] region we experienced our 10th quarter of record sales. Supply chain engagements continue to grow as we add valuable customer services throughout the region.

We saw improvement in China over last quarter and expect continued improvement as the government makes progress with its macro economic policies. Although the credit restrictions we spoke about last quarter have not been removed, it is anticipated that no new credit control measures will be added. The removal of uncertainty has created a more relaxed regulatory environment. And sales in China were up 28% sequentially and were flat year-over-year.

Despite the telecom sector being severely down, this has been affected by the granting of the 3G licenses and the more successful, government supported, second test of the S-CDMA technology in China. Last week's revaluation or the Chinese Yuan should have minimal impact on our Asia-Pac business.

This quarter, our customers named Arrow China the most preferred distributor in 5 of 8 categories in Electronic Supply and Manufacturing Annual Electronic Component Distribution survey for China. We also received numerous customer awards throughout the quarter. And we continue to outperform the market with strong sequential growth and strong signs of increased market share.

We remain committed to our long-term strategy in Asia-Pac. This region will continue to play an important role in the supply chain and we expect to be the clear number one in this region as we are in North America and in Europe.

Thanks, Harriet. Mike Long will now discuss computer product.

Thanks, Bill. As you know, our second quarter is seasonally strong. Sales in North American computer products were $621 million, up 12% both sequentially and year-over-year. Our operating income was up 16% sequentially and up 30% from last year's second quarter as we continue to lever our cost structure and drive for continued operating efficiencies.

With this quarter's performance we have now achieved 16 consecutive quarters of year-over-year operating income growth. Our strong performance was driven by continued impressive execution on our two tier business model in our enterprise computing group.

Sales in our enterprise computing group were up 18% sequentially, and 23% from last year, in a market that continues to have an underlying growth rate in the mid single digits. Our growth in servers, storage and services continues to outpace the market and we are pleased with our continued strength and performance over the last year.

Sales in our OEM computing group were up 1% sequentially and draws down 12% year-over-year due in part to a termination of a large engagement which we described last quarter.

In conclusion, we had another very strong quarter posting our 16th consecutive quarterly year-over-year increase in operating income. Excellent execution in our business model of selling total solutions to our customers has enabled us to once again grow faster than the market and gain market share while prudently focusing on cost control. By continuing to expand the products and services we offer and capitalize on market opportunities, we expect to continue to outperform the market going forward.

Thanks, Mike. And congratulations to all of our business leaders for a great quarter. Let me reflect a little bit on the quarter in which I believe we preformed well.

Our worldwide components business operating performance continued to outpace the competition and our initiatives to better manage working capital resulted in strong cash flow performance.

In North America we increased returns on working capital to the highest level in five years and we reduced operating expenses as a percentage of sales to the lowest level in four years. North American computer products business, once again, delivered strong increases in sales, operating income and operating income as a percentage of sales, as a result of their better market penetration, their product expansions and their cost containment.

One of our key goals is to grow our profits faster than sales and despite modest sales growth our operating income increased by 11% sequentially, again, excluding certain charges. We reduced the amount of working capital required to support a dollar of sales to another record level with no negative impact on our superior levels of services.

All of our businesses were cash positive and the first two quarters of this year we generated more cash than all of 2004, further strengthening our balance sheet and reducing net debt to its lowest level in 8 years. And for the 6th consecutive quarter we had a return on invested capital in excess of our cost of capital.

I'll repeat again, that we were named the 2005 Most Preferred Distributor in North America by our customers in the Electronic Supply and Manufacturing Annual Distribution Preference survey. And we were named the Most Preferred Distributor in 5 of 8 categories in their survey in China. And we also continue to receive substantial amounts of awards for outstanding performance from both customers and suppliers around the world.

We continue to outperform the competition in all regions and are very proud of our performance this quarter and I really want to thank all of the entire team at Arrow for their hard work this quarter and as we look forward to continued successes in the future. Let's look forward into the third quarter.

Looking into that quarter, while we expect normal seasonality, the market is stable, inventory seems to be under control. Component customer buying patterns also remain stable and our book to bill remains positive. Lead times continue to hold steady and product remains readily available. This quarter when we surveyed a cross-section of our customer base, the majority of those customers continue to feel that their inventory is at an appropriate level.

Based on the information known to us today, we expect normal seasonality in the third quarter. With that said, we believe that sales in the third quarter will be between $2.65 and $2.75 billion. And we expect earnings per share on a diluted basis, excluding any charges, to be in the range of $0.49 to $0.53 per share.

I would like to once again reaffirm that we are committed to our strategic frame work of executing on our growth strategies to ensure we continue to outgrow the market, focusing on operational excellence where we continue to look for new ways to improve our processes and drive higher levels of customer service. And the financial stability we will remain focused on improving our management of working capital in growing profits faster than sales.

And with special emphasis on our shared leadership throughout the Company, which ties all of these together as the means of execution across all of our businesses. These activities support our continued focus on delivering a premium investment return to out shareholders.

Thanks, Bill. Let's open up the call to questions at this time.

Thank you. The floor is now open for questions. If you do have a question, please press star one on your touchtone phone. If at any point your question is answered you may remove yourself from the queue by pressing the pound key. Questions will be taken in the order they're received. We do ask that while you pose your question that you pick up your handset to provide optimum sound quality.

Please hold while we poll for questions.

Thank you, our first question is coming from Brian Alexander with Raymond James. Please go ahead.

Thank you. Just if you could just comment a little bit more on your revenue guidance for the September quarter if I just look at the mid point sequentially you are expecting revenue to be down about 2.5%. Last year you were down less than that and that was during a period where inventory was being worked down throughout the supply chain, so maybe if you could give us a little more color by segment.

Sounds like based on your comments about seasonality we would expect the components business to be at least flat sequentially which could imply the computer business is down close to 10% so if you could help us understand that a little better.

Brian, thanks for the question. We have a couple of pieces moving around both in computer and in the components business.

First, when we talk about computer products it is not unusual to see during the third quarter a decline in sales of anywhere from 5-10% based on historical basis. As you know, the third quarter in our computer business is probably the one that has the softest market conditions. We would expect to see normal seasonality there also.

In the components business, as you heard from Harriet, we do have full expectation that the markets will continue to be robust for us -- the markets we serve in Asia-Pac, but we also expect normal seasonality in Europe and that means that there will be a bit of a dropoff in sales there.

We also know quite honestly that September is the month in the components business that drives the entire quarter because we do get seasonality even in North America components where the plants go through the normal shutdowns of a week to two weeks as they do repair and maintenance work and it is more efficient to have all the employees out as opposed to piecemeal as they take summer vacation.

We think we will see normal seasonality and we are looking forward to see what happens in the month of September.

Great. Just a couple of follow-ups. You talked about within your components business profitability being up sequentially, I believe in both North America and in Europe despite the sales decline but I didn't hear any commentary about profitability in Asia. Can you give us an update on whether you were able to grow profit sequentially in Asia and where that stands?

Yes, Brian. We did grow profit sequentially in Asia-Pac also.

Any order of magnitude?

We normally don't quantify yet, what our earnings levels are. As we talked about in a period of investment in Asia-Pac, and we are quite proud of the fact that we are profitable as we're investing in that very important region going forward.

Great. Last question for Mike. You may have heard the other day, HP talk about their restructuring and they commented about doubling down on loyal partners and I wanted to get a sense for your interpretation of that message and maybe give us sense of where HP is in that shift of enterprise customers into the channel. Thanks.

As you know, Brian, they started this program late last year. We have seen the shift within our business. We expect to continue to see them segment between the channel and what they will call on both from a cost perspective and from a total value perspective that they will offer the -- the customer base. We have seen their management team come back to us and re-emphasize their strategy is correct at this point in time, and expect to continue the relationship in a big way with HP.

Thanks.

Our next question is coming from Matt Sheerin with Thomas Weisel Partners. Please go ahead.

Just a question on the inventories which were down. Lot of your suppliers are talking about distribution and replenishing stocks, so I was a little surprised that it was down. What is your approach to inventories now that lead times are still pretty short and there is no -- doesn't look like customers are building much backlog here. Do you expect to keep them lean or see opportunities to build a little buffer here?

Matt, as you know, inventory is our life blood and so we monitor very, very carefully the amount of inventory we have and that is really aimed at making certain that we provide the needed service levels to our customers and so we will always monitor that.

We think we have the right amount, our service levels have been good. We will continue to focus on making certain that we manage all of our working capital well and we are focused on that but we never take our eye off the ball in the -- in what the key metric is which is service levels to our customers. Paul, would you like to --

One other point of reference Matt, and it is tough to see when you look at the financials, but I think we were down round numbers $52 million on a sequential basis in inventory. About 30 million of that decrease was tied to changing foreign exchange rates. So, in fact, if you were to exclude that you are talking about a very small percentage change as we tweak our inventories to be sure that we meet the right demands of our customers as we move forward.

Great. And then the question on the components business, a two-part question. One if you could talk about strength and weaknesses in any product or in customer areas. And two, are you starting to see some opportunities based on the Memec-Avnet merger, and are there some market share opportunities, are you seeing any yet?

Matt, it's Bill. Let me take the second part of your question first about the Avnet Memec merger. As we reported last quarter we have seen that as an opportunity and we've been on the offensive knocking on doors.

Given the uncertainty in the market, we found customers to be open to looking at other sources and since the suppliers and customers and employees have only recently found out where they fit in the post merger Avnet Memec combination, we expect more opportunities to open up next quarter.

Jan, you might want to take the second piece of that.

Sure. Hi, Matt. As you heard from Brian, Germano -- actually, Bill and Harriet -- the lead times continue to be relatively stable across all the product sets. We see most products in the 6 to 10 week range and don't see anything on the horizon that changes that dramatically.

There continues to be a lot more discipline in the total supply chain as customers are keeping their inventories in line and suppliers are managing their backlog very closely. As for pricing, that, too, continues to be stable. Across the technologies ASPs were up or down in the low single digit for both PEMCO, which is our passive electrical mechanical and connector products, as well as for semiconductors. No specific technology products really stood out in terms of pricing changes.

Well, Jan, that is a bit of a change from last quarter when you talked about some pricing pressure so I'm trying to figure out why things are more stable now --

-- are more stable? It is funny, we have been talking consistently about competitive positioning and that prices have been under pressure. But I think what you will always see, is that as we do a better job introducing our suppliers' technology, you always find that quarter-on-quarter new technologies with higher ASPs help keep the ASPs overall on a stable basis.

Um-h'm.

And then if you look at it across technologies on the growth front, we experienced growth across our very broad customer base, as well as across the very broad technology in just about every one of our technology segments in both PEMCO and semi showed growth on a sequential basis.

Thank you.

Thank you. The next question is coming from Jason Gursky with J.P. Morgan. Please go ahead.

Good morning, everyone. Given current demand trends in the component business can you walk us around the globe and perhaps compare and contrast near-term opportunities in the PEMCO and semiconductor components?

Let me take a start at that, why don't we just walk around the boat, Brian. Why don't you start with North America.

What we saw in quarter two, when we look at it from a customer perspective, is we saw some strength in the broad contract manufacturing space, and strength in the middle aerospace while the North American transportation market was the weakest. Harriet, do you want to comment on Asia?

Yes, I think the broad customer base was strong and what we have also experienced in Asia is that customers requiring broader support, so across the range of semiconductors and across the range of PEMCO. So both in the sectors that are strong on the products that they are asking for we are seeing a broadening which, of course, is positive for us to serve.

Okay. It sounds like PEMCO is strengthening in Asia. Brian, what are the trends in North America?

Yes, we continue to see broad based customer expansion in North America which is very good for our PEMCO business. As you know, that is a very large product set and serves many, many areas. And we're number one in that marketplace in North America and are driving to be the clear number one and while the share numbers aren't in, we're looking for some good share growth this quarter there as well.

Jason, it's Bill. In terms of PEMCO, that's been one of our real initiatives for some period of time now. And we're showing some real progress around the world. It is a very positive trend for us and we continue to focus on it and we are having good success in that area.

I might just fill in a bit for Germano in Europe to give you the other piece of the puzzle on what we see in the markets. In Europe the automotive, medical, general industrial, and consumer electronics, which, for us means set-top boxes, performed the best and telecom was a little weak. So we see some differing trends around the world as we would expect.

One of the things that has always struck me about Arrow is, this breadth of markets that we serve all around the world, breadth of market, breadth of customers, broadline cart is a real advantage that we have in being able to provide what our customers need in whichever segment and whichever region of the world.

And would you characterize this initiative in PEMCO has having gained some momentum in the recent quarter two, and the outlook for it. And maybe just to give us a sense of perhaps what your quarter-over-quarter and year-over-year growth rates were for PEMCO, if you've got that kind of detail.

We really don't. That is not something that we disclose. We have had strong growth in PEMCO for quite some period of time. This has been an initiative that we launched some time ago and we do see it gaining some steam. We see very nice opportunities for us throughout the world and it is one that we'll continue to stay focused on.

Thank you, guys.

Thank you. Our next question is coming from Steven Fox with Merrill Lynch. Please go ahead.

Hi, good morning. A couple of questions. First of all, I think Harriet said that you are not expecting or expecting a minimum impact from the new currency policy in China. I assume that is a short-term discussion. Can you sort of support why you think that is going to be the case? And then looking longer term if you can continue to see revaluation of the Chinese Yuan, what affect could it have on your business. That's my first question.

Yes, of course, Steven. Last week's revaluation of the China Yuan we think should have minimal impact. Why? By adhering to our policy of hedging balance sheet exposures, we minimize the impact of any change in China's currency policy, on any booked balance sheet exposures. And note that since last Thursday the Yuan has remained pretty stable, pretty close to the 8.1 level per dollar. The longer term implications may be playing out as we speak, but right now that is how we see the situation.

How much business in China is done in dollars versus local currencies?

Still, for us, the vast majority of our business is done in U.S. dollars, but giving customers the choice to buy in whatever currency suits them is part of our major initiative.

Thanks. And then just looking out to the December quarter. I know you guys don't want to provide guidance, but given typical seasonality in the summer quarter, is there anything you are seeing that would not have typical seasonal ramps as you get into September and beyond?

Steve, you're right, we don't like to talk about two quarters out because visibility is basically the same and has been for the past year or so to tough for us to call what is going to happen in the fourth quarter at this time.

Fair enough, thanks.

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

Good morning. A couple of questions in regards to the Avnet Memec deal. First off, does your guidance imply any share gains in the September quarter from the combined Avnet Memec company?

Carter, our guidance implies what we think is going to happen for your business going forward. We are not going to, at this point in time, get into detailed discussions around what we think is going to happen either in the market itself or from any of our competition. But the opportunity is there and we are looking forward, as Bill mentioned today, and we talked the last time, on really driving hard to ensure that we get as much as we can.

Okay. Great. As a follow-up there, the combined company along with world peace have become kind of the two dominant players on a revenue basis in Asia. How do you guys feel about being a kind of distant third in regards to overall revenue in Asia and have you guys started to look at acquisitions increasingly so over the past couple of quarters and how is the overall outlook for acquisitions in Asia right now? Are you seeing a handful of accretive acquisitions out there or are they viewed more as kind of strategic acquisitions?

As we talked about in the past, we no longer believe that being acquisitive is a requirement to guaranteed success of Arrow. In fact, we are very much focused on operating the Company at the highest levels. We've also said we'll always be opportunistic if there is opportunities out there in the acquisition world that fit our strategic and financial opportunities.

With that said, we've been pretty clear that being a clear number one is not just based upon size, but, in fact, based upon a combination of size, capabilities, serving the customer base and the suppliers as we want to service them, and delivering premium investment results. So, we're pretty excited about our opportunities in Asia-Pac. We remain committed to our strategy and we look forward to continuing to grow very healthy there.

Harriet, we might want to hear from you just for a follow-up comment on that.

Yes. I think,as Paul said, Carter, Asia continues to be highly competitive and even though the pace of acquisitions is quickening, as Paul said, we're extremely well positioned with our organic growth in our investments to serve customers across the region, not just in China. So we're excited about the yields and the returns that we're making there.

Maybe just as a follow-up. I guess what I was trying to understand is now that we have seen more acquisitions amongst the indigenous Asian distributors are you starting to see a few more viable acquisition targets that are starting to look a little bit more attractive on a scale basis and on an accretion basis, or is it still a pretty tough market in regards to acquisition markets?

Carter, this is Bill. As Paul pointed out, we are always looking and we are certainly well aware of what is going on in the market and we watch it very, very carefully and if things come up that would meet our strategic, financial, and operational criteria we are certainly prepared to look at them and look at them seriously.

Great. Do I have time for one more question here?

Sure.

Sure.

Maybe for Mike on the computing division. I was wondering if you could kind of break out the overall share gains you have experienced in the computing division relative to sending up new customers? I guess I'm trying to understand how much is a shift from your existing customers into channel versus Arrow signing up more suppliers?

Most of the growth that you have seen have come from our current supplier base and an expansion of account base. So that has been the real growth. Again, we have opted, and are focusing on, getting our resellers to sell the complete solution to a customer's problem and that includes not only the server but the storage and the services that go along with that. And as we have said for many quarters, that is the tract we have been on and we believe that it the reason that we are being successful.

How does the pipeline look in regards to signing up incremental or more suppliers? Is there a lot of suppliers out there who are not using the distribution channel right now, or maybe using competitors that you see as an opportunity going forward?

I wouldn't say that this is something where we are looking for quantity, really you know, in our case we are looking for quality because when we bring a line on we have to train some 5, 6,000 resellers to be able to sell that particular line and right now we're very happy with the supplier base we have. We put a lot of effort into training our resellers to sell the total solution today, and that is really the essence of what we are attempting to to do.

Great. Thanks a lot, that helps.

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

Good morning. A quick question on gross margins. I was kind of surprised they stayed flat on a sequential basis, kind of given the mix shift to computers as well as I thought there was kind of a competitive pricing environment. Could you just talk about little bit about how you managed to maintain those gross margins?

Sure, Bernie. Much like we said in the last quarter, the market is very competitive, pricing and we continue to see competitive pricing pressure there. With that said, price is not the main way by with which we compete.

Our capabilities and our services around supply chain management and valuated programs are critical aspects for us as we move forward with customers. As long as we can demonstrate for customers that we are creating value for them.

The same thing is true around demand creation from a supplier point of view. We believe being number one in design wins is a critical asset to not only securing top line growth but securing the best GP possible. So those are the factors we look at that really help us strive for a strong GP.

Is it safe to assume that gross profits in the components business increased sequentially?

Yes, Bernie, I'm sorry, I think I may have gone through too quickly. In fact, in our core customer base we did see an improvement in gross profit percent.

Thanks a lot.

Thank you. Our next question is coming from Michael Walker with First Boston. Please go ahead.

Thanks. I know that the December quarter is still two quarters away and you are seeing some negative seasonality in the September quarter, but I'm wondering if you could put your macro hat on. Just based on the fact that inventories seem to be pretty lean in the supply chain, and as a result lead times are pretty short and prices low. Is there any reason to believe that maybe with some better seasonality in Q4 that we could actually see an improving lead time in pricing environment going into the end of the year?

Michael, first off, I wish we could look that far into the future. Conditions really haven't changed, and we are prepared to operate the Company no matter what the conditions are to maximize profitability and cash flow and returns for our shareholders.

I think one of the things that is important for us is that on a macro basis if there is an opportunity for the economy or our industry to improve, we'll benefit very strongly from that as we demonstrated in the past that we can lever our cost structure to deliver strong operating income performance on relatively modest incremental increases in sales whether that is more units sold or pricing increasing. So we feel good where we are right now and we are prepared to really as the fourth quarter proves to be stronger to participate in that marketplace.

Right. And again, in terms of the overall macros that we have seen, what we did say was that we believe the market strengthened a bit this quarter, not hugely, but strengthened. We did see strengthening in North America. We saw strengthening in Asia and particularly in China. And Europe remains a bit soft. And so that is the world that we are living in right now and as Paul says, we will be prepared, we would be delighted if it turned up on it, that would be great and we're prepared for it, but we will give you the best knowledge tha t we have with the facts that we have at hand today.

Then the second question is on the computer business specifically. I think you are operating above the rim, as it were, from the perspective of your target margins I think you talked about 5.5 to 5.7 as being a target operating margin and you are at 5.9 right now. Is it realistic to assume that over the next several quarters you could start to see margins go well above 6 on the computer side?

One thing that we have to stay focused on is the fact that even in our computer products business we are very much focused on expense control as well as leveraging our cost structure to handle incremental sales. So, in fact, as sales go up we are able to drive a stronger operating income performance.

But, you know, Q2 is a historical very strong quarter, and Q3 is a weaker quarter. So, in fact, when we look at the averages throughout the year we think we can deliver what we said in our business model discussion over the full year. We are looking at a bit of a snapshot for a quarter and would expect to see changes in our operating income performance based upon the level of sales.

Okay, thanks.

Thank you our next question is from Kevin Sarsany with Foresight Research. Please go ahead.

Thank you. Good morning. I have a question on the component product mix. It sounds like PEMCO has become, you know, kind of a strategy of growing that business. Could you talk about the profit profile for the PEMCO versus the semiconductor and do you have a target mix? It looks like 2004 you ended up with about 30% of component revenue from PEMCO.

This is Jan, Kevin. If I look at, first of all, you're absolutely right, we believe that the PEMCO growth is good profitable growth for Arrow and part of the reason that we are focused on it is that we believe that that will help improve our overall profitability.

We do have PEMCO targeted to continue to increase as a percentage of our component sales because we believe that there is even more room for growth on the PEMCO side as customers and suppliers view the value added services in the investments that we are making in PEMCO as meeting their needs. So you will see us continue to try and outgrow the market in semiconductors but at the same time try to grow PEMCO even faster.

And Kevin, this is Bill. Just a quick follow-up to that. Sort of a rule of thumb that is useful, is that in a typical electronics circuit about 70% of its value is semiconductors and 30% is PEMCO and changes by product and changes a bit by region. And so our overall strategy is to make sure we get all of the products in the bill of materials. And as we look at it, we have some additional room to go on the PEMCO side and so that is a place where we push and we think that is a very exciting area for us and we are having some success at it.

Can I do a follow-up here?

Sure.

I was wondering if you could comment on the RoHS initiative in regard to where you think customers are, suppliers and how you see it potentially helping our hurting your business in regards to timing of designing in different components and so forth, I'd appreciate it.

Kevin, it's Jan, again. Thanks for a question on RoHS. It happens to be an area where we are working very hard to be a leader in helping our customers address the RoHS issue. For those of you who don't know, it's the restriction on hazardous substances, and started as a directive by European colleagues, who said by mid-next year all products manufactured should be free of hazardous substances.

It's interesting, since it started in Europe the European customer base was the most accelerated in their requirements and it was the most visible there. What we are seeing is it is kind of moving around the world. More regions are creating their own legislation and directives, although nothing in cast in concrete, yet. And the way we view our value proposition is in several fronts.

The first is on the information side. It's a constantly changing landscape and our goal is to help our customers interpret what's going on around the regions and stay in front of what that legislation will finally turn out to be.

Second is on the information about part specific. And our suppliers we're getting information across our suppliers and we are the one place our customers can come to get a broad range of information.

And third, it's helping our customers transition their own supply chain to a RoHS compliant one. In all three areas we are feeling quite well invested, prepared to help our customers do that.

And one of the things that we look at, we think this is a good opportunity for us. This is a very complex set of regulations, it is extremely complex if you are looking at it from the point of view of a customer that has to look back at hundreds of potential suppliers and try to figure out what each one of them is doing.

We can come in and with our tool sets, our advanced data information, and the kinds of investments that we are making in this area, that we can sort out that complexity for our customers and in fact, turn this into a real opportunity for us. We are certainly doing that. We do have large investments going on around the world. We are rolling out those tool sets and those capabilities. And we view it as a strong way for us to grow our business because it allows us to sort out complexity for our customers and that is something when we do it and do it well, we get very, very long and deep relationships. This is an opportunity. We don't view as a threat at all.

And is there any type of competitive advantage that you and Avnet or the larger players have versus the not global or smaller players?

It as little hard to say. I'm going to turn this over to Jan because she is the one that's right in the middle of it. Certainly these are large complex problems and you have to spend a fair amount of investment dollars to get your hands around them to build the databases to understand what is going on, to build the tool sets, to deploy the tool sets and do the training, et cetera.

And that is where we think our global footprint, our access to large customer base is and our strong and deep line card where we have excellent relationships with all of our suppliers is an advantage for us. We do think that we bring some advantages to this. Jan, would you like to add a little more to that?

I think you really hit it, though, Bill, I think it is the vantage point that we have got of the very broad supplier base and that range of information. And in Asia, Europe, and North America we have aggressively been out there with seminars communicating to our customers to help them through the process. And so I'd say our competitive position is one where we think the tools, the systems, the information, we have our own set of tools that we've invested in which allow us -- we made a decision that our own tools are going to allow us to create real value added for our customers and we are out promoting them and making sure your customers going to have a smooth transition.

Okay, thank you.

Thank you. The last question is coming from Wayne Klein (ph) with AIG. Please go ahead.

Good morning. Thanks very much for taking my call. Obviously cash generation has been strong and balance sheet improvement has been pretty impressive. Hopefully S&P will take note of that fact sooner rather than later. Just curious, Paul, whether you can tell me, the short-term borrowings of $227 million, I assume that the convert that is putable in February?

Yes, that's correct. In fact, it is principally all of that amount is the convert and as you mentioned it is putable to us in February of 2006.

Okay. Thanks very much.

Okay.

Thank you. Now, I would like to turn the floor back over to Ira Birns for closing remarks. Please go ahead.

Thank you. Before I leave today's call for those participate big webcast we will quickly scroll through the slides referenced in the webcast that contain a reconciliation between GAAP and adjusted results. This reconciliation is also included in the earnings release. They can accessed at our website at www.arrow.com/investor. I would like to thank all of you for taking the time to participate in our call this morning. If you have any questions about the information presented today, please feel free to contact Paul, myself or our Investor Relations department. Thank you and have a nice day.

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