艾睿電子 (ARW) 2005 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Arrow Electronics third quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the call over to Mr. Ira Birns, Vice President and Treasurer of Arrow Electronics. Please go ahead, sir.

Thank you. Good morning, everyone, and welcome to the Arrow Electronics third quarter conference call. Once again, I am Ira Birns, Vice President and Treasurer, and I will be serving as the moderator on this morning's call. This call is also available via webcast. To access this webcast or future web casts, please visit our investor relations section of our website at www.arrow.com/investor, and click on the webcast icon.

With us on this morning's call are Bill Mitchell, President and Chief Executive Officer, Paul Reilly, Senior Vice President and Chief Financial Officer, Mike Long, President North America, Ed Coleman, President Arrow Enterprise Computer Solutions, Brian McNally, President North American Components, Germano Fanelli, President of Arrow EMEASE, Jan Salsgiver in the role of Executive Vice President Supplier Marketing, Harriet Green, President Arrow Asia Pacific, and Bhawnesh Mathur, Senior Vice President and Chief Supply Chain Officer.

By now, you all should have received a copy of our earnings release. If not, you can access our release on the investor relations section of our website, www.arrow.com.

Before we get started, I would like to review Arrow's Safe Harbor statement. Some of the comments we made on this morning call may include forward-looking statements, including statements addressing future financial results, that are subject to a number if risk and uncertainties that could cause actual results or facts to differ 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 a reminder to members of the press, you are on a listen-only mode on this call, but please feel free to contact us after this call with any questions you may have.

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

Thanks, Ira, and thanks to all of you as always for taking the time to join us this morning. It's actually evening where I am. I'm in China,and we have people all over the world for this call. Paul Riley will act as the quarterback for the call, and if we have a bit of trouble getting hand-off's, it's because we are stretching the limits of the telecommunication industry.

Would like to talk about some of our results -- We delivered solid results against the backdrop of seasonal weakness in the third quarter, consolidated sales were 2.71 billion, and net income was 63.8 million, as always, excluding certain charges.

We posted our eleventh consecutive quarter of year-over-year sales growth with an increase of 3.5%, and, once again, operating income grew at a faster pace than sales. Those are both strategic targets for us, and we're glad that we're hitting them.

Overall, the markets appear to be acting rationally with stability in North America, strength in Asia, and continued weakness in Europe. Our North America components business experienced its second consecutive quarter of sequential increases in daily run rates and excluding the technology bubble period the North America components business increase its return on working capital to the highest level in nine years and reduced its operating expense as a percentage of sales to its lowest level in seven years.

Asia again achieved record sales with continued strength in China; while our European business experienced normal seasonality in the face of tough market conditions. Our North America computer products business achieved it's tenth consecutive quarter of year-over-year sales increase, and efficiency initiatives are continuing to pay off, as evidenced by our seventeenth consecutive quarter of year-over-year operating income growth.

I would next like to review some of the key third quarter financial highlights with you.

Sales came in above the mid-point of our guidance at 2.71 billion, while diluted earnings per share was at the higher end of our range at $0.52, excluding certain charges. We continue to grow profits at a faster pace than sales, and we gained market share in each one of our businesses.

Operating income increased by 12% over last year's third quarter, again, excluding certain charges on a less than 4% year-over-year increase in sales. We reduced the amount of working capital required to support a dollar sales to a third quarter record low.

Cash flow generation remains strong, with 80 millions of cash flow from operations generated in the third quarter. Year-to-date cash flow now totals $296 million, compared to the use of $108 million during the same period last year. While all measures related to customer service that we track continue to improve, and for the seventh consecutive quarter, we generated a return on invested capital in excess of our cost of capital and increased it 15% over the same quarter a year ago.

In summary, we continue to execute well. We achieved our over-arching financial goals of growing earnings faster than sales, growing sales faster than the market, being cash positive, and generating returns on invested capital in excess of our cost of capital on a consistent basis.

This morning, we also announced the acquisition of DNS, a $375 million distributor of mid-range computer products in Central and Northern Europe, whose business model, like ours, is built on providing value-added capabilities to customers. DNS, the largest Sun distributor in Europe, will serve as the strategic platform to expand our successful enterprise computing solutions business throughout Europe. Given our broader global focus, we have renamed our computer products business, Arrow Enterprise Computing Solutions. We are very excited to be bringing our two very successful organizations together, and the acquisition, which is expected to close within six to eight weeks, should be $0.06 to $0.09 per share accretive in 2006.

Before I turn things over to Paul, I would also like to take a moment to welcome the two newest members of the Arrow team to today's call. Ed Coleman recently joined us as President of our North American Computer Products group, which I mentioned will be named Arrow Enterprise Computer Solutions going forward. Ed will be responsible for the further advancement of our enterprise computing growth strategy. As the former President and CEO of Compu-com Systems, Ed brings a wealth of experience in the computing industry to this position.

Bhawnesh Mathur joined us as Senior Vice President and Chief Supply Chain Officer, and in this newly created position, Bhawnesh will be charged with identifying current and emerging competitive trends and opportunities to insure that Arrow has the most effective set of capabilities to service our customers and suppliers. Bhawnesh Mathur joins us from Sanmina-SCI, where he held the position of Executive Vice President Global Logistics and Services, and Executive Vice President of Global Supply Chain Management prior to that.

I'm absolutely delighted to welcome these seasoned executives to our team, and lastly, but by no means least, as previously announced, Jan Salsgiver has joined Germano Fanelli's team in the new role of Executive Vice President Arrow EMEASE and will also maintain a role of Vice President of Supplier Marketing.

Now going to turn it over to Paul to give you a more detailed review of the third quarter, and then Brian, Germano, Harriet, and Mike will discuss business 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 third 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 information we provide to you should be used as a compliment to our GAAP numbers. For 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 third quarter were $2.71 billion, down 2% sequentially, and up 3.5% year-over-year. Excluding the impact of changes in foreign exchange rates, sales were down 1% sequentially and up 3.6% over last year.

Sales in our worldwide components business were $2.08 billion, which is flat sequentially and up 4% year-over-year. Our components business in North America with one less shipping day being offset by an increase in our daily shipping rate, was flat sequentially and up 2% year-over-year. Sales to our core customer base of small to medium-sized customers, were up nearly 5% year-over-year.

Excluding the impact of foreign exchange rates, European components declined 5% sequentially, which is consistent with normal seasonal patterns seen in prior years, and declined 2% year-over-year. Component sales in Asia advanced 18% sequentially, and 28% year-over-year, to a record levels.

Worldwide operating income, as a percentage of sales, was flat with the last quarter, representing good performance in light of the traditional seasonality we experienced and increased 20 basis points over last year.

Worldwide computer products had sales of $632 million, down 8% sequentially in the seasonally week quarter, and up 1% year-over-year. Operating income as a percentage of sales was down 20 basis points from last quarter, and up 80 basis points from last year.

Our consolidated gross profit margin of 15.5% was down 40 basis points sequentially and 50 basis points year-over-year, driven principally by continued competitive pressure.

While pricing from supplies remains generally stable, we continue to leverage our cost structure to meet our over arching goals of driving for improved financial performance, regardless of the current environment.

Operating expenses as a percentage of sales were 11.1%, that's down 40 basis points from the second quarter, and down 90 basis points from last year. This represents a year-over-year decrease of $13 million, excluding the impact of foreign exchange rates.

Our continued focus on efficiency initiatives led to us achieving the eleventh consecutive quarter of year-over-year decline in operating expenses as a percentage of sales. Year-to-date, we have achieved $28.5 million of the $40 million of annual cost savings we said we would achieve in 2005, and we are tracked to achieve the -- an additional $11.5 million during the balance of this year. Looking to 2006, we will achieve our goal of $50 million of reduction in annual expenses.

Operating income was $118.5 million, an increase of 4% sequentially, principally due to the impact of the extended summer holiday period in Europe. Year-over-year operating income increased 12% on a less than 4% increase in sales, again demonstrating our success in leveraging our cost structure to grow earnings at a faster rate than sales. Operating income as a percentage of sales was down 10 basis points from the second quarter, but up 40 basis points from last year.

Our effective tax rate for the quarter remained at 34.3%, and for modeling purposes, you should assume that our tax rate for the remainder of 2005 will be approximately 34%. That income at $63.8 million was down 3% sequentially, and up 14% from last year.

Earnings per share were $0.54 cents and $0.52 an a basic and diluted basis respectively, compared to earnings per share of $0.56 and $0.54 on a basic and diluted basis respectively in the second quarter, and up over last year's $0.48 and $0.46 cents on a basic and diluted basis respectfully.

We remain our industry's clear leader in operating income, operating margins, and return on invested capital. Our relentless discipline puts managing working capital, in each of our businesses, contributed to our seventh consecutive quarter in which our return on invested capital was in excess of our cost of capital. We reduced the ratio of working capital to sales to a record third quarter low of $0.19, while continuing to improve customer service levels. This led to continued strong cash flow performance of $80 million this quarter, bringing our year-to-date cash flow from operations to $296 million, and that's compared to a use of $108 million of cash in the first nine months of last year, and we expect to remain cash positive in the fourth quarter.

Each of our business unit Presidents will now discuss their results for the third quarter.

First, Brian McNally will discuss our North American Components business.

Thanks, Paul.

North American Components performed well this quarter with strong profitability and cash flow gains on stable sales levels. While sales were flat sequentially at 964 million, sales were up 2% year-over-year, and we saw our second sequential increase in daily run rate this quarter.

Early indicators from our own internal share measures and the Semiconductor Industry Association for year-over-year sales growth in July and August indicated we outgrow the market and gained share in the quarter.

We continue to validate our ability to leverage our cost structure, thereby growing profits faster than the market. With operating income up 4% sequentially, and 22% over last year.

Excluding the tech bubble years, we drove operating expenses as a percent of sales to its lowest level in seven years, and our efforts to manage our balance sheet more efficiently, once again, resulted in positive cash flow generation during the third quarter, and our highest return on working capital in nine years.

Pricing still remains competitive at the customer level, as evidenced by the 30 basis point sequential decrease in gross profit margin this quarter.

Lead times are at the mid-point of normal level, generally eight to 12 weeks.

Book to bill ratios remain in positive territory, and our cancellation percentage is within a normal range.

Last quarter, about half of the customers are that responded to our quarterly survey, felt their inventory was at the appropriate level. For third quarter, we found that the percentage has grown even more, and feel they are well positioned heading into the December quarter.

Thanks, Brian.

Germano, could I ask you to comment on our European business?

Thank you, Bill.

As you are well aware, economic conditions in Europe remain difficult, yet we perform as expected during the seasonality's low third quarter. Sales were $772 million, down 4% sequentially, and down 3% year-over-year, excluding the impact of foreign exchange. Reflecting the strength of our broad customer base, our sales were down less than the year-over-year decline we're seeing reported by Semiconductor Industry Association in July and August.

Year-over-year, our largest percent of decline came from global OEM and CM customers. We continue to perform well in a tough marketplace, and our focus an efficiency initiatives resulted in other strongly profitable quarter.

In the third quarter, we further strengthened our business in the very important Central and Eastern European markets. This supports our overall growth strategy in Europe of driving increased sales in our very broad core, small to medium customer base. In addition, despite the tough market conditions, our initiatives to improve working capital performance resulted in another quarter of positive cash flow, and solid working capital performance.

Thanks, Germano.

And Harriet, can you give us the round-up on Asia?

Yes, indeed. Thank you, Bill.

Sale for the third quarter once again reached record levels at $385 million, up 18% sequentially, and up 28% from last year. We continue to outgrow the market while improving our operating performance, and the majority of our businesses in the region posted sequential increases in sales, with growth for our China business exceeding 20% for the second quarter in a row.

We have also experienced year-over-year growth in most regions. Early market indicators show that Arrow Asia Pacific's 28% year-over-year growth clearly outpace the market, and that we achieved strong share gains for the quarter.

Our in the passive electro-mechanical and connector segment continue to strengthen as we added resources also across the region and remain focused on this exciting opportunity. We also won several major supply chain engagements this quarter, as our broad line card, local product warehouses, superior supply chain services, and global relationships continue to give us the competitive edge that enables us to provide unmatched support to our customers and our suppliers in the region.

We are also particularly proud that in addition to customer and supplier recognition, engineers ranked us the number one distributor in China in the electronic distribution news worldwide semiconductor and integrated circuits brand study, which was released in August.

In summary, our sales growth continues to outperform the market. Our profitability has improved, and we remain focused on further improving profitability levels.

We continue to invest for the future and are excited about the progress that we've made on our journey to be the clear number one in the Asia-Pac region.

Thanks, Harriet. Great quarter.

Since Ed Coleman is still in a transitional phase, having been with us for only a month, Mike Long will discussion our computer products businesses one last time, and Ed will pick up next quarter, and we'll be available to answer some questions during the Q&A session.

Mike.

Thanks, Bill.

As you were, traditionally, we experience a seasonal decline in the third quarter, as it's historically the weakest our business. While North American computer product sales of 560 were down 10% sequentially, in line with historic seasonality, we did achieve our tenth consecutive year-over-year increase in sales with growth of 3% this quarter.

Our operating income was down 14% sequentially, but up a strong 16% from last year's third quarter, as we continue to leverage our cost structure and drive for additional operating efficiencies.

With this quarter's performance, we have now achieved 17 consecutive quarters of year-over-year operating income growth.

Sales in our enterprise computing group were down 13% sequentially, from about 14% from last year, in a market that continues to have underlying growth rates in the mid-single digits.

Our growth in servers, storage, and services continue to outpace the market, driven by continued strong execution across our broad customer and product bases. We continue to perform well with ten consecutive quarters of year-over-year increases in sales, and 17 consecutive quarters of year-over-year increases in operating income.

Our team maintains focus on our strategy of selling the total solution to our customers, and expanding the products and services we offer, while carefully controlling our cost base. Going forward, we expect to continue to outperform the market and leverage our cost structure to grow operating income at a faster pace than sales.

As Bill stated, we announced the acquisition of DNS will enable us to expand our enterprise computing business beyond North America, further enhancing both our growth and profit potential.

Thanks, Mike. Let me move on to just some closing comments.

Reflecting on the quarter, I continue to believe we've performed very well. Our worldwide components business, operating performance, continue to outpace the competition. Our initiatives to better manage working capital resulted in strong cash flow performance. Excluding the technology bubble years in North America, at a market with relatively modest growth, which we increased our return on working capital to its highest level in nine years and reduced our operating expenses as a percentage of sales to its lowest level in seven years.

Our North America computer products business achieved it's tenth consecutive quarter of year-over-year sales growth, while continuing to drive for efficiencies. And once again, they delivered a strong year-over-year increase in operating margin, and achieved the 17th consecutive quarter of year-over-year operating income growth. And the DNS acquisition will serve as the platform to expand our very successful value-added enterprise computing solutions model throughout Europe.

We continue to grow profits at faster peace than sales and to grow sales faster than the market. Operating income increased by 12% over last year's 3% on less than 4% year-over-year increase in sales.

We grew market share in each one of our businesses. We reduced the amount of working capital required to support a dollar of sales to a third quarter record low.

Cashflow generation remains strong with $80 million of cashflow from operations generated in the third quarter. Year-to-date cashflow now totals 296 million, compared to a use of 108 million during the same period last year, while all measures related to customer service that we track continue to improve.

And for the seventh consecutive quarter, we generated a return on invested capital in excess of our cost of capital.

We continue to execute well. We're achieving our over arching goals of growing earnings faster than sales, growing sales faster than the market, being cash positive in generating returns on invested capital in excess of our cost of capital, and I really want to thank the entire team at Arrow for their very hard work this quarter, as we look forward to continued successes in the future.

As we look into the fourth quarter, the components markets continue to be stable. What we are seeing and hearing, that lead times are stretching, they are still within what would be considered normal levels at eight to 12 weeks.

Our book to bill remains positive; cancellation are also within the normal range. Component bookings remain steady during the quarter, and product is readily available.

This quarter, when we surveyed a cross-section of our customer base, we found that the percentage of our customers who felt that their inventory was at an appropriate left has grown from last quarter. The modest -- the current modest growth environment placed our strengths as we continue to leverage our cost structure to provide significant earnings growth independent of revenue gains.

Based on the information known to us today, we expect normal seasonality in the fourth quarter, and with that said, we believe that sales in the upcoming quarter will be between 2.8 and $2.9 billion. We anticipate that normal seasonality in Asia Pacific, stability in North America, and continued weakness in the European economies will result in worldwide component sales between 2.05 and $2.1 billion.

We fully expect our worldwide computer products business to experience a combination of organic growth and traditional seasonality to generate worldwide computer product sales between 750 and $800 million in the fourth quarter, and we anticipate earnings per share on a diluted basis, excluding any charges, to be in the range of $0.56 to $0.59 per share.

I said this for the last several quarters, but I want to re-emphasize that we remain committed to our strategy framework of executing on our growth strategies to ensure that we continue to outgrow the market; of operational excellence, where we will continue to focus on new ways to improve our processes and drive higher levels of customer service. A financial stability, where we remain focused on improving our management of working capital, growing profits faster than sales, and growing sales faster than the market; and a shared leadership, which ties all of these together through all of the people of Arrow as our means of execution across all of our businesses. These activities support our continued focus on delivering a premium investment return to our shareholders.

Thank you, Bill.

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

Thank you.

[OPERATOR INSTRUCTIONS]

Our first question is coming from Matt Sheerin of Thomas Weisel Partners.

Thanks. Good morning.

My first question has to do with the gross margin pressure you saw in the components business. I'm trying to figure out, is that North American only, and why are you seeing that? If demand appears to be relatively stable and customers rational, why are you seeing that pressure, and do you expect to see it continue into the fourth quarter?

Hey, Matt, it's Paul.

Good morning.

We're seeing the same type of competitive pressure around the world, so it's not in a particular region, each of the regions are seeing the competition fight hard to take market share back from us. You know that we're growing market share, and that's where it is right now.

The think that I keep in mind is we're talking about 10's, 20's, and 30's of basis points here, we're not talking about hundreds or two hundreds of base points, so it is at a relatively modest level. The other thing I focus on is the fact that we're still ability to drive up our operating income, even in a competitive environment in which [inaudible] are under pressure at this point in time.

Okay.

And do you think anything -- any of thus has to do with Avnet's acquisition Mimic, and are you seeing some more competitive pressures because of that?

Matt, let me take that one. This is Bill.

We're obviously watching that real -- very carefully, and some of it, we would like not to comment about for things I think you would understand for competitive reasons, one -- but there are a couple of things we would likes to say.

First of all, if you just look at what some of the suppliers are saying, and then get a flavor from that, note what Paul has said. Avnet has put out their results, and they've made their own comments and their own -- and I'm sure you'll be asking them the same questions later today. And -- but at the end of the day, I think what we would like to ask everybody to do is look at our results, and we're very proud of them, very proud of what we've done, and we're clearly watching the Avnet-Mimic situation and the merger very, very carefully. We continue to think it provides great opportunities for us, and we're very proud of our results.

Okay. Thanks.

And just lastly, it looks like your guidance points at seasonality in computing, seasonality in the semi and component world, but you have got a pocket of IT companies out there, particularly the EMS guys, that are see some softness, talking about broad base softness from certain customers.

Do you have a little bit of overlap there? I'm just trying to figure out --are you get any sense that these weakness in any specific markets, and if so, what are they?

Paul, do you can to take that one?

Yes, let me lead off, and then I'll give -- her a chance to also respond to that.

Matt, keep in mind that we're more focused on a broader smaller -- or broader customer base that has small to medium-sized customers with not that heavy reliance on a limited number of customer that you might see in the EMS world. So, for us, we look across all of these customers, and maybe get less up and downs that you may hear about from EMS, so not really seeing anything that would be an indication of a specific customer base, that type of thing.

We feel that the larger OEM are a big customer base. We do feel that even the contract manufacturing market space is a good customer base, but we have been growing our small to medium-size customer base while, generally, you see some bits and some pieces of ups and downs in a large customer base.

Jan, do you want to add anything to that

Not much else to add, Paul.

I think that reflected it very well, and I would just comment that in addition to the broad customer base, we also, through the technologies that we participate in, continued to be as broad as possible. For example, things likes the analog space where that's got the broadest customer base possible. Those are areas where we focus on and make sure that what we are doing is enriching that customer base, so we aren't impacted by any one segment.

Okay. That's helpful.

Thanks very much.

Our next question is coming from Scott Craig of Banc of America.

Please go ahead.

Hi. Good morning.

Just a question for Harriet over in Asia -- Harriet, when you look at the vendors and the customers over there --the suppliers and the customers -- are you starting to get increased pressure for distribution consolidation over there? Your growth seems to be pretty strong. I'm just wondering how much of that is new product lines versus a push for consolidation.

Hi, Scott. It's Harriet here.

I think Asia continues to be very competitive. The dynamics that you've just described are in evidence, and the market remains still very fragmented. So that gives us plenty of opportunities to use our financial strength, our broad line card, and our value-added capabilities to outgrow the market and to gain share. So I think the dynamics of the market that we've observed continue into this quarter and going forward.

Scott, it's Bill.

Just to follow on to what Harriet has to say -- as we've talk about in the past, we continue to monitor that situation very, very carefully and very, very closely, and if the right opportunity comes up to it, we will clearly be ready to look at that and see if there's a good way to add to the strategic value of the corporation. And -- so we do watch that really carefully, and we do listen to all of our suppliers and all of our customers.

And just a quick follow-up for Paul -- Paul, when you look at the components business and sort of a flattish revenue environment sequentially, can we grow the operating profit there, or do you think that some of the cost efficiencies right now are being offset by the pricing pressures that you've talked about?

Well, it's interesting. I think we've talked about a couple of different factors. First, we need to look at each of the market around the world, so we feel that we'll see strength in Asia-Pac, and we think that we'll have relatively modest opportunities in North America, with, as we've said, very tough market conditions right now on a broad macro-economic basis in Europe.

With that said, we do believe that we can continue to push forward in making the Company be more efficient and more effective. So, I would haven't quite say that the margin pressures are offsetting any efficiency settings that we're getting because we are able to push our operate income up year-over-year with relatively modest growth.

Okay.

Thanks.

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

Yes, just a couple of questions. Just want to make sure I understand, on the gross margin pressure that you've talked about, it sounds like it's pretty broad-based, and just trying to understand a little bit better to what extent you're assuming that it continue into the fourth quarter as part of the guidance you just gave.

It is broad-based, Brian, and we do expect to see continued competitive pressure there.

What we are really focused on here, quite honestly, is not competing on price alone. We really feel that we create a tremendous amount of value, both for customers and suppliers. So we're not just looking to sell on price, we're looking to sell on value we create, the capabilities we have, the knowledge we have, technical knowledge, et cetera. So there may be some bits and pieces of pricing pressure going forward, but we feel the broad offerings we have really ought to create value for customers and suppliers and, ultimately, keep the business with us.

Great.

Paul, what was the incremental cost savings from Q2 to Q3?

You had a pretty dramatic sequential decline in SG&A despite a modest decline sequentially in revenue, so clearly some very good OpEx controls. I just want to understand the incremental savings from what you had already announced, and then, in addition to that, why the decline in depreciation sequentially? How should we think about that going forward, and did you take any other actions during the quarter that led to the OpEx decline? Right. Well, We're on track, so the incremental pick-up was round numbered to about $2 million -- 2 to $3 million. In fact, part of that did come out of us de-leveraging, if you will, our investments in PP&E.

We talked about, in this cost saving initiative, being more efficiently organized, including in our real estate. So some of the things we were able to do was we were able to consolidate what had been two buildings here in Melville, into one building, and we sold the extra space that we had off. So that helped us reduce our depreciation, amortization.

We did the same type of activities in the UK, where we consolidated two buildings. Also, we have run down some of the systems that we use, so that we're getting near to the end of their -- their depreciable lives, if you will.

So that really accounts for most of the decrease in the depreciation amortization number, Brian, and, in fact, is where we picked up some more of the cost savings that we talked about earlier in the year. So that's how we were able to accomplish it this quarter.

Generally, also, just looking at the expenses, we do have a lower volumes in Europe -- sales volumes -- so that naturally means lower commissions and incentives for the quarter. Also, because of the extended holiday period -- this is not to get into a real detailed accounting -- but we approve vacation time throughout 52 weeks of the year. When somebody takes vacation, they no longer get charged to salary expense, that goes against their vacation accruals, so that has a bit of an impact also on SG&A.

And then just -- thanks for that, Paul.

And just two questions for Mike -- I know you've been looking to expand your value-added distribution business into Europe for quite some time, just give us a sense of what has changed from a competitive landscape standpoint, or maybe, how different manufacturers are approaching the channel in European that made you decide now is the right time?

And then an add-on to that -- you didn't really talk about the OEM business this quarter. Could you just give us an update on how that performed?

Thanks.

Thanks, Brian.

First off, on the expansion, as you know, we have been looking for some time, and we have been talking to, specifically, DNS for some time. As you know, they're the largest Sun distributor, and we're very happy to be with them. The quality of that business is what caused us to make the move now, and they are -- they have a nice software business. They have a nice storage business, and they have a nice server business, as you know. Expanding with a quality company is what we've been looking to do, and that, in fact, is what we were waiting for, somebody that we could expand with and then use that as a foundation to continue to expand our business across Europe, and now was the time, because, Brian, the opportunity was there.

In terms of the OEM business, that business has performed as it has been. It was down a little bit quarter-on-quarter. As you know, we had a disengagement with a large customer that was not as profitable as we like, and that business now is seeing basically the same type of cycle business that the semiconductor business is, so hopefully that helps.

Okay.

Thanks, guys.

Thank you.

Our next question is coming from Bernie Mahon of Morgan Stanley.

Hi. Good morning.

Question on the computer side of the business -- if I look at that on a year-over-year basis, it looked like in September it grew 1% after more significant growth - the previous four to six quarters -- kind of the mid-point of the guidance for December showing 5% growth. Excluding the acquisition, is the right way to look out over the next year or two, maybe closer to mid-single digits growth there, or do you think we're going to be able to get back up to double-digit growth?

Yes, Bernie, let me answer that question for you.

We have built nothing into our guidance for the fourth quarter related to the DNS acquisition. We need to go through some normal traditional regulatory filings in Europe, and at the closing, we think we'll be four to start -- I'm sorry, six to eight weeks out, so mid-December to the end of the year -- beginning the new year - so we have nothing in our guidance around DNS.

With that said, the year-over-year growth in computer products is a bit distorted by the fact that we did, as Mike mentioned, have a relatively large engagement in the -- the OEM business that's in last year's third quarter sales, and it's zero this year. So where we looked it, we looked at our growth in the enterprise business, and that's 12%, 13%, 14%, so we feel good about that going forward.

Fourth quarter, there is also a bit of an overhang if you will, because last year's fourth quarter included some of this large customer engagement. We also don't see some of the computer products business -- the OEM business that we have in Europe -- growing at the same piece pace as our enterprise solution business. So we absolutely, in enterprise solutions, feel we'll have double-digit growth in what is a low to mid-single digit market.

Okay.

When does that disengagement end? When were the last sales there?

We had a bit of it in the first quarter, and a bit of it in the second quarter, so it's really out now completely in the third quarter.

Okay. That's helpful.

And then just on the balance sheet -- so what should we expect in terms of inventory? It sounds like some of the components and lead times are stretching, your expecting normal seasonality. The first quarter, you typically have a pretty strong quarter, just given there's more selling days. Should we expect you to build some inventory, or what do you think there?

We've talked about this a bit in the past, Bernie, and what we're trying to do is to drive overtime, an improvement in how we manage our inventory, and the way we look at it is, while inventory levels may not go up or down, the quality of our inventory may improve. We may take slower moving inventory, be take get it out of the house, and buy in or replace it with faster turning inventory. It may not change our total inventory picture, but it's fresher and has a higher quality.

So as we look into the fourth quarter, we're going to continue to manage all of the levers in working capital, whether it's payables, receivables, or inventory. We'll do that, but we are trying to drive a better process around inventory, specifically by moving slower moving inventory up to faster moving.

Okay. That's great.

Thanks.

Thank you.

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

Please go ahead.

Hi. Good morning.

A couple of things -- first of all, when you look at the commentary revolving around gross margins, it sounds like you're changing your thinking of gross margin trends over a longer period of time. Does that adjust then how you're going to manage your SG&A, excluding, hopefully, charges? Do you plan on reducing SG&A, or growing it slower over the next few quarters?

Thanks.

Thanks, Steven.

It's interesting. The way we really -- we really look a those as two different issues, quite honestly.

Let me first address the expense issue. We've had 11 quarters now -- consecutive quarters -- where we've had year-over-year declines in operating expenses as a percentage of sales. That, we feel, is a combination of three factors. We have restructured the business to be more efficient. We've talked a bit about this continuous process improvement initiative that we're trying to build throughout the Company, and we'll have many more of those people trained by the end of the year, and that will result in how we do business in a more efficient and effective way. And we've been able to drive sales up without having to add on a lot more costs. We think that's really a combination of those three factors, or how we'll manage expenses, and we'll try to not to look at what's happening from a cyclical point of view, whether the top line is growing dramatically or more rationally, and we'll manage it separately from the GP pressure we're on.

It's interesting, we have built different models, and we've talked also a bit about this. You look at Asian Pac, where even computer business, where we expect gross profit margins to be lower, we have built business models that have lower SG&A requirements.

We're really focused around expenses. When I look at GP, it's really up to us to be able to demonstrate the value we create for customers and suppliers, and the things that I take as encouragement is that you don't see dramatic margin pressure. You don't see hundreds of basis point offers decline. While we're definitely focused on gross profit initiative, and ensuring that we get paid for the value we create, we're not really concerned about a dramatic decline going forward.

Okay. Thanks for your explanation.

And then just secondarily, on the components business, your customers are typically more tied to the industry economy, and you mentioned that their inventories are in pretty good shape. Are they also still fencing a fairly good economic outlook? Have you talked to them about what they're thinking in terms of their own businesses going forward?

Brian, I'll let you to take that one.

Sure, Steven.

We did, if fact, do that. So what they've told us about the inventory levels -- remember last year, about half of the customers that we surveyed -- we survey a little bit more than a couple hundred -- said the inventory was at the appropriate level to drive their business in Q4.

For this quarter, when we surveyed them, actually more of them felt that their inventory was in line, and we also saw increased optimism on the outlook -- slightly increased optimism on the outlook -- as well, compared to the prior survey.

Thank you.

Thank you.

Our next question is coming from Carter Shoop of Deutsche Banc.

Please go ahead.

Good morning.

A couple of questions here -- first off, on Europe, could we talk about what you guys are seeing in the end of the third quarter and beginning of the fourth quarter? Do we see September set back as usual, or did it not set back as expected, and what is your outlooks, roughly, for Europe in 4Q, and I was hoping to get a little bit more color there by market or type of customer?

Hi, Carter. Good morning.

What we saw was normal seasonality throughout the whole quarter. So really, Europe performed the way we expected it it to perform as we moved throughout the quarter, so no real unusual pattern, if you will, compared to prior year's third quarters at this point in time.

And, I think Germano mentioned the fact that year-over-year, where we've seen sales pressure, if you will, is in the contract manufacturing and the large OEM business, where, in our core customer base, the small to medium-sized customers, we've seen we're in relatively stable conditions there. So when we look to the fourth quarter, we pretty much expect more of the same.

Okay. Great.

And then maybe on the cost savings going forward -- how many -- what kind of opportunities do we have on a go-forward basis, maybe over the next couple of years in regards to reducing duplicate facilities, warehouses, corporate functions, et cetera? Is there a lot of opportunity left within the Company, or are you running it pretty lean operating efficiency right now?

I'm going to answer that, and then I'm going to ask Bill to join in on it. I'll give you my view on it.

I think this continuous process improvement philosophy we're building throughout the Company will really give us an opportunity to be more efficient and more effective. That may not necessarily result in to lower expenses, as we may choose to reinvest those cost savings, if you will, in growing the business and being more aggressive in in the marketplace. So it's that's one thing is I look at.

I think, if you want to get into details, Germano is driving an initiative that will take several years around a one Europe philosophy, and that could result -- it's too early in the process, quite honestly -- in a change in our logistics footprint, for example, or a change in our IT strategy there. We look at this as how we're going to have overtime improvement in how we manage the business, and there will be different business models for different types of customers for different regions of the world.

So I think we have opportunities to drive forward to be be more efficient and more effectively organized.

But, Bill, I'll ask you to answer -- give your input on that also.

Paul, I completely agree with you that we are very much committed to the continuous process improvement, and that, as we we've discussed, it doesn't come in large lumps. I thinks that, by and large, is behind us.

What we are going to see is continuing opportunities to lower our cost structure, get more efficient, as Paul says, we may choose to reinvest that, but that's going to going to be reinvested where we see real opportunities to grow the business for the future, and we've already shown that when we can grow the top line, we'll grow the bottom line faster than we grow the top line.

And we're going to continue on with it, we see no lack of opportunities to continuously improve, and we are very much focused on it. We're going to continue to -- continue to do that.

Great. That's really helpful, particularly on the European part there.

Last question here on Asia -- could we talk briefly about the profitability in that region, and also talk about inventory? Do we build inventory in the third quarter in Asia, or are we expecting to build it in the fourth quarter?

Well, we certainly remain very committed to our long-term plan, which we've talked about on previous calls. It was initiated about a year and a half ago, and our plan is based on organic growth, enhanced by, as Bill mentioned earlier, appropriate or opportunistic acquisitions that make sense for us both financially and strategically.

And we're on track with that, and with our goals, as we said in the prepared remarks, we remain committed to increasing profitability, and we expect to see higher returns in the second half of 2006, and into 2007.

In terms of inventory, I done think any change in Q3. I think the channels and the inventory levels through customer bases remain the same, as we've reported, and as we move into the seasonal Q4, the ramp in Q4, clearly those inventory levels are in position to support that.

And, Carter, this is Bill.

Just a follow-up to that -- as we announced at our analysts' conference back in May, our model in Asia continues to be one that is a low cost model. One in which we recognize lower gross margins, a lower operating expense, slightly lower operating margins, higher asset velocity, leading to a return on working capital that's equivalent, a lower tax rate than we see in other parts of the world, and a bottom line that's equivalent to what we see from our -- from our other components businesses around the world.

We are marching toward that. We had a good quarter in terms of sales growth. We're making progress on the profitability front. We're not there yet, but we're continuing to make good progress there, and we couldn't be more pleased with the way it's going. When we're growing 28% year-over-year, which is significantly in excess of the market, we're doing a lot of things right in Asia right now. We're pleased at how this is shaping up for us.

Great. Thanks a lot.

This is a follow-up comment to Bill. Just a reminder to the people on the call, a week from tomorrow, we'll be hosting an investor event in Asia-Pac from our Hong Kong operations with Bill and Harriet and the Asia-Pac team, and some of the executive committee from the Arrow team with some suppliers and customers there, and we'll be having a webcast, so that if you can't make the actual meeting, you can definitely look at the webcast and get some more details about our business in Asia Pac.

Great.

Thank you.

Thank you.

Our next question is coming from Michael Walker of First Boston.

Hey, guys. It's Will Stein for Mike.

Just a couple of questions on inventory -- the component segment was flat and overall sales were just down slightly, but inventories are still up. Can you just clarify whether that intended to support demand going forward, or if there's something else going on there?

Yes. It's interesting, Will, our overall inventory turns were flat sequentially at 6.6, but it is interesting, as we look forward into the quarter, we do expect a little bit of a surge on some parts of our business, so we would have added a few dollars of inventory, but nothing dramatic.

I thank Harriet talk about -- a bit about profiling a little bit more inventory, nothing dramatic in her region, to be able to ensure that we can support the Q4 sales, but let's not lose sight of the fact that while lead times are expanding a bit, they're moving from the low end of normal to the mid-range of normal, so no real issues there.

Just one quick follow-up -- can you comment on any positive impact from the Avnet-Mimic acquisition? We know that we've seen some of their principals sign on additional distributors, and I'm just wondering if you guys have seen any disruption that's benefiting you in any way?

Will, it's Bill.

As I said, we follow it really closely, and we think it still represents a great opportunity for us. One of the things that we probably won't do is comment on any of the specifics of it. I'll refer you to the supplier announcements, refer you to Avnet's announcement. They are obviously calling it the the way they see it, and point to our results, which shows we're growing market share. So that's how we see it, and we're very proud of how we've performed in this area.

Thanks, guys.

Thank you.

Our next question is coming from Thomas Dinge of J.P. Morgan.

Hello, everyone, this is Jason Gursky, stepping in for Tom.

I would like to direct my first question to Mike.

I was wondering if you could comment a bit on the competitive landscape here in the States for the computer business and pricing trends that you're seeing at this point, and whether there have been any new entrants into the market recently?

Sure.

The business has been progressing as we had expected. The forecast that came in for the market from you guys were in the 7% range of growth year-over-year. We've seen good steady improvement in the market, as evidenced by the result.

We have not seen any change the competitive nature of that business. It still tends to be be a competitive business, and the top suppliers in that business have moved to a more solution oriented approach. So there's not any major disruption at this point in time that we've seen that hasn't been expected, and it's, quite candidly, for the last several quarters, been business as usual.

Okay. great.

And then just moving to the components business, I know that you've been increasingly been putting emphasis on [PEMCO] products. I was wondering if you could just comment a little bit whether that growth is primarily coming from Asia or if it's in other regions, and then, just talk a little about gross margin and pricing pressure for these products relative to semiconductor products.

Hi, Jason, it's Jan Salsgiver. I'll take that one.

Thank you for recognizing that we view [PEMCO] as an important part of our overall growth strategy. We include passive connectors and electro-mechanical in that area, and, yes, our Asia team has been leading the charge with growth on a percentage basis. And we have -- we are the clear leader in [PEMCO] products throughout the world for distribution.

As it relates to pricing, what we saw -- we continue to see that there's modest pressure on the passive area. What we saw in general on prices was the more commodity brand products have more pricing pressure than when you get into the differentiated products, and some of that I think is probably to Paul's point, where we can add a lot of value in both designing in, add value to our customers and suppliers, and find that there may be a little less ASP pressure.

So we did see some pricing pressure quarter-on-quarter in the [PEMCO] world, and that was really in the passive area, and a little bit on connectors, more in Asia, but they also had awfully strong growth.

Okay. Great.

And then one strategic question for Bill, and then one for Paul --

Bill, could you just make a few excellence on your acquisition strategy going forward, whether there's particular product -- components versus computer -- and maybe regionally where you think the next move, strategically, makes sense?

And then, Paul, for you -- have you have done any back-of-the-envelope calculations on what you expect for stock-based compensation expense going into 2006?

Sure, Bill, why don't you take the first question, and I'll be ready for the second one.

Sure, Jason.

Our acquisition strategy hasn't really changed. It is to be opportunistic, look where we can get a company that fits our strategy, as an operational fit, and where we think the financial fit is good. We made one about a year ago with [Visway] in Europe, and, as Germano announced, it's now been fully and successfully integrated into Europe, and is positive to us.

We made the same one with DNS, which is an important strategic move for us because it's our first strategic move for our computer products business outside the US, and we'll continue to look for those, assuming again, we can find that strategic and that financial fit. And we'll continue to look at Asia, but, again, these will be on a opportunistic basis, when we make all of the pieces come together.

Fundamentally, we want to drive the business through organic growth. We've added a whole lot of growth to the Company over the last couple of years. Organically, I think longer term, that's the right strategy for the Company, as to really be focused on organic growth as the main lever that we use to increase our profitability.

And -- but we'll obviously look at acquisitions like we did with [Visway], like we did with DNS, and we'll continue to look for those in the future.

Jason, on your question around the potential impact of the expensing of stock options -- we're still in the prosecution to of doing some work, we're still monitoring what other companies are doing around assumptions, et cetera.

You may recall that in our last year's 10-K, we talked about a range, or a potential range, that would be on an annual basis, somewhere around $0.10 to $0.12 potentially, so$0.02 to $0.03 per quarter, but more work needs to be done on that. We're not quite ready -- we're not quite there, actually, to be able to say with a lot of assurance that we've closed the gap on a final decision.

Okay. Great.

That does it for me. Thanks.

Thank you.

Our next question is coming from [Kevin Carseni] of Foresight Research Solutions.

Hey, guys.

I don't really care who answers this question, but if you could help me out on the accretion for the DNS acquisition -- my first question -- I mean my original question is why Europe, but I think I would get the same answer -- but is you could help me on where the margins are and where you -- how you expect to take on costs and get to that $0.06 to $0.09 accretion? That would be helpful.

Thanks for the question.

In fact, we don't see much in the way of cost synergies in this opportunity because this is a very different business from our own business. We feel we struck a good deal with them. We feel that they're well managed. We also feel that, quite honestly, we can help accelerate their very strong growth. If we went back and looked at their performance over the last several year, we've grown the top-line number pretty dramatically, out-paced the market place.

We feeling that that can continue, and we also feel that we can help them accelerate that because of our deep relationships with suppliers here. So, we feel that -- real good about our ability to deliver $0.06 to $0.09, minimal risk around most companies that do acquisitions because these usually a cost synergy piece to it, and there is no cost synergy as we're concerned around here at this point in time. We're driving forward with the business that they had and driving sales at a faster pace.

From a modeling point of view, they're not too different from an expense or from a GP point of view that our own products here in North America.

Okay.

And a follow-up on that -- I think last quarter you talked about design wins and trends there. Could you kind of update us on your design-win activity?

Brian, maybe I can answer that question as it relates to at least North America.

Sure. Absolutely.

Kevin, we continue to see good opportunities in the area of design win. As Jan mentioned earlier in her discussion around analog, this is a perfect product set for the small and mid-sized customers, and we see -- we see good growth there.

In addition, often times, when people talk about design wins, they don't think about the [PEMCO] products, and there are a number of opportunities to drive increased design there. So we're continuing to see good opportunities pretty much across the board in semi, in design wins, and also significant opportunity in the [PEMCO] space.

All right. Thank you. That was helpful.

Thank you.

Our final question is coming from Harry Blount of Lehman Brothers.

Please go ahead.

The question has been answered. Thanks.

Thank you.

At this time, I would like to turn the floor back over to Ira Birns for any closing remarks.

Thanks again, [Tony], and thank you, everyone, for joining us today. Before ending today's call, for those of you participating by webcast, we will quickly scroll through the slides referenced in our webcast that contain a reconciliation between GAAP and adjusted related results. This reconciliation is also included in our earnings release. Both the release and this presentation will be available on our website for the next couple of weeks.

I would like to thank all of you for taking in the time to participate in our call. If you have any questions about this information -- the information presented today -- please feel free to contact Paul, myself, or our Investor Relations department.

Thank you. Have a nice day, and we look forward to seeing many of you in Asia next week.