艾睿電子 (ARW) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2011 Arrow Electronics earnings conference call. My name is Towanda, and I will be your coordinator for today. At this time, all participants are in listen-only mode. Later, we will facilitate a question-and-answer session.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to Ms. Greer Aviv. Please proceed.

Thank you, Towanda. Good afternoon, everyone, and welcome to the Arrow Electronics third quarter conference call. I'm Greer Aviv, Senior Manager of Arrow's Investor Relations program, and I will be serving as a 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, Finance and Operations, and Chief Financial Officer; Andy Bryant, President, Global ECS; and Peter Kong, President, Global Components.

By now you should have all received a copy of our earnings release. If not, you can access our release on the investor relations section of our website. I would also like to point out that we issued a CFO commentary that has been posted to the investor relations section of our website that should be used as a complement to the earnings press release. You can access a copy of our earnings reconciliation for the third quarter in our press release or the investor relations section of our website.

Before we get started, I would like to review Arrow's safe harbor statement. Some of the comments to be made on today's call may include forward-looking statements, including statements addressing future financial results. 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 Arrow's SEC filings.

We will begin with a few 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 for all of you for taking your time to join us today.

We had another record breaking quarter. Third quarter revenue of $5.2 billion increased 11% year-over-year, and it was in line with our guidance. Global ECS sales were in line with the high end of our expectations, while component sales came in below our expectation.

Earnings per share of $1.20 represented the highest third-quarter level in Company history and the sixth consecutive quarter of record earnings. Based on our guidance for the fourth quarter, we are on track to achieve earnings per share in excess of $5.00, an increase of more than 20% from 2010's record level.

Gross margins continue to improve for the quarter, increasing 60 basis points year-over-year. This represents the seventh consecutive quarter of year-over-year gross margin increases. And it reflects the hard work our teams across the world -- to drive enhanced profitability and our initiative to acquire companies in markets that have higher margins. We continue to create shareholder value with return on invested capital of 11.7%, well in excess of our weighted average cost of capital and return on working capital of nearly 28%.

The third quarter was yet another quarter of strong cash flow generation, as we generated almost $120 million in cash from operations. On a trailing 12-month basis, we generated $436 million in cash from operations during a period where we were growing the business.

In global components, sales increased 6% year-over-year, with growth in the Americas and Europe, was partially offset by weakness in the Asia PAC region reflecting difficult market conditions.

Since we reported our second-quarter earnings in late July, macroeconomic conditions around the world have weakened, with an increasing volatility in global markets and cautiousness across our customer base. Gartner now expects worldwide semiconductor revenue growth to be flat to down slightly in 2011, due to economic weakness, excess inventory in the supply chain and manufacturing overcapacity. For 2012, Gartner expects semi revenue to grow a conservative 4% to 5% with overhang of certain macroeconomic conditions. Despite these external pressures, our core business fundamentals remain healthy, and we are in constant communication with our customers and suppliers.

Given the lack of visibility and choppy market conditions, we expect our global components business to be below normal seasonality in the fourth quarter. With the Americas and Asia PAC in line with normal seasonality, and Europe below normal seasonality due to macro and sovereign debt issues.

In our global ECS business, sales growth of 26% year-over-year was at both the high end of our expectations and the high end of normal seasonality. The ECS team, again, posted record quarterly revenue of $1.5 billion in the third quarter, driven by extremely strong year-over-year growth in all of our product lines led by services, software, proprietary servers, industry standard servers, and storage.

We are focused on several growth opportunities, including the addition of new suppliers, penetration of new market segments, and the expansion of our services portfolio. In particular, our mid market initiatives has seen great success as we have increased our market penetration in this segment and expanded our customer base. Additionally, this week, we signed a US distribution agreement with Juniper Networks to distribute their full line of products, thereby increasing our depth and networking and other data center convergence solutions.

Enterprises expending is expected to remain solid, and we look forward to a seasonally strong fourth quarter as our global teams leverage our industry-leading position and complete portfolio of data center offerings. We continue to seek out value-creating acquisitions that will fit our strategy of building on our core competencies, with products and services to expand the technology lifecycle.

During the third quarter, we announced and completed the tender offer for Chip One Stop. Chip One Stop has offices throughout Japan and is focused primarily on supplying electronic components to design engineers through an e-commerce platform. This acquisition represents an exciting opportunity for Arrow to expand our presence in one of the largest markets of the world.

In addition to M&A, we remain focused on creating value for our shareholders through our stock buyback program. Since 2007, we have returned almost $550 million to our shareholders, and we continue to view this as an effective and important use of our capital.

In the face of the uncertain economic times, our strategic priorities have not changed. We remain focused on outgrowing the market in our core global components and global ECS businesses, expanding into faster-growing high-margin products and services, and growing profits faster than sales, and increasing returns on capital. We have been extremely successful with this strategy, reporting record level third-quarter revenues and earnings per share, and we expect to be successful into the future.

Paul will now provide an update on our financial results for the third quarter.

Thanks, Mike.

Third quarter sales of $5.2 billion were in line with our expectations and represent an increase of 11% year-over-year. Pro forma for acquisitions and excluding foreign exchange, sales were down 1% year-over-year. Our consolidated gross profit margin was 13.7%, an increase of 60 basis points year-over-year. And pro forma for acquisitions gross profit margin was flat year-over-year.

Operating expenses as a percentage of sales increased 70 basis points year-over-year. Pro forma for acquisitions and excluding foreign exchange, operating expenses declined 1% year-over-year and are flat as a percentage of sales compared to third-quarter of 2010.

To assist you with your analysis, on an absolute dollar basis, the operating expense increase year-over-year was due to acquisitions, which added $76 million this quarter; a weakening dollar, which added another $15 million due to translation; and efficiency gains, which lowered expenses in the base business by $10 million.

Operating income was $218 million, an increase of 10% year-over-year. Operating income as a percentage of sales was down 10 basis point year-over-year. Our effective tax rate for the quarter was 29%. But for modeling purposes, you should assume that our tax rate for the next few quarters will be between 29% and 30%.

Net income was $138.3 million, an increase of 8% year-over-year. Earnings per share were $1.22 and $1.20 on a basic and diluted basis, respectively. Again, this was a record level of third-quarter earnings for Arrow.

We generated $119 million in cash from operations in the third quarter. On a trailing 12-month basis, we have generated $436 million in cash from operations, all during a period where we were growing the business.

Return on working capital of 27.8% is a near record third-quarter level. Return on invested capital of 11.7% is well in excess of our weighted average cost of capital and is a key driver in creating lasting shareholder value.

We completed our previously announced $100 million buyback authorization during the third quarter, bringing the total amount returned to shareholders to $550 million over the past five years. The average price of the repurchases was $32.07. Our Board just approved an incremental $150 million repurchase authorization as we continue to believe this is an effective method of returning capital to investors.

This is a high-level summary of our financial results for the third quarter. For more detail regarding the business unit results, please refer to the CFO commentary published this morning.

Looking ahead to the fourth quarter, we believe that total sales will be between $5.29 billion and $5.69 billion. With global component sales between $3.29 billion and $3.49 billion, and global enterprise computing solution sales between $2 billion and $2.2 billion. As a result of this outlook, we expect earnings per share on a diluted basis, excluding any charges, to be in the range of $1.25 to $1.37 per share. Our guidance assume that the average euro to US dollar exchange rate for the quarter will be $1.38.

In the fourth quarter, we would expect global ECS sales to be in line with the low end of normal seasonality. Sales in our core global components business are expected to be below normal seasonality, reflecting weaker global macroeconomic conditions. The outlook reflects selected targeted operating expense reductions across both businesses.

As Mike mentioned earlier, based on our current guidance for the fourth quarter, we expect 2011 full-year earnings per share to be in the range of $5.06 to $5.18, representing another record year for our Company and year over growth -- year-over-year growth of 24% at the midpoint of our fourth-quarter guidance. We also expect to be cash flow positive for the fourth quarter and for all of 2011.

Thank you, Paul. Towanda, please open the call for questions at this time.

Thank you. (Operator Instructions). Your first question comes from the line of Brian Alexander with Raymond James. Please proceed.

Thanks. You're guiding computing up 36% sequentially at the midpoint, which is in the middle of the range of normal seasonality. You're coming off of two consecutive quarters of above seasonal growth, and in some of your key suppliers like EMC you're guiding below. So what gives you the confidence you will see normal seasonality in the fourth quarter on the computing side? Maybe comments on the pipeline you're seeing, or conversations with [VARS] about what they are expecting for a budget flush? Thanks.

Sure, I will let Andy lead off with this, and then possibly have some comments at the end of that.

Hi, Brian. So as, I think the budget flush in the fourth quarter is unique to Arrow's value-added model and our focus on data center. And there is budget dollars to be spent. And right now, we do you still see that playing out to the low end of seasonality. As always, it is heavily back-end loaded, but most of our input from the VAR base is that there is still relative strength in the market. And we came off of a very good summer quarter in the federal spending area and had some carryover there. So, most of the indications are that it will still play out in the fourth quarter.

Okay, and then just on the component side, how much of your below seasonal guidance there, Paul, is really due to end-demand weakness versus customer inventory reductions to the extent you can maybe size that for your 7% sequential decline? And maybe additional commentary on what end markets are weaker than others? Thanks.

Peter, you want to take a shot at that one?

Sure, we are still seeing some general softness in the overall market in all of the three regions. I think at this moment, I think based on what we are seeing is even though the book to bill is improving through the month of October, but still it is still well below, it is still below one. So, and also looking at the cancellation rates and the lead times, this is all pointing towards a below seasonal seasonality on a global basis.

Brian, to answer that question also around inventory rebalancing versus, as Peter just described, end-market demand, for sure we saw a bit of an inventory hangover coming out of the second quarter. And it took folks, at the customer level, most of the third quarter to get rebalanced around that. So I think that is principally behind us. And I think, as Peter described, it is more so around end-market demand and choppiness in the economies that we serve.

Okay. Thanks, guys.

Your next question comes from the line of Jim Suva with Citi. Please proceed.

Thank you, and congratulations to you and your team there at Arrow. Asking a question about the impact from the Thailand floods, can you address that. And specifically does it impact your hard drive business both on a sales or your computing business on a sales? Did you bake it into anything? And typically does this give you an opportunity, since you can get supply, an opportunity to maybe get a little bit more of a premium, because you are a go-to supplier for many different OEMs and customers? Just if you can assess that entire situation of Thailand and the impact to your Company and the outlook?

Sure, sure we will take a look at this. Right now we don't see a material impact from the flooding in Thailand on our business. And really from our perspective, our offices and the warehouse have not been negatively affected. I think the biggest impact we have seen has been in some transportation delays. Compared to Japan, there really are fewer suppliers involved and a lot less parts affected, but we are still monitoring it and watching it. You have to realize, our hard disk drive sales are a real small portion of our total sales here at Arrow, sub 1%. So, Jim, we don't see any material impact of this strengthening. We have seen those drives increase in price, but we don't think that will have a material impact on our total numbers.

Great, and then a follow-up question, a different topic on cash flow used. Your Company has now instilled a used to give cash back to shareholders. Is that something that we should expect via the dividend -- or via the stock buyback? Is that something we should expect as a recurring thing or only when the stock comes in opportunistically, or when M&A becomes less much of a pipeline filler? How should we think about the use of cash as a lot of times people ask me about that?

I'll let Paul follow-up, but in general as you can see since 2007, we have started to put returning cash to our shareholders in our thinking. And, we believe it is an effective use for our cash over time. I would not speculate on what we may or may not do in the future, with that cash. But as you have seen, we've found a way to do both M&A opportunities on a consistent basis. And we have found ways to return cash to the shareholders on what I would say is a relatively consistent basis, now. And I believe were getting comfortable with our approach. Paul anything to add to that?

Right. Yes, Jim, what we've been talking about for several years now and we tend to believe is that the most effective way of deploying excess capital is to reinvest in the of business to accelerate growth. The second choice for us would be M&A, the obviously third, returning capital to investors. And we will continue to pursue that and try to get the right balance. We don't want to get too much of one because it could impact us negatively on our long-term strategy, so we will continue to balance that out.

We have been pretty consistent in the buyback as it relates to the fact that we want to offset that dilutive impact of our equity programs, effectively convert them to cash programs. But invest (inaudible) equity programs for us as a management team. We will continue to do that. And for sure when we think the stock price is undervalued, we will be opportunistic there also. And we will continue to evaluate, as we have discussed, dividend also. But we are trying to get the right balance, and it is a more longer-term focus on the dividend side than anything else.

Thank you, and congratulations to you and your team there at Arrow.

Your next question comes from the line of Robbie Wilkins with Goldman Sachs. Please proceed.

This is Robbie Wilkins on for Craig. Could you talk a little about pricing in the components business and where it's at in the cycle, and then maybe implications on gross margin?

Sure, as with any slow downturn, the markets do get more competitive. I don't see it as the same situation we saw when we had the big downturn, because at that time, the downturn was what I would say, rather dramatic and it extended several quarters. And, we were all looking to reduce our inventory by pretty good amounts at that time to stay in the market. So it was in the best interest of us and it was basically in the best interest of the shareholders for not only us, but for the entire channel to reduce the prices and get the inventory out.

I wouldn't say we are in that type of a situation right now. What I would say is we have seen some softening, and with softening you do see prices soften a little bit. But we are not expecting the same type of downturn or the same type of pressures on margin that we had the last time.

Okay, great. And if I could ask maybe one follow up on OpEx cuts. If you could provide a little more color on what actions you are taking there, and then maybe any breakout by business segment or geography would be helpful.

Sure. Well, we entered the back half of last year and even the first half of this year expecting, on a macro basis, a continued improvement in the world's economy. And we have all seen how choppy it has been. And we've even seen the extreme of the US downgrade along the way. So in certain regions, we probably got ahead of ourselves in investing in growth, and we need to slow that down a bit. And in some of the regions, we are probably ahead of ourselves in investing. But the fact of the matter is we think those business have great long-term potential, so we are probably going to take less actions in those areas.

I'm not really going to discuss whether it is by geography or business, but we did see a decrease year-over-year in our base business and operating expense dollars in the third quarter. And we will continue to push forward on that, as we always strive to be more efficient and to ensure that we can deliver the quality service that both suppliers and customers need and require.

I think another point that we should get out there is that the Gartner and the data is still expecting some growth and components early next year. So this whipsaw approach without getting a better handle on which way the market is growing, is really not something we subscribe to, here. If the market does take a turn for the worse on us, we will initiate cuts, just like we did the last time. And we will keep up with the market to protect our profitability. But, right now, we don't see any impending disaster, if you will, in the business. We do see some softening, but yet, we don't see it like the last one.

Thank you, very helpful.

Your next question comes form the line of Scott Craig with Banc of America Merrill Lynch

Thanks. Good afternoon. Paul, a question for you on the components margins. If I look typically at what the ECS margins do in the fourth quarter versus the third quarter, being up anywhere 100 basis points to 200 basis points quarter over quarter over the past five years or so, that would imply components margins, based on your EPS guidance go down again in the range of 20 basis points to 50 basis points quarter over quarter. Is that the right way to think about it?

And the second part of that is how much of the components margin decline next quarter versus -- is a mix versus operating leverage versus gross margin declines etc? Is there a way to quantify that? Thanks.

Sure, Scott, so you're right. We would expect to see a downward move in operating income percent. I think you are probably close on the low end of the range, but I think the upper end of 50 BPs is a bit too much around our expectations. And, it is really driven, principally, around leverage, because we expect to see less than normal seasonality, generally, round numbers, low end to normal seasonality components And the beauty of our businesses we have tremendous earnings leverage up. The not-so-beautiful part of it is we also have that impact going downward.

So, that's really, when I look at, it is not around GP pressure. It is around, hey we are losing some of that top line, and the contribution margin on that loss is pretty high. That is principally driving the contraction in the margin in the fourth quarter.

And maybe just a follow-up along the lines of one of the prior questions then. From an OpEx perspective, can we assume that you are not cutting as much as what you need to maintain margins because you don't want to cut too deeply? Is that the right way to think about it? And when do you make another decision on whether or not you have to cut some further expenses? Is it throughout the quarter and as you enter into what would normally be a seasonally strong quarter in Europe in the first quarter? Thanks.

No. It's tough to make those decisions quarter by quarter, right, because one quarter could be under pressure, and the next quarter could be rebound. So we are trying to look a little bit longer term, and that is why we are making cuts and we are reducing expenses. We are also not prepared to take a big step down, because we don't think the long-term opportunity in this business reflects a big step down.

So, we will continue to watch the macroeconomic factors out there during the quarter, and we will continue to adjust our future thinking as we go forward. So, I think to Mike's point, we don't want to be whipsawing back-and-forth, bringing in a lot and then exiting a lot. We just want to think about the long-term nature of our business, if that means there are a couple of quarters where it is not as robust as we have done in the past, that's okay, because we are looking for the long-term payoff.

Okay, thanks, Paul.

Thanks.

Your next question comes from the line of Matt Sheerin with Stifel Nicolaus. Please proceed.

Yes, thanks. I wanted to drill down a little more on the commentary around components. So, you talked about seeing, like Peter you talked about an increase in cancellations. It also sounds like orders got worse in the September quarter, but have flattened out. But you still have a negative book to bill. So, I'm trying to figure out, what is your sense of a bottom here? Do you sense that we are below seasonal in Q4, and things will stabilize in Q1? That is what a lot of semiconductor suppliers are seeing right now, but obviously nobody seems to have a lot of visibility. So what is your sense of where we are here when orders start to stabilize?

I think, Matt, I'll start off with this. It really has to do with the total business and a lot of what Paul just said. Right now the impact are the vast majority think things will start to rebound in the first quarter and even a little stronger in the second quarter. The manufacturers have a little bit more distant visibility than we do by nature of their customer base. And, as they are starting to see orders pick up going into the first quarter, we view that as relatively good news and a possible soft landing on this thing.

The data that has come in from Gartner is calling for growth next year still in the business, and we do use that data, even though it is delayed some. And, we have seen most of our customers have the same type of conversation with us, that they believe this is a temporary pause. And what will happen with us is, of course, we will continue to review this over the balance of the fourth quarter and continue to implement what we think is necessary. But, if this is what we are looking at right now, we would view that as relatively good news, not only for Arrow, but we view it as good news for the industry.

Okay, thanks. And on the inventory situation, it wasn't down that much. I assume that some of that inventory is based on the acquisition that you did in Japan, so, could you tell us how much was from acquisitions and on a like or apple to apples basis how much was inventory down? And then maybe even drill down and talk about inventory days on the component side of the business. Where it is now and where do you expect it to go?

Right. I'll give you a little higher view, and then I'll turn it over to Paul. As you know, we had forecasted a little bit more to come out of the inventory. The principal reason that that did not happen is we did not see the typical end of quarter uplift in the business that we normally see. And as a result, we did not get as much out as we wanted. I think it was 2%, 2.5% of the inventory went down. We would fully expect the inventory to continue to reduce going into the fourth quarter. And we would expect it to reduce based on the guidance that we gave you. Paul, you can add to the mix. Acquisitions were not that much.

Yes, the impact of the acquisition in Japan was less than $10 million, Matt. So, not a big driver there as we look at it. And as Mike said, we thought we would have a more robust month of September. We are confident that will trend down, the inventory will trend down and be at our targeted levels by the end of the year so, that we are appropriately sized as we leave 2011 to see what the business is like in 2012.

So, yes, for sure, were not happy with it. We thought we could deliver on a target that was aggressive, and we will get it this quarter. It is not unusual to see a one or two quarter lag in getting inventory out of the business. We thought we could do it in one quarter, and it's going to take us two.

Interestingly, when you look at inventory turns year over year, they are flat in the components business, or actually, they're down 10 basis points. It was 6.1 turns last year in the third quarter, and we were at 6.0 this quarter, the way we calculate it. So, it really wasn't that different, per se, from where we were year ago, but for sure, we can do better as we move forward throughout the fourth quarter.

What is the target then? So it will be down in line with revenue, so 7% or so?

Well, I would say at a high-level, yes, to that. But I would also say we have also got to be looking to what is going to happen in Q1. So, we will have a better feel for that as we move throughout this quarter as to what the pace of activity will be in Q1. And then we will have a better idea on whether we are going to be bringing inventory in in the month of December. Your assumption around tracking what the sales decline might look like for this quarter, I think that is a fair assumption to start with.

Okay, thanks a lot.

Your next question comes from the line of Sherri Scribner with Deutsche Bank. Please proceed.

Hi, thank you. I was hoping you could give us some detail on the components business geographically. You noted Asia being weak this quarter, which would be a bit of a surprise to me. I know in the past you've have some

Well, in the Americas we were below seasonality, and we view that as really a weaker demand and increased customer cautiousness. And that had an impact. Looking ahead to the fourth quarter, we do expect sales to be in line with seasonality, which was the flat to negative 7%, and we believe that the inventory at the customer levels will return to more normal.

In Europe, they had a solid quarter. They were up 13% year-over-year, and they were within really normal seasonality on a sequential basis. The vertical markets there, we saw good growth, and we saw automotive and lighting customers increasing 5% year-over-year. We are expecting to see below normal seasonality, which I think is the driver for the seasonality for us in components in Q4, here. And we believe that is due to the macro and sovereign debt issues. We do believe there is going to be a slowdown in that market.

And in Asia PAC, part of the change of the market is really Taiwan. We are very strong in China. We are not as strong as Taiwan, so part of that is mix. We do see transportation and lighting increasing there, and we have done well at outgrowing that market. We do expect the balance of the Asian market to return back to normal seasonality, which is typical minus 4% to minus 5% quarter on quarter. So the real linchpin for us, Sherri, in the woodshed here, is really what the economic conditions in Europe look like in the fourth quarter, and that is really the market.

Okay, that is helpful. And then just quickly, a question on the model, Paul. Thinking about SG&A going forward, it sounds like there is some puts and takes, some reductions, potentially in workforce, some cost reduction. Can you help us understand on a dollar basis how to model SG&A as we move forward?

Sure, as we think about the actions we are taking, I would put them in about a range of $20 million $30 million, right now in the business. And, we are not going to be able, obviously, to get all of that out this quarter, but we would expect to be very close to the full quarterly run rate entering Q1.

So the reductions are $20 million to $30 million on a quarterly basis?

No, I'm sorry that is an annual basis.

Okay. So you would expect SG&A to be down next quarter?

I would expect that by the time we get to Q1, we will be able to take our core expenses down by the equivalent of, let's call it, $5 million to $8 million quarterly. We have already taken $10 million out, as we said, year-over-year in the third quarter. And we will continue to refine our cost structure as we move forward.

Okay, great. Thank you.

Your next question comes from the line of Amitabh Passi with UBS. Please proceed.

Thank. Mike, first question for you, any commentary on the expectations for IT budgets heading into 2012? What are you hearing from your customers? We started to hear some rumblings of budgets being down next year, but would love to hear your perspective in terms of the conversations you are having with your customers.

Sure, really, as you heard in the prepared remarks, we had a pretty good quarter with all the product lines demonstrating growth. And, partially what we see, which may be a little bit different, is that we have been able to enter some new markets, and we have also had some expansion of our services portfolio. We are looking forward to getting kicked off with Juniper. And we've been able to increase our market penetration through matrix management. We think enterprise spending will remain relatively solid when we look forward to the fourth quarter. And we believe that given that spending rate in some of the new lines that Andy and team have signed, that we won't see a decline, but we do believe that our fourth quarter will be certainly in line with normal.

We did talk about the fourth quarter for him being a little below what we would say the midpoint. I think it is important to note that in Andy's business, we also did an acquisition of cross telecom and shared telecom. And those businesses operate just a little bit different than our core ECS business in that they don't get the 30% uplift in the fourth quarter. And that is something that in the results, why that seasonal mix looks a little odd. And after we get through this year, we will probably have to adjust that seasonal mix given the impact of the business that we have now on the telecom side, which is a more stable, more quarterly type approach than we see on the core ECS business. But by all indications we've had, all of our surveys that we have done in dealing with the manufacturers, most of our manufacturers are expecting a pretty solid Q4. And we actually concur with that.

Mike, I was just wondering if you had any initial sense of how 2012 might shape up with respect to IT budgets?

Yes, we still believe that it is going to be mid-single-digit type growth for IT spending. We are not expecting it to dip below that at this point.

Great, and the just as a follow-up for me, given all the macro-related issues in Europe, are you starting to hear or see any of your smaller customers have any credit-related issues? Is there any impact there?

Paul?

No, we haven't seen a change in either the credit worthiness or bank pressure on our customers. Nor have we really seen, you may or may not be aware, that in Europe it is quite common to use credit insurance with customers.

Yes.

We haven't seen any pressure yet either on credit lines or more customers not being covered at all. So, we haven't seen any real change at this point in time.

Okay. Thank you.

Your next question comes from the line of William Stein with Credit Suisse. Please proceed.

Thanks. There is some discussion earlier about book to bill being below one, and a discussion of looking at the cancellation patterns, and as a result guiding below normal seasonal components. Should we think about that pattern as having troughed here? In other words, are you sensing that you are starting to see an upturn in the business or a flattening out of the pace of orders? Or as we have gone through most of October already, is it still declining?

Well, in global components, you typically do see a decline in the fourth quarter. That's traditional seasonality that we do see. Our negative book to bill causes us to believe it will be a little bit more than normal seasonality, but our expectations are that it isn't a continuing decline.

Remember, we spoke before, and it had everything to do with what we were going to do on the cost side, what we thought was going to happen on the margin side. And it is something we will certainly watch very close going through the fourth quarter. And start evaluating what we think is happening for the first quarter and into next year. But it really is the same question that ties to all of that. Right now, this is what we see, and we are not panicking, but we believe we are nearing the end right now. And again, if something materializes different, then we will take action later this quarter to prepare us for the first quarter.

Mike, that is helpful. And then maybe turning to the system's business for a minute. You added Juniper recently, congratulations on that. Can we think about growth long-term in that part of the business continuing to really be driven more by M&A or driven by these organic supplier agreements that you signed?

Yes, I would say yes to both. That has been our history. We are entering new markets; we are expanding the service content by which we operate in the computer business. We are expanding product lines. And if there is an opportunity to continue to expand to get into new markets with value creating M&A, we will certainly do that. We have not ever said that we would slow down M&A on either side of the business. And I think as the opportunities present themselves in either markets where we don't have the penetration we think we would like to have, or if they are in products that would help expand Arrow's overall reach in expanding the market, we will certainly be there, too. The product expansion really helps us get involved with and learn products as a Company and to see how those products act, and then we can follow-up with something else later.

Great, just one follow-up if I can. You haven't talked about ERP lately. If you can give us a quick update on where you are in the rollout of the global ERP update. Any expected incremental savings from this point going forward?

Will, it's Paul. This coming weekend, we hit the switch and [converted] in Central Europe in our components business. We are pretty excited about that because that will be, once that's behind us, we are two-thirds of the way across Europe. And remember we feel that some of the big benefits are going to come out of getting Europe on a single system where we can get better organizational structure in the back office. We can get better buying and better manage the inventory.

With that said, we still got to get Southern Europe done, and we think that will be done in 2012. We will see those benefits about six months after we complete that. So, we feel very good about it. And I know the team has worked very hard in Europe. We need to get good information and confirmation this week from them that they are ready to go this weekend.

Is the US done?

The US will be the last piece that we do.

Got it. Thanks very much.

Your next question comes from the line of Shawn Harrison with Longbow Research. Please proceed.

Hi. Good afternoon. Just wanted to follow up on the Asia business, in particular the commentary on Ultra Source being up sequentially this quarter. Absent seasonality, does that business look as if it has bottomed, and are you expecting growth as we move into 2012?

Peter, do you want to take that one?

Yes, I think the Ultra Source business is quite dependent on the performance with the [MTK] chip business. We are just seeing the recovery of the MTK business through the fourth quarter, and we are expecting that will continue definitely through next year.

Okay, thank you. And then as a brief follow-up, just on the M&A environment, are you seeing potential targets clam up in terms of wanting to wait out maybe this, what seems to be a correction here in the market to sell the business? Are you still seeing the M&A environment go full-steam ahead?

I think the M&A environment is driven a little by the economy. Obviously, when people are selling a company, they want to get the highest valuation, so they want to show the best results. And if those results dip, they like to wait and let you know it is not them, but it is the market and the opportunity is out there. So, really what fluctuates during these times for the target is what they are projected price is.

We still do see activity in the pipeline. We really don't ever see the activity slow. I think the point for us though, is if it is a good target, has a good return, and is going to bring value to both Arrow and expand our marketplace, we are interested. And if it gives a return to the shareholders that we want, we are interested. But, I would not say at this point that we are either seeing the markets become more attractive or we are seeing them dry up. I would say were seeing business as usual there.

Okay. Thanks so much.

Your next question comes from the line of Steven Fox with Cross Research. Please proceed.

Hi, good morning. Thanks for taking my question. Really quickly, some of your comments are in contrast to some of what your suppliers are saying. And one area that you have not really touched on, I'm wondering if this is possibly the differential, is the competition among distributors. Is it possible that you guys are managing better than some of your competitors, not just the large ones but the smaller ones, in terms of inventories and sales out? Is there any competitive dynamic that you can talk about, there?

As far as how the other distributors manage, I think that for the most part, the industry has managed fairly well. If you made it through that last downturn and you were a survivor, and you came up today, I applaud that. But as far as I know, we're focusing on our management skills here at Arrow. And really, I'm not qualified to say how another distributor is being managed.

So you're not seeing anything unusual in the market among distributors?

No, I'm not seeing anybody do anything crazy, it that's the question you're asking.

Yes, it is. And then just finally, not to put words in your mouth, Mike, but it sounds like you really don't have clear evidence of a bottom, but you have seen some settling out. It sounds like you touched on all the evidence you possibly could, but is there anything else specifically among cancellations or ordering patterns that you can point to to give us confidence that maybe things -- we have seen the worst of this correction?

Well, I think right now, we've given your guidance based off of all of the information we have. And that guidance really rolled up to something that was probably better than what everyone was expected. We have not only gone through the guidance with our supplier partners, we've talked to many of our major customers, and we've dug into the information that is out there.

I think it would be great if I could sit here and say, boy we are really bullish and we are back into double-digit growth, but I do not see that. And I don't think that is the expectation for anybody. A lot of the suppliers are seeing requirements going into next year picking up. We've also utilized that more from a cost perspective than a market growth perspective, because remember, we are forecasting Q4 based off of our data, what we see with incoming orders, our book to bill, and our backlog. And we compile all of that together. So at this point, we believe we have come out with the absolute best guidance we can based on all that data.

Okay. Fair enough. It's not like you guys are known for whistling through a graveyard, so this is very helpful. Thanks.

Your next question comes from the line of Brendan Furlong with Miller Tabak. Please proceed.

Good afternoon, everybody. Following off of the previous questioner there, if you're taking inventory down pretty hard here in the fourth quarter like your suppliers are expecting, do you think that gets you to a point where you're done being aggressive on the inventory into the March quarter?

I'm not sure if your aggressive term has the same definition as my aggressive term. I think Paul had said that our inventory turns last year were 6.1 turns, and we are at something like 6.0 based on our internal calculation, which gives you about a 10 basis point difference. I'm not looking for heroics here; I'm looking for inventory balance. I'm looking to have our inventory balance based upon the incoming orders and the outgoing orders, because that is what is important to capture the market when the market is available. And again, that is something we do on a normal course.

We would have expected a little more to come out of the inventory in the third quarter, as we have said, but the last month of the quarter did not materialize in a way that was previously thought. And that had an impact on it. That is why Paul made the comment we are pretty sure we will get it this quarter, because we are able to push out and reschedule some of our incoming orders to slow the pace of what is coming in while we balance what is in here. But, it again is not our effort to go back and again whipsaw the manufacturers by taking out too much inventory in the fourth quarter and then reputting those orders in and asking them to FedEx everything in here. That is not our approach, and that is not were we are trying to do.

Okay, great. The other question I have you is on the cycle. My assumption is we are not in the 2008,2009 cycle, but do you think we are in the 2003, 2004 type of cycle, or more of a 2009, 2006 type of cycle on the component side on all your businesses?

We're not looking for a downturn like the last big one, that is for sure. That's not something we see. We do believe that the market is coming to a head here. Our customers are and have been working on their inventories to get those balanced correctly. And I think, if you look at the forecast for manufacturing increase next year, the forecast for GDP growth, I just saw something yesterday from the Federal Reserve. It was something like 2.5%. If you consider that the industry typically outgrows that by two times, you're somewhere in the 5% to 7% range for growth next year. I don't know what else we could use to cause us to draw a different conclusion than what we are drawing now.

Okay, perfect. Thanks a lot.

Your next question comes from the line of Ananda Baruah with Brean Murray. Please proceed.

Thanks, guys, for taking the question. Congratulations on a solid quarter. I guess, Mike or Andy, can you comment on any end markets in any of the GOs where you might have seen particular strength or particular softness this quarter relative to your expectations in service and storage? And then I have a follow-up. Thanks.

Yes, this is Andy. How are you doing? As I mentioned earlier, we did see a pretty good close to the federal spending as we left September, so that vertical was pretty good for us. But, we still see strength in the areas that we focus on most of the time, which would be healthcare, finance, and manufacturing, holding up pretty good. So, from our perspective, it's still occurring in a broad vertical base. And, that is good news for us.

And then can you just make some comments I guess on general server trends? Are you seeing -- seasonality aside, are you seeing any noticeable strength or weakness in server orders, server inputs and customers through the second half of the year?

I would just refer to our numbers. We had an 18% uptick, I think in proprietary, 18.4% growth year-over-year. And our industry standard server segment grew about 6%. So the combination of the two would lead you to say it is still a pretty strong business for us as we enter into the fourth quarter.

Thanks, and just last one for me. Can you just give us, I guess can you talk a little bit about what some of the end market initiatives that you put into place are. Where you are with those now and what we should expect for the balance of the year heading into 2012?

Are you referring on the computing side, specifically?

Correct, yes.

Well, we continue to focus, as Mike said, on the high-growth specters, like unified communications, which we have entered into. I think another key area remains security. We are very focused on growing our security business. And with the announcement of Juniper, I'm very excited about that announcement. That takes us into the routing, switching, and security market in the United States with a data center focus. So you will see us continue to drive towards these high-growth segments to keep the business growing profitably.

Where are you now in deploying the programs? Are you -- so say for unified communication security, are you -- do you have all the infrastructure in place? Do you have the SMEs and stuff like that? Are you propagated through your VAR network for those? I guess Juniper is probably early days in ramp.

Well, unified communications now is approaching the $500 million mark. We believe we have all the infrastructure we need to carry out our goals in that. It is not uncommon for us to add new lines. The reason we add lines is that we are seeing opportunities with those lines that we don't have, and we want to capture the market. So, as far as spending or infrastructure growth that you would see here, from any of the things that we have talked about right now, would be minimal. We believe that is going to be additive sales for us now, and it will be additive sales for us into the future.

It is pretty early to call, what we think is success rate will be with Juniper, since we just announced the -- signing the line pretty much to you guys on the phone here. It was done yesterday, so it's too early to tell what the final business plan is for that. But, overall, we are still bullish, and Andy's business, we think the team has done a great job of expanding for us profitably. And, we would look for more of that going through 2012.

Great, thanks a lot.

And with no further questions, I would now like to turn the conference over to Greer Aviv for closing remarks.

Thank you Towanda. If you have any questions about the information presented today, please feel free to contact Paul, Mike (inaudible) or myself. Thank you, and have a nice day.

Thank you for joining today's conference. That concludes the presentation. You may now disconnect, and have a great day.