艾睿電子 (ARW) 2006 Q4 法說會逐字稿

Good day and welcome to Arrow Electronics conference call to discuss their fourth quarter earnings. As a reminder, this call is being recorded.

At this time, I would like to turn the call over to Mr. Ira Birns, Vice President and Treasurer, for opening remarks and introductions. Please go ahead, sir.

Thank you, Jimmy. Good morning, everyone. Welcome to the Arrow Electronics fourth quarter and year end conference call. I am Ira Birns, Arrow's Vice President and Treasurer, and I will be serving as the moderator on this morning's call. Today's call is also available via webcast. To access this webcast, or any future Arrow webcasts, visit our Investor Relations website, and click on the webcast icon.

With us on the call today are Bill Mitchell, Chairman, President, and Chief Executive Officer, Paul Reilly, Senior Vice President and Chief Financial Officer, Mike Long, President of Arrow Global Components, and Cathy Morris and Kevin Gilroy, Presidents of Arrow Enterprise Computing Solutions. By now, you should have all received a copy of our earnings release. If not, you can access the release on the Investor Relations section of our website.

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 calls 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 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 in a listen-only mode on this 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 Chairman, President, and CEO, Bill Mitchell.

Thanks Ira, and thanks to all of you for taking the time to join us this morning. We ended an exceptional year with another strong quarter, as we once again continued to post impressive results and industry leading levels of profitability. Consistent execution on our strategy enabled us to outperform and create shareholder value, independent of market conditions. We are consistently improving our operating performance, while entering new geographies and new markets, expanding our product service and solution offerings to insure we touch every region, every end market, and every technology.

In our Components business, sales increased 15% year-over-year, as each of our businesses around the world achieve year-over-year growth. Sales in Europe and Asia Pacific reached record fourth quarter levels, while strong working capital management and progress on efficiency initiatives resulted in Europe's highest fourth quarter return on working capital in five years, and a record low level of working capital for sales for the fourth quarter in Asia PAC.

In North America, our core business, through small and medium-sized customers performed well, and we reached our second highest level of profits since 2000, all on the face of the well publicized broad market weakness and the large customer base. Book-to-bill ratios remain positive worldwide with levels in the 1.0 to 1.15 range in Europe, Asia PAC, and our core small and medium-sized businesses in North America. Pricing at the supplier level remains stable. Cancellation rates remained low, and lead times are still within the normal range. The markets performed as we expected, and we gained share globally on a year-over-year basis.

Our Enterprise Computing Solutions business had a very strong quarter, with sales up 32% year-over-year, and continued leading levels of profitability driven by strong performance in every product line. Execution on our strategic initiatives has results in a much stronger organization, with broader geographic reach, stronger supplier relations, an expanded set of product, service and solution offerings, and increased market share in the fastest growing segments of the market.

On the next slide, I would like to review some key fourth quarter financial highlights with you. Our results in the fourth quarter are a bit complicated, and there are several items that impacted our results. I will review the results, excluding these items that impact comparability, and Paul will walk you through them in detail in a moment.

First of all, consolidated sales increased 18% to $3.49 billion, the highest fourth quarter level since the bubble year of 2000, and an increase of 8% pro forma for acquisitions. Earnings per share on a GAAP basis were $1.05 per share. On a comparable basis, earnings per share were $0.75, and operating income of $158.3 million also reached its highest fourth quarter level since 2000. Continued focusing on efficiency initiatives throughout our businesses, enabled year-over-year decreases in operating expenses as a percentage of sales for the 16th consecutive quarter. That is four years of success.

Our working capital sales ratio decreased 160 basis points sequentially, to 18.1% pro forma for Alternative Technology, and excluding In Technology, on which we closed on the 31st of December. This resulted in strong operating cash flow generation of $288 million in the fourth quarter. Our return on invested capital was higher than our weighted average cost of capital for the 12th consecutive quarter. That's three years in a row that we have done that.

Looking back over 2006, we had a terrific year. By pursuing our various growth initiatives in all of the markets in which we operate, we grew sales 22%, which was an increase of 11% organically. We outgrew the market, and we reached our highest sales ever, and again, we gained market share in all of our businesses. Our continued pursuit of operational excellence enabled us to grow earnings faster than sales for the fourth year in a row, with comparable diluted earnings per share of $2.95, an increase of $0.35, and the second highest level in Company history.

Our continued strong focus on carefully controlling our cost base, resulted in a decrease in our operating expenses as a percent of sales by 90 basis points on a comparable basis. And our consistent focus on efficient management of our asset base brought our return on working capital to the highest level since 2000, and led to solid positive cash flow generation for the sixth consecutive year, while we have continued to invest in growing the business.

For a full three years in a row now, we have generated a return on invested capital in excess of our cost of capital, and for the full year 2006, our ROIC increased 120 basis points from the previous year to 11.4%. That is excluding acquisitions. In summary, we had a good quarter and a terrific year. Despite a slowing in the components market in the second half of the year due to inventory corrections at our large EMS and OEM customers, we continue to demonstrate consistent and systemic improvement throughout the year.

We have shown that we can post strong financial results regardless of the current market dynamics, and we expect to continue to manage our company for consistent, steady improvement. Before we move on, I would like to tell you about a new and very important strategic initiative, that will enable us to be more efficient and more effective.

In the fourth quarter, we made the decision to accelerate an initiative to introduce a worldwide enterprise resource planning system, that will provide us with a single common infrastructure to best serve our business partners. We recognize the increasing level of globalization in our business, which naturally brings greater complexity in how we serve our customers and suppliers. As we have said in the past, complexity is a fact of life in our business, and solving complex issues for customers and suppliers is critical to our success. We do it well today. We will do it even better in the future.

This strategic initiative is an opportunity to insure we adopt the most efficient processes around the world, and empower our employees with the right tools to be more productive, while providing superior levels of service to our customers and suppliers. We are laying the foundation for the future, and we are creating greater value for our business partners, as well as for our shareholders. This initiative that follows on the successful implementation of the first phase of our global financial system, which will provide us savings in 2007, only one year after beginning the implementation.

The new ERP will create significant efficiencies on a global basis, and all of our employees are really excited by this significant opportunity. Implementation will occur in phases to minimize business risk, and is expected to be completed in four years. This is a long-term investment in the long-term profitability of the company.

We expect to fund this investment with cash flow from operations, and we do not expect these activities to dilute earnings going forward. This initiative will have a significant positive impact on our long-term performance. We will further drive improved customer and supplier satisfaction, wile lowering the level of working capital needed to support sales. This results in improved cash flow and more efficient, effective, and profitable organization.

Now I will turn it over to Paul to give you a more detailed review of the fourth quarter, and then to Mike and Cathy to discuss their businesses performance. I will come back at the end to provide guidance for the end of the year.

Thanks, Bill. Good morning, everyone. As Bill just mentioned, there are a number of items that impact the comparability of our results in the fourth quarter. I will walk you through these items and review our results, excluding their impact, to give you a better sense of our operating performance. As always, the operating information we provide to you, should be used as a complement to GAAP numbers. For a complete reconciliation between our GAAP and nonGAAP results, please refer to our earnings release or the earnings reconciliation slide at the end of the webcast presentation.

Sales for the fourth quarter were $3.49 billion, up 18% year-over-year, and up 1% sequentially. Pro forma for the impact of acquisitions we grew sales 8% over last year. Sales in our worldwide components business were $2.7 billion, an increase of 15% year-over-year, a decrease of 5% sequentially, principally due to fewer shipping days, and a well-publicized weakness in large OEM and EMS companies. pro forma for acquisitions, sales increased a strong 10% year-over-year, as each of our components businesses around the world achieved year-over-year growth, and market share gains.

Excluding the impact of acquisitions, operating income percent for the worldwide components business was flat year-over-year on strong performance in Europe, Asia Pacific, and our small and medium-sized customers. Offset by increased investments in North American growth initiatives, as well as a decreased demand for supply chain services in our large customer base.

Worldwide computer product sales came in ahead of our expectations at $834 million, up a strong 27% year-over-year, and 26% sequentially in the seasonally strong quarter. Pro forma for acquisitions worldwide computer product sales increased 4% over last year. Growth was driven by strong performance from all product groups, on both a sequential and year-over-year basis.

Operating margins for the worldwide computer products group increased 90 basis points sequentially, driven by favorable product mix and earnings leverage. And we decreased 20 basis points year-over-year excluding acquisition. Our consolidated gross profit margin was 14.6%, a 50 basis point year-over-year decline was driven entirely by the change in our mix, as a result of acquisitions. Excluding acquisitions, our gross profit margin increased 40 basis points year-over-year, to 15.5%. Sequentially gross margin was flat excluding acquisitions, which is less than the typical seasonal decline in the fourth quarter, from a higher mix of computer products and Asia Pacific sales.

In the fourth quarter, we incurred a one-time incremental expense of $6 million, related to the acceleration of our ERP initiative that was not previously anticipated. Excluding these costs, operating expenses as a percentage of sales decreased 30 basis points year-over-year. We do not expect the ERP initiative to be dilutive to future earnings. This represents the 16th consecutive quarter of year-over-year declines in operating expenses as a percentage of sales, to the lowest level in six years. Operating income, excluding the accelerated ERP costs was $158.3 million. That is up 14% year-over-year. We now have grown earnings faster than sales for four consecutive years.

Our operating margin, excluding acquisitions and the accelerated ERP costs, increased 10 basis points year-over-year. During the fourth quarter, we settled several multi-year tax matters resulting in the reduction of our provision for income taxes of $46.2 million, and a reduction of related interest expense in the amount of $6.9 million before taxes.

The impact on net income was a net increase of $50.4 million, of which $1.9 million related to the fourth quarter of 2006. Excluding the impact of those items relating to the periods prior to the fourth quarter, our effective tax rate for the quarter was 31.9%. Of the amounts released, $5.8 million related to full year 2006 income taxes, and $2.9 million related to full year 2006 interest expense. And going forward, we expect an annual reduction in tax and interest expense of the same $5.8 million, and $2.6 million respectively.

Net income excluding accelerated ERP cost was $92.2 million, that is up 19% from last year, and up 6% sequentially. Earnings per share on a comparable basis, that is excluding the favorable tax settlements and the unanticipated ERP costs and other charges, but it does include options expense of $0.75, on both a basic and diluted basis. That is a 17% increase over last year's fourth quarter.

Focused management of working capital resulted in a decrease in our working capital sales ratio of 160 basis points sequentially, to 18.1% on a pro forma basis. Inventory turns were at 7 times, for only the second time in our Company's history in the fourth quarter. We remain comfortable with our current levels of inventory heading into the first quarter. Our strong inventory management led to strong operating cash flow performance, as we generated $288 million of cash in the fourth quarter. Our return on invested capital exceeded our cost of capital for the 12th consecutive quarter.

Our balance sheet remains very strong and liquid with net debt remaining near a ten-year low, and net debt to cap at 23%. As we have mentioned, in 2007, the incremental cash flow impact of the ERP initiative is expected to be in the $70 million range, and we fully expect to finance these costs with cash flow from operations. In addition following the extension of our existing credit facilities in January, we currently have over $1.3 billion of available liquidity.

We will now discuss the results of each of our business units for the fourth quarter. First up, Mike Long will discuss our global components business.

Thanks, Paul. In the fourth quarter, the components markets performed generally as we expected. Preliminary data indicates that we gained market share globally year-over-year, and lead times are at the mid-points of our normal range.

Pricing from suppliers continued to be stable, and we saw no notable increases in cancellation rates. Book to bills in Europe, Asia, and our core business of small and medium-sized customers in North America, were at the 1 to 1.15 range worldwide, while our book-to-bill for our large OEM and EMS was somewhat softer, as they continue to work down elevated levels of inventory. We see stable markets through this point in the quarter.

In North America, sales reached the second highest level for a fourth quarter in Company history at $1.1 billion, up 4% year-on-year, and down 6% sequentially. Sales to our small and medium-sized businesses and our military customers were strong, and while we did experience continued weakness in our large customer segment, our operating income reached its second highest fourth quarter level since 2000.

We expect trends in our large OEM and EMS customers to improve, and note that the book-to-bill through January in North America was approximately 1.1. Our initiatives in passive, electromechanical, and the connector segment continue to produce strong double-digit growth year-over-year in the fourth quarter. As the #1 PEMCO distributor in North America, we remain focused on expanding our presence in this area. Our quarterly survey indicated that the majority of our customers surveyed continue to feel their inventory levels are well positioned.

Looking back over 2006, we had a very strong year. Sales increased to the highest level for North America, excluding the year 2000. While further efficiency initiatives initiatives increased operating income by 11%. Our focus on asset management resulting in working capital to sales reaching the second lowest level in Company history, and return on working capital at its second highest level, excluding the year 2000.

We continue to pursue our growth initiatives in PEMCO, and in new markets such as lighting, medical and transportation, to further take advantage of the opportunities in the North American market place in 2007. In our European region, we had an excellent quarter, with fourth quarter sales of 949 million, up 16% year-over-year, and down 3% sequentially.

Our European components business grew at an even stronger 19%, compared to the fourth quarter of 2005, or 10% in constant dollars. We continue to grow earnings faster than sales, with an increase of operating income of 46% over last year's fourth quarter, or almost 3 times our growth in sales. Our focus on efficiency improved operating margins 120 basis points, and return on working capital, more than 350 basis points year-over-year, to it's highest fourth quarter level in five years. 2006 was a great year for us in Europe. Our increased sales focus and investment in the region led to the highest level of sales in the history of the Company.

We have made continued progress on our One Europe initiative, which we have renamed One Arrow, to reflect the global impact this initiative will have on our business. We achieved our highest level of profitability, excluding the tech bubble, while return on working capital improved 40% to it's second highest level ever. Book-to-bill continues to be positive this quarter to date, and we look forward to further progress as we continue to pursue ongoing initiatives in the region this year. In Asia PAC, we continue to move closer to our targeted levels of profitability, while sales increased 39% year-over-year, and decreased 4% sequentially to $627 million.

Sales on a pro forma basis adjusting for the Ultra Source acquisition increased by 10% year-over-year, which outperformed the competition. Continued focus on our higher margin passive electromechanical and connector products, resulted in another quarter of double-digit growth year-over-year in these product lines. Improved profitability with the highest inventory turns for our fourth quarter, resulted in fourth quarter record low working capital to sales. So 2006 was a phenomenal year for the Asia PAC region. Sales increased 63%, or 20% pro forma for the Ultra Source acquisition.

As a result of our initiative to expand our customer base and product offerings, coupled with strong market growth, and solid performance from Ultra Source, we grew earnings 8 times faster than sales, as we remain focused on generating profitable growth. While we do see growth in Asia slowing somewhat, due to a great part of the widely reported slowdown in the large OEM and EMS segments, we are beginning to see a more favorable market dynamic, as distributors in the region demonstrate greater discipline, and become more focused on profitable growth.

This will benefit our business as we operate in a more rational margin environment, and we are proud of the progress that we have made to date, and we stand well positioned to continue to outperform the market, gain market share, and achieve our targeted levels of profitability for the region. We look forward to achieving our goal of being the clear #1 in Asia.

Bill?

Thank you, Mike. Really nice progress in 2006. I would like to turn to the Enterprise Computing Solutions group. I want to welcome Kevin Gilroy who joined us on January 2nd, after a distinguished 25-year career in the industry. Kevin has teamed with Cathy Morris in the office of the President, and together they are already beginning to have a really strong impact on our business and on our industry.

With that, I will turn it over to Cathy, who will comment on the Enterprise Computing Solutions business.

Thank you, Bill. Enterprise Computing Solutions achieved solid top line growth, with sales of $761 million in the fourth quarter, an increase of 32% year-over-year, and 28% sequentially. Sales on a pro forma basis, to include the impact of acquisitions increased 5% year-over-year.

Strong growth in all of our product segments led to us our 12th consecutive quarter of year-over-year growth. We saw continued strength in Storage worldwide, as well as in Security and Infrastructure software at DNS in Europe. We were also able to reverse the negative growth trend in proprietary service this quarter, while maintaining focus on industry standard servers, which grew double-digits in North America.

Alternative Technology, which closed on November 30th continues to perform at a high level, and is anticipated to achieve year-over-year growth, in excess of 30% in the first quarter. This continued acceleration is due to rapid growth in the Security and Virtualization markets. Over the last 15 months, we have transformed our Enterprise Computing Solutions business, by expanding our presence around the world, and strengthening our position in faster growing product segments. In 2006, we grew sales by 23%, and since December of 2005, we have expanded our reach from operations in two countries to almost 20.

We continue to deliver industry-leading margins and returns as we integrate DNS, Alternative Tech, and In Tech into our business, and take advantage of the significant opportunities to cross-sell our expanded product offerings around the world. We also look forward to completing our acquisition of the KeyLink Systems Group, which will diversify our portfolio, and make us the leading distributor of IBM and HP enterprise products.

Cathy, thanks very much. And thanks for a really nice job on the quarter.

I would like to close now just by giving you a summary, and then we will close with the guidance. We continue to manage the Company for steady, consistent growth, and continue to execute on the goals we set out to achieve.

Again, I think that's the hallmark of this management team is consistent improvement, consistent steady execution, consistent improvement. We reached our highest level of sales in our Company history this year, as we continued to take advantage of the opportunities in all of the markets we serve around the world, and we gained market share in all of our businesses. Our dedication to improving operations excellence initiatives in all areas of our business, resulted in our ability to grow year-over-year earnings faster than sales for the last four years, while our net income, excluding items impacting comparability has advanced from $15 million to $362 million, and our annual earnings per share have grown at a compounded annual rate of 110%.

We have consistently managed our asset base to bring our return on working capital to the highest level since the bubble year of 2000. We generated cash for six consecutive years, while strongly investing in the future of our business. Our strong cash flow has allowed us to self-fund recent acquisitions, as well as to make investments in our global financial system, and now our ERP system. We have consistently generated a return on invested capital well in excess of our cost of capital for three consecutive years, and during that time, we have more than doubled our ROIC to 11.4% for 2006, excluding acquisitions.

And so we continue to transform Arrow in 2006. We saw a window of opportunity open to us in the Enterprise Computing Solutions market place this year, and we are prepared to take advantage of it with our strong balance sheet and our exceptional liquidity. We effectively transform our business to one with a broader customer and supplier base, a broader geographic reach, and a broader product service and solution offerings. We began the year having just closed on the acquisition of DNS, our first foray into Enterprise Computing Solutions market in Europe, and we are very pleased with that one.

We closed on SKYDATA in Canada in the first half of 2006, that expanded our storage and solutions reach. And in the fourth quarter of 2006, we acquired Alternative Technology, which has created significant opportunities for us in the value-added software market in the U.S., and brought over 3,000 new SMB VARs that we can now cross-sell hardware into.

And we also closed on In Technology in the U.K., where their focus on storage and software has further added to our presence in Europe. And most recently, our announced acquisition of the KeyLink Systems Group, will diversify our revenue stream even further towards rapidly growing product segments, and provide us with substantial cross-selling opportunities, while making us the #1 distributor of HP and IBM enterprise products.

And so over the last 15 months, we executed on our strategic goals to increase the geographic depth of our business, expand the breadth of our product service and solutions offerings, and focus on the faster growing segments, and to achieve scale for greater operating efficiencies. I want to emphasize our ability to grow our business is not dependent on acquisitions. I would also emphasize that when we do see windows of opportunity, we will act as we did in 2006.

Going forward, we see significant opportunities for further growth organically, and we will remain opportunistic, making further acquisitions, should they meet our strategic, financial, and operational goals. We have also continued to invest in initiatives that will increase our ability to service our customers and suppliers, while significantly improving our operating performance.

Our global ERP initiative will standardize our systems and processes worldwide, and enable us to adopt Best Practices around the world. This will empower our employees with the resources they need to provide our customers and suppliers, with enhanced levels of service worldwide while increasing productivity and creating significant efficiencies.

We are successfully pursuing growth initiatives to insure that we can continue to outgrow the market, while managing our business for consistent performance and continuous improvement. I would like to congratulate everyone at Arrow for a great 2006, and say thank you for your continued commitment to the Company, and our journey to be the clear #1. As always, it's a privilege for me to lead such a fine company, and I am very excited for the opportunities that lie ahead of us.

Looking ahead to the first quarter, we expect continued strength in our small and medium-sized customer base in components, while our customers continue to work down their inventory positions. Our large customers continue to work down their inventory positions. Regionally, we anticipate continued strength in Europe, stability in North America with the benefit of an increased number of shipping days in the first quarter, and normal seasonality in our core Asia PAC business, due to the Chinese New Year.

We expect the traditional seasonal slowdown in our computer products business to be offset in part by the impact of the Alternative Technologies and In Tech acquisitions. We believe that total first quarter sales will be between 3.525 and $3.725 billion, with worldwide component sales between 2.775 and $2.875 billion, and worldwide computer product sales between 750 and $850 million. Earnings per share on a diluted basis, excluding any charges are expected to be in the range of $0.72 to $0.76 a share, an increase of 6 to 12% from last year's first quarter.

With continued focus and execution, we see a clear road map to achieving our timeless business model targets. We will continue to create value for our business partners and our shareholders, as we invest in future growth and profitability.

Thanks Bill. Jimmy, can you please open up the call to questions at this time?

Certainly. [OPERATOR INSTRUCTIONS] We will take our first question from Brian Alexander with Raymond James.

Yes, can you just go into a little bit more detail on the operating margins in the component segment? It looks like it was down 22 basis points sequentially, after being down sequentially in Q3, and your guidance for Q1, I am implying or interpreting that as implying about a 5.3% margin in the components business. So a little bit more color on the sequential declines, and your confidence level seems to be still pretty high that you can get that to your goal of 5.7 to 7 by the end of the year? That's my first question.

Hey, Brian, it's Paul. Thanks for the question. One of the big drivers that exist in our business, and you have heard us talk about this for several years now, is that we do look to create opportunities for us in the nontraditional distribution sales. So that is code for fee-for-service, those types of engagements, with principally the large OEMs and the large EMS companies. So as they have seen a surge in their inventory and everyone has been talking about the dropoff in the business.

Some of that dropoff has been in gross sales like we traditionally see, and some of it has been in our fee-for-service business. Fee-for-service business has very low sales, because you don't recognize the gross amount of the sales, it has virtually no cost to it. It is all GP and NOL operating income. So it kind of distorts the operating income percent trend, when it hits this particular market.

That is the major driver for what has happened, and yes, since we continue to believe that the first quarter will see continued weakness in the large OEM, EMS customer base, we expect to see that negative impact carry over. We don't see that reversing over the long term.

I guess that just answered my question. You don't think that this is a trend, where the large customers will be relying on those services less?

I don't think so. I think the opportunity is there for us to go further than where we are. I mean what we are talking about today is really focused in North America, to a lesser extent in Europe, and a growing demand for those types of services in Asia PAC. But when you look at Asia PAC, it is very small right now.

As we see large OEMs and large EMS companies going to Asia PAC to take advantage first of labor arbitrage, and now saying there are other types of services that distribution brings to them around the world, let's have it in Asia PAC also. You know, that is part of our vision for Asia PAC that will grow the margin ultimately, is that they will want value-added services, we will charge a differentiated gross profit for that, and it will drive our margins in that region.

Thanks, Paul. My second question relates to the ERP initiative. I guess I have a few different questions within that. First of all, the timing of the 70 to $80 million in '07, is that going to be linear throughout the year? Are you going to be able to completely offset that cost in year one with the savings? Because I would assume there would be some sort of lag effect. And then I guess the final part of that, just talk us through how you will mitigate the operational risk for what seems to be a pretty significant undertaking? Thanks.

Let me take the operational risk first, and then I will turn it over to Paul, to walk you through some of the numbers. First of all, this is a big initiative. It takes place over a long period of time. We have studied in great depth and detail, how we will phase this in over a period of time to make sure that we minimize the operational risk, and we have built very substantial contingency plans, in case we do run into problems. I would point out to you that we have in effect been building global systems over the last year and a half.

We haven't talked a lot about it, in terms of our global financial systems, so in effect we have been prototyping what it takes to install global systems, and bring up global capabilities over the past year and a half, and we are successful with that. And we are already, we are going to begin to see the savings from that this year. We continue to believe that we can do that. We will watch this very, very carefully.

This is something that I spend time on, the senior management team spends time on, our CIO, Vin Melvin, spends virtually all of his time on. And this is a very powerful initiative for us in the future. We absolutely expect that we will be able to run the Company as we are running it, and continue to improve it, and then have some very positive results as we start moving through this.

Paul, let me turn it over to you.

Sure, Brian on the cash flow impact, it is generally linear throughout the entire year. And that 70 to $80 million is cash outflow, not cost per se that would impact the P&L. Obviously some piece of this is capitalized, some piece is expensed. We believe that we have initiatives already identified and underway that will pay for the incremental investment we are making in the future of the Company. And as Bill mentioned, an example would be our global financial system, in fact, we called that in North America in early parts of Q3 2006, without any disruption in the business, that is part of our risk management.

In fact, the business case we built around it, we are not just putting systems in for the sake of systems. We have a business case that we review on a regular basis every month, and the fact, as Bill mentioned we reviewed with the Board, have cost savings in the business model, and we are getting what we thought we would get six months in. We just turned on the system in southern Europe in the month of February, and no disruption in service there either at this point in time. We did it. The customers got billed, we collected cash. We paid suppliers, we received product.

So once again, about six months from now we will begin to see some of that pay off. We have a whole series of initiatives, and we are not going to talk about each one of them, that we invest in throughout the year, and they start to pay off, and we are redirecting some of that payoff in investing to the future. So I am confident that we will be able afford this from the cash flow point of view, and I am confident that our initiatives underway will insure that there is no future dilution of this project.

What platform will you be running on when all is said and done? Is this SAP or something else?

This will be an Oracle platform. We have installed the Oracle financial system, and we are in the process of installing the Oracle full business suite that will go along with that.

Thank you very much.

Our next question will come from Matt Sheerin with Thomas Weisel.

Yes, thank you. Good morning. My question goes back to your commentary about components and the weakness in EMS and OEM. If you look at your sequential guidance, it looks like for components, it looks like it's a couple points below what you normally see. Is that weakness all due to the EMS and OEM customer base? And what is your sense of the inventory question or demand situation there? When do you think you will get back to the more normal booking trends there?

Hey, Matt, it's Paul. In fact, you are absolutely right. A little bit less growth than we would normally see from a seasonal point of view. All tied directly to the large OEMs and EMS customer base. I don't have a clear vision as to when this might turn off. I have looked at some inventory-type information for some of the larger EMS companies.

Some of them have had a decline in inventory. Some have been flat to up a little bit. I wish I could say with definity, whether it will be over in the first quarter or there might be a tail in to the second quarter. I can't really say that for sure, but feel better, as Mike pointed out, our overall book-to-bills in the month of January, not just the SMB, but the overall book-to-bill, for example, in North America is 1.1. So there is more confidence growing for that particular market place. I just can't put my finger on when it will be full steam ahead.

I would absolutely echo that comment. We don't have great visibility as to when it will turn. We are very confident that it will, but those large OEMs and EMS companies will get through this correction, and we look for good future opportunities, not exactly sure exactly when it will be, and it will depend on individual companies.

Okay.

Longer term the outlook looks good.

In terms of the end markets here, is that weakness primarily in the Comms infrastructure area? And then regarding the book to bill, is it positive for those customers, or still below 1?

It is primarily in the Comm sector, and Mike, you might comment on the book-to-bill as to where it specifically it is. It is greater than 1.

Yes, Matt, what we have seen, you know, we saw the fourth quarter, but we are seeing pretty strong book-to-bills in the first quarter right now with that 1.1 range, and that is for all of our customers. So we are seeing a little bit of strengthening in the bookings at this point.

Okay. And I guess, you know, you have got a higher percentage of variable cost than you used to in the past and in situations like this, when things are weak and it sounds like it's more of a blip than a big trend, but what kind of processes do you have in place, in order to cut costs and take some of those variable costs out during weaker times?

Hey, Matt, let me take a shot at that one. You know, it's very interesting. The cycles are becoming shorter on the downstroke, and shorter on the upstroke for that matter.

And, you know, we have a vision of where we want to take the Company longer term. You are absolutely right, we have more variable costs. In looking at, if you want to call this particular time a cycle, we made a conscious decision to say that this is a relatively short period of time, and we are really not going to hurt the long-term opportunities of the business. In fact this ERP is a perfect example of that, where we want to keep investing.

So you know, our view is that today are we getting some of that benefit in leveraging more variable costs, but we wouldn't necessarily this time around, look to have a significant reduction, but I am sure that both Mike and Cathy and Kevin can tell you that we have a very healthy discussion around spending every month, in the business reviews that we have, and even in the off weeks when we have our executive committee meetings.

Just my last question on the inventories, it was up just a little bit. What was the component inventory quarter to quarter? Was that down?

Yes, there's two factors to consider. First off, when we looked at our inventory levels. One is that we had In Tech and Alternative Technology in there, and also if you look at the period end currency rates, they have strengthened versus the dollar, compared to the end of the third quarter. So if you adjust for that, put it all on an apples-to-apples basis, inventory is generally flat with the third quarter.

Okay. Thank you.

Our next question will come from Thomas Dinges with JPMorgan.

Good morning. Just a couple of quick modeling questions for you, Paul, maybe I missed it, what was the assumption on the tax rate going into the first quarter? And also with the prepayment on the debt and so forth, what is the expectation on the interest expense? And then I have a quick follow-up question.

Okay. On the tax rate itself, we are looking probably, I am going to give you a range, probably from 31.7 to about 32.2%. So it will be in that range from an effective tax rate point of view.

From an interest point of view, what we would expect to see, if you even out all of the pluses and minuses around the reserve releases that we had associated with the tax adjustment, that we would probably see interest expense in that 22 to $23 million range for the quarter, and that is obviously ex any acquisition.

Okay. And a quick follow-up for Cathy, specific to the enterprise business. You mentioned that virtualization was a strong driver this quarter, and just to get your perspective on what your VAR base is telling you, the impact of that is going to be on overall server sales this year, because there is a lot of discussion in the market as to, you know, is that going to lead to slower growth on the unit volumes, as people can use processor power distributed? Just some clarity there, and any perspective you can give from your customers would be great.

Cathy and Kevin, do you want to take that one?

Sure. We haven't seen a true correlation between the growth and the virtualization market, and the downturn in server markets and storage markets. So we have not heard that correlation, Kevin, if you have anything else to add.

No, in fact, it's a topic of conversation as we talk to many of our customers, and they are not seeing that correlation either.

Okay. Thank you.

We will take our next question from Michael Walker with Credit Suisse.

Good morning. It's actually Will Stein calling in for Mike. First, I would just like to touch on the cash for a minute. You had a good cash flow quarter, but you know, earlier in the year, had not performed as well as you have historically. What are we thinking for '07 at this point?

I'm sorry, it's Paul. Did you say for the first quarter.

For the first quarter, and then more so for the year. In calendar '06, you consumed cash in the first three quarters, and then made it all up in Q4. I am curious what you are thinking as to the linearity of the cash flow for next year.

Yes, we would expect it to be both cash flow positive in the first quarter. We said that our goal, we have delivered that for six years in a row would be cash flow positive for the entire year. So that is our expectation at this point in time. There is always a little bit of a change from quarter to quarter, and in fact, if you look, if you exclude 2006, I think you will see that 2005 first quarter and 2004, had a lower number than maybe some of the later quarters, and that's as a result of the pattern around payments for computer product sales.

Okay. And can you talk about the Agilisys, when is that deal expected to close? And is there any update in terms of your expectations on that deal on your income statement?

Will, this is Bill. As we have announced and that continues to be our expectation, we expect it to close at the end of this quarter, as of March 31st, and we believe that will happen. And we are continuing to move along with that. So there is no new news in that area.

It won't close in the March quarter or, like last day of the quarter kind of thing? Is that how we should be thinking about it?

That's what we would expect.

Okay. I'm sorry, I guess that's it for now. Thank you.

Thank you.

Our next question will come from Steven Fox with Merrill Lynch.

Hi. Good morning. First of all, just a CapEx number for the full year, including the ERP investments.

Steve, are you asking for 2006 CapEx?

No, I'm sorry, 2007 estimate.

2007. My estimate would be that we would probably increase by about, round numbers, I am going to say $60 million over what our expending levels were in 2006.

Okay. And then how much are the recently closed acquisitions contributing to sales by your estimate in Q1?

Yes, sure, that's a question I think I can answer for you. What we are looking at right now is that combined, they will add in sales somewhere between 140 and $160 million of incremental sales, I'm sorry, of first quarter sales.

Great. And then lastly, just looking at the component market, I am a little confused by the comments on Asia. You talked about more days, but then you have the holiday in Asia. If you exclude seasonality, can you just comment on how the market feels, and what visibility you have into March for Asia component demands?

Steve, this is Bill. In terms of Asia, what we see is that the market is probably a bit more disciplined than it has been in the past. That means it is growing at a little slower rate, what we have seen and what we feel is quite positive is that the top players in Asia, the top distribution companies are really focusing on profitable growth, as opposed to growth at all costs and that is a good trend for us.

That is also happening as some of the end markets continue to be stable, not bullish. They are certainly not as strong as they were in, for example, the beginning of 2006, but it's still good, positive growth. And we would expect to continue to show good, positive growth throughout the year, perhaps not quite at the very strong rates of the first half of '06.

Okay. Thank you.

We will take our next question from Jim Suva with CitiGroup.

Can you hear me?

Yes, your line is open.

Can you talk about your operating profit margins, as it seems like it's declined here for the third consecutive quarter. What should we expect going forward? Has it stabilized, and what has been the drag on that?

Hey, Jim, it's Paul. The major driver in the decline has been the change in mix, which is more heavily tilted towards computer products, as well as Asia Pacific. So that is a significant driver for us.

With that said, while they inherently have lower operating income percent, they have greater asset utilization. So they use less assets effectively, and that is helping to keep our returns and invested capital well in excess of our cost of capital, as well as our returns on working capital higher.

So that is what we see right now happening in the business, also as I mentioned because of the decrease in the last two quarters of fee-for-service type engagements, which inherently have a much higher gross profit and operating income percent, that has also hit us a bit, and we expect that to turn around once the large OEM, EMS customer base spreads them.

And then as a follow-up to that. As we look at Asia to do more and more higher volume, lower per unit items, should we expect operating margins to continue to be under a little bit more pressure, or are we seeing that mix all worked out now?

We will certainly see the gross profit will continue to shift as the mix shifts more towards computer products, and more towards Asia PAC. As we have said, as we move towards our timeless business model in Asia, and we are making good progress towards that, and as we get the higher returns from our activities in the computer products business, we would not expect to dilute our operating margins. In fact, we expect to make continued progress towards the timeless business models that we have projected to you, and we think we are on track to do that.

Again, the models that we look at in Asia would say we will have a lower gross profit margin, we will have a slightly lower operating margin, higher asset velocity, a lower tax rate, and therefore at the bottom line, Asia will be, will not make any difference at all in terms of the our net bottom line profit. Growth in Asia will be like growth every place else. We are not quite there in Asia, but we are making progress toward it, and we have a good year of progress in 2006.

So for Asia, do you need to look at some acquisitions there, or is that more organic growth, or a combination of the two?

Jim, what we will continue to say is we believe the market in Asia will consolidate. There are still a lot of players out there, and what we have seen is that the Top three players, in fact have emerged as ourselves, Avnet, and WPG.

There are a couple of players right next to us, people like Wintech and Yosun, and then a whole lot of players, I think there are still well over 20 publicly traded distribution companies in Taiwan alone, and we would expect that to consolidate at some point in time. We don't know exactly when. We are pleased with our Ultra Source acquisition. We are glad we made it. It's been strongly positive to us.

We will continue to look for those acquisitions that make sense, and we will absolutely play when and if that market starts to consolidate. I believe it will at some point. I just don't know when.

Great. Thank you very much, everyone.

We will take our next question from Bernie Mahon with Morgan Stanley.

Hey, good morning. A question for Mike. What is the percentage of sales in the components business that goes to these large OEMs and large EMS companies that you are talking about with the weakness?

Hey, Bernie, I will take a shot at that one. Mike may not have all the data in front of him. When we look at it in North America, which is where the biggest mix is. It's, you know, between 15 and 20%. When you look at it for the entire components business, it's down in the low teens, somewhere around 10 and 15%, because there are certain regions that just don't have that type of mix.

Okay. That's helpful. And then just in terms of the components, your expectations there for the March quarter, could you just talk about the linearity? I mean, is it very back end loaded, kind of after the Chinese New Year? Or do you have a really strong first six weeks in front of the Chinese New Year? Just kind of what you are expecting, you know in terms of the linearity there.

Bernie, it's Paul once again. On this one, it depends on the region, quite honestly. We have a shorter new year celebration in North America, for example. So January starts a bit stronger in the United States than it may in Europe, as example, as many people in Europe take New Year's celebrations through the 3rd or 4th or 5th of January.

You are absolutely right that there's a bit of a wild card, if you will in Asia, because the Chinese New Year is a bit later this year. So there is some of that business is waiting to see what happens in the month, versus what may have happened in January or February, when the holiday was earlier in the past.

So would you say in Asia Pacific for components, would the month of March, I mean, could that contribute up to 50% of the total quarter sales, or is that too high of a percentage?

Bernie, this is Bill. I'm not sure we have a good insight on that one. Typically though, the business strengthens considerably after the Chinese New Year, and we would expect that to happen this year. As Paul said, since it's late this year, it's being celebrated basically right now, during this week, we will know a whole lot more in another couple of weeks, but clearly we would expect the Asia PAC business to be back end loaded to March this year. Moreso than it is in normal quarters. This is, I think I'm right. This is the latest it is in every 12-year cycle, very late this year.

Okay. And then Paul, just a quick follow-up. On the ERP system you said some of it would be capitalized, the other part in SG&A. What is the percentage there? Is it 50/50 of the costs or --?

Bernie, we are holding that close to the vest as we drive forward. So you might not see any real change in expenses, because we do have initiatives that will offset that. As an example, my global financial system initiative will reduce some expenses going forward, so you will see an offset there. So not a big impact I don't think on SG&A going forward.

Okay. Thanks a lot.

Next we will hear from Kevin Sarsany with Next Generation.

The first question is on Asia Pacific. Your commentary talking about the dynamics in Asia Pacific, and I take it as being from a volume price-related market to service. Wouldn't that imply that margins would go up?

Kevin, it's Bill. The short answer is yes. One of the things that we view as very positive in Asia, is that a couple of things are happening. One, the market is starting to mature, and as the market matures, more of our classic small and medium-sized customers serving local markets become a greater portion of our mix. They demand varying levels of services, which includes supply chain, and all the things we bring to our customers in both North America and Europe.

That is positive. That has higher margins. We are already beginning to see some of that. What we also are seeing is much greater discipline on the part of the large distributors in Asia, who have all quite publicly stated that they are looking for more profitable growth and, in fact, are exhibiting that. And so you can see that in terms of the operating margins.

That is also positive for us as there is no longer the growth at all costs modes. As everyone recognizes, that we have to make money in the region. We also view that, as Paul pointed out earlier, in our large EMS customers, and our large OEMs for export manufacturing, we have not historically provided them with the full range of value-added services that we do in North America and in Europe. That's starting to happen as they begin to move away from a strict fulfillment model, to a supply chain services model.

And then finally in our transfer business. The business that is designed in North America or Europe that transfers to Asia, we have gotten much better, in terms of understanding it, tracking it, and enabling us to capture that business. And that is also higher margin business.

So net/net, we feel comfortable that our margins in Asia will improve, because we believe strongly that in fact the market dynamics are moving in the direction for a full line, broad line global distributor. That is how we continue to be very bullish about Asia.

Do you think margins can get up to the regular component average?

No. What we have always said, is that we expected gross profit margins to be below that.

Right.

They will be serviced by a lower cost to serve model, because our costs are lower in Asia. Our operating margins will be slightly less than we see in other parts of the business.

Our asset utilization will be higher than in other parts of the business, and our tax rate will be lower, such that the net operating profit after tax, will in fact, be the equivalent of what we see in the other operating regions of the world. Again, we are not there yet, but we are making good progress along that way.

And a follow-on to that is, you know, moving from the volume to service. The volume, anyone can set up a shop and get customers, and go out there and get revenue. But moving to the service, how are your indigenous competitor positioned in the service arena? And wouldn't that, if they were not as well prepared as you are, which I assume they are probably not as a whole, wouldn't that make acquisitions probably more available?

That is certainly one of the conclusions that you could come to, and that's why we think the market, in fact, will move in our direction. It will consolidate at some point in time. You know again, we have made investments over many, many years in the additional services that the market requires.

We have made them. We have installed them in Europe and Asia. So we have those costs already behind us. Those are costs that many of our competitors would have to go out and build, and they are not cheap.

These are not cheap services. We spent hundreds of millions of dollars over, many, many years to build all of those things. We just have to deploy them and implement them and modify them for use in the Asian area.

So again, I think the market moves in our direction and that's one of the reasons why I do believe the market will consolidate, because some of the competitors will very quickly figure out that the market isn't moving in a direction that makes them competitive. Again, I would emphasize, I don't know when that consolidation is going to take place. I think it will take place, and we will absolutely play when it does.

Two more. On the ERP system, could you quickly explain why you decided to accelerate it, and you have talked about internal cost savings there. What are the benefits are the customer and the supplier facing applications that you plan on putting in that put you in a better position on that arena?

Well, again, this is Bill. Accelerating is a good news story, and it's one of these that I think a management team always needs to be looking at. If we see an advantage to bringing an investment forward, we should do that and we did. The simple advantages are for us to go from multiple systems that we have around the world, that are legacy platforms, to a common and standard platform around the world. That enables us to give global capabilities to both customers and suppliers. Both the stakeholders, the groups of stakeholders have given us very strong feedback through our voice of the customer, and the voice of the supplier programs, that say we really want you to go from being an international company to being a global company.

We need to have global visibility of inventory. We need to have global visibility on supply chains. We need to have global visibility on product flows. We need to have global visibility on logistics, all of these sorts of things, which are very difficult to do, when you have multiple systems based on legacy platforms. We provide those services.

We are saying that we can go in and provide better service, by installing a consistent global worldwide system, we will do it carefully, we will do it over phases, and we will do this right, and we will provide significantly better service to customers and suppliers at significantly greater internal efficiencies to ourselves.

I guess the timing that you mentioned that North America was turned on in Q3, southern Europe was just turned on in Q1. I assume northern Europe is probably going to be sometime this year. Why will it take four years? Is Asia Pacific the big hurdle?

Kevin, just one point of clarity, is that when we were talking about systems coming online, it was just the financial system that we were talking about, not all the other systems that would be touched by the Oracle implementation. So that's just a point of clarity.

In fact, Asia PAC for finance will be done in the second quarter. So it's not so much around Asia PAC as a region, or anything like that. What we are trying to do is learn from the experiences we have had from the global financial system.

Also don't get we are not just putting in a new system. We are going to improve the processes that we have, be greater efficiency, better management tools, better view in to around the world. So we are actually changing how we go forward. So you need to have a full understanding of how the four systems work today, how the processes work today, how we will take it to the vision for the future, have the system around that, and the phase-in period also is around risk management.

Okay. And my last one. Sorry, is just the KeyLink acquisition, obviously you know, you are going to close here coming up, but I am sure the vultures are circling, you know, potential customers here. How are you managing that whole revenue retention, and the sales force out there when you don't specifically own them right now?

Well, that's a very good question. The short answer is that we go out and we spend a good amount of time, and Cathy and Kevin are spending a substantial amount of time with our customers, with our suppliers, talking with them about what our plans are, what we can do, how we want to work together, listening to them, understanding what their needs are, making sure that that's fully baked into our integration plans.

As I am sure you know, we have substantial numbers of people working on integration plans right now, and a very key portion of that is to make sure that we secure both the customer and the supplier base, and that they fully understand what our plans are going forward, bought into them, that we have listened to them, that we understood what they have to say, and that we have painted for them a picture of why, in fact this is good news for them.

By and large, the reaction we have gotten has been very, very positive. As the people believe that this is a good thing, both for Agilisys, and they focus on the core competencies that they want to focus on, and for us to focus on something that we believe we do very will, and will provide a better service to the broader market as a result of that.

Okay. Thank you very much.

And we will take a follow-up question from Michael Walker with Credit Suisse.

Thanks again. It's Will. Guys, I just want to understand a little bit better on the systems guidance. The midpoint of that $800 million implies a 4% sequential decline, which is healthfully above the normal seasonality in that quarter for the systems business. And perhaps you have said this before, but can you maybe highlight, you know, what of that strength is driven by acquisitions versus other items?

Yes, I think, Will, there's two items affecting us. The decline will be less than we have seen in the past, because of the impact of acquisitions. That is for sure true. Also remember that we have been investing in this business for organic growth also. And that means that we have opportunities in the fastest growing product set.

And then lastly, of course we do believe that there's cross selling opportunities between the companies that we have acquired, their customer base, and our product lines, and conversely, the customer base that we had in their product lines. I think if you look at all of that, that is the reason why we will see less of a decline than you may have seen in the past.

And then on the operating margin in that business, we are above 5%, and in the current quarter. Can you give us an idea as to how Agilisys when that closes in Q2, how we should expect that to impact margins in that business?

Yes, Will, generally we talked about it on an annual basis, because there's some seasonality to that business. But what we have said is that annually, the operating income percent we believe we will achieve, will be at least at our corporate, at our computer product average, and the returns will be very strong.

Great. Thank you very much.

That is all the time that we have for questions today. At this time, I would like to turn the conference back to Mr. Birns for a final or closing comment.

Thank you, Jimmy. Before ending today's call, those of you participating in today's webcast we will quickly scroll through the slides referenced in our webcast, that contain a reconciliation between GAAP and adjusted results. This reconciliation is also included in our earnings release. We have also included a balance sheet reconciliation, to walk you through the adjustments relating to our recent acquisitions. Both the release and this presentation will be available on our website.

I would like to thank all of you for taking the time to participate on our call this morning, and if you have any follow-on questions about the information presented today, please feel free to contact, Paul, Sabrina Weaver, or myself. Thank you, and have a great day!

That does conclude our conference. Thank you for your participation. We hope you enjoy the rest of your day.