艾睿電子 (ARW) 2007 Q3 法說會逐字稿

Good day and welcome to Arrow Electronics conference call to discuss their third quarter earnings. As a reminder, this call is being recorded. At this time for opening remarks and introduction, I would like to turn the call over to Ms. Sabrina Weaver. Please go ahead, ma'am.

Thank you. Good morning, everyone, and welcome to the Arrow Electronics third quarter conference call. I am Sabrina Weaver, Arrow's Director of Investor Relations, 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 future Webcasts, please visit our Investor Relations Web site 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, Kevin Gilroy and Cathy Morris, Presidents of Arrow Global Enterprise computing solutions, and Mike Long, President of Arrow Global Components.

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 Web site. Before we get started, I would like to review some of Arrow's safe harbor statements. Some of the comments to be made on this morning's call can 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 also included in Arrow's SEC filing.

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, Sabrina, and thanks to all of you for taking the time to join us this morning.

The third quarter was a complicated one for us.

On the positive side, our level of sales as well as working capital sales remained near record levels and we continue to generate positive cash flow as we generated the highest level of cash flow for any third quarter in six years. Our balance sheet and capital structure remain very strong.

Profits, while strong, were, however, at the low end of expectations.

In our components business, pricing pressures increased in September as competition intensified in all regions.

In Enterprise Computing Solutions, unfavorable product mix affected margins and we made a conscious decision to invest in important strategic investments for the future.

We will continue to invest in what we see as very positive long-term future of Arrow in vertical market initiatives, in geographic initiatives in Asia and Europe, and further penetrating the small and medium-sized businesses to truly own this segment and in global systems to leverage our scale worldwide to transform the way we do business. But we will take, and have taken, steps to be more efficient in all areas of our business to make sure that we provide premium returns to our investors. The strategic initiatives we are pursuing are resonating strongly with our business partners and we intend to continue them.

However, and as always, you can be assured that we will make the necessary adjustments to achieve our financial targets in the time frames we have committed to.

In our Enterprise Computing Solutions group, we again outgrew the market with year-over-year growth in all product lines, including proprietary servers. In the third quarter, sales pro forma for acquisitions more than doubled the rate at which the overall market is expected to grow.

While our business is performing well, our product mix had a negative impact on profitability this quarter. It has been reported by major suppliers in this area uncertainty in the capital markets led to end- of-quarter hardware weakness.

We made a conscious decision to invest in several strategic investments that will transform this business from the combination of product mix and continued strategic investments made our operating results challenged for the quarter. We believe this is a short-term phenomenon and expect results to return to more normal operating levels in the fourth quarter.

On the components side of our business, we continue to gain share as competition intensified this quarter, primarily in September and throughout all regions.

The weakness in our large customer segment continued and this, coupled with a weaker-than-expected European market, put pressure on results. End market demand was as expected elsewhere.

We had good success with efficiency initiatives to drive down our operating expenses worldwide.

Let's now review some of the key financial highlights.

We grew 17% year over year in pro forma for acquisitions. This was at the high end of expectations and demonstrates that we continue to have success in the markets we serve.

Earnings per share were at the lower end of expectations for the reasons cited in my previous comments. They were, however, at near record levels.

Cash flow generation was strong again this quarter at $171 million, and in the last 12 months we have generated more than $900 million in cash flow from operations. This is something the company has never done in a period of growth and this was our sixth year of positive cash flow generation. We're proud of the excellent cash flow management throughout the company.

Working capital of sales remain near record lows at 15.4% as we continue to be focused on managing our asset base, and our return on working capital reached the highest third quarter level since the bubble year of 2000, while our return on invested capital was higher than our weighted average cost of capital for almost four years. And this has not simply been done in the past. So in summary it was a challenging and complicated quarter. We grew faster than the market, generated a significant amount of cash flow, and generated returns in excess of our cost of capital.

We continued to make strategic investments in our future, and we are committed to generate consistent short-term performance as we also investment in Arrow for the long-term.

Paul will now give you a more detailed view of the third quarter and then Cathy and Mike will discuss their business' performance 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 performance excluding these items to give you a better sense of our operating results.

As always, the operating information we provide to you should be used as a complement to our GAAP numbers. For a complete reconciliation between our GAAP and non-GAAP results, please refer to our earnings release or the earnings reconciliation slide at the end of the Webcast presentation.

Sales for the third quarter were $4 billion, an increase of 17% year over year and flat sequentially.

Pro forma for the impact of the KeyLink, Alternative Technology, and InTechnology acquisitions we grew sales by 4% over last year.

Global Enterprise Computing Solutions achieved its 15th consecutive quarter of year-over-year sales growth with total sales at $1.2 billion. Sales increased 97% year over year and decreased 8% quarter over quarter, in-line with normal seasonality.

We continued to outgrow the market with sales increasing 15% over last year, pro forma for the acquisitions of KeyLink, Alternative Technologies, and InTechnology.

Operating income as a percentage of sales decreased 80 basis points year over year as a result of unfavorable product mix and investments in the future growth of our business. Yet, our return to working capital improved over 40% year over year in the third quarter.

Global component sales of $2.9 billion increased 3% sequentially as normal seasonal weakness in Europe was offset by the typical holiday build in Asia-Pac.

Sales were flat year over year as the well-publicized weakness within the large EMS customer base in North America and Asia-Pac continues to linger.

Despite stronger than anticipated competitive pressures this quarter, intense focus on cost containment, and ongoing initiatives to drive down our operating expenses enabled to us increase our operating margin by 20 basis points year over year at a decrease of only 20 basis points sequentially.

We continue to improve our working capital management, a 240-basis point drop in the ratio of working capital to sales compared to the third quarter of last year.

In Asia-Pacific, sales increased 22% sequentially and increased 5% year over year to $687 million. We continue to make great progress towards our profitability goals in the Asia-Pac region with operating income up 43% sequentially and 173% year over year.

Remember that we are strategically passing on high volume, low-margin opportunities in the region to focus on a small and medium-sized customer base. This, along with other efficiency initiatives, enabled us to generate record operating income dollars for any third quarter while improving our return on working capital by over three times last year's third quarter level.

In Europe sales of $1 billion decreased 3% in this seasonally soft quarter and increased 3% over last year's third quarter, which was stronger than normal due to the RoHS conversion.

Our continued focus on the broad small and medium-sized customer base, combined with ongoing efficiency initiatives there, resulted in the second highest level of operating income to sales for any third quarter since 2000.

In North America, total sales were $1.1 billion, representing a normal seasonal decline of 2% sequentially. While sales decreased 7% year on year as a result of continued EMS weakness, we increased return on working capital by 12% over the same period last year.

Our consolidated gross profit margin was 13.7%, a decrease of 50 basis points year over year, pro forma for the acquisitions, was impacted primarily by an increased mix of business in the global enterprise computing solutions segment due to acquisitions and increased competitive pressures in our global components business.

Gross margin for our core small and medium-sized customer base and worldwide components decreased 20 basis points year over year.

Operating expenses as a percentage of sales decreased 30 basis points sequentially and 60 basis points year over year to 9.7%, the lowest level achieved since 2000. We continue to capitalize on opportunities to leverage our global scale and develop best-in-class global practices to transform our organization for the future.

By centralizing certain back-office operations in our North American components business and creating a shared service environment, we have identified $30 million of annual cost savings in the third quarter. Approximately $3 million of which we achieved in the third quarter. We expect to realize approximately $7 million in the fourth quarter and the full run rate amount of $7.5 million in subsequent quarters. Operating expenses in the third quarter include an estimated $4 million, or $2.6 million that are taxed, of amortization of intangible assets related to acquisitions.

Operating income was $162 million, an increase of 5% year over year and a decrease of 8% sequentially as we experienced an increase in competitive pressure in our components business, a change in product mix in ECS, and continued investments to profitably outgrow the market.

Operating income as a percentage of sales, pro forma for acquisitions, decreased 30 basis points year over year due to the previously-mentioned items.

During the third quarter the German government signed into law a reduction in its corporate tax rate beginning January 1, 2008. As such, the settlement of deferred tax liabilities in Germany, principally related to the amortization of intangibles for tax purposes, which are not amortized for accounting purposes, will be at a lower rate.

As such, we adjusted our deferred taxes to reflect this lower tax rate by a net $6 million. This is a nonrecurring item that will have a minimal impact on our effective tax rate going forward.

Our effective tax rate for the quarter, excluding this tax item, was 31.7%, and for modeling purposes, you should assume our tax rate for the fourth quarter will also approximate31.7%.

Net income was $95 million, up 9% from last year, a decrease of 6% sequentially.

Earnings per share was $0.77 and $0.76 on a basic and diluted basis, respectively, an increase of 8% and 7%, respectively, compared to last year's third quarter and the highest level since 2000. The diluted earnings per share include $0.02 of estimated amortization of intangibles related to acquisitions.

The strong cash flow performance with positive contributions from all regions generating a total cash flow of $171 million. In the last 12 months, we've generated more than $900 million of positive cash flow and we expect to be cash flow positive in the fourth quarter.

The level of net debt remains below $1 billion and net debt to cap declined again this quarter to the lowest level in ten years. In today's capital markets, being able to generate cash and having a more conservative debt level is certainly a competitive advantage for us.

Working capital to sales remain near record low levels this quarter at 15.4%, decreasing over 400 basis points year over year on a combination of focused execution and favorable working capital mix as a result of the KeyLink acquisition...

We also achieved the highest level of return on working capital for any third quarter since 2000, the return on invested capital exceeded our cost of capital for the 15th consecutive quarter.

We will now discuss the results of each of our business units for the third quarter. First, Cathy Morris will discuss our Global Enterprise Computing Solutions business.

Thank you, Paul.

We continued to outgrow the market in the third quarter. Growth was driven by strong, double-digit year over year performance in industry-standard servers, storage, software, and services, as well as modest growth in our proprietary server market.

Our expanded portfolio and focus on selling total solutions has changed the mix of our business and we have increased our penetration into rapidly-growing market segments. Now over 60% of our revenues are generating from storage, software, and services segments.

Alternative Technology continues to post strong performance with year-over-year sales growth in excess of 50% for the third quarter in a row.

Our cross-selling initiatives continue to take hold, and year-to-date we have achieved almost $30 million in additional sales through our targeted pilot program with Alternative Tech.

We also announced the strategic acquisition of Centia and AKS group, one of Europe's leading specialty distributors of access infrastructure, security, and virtualization software solutions. The addition of Centia/AKS further diversifies our product portfolio in the European region and strengthens our strategic fox on software and solutions.

Our recent acquisitions are performing as we expected. As an example, they have contributed to our year-over-year improvement and return on working capital.

While we achieved strong topline performance with revenue near the high end of our guidance, our mix of products had an unfavorable impact on operating income. As was publicized by major suppliers in the market, uncertainty in the capital markets resulted in end-of-the quarter weakness in certain hardware lines.

We are making investments in the future growth of our business, such as the fast-growing markets of Eastern Europe and high-growth customer segments in North America.

Our strategy is resonating with our business partners at the highest levels. We are laying the groundwork and investing in the long-term to create some very exciting opportunities for our vendors and reseller partners.

Thanks, Kathy. Mike Long will now comment on our global components business. Mike?

Thanks, Bill.

In the third quarter we again gained market share and added to our industry-leading position. Our focus on continuously becoming more efficient provided us with an opportunity to drive down operating expenses again while investing in the business.

Some structural changes have occurred in our marketplace, causing us to shift the focus of our resources to make sure our costs are in-line with the market realities and we took specific actions in North America in the third quarter.

September was weaker than expected in Europe and the activity levels in our large EMS segment still remained below last year's levels. This led to an increase in competitive pressures in all regions.

In Asia-Pac, our business outgrew the market with strong sequential growth on the strengths of the mobile and LCD end markets. Our focus on the small and medium-sized customer segments, along with efficiency initiatives in the region, are producing consistent increases in profitability as we move closer to our operating targets for the region.

Our investments in this region have been recognized by customers around the world as Arrow Asia-Pacific received top rankings for the third consecutive year in EDN magazine's worldwide branding study.

In Europe our business was weaker than expected due to the summer holiday period, and September was slower than expected. Our performance there was led by central Europe and Nordic, where we continue to leverage our market-leading positions.

In the third quarter, we established an office in St. Petersburg, increasing our presence in the Eastern European region.

We continue to invest in efforts to broaden our existing customer base and drive for more consistent and efficient operations in the European region.

In North America we saw strength in vertical market initiatives as we achieved record sales in our lighting group and we continue to move ahead with strategic initiatives to further penetrate the small and medium-sized customer segment. Amidst the continued EMS weakness, the region successfully reduced operating expenses in the third quarter, and as Paul mentioned earlier, we have identified additional ways to better leverage our cost structure going forward. Operational efficiency is a continuous process and we're always looking for ways to consistently improve our operating performance while meeting the needs of our business partners.

Looking at the global trend, book-to-bill on a global basis increased sequentially to 1.04 on a worldwide basis.

Lead times remain stable and are still within normal ranges, between 8 to 12 weeks, and we saw no notable increases in cancellation rates. Our quarterly customer survey in North America indicated that the majority of our surveyed customer base continued to feel inventory levels are well positioned heading to the fourth quarter.

Looking forward we see normal seasonality for global components through this point in the fourth quarter.

Thanks, Mike. Let me close now.

Overall, this was a challenging quarter for us.

As I stated, we have and will continue to invest in the future growth of Arrow. That's important for us to do and it is important that we do not lose momentum.

Even though our performance was near record levels, however, we are not satisfied with the level of profitability this quarter. And we have as we always do taken steps to adjust our business model to reflect the ongoing market realities that we see.

We do believe that the profitability was more reflective of short-term market conditions, seasonality, and our conscious decisions to maintain strategic investment levels for the future and we fully expect to return to our industry-leading levels of profitability in the fourth quarter.

I would like to thank the entire Arrow team for their continued commitment as we move ahead with strategic initiatives and to build that very bright future that we all believe in for Arrow.

Looking ahead into the fourth quarter, we generally expect normal seasonality in both of our businesses. We believe that total fourth quarter sales will be between $4.15 and $4.45 billion, with Global Component sales between $2.65 and $2.85 billion, and Global Enterprise Computing Solutions sales between $1.5 and $1.6 billion.

Earnings per share on a diluted basis, excluding any charges and including estimated amortization of intangible assets of $0.02 to $0.03 a share, are expected to be in the range of $0.90 to $0.95 a share, an increase of 25 to 32% from last year's fourth quarter.

We are managing our business with strong financial discipline and we are continuing to pursue growth initiatives to ensure that we outgrow the market. We are confident of our ability to perform in any marketplace due to our strong global market position, our broad customer base, and our global scale.

We continue to invest in initiatives that will increase our ability to service our customers by entering new geographies, by expanding our product and market offerings, and by leveraging our cost structure to be able to provide enhanced services. And we will continue to create value for our business partners and our shareholders while we invest in the future growth and profitability.

Thank you, Bill. Please open up the call to questions at this time.

Thank you, Ms. Weaver.

[OPERATOR INSTRUCTIONS] Our first question comes from Matt Sheerin, Thomas Weisel Partners.

Yeah, thank you. My first question is in regard to the components business. You talked about -- there's several areas of weakness, Europe and also pricing pressure, yet your guidance implies a return to more normal seasonal patterns and if you crunch the numbers, it looks like operating margin will come back pretty nicely.

I know that you've got strength in the computer business, but just help us understand what's happening in Europe? Are you starting to see things come back there? And the also, are you continuing to see the pricing pressure on the components business, or is that starting to ease a little bit?

Mike, why don't you take that one?

Okay.

Well, Matt, one of the strengths of the our business is the diverse nature of our customer base and the breadth of the industries we cover. We've benefited from exposure to sort of the nontraditional or what I call some of the specialty markets that exist out there, you know,and that'd be the industrial, the military, the aerospace markets.

While we've seen the well-publicized weakness in the large EMS segment and how that affected our business, as you know during that time we've been working to increase our penetration in the small to medium account base, and I actually see that as the piece right now that will provide us the return to normal seasonality for Arrow in the fourth quarter.

Okay, and that book to bill you talked about, is it positive in Europe as well?

The book-to-bill, overall, for us, Matt, is 1.04.

Again, we did see softness in Europe. It was a little stronger than we had expected, and to be honest with you, that showed up in September as more of a negative than the typical bounceback that we get after the summer holiday. We have seen Europe slow from where it was before.

So it hasn't come back yet?

It has not come back yet.

Okay, but that's in your guidance. Okay.

And then so will that then also have a negative impact on your gross margin mix in the Components business in this quarter, or is that properly factored into your guidance?

I think the current guidance we've submitted does show any margin changes that we've talked about.

Okay. Just as a last question, on the computer business, you talked about product mix adversely affecting your margins. Could you be more specific about that?

Kathy, why don't you take that one?

Well, it was a weakness across multiple different product mixes, between technology as well as vendors. And as you've known, certain suppliers have come out that the uncertainty in the capital markets resulted in some end-of-the-quarter weakness in certain hardware lines.

And So it is across multiple vendors and across multiple technologies. Kevin, I don't know if you want to add anything.

No. I think that's pretty much clear.

But did it also impact rebates and other margin support that you get from vendors because of that? Does that play a role there?

No. At the end of the day, our rebates and our front end and back end compensations are things that we negotiate every quarter as everyone does in our industry, and we did not see any difference as a normal quarter would do in our front end and back end compensations.

Matt, one follow-on to that that might provide some additional detail.

One of the things that has clearly been going on and had been widely commented on is the shift between proprietary servers and industry standard servers. We have very strong results in industry standard and software and storage and services, and although we were positive in proprietary, we weren't as positive as we were in the other things. That is part of a longer-term secular trend that's been well focused upon. And that we think is certainly something that we've seen and we will continue to see.

At the same time, we saw more product mix exacerbated in this quarter really due to some of the uncertainties in some of the capital end markets. And again, that was highly publicized and we would expect that to be a more short-term impact as we would expect those markets to recover overall.

Okay. That helps. Thank you.

And we'll take our next question from Jim Suva with Citi.

Great. Thank you very much.

Can you talk a little bit specifically about -- I just don't get the profitability of ECS of only 3.3%. It's about the lowest in multiple years and it looked like sales came in.

Did you have to like more aggressively bid in to get that sale, or how should we think about that and what type of visibility do you have that that will return, because the 3.3% is very, very concerning.

I think there's two important things to think about here, and that's the nature of our product mix with the acquisitions, and then geographic footprint that the acquisitions have provided us and what that seasonality means to us.

Traditionally, third quarter is a soft quarter in Europe. Traditionally, third quarter is a soft quarter in certain supplier results and with the new mix of business that we have in ECS, I think that's part of the phenomenon that we're seeing in the third quarter and as we said, we expect the fourth quarter to return back to the levels of profitability that we've seen.

With the KeyLink acquisition, though, doesn't it change the mix a little bit, as I thought that was very accretive, and how should we kind of think of that, because a rebound to more normal when we're layering on a more accretive acquisition, I guess I'm just struggling to triangulate that.

I think if you look at the seasonality of the major products that KeyLink sales, that you will see that that seasonality tracks with our results.

And your visibility's calling for a return to normal for December?

Yes.

But, Jim, you bring up a good point, again. And one of the things that has occurred as a result of what we think are very strong strategic moves on our part, is that because of increased exposure to our European operations and because of the way our suppliers profile has changed, the seasonality of the business is probably more pronounced than it has been in the past. That's -- we recognize that and we are certainly taking steps to overcome that.

But one of the things that has happened is we've dramatically changed our profile over the last 12 to 18 months is that we do believe that seasonal trends will be a bit more pronounced in the future than we have seen them in the past, because of increased geographic, both exposure and opportunity in Europe, and also because of the mix shifts, which we overall view as very positive.

Again, we believe that a number of things came together in the third quarter, not only mix, but some uncertainty in end markets that made this a bit below where we would have liked and expected them to be, but we do fully expect to be back on track in the fourth quarter and beyond.

And quick clarification. When you say back on track, are you building in any type of discount for that softness that you saw the end of September from the -- you mentioned some of the tech spending softness, or are you expecting that to completely 100% rebound?

We are expecting normal seasonality and normal results in the fourth quarter.

Thank you.

And we'll take our next question from Steven Fox, Merrill Lynch.

Hi, good morning.

First of all, on the Components side, could you just be more specific on what you meant, Mike, when you said there was a structural change that caused you to shift -- that has caused a shift in focus in market reality in North America? Not quite sure what that means.

Yeah, I'm sorry.

As you know, we have seen business transfer from the U.S. to Asia, specifically around the large EMS customers, not only over the last year, but in prior years. And if you also look at the general market of North America, it's not projected to grow this year. While we're seeing the faster-pace growth in the Asian market and as a result of that, as you know, we've had to do some rightsizing in our business to become more productive. And we're going to continue to look for more opportunities to make that happen.

Was that a surprise in the quarter specifically, or were you just highlighting as a long-term trend continues?

It's a long-term trend that has started a couple of years ago and it's continuing.

I do not see the slowdown in it.

It is not in response to this quarter, but I think that's something that we have to attend to over the long-term to keep our business healthy and that's exactly what we're doing.

Okay, and then just one other question on components, what -- where, specifically, then, was did you see the increase if competitiveness? Was it among distributors, and if so, in what region?

Actually, what has happened is it's become increasingly competitive in all regions.

We saw Europe become more competitive after the holiday into the September time frame as the market did not come back as much as we had expected. The lack of the North American market in terms of overall growth has caused competitiveness there. And as you know, Asia has been a hotly competitive market from day one.

So I'm not saying right now it's easy in any market and wouldn't expect it to be for the next quarter.

But that's within the distribution channel competing, or you're saying there's general pricing pressure on top of that?

That's within the distribution channel.

Okay. One last question, please, Paul.

On the investment spending that you called out, how much of a drag was that on the quarter?

Steve, that's a competitive advantage for us that we're not quite ready to disclose because we have multiple programs around that. So I think we're going to keep that one in abeyance at this point in time.

Fair enough. Thanks.

And we'll take our next question from Brian Alexander, Raymond James.

Thanks. Just back to the Enterprise Solutions business, sorry to beat a dead horse, but your overall sales were basically in-line with your guidance and our estimates. Your profitability was 15% below expectations.

All I really hear about is mix shift within that business, which sounds like proprietary servers were not as robust as expected and one of your major vendor results supports that. But this has been happening for a while now and it doesn't seem like it was more pronounced this quarter than in prior quarters, so was there anything else besides mix that caused margin weakness in the computer business? For example, was there margin weakness within certain product categories, etc.?

And what gives you the confidence again that you'll come back in Q4 and beyond in this segment to your range of I think 4.9 to 5.3% operating margin given that we do have secular trends away from proprietary servers, your margins have been falling for the last couple of years and you're probably going to end up this year 50 basis points below the low end of that guidance? Thanks.

So I'll start on the first (inaudible), and I won't take personal offense to being called a dead horse, thanks.

But one very important part about our results in the quarter are the investments that we're making in the business and the acquisitions were just the forefronts of the investments that Arrow is making in the ECS business. We are making significant investments ahead of revenue, and that's on the front end on the selling motion as well as on the back end on our systems and integrating -- transforming our business to a solution sales model.

We , as we mentioned, we have moved over 60% of our sales coming from different markets of software, services, and storage away from the proprietary server market. So we're quite pleased with our progress there.

So to answer your first question, which is specifically, is it all margin degradation, and the answer is no, it's also conscious investments into the business.

I'm sorry, the second part I think is the secular

Well, I guess the bigger picture question here is is the range of 4.9 to 5.3 for your timeless business model still appropriate in light of the changing mix that you're seeing, in light of the increased investments, and kind of what's the time frame on when we might be able to achieve that if it's still a relevant range?

Well, we do -- we're very confident that we will hit our targets in 2008. And I also would encourage everyone to keep in mind that KeyLink is only into its second quarter of integration.

Alternative Tech and InTech have only been in the fold of the family for nine months, and the cross-selling initiatives and the full power of these initiatives to be leveraged in the system have yet to be realized.

Brian --

To be clear on the investments in this business, we're -- I guess we're investing in sales headcount and back end systems to -- I guess to accelerate the growth of existing franchises as opposed to investments in new product lines, new vendors, or new geographies?

Brian, this is Kevin.

We're making investments in the solutions area. It gets back to your comment about proprietary versus industry standard servers and blades. Let me comment on that one and then I'll go into our solutions initiative.

First, we do see Q3 slow down in proprietary, although we did have growth as an anomaly. We track our funnel, our pipeline, we talk to our suppliers, we have multiple data points that we look at to see, are these trends or are these anomalies.

We do believe Q3 is an anomaly.

Having said, we're very aware, as Bill said, that there's a secular trends towards ISS and blade, but what we're seeing and what we're delivering is blades and industry-standard servers sold in a solution methodology. That's blades with security software, virtualization, edge -- the edge layer, all of those capabilities and capacities brought by our acquisition of Alternative Technology in the U.S.

So we do think that our margins will improve -- come back to where they should be in Q4 and in '08.

Our solution selling approach that Bill mentioned, we continue to make those investments, particularly in mid-market where that route to market has not been clear for our suppliers, it has not been clear for our resellers. We have some compelling work being done there, some profound work being done there.

We soft-launched this week some of the low-hanging fruit on our mid-market initiative and we'll continue to roll out the more compelling components of it in Q1 of '08.

Brian, it's Bill again. Just a quick follow up on that.

I think what we saw in the third quarter were -- and this is why it's been a complicated and challenging quarter for us, is a number of things that really were short-term anomalies.

There are some longer-term trends, the switch from industry standard -- or to industry standard from proprietary, and a very conscious decision on our part to continue with what we believe are very powerful investments to change our selling motion and our go-to-market strategies. And we think those are the right ones to do.

All of that came together and we have results that were below what we would like them to be and we have every intention of getting those back on track for the fourth quarter and beyond.

We think we're on the right track and we think we know what we need to do and are doing those things, and we remain very bullish about the long-term opportunities in this marketplace.

Thanks, Bill. Just one last one on the components side.

I guess, why do we think we're seeing more competition now, given that it seems like inventories are as lean as they've been in a while in the supply chain, all the cycle indicators seem to be stable, your suppliers are generally reporting in-line results.

I heard you on the weakness you saw in September and Europe, but you said the competition was really broad-based. I guess, why do you think we're seeing it now and I don't know that we ever got an answer on Matt's question before. Are we seeing that competition continue at that same level into October?

Let me try to put your questions in order.

But in general, again, if you look at the PC -- or the results, a lot are around the PC industry, as you know, which has been absolutely on fire for a period of time here.

We do not really participate in the PC industry, so there's a difference there.

If you take a look, Asia has been competitive from day one, so that was no change.

The competitive nature in Europe, as I said before, as a result of the business not strengthening, has caused the channel to go after more orders more aggressively.

Also, North America, we have seen the competitive pressures pick up, especially around the high dollar volume products that require engineering that didn't exist before. And that's mainly because that market has not grown this year. And we have seen that in this quarter in particular, more aggressive pricing in the channel than we have seen in some time.

I would expect that to continue into October, as your question asked, Brian.

Thank you very much.

And we'll take our next question from Jeff Walkenhorst, Banc of America.

Hi, good afternoon. I wonder if we can talk-- a lot of ground has already been covered on the computing side, I may touch on that. But, Paul, could you talk about the organic growth? I think you mention that the overall pro forma growth if you back out the acquisition for the total company was 4%.

I actually have a number that's less than that that makes me think that maybe the numbers I'm including for the acquisitions are too high, so maybe the acquisitions, whether it's KeyLink or Alt Tech is underperformed. Can we talk on that for a second, please?

Jeff, we can help you offline with the actual details of the numbers you're using in your model, but when we looked at it we know Alternative Technology is up 50% year over year, as an example.

InTech is tracking exactly to the plan that we had for them as justification for the business model.

KeyLink's a little bit harder for us to delineate because we've merged it into our existing IBM business and segmented it a bit to get customers into the right place. But once again when we look at the business model what a we expected their quarterly sales rate to be, combined with our existing business, it seems to be tracking now to what we thought was going to happen.

So when we look at it, we think those three acquisitions performing at least to plan and in fact Alternative Technology, we know, is much better than plan, because there's no way we thought it would be a 50% growth rate year over year there.

And have the margins outperform with Alt Tech with the revenue strength on that front?

It's pretty interesting, the returns we had set as targets for Alternative Technology are in excess of the targets. So we're seeing good performance there also and the margins seem to be holding up pretty well in the core business there.

I would say that we're also being opportunistic so if there's a chance for us to take a larger sale with maybe a little less margin, we're willing to do that as long as the returns profile fit our overall targets and they're outperforming that also. So when we look at Alternative Technology, I see that as a real win for us, both from a financial performance point of view, and to Kevin's point before about a critical part of our solutions sell, where we're able to sell the entire solution to the customer, not just bits and pieces of it.

Okay, so on an organic growth basis, you guys believe that the ECS segment was up 15% year on year?

Yes.

Okay. We'll come back to that offline. But the last thing I'm kind of grappling with is the visibility given what happened in the third quarter and it seems like there may be some broader macro weakness than what has happened on Wall Street.

Are you seeing that at all kind of outside of the channels, your different data points, on the industrial side, or even aerospace? As you move in through October and into the fourth quarter?

Jeff, our comments around the capital markets are really driven towards the impact in the month of September they had on our computer products business. So if that's a question you're asking, are you asking about the components side, we haven't seen the components too much sentiment in the marketplace, because of the threat of a credit crisis in the month of September.

Right. I guess I'm talking kind of both components and computing. But you are confident based on your data points that you will see this sequential improvement in your margins come back up to a level in the fourth quarter?

Absolutely. The way the markets look today, we absolutely believe we'll be able to deliver in the fourth quarter.

Good luck, guys. Thank you.

And we'll take our next question from Thomas Dinges, JPMorgan.

Hi, good afternoon, guys. A real quick one for you.

If you back into it, you get maybe about $0.04 from the restructuring cost savings next quarter.

Is that kind of roughly equal to with a you guys think you're seeing on the pricing environment and kind of just the overall slowdown there, or is it even kind of a little bit worse than that? I'm just trying to tie these two together like a lot of guys are on this call.

That's a good question, Tom.

Tom, really what we looked at in the components world, we were not making these actions -- or taking these actions because of a perceived short-term pressure in the marketplace around competitive pricing.

We're taking these actions on a pretty regular basis and we've been doing it now for several years. The fact of the matter is that we do try to usually aggregate them so it's not death by a thousand cuts, but in fact we're able to go through a process that's very respectful of the employees and move people into either new roles around the company all at once.

So it really wasn't an action that we took in response to the short-term pressure we see in the marketplace, but as Mike mentioned, we're looking longer term to where we should be investing, what our cost structure should be, and what the growth rates are to make sure that we're positioned in the right marketplaces to be able to maximize profitability.

Okay. A quick one for Bill.

Obviously, you've been getting this question a ton of different ways in terms of whether it's macro weakness or whatever, but I'll ask you a different question, which is as you look at the environment you're seeing over the next 12 months, obviously you guys have done some timely acquisitions over the last couple of years, but the underlying backdrop has been you've had reasonably good economic growth globally, now that probably changes quite a bit, especially in some of the bigger markets here that you've already seen.

So what is the pipeline overall look like on the acquisition front as it seems like those are going to play a much bigger role for you guys continuing to drive earnings higher as the macro is probably a little bit softer as you look out over the next 12 months?

Tom, a couple of responses to that.

First of all, in terms of the acquisitions that we've made, I'd point out again that we are in the early stages of the integration of a number of those with Alternative Tech, with InTech, with KeyLink, with our new AKS Centia, and we would certainly expect to see improvements as those integrations take hold and we move much more towards the solution sale and that begins to have some real impact.

So, yes, we do expect some positives from that.

In terms of new acquisitions that are going on, that's obviously something that we don't comment on.

We clearly view acquisitions as a way to strategically accelerate our strategic goals and if there are attractive acquisitions out there that are accretive to earnings, that are affordable to us, that are operationally fit and that are strategically important, we are well-positioned with our strong balance sheet to move forward with those and will continue to look at those as accelerators.

I would also point out, though, that in terms of our organic growth, that we continue to outgrow the markets organically. We certainly did that in our ECS business very substantially, probably 2X, and while we may not have been clear in our components business, but as best we can tell, the data's not all in yet, we outgrew the market in the components business too, and continued to gain share, which we have done for a number of years. So we will continue to invest in the future.

Much of those investments will be paying off in the 2008 period and beyond.

We have tried to make our company as impervious as it can be to macro economic conditions by keeping ourselves in a strong financial position, by not getting jerked around by changes in interest rate or by short-term issues in credit markets and we think we're well protected on that, we think we're well protected on currency swings.

So we think we're in a good position. Clearly, we're not impervious to everything that goes on in the macro world. If the world goes into a recession, we will be impacted by that.

By and large, the world looks pretty good to us right now. There are clearly some issues in the U.S. The U.S. is not the driver of the global economy that it was a few years ago and certainly 10 or 15 years ago.

So as we continue to see strength in the Asian economies, Europe did appear to slow down a bit to us, but by and large that's still okay. So we think we are well-positioned and will make whatever adjustments are necessary to make sure that we deliver the results.

So I am -- I'm pleased with where we sit both from the acquisitions that we made, the acquisitions that we could look at through our very strong balance sheet, and the organic growth that we are generating and we will continue to make sure that we've got the cost structure in-line and the profitability structure in-line to deliver those results and we want to be able to do that no matter what the market conditions that we see.

That's really how we're trying to run the company. Long answer, I hope that helps you.

No, it does. Thank you very much.

We'll take our next question from Carter Shoop, Deutsche Bank.

Hey, guys.

A couple quick ones here. For the Centia, I think I'm pronouncing that correctly, and AKS acquisition, did that close and is that factored into guidance?

Yes, it's closed, and yes, it's factored into guidance.

Okay. And then in regards to both the depreciation and amortization, that was below my expectations, as was the interest expense.

Combined, that added about $0.03 sequentially to EPS. Can you comment on why both of those were down and what your expectations are for 4Q?

Yeah. Carter, let me start backwards with the interest. We expect our interest expense to be about the same level in the fourth quarter as it is in the third quarter.

The fact of the matter is that we had another really terrific cash flow quarter and we keep kind of saying to ourselves that we don't think we can keep this pace of improvement in how we manage all the working capital going, and then the team comes up with more creative ways of being more thoughtful in how we manage it.

So we're getting better performance there than we thought we could do, and we think that's very positive for us as we go forward.

On the depreciation and amortization, some of that's changing because of the impact of the valuation approach to the intangibles we are getting in the acquisitions. So you have up to a year to do that under the U.S. accounting rules. And we're working through all of that, so I think that the depreciation and amortization will be marginally higher in the fourth quarter than it was in the third quarter.

Okay, great. Thanks.

In regards to components, can you maybe single out the two categories, maybe what were their best and worst-performing product categories within components. Kind of a broad basis.

That's a question we don't like to answer because sometimes people can triangulate to suppliers, sometimes it's competitive. So we're probably not going to address that one at this point in time.

Okay. In regard to inventory turns, can you break out what they did sequentially by division?

Sure. I can absolutely do that for you, if you would like.

I can tell you that our inventory turns sequentially in Global Components went up by 40 basis points and that was really driven by our Asia-Pac business, as well as our North American business, both had improvements in turns.

Our European business had a flat inventory turns in components.

Great. Thanks.

And the last question for you, in regards to margin expansion, to get to the midpoint of guidance, assuming the midpoint of revenue there, it looks like about a 40-basis point margin expansion and I know a lot of different people have asked this question. Can you maybe talk about where you expect the largest sequential improvement in margins, be it either the components division or the hardware division?

Yeah, Carter, we definitely expect that to come out of the ECS business as one factor. Kathy and Kevin have talked about the seasonality that we'll get out of KeyLink, which will have a natural uplift. We'll see some payoff from the investments we made also, in the third quarter.

So that will have the biggest uplift for sure in operating income percent, but our expectations are that Mike and his team and Components will continue to drive improved performance there also. So we're pretty confident that both businesses will drive for improved operating income percent in the fourth quarter.

Great. Let me sneak in one more here.

In regards to the pricing pressure intensifying and most of the geographies, are you seeing that with most of your competitors, or are there just a couple of large competitors where you're seeing that environment intensify?

Carter, my response to that would be this is not a onesie twosie approach, this is more of a broader type of phenomenon we're seeing, so not just big, not just small, but just across the entire industry at this point in time.

Great. Thank you.

And with no other questions left in the queue, I would like to turn the call back over to Ms. Weaver for any additional or closing remarks.

Thank you. Before ending today's call, for those 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. Both the release and this presentation will be available on our Web site.

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

Thank you and have a great day.

Once again, ladies and gentlemen, that does conclude today's conference call. We do thank you for your participation. You may disconnect at this time.