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Arrow Electronics, Inc. (NYSE:ARW)

Q3 2008 Earnings Call

October 22, 2008 3:00 pm ET

Executives

William E. Mitchell - Chairman of the Board, Chief Executive Officer

Michael J. Long - President, Chief Operating Officer, Director

Paul J. Reilly - Chief Financial Officer, Senior Vice President

Greer Aviv - Investor Relations

Analysts

Matt Sheerin - Thomas Weisel Partners

Brian Alexander – Raymond James

Jim Suva – Citigroup

Steven Fox – Merrill Lynch

William Stein - Credit Suisse

Kevin Kessel - J.P. Morgan

Greer Aviv

Welcome to Arrow Electronics third quarter conference call. I am Greer Aviv from Arrow’s Investor Relations department and I will be serving as the 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 Bill Mitchell, Chairman and Chief Executive Officer, Mike Long, President and Chief Operating Officer, and Paul Reilly, Senior Vice President and Chief Financial Officer.

Before we move on, I would like to review Arrow’s Safe Harbor statement. Some of the comments 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 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 and CEO Bill Mitchell.

William E. Mitchell

Thanks to all of you for taking the time to join us this morning. I want to start by saying that our formal comments will be shorter than usual and therefore we’ve chosen to forego our usual slide presentation. Given the current economic environment we believe it’s more important to focus on looking forward as well as to allow more time for your questions. I will begin with some brief remarks, Paul Reilly will give you an overview of our financials for the third quarter, and Mike Long will discuss the outlook for the global components and global enterprise computing solutions businesses. I will then wrap up and provide our guidance for the quarter.

Though our revenues met our July guidance our earnings per share came in below our expectations and we have seen a significant weakening in most of our markets since we last spoke to you. September did not show the recovery from the seasonally slow months of July and August as we had expected when we provided our guidance in late July.

The economic situation became more volatile as the credit crisis spread, expanded around the globe and ultimately impacted businesses everywhere in global components and an increasingly competitive environment which in turn drove greater-than-expected pricing pressure to a top line that met expectations but a bottom line that did not.

In our enterprise computing solutions unit an unfavorable product mix with a lower-than-expected sales of higher margin proprietary servers affected margin negatively.

There is no doubt in our minds that market conditions will continue to be difficult in light of the uncertainty and volatility surrounding the global macroeconomic environment, the tight credit markets, soft consumer confidence and deteriorating business outlooks.

However there were some bright spots in the third quarter. Our revenue was in line with our expectations in the face of weak market conditions with consolidated sales reaching a record third quarter level. We continued to generate positive cash flow as we generated over $200 million which was the highest level of cash flow for any third quarter in seven years. I’m pleased to say that our balance sheet and capital structure remain very strong enabling our company to withstand fluctuations in the market place.

We believe we have the right strategy in place and we will continue to execute our plans accordingly while recognizing the realities of the market conditions we face. So despite the difficult and volatile market conditions our business fundamentals remain solid and our strategic priorities for the future are clear and have not changed. We will continue to pursue operating efficiency across all units and will move forward with our global systems implementation as a critical enabler of our future successes.

We will achieve these goals while managing the company in a prudent fiscally disciplined manner to maintain and increase profitability, generate significant positive cash flow and strengthen our already strong balance sheet. I want to emphasize that we will as always make all necessary adjustments to our business model to reflect current market conditions to be certain that we maintain our company in a strong financial and market position.

Paul will now give you a more detailed review of the third quarter and then Mike will discuss the outlook for our business unit performance in greater detail.

Paul J. Reilly

As reflected in our earnings release, there are a number of items that impact the comparability of our results with those in the trailing quarter and the third quarter of last year. I will review our performance excluding these items to give you a better sense of our operating results. As always, the operating information we provide to you should be used as a complement to GAAP numbers. For a complete reconciliation between our GAAP and non-GAAP results, please refer to our earnings release or the earnings reconciliation slide at the end of the webcast presentation.

Third quarter sales of $4.3 billion were in line with our expectations and represent an increase of 7% year-over-year and a decrease of 1% on a sequential basis. Pro forma for LOGIX and excluding the impact of the foreign exchange, sales grew by 2% year-over-year and declined 2% sequentially.

Global enterprise computing solutions sales increased by 12% year-over-year and decreased by 6% sequentially to $1.3 billion in the seasonally slow third quarter. Pro forma which include the acquisitions of LOGIX sales were up 2% year-over-year and decreased 11% over the second quarter in line with normal seasonality.

This represents the 19th consecutive quarter of year-over-year growth for ECS.

Our core North American ECS business performed well posting a 30 basis point in increase in operating margin year-over-year. With the addition of LOGIX the impact of the summer slowdown in Europe was more significant causing a drag on our overall operating margin. However on a pro forma basis our global ECS business had an operating margin increase of 30 basis points compared to the year ago period. Additionally, return to working capital performance was very strong this quarter increasing almost 350 basis points from the prior year to a near record third quarter level.

Global component sales of $3 billion increased 5% year-over-year and 1% sequentially or an increase of 2% year-over-year and 3% sequentially excluding the impact of foreign exchange.

Over the past year we have diligently worked on improving our operating efficiency through targeted cost reduction initiatives. Our continued focus on these initiatives as well as an increased contribution of business from Asia Pac resulted in a decrease in operating expenses to sales of 50 basis points year-over-year and 90 basis points sequentially. However continued softness in Europe, a greater mix of business from the Asia Pacific region, and increased gross profit margin pressure resulted in a decline in our operating margin on both a year-over-year and sequential basis.

Our consolidated gross profit margin was 13.1%. Gross margin in our core components customer base, that being small to medium size customers, declined only 20 basis points year-over-year while our total business saw a decrease of 60 basis points year-over-year primarily due to an increase in the mix of our Asia Pacific business from 24% to 30% of our total component sales and from 13% of total sales to 16% as well as weakness in European components.

On a sequential basis gross profit margin declined 100 basis points driven by the aforementioned mix shift as well as an increase in competitive activity.

Operating expenses as a percentage of sales increased 10 basis points year-over-year primarily due to increased spending related to our ERP initiative and decreased 30% sequentially to 9.8%, the second lowest third quarter level since 2000.

Operating income was $142.8 million a decrease of 12% year-over-year and 18% sequentially. Operating income as a percentage of sales decreased 70 basis points year-over-year and quarter-over-quarter due to the mix, an increase in ERP spending and competitive pricing pressure.

Our effective tax rate for the quarter was 30.2%. For modeling purposes you should assume that the tax rate for the fourth quarter of 2008 will be between 30% and 31%.

Net income was $83.7 million down 12% compared with last year and down 18% sequentially. Earnings per share were $0.70 on both a basic and diluted basis. This represents a decrease of 9% and 8% compared to last year’s third quarter on a basic and diluted basis respectively.

This marks our eighth consecutive quarter of positive cash flow generation with cash flow from operations of more than $200 million, well ahead of our expectations for the quarter. Our balance sheet remains strong with very conservative debt levels and debt-to-cap near record low levels. In today’s uncertain capital markets, being able to generate cash and having a more conservative debt level is a competitive advantage. We have access to $1.4 billion in committed liquidity facilities that will allow us to be opportunistic should the occasion arise.

Focused management of working capital enabled us to achieve a near record low level of working capital through sales at 14.6%.

While our stock price is only slightly above our tangible book value at $15 per share, our commitment to creating value for shareholders is reflected in our return in invested capital which exceeded our cost of capital for the 19th consecutive quarter.

Mike will now discuss the outlook and business trends in global enterprise computing solutions and global components.

Michael J. Long

In our enterprise computing business sales were in line with our guidance. Double digit year-over-year growth in storage, software and services was offset by a weakness in servers. The back end of September saw incoming orders slow dramatically. As has been widely reported, the increasing uncertainty in the global macroeconomic environment has caused IT spending to soften and as a result our customer base became more cautious in the latter part of the third quarter.

Since the end of the third quarter there has been a further softening in the global end user demand which has extended from the US to Western Europe. There has also been a significant increase in competitive activity in a number of our markets.

While we have seen relative stability in ECS at this point in the current quarter with incoming order rates returning to more normal levels, you need to remember that fourth quarter is very back-end loaded and our performance will depend on the month of December. At this time IT spending trends and the typical year-end surge remain the key variables and there is extremely limited visibility given the backdrop of the global economic slowdown. While there’s a great deal of uncertainty regarding the outlook for IT spending over the near term, we believe we’ve made the right investments to ensure our ECS business is well positioned for the long term.

Global component sales were in line with expectations at $3 billion while operating performance was impacted by a slowdown in the more profitable businesses in North America and Europe and the increased contribution of the business from Asia Pac.

The beginning of the fourth quarter has seen weakness across the board with softness in all regions. In Asia Pac we’ve seen the global economic slowdown begin to impact the Asian markets which until recently have been somewhat immune to the effects. We experienced a slowdown in Korea and [Anzon] which has been widely reported. Our customers and suppliers are taking a cautious approach to their business.

For the fourth quarter we would normally expect sales to decline in the low to mid-single-digit range. Given the limited visibility and the outlook for muted growth rates over the near term, we believe our sales in the region will likely be below normal seasonality in the fourth quarter.

In North America year-over-year softness was driven primarily by weakness in the EMS segment and we’ve seen no clear signs of a turnaround of this trend. Sales in North America will also likely be slightly below normal levels as we expect to see a continuation of the significant competitive pressures we witnessed in the third quarter.

The European market place continued to be affected by the weakness we’ve seen over the past few quarters as well as the typical summer holiday period. However we did not see the expected pick up in September that we normally would expect to see as the financial crisis has expanded globally. Economic signals indicate the situation in the United Kingdom is deteriorating while the Central and Nordic regions are also experiencing a marked slowdown. However on a constant currency basis we expect our European business to post sales at the low end of normal seasonality in the fourth quarter.

Taking a look at the leading indicators, lead times and cancelation rates were within normal levels while pricing remains stable. In line with normal seasonal trends our book-to-bill in components increased quarter-over-quarter and was slightly above one on a global basis for the quarter. Book-to-bill in Europe was down modestly. North America held above one with a higher level than last year’s third quarter despite macro weakness. Asia Pac increased in line with seasonal trends.

In our quarterly survey of over 300 customers in North America results showed that customers are being very cautious and taking a wait-and-see attitude. That means more book ship business and potentially greater volatility in results depending upon the overall economy. Overall the market continues to be cautious with the macroeconomic situation causing our customers and suppliers to carefully evaluate their business needs.

William E. Mitchell

As I said before, there’s no doubt that market conditions will remain challenging and volatile for the foreseeable future. As we look to the fourth quarter, it’s clear that the turbulence in the financial markets has caused a significant slowdown and weakening in virtually all of our markets. Customers have become extremely cautious in placing orders and our forward visibility is as low as it has been for many years. Suppliers as evidenced by recent press releases are expecting material declines in sales levels to well below the lower end of traditional seasonality.

In response to this rapidly-changing and weakening outlook, we have taken steps to ensure our cost structure is in line with current market conditions. We have worked hard as a management team over the past five years to get our company into the sound financial shape that it is in and we will do whatever is necessary to keep it there. We remain focused on operational efficiency across our company and will continually look for ways to improve our performance. We will continue to manage our company prudently, stay attuned to the realities of the markets in which we operate, and make the appropriate and necessary decisions and adjustments to our business to ensure continuing success and long-term sustainability.

As you’ve heard us say in the past, we typically have about 90 days of visibility in giving guidance. But as we sit here today, given the extreme volatility in the global economic environment, we believe we have less than 30 days of visibility at best. Just as a note, should the economic uncertainty continue, we may choose to re-evaluate our policy of providing specific quarterly numerical guidance and instead update you on business conditions and the overall economic environment.

In addition, we think it is prudent to provide you with a wider-than-normal guidance range to account for the greater degree of uncertainty in the market place as well as the impact of the stronger dollar.

Looking ahead we believe total fourth quarter sales will be between $4.05 billion and $4.45 billion with global component sales between $2.45 billion and $2.75 billion and global enterprise computing solutions sales between $1.6 billion and $1.7 billion. This is well below normal seasonality and reflects our view of the weakening markets that we serve. As a result of these weakening conditions, we expect earnings per share on a diluted basis excluding any charges to be in the range of $0.60 to $0.68 per share. This is our best view of the market at this time.

We’ve stopped all discretionary spending and instituted a hard hiring freeze in all positions except sales positions and are evaluating all programs underway to ensure that they deliver returns commensurate with risk and investment.

In summary, we will continue to take the actions required to keep our company in the sound financial shape that it is in and continue to review all aspects of our business to ensure strong financial performance in the future.

Greer Aviv

Please open up the call to questions at this time.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Matt Sheerin - Thomas Weisel Partners.

Matt Sheerin - Thomas Weisel Partners

Before I get into some questions, you normally provide specific results by product in region and you haven’t’ given that. Will that be provided in the supplemental information after the call?

William E. Mitchell

We can definitely talk about that if you’d like after the call.

Matt Sheerin - Thomas Weisel Partners

Yes. That would be helpful. Mike, you talked about the book-to-bill being around one for components yet the midpoint of your guidance is down in the mid teens, certainly a lot worse than seasonal. Is it just a function of sales falling off dramatically at the end of September so that book-to-bill is even but you’re really not getting much at all in terms of forward orders and it’s just a turns business right now? If you can elaborate there.

Michael J. Long

The market itself has clearly slowed down and at the end of the third quarter lead times were within the normal range. Book-to-bill was slightly above one globally which is ahead of last year but in a weaker macro environment. The book-to-bill in Europe was down modestly. North America if you will held above one. Then Asia Pac was in line. In Europe though the market remains weak and what we’re seeing are shorter lead time orders that are more book ship type orders and a changing of how those orders are coming in.

We also had our survey that we talked about of 300 customers in North America and we’re also expecting a potentially greater volatility given how that business is moving more towards the book ship. Overall really the market is looking pretty cautious and our customers and suppliers are very much evaluating their business needs. We had also indicated after a survey of many suppliers that they’re seeing the same effect so we do expect that book-to-bill to get more volatile as we get into December.

Matt Sheerin - Thomas Weisel Partners

It just seems like it’s not as relevant right now because visibility is so limited.

William E. Mitchell

I think that’s exactly right. Book-to-bill in many of the indicators is less relevant in a really volatile time because more of the business goes towards book ship. That’s happening. Visibility gets lower and since the visibility is low book-to-bill is not as good a leading indicator as it often is. We’re monitoring the trends carefully to make sure that we’re properly configured particularly with inventory.

Matt Sheerin - Thomas Weisel Partners

On gross margin in the December quarter, you have a lot of things going on with mix. Europe will be down in components more so than other regions it sounds like so that would be a negative on gross margin in components. Your computing business will be up sequentially while components will be down. I know that there are some rebates and other things that play a role in gross margin there but should we assume that gross margin will be flat to down sequentially because of that mix?

Paul J. Reilly

We’re not necessarily focused on rebates, not getting rebates. What we’re focused on is that activity levels will be lower than what we’ve seen historically. In light of the pressure we saw in gross profit in the last couple of months of the quarter, we think that will continue into the new quarter, the fourth quarter. Right now it’s a combination of mix as well as continued pressure in the market place as competitors try to attack our dominant position in the market place to get business.

Matt Sheerin - Thomas Weisel Partners

I take that to mean it’s going to be under pressure again. My last question regarding costs overall. You talked about some cost cutting. I’m not sure if it’s as specific as maybe we’d like to see. On a year-over-year basis just doing the numbers, it looked like your SG&A will be up while revenue will be down. Going into ’09 if we assume that ’09 is going to be a down year and just flowing the numbers through, it looks like that’s going to be the fact, will you be able to get SG&A down commensurate with revenues?

Paul J. Reilly

Let me try to take a shot at the fourth quarter and then next year, and then I can ask Bill to help us out too. The fact of the matter is when you look year-over-year at our expense performance, you have to factor in that there’s a change in foreign exchange, you have to factor in the acquisitions, and you have to factor in the ERP spending. If you factor those three things in, in the third quarter they account for all of the increase in expense spending. So, as you build your model you have to think about that.

We’ve obviously taken actions for five years now constantly to be more efficient and more effective. Sometime they’re based upon activity levels, as activity levels go down those are more easily reduced and sometimes they’re around efficiency initiatives where we’re able to do things more effectively and more efficiently we’ve been able to do that.

We obviously recognize that we want to keep the company in the very strong position where we’ve worked hard for five years to get to where we are and we’ll take the actions that we need to, to make sure we’re balancing long term and short term. Long term health for the company and short term desires to perform at a high level.

William E. Mitchell

Let me just give a quick follow up to Paul. We’ve clearly taken the short term steps that you would expect us to, hiring freezes, discretionary spending cuts, all of the things to make sure that we do all of the things that are necessary in light of existing marketing conditions. What we also are doing and you would expect us to do is looking back through all of the programs that we have going, all of the things that in fact it makes sense for us to continue to make those investments at the levels, we’re not ready to talk about any decisions because that evaluation is undergoing.

But, as we’ve said and will continue to say, we will take whatever steps are necessary to make sure that we maintain the company in a strong and viable position. At the same time, we’re going to be opportunistic because we’re in a good position and there are some potentially interesting opportunities that are out there where we could use our strong balance sheet to gain some long term strategic advantage.

That’s what we’re doing is we’re trying to make those tradeoffs between the short term reality and the long term viability and sustainability of the company and we’ll keep you fully informed as those decisions are made and announced.

Matt Sheerin - Thomas Weisel Partners

So just right now then you haven’t made a decision to take a big chunk of costs out because you’re continuing to see investment opportunities, is that correct?

William E. Mitchell

We are evaluating all activities right now and we have no announcements to make at the present time.

Operator

Our next question comes from Brian Alexander – Raymond James.

Brian Alexander – Raymond James

Following up on cash, you did a great job generating $200 million in operating cash. Have your priorities for cash usage changed given the valuation of your stock leading you to maybe consider more heavy repurchase or what are you seeing in the M&A market? Are seller’s expectations being adjusted downward where you think you could have more activity on the M&A front? Or, are their expectations still a little too high which is making you not move forward with acquisitions recently?

Michael J. Long

In terms of acquisition activities, as we’ve always said we are always evaluating them and the acquisition pipeline is full. We will as always, make sure they meet strategic financial and our operational goals and we’re not going to give up anything in terms of the rigor with which we go after any of the potential acquisition activities.

Having said that, it’s been widely put out that the difference between seller’s expectations and buyer’s sense of what value is, is quite wide right now so that probably has to come back together again and that’s not specific to any specific thing that we’re looking at, that’s a general comment that’s been widely remarked about throughout the press. But, we will continue to do that.

Having said that, we’ll also look at all the other alternatives for cash, we do that regularly with the board, we look at all the opportunities whether those be dividends, whether those be buybacks, whether those be debt retirements, whether those be any of those things and that’s a regular activity that we undergo with our board and we will continue to do that.

Paul J. Reilly

Brian, it’s a great question around use of cash. We’ve been prudent using our cash over the last several years selectively putting it in to acquisitions, selectively doing buyback but we really feel that we’re very strong positioned now and we’ll continue to evaluate that. There’s lots of different views on buybacks right now in the marketplace. We want to make sure we’re well positioned for when the economy eventually turns because it will.

We don’t want to be doing, at least in my mind anyway, short term initiatives that hurt us long term. There’s a big question as to how deep or how long the downturn may be in the broad economic basis around the globe but we know it’s inevitable we’re all going to come out of it and we want to be as strong as possible to take advantage of opportunities at that point in time also.

Brian Alexander – Raymond James

Just another question if I could, Bill you mentioned the virtual shut down of the credit markets I think. To use your words, made the third quarter particularly difficult yet if I look at your overall revenue performance it was in line with expectations albeit it on weaker, or I should say more aggressive pricing.

The question is, are you getting direct feedback from your customers or their customers on the computing side that suggest that they’re not able to spend because of the credit constraints? And, how much of a factor is that in your below seasonal guidance?

William E. Mitchell

We are seeing some of that. Again, much of this happened well in the back half of the month of September and in to October. In many cases the Lehman bankruptcy has certainly triggered a follow on effect that, at least in my view, has caused a lot of businesses to go very conservative and say, “Let’s wait and see.” In terms of specifics, we watch our working capital very, very carefully and I’ll ask Paul to comment a bit on that.

But, clearly our customers and our suppliers have gotten much more conservative, have adopted a much more wait and see attitude, are saying, “Let’s see what happens.” At the same time, business is out there. Business is not shut down completely and it continues to move on and that in fact is a place where we like to point out that it hasn’t completely gone away but it has certainly slowed down in the last weeks and month. Paul, any thoughts along those lines?

Paul J. Reilly

Brian, it’s interesting since you asked your question specifically about the IT marketplace, from our viewpoint with inventory turns in excess of 20 in that business we don’t have to hold on to large amounts of inventory. So, from a working capital and managing the balance sheet point of view, even as we see sudden stop and start in that business, we don’t have as much at risk if you will from a cash flow point of view.

For sure, it’s very interesting if you look at the volatility that has existed around the world in financial markets this year, it seems to happen in the last month of every quarter. If you look at Bear Stearns in the month of March, it really impacted the first quarter. The month of September was [inaudible]. As Bill mentioned, Lehman Brothers, if we talk about AIG bailout by the government, if we talk about the force marriage for WaMu and for Wachovia, Lehman Brothers, etc.

It just creates a tremendous amount of volatility in a month where we expected to see, as we talked about on July 23rd, expecting September to be very strong. I think most people are taking a wait and see attitude. If you go back last week, the credit markets were very, very tight. If you look at this week, there’s been some activity. I don’t know if that’s a one off type thing or if that’s going to be the general trend.

If you listen to Bernanke and Henry Paulson they were saying that come mid November we’ll see the credit markets go back to normal. Everybody is looking at the same crystal ball and reading different things about it. We just have to see what happens. There’s a lot of cautiousness in the marketplace, IT or components world.

Brian Alexander – Raymond James

Let me just ask one final one and perhaps putting you on the spot a little bit Paul. But, at the analyst day you laid out a pretty specific downside earnings scenario of around $2.20 where you said if revenues fall 10% here’s how the model works and I don’t think we thought we’d be looking at that potential decline at the time but perhaps that’s more realistic today.

So, the question is are you still comfortable with that level of earnings as a downside scenario or have things changed i.e. pricing pressures have picked up beyond what you contemplated and therefore we should no longer look at that as trough earnings.

Paul J. Reilly

I am still comfortable with what we said at the investor conference. If that’s the type of downturn that we’ll see we’ll still be able to deliver earnings in that range.

Operator

Our next question comes from Jim Suva – Citigroup.

Jim Suva – Citigroup

Can you just quickly clarify, there’s a lot of confusion on the book-to-bill more than one yet led time is stable and cancelation is not getting worse. Can you just quickly clarify that especially since the 13% quarter-over-quarter decline next quarter for components.

Michael J. Long

First off, one of the things we’ve seen and again, daily book-to-bill holding, we’ve actually seen a slowdown begin to impact the Asia markets which as we’ve said the last two quarters we have been uncommonly strong in Asia with our sales. They’ve been immune to the effect. But, what we’ve seen with the limited visibility that we have is that we do expect this to mute over the near term and in to the December quarter.

So, we do believe that in Asia Pac we’ll be slightly below normal seasonality for the fourth quarter. In North America, what we’ve seen is a weakness in the EMS segment. We don’t see any clear signs of a turnaround in this and in fact, we are expecting the December quarter to the EMS customers to decline significantly versus past years.

While we see continued weakness in Europe, on a constant currency basis we expect that to be at the low end of normal seasonality for the quarter. So, a deteriorating position in Asia Pac, we expect North America to deteriorate and we don’t expect Europe to improve, if that helps you.

William E. Mitchell

A little follow on to that one, book-to-bill is a very useful measure in places like North America and Europe where typically much of the business is scheduled business and therefore a book-to-bill is relevant. Asia happens to be one where the majority of it has and it will continue to be book ship business and as a result the book-to-bill in Asia typically runs pretty close to one. That’s just the way that business looks.

So, what we’re looking at in Asia is that declining trend, the weakening trend in terms of incoming order rate which wouldn’t show up in a book-to-bill ratio. As Mike said, book-to-bill in Europe and in North America has been oneish but again, more of the business is moving towards the book ship business which increases the volatility and decreases our visibility in to what’s out there.

Therefore, what we’re trying to do is take our best estimate given the limited visibility that we have to reflect what we see as market conditions going forward with substantially more limited visibility than we would normally expect to have at this point in time.

Jim Suva – Citigroup

Then as a follow up, if I do my math correctly I think it gets to combined corporate overall operating margins for the December quarter about 3.3%. And, if my math is correct, that looks like the last time you hit that for December was about December of ’02. It seems like competition has gotten more intense and I guess the question is why won’t you have trouble meeting your rebate issues in December quarter if your outlook is below season normal?

How come you’re not getting a little bit more leverage in the model given your increased scale and scope now versus say December of ’02?

Paul J. Reilly

First, around the rebates remember that the level of revenue goals if you will, or units shipped are set every quarter. So, it’s not like the targets generally have been set six months ago or nine months ago and now because the economy has changed and with less IT spending we’re going to see a drop off if you will in the amount of the gross profit level.

So, that’s not really a big driver for us when you look at operating income percent. If you want to go back to 2002 and talk about that a couple of things, one we have to look at where has the revenue growth come from. First off we look at Asia Pac as an example where there’s been an acceleration in growth. That has obviously changed our mix which does impact operating income percent but I’d also point to the potential impact its had on returns on invested capital.

As you know, we’ve talked about Ultra Source which has been a real create acquisition for us. Operating income percent runs well below the corporate average yet returns on working capital are approaching 40%. That’s a good investment for us. So, while we made trade operating income percent we’re gaining operating income dollars and returns.

The same thing is true when you look at the way we manage the balance sheet where working capital today has been worked downward, both [inaudible] a change in mix but how we approach the balance sheet so that we’re generating cash in every quarter just about whether it’s an up quarter or down quarter and unequivocally, every year we’re generating cash whether it’s a growth year or a declining year.

So when you look at it operating income percent may be down but when you look at it from an earnings per share and returns and cash flow generation, we’re all up compared to the period of 2002 that you’re referring to. One other point that I would make is that we are making a very substantial investment in ERP which is something we did not have in the quarter that you’re asking about and that does impact our ability to get leverage and our ability to make that comparison.

Jim Suva – Citigroup

Just to be clear, the rebate levels for the December quarter have recently been reset to below seasonal normal levels?

William E. Mitchell

Jim, those are set every quarter as you come off the previous quarter and put your forecast out there. With each manufacturer they are renegotiated on a quarterly basis.

Jim Suva – Citigroup

So after the world is really starting to fall apart you’re able to still reset them lower? Because, things have changed now say versus a month ago.

William E. Mitchell

Absolutely. You set your rebate targets in conjunction with the manufacturer. I would call them less of a negotiation more of a business plan and they are done with more consensus than not if you will.

Operator

Our next question comes from Steven Fox – Merrill Lynch.

Steven Fox – Merrill Lynch

A couple of things, first of all thanks for the frank discussion on where you see the markets. The one thing I’m having trouble with is your outlook for enterprise spending for Q4. You’re looking for a very strong seasonal uptick but you also said that Q3 ended fairly badly, you’re seeing some competitive pressures, mix issues. I’m just curious how specifically you get to that type of number?

William E. Mitchell

If you remember, one of the things that we said was that the September quarter did not respond as we thought and as you know, it’s very back end loaded. We saw a slowdown as we neared the end and what we did see was a pick up again back to normal levels so far this quarter. But again, you have to remember that the quarter that we have is very back end loaded and most of the activity happened within the last two weeks, two and a half weeks in December.

That part has muted for us in terms of visibility so we are taking the cautious approach and our thinking is around how the market acted in the third quarter and really taking that forward. So again, if you look at it we’ve returned to normal levels but the big shipments happened the last two and a half weeks of December and that’s where we are taking a cautious approach.

Steven Fox – Merrill Lynch

Paul, you mentioned how close your stock is to tangible book levels. I perceive one of the concerns to be about your collections from small or medium size businesses. Can you just talk about your history of handling these collections during recessionary times and what you’re doing to make sure that credit is being handed out responsibly right now?

Paul J. Reilly

First, if you look at the third quarter; I’m sure you have looked at it; you’ll see that our DSOs are actually down compared to the second quarter of 2008 and the third quarter of 2007. Our actual performance has been improving throughout the year and we continue that in the third quarter. That obviously lessens our risk.

The second thing, let me just touch upon the overview which is that keep in mind we use open trade credit in North America, we use credit insurance in Europe, and in Asia Pac we use a combination of credit insurance and open trade credit. In those countries where we’re using trade credit, remember there’s a deductible. If we choose to ship over the credit limit obviously we’re at risk. But generally when you look at it, we have less exposure there.

We have protection because of that, a wide range of customers, geographic dispersion, and improving performance throughout this year. So those are all very positive things for us.

The last thing I would point to is we only had in the last downturn one very large customer that we ended up in a bankruptcy situation with. I guess if we only had one out of what we saw in 2002/2003, that was fairly good performance.

What we’re doing on a credit point of view is every month we’re taking a look at the collections, we’re taking a look at our experience, and every quarter we do a deeper dive looking at all of the large customers and looking for trends in the smaller customers. Is there a certain class of smaller customers that see a trend developing? If that is the case, how do we work down that receivable versus having the risk?

So we’ve been, knock on wood, fairly successful so far; haven’t seen any big write-offs at this point in time. As I say, our collection efforts have improved. You’re right; it’s a risk but we feel pretty good based upon the learnings from past history, based upon what we’ve been doing so far that we’re in a good position with our receivables.

William E. Mitchell

One of the things I think this company does well is in fact manage its working capital. The processes that are in place for managing receivables risks are robust, as Paul talks about they go on daily/weekly/monthly/quarterly, they’re absolutely part of our overall processes and we watch that extremely closely, as we do on the inventory to make sure that we’re not exposed and don’t have inventory exposures moving forward.

That doesn’t mean we’re bullet proof but that is certainly I think one of the real core competencies of this company is to manage the major portions of our working capital, inventory receivables and payables well to minimize the exposures and to make sure that we keep the business flowing in a responsible and prudent fashion.

Steven Fox - Merrill Lynch

Where you talked about competitive pressures, can you be more specific? Are we talking components or computing and are you talking just specifically within distribution or how do we think about that?

William E. Mitchell

I think we see competitive pressures pretty much everywhere; in all regions, all markets. We don’t have a lot of visibility outside of our own world but certainly the talking we’re having with our suppliers and with our customers just says that the whole world has gotten a lot more competitive as you would expect. If things start to get more cautious, people scrap harder for the existing business that’s out there. We think that particularly in our world some of the weaker competitors, the first lever that they pull is price and we’ve certainly seen some of that.

We think we are well prepared to deal with that. We think that with our strong balance sheet and our global reach and financial strength that we have that in fact we’re well prepared to go and win our fair share of the business that in fact is out there, and we will be very competitive. But it is competitive. It’s across the board. It’s across regions. It’s across business units. The world is just very competitive out there, and again I think that’s what we would expect at this point in time. As things turn down, people scrap like crazy for whatever’s out there.

Operator

Our next question comes from William Stein - Credit Suisse.

William Stein - Credit Suisse

I’d like to dig just a little bit deeper on the receivables question. Can you remind us if you factor any of your receivables? Is any of the stuff off balance sheet?

Paul J. Reilly

We do not factor in North America or Asia Pac. In Europe we do in some countries something that’s akin to factoring but it’s not really the traditional factoring here. You actually go to the banks and present the banks with the invoices and then the bank prepays you effectively. But that doesn’t take the receivable off the balance sheet.

William Stein - Credit Suisse

The receivables days outstanding in September showed modest improvement. You guys have quite good visibility into this issue as I recall, around 100,000 customers in any given year in the component business. Have you seen your ability to collect change at all in the current month versus how things were tracking in September?

Paul J. Reilly

Just to make sure I have the question clear, have things changed in the month of October versus the month of September?

William Stein - Credit Suisse

Specifically regarding your ability to collect.

Paul J. Reilly

I have not seen a dramatic change in the month of October. Generally we have good inflow of cash right after the end of the month, end of the quarter; no surprise there. But no real change in pay patterns and no one around the globe has called me to say they’re concerned about any customers as part of our review process, and we do that review process with real scrutiny at the end of every quarter as we get ready to finalize our results. Not only do we look backwards when we do that but we also talk about what’s happening today with all of our financial leaders and their general managers, and no one has raised the issue of a change in pay patterns.

William Stein - Credit Suisse

I think there was a new IBM relationship or an extension of a relationship announced maybe yesterday but I didn’t see the details. I’m not sure if there was a full press release. Any details you can provide there?

Also, just taking a step back, given that we’re seeing clearly eroded demand maybe you can compare a little bit how this environment feels compared to 2001 and whether you think there might be any structural changes in the industry, things that we should look out for over the next, kind of thinking longer term, maybe two or three years?

William E. Mitchell

Mike, why don’t you take the first one about the IBM relationship; the announcement that we made just yesterday of the extension of our IBM services agreement. That’s a pretty straight forward one. And I’ll take the one about structural changes.

Michael J. Long

Maybe I can take that up a level for you so you can understand. We really have a view that in our computer business that with IBM as with many of our other suppliers that we do want to be in the same businesses that they are, we do want to service the channel, and this is just one more announcement of how we’re doing that by expanding our services impact with IBM. I would fully expect us to continue doing this over the next several quarters and the next several years. It’s really not a dramatic change in our business but a continuation of expanding with one of our premier suppliers.

William E. Mitchell

I think really that’s just the business-as-usual kind of thing that goes on all the time and is indicative of strong relations that we have with many of our suppliers.

If I turn to the question of comparing it to 2001 and would there be any structural changes, it’s hard to say. We’re at the front end of this and of course in 2001 it was absolutely sort of the tech rack at that point in time. I was sitting in the midst of an EMS company at that time and you could see it coming. You absolutely knew that it was going to fall off the cliff.

This one we certainly saw the financial crisis developing. It’s been with us for a year. The impact really didn’t hit into our business world until in the September and into October range. How deep and how long it is is I think very much up for question and we have to maintain flexibility and be responsive to the market conditions that we see. But I would not hazard a guess as to how long or how deep this one might be. It may be driven much more by things that happen in the financial world and the bringing up of credit and getting all of that going that it does than specific business kinds of indicators that we would look at.

In terms of structural differences in the industry, I think that this is one where the industry will continue to consolidate. Many people have talked about consolidation that will go on in the supplier side of the business, it has been going on in the customer side of the business and it’s been going on in the distribution side of the business.

We have been part of the consolidation wave. We’ve certainly helped to consolidate in parts of the enterprise computing space. We think there’s more to go there. In the components world North America and Europe are pretty well consolidated. There’s not a whole lot left to do there. Asia is still very much up for consolidation and as we’ve said before we will play as appropriate in the consolidation of Asia if and when it comes.

So structural I think as you see in the distribution industry you will see a few years out, and again this is my guess, that you’ll see a more consolidated industry, the strong players will continue to be strong, and we’ll play the role of consolidators. We expect to be part of that consolidation wave.

Operator

Our next question comes from Kevin Kessel - J.P. Morgan.

Kevin Kessel - J.P. Morgan

I just wanted to revisit again the question on your guys’ forecast on your enterprise business. At the midpoint it’s up a little bit more than 25% and if I understand correctly, this is really being driven by the back-end loaded nature of this segment in terms of just being the fourth quarter and typically it’s up substantially. I think last year it was up almost 40%. Is it true that I think what you guys were also explaining is that the majority of this really does come together in the last month of the quarter?

Michael J. Long

We’ve been monitoring this very closely and keeping a watch on the trends with our customers and suppliers. As I did say, we were back up to normal levels but the IT spending trends in a typical year really surge the last half of the December month in the fourth quarter. At this point that’s really where we have limited visibility right now given the backdrop of the slowdown. Again as I said, this was the same phenomenon that we saw in September that spending did not pick up to where we thought it would be. As we continued to move throughout the quarter, this is the point in time that December month that is so important to us. Again we’re hoping that becomes clearer sooner rather than later.

Kevin Kessel - J.P. Morgan

I think I understand but when you give a range then, the range for that business isn’t necessarily that large of 1.6 to 1.7. I’m just wondering at the end of the day, it almost sounds like by the nature of it it’s either going to be in that range or it could actually if things don’t materialize in the last two weeks of December because other companies let’s just say do some of the things that you guys are doing in terms of limiting any sort of discretionary spending or limiting the end of your cap ex spending or what have you, it could be quite a bit below that level or am I misreading that that somehow you have some early front-end loading in the quarter that would at least take care of some of the linearity that you’re looking for?

Paul J. Reilly

Let me give it a shot. As Bill mentioned, as Mike mentioned and as I talked about, our visibility’s only about 30 days right now. We’re giving you our best shot today of what we think could happen for this quarter. It obviously could be better or it could be worse. If credit markets open up, then as Mike mentioned, the pace of spending is usually driven in the month of December as people clean up their cap spending. So it could go either way. We’re just saying today this is what we expect it to be. Our range is usually this big. It’s less than the normal seasonality but it’s our best shot right now.

William E. Mitchell

I think that’s the critical point that it’s substantially less than what normal seasonality would be. We’ve taken a more cautious position based on exactly what Mike and Paul said, which is we don’t have a lot of visibility so therefore we have taken the forecast down below normal seasonality by a pretty fair amount. But again we’re not going to know. We don’t have a whole lot of visibility. We’re not going to know until we get into December as to what the business is really going to look like. It could go either direction.

Kevin Kessel - J.P. Morgan

Just so I’m clear on the component side of the business, it sounds like really it’s the fact that you’ve started to see Asia weakening. That’s one of the big drivers behind the forecast there of it being down kind of mid-teens. The other thing being I think if I’m not mistaken you were saying that EMS weakened in the end of your September quarter but it sticks out as maybe being pronounced weakness in the December forecast that you have. Would that be the two drivers behind the components part of the business being down 15%?

Michael J. Long

Absolutely. Those are the two main drivers. As we’ve said in the past, EMS can be up to 20% of our business in a given quarter. We are seeing that drop and we are seeing the drop in Asia right now. As we also said, Asia has performed extremely well over the last two quarters so the drop appears more pronounced than normal seasonality.

Kevin Kessel - J.P. Morgan

Is there any way to draw any sort of end market analysis out of either one of those? Is your Asia business more skewed towards the consumer like most are? And in your EMS business is there any way to know where the end markets are more pronounced?

Michael J. Long

In the EMS markets it’s hard for us to tell where that’s going so that one we typically don’t. We do have a broad range of EMS customers ranging from the large Tier 1s, the Foxconns and the Flextronics and [Jacos] and [Samenas], etc. But we have a pretty large Tier 2, Tier 3, Tier 4 EMS business and that we have very limited visibility as end markets go.

In our Asia Pac business we do have more exposure to consumer but we typically aren’t very heavy into the consumer business in Asia. We do have some exposure in the wireless handset business, in the PC and laptop business, in the flat panel displays, etc. but in terms of the direct consumer business that would be potentially heavily impacted by a weakening of consumer sentiment in North America and Europe, that’s of less importance to us than it is to some other companies.

Kevin Kessel - J.P. Morgan

On the inventory, it looked good in the quarter. You guys were able to draw that down nicely and I think more than historically it’s come down in this quarter. What would you think going forward here? Would you expect a continued drawdown in inventory, reduction in inventory in the fourth quarter?

Paul J. Reilly

The pace of the business is such that our inventory turns are 20+ in the ECS business, so just by nature of a change in mix with more ECS in the fourth quarter we should get an increase in inventory turns. With that said, we’ve been working very diligently around all of the inventory. You heard Mike talk about it, Bill talk about it. We want to make sure we have the right inventory on the shelf and we’re working very hard at that. Do we think we’ll be able to bring inventory down some more? Absolutely. Will inventory turns go up? Absolutely. That’s all part of what Bill referred to before as really solid working capital management. So yes we could continue to see it drift down a bit.

Kevin Kessel - J.P. Morgan

Any sense for where your cap ex will end up for the fourth quarter as well as, I don’t know if you guys have spoken yet about 2009 expectations?

Paul J. Reilly

We have not spoken about 2009. We’re working our way through that as you can imagine right now. Cap ex in the third quarter was $40 million+ really driven principally by ERP. I would suggest for your model assume that it’s between $40 million and $45 million and you should be pretty close to being on track.

Operator

We have no further questions on our roster. Therefore, Mr. Aviv, I will turn the conference back over to you for any closing remarks.

Greer Aviv

Before ending today’s call, for those participating in the webcast we will quickly scroll through this slide reference in our presentation between GAAP and non-GAAP results. This reconciliation is also included in our earnings release, and both the release and the reconciliation will be available on our website.

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

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