艾睿電子 (ARW) 2008 Q1 法說會逐字稿

Good day, everyone, and welcome to Arrow Electronics's conference call to discuss their first-quarter earnings. As a reminder, this call is being recorded. At this time, I would like it turn the call over to Sabrina Weaver for opening remarks and introductions. Please go ahead.

Thank you. Good morning, everyone. And welcome to the Arrow Electronics first-quarter conference call. I am Sabrina Weaver, Arrow's Director of Investor Relations and I will be serving as the moderator on today's call. Today's call is available via webcast. To access our webcast, or future webcasts please visit our Investor Relations website and click on the webcast icon. With us on the call today, are Bill Mitchell Chairman and Chief Executive Officer; Mike Long, President and Chief Operating Officer; and Paul Reilly, Senior Vice President and Chief Financial Officer. By now you should have all received a copy of our earnings release. If not you can access our release on the investor sections 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 call may include forward-looking statements including statements regarding future financial results. These statements are subject to am inform 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 remark which is 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 free to contact us after today's call with any questions you may have. At this time I would like to introduce our Chairman and Chief Executive Officer, Bill Mitchell.

Thank you for joining us this morning, the first quarter was a challenge for us and did not meet all of our expectations. We achieved record-level first-quarter sales and working capital to sales and after exceptional cash flow performance in our 2007, we again generated positive cash flow in the first quarter.

We saw increasingly challenging and volatile market conditions during the quarter, particularly in the last few weeks, and primarily in our Enterprise Computing Solutions business. This in turn created headwinds for our operating performance. When we last spoke on February 7, we communicated that market conditions were cautious and the macroeconomic picture had become more negative; yet, business appeared to be more stable. As the fourth quarter progressed the turmoil in the financial markets increased to unprecedented levels, and as a result, we did not see the typical uplift at quarter end. This caused us to miss our guidance range for earnings per share.

In ECS, we saw mixed results with very strong growth in storage, software and services offset by weaknesses in all areas of our server markets. Our customer base reacted to the uncertain economic backdrop with caution at quarter end. This in turn led to lower sales volumes and margins and that, in turn, resulted in lower supplier rebates that impacted our results. As we always do, we took appropriate actions to adjust our cost structure to reflect existing market conditions. However, despite current market weakness, we are going to continue to focus on prudent investing in this business for the long term.

First quarter saw the launch of our mid market initiative, the announced acquisition of LOGIX, as well as the successful implementation of our global ERP platform in our North American Sun business. In components, we executed well in a market that continued with its cautious tone. After resuming year-over-year growth in the fourth quarter, conditions in North America remain generally stable. Our Asia Pacific business saw strong double-digit growth while conditions in Europe were soft with less-than-seasonal performance on a constant currency basis. Book-to-bill was above 1 globally with both North America and Asia Pac above 1.05 and we achieved a strong increase in design registrations in North America year-over-year, a very positive sign that customers were still designing new products despite the macro uncertainties.

We also announced three strategic acquisitions in our components world, ACI, to help strengthen us in our military aerospace operations, Achieva to help us in the ASEAN Asian region, and Hynetics to strengthen our capabilities in the emerging market of India. Though we did not meet our expectations, the Company is fundamentally sound both financially and from a market perspective. Our global scale and financial strength allow us to take advantage of opportunities to invest in both organic and M&A-related growth during periods of market weakness. And this is precisely what we are doing. As we previously mentioned, we announced four strategic acquisitions in the quarter.

We will continue to invest in the long-term future of Arrow to increase our opportunities in higher growth markets, to better leverage our global scale, and to further diversify our revenue streams. At the same time, we have taken steps to be more efficient in all areas of our business. I would note that we have done this on a consistent basis over many years, and we will continue to do so to be able to maintain our cost and capability structures in tune with the prevailing market conditions. Our strategic priorities for the future are clear and have not changed. We will continue to pursue transformational opportunities in Enterprise Computing Solutions. We will leverage our best-in-class capabilities throughout our Global Components organization, we will install world-class systems and processes to take us to an entirely new level of global operations and we will pursue significant growth opportunities across products, markets and geographies. And we will do this while continuing to manage the Company in a prudent, fiscally disciplined manner to increase profitability, maintain positive cash flow, and strengthen our already strong balance sheet.

Paul Reilly will now give you a more detailed review of the first quarter and Mike will discuss our business unit performance in greater detail.

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

As always, the operating information we provide for you should be used as complement to our GAAP numbers. For a complete reconciliation between our GAAP and non-GAAP results, please refer to our earnings release for the earnings reconciliation slide at the end of the webcast presentation. Sales for the first quarter were $4 billion, an increase of 15% year-over-year and a decrease of 9% sequentially. Pro forma for the impact of the KeyLink acquisition and related procurement agreement grew sales by 5% over last year. Global Enterprise Computing Solutions increased sales by 55% year-over-year and decreased 31% sequentially to $1.1 billion in a seasonally soft first quarter. Pro forma for the acquisition of KeyLink and the related procurement agreement, on our top line increased 6% over last year's first quarter. This represents the 17th consecutive quarter of year-over-year growth for ECS.

Server weakness led to lower-than-expected volumes and lower rebates this quarter. When combined with a lag in return on investments in growth initiatives, our operating margin came under pressure, decreasing 140 basis points year-over-year to 2.8%. Further improvements in managing our asset base and the scale provided by our North American acquisitions allowed us to increase return on working capital by 28% year-over-year. Global Component sales of $2.9 billion increased 5% year-over-year and 4% sequentially. In this uncertain environment, we remain focused on cost containment. We are able to decrease our operating expenses to sales by 20 basis points year-over-year. We remain very close to the financial target for Global Components with an operating margin of 5.5% in the first quarter. That is flat with the first quarter of last year in what is a more cautious environment this year.

Our working Capital Management also continues to improve as working capital to sales decreased 70 basis points year-over-year. In Asia Pacific, sales increased 20% year-over-year and were flat sequentially at $653 million, which is stronger than normal seasonality. Operating income increased by almost 47% year-over-year and combined with better asset management, return on working capital decreased 200 basis points year-over-year in this year's first quarter. In North America, total sales of $1.2 billion were up slightly compared to the previous quarter and flat with the first quarter of last year. Sales in our core customer base of small and medium-sized businesses increased 2% sequentially and 2% year-over-year while operating income for this customer segment grew three to four times the -- at the rate of sales growth sequentially and year-over-year.

We also increased return on working capital in this region by 18% over the same period last year. In Europe, sales of $1.1 billion increased 11% sequentially and increased 3% over last year's first quarter. Excluding the impact of foreign exchange, sales increased 8% sequentially but decreased 9% year-over-year as markets have weakened compared to the first quarter of last year. While year-over-year operating comps proved tough to beat, our continue to focus on the broad small and medium-sized customer base, combined with ongoing efficiency initiatives, allowed us to increase our operating margin by 70 basis points and grow earnings at twice the rate of sales sequentially.

Our consolidated gross profit margin was 14.6%, an increase of 70 basis points sequentially. Gross profit margin declined 90 bases points year-over-year due to the increased mix of business and global ECS from 20% to 27% of our total sales, as well as the impact of lower rebates in ECS. When you look at our core customer base of small to medium-sized customers and components, gross margins were flat year-over-year.

Operating expenses as a percentage of sales decreased 50 basis points year-over-year to 10.5%, the lowest first-quarter level since 2000. Our operating expenses as a percentage of sales in the first quarter were lower on a year-over-year basis, despite an increase on ERP spending of $3.5 million. Demonstrating our ability to drive costs down while investing for the long term.

In the back half of 2007 we identified $40 million of cost initiatives in our North American components group from centralizing certain back office operations and creating a shared service environment. We have messaged consistently that we continue to see opportunities to leverage our global scale and operate more efficiently. In the first quarter, we identified an additional $7 million of annual cost savings with our -- within our components business in North America and Europe, as well as our ECS business. Approximately $1 million of savings relating to these initiatives was achieved in the first quarter. This brings our total annual expense reductions announced in the last three quarters to $47 million, as we managed our business prudently to achieve even higher levels of operating efficiency.

Operating expenses in the first quarter include an estimated $3.8 million or $2.6 million net of taxes of amortization of intangible assets related to acquisitions. Operating income was $163.6 million, an increase of 5% year-over-year and a decrease of 20% sequentially. Operating income as a percentage of sales decreased 40 bases points year-over-year primarily due to a higher mix of business from ECS, lower than expected server rebates, server related weakness in both North America and Europe and a lag on return investments and growth initiatives in ECS. Operating margins decreased 50 basis points sequentially, primarily due to the aforementioned rebate and ECS server volume misses.

Our effective tax rate for the quarter was 30.5%. For modeling purposes, you should assume that our tax rate for the remainder of 2008 will be between 30 and 31%. Net income was $97.9 million, that's up 7% from last year, a decrease of 19% sequentially. Earnings per share were $0.80 and $0.79 on a basic and diluted basis respectively. This represents an increase of 7% compared to last year's first quarter on a basic and diluted basis and represents a record first-quarter level. So while our earnings per share are not where we anticipated, it would be this quarter, we did come in at a very respectable level of earnings given the economic backdrop. We believe we have created a floor in our earnings through reducing our cost structure, increasing our valuable costs, and diversifying our revenue streams.

This marks out 6th consecutive quarter of positive cash flow generation with cash flow from operations of $40 million. Our consistent ability to generate cash has enabled us to self-fund many of our growth initiatives. In today's financial market that is a clear competitive advantage. Our strong balance sheet and access to committed liquidity facilities provides with us a level of comfort that Arrow has the financial stability to perform and take advantage of market opportunities throughout the cycle. Focus management on working capital resulted on our return of working capital increasing almost 160 basis points year-over-year for the second highest first-quarter level since 2000. Return on vested capital significantly exceeded our cost of capital for the 17th consecutive quarter. We were able to decrease working capital to sales by 280 basis points compared to the same period last year.

Mike will now discuss our performance and business trend in global ECS and global components.

Thank you, Paul. Our enterprise computing solution product group saw mixed results for the first quarter. Storage, software, and services hosted impressive double-digit year-over-year gains, and we expect continued growth here given the strong underlying demand for virtualization in security solutions. Yet we experienced year-over-year declines in both proprietary and industry standard service -- servers as have been widely reported. The uncertainty of the macro environment has caused IT spending to soften and as a result, our customers base became more cautious with our server investments in the first quarter.

Server weakness led to lower-than-anticipated volumes and lower rebates. And a lag in return on investments in an organic growth initiative resulted in operating margin pressures. We planned our level of operating margin this quarter to be unacceptable and we believe we have plans in place to get it back to track on improving our profitability. One key element of our strategy is expanding our European footprint, which we began to do two years ago with the acquisition of DNS.

We have continued to make investments inform line card expansion and geographic expansion to increase our scale. This has impacted our progress toward profitability targets for this region, but we are on our way. On February 19, we announced the acquisition of LOGIX, an Enterprise Computing Solutions provider in Europe that will expand our pan European footprint into six new countries and diversify our suite of solution business almost doubling our existing line card in this region. The acquisition represents a key step in our European expansion and it will bring an extremely talented management team and provide us with the necessary scale to improve our operating performance in this region.

In addition, Andy Bryant, the new President of our Enterprise Computing Solutions group will be spending a large amount of his time in Europe to ensure we bring our performance up to the next level. Andy has over 25 years of distribution experience and one of the longest track records in Enterprise Computing Solutions distribution which makes him the perfect candidate to build a bond and further accelerate the success of our ECS business. We are all very excited about his decision to join us and I would like to take the opportunity to formally welcome him to the team.

This quarter, we also launched our midmarket initiative, dedicated to building a channel for vendors and value-added reversals to expand their reach in the mid market, which is the fastest-growing IT segment. Our mid market initiative offers VAR solutions customized for mid sized companies. Research and data analytics to retarget the right prospects, training and marketing and expert support. We are very excited about this initiative which will provide more insight into our opportunities here in the investor day on June 5.

I am also extremely proud to report that on April 1, we achieved an important ERP milestone. In North America Sun business of our enterprise computing solution group transitioned smoothly and is now operating on the Oracle platform without any delay in processing orders or shipping or receiving product. For more than 18 months, our project team has been planning, developing, testing, and training to make this vision a reality. This technology will create the infrastructure to produce best-in-class services to our partners and truly change the value proposition of ECS. We are rolling out systems that will fundamentally change how we go to market with data analytics and intellectual property that has not been seen before in the marketplace. This global system takes profitability tracking in the mid market from the dream to reality. We are extremely proud of our ability to deliver ERP on budget and on schedule. And we will take those key learnings from the Sun implementation to further improve our processes as we move forward with our implementation throughout our business units.

Our customer and vendor feedback on the conversion has been positive, and we look forward to the game-changing benefits this global implementation will bring to our business. We are laying the groundwork and investing in the long term to create some very exciting opportunities for our vendors, our reseller partners, and our shareholders. In Global Components, we executed extremely well in a cautious marketplace with sales at the high end of our expected range of $2.9 billion.

In Asia Pac, we achieved strong year-over-year growth in Taiwan, India, Australia, New Zealand and the ASEAN region. We again outgrew the market despite seeing softness in China. Our strategic expansion in Asia Pac continued in the first quarter as we closed the Hynetic and Shreyanics acquisition which is a leading components distributor in India.

This provided us additional scale to increase our profitability in the Indian marketplace. We also announced the acquisition of Achieva, a value-added distributor that will further strengthen our position in the ASEAN region and enhance our existing demand creation activities. Achieva's management team is a highly experienced -- and will be an impressive addition to our bench strength as we move forward with our growth and profitability initiatives in this very important region. We anticipate this transaction will also be immediately accretive to earnings.

In North America, we saw strong sequential in strength increase in book to bill in the first quarter and design registration showed strong double digit year-over-year growth. While customers may be cautious in the short term, they, too, are positioning themselves for the long term by designing new products to take advantage of anticipated future strengthening in the marketplace. Year-over-year softness in North America was driven primarily by weakness in the transportation end market.

Our defense and aerospace segment performed well again this quarter and in February we announced and closed a niche acquisition in the rapidly growing area with ACI Electronics. ACI is one of the largest independent distributors of electronic components used in the defense and aerospace applications. This acquisition further bolstered our number one position in North America defense and aerospace market and provided us with leading market share and many technology segments including military discretes.

In Europe, we saw conditions weaker in the first quarter. The European marketplace typically lags behind North America by two to three quarters and moderate conditions were expected. In addition to anticipated cyclical trends, the strength of the euro began to impact the competitiveness of the regions export markets which created additional headwinds for us in Europe. Through this market weakness, we are moving forward with our ongoing efforts to broaden our ongoing customer base and drive for more consistent and productive operations throughout the region.

Taking a look at leading indicators, our book to bill remained above 1 at 1.03 for the third consecutive quarter. Levels strengthened in North America and remained stable in Asia Pac. In Europe our book to bill materially weakened and the outlook here is extremely cautious at this time. We are carefully monitoring the conditions in Europe as we move forward. Lead times in pricing remain stable with lead times still within normal ranges of 8 to 12 weeks. Importantly we saw no notable increases in cancellation rates.

In addition the results of our quarterly customer survey in North America indicate that the majority of our customer base continue to feel their inventory levels are well-positioned heading into second quarter, yet their outlook for purchase requirements did soften. As we navigate through the current cautious marketplace, we will continue to build best-in-class capabilities while at the same time further leverage our global scale and take us to the next level of growth and profitabilities. Bill?

Thanks, Mike. Overall we had mixed performance this quarter on a cautious marketplace. While we achieved the high end of our guidance range in our components business our performance in ECS did not meet our expectations and we will not accept the current levels of profitability. We believe we have the right strategies in place. We have the right team in place to move forward with these strategies.

We will continue to manage our Company conservatively and prudently based on the changing market conditions while at the same time we will maintain or flexibility to take advantage of opportunities for organic market share growth and opportunities in M&A. We will continue to generate cash. Our balance sheet is in great shape. And we remain committed to investment initiatives that will position Arrow for future growth. With vertical market initiatives and geographic initiatives in Asia and Europe and further penetrating the small and medium-sized market place and in global systems to leverage our scale worldwide to transfer the way we do business.

At the same time we will take steps to be more efficient in all areas of our business to make sure that we provide premium returns for our investors and we will continue to manage the trade-off between a conservative and largely defensive posture versus seizing the opportunities that are all around us, short, medium and long term. That is what this team has shown it can do. And that's what we will continue to do.

With the start of the new year, the macroeconomic environment has continued to be under pressure. The commentary seems to have moved away from will there will be a recession to how long will it last. We have been monitoring our leading indicators very closely, and we are keeping a close watch on trends with our customers and suppliers. And we will adjust as necessary to mean and to increase our competitive position.

Looking ahead into the second quarter, we anticipate that our server business will continue to be under pressure worldwide and that the components market in Europe, a high margin region for us, may continue to soften in the second quarter. We believe that total second-quarter sales will be between 3.85 billion and $4.15 billion with Global Component sales between 2.70 billion and $2.9 billion. Global Enterprise Computing solution sales between $1.15 billion and $1.25 billion. As a result of this volatile outlook, we expect 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 to be in the range of $0.74 to $0.80 a share, a decrease of 1 to 9% from last year's near record level of second-quarter earnings.

As I often say when I am asked questions by the investment community, I truly like the hand we are playing. This is true today even in the midst of some of the most challenging conditions we have seen in years. We are confident of our ability to perform in any marketplace given our financial strength, our leading market position and our broad supplier base and our global scale. I would like to thank the entire Arrow team with their continued commitment as we move ahead with our strategic initiatives and build a future for Arrow. We will continue to create value for our business partners and our sharehold as we manage prudently and wisely in the short term while continuing to invest in future growth and profitability.

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

Thank you, Ms. Weaver. (OPERATOR INSTRUCTIONS) We will take our first question from Brian Alexander with Raymond James. Please go ahead.

If I can just focus on the computer business. Your guidance for June, 9% sequential growth at the midpoint, that is obviously below seasonality of 15% to 20%. Sounds like most of the weakness you are seeing in that business is server driven. And my assumption is that that business is declining year-over-year, but when I look at your largest vendors' results they have already reported, they weren't very good in aggregate, but they weren't down. So I guess -- we haven't seen another one of your big vendors report yet, but my question is, how broad based is the weakness you are seeing in the server business? I think, Bill, you alluded to earlier across midrange and industry standard, but can you give a little more color on the rate of decline you're seeing between each of those platforms? Is it across vendors and then just remind us how big of a percentage of the computing business is the server category? And then I have a follow-up.

Brian, I am going to ask Mike to answer that. He has been digging into that business and can give you the best answer.

Sure, Brian. We did see server demand - materially soften in the first quarter. That was noted by one of our major suppliers, and we really anticipate that our server business will continue to be under pressure. As a result, that is why we see a little bit less than normal seasonality in the top line for the second quarter. The server business for us is around the 40% range so it does have an impact on our business overall. And I believe it will have an impact. Now having said that, as you know in virtualization, it takes more storage and more software. So with those servers, we do get an impact of good growth in software sales and in our storage sales, and I would expect those to continue being strong, but the server area is the area where we are experiencing the weakness.

And so, Mike, you are viewing this as virtualization driven weakness for the industry as opposed to maybe a more Arrow specific issue with more of your exposure being proprietary which is lower than industry standard. Is that fair?

No I -- I am sorry, Brian. What I would have to say that virtualization is causing the increase for us in software and in storage. We did see some push-outs in the first quarter, and believe that it is really not slowing, but the pushouts were due to customers waiting a little longer and sort of seeing and assessing the marketplace, and I do believe it is economy-driven, not technology driven and not virtualization driven.

Okay. And maybe just one other question on the computing business. Are any of your major vendors changing the rules of the game such that your profitability is going to be structurally lower than it has been? Or are these -- are these profit challenges really just really short-term volume and rebate driven?

What I would say, Brian, is -- as you know, I have been in this business longer than I probably care to admit. The suppliers have not changed their rebate programs. The best I can tell for around 15 years. This has been an extremely stable model. I expect it to be very stable. Our performance was not good in servers due to the economy and probably some of our own doing. And the model is based on really consistent sales and sales growth. So when you have a downturn like we had in Q1, we not only lost the margin from the volume of the sales that we had, but we did see lower rebates. This was not due to any change that our suppliers have given us in a rebate program. Those programs have been very table. We do know how to operate within those programs, and I equate it to pure volume in the first quarter.

This will be my final follow-up on this. Typically in a situation like this, Mike, where volume is below expectations and you miss rebates you go back to your suppliers and renegotiate those levels so that in future quarters you could restore your profitability. Yet, when I look at your June guidance from an overall perspective it kind of implies maybe a little bit of an increase in margins that is more seasonal in nature but it does not imply that you get closer to the run rate that you guys have been achieving. Can you walk us through whether these rebates are permanently lost or how quickly can you get the margins back up to where you are comfortable?

Well, when the environment stabilizes, obviously at this point in time, we are in negotiation with our suppliers, but the outlook for the server market to us is cloudy. And when you have a cloudy environment going back and negotiating the proper levels for rebate, it is also cloudy. And while we are expecting it to improve, this isn't anything where the suppliers are pulling back and not willing to work with us, but I believe it is purely market conditions, Brian.

Okay, thank you.

Brian, it is Bill. Just to follow-up to that. Just to emphasize the point that Mike has made that no structural changes in the marketplace. Misses were due to volume and that's a double whammy effect. When you miss volume, you miss margin and then you miss the rebates. We have ongoing discussions that are daily, weekly, monthly, quarterly about the structure of the markets with our suppliers. We have had great relations with our suppliers. Those discussions are ongoing, but the market is quite cloudy right now and that's what we are trying to reflect in terms of our guidance.

Thanks, Bill

We will take our next question from Steven Fox from Merrill Lynch. Please go ahead.

Hi, good morning. Just going back over the disappointment on the server side. Bill, you threw out a couple of sound bites about the turmoil in the financial markets and how customers reacted to that turmoil, but you don't have a lot of customer in the financial vertical. So can you sort of dig into that a little bit? Why all of a sudden -- are they seeing changes in their own business, anticipating changes, are there changes in capital spending plans? I am not sure why the sudden change in something like servers at the end of the quarter.

Steve, it is a terrific question. And here an opinion, and it is an opinion. I think that what has happened is that the turmoil in the financial markets -- and you're correct, we do not have correct, we don't have a large exposure to the financial market -- we have some but it's not a large exposure to the financial market places. What I think has happened is particularly in our business enterprising business, these are capital purchases. Long-term capital purchases and the market has gone conservative. That people are saying I am going to wait.

I am going to see what is going to happen. It is not particularly prevalent in my business yet, but -- but I am worried and I am concerned and, therefore, I will push some things out. That is where I fundamentally think we are seeing. That people just simply have gone cautious over the last quarter and got increasingly so in the face of the drumbeat of negative news that you read every day in the -- in the financial press. And it is true. So I, though I made the argument last quarter that we havdn't seen any spillover from the financial turmoils into our marketplaces, they appeared stable, I think what has happened -- again it is my opinion, is that the markets got conservative. They pulled back on capital expenditures, and our part of the business that would primarily be related to servers and -- I think that's what we project going forward.

Okay. That's fair. And just a question on the growth numbers. Just so I am clear. If I look at total sales growth over year excluding acquisitions and excluding currencies. What would that number be. Then just to make sure I am also clear. In terms of the acquisitions you have announced in January and February which ones were in the quarter? Which ones were in the guidance? And which ones were yet to be in the guidance?

Hey, Steve. It is Paul. If you exclude the impact of foreign exchange, 1% to 2% up in sales year-over-year. When you look at our guidance it does not include any of the announced but not closed transactions. That will exclude LOGIX as well as Achieva. And then what we have is ACI was in for a one month in in Q1. They will be in for a full quarter obviously in Q2. Hynetics was in -- obviously Hynetics, a very small transaction relative to the Big Arrow was in for about two months in Q1. Will be in for all of Q2.

And ACI was pretty small also, right, $60 million.

ACI's run rate last year was $60 million.

Okay. Thank you.

We will take our next question from Matt Sheerin with Thomas Weisel. Please go ahead.

Yes, thanks. I just want to follow-up on the questions regarding the computing business. You did talk about weakness in demand certainly and that looks like it is in your guidance but can you talk about any market share losses that you may be seeing in that business. You just put in a new President so you . replaced the management team there. There have also been reports of losses for our customers. So could you talk about why they made the management changes? Whether or not you are losing any big customers. Is that factored into your guidance and should we expect any changes to the structure of the business or strategy going

This is Mike. I will take that one. We did have a loss of a supplier, Symantech, that I think you are aware of, that is probably what you are referring to. And really with that our portfolio solution is really continually changing. Symantech is currently undergoing a series of changes in their channel strategy. While we no longer carry those lines, we can provide our resellers with similar solutions from Comvolt, McAfee and BlueCoat. Which are lines we have engaged with. We lots of time don't talk about our additions and we have campaigns to replace that business. So we are not expecting any slowdown from that in the second quarter if you will. As far as customers go, I think you've probably heard there are ins and outs every quarter of customers that leave and customers that come. And we are not expecting any decline in our sales as a result of any customer losses in Q2.

And the reasons for the management change?

Look, I think there is a piece here that we have a business that we don't make any decisions based on any short-term or quarterly performance, if you will. This business has really evolved from a $2.5 billion North American operation to a $5 billion global enterprise in really a short period of time. And with that the transformation sometimes needs a change in leadership. With Andy, we believe we are bringing on board a well-trained, well-seasoned veteran. Andy has over nine years of enterprise experience and 25 years in the distribution business. And he has built an integrated European operation. So I would call it more of a normal transition if you will for an enterprise that is growing this quick.

Okay, thank you. Then my second question regarding components. On Europe, you sounded pretty terrible about what you are seeing there. You said the book-to-bill was weak. Could you tell us what the book-to-bill was? And also how much of that do you think is just customers maybe going around the channel for better pricing or is it just the weakness you are seeing in -- across the markets.

Well, we are seeing the -- that the market has clearly weakened both due to normal lag behind North America and due to the euro strength which is impacting their export competitiveness. We anticipate that the components market in Europe which is a high-margin region for us will remain soft into the second quarter. And during this time, we will continue to drive our results by broadening our customer base and really working ourselves toward more sufficient and consistent operations in the region. We will continue our plans in Europe, but we do see a softening.

What was that book-to-bill, Mike?

The book-to-bill has clearly gone below 1.

Okay, thank you.

Matt, it is Bill. A quick follow-up to that. We have not seen any indications of anybody going around the channel. I don't think we've see that anyplace in the world. In fact quite the contrary. We are seeing stronger relationships worldwide with virtually all of our suppliers with recognition of the value of the channel. I think what we are seeing is just generally weaker market conditions in Europe right now and it's very incredible given the strength of the euro, the lag time with the U.S., other economic factors that are -- that we have seen before.

And as you are seeing that competitive environment and softness across the board, are you seeing pricing pressure? And when you are, are you getting any sort of margin support from the suppliers? Or are you on your own there.

I think, Matt, what -- what Paul said and it is really the operative term is that in -- on a like-to-like basis across our North American and European component businesses, margins have been quite flat for some period of time. Is the business competitive out there? Absolutely. Is it getting more competitive? You bet, , it always does. But our margins on a like-to-like basis products into end markets and geographies has remained relatively flat. Our shift in margin as a Company has been entirely due to the mixed shift between our business units that have different structures around

Okay, great, thanks

We will take our next question from Jim Suva with Citigroup. Please go ahead.

Great, thank you very much. Can you talk a little bit about linearity. What I mean is starting points. When you started to see that fall-off in March, and just kind of how the first three weeks of April has progressed and then importantly, this quarter as we look at it, is it significantly back-end loaded with Sun and are we looking at another opportunity here for risk of you missing.

Jim, it's Paul. A couple of points on that. We did see as Mike mentioned and Bill mentioned a drop-off in the month of March. The computer business in general the last month every quarter is the biggest month. So saying how the first three weeks of April is a bit of a -- a bit of a fakeout if you will because there is not that much activity going on. So we did see a drop-off in March. It's the strongest month of the quarter just like June, September, and December are. I would say that while there is always the opportunity for macroeconomic conditions to change, we are taking a conservative view to what is going to happen in the marketplace.

And, Jim, just to follow-up on that. There are some normal seasonal trends at play here. They play out differently by region and they play out differently by business unit. Clearly in our enterprise group, we benefit in the fourth quarter from the year-end closes for two of our largest suppliers, HP and IBM. The second quarter benefits from the year-end close for Sun and so we see some impact on that. Normal seasonal trends in our components business. The first quarter in Asia is typically down a bit because of the lunar new year. Ours was flat and up strongly on a year-over-year basis. Europe is typically up in the first quarter and then down in the second quarter in components due to fewer shipping days and lots of holidays that come non Europe. We expect to see that. North America is typically slightly down in the second quarter from the first quarter again due to fewer shipping days.

So it is probably a long way around to say there are a lot of things going on. There is seasonality. There is year ends for customers and then there are market conditions. And the market conditions are overlaying at this point in time and having some impact particularly in our -- as we said in our server markets. Where we do see some cloudiness and uncertainties in our European component marketplace is where we see greater-than-normal seasonality.

Exactly. But just to clarify, does your guidance include a continued deterioration in the macro environment? Or stabilization or some type of pickup? I am trying to assess the risk of a potential, another risk of a miss versus is there some type of buffer if things continue to soften.

Sure, Jim. Let me see if I can take a shot at that one. Again, it is mixed. In Asia Pacific we think things are stable and normal seasonality and we are on a strong run there. In Europe we see there is a good chance for continued softness, and we have certainly built that into our outlook. In North America, we think it is relatively stable, but it has been at a pretty low level for some -- for some period of time. If you notice we have had essentially no growth in North America for a couple of years, and so that is stable but at a relatively low level. In our ECS business, as we say, we see very strong business in software storage and our services business. That is about 60% of our business and so we would expect to be in the normal range there. But 40% of our business is in servers and we see weakness worldwide in both the industry standard, as well as the proprietary servers. There has been lots that has been remarked about the secular shift from industry standard -- to industry standard from proprietary. We certainly see that, but at the same time, there is just the weakness across the server market. And we have reflected that in our -- in our good guidance.

Great. Just on inventory it ballooned up 7% quarter over quarter and you are expecting sales to decline next quarter. Can you talk about inventory, do you intend to work it down or did you get stuck holding the bag there? And thank you very much.

Jim, I will take that question for you. In fact when you look at that time, over half of that increase is due to changes in foreign exchange as well as the inventory we bought on for the ACI acquisition. The rest of the inventory when you look at it, inventory turns were actually up year-over-year. Our components business by 20 basis points. So, no we didn't get stuck. No we didn't see a real issue there, just a combination of factors to be able to meet the marketplace in Asia Pac, as well as as I mentioned foreign exchange and acquisitions.

Thank you very much, everyone.

We will take our next question from Will Stein with Credit Suisse.

Thanks. I was wondering if could you comment on the relative -- on the leading or lagging effect between the two businesses that you are in? Do you see the server weakness as potentially a leading indicator for what could go on in semi demand or is the the other way around or is there no good leading lagging effect there.

Well, it is a good question. I personally don't think that they are -- that there is a strong correlation. We have never seen it and have no reason to believe. They are really very different cycles. The server cycle is driven by the capital expenditure cycle. It is driven by CIOs in enterprise and small and medium businesses who are making decisions to create the kind of systems and solutions that they need to meet their market. So it is a much broader indicator of overall economic trends than would be the semi cycle.

The semi cycle, as you know, we have argued for some period of time has changed -- we believe has changed in its depth and its complexity. We think cycles are shorter and shallower. We think that the supply and demand remains in better balance. The channel is still in good shape overall from supplier through to distribution through the EMS companies through end customers. But we simply don't see a correlation there. That is really built on the specifics of individual markets and what they need in the way of new electronic gear, whether that be in the military aerospace field, whether that be in industrial controls, whether that be in automotive or transportation or consumer electronics, all of them have some different rhythms to them.

We participate broadly in those, and that's a good thing if -- because it buffers us from -- from a downturn in one particular one. But -- but, again, I simply don't see a strong correlation between the semi cycle and the -- our enterprise computing cycle. One of the reasons why we invested in the enterprise computing cycle quite frankly, was to make sure that we decreased the dependence on the semiconductor cycle for consistent earnings, and we still think that is the right decision.

Okay, great. One other -- I wanted to address this rebate issue again. I think we all know that one of our big competitors stated that at least one of their system suppliers changed the rebate formula, if you will, at the beginning of the quarter, and they kind of got caught in that. What we are hearing from you guys is haven't changed in 15 years. Is it, perhaps, because of different -- different agreements or different supplier relationships or different geographic exposure or is this kind of no clue what is going on in terms of difference--?

It could be a lot of factors, the overall macro rebate policies have not changed. From time to time there is a rebate that gets put in for the launch of a new product. How fast we can take that product to the mid market to the VAR community and sometimes there are incentives for those type of things. That can get negotiated regionally, if you will, but it typically is the same for every value-based distributor. My guess is what you are alluding to could be a mix or a change between the two companies and how they operate, what their sales volumes are by region, but, again, we have seen a stable approach to rebates. haven't seen significant changes in the rebates. And believe that it is truly a partnership with us and our suppliers and haven't seen that change in any way either.

Great. Thanks, guys.

We will take our next question from Mark Moskowitz with JPMorgan. Please go ahead.

Thank you, good morning. Two questions. Paul or Bill, can you kind of maybe comment on your overall suggestion that we are going to go into a market contraction at least in the near term, but can you maybe comment on what type of puts and takes you have within your model to introduce some buffers. I know you probably don't want to include how explicit they are as part of your guidance, but can you increase feet on the ground or sales and marketing in certain segments or certain regions where you do have opportunity right now and maybe chase revenues to offset what is going on in the server, in the euro component environments.

Mark, it is Bill. It is a great question and it is one that we are dialoguing potentially thin the Company. It goes as follows. First of all, market conditions are clearly volatile and they clearly are not as positive as they were a few months ago or six months ago. So that says, let's take the steps that we need to make sure we've got our costs in line, that we have our capabilities properly deployed, et cetera. And that's marginally a defensive position that says make sure we put a floor under the profitability of the Company, we continue to generate cash. We continue to keep a strong balance sheet, et cetera. That is all good and we are doing that.

The opposite side of that says, you know, in down markets, there are always opportunities, and there are opportunities for organic growth, and we have a number of terrific opportunities across all of our business units and across all of our geographies and across all of our product segments to generate organic growth. So we are going to go after that, we simply are not going to cut back on field facing, sales-related kinds of activities. We are going to go after that, we compete are not going to cut back on field facing, sales related kinds of activities. We're going to go after it and compete aggressively for the business that in fact, is out there and we think we have a good chance of getting it. We do believe that the strategic initiatives that we have in place, things like the midmarket initiative in the ECS business, which is all about generating additional sales to -- to small and medium customers or the small and medium customer initiatives in -- within the Global Components group are attractive and we will continue to focus on those. We do not expect to back off on our global ERP efforts. These are transformational activities that are -- are truly important to the long-term future of the Company. We had out first big success this quarter and we are on track, on budget, and on time to roll that out, and we think that s going to give us substantial competitive advantage when it is fully completed.

Finally, we have seen the M&A activities where we have been able to use that strong balance sheet and our strong cash flow to go out and make some very strategic acquisitions which we announced four of them in the first quarter and we will continue to look for them where, again as always we look for the operational fit, the strategic fit and then the financial fit.

So the challenge for the management team and I absolutely believe in this management team is to maintain ourselves prudently and conservatively and manage for the economic realities that we see so that in fact we do stay profitable, we do generate cash and have a strong balance sheet while remaining absolutely open and flexible to the opportunities that are there for organic growth, for new market initiatives, and for M&A types of activities. That is the challenge, and it is a big one, and I think we are up to it.

Sure. As a follow-up -- I appreciate the expanded response. As a follow-up, can you give us a sense then, Paul, in terms of the $47 million in the annualized savings. Could a decent or meaningful amount of that be devoted to what Bill has commented in terms of front line support?

Yes, Mark, that's a good follow-on to that question. We have seen many of the -- if I break that down there's $47 million in total. $40 million of which we had squeezed out of the business by the end of the year and so you're seeing some of those benefits in Q1 and we'll some of the benefits from the $7 million in Q2. The one thing that we definitely remain focused on. It's interesting we refer to creating a shared service environment, if you will, is our focus is making what you might call the back end of the business more efficient, more effective while not impacting customer facing and supplier facing positions. So we do not want to see fewer salespeople. We want to see more salespeople. We want to see more productive salespeople because that is where the action takes place. That's really what we are focused on is how do we get right sized internally in the back end without it impacting those forward-focused people.

And then just lastly, I know folks like to always focus on the very near term, particularly given the negative environment we are facing, but trying to see the silver lining, I want -- it is kind of a loaded question but I want to get a sense in terms of your business development efforts. Are you guys actually seeing increased activities where because of your strength and your market position and your cash position that you actually have an increasing level of discussions with potential takeout candidates as part of your acquisition strategy?

Another terrific question. The answer is that we are always looking at potential acquisitions. Our pipeline is quite full right now. We are having increased opportunities. We think that those are attractive ones. We have a rigorous and disciplined process for looking at them. And I believe we are quite good at identifying them and bringing them in, integrating them and creating the value from them. But as you would expect, and, again, it sounds a bit like a cliche, but it is true, that in some down times, the strong can get stronger and the weak look for exit strategies, and then I think we are part of the strong, and we are going to continue to be looking for those opportunities and those pipelines are quite full right now.

Thank you.

We will take our next question from Louis Miscioscia with Cowen & Company. Please go ahead.

Okay. Thank you. I wanted to ask I guess about the disconnect between servers and storage. I mean in general those are the two areas that obviously most had talked about holding up the best. And you were mentioning obviously that storage was doing pretty well here, but obviously you mentioned a couple times how servers are weakening. Maybe you can give us the thoughts about the drivers behind storage and whether you think that will hold up as we go through the year?

Sure, well, when you virtualize your systems, you are really displaying the need to have less servers, if you will. The requirements when do you that are more storage and more software. So really if the demand can stay up in servers, that will cause an explosion, if you will, in server or in storage and software. So despite the fact that the market has slowed on the server side, the ratio between software and storage is very high, so that's -- you are still seeing quite good demand in those areas. Does that help you?

Okay. Just to sort of follow-up that a little bit. When you look at virtualization, do you have any feel of how many of your customers have actually deployed it? The sense is that obviously it is a huge trend that is going on right now but a lot of companies are still in the deployment phase, and you would actually think that given the incredible ROI that they are getting on that, that it would be something that they would not defer, and it would actually be getting rid of all that three-year-old and four-year-old equipment out there given the savings they can get or maybe in the SM, small-medium business space it may not be as prevalent as the bigger companies.

Lou, it is Bill. Let me give you some of that. First of all, we think there is an enormous opportunity in the virtualization space. We think that less than 5% of our available customers have in fact virtualized their environments, and we see that as a very strong positive for us. We also think that when you get into a period of weakness, the thing you probably pulled back on first is your server refurbs. You will continue to move on storage and software kinds of things because you need those to run your businesses and as business comes back exactly as you say we would expect the server part of the business to come back to its more normal growth levels and that will accelerate the growth in the software and storage part of the business. There really is a nice story in there that we will participate -- we do believe the server market will come back. We are not quite sure when. When it does come back, we will have very accelerated growth in the software and storage parts of our business. And we are showing strong growth there right now in spite of the weakness of the server market. That is the silver lining there that is sitting in there that it will come back and it will be good for us.

Okay, thank you.

This will conclude today's question-and-answer section. Miss Weaver. I will turn the conference over to you for closing comments.

Thank you. Before ending today's call, for those participating in today's webcast, we will quickly scroll through a few slides referenced in our website that contain a reconciliation between GAAP and adjusted results. This reconciliation is also included in our earnings release and both the release and this presentation will be available on our website. We would like to thank all of you for taking the time to participate in our call this morning. And as always, if you have any questions, please feel free to contact Paul or myself. Thank you and have a great day.

Ladies and gentlemen, this will conclude the Arrow Electronics conference call to discuss their first-quarter earnings. We do thank you for your participation, and you may disconnect at this time.