艾睿電子 (ARW) 2010 Q2 法說會逐字稿

Good day, and welcome to the Arrow Electronics conference call to discuss their second quarter earnings. As a reminder, this call is being recorded. At this time, I'd like to turn the call over to Greer Aviv, for opening remarks and introductions. Please go ahead.

Good afternoon, everyone, and welcome to the Arrow Electronics second quarter conference call. I'm Greer Aviv, Manager of Arrow's Investor Relations program, and I will be serving as moderator on today's call. If you would like to access today's call via webcast, please visit our Investor Relations website at www.Arrow.com/investor, and click on the webcast icon. With us on the call today are Mike Long, Chairman, President and Chief Executive Officer, Paul Reilly, Executive Vice President of Finance and Operations, and Chief Financial Officer; Andy Bryant, President, Global ECS, and Peter Kong, President, Global Component.

By now you should have all received a copy of our earnings release. If not, you can access the release on the Investor Relations section of our website. Before we get started, I would like to review our Safe Harbor statement. Some of the comments to be made on today's call may include forward-looking statements, including statements addressing future financial developments. These statements are subject to a number of risks and uncertainties that could cause actual results or facts to differ materially from such statements for a variety of reasons. Detailed information about these risks is included in our SEC filings. We will begin with several minutes of prepared remarks,which will then be followed by a question-and-answer period. As a reminder to members of the press, you are in a listen-only mode on this call. But please feel free to contact us after today's call with any questions you may have. At this time, I would like to introduce our Chairman, President and CEO, Mike Long.

Thank you, Greer, and thanks to all of you for taking the time to join us today. The second quarter was another outstanding quarter for Arrow, as we achieved record-level second quarter revenue and earnings per share. Both business units drove the strength in this quarter with continued strong momentum in Global Component sales, which increased 44% year-over-year, and better than expected sales growth of 21% year-over-year in ECS. In addition, our cash flow generation was very good, and came in well ahead of our expectations. Operating income growth substantially out paced sales growth on both the year-over-year and sequential basis.

Our operating income margin reached the highest level since the fourth quarter of 2007. Earnings per share, more than tripled year-over-year, substantially ahead of our revenue growth. And we also set a new record for return on working capital, which exceeded 36% in the second quarter, and is more than two times greater than a year-ago level. The return on invested capital is also near record levels. These results clearly demonstrate our commitment to sales excellence, operational excellence, and the ability to maximize shareholder value. Time and time again, we have proven our ability to manage well through cycles.

As you will hear more in detail later in the call, all of our components regions contributed to the superb second results and we continue to see and upward trend in growth margin. Both the Global Components and the Global ECS businesses posted sales ahead of normal seasonality. We're especially pleased with our Enterprise Computing business with their better than normal seasonal sales growth, driven by good double digit growth in practically all of our products. Our teams around the world have worked diligently to deliver industry-leading results in what is still a recovering global economy, and their dedication to Arrow has certainly paid off.

Following the end of the second quarter, we achieved another milestone in our Global ERP implementation, with the successful Go Live in our northern European components business on July 6th. As a result of this Go Live, the global components team in northern Europe is now managing critical activities, such as demand creation, quote to order, order to invoice, and other crucial processes with the new system. More importantly, we have not missed an order, receipt of inventory or shipment in northern Europe this month.

The transition in this region was seamless, thanks to our CIO, Vin Melvin, and his global team for a job well down, and to Brian McNally and the European components team for ensuring a true partnership with the IT team, all working for our collective success. As we have previously mentioned, the pace of activity in northern Europe is 10 times the pace of activity that we had in the implementation of the Australia-New Zealand conversion. Our solid cash position, and strong balance sheet has enabled us to continue to invest in initiatives to grow the business, including our vertical markets, geographic expansion, expansion of our value-added services, and our global ERP implementation.

We also increased our investment in inventory this quarter, as lead times remain extended, and the supply chain is constrained. We're working to smooth the supply chain for our customers, and to keep production moving. During the quarter, we completed the acquisition of Converge and Verical. As well as announced and completed the acquisition of Sphinx Group Limited, a UK based value-added distributor of security and networking products. The addition of Sphinx strengthens Arrow ECS, by bringing increased scale to Europe, and then additional expertise in the high-growth security and networking information technology markets, in addition a highly talented team and expanded line card. Cumulatively, these acquisitions are expected to be accretive to earnings by $0.05 to $0.10 per share on an annual basis, in addition to the $0.10 to $0.12 accretion from the AE Petsche acquisition we closed in December of 2009.

I'll now turn to our business results. Global component sales of $3.3 billion reached a new record level, and were ahead of normal seasonality, as we saw exceptional sales growth in all of our components region in the second quarter. The Americas, sales continue to rebound, and we are now approaching levels last seen in 2001, driven by strength in both the semi and PEMCO businesses. Operating income in the region more than doubled year-over-year. Our focused efficiency initiatives in Europe and improving conditions in the region resulted in impressive year-over-year sales growth, while operating income had been extraordinary compared to this time last year. Asia Pacific posted its second $1 billion sales level, a record level of operating income dollars. The upward trend in gross margin for the global components business carried into the second quarter, as gross margins expanded 170 basis points year-over-year, and is up 40 basis points sequentially. Moving on to current trends, lead times remained extended, bookings increased continually throughout the quarter, along with our daily run rates. And book-to-bill in components is above 1.1 on a global basis, and is at the same levels we saw in Q2 of 2009.

Importantly, we have seen no meaningful change in cancellation rates. Our quarterly survey of approximately 300 customers in North America shows the outlook for purchase requirements heading into the third quarter remained robust. As always, we'll continue to monitor the behavior of our customers and suppliers closely. We are confident that we're well positioned to take advantage of opportunities in the marketplace and ensure that we out perform the market. Our Enterprise Computing Solution segment sales of $1.4 billion increased 21% from the same quarter a year ago. Sequentially, sales increased 22%, and we're above normal seasonality and our expectations. Storage, software, services and industry standard servers grew at strong double digit rates on a year-over-year basis.

Sequentially we saw very strong growth in proprietary servers, along with industry standard servers, storage, and software. Sales growth has been better than expect in ECS, and many of our strategic investments and key solution segments are paying off. With our explosive growth in storage and software, and an increase in industry standard servers, our sales mix and business model are changing. At Investor Day, we committed to a $20 million annual efficiency initiative in ECS, based on our completed ERP rollout of North America. These savings come from gaining full back office benefits, and better resource alignment in our sales coverage models.

We executed $8 million of cost savings in June, and we expect the remaining $12 million of actions to occur in Q3. These efficiencies will enable us to maintain our position as the leading provider of value-added enterprise computing solutions. In summary, our performance this quarter was terrific. The second quarter results proved further confirmation of our dedication to a strategic objective, while continuing to manage the business at best-in-class levels. Our strategic evolution to a sales excellence organization through profitable market share growth, gross profit optimization, and continued operational efficiency is evident across our organization, and can be seen in today's results. Paul will now give you a more detailed review of the second quarter financials.

Thanks, Mike. As reflected in our earnings release, there are a number of items that impact the comparability of our results, with those in the trailing quarter, and the second of last year. I will review our results, 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 compliment to our GAAP results. 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.

Second quarter sales of $4.6 billion were ahead of our expectations, and represent and increase of 36% year-over-year, an increase of 9% on a sequential basis. This is the third consecutive quarter of year-over-year sales growth coming out of the downturn, and represents a record level of revenue for Arrow. Operating income grew more than 2.5 times on a year-over-year basis. Global component sales of $3.3 billion increased 44% year-over-year, and 4% sequentially, for an increase of 46% year-over-year and 7% sequentially, excluding impact of foreign exchange.

Gross margins increased 170 basis points year-over-year, and increased 40 basis points from the first quarter. That rebounded to 2008 levels. We reduced our ratio of operating expenses to sales to a near record low level this quarter, as we have remained focused on operational excellence and running the business at best-in-class levels. Our operating profit grew five times, and four times faster than sales on a year-over-year and sequential basis respectively, again demonstrating exceptional expense control and operating leverage in our business. And our operating margin increased 300 basis points year-over-year That's more than double last year, and 70 basis points sequentially. This represents the highest level we have seen in any quarter since the second quarter of 2007, and is above the low end of our targets. All of our regions have seen operating margins rebound to levels in line with or above their respective financial targets.

We continue to exceed the expectations of our suppliers and customers on a global basis, as a testament to our commitment to operational efficiency. Disciplined working capital management resulted in a 110 basis point year-over-year decrease in working capital to sales, to a record low second quarter level. Our returns of working capital more than doubled, and exceeded 32%. This is the highest level of returns on working capital we have seen in the last 10 years. Sales in the Americas increased 54% year-over-year, and 11% sequentially, substantially ahead of normal seasonality. Our growth is driven by strength across the board, in both semis and PEMCO, with notable sales growth seen in the aerospace, defense and lighting markets.

Daily run rates improved throughout the quarter, and our backlog is up from the first quarter. Our operating income grew 114% year-over-year, and 20% sequentially. That's more than two times faster than sales year-over-year. Operating margins in the Americas increased almost 220 basis points year-over-year and 60 basis points sequentially. And looking ahead to the third quarter, we would again expect sales to be above normal seasonality in the Americas.

The pace of recovery in our European business remains strong, as sales increased 52% year-over-year, and were off slightly on a sequential basis to $968 million, ahead of normal seasonality. Excluding the impact of foreign exchange, sales were up 60% year-over-year, and up 8% quarter-over-quarter. This out performance was driven by strength in all regions in our core business, particularly central Europe. We saw solid growth in a number of vertical markets including an all-time record level of sales in transportation and lighting. And lighting continue to be our fastest growing segment. Our daily run rates were up double digits, compared to the year ago period, and to a level similar to the sales we saw back in the second of 2008. We continue to see the effects of our efficiency initiatives in the region,as operating expenses for sales declined 460 basis points year-over-year, to a level last seen in 2001. Operating income growth has been outstanding, and is up almost 70 times last year's depressed levels, and up 13% above the first quarter, Year-over-year and sequentially, operating income significantly out paced sales growth, while our operating margin has returned to 2007 levels.

Looking forward, we would again expect sales growth to be above normal seasonality. Our Asia-Pacific business achieved a record level of sales, gross profit, and operating income in the second quarter. Sales growth continued to be strong, increasing 26% year-over-year, and growing 1% sequentially, over a better than expected first quarter. Our core broadline business was particularly strong, growing by more than 50% year-over-year, and 10% sequentially. Growth in the quarter driven by strength in China and Hong Kong, but we saw strong performance in a number of vertical markets, including lighting, industrial, PEMCO and automotive. Operating profit was up 153% year-over-year, and 31% sequentially, and increased considerably faster than sales growth. Operating income margin doubled compared to last year's second quarter. It's at the highest level since 2000.

Looking ahead to the third quarter, we expect sales to be in line with expectations for the market's growth in that region. Global Enterprise Computing Solution sales increased by 21% year-over-year, and increased 22% sequentially to $1.4 billion in the second quarter, ahead of our expectations and above normal seasonality. As Mike mentioned earlier, we have seen a change in our product mix and a shift in our business model. However, we remain focused on managing well our costs and improving productivity, which resulted in and increase in operating profit of 25% year-over-year, and 80% sequentially. The second quarter, again, demonstrated the leverage we have in the ECS model, as operating income grew almost four times faster than it's sales growth. Looking ahead to the third quarter, we expect sales to be in line with the low end of normal seasonality.

Geographically sales in North America were well ahead of normal seasonality, increasing 32% from the first quarter. On a year-over-year basis, sales increased an impressive 22%. Strong top-line growth, coupled with focused expense control resulted in an increase in operating income of 30% year-over-year and 79% sequentially. Operating profit grew 2.5 faster than sales sequentially, and return on working capital is at record levels.

In Europe sales were relatively in line with out expectations. Excluding the impact of foreign exchange, sales increased 28% year-over-year, and 12% sequentially, in line with the high end of normal seasonality. Our efficiency initiatives in the region resulted in and increase in operating profit of 28% from the first quarter, and operating income out paced sales growth by almost 14 times. Return on working capital in Europe has more than double -- or more than doubled year-over-year to a record level, and is now almost two times corporate average. Our consolidated gross profit margin was 12.8%, an increase of 90 basis points year-over-year, representing a significant improvement in the pace of recovery in our margins. In fact, we have 130 basis point improvement from the low point in the third quarter of 2009.

On a sequential basis gross margin increased 10 basis points. This marks the third consecutive quarter of gross profit improvement on a consolidated basis. Importantly, gross margin in our core components customer base, increased 20 basis points from the first quarter. Operating expenses as a percentage of sales decreased 130 basis points year-over-year, and decreased 60 basis points sequentially to 8.5% representing a record second quarter low for Arrow, and a near record low level for any quarter in our history. Operating income was $194.8 million, an increase of 177% year-over-year, and an increase of 28% sequentially. The results this quarter, again, demonstrate our ability to out grow the market, improve gross profit margins, and a significant operating leverage we have in our model, with operating income growing three times faster than sales on a year-over-year and sequential basis respectively.

Operating income as a percentage of sales increased 210 basis points year-over-year, effectively doubling, and a 60 basis point increase sequentially. Tax rate for the quarter was 31.6%, and you should assume for modeling purposes, it will remain between 31% and 33%. Net income was $121.3 million, that's up 226% compared with last year, and up 31% sequentially. Earnings per share were $1.02, and $1.01 on a basic and diluted basis respectively. This is a new record level of second earnings per share for Arrow.

Cash flow generation was again very strong this quarter, and came in ahead of our expectations. We generated almost $65 million in cash flow from operations in the second quarter, while investing in the business to support growth. In addition, during the quarter, we repurchased $75 million of our stock, leaving us with $25 million under the Board authorization. The Board has also authorized management to acquire and additional $100 million, bringing the total that can be spent on future buybacks to $125 million. Focused management of working capital resulted in a 100 basis point year-over-year decline in working capital to sales, as we continued to manage efficiently all the levers within working capital. This represents a record low level for any second in our history. As Mike mentioned earlier, return on working capital more than doubled year-over-year, the highest level yet.

From an inventory standpoint, our Q2 inventory turns in North America were 5% better than Q2 in 2008. In Europe, turns are better than Q2 2008 by 10%, and finally in Asia, we are 30% better than Q2 2008 inventory turns. Three times in 2008, I think we'll all agree ,we're much nearer to normal, and today we are extended in the period of lead times. And just to be clear, turns in the second of 2010 were better than any region than 2009 second quarter. So we look at this as good performance.

Working capital management in general, and inventory specifically remains a critical aspect of our strategy as we go forward. Our balance sheet and capital structure remains strong with conservative debt levels, and a net debt EBITDA ratio that is less than one. This gives us a strength to participate at a greater extent in the marketplace. Our financial position remains extremely strong with $1.1 billion in committed liquidity facilities, in addition our cash, we have the flexibility to take advantage of opportunities in the marketplace. And finally, return invested capital increased 2.5 times over last year's second quarter to 14.3%.

Thank you, Paul. In summary, our results speak for themselves this quarter, with record level revenue and earnings per share, exceptional returns and very good cash flow generation. Our components business posted another terrific quarter with each of our regions experiencing continued momentum and robust growth trends, while generating significant increases in profitability and returns. In ECS, sales growth exceeded our expectations, we substantially improved profitability, and again, delivered exceptional working capital management. I think it's important to point out, again, that we did emerge stronger from the downturn, and we are executing on our objective of profitable market share growth, operational excellence, and an increasing mix of value-added services and capabilities.

We are in a period of accelerating sales right now, and we believe we are outgrowing the market. There is significant earnings leverage inherent in our model, and we expect to generate premium earnings and returns for our shareholders. I would personally like to thank our employees around the world for a job very well done, and their unwavering equipment to our long-term success. Looking ahead to the third quarter, we believe that total sales will be between $4.39 billion and $4.79 billion, with Global Component sales between $3.32 billion and $3.52 billion. And the Global Enterprise Computing Solution sales between $1.07 billion and $1.27 billion. As a result of this outlook, we expect earnings per share on a diluted basis excluding any charges to be in a range of $0.96 to $1.06 per share. Greer?

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

Thank you.

(Operator Instructions)

And our first question, we'll hear from Craig Hettenbach with Goldman Sachs.

Yes. Thank you. Mike, can you provide any more detail on the increase in inventory, how the bill progressed through the quarter, and, then also, what you're hearing from your suppliers in terms of the constraints, and when they might free up a bit?

Sure. As we've said, I'll answer this, and I'll let Paul put some numbers around it. We still see supply constraints in many of the products that we're selling. And conversely to that, we are still seeing good customer demand. What we're attempting to do is to increase our inventories to make sure that we can supply our customers their needed products to keep production going. And how we're doing that is, we have our customers now giving us a little longer view into what their production needs are. And that's helping us balance our inventory to levels that should help, over time, smooth out the supply chain. And it will also help our suppliers get their products to market faster as they're in the supply constraint period, by satisfying more customers. Paul, you want to add to that?

From a pace of increase point of view, we saw an uptick in the first month of the quarter, and then another uptick in the second month, and then it flattened out for the third month, as you'd expect. Keep in mind, though, that the sales activity strongest also in the third month of any quarter. So that -- so that's the way the pace went. We're trying to manage working capital in total, so we actually saw an increase in inventory at the end of the quarter. We also increased accounts payable. So we're profiling inventory to meet the needs of our customers as they need it.

Got it. And then Andy, if I can follow up on the systems, the outlook for the low end of typical seasonality, does that reflect the stronger than expected Q2, or anything else you've seen in that market?

It's a little bit tied to the strength of Q2, but also to the seasonality of Europe, which we typically see a little slower business climate in Europe during the summer. So we'll have to see how the quarter plays out.

Just one other point around that, you know, we're not quite sure what normal seasonality will be going forward, quite honestly, Craig, because we're seeing a change in the model. Right, Andy? So what we're seeing is obviously a change in the channel. So we're trying to evaluate that at the same time. So really what we're building on or comparing normal seasonality to, is really a period of time before the model changed. So it's a little bit tough to say whether it's strong in Q2 or products, et cetera. It's really a change in the model in general.

Okay. If I could just follow up on the comment on Europe, anything new to report in terms of customer sentiment there, or what you're seeing for Europe specifically, in systems?

No, in systems we have not seen an impact in our business. You saw the numbers that we just reported in Europe for Q2. And, so, quite honestly, business has remained pretty strong.

Okay. Thank you.

And next we'll hear from Amitabh Passi with UBS.

Hi. Thank you. I just wanted to follow up on the comment. You talk about potentially a change in seasonality in your Computing Solutions segment. Hoping you can elaborate a little more. I didn't quite get that.

I'll lead off and maybe Andy can jump in if I don't get it right, which is we know that the Sun model is changing with the business being managed now by Oracle. So that change in the model is going to impact seasonality, from the standpoint of what drives year-ends and pricing around intraquarter months.

Yes, I would just add that our mix with software and services is -- changes the way we look at seasonality. And we're also heading into, with proprietary servers, we're heading into the September through December time line where that typically builds. So, some of this plays out normally. And then, as Paul mentioned, because of our mix change, a little bit different of a percentage looking at Q3.

Okay. Got it. And then, just with respect to supply chain constraints, any updates in terms of where you're seeing some of the biggest pain points and incremental color?

Sure. I can -- I can help you with that. We saw average lead times increase to a range of 11 to 19 weeks. That was up a little bit from last quarter, which we had at 10 to 18 weeks, and Q2 of 2009, when it was really down to the 7 to 13 week range. Sequentially, I'd say the biggest increases we saw were in discretes, analog, and electromechanical products. Lead times for the passives came in about 1.5 weeks on the high end compared to last quarter. And I would say over the next three months with the exception of memory discretes and programmables, as well as passives are probably stable to up. Standard logic, analog, electro mechanical and connectors are stable. And I'd say the expectation for us in embedded is also up a little bit. We see the supply chain, if you will, acting efficient. And that's the reason that you can see that we've worked to increase our inventory and get levels, so we can smooth the demand patterns to our customers a little better.

Great. And then just one final question. I think, if I include the September quarter, you basically would have seen five consecutive quarters of better than normal seasonality in your components business. Mike, just curious, when do you think we get back to normal seasonality? Would it be the December quarter? And, then, do you have any concerns that we probably could see below normal seasonality, as we exit 2010 into the first half of 2011?

I can tell you, I hope it never stops, you know. To answer your question, if hope is involved. So what I can tell you is this, our bookings did increased continually throughout the quarter, and so did the daily run rates of our bookings. Our book-to-bill line components was still above the 1.1 level on a global basis, and it's the same level we saw in Q2. Now, if I go along with that, we've seen no meaningful change in cancellation rates. And then I compile that with our survey of our top 300 customers in North America, it really showed the outlook for purchase requirements headed into this next quarter remains strong and robust. And it's still at about four times stronger than a year-ago level. So we have not seen incoming orders increasing -- or we haven't seen a decline in incoming orders, or an increase in cancellations, and we are seeing better fulfillment of hard to get parts from our inventory to customers. So we are still in pretty good shape going into the next quarter.

Thanks a lot for the incremental color.

Okay.

And next we'll move to Jim Suva with Citi.

Great . Thank you very much. And congratulations to you or your team on the great results and profitability. It's very,very commendable. Can you talk a little bit more on the inventory, exactly how much of it was organic, versus, I believe you closed three acquisitions in the quarter? And then on that inventory, it seems like, if I get this right, the supply chain with the EMS companies having some shortages, and you guys having product available, and you're helping to smooth stuff. Some people are, kind of, saying it looks like Arrow may have double ordered some inventory, and it's sitting on a lot. Help me understand exactly why you need to carry so much inventory and if things are so tight, how come you haven't been able to clear it? Because clearly a sale today is better than a hope for sale

Hello, Jim. It's Paul. Let me lead off with your question around the impact M&A. In fact, if you think of the three acquisitions, Sphynx is one, and the ECS business, which you know has inventory turns that are 20 to 30 times. The second one was in Converge, which has very low inventory requirements, and high inventory turns. So that was less than $10 million for Converge, less than about $10 million for the Sphynx acquisition, and the other acquisition has no inventory at this point in time. If you look at it, about $20 million of increase comes from M&A, and the rest is organic growth.

And Jim, what I would also add is we saw our inventory start to come in towards the end of the quarter. And given what the lead times were, many of those investments were placed a quarter ago, if you will. So we're starting to get the inventory for the orders we had, we still did go out of the quarter with good demand. But as that inventory hit, some of what you see is a little bit of timing issue, as well as, what I would say strategic investments we made in certain products going into third quarter.

Finally, Jim, one last piece of statistical information. If we look at inventory turns in Q2, in the global components business, they are still above seven turns. And, our business model is not really built to have seven turns. It's actually something less than that. So if you were -- and the fact, the record turns we have a hit was Q1 2010, and we felt we were running too hot quite honestly. So that's how I look at it from a statistical point of view. The turns in the second of 2008, while not at the Q1 record levels we set, are at levels comparable to the previous records we had set. So we're looking at it as a service level opportunity for us, and not really concerned at this point in time that the levels are out of control or not manageable.

And with the lead times, three to six months, is it fair to say that since you placed these orders earlier in the year, that then as time rolls forward, next quarter we should also see another bump-up since lead times three months ago were also pretty lean?

Yes, I think Jim, what we would see is something that would be more flattish with what we have right now at the end of the second.

Great. Thank you, and congratulations again for great results, especially on the profitability.

And Matt Sheerin with Stifel Nicholas will have our next question.

Yes, thanks, and good afternoon. So a question on -- on your gross margin, which was obviously up nice year-over-year and sequentially. I know that some of it was mix related, but how much of it was a benefit from overall pricing? Given that you do have inventory and certain customers that are asking for expedited orders, which obviously puts you in a better position. So is your pricing helping you here?

Hello, Matt. It's Paul. Let me first start off by saying that gross profit was up year-over-year in all regions. And that is -- has nothing to do with mix. So look at each of the individual regions, and look at the two business segments. So we were up in each region around the world.

Okay.

Yes. Most of the -- up I would say has been, as we've been getting the inventory, we've also been working on longer-term orders. And if you remember, as we started to talk to you about the GP decline, Matt, when you go to buy a car, the car that's on the lot is much cheaper than the car you need three months from now. And our ability to strategically place our inventory has had an impact for us. The changing demand requirements, though, I might add for you, in aerospace and defense, we've seen an increase quarter-over-quarter. We've seen the alternative energy market pick up for us substantially as well as the lighting market. And with the added design win work, you'll remember we talked about the increase in design wins and design activity we had which would lead to higher gross margin for us. Those are really what account for it.

Okay. So it's a mix in business, increased value add, but also opportunistic or strategic buying, where you've got inventory where you're buying ahead of market price increases, and you're getting a benefit there. Is that fair?

I think that's fair, but that would be the least amount of it, because as you know the ability to really build inventory at a great pace right now isn't there, given the extended period of lead times.

Okay, great. And just finally, on your comments about components, it looks like Asia was up about 1%. Is that seasonal? It looks like it might be a little less than seasonal? Are you starting to see any signs of sluggishness in Asia at all?

Hey, Matt, yes. It is what we consider less than normal seasonality, but you have got to bifurcate the two businesses. So when you look at our core broadline business in Asia Pac, we were up 10% on a sequential basis, which is above normal seasonality. In our ultra source business, that's where we saw a drop-off around low end -- low end handsets. So when you really look at it, there was very good growth in our -- in our broadline business, and more of a short- term settlement in the marketplace for the Ultra Source business.

Yes, let me -- Matt, I think I can help you a little with the Asia Pac piece of that, we still saw consumer very strong. The data processing business, the industrial business, the lighting business, and the automotive business were all up more than double digits. The only place we saw a slowing in Asia Pac region, which is what equates to our Ultra Source business, was in the communication market. Every other market there we did see relatively strong increases quarter-on-quarter. So we can pinpoint it directly to the communications business.

Okay. And then so -- the book-to-bill in Asia in that core business that you talked about, is that in line with the company average then?

Yes.

Okay. All right. Thanks a lot.

And we'll move on to Brian Alexander with Raymond James.

Yes. Maybe just one follow-up on inventory. If you're buying inventory to meet production schedules, with inventory up 22% sequentially in the June quarter, why wouldn't you expect your component sales to be up more than mid single digits in terms of your Q3 outlook? And then I have a couple of follow-ups in the computing business.

Sure, Brian. It's Paul. So once again we have to parse the businesses, right. So we're seeing good sales growth in North America and Europe, well above normal seasonality is the first reason why our inventory is up. The second reason is we see this as an opportunity for us to take advantage of the marketplace. You may recall we've spoken about this over the last six quarters or so, but we said we would use our balance sheet opportunistically to be able to drive and get more market share. That's whether we were deciding to hold a bit more inventory, to be able to take advantage of disruption in other customers. Not our customers, but other customers' supply chain. It's an opportunity that we see, it's a strategic move we see, to be able to get new customers and new market share by having the inventory on hand, that's either in short supply or very difficult to get.

Okay. And then just on the computing business, the Sun Oracle relationship, how much incremental revenue do you think from here is at risk? And is that -- is that really what the primary delta is in terms of your Q3 outlook relative to what we would consider to be normal seasonality, although I realize that's changing?

Yes, Brian. It's Andy. We've seen in our entire proprietary server portfolio. We almost got back to a little growth in the second quarter. And Sun was actually the second strongest line in the quarter. So I think our risk is mitigating. I think we see an opportunity actually to have an upside in Europe. We're undergoing a -- an expansion with Oracle Sun in Europe, as they look at the countries that they want to roll out their value-added distributor model in. We've been assigned a global account rep from Oracle, which is a very positive sign. So we'll just have to see how their product cycles play out, and where they go with their hardware sales. But I think we're getting to the point where the risk of revenue decline is going to mitigate a bit.

Okay. And then final question, how should we think about, maybe for Paul, the operating margin progression for the computing business in the back half of the year, given that your largest supplier is refreshing its mid range line. And this tends to have above average margins. That would suggest that your mid range mix probably gets better in the back half of the year, certainly in Q4. And you've got incremental cost savings, I think you said earlier, of about $12 million going forward. So should we expect some pretty meaningful operating margin expansion in the computing business on a year-over-year basis in the second half?

Your analysis is correct. If the pace of new part introduction picks up in the fourth quarter, and around proprietary service, we should see a good uplift in margin.

Thank you very much. And nice job.

Thanks, Brian.

And William Stein with Credit Suisse will have our next question.

Great, thanks. I'm wondering if the component shortages that you discussed limited your own revenue in the quarter on the component side in particular, obviously.

That's an interesting question. We believe that we've seen -- we've been going at it the last several quarters with about the same amount of unfulfilled orders. So pending the orders flopping into the next quarter, we think right now, we're doing a pretty good job filling what we have, and we would expect to stay on that pace. If you really look at how we've positioned ourselves, we've seen the business start to materialize in these design win activities that we had discussed the previous several quarters. And those are really key products for our customer base, and it's important that those are the products we have on the shelf. As well as that mix of products is a higher margin product for us, helping to lead some of our margin expansion efforts. But I don't believe that it would be a significant amount of increase in sales if we would have fulfilled every one of those orders.

It sounds like there was some missed opportunity, but it didn't increase sequentially, is that the right way to go?

Yes. Anytime you have extended lead time situation, you always have missed opportunity. It slows all the way back from the supplier through us, and to the customer. And, as these shortages abate a little, there will still be opportunities. But the customer needs it's full bill material of products so they can go into production. And when you his one, and they don't go into production, you do not realize that. But today, from what we're hearing from our customers, the standard flow of production, and the line down situations are much, much less than they were a quarter ago, and even a quarter before that.

Okay. And like everyone else, I'm also going to focus on systems for a second. It looks like if -- assuming the Converge and Sphynx revenue was contemplated in the guidance, it looks like organic growth is down about 18% sequentially, which it looks like well below the low end of what used to be typical seasonality. So first is my math correct there, down about 18%? And then, second, with Sun changing, I would assume that that would kind of moderate the seasonality. That instead of exaggerate the seasonality that we're seeing, let's say, from June through assignment, but generally throughout the year. And, so, I'm a little confused there. I'd appreciate any help understanding that.

Hello, Will, it's Paul. A couple of points of clarity from our side. The Converge business is part of the Component segment, and Sphynx is part of the ECS segment. The second thing was their results were not included in our guidance, because we were not sure of the actual closing. So we did have one month of Converge and a couple of weeks of Sphynx, so really didn't have a meaningful impact on sequential growth or anything like that. So by our calcs, sequentially sales increased 22%.

I meant the September guidance.

Ah, oh, sorry. Sorry about that.

Yes.

So we still think we'll be within the low end of normal seasonality for Q3.

Thank you.

And next we'll move on to Steven Fox with CLSA.

Hi. Good afternoon. Not to beat a dead horse on the inventories, but is there any way to parse the difference between, say, the fast moving parts in the components inventory and the slow moving parts? And then, secondly, could we step back and look at the computing business from a cyclical standpoint? Any signs that you would point to that the cycle has legs beyond Q4 of this year that would be encouraging to investors at this point?

Steve, it's Paul. I'll take the first question, which is around the quality of the inventory. We have seen very little dollar change in what we might call slow moving inventory. So when we look at the quality of the inventory, it's all fresh moving product at this point in time. So we don't see any meaningful growth around the globe in that business. In fact, if my recollection was right, we still see improvements in Asia Pac and in Europe. And we saw a small increase, and what I mean by small increase, of less than $20 million in North America,in that bucket of inventory.

Okay.

Steve, I'll try to add a little color, if you will, to the -- what we're seeing on the IT side of the house. We do see spending returning to more normalized levels. We do see some areas growing faster than others. As an example, everyone knows proprietary servers were suppressed going into the quarter. But we did see a 21% increase in proprietary servers quarter-over-quarter, and they actually out paced the increase in industry standard servers for the first time, in a long time. Our storage products are still growing very strong, year-over-year in the 29% range. Having said that, is we're looking to the seasonally strong fourth quarter right now, we see no reason to expect anything other than normal seasonality going into the second half of the year here.

That's encouraging. Thank you very much.

And just a five-minute warning. Next we'll move to Furlong, Brendan Furlong with Miller Tabak.

Hi, how are you doing, everybody? Earlier on in the call, in the preamble, you said the gross margin is in an upward trend. Nobody has seemed to have challenged you on that one. I was just curious, if you could throw some color on what that upper trend actually means?

Yes. From our viewpoint, you may recall that we saw a rapid and sharp decline in gross profit entering the economic malaise, if you will, that started in 2008. And we said that the recovery would continue slow, slow for sure, about the same pace as the down turn. So we continue to see on a region by region basis, improvement in gross profit percent. So we still see that momentum continuing into Q3. And if we see normal seasonality, which is fully our expectation into Q4, then we would expect to see that GP continue to move upward.

And I know you're not going to endorse this, but assuming that the last four or five quarters were above normal for you, now as we've had in components, suddenly grinds to a halt, what do you think the impact will be on that improvement in gross margin situation, in terms of regressing or what have you?

Well from my viewpoint -- and you're right. I'm not going to endorse the idea. That's going to grind to a halt. I think one of the things we ought to keep in mind as we start to count the number of quarters, and we think it's four, not five. But anyway, whatever it may be, is we're coming off unusually low level of revenues. So we are trying to get back to, (inaudible) this, a new level of normalcy. With that said, if it was to grind to a halt, if lead times stay around normal, there should be no negative impact on gross profit percent. And as we've been saying, the biggest area of opportunity regionally for us, in gross profit, is in Europe. And Europe came into the recovery about two quarters later than North America.

So we would think that if you were to see a slowdown in the recovery in North America at the top line, we probably have two more quarters to go in Europe. So we'd see that also continuing to grow. So it's a lot of different data points, a lot of different moving parts, but doesn't necessarily mean that it would shut down in one quarter. For sure at that point in time, we'd still look for opportunities to increase it and don't believe that there would be a decline in gross profit then.

Okay, that's kind of what I was looking for. And my other question, the SG&A, percent of sales were pretty much record lows. Do you plan to keep it at kind of record lows on a quarterly basis? Or am I reading too much into this, that you are kind of expecting things to moderate somewhat next year, and that's why you're trying to keep your expenses at such low levels?

There's -- there's several factors that go into this. First off, we did get our Enterprise Computing group on a new computer system. That has helped us with efficiencies in the back office, and those efficiencies, we would see going forward. As we continue to do our implementation of the system in the Components group, we expect to get efficiencies on that as we go forward. Right now our third quarter that we gave you is banked in. It still shows good cost, what I would say containment. But I would also say that we have done some new hiring at the same time, and we're able to get the back end of our system more efficient, as we continue to expand with that. And we'll continue to hire where necessary. So we're not expecting any major change in our expense levels.

Excellent. Thank you very much.

Okay.

And next we'll move to Sherri Scribner with Deutsche Bank.

Hi, thank you. You provided a bunch of different detail on the segments and geographies. I was hoping we can maybe take a step back, and if you can give us, like, your view on how the geographies are progressing. I know Europe was a bit behind. It seems like from your commentary that all of the geographies continue to move along, and you're not seeing any hiccups, but just wanted to get your thoughts.

Yes. Well, Asia, we've seen the sales growth in Asia Pac for us be very robust. It's been growing double digits compared to last year. Asia Pac did achieve a record level of sales, gross profit, and operating income in the second quarter. The core business that we have was really particularly strong, growing almost 50% year-over-year. And then we saw, as I had indicated before, strong performance in a lot of the vertical markets around lighting industrial, PEMCO, and automotive. And the slowdown that we saw there was in our lower margin, Ultra Source business, primarily tied to the communications market. So overall we've seen a pretty good marketplace there.

The pace of recovery that we've seen in Europe remains very strong. That out performance was actually driven in all regions of our core business, but particularly central Europe, and a continued strength in our alliance customers, which are some of the larger customers in that region. The vertical markets, we did see several of them start to kick on. But we saw -- I would say the exceptional markets for us were transportation and lighting, and lighting continues to be the fastest growing segments. So we see that continuing on, if you will, for Europe.

Our sales in North America, if you will, were substantially added. What I'd say is normal seasonality would be there. But that was driven across the board in both semiconductor products and in our passive products. We did have notable growth, if you will, in the aerospace and defense and lighting market industries. But what is really encouraging about North America is the daily run rates improved as the quarter went on. And our backlog, meaning customers placing long-term orders on us was also up compared to the first quarter. So we expect the sales to continue in that market, and really the vertical performance there, again, aerospace, alternative energy, lighting were the main drivers for the quarter for us.

Okay. That commentary is helpful. And then, at the Analyst Day there was a lot of questions about Europe and the impact of the -- what was perceived at the time to be a weakness in Europe. Doesn't sound like you saw any weakness in Europe. Just wanted to get a sense of, did you have any currency impact from what was going on during the quarter?

I'll let Paul answer the currency piece. As far as Europe, you're correct. We've continued to see Europe perform and perform well this quarter.

And Sherry, from a currency translation impact it was about a negative $0.02 for us this quarter.

Okay.

It depends the rate we use for giving guidance.

Right, okay. Great. Thank you.

And next we'll take a question from Shawn Harrison with Longbow Research.

Hi, good afternoon. Hopefully, two brief questions. At ECS, EBIT margins were up slightly year-over-year, even though sales were much higher. Is the variance, just in terms of, where they potentially could be, just solely mix right now; and to your earlier comment that you would just need to see, some server refresh be relatively healthy from your largest customer coming back in the fourth quarter, and you should see a more normalized level of profitability there?

I think you've pretty much nailed that. We did see increases. As I said, we -- for the first time, really saw some improvement in the proprietary servers, and as we go back into the second half of the year, if the refresh that we've all been discussing on this call comes true for sure, you'll see benefits of that.

Okay. And then my follow up question is on acquisitions. You've done a number of deals here in the first half of the year. Maybe you could just comment on your appetite for larger acquisitions, say $500 million in revenues at large, or if you are looking for more smaller to midsize acquisition opportunities? Thank you.

I'd love to give you detail, but I -- I, just won't do it. I think we're making acquisitions, on what we think makes the best sense for Arrow. And again, we're making our acquisitions based upon services that we want to bring to the market, relative benefit, in either the computer or the component space for us, and it really doesn't matter, the size of the acquisition. Every one of these acquisitions has to produce financially for Arrow and for our shareholders, and that's really how we've been doing it and that's how we'll continue to do it.

Okay. Thank you very much.

And we'll take a followup question from Amitabh Passi with UBS.

Hi. Thank you, just a quick clarification. The share buy-back that you did in the quarter, I understand there's about $25 million still left on the existing $100 million, and then you said you got another $100 million approved by the Board.

Correct.

Any sense -- I mean is there a timing limitation as to when you exhaust the full $125 million, or any sense of how you should think about your interest in buying stock at these levels?

There is no time limit. That's the best we can tell you at this point in time.

Okay. All right. Thank you.

And that will conclude the question-and-answer session. I will turn the call back over to the speakers for any additional or closing remarks.

Thank you. Before ending today's call, for those participating in today's webcast, we will quickly put up the slides referenced in our webcast that contain a reconciliation between GAAP and adjusted results. The reconciliations also included in our earnings release, and both the release and the presentation will be available on our website. I would like to thank all of you for taking the time to participate in our call this afternoon. If you have any questions about the information presented today, please feel free to contact Paul, Mike Taunton, or myself. Thank you and have a nice day.

And that will conclude today's call. We thank you for your participation.