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Executives

Greer Aviv - Financial Analyst, Investors Relations

William E. Mitchell - Chairman and Chief Executive Officer

Michael J. Long - President and Chief Operating Officer

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

Analysts

Matthew Sheerin - Thomas Weisel Partners

Brian Alexander - Raymond James

William Stein - Credit Suisse

Steven Fox - Banc of America-Merrill Lynch

Shawn Harrison - Longbow Research

Jim Suva - Citigroup

Carter Shoop - Deutsche Bank Securities

Brendan Furlong - Miller Tabak and Company

Arrow Electronics, Inc. (ARW) Q4 2008 Earnings Call February 10, 2009 10:00 AM ET

Operator

Good day everyone, and welcome to the Arrow Electronics Conference Call to discuss our Fourth Quarter Earnings. As a reminder, this call is being recorded. At this time, I'd like to turn the call over to Greer Aviv for opening remarks and introductions. Please go ahead.

Greer Aviv

Good morning everyone, and welcome to the Arrow Electronics fourth quarter conference call. I am Greer Aviv from Arrow's Investor Relations department. 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 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 turn the call over to our Chairman and CEO, Bill Mitchell.

William E. Mitchell

Thanks Greer, and thanks to all of you for taking the time to join us this morning. Despite increasingly challenging market conditions, I'm pleased to report we are able to achieve sales and earnings inline with expectations in the fourth quarter.

While 2008 progressed on a relatively normal trajectory through the first nine months of this year, we began to see business slow in September as the financial crises in the U.S. deepened and expanded into a global financial crises. Macro pressures intensified in the fourth quarter. And as we said year-to-date, we see that 2009 is off to a difficult start in both our global ECS and global components businesses

Demand is continued to weaken, impacting all markets and economies around the globe. We expect the marketplace to continue to be unsettled and that visibility will remain limited for at least the next few quarters and then in our view through most of 2009. We are not prepared to call a bottom yet. And while we cannot control external forces, we will continued to manage our business discipline necessary to stay ahead of the curve in these uncertain times.

As I mentioned last quarter, we'll do whatever is necessary to keep our company in the strong financial shape that it is in. Mike, will provide you with more details later in the call about the specific actions we have taken thus far. But let me emphasize that we believe the efforts we're implementing to reduce our cost structure today will better position us to navigate through these difficult times and emerge as a stronger, more profitable company.

We've been faced with making very difficult decisions over the past few months, but as our responsibility as a management team to be committed to taking whatever actions are necessary to support earnings in the long-term health of Arrow.

At the same time, we are still selectively investing in the future of Arrow to ensure we remain in a position of financial and market strength. This will allow us to take advantage of opportunities that may arise as a result of the widespread economic downturn. We're committed to our global ERP implementation, and believe this initiative has and will create a competitive advantage and allow us to operate more efficiently in a global environment. We expect that our value-added model and our focus on strategic priorities will enable us to be in a strong position when the global economic environment ultimately improves.

As it's been widely reported, 2008 was a year marked by many challenges. And I'd also like to note some of the many successes that we have within Arrow. We continued to execute on our strategic goals to achieve profitable, sustainable growth by entering new geographies and new markets like expanding our product service and solution sets to ensure we touch every region, every end market and every technology.

Acquisitions remained a strategic accelerator of our growth and we closed on a number of transactions this year which have increased our global footprint. We achieved a major ERP milestone and with the successful transition of our North American Sun group in April, and our North American IBM group just early in February. While we just went live last week, early indications are that the IBM implementation will be just as successful as the Sun conversion. We are on track to transition additional businesses throughout 2009. We've remained committed to this initiative, so we believe it will create a competitive advantage and allow us to operate more efficiently in a global environment.

We also remain committed to our selected market, geographic and people development initiatives, as well as continuing to evaluate acquisitions as strategic accelerates.

Just as important like, we continued to make progress in certain key areas of our operations while maintaining our financial strength. Despite the impact on our business from the global macro economic crisis, we grew sales faster than the market in 2008 to achieve record levels of revenue of almost $17 billion.

This year marked our eighth consecutive year of positive cash-flow as we generated almost $620 million in cash from operations over the past 12 months. This has enabled us to self fund all of our growth initiatives.

I am pleased to say that our balance sheet and capital structure remain very strong, with net debt to capital near historic low levels and we've generated returns in excess of our cost of capital. I would be again emphasized that we are managing our business for continuous improvement throughout all economics cycles.

In summary, our disciplined financial strategy and solid market position will allow us to weather the storm and emerge as an even stronger company. Michael discussed the outlook in business trends and global enterprise computing solutions and global components. And the later, Paul will discuss our fourth quarter financial performance.

Michael J. Long

Thanks, Bill. Before I provide an update on our business trends, I would like to discuss the actions we've taken given the deterioration in the global economy. The current economic conditions supports many companies, including Arrow to make difficult, but necessary decisions over the past few months.

Our initial response was to eliminate all discretionary spending throughout the company. But it soon became clear that this was not enough to counteract the diminishing revenue growth. While we seek to prioritize expense reductions that will minimize job loss, we did have to make significant head count reductions over the past several months. These were difficult decisions, but required to maintain our financial strength and ensure that we retain our leadership position during these challenging times.

We have already implemented a number of cost savings initiatives to reduce the severity of the impact of the deteriorating economic conditions that will have on our employees and our business.

In addition, the head count reductions, we have instituted other workforce actions including lower incentive structures, furloughs and elimination of salary increases. While all aspects of discretionary spending have been curtailed, we have also had a number of facility closings and consolidations.

We estimate the total impact of these actions will reduce costs by more than $175 million on an annual basis, while still selectively investing in the company with initiatives such as the RP, critical markets, emerging markets and our talent.

In summary, we believe the actions we have taken to align our cost structure with the market realities have been a prudent response to the deteriorating environment. And are also based on facts as we see them as opposed to speculations about what may happen tomorrow.

As Bill said earlier, we do not see a bottom and we will continue to evaluate our cost structure to identify additional opportunities to improve our productivity. It has been our consistent message. We remain committed to the ongoing efforts to improve the efficiencies across our organization.

Now, I will talk about our ECS business. Sales in global ECS were inline with the midpoint of our guidance, at strong double-digits sequential growth in storage, software services and proprietary servers was offset by continued weakness in industry's standard servers. Our ECS business did experience the expected year-end budget flush, although not to the same degree as would be expected under normal economic conditions.

While growth has been pressured by the slowdown in IT spending that has been seen across the globe, our diversified and expanded portfolio of product offerings has served as a buffer to the softening demand environment. As I mentioned previously, our value model remains strong even as overall IT spending continues to slow.

With the focus on high growth enterprise markets like storage and software, along with our traditional mid-range server business, customer should continue to use data center enterprise solutions to boost productivity through the downturn. While IT spending forecasts are muted for 2009, our model is not tied to discretionary commodity products like laptops, printers and accessories, which appear to have fallen faster than our space.

Looking ahead, our outlook for ECS is decidedly mixed. As visibility continues to be extremely limited, we would expect this to be the case for at least the next few quarters. With the assumption that IT spending will remain soft as macro issues continue to impact customer behavior, coupled with foreign exchange headwinds, we would look for Q1 sales to be at the higher end of normal seasonal sequential decline of 25 to 35% excluding FX.

Expense control will continue to be a focus in the first quarter of 2009, although our operating income margin will likely be under pressure until we see a turnaround in the global economic situation.

In conclusion, the fourth quarter ended with the reality that the market continues to deteriorate and through February to-date, we have not seen any signs of improvement.

That said, we performed well in a difficult period. We managed the balance sheet very well, controlled expenses and outperformed the market.

In our global components business, sales were inline with expectation at $2.5 billion, while operating performance was impacted by a change in sales mix and gross margin pressure as well as continued softness in most of geographies and markets we serve. In the beginning of the first quarter has seen a further weakening in demand, with run-rates declining from the end of the fourth quarter.

In Asia-Pac, as we expected sales growth was negatively impacted by the global economic crisis and this region posted larger than normal seasonal declines. We began to see a deterioration in business conditions in mid-November, particularly from increased cancellation levels which is a material change in customer behavior. However, our Taiwanese business outperformed our expectations in December.

In Europe, the sales declined accelerated in December with particular weakness in the Nordic region, Germany and Southern Europe. While emerging markets have continued to show growth, the pace of growth is slowed and could even become negative in the coming quarters.

As a bright spot, our design win business in the region has been growing as a percent of revenue and certain vertical markets such as lighting continue to show growth.

Similar to what we experienced in Europe, sales growth in North America was significantly impacted by an accelerating slowdown in demand in December, as many customers shutdown operations in response to the economic downturn. And we began to see cancellations in mid-December. However, some of our vertical markets including medical, lighting and defense did not show the same level of deterioration as the rest of our North American business and have been more resilient in the face of the current economic crisis. And our design win business has been showing relative strength.

Taking a look at leading indicators, pricing remained relatively stable and lead times were at the low end of normal. Our book-to-bill and components decreased quarter-over-quarter and were slightly below one on a global basis for the quarter. Book-to-bill in Europe was up in Q4, but had declined dramatically in Q1, while North America and Asia-Pac decreased strongly as orders have slowed dramatically in those regions.

As you heard earlier, cancellation rates have increased in all regions. In our quarterly survey of over 300 customers in North America, results show that customers continued to exhibit a great deal of caution as the outlook for purchase requirements weakened sequentially and we would expect this customer caution to continue.

Paul will now give you a more detailed review of our fourth quarter financials.

Paul J. Reilly

Thanks Mike. As reflected in our earnings release, there are a number of items that impact the comparability of our results with those in the trailing quarter and the fourth 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 compliment to our GAAP numbers. For a complete reconciliation between our GAAP and non-GAAP results, please refer to our earnings release, or the earnings reconciliation slide at the end of the webcast presentation.

Fourth quarter sales of $4.1 billion were inline with our expectations, and represent a decrease of 7% year-over-year, a decrease of 5% on a sequential basis. Pro-forma for LOGIX, and excluding the impact of foreign exchange, sales declined by 9% year-over-year and 1% sequentially.

Global enterprise computing solutions sales increased by 2% year-over-year and 26% sequentially to $1.6 billion in a seasonally strong fourth quarter. And were inline with the mid-point of our guidance. This represents the 20th consecutive quarter of year-over-year growth for ECS.

Pro-forma, to include the acquisition of LOGIX and excluding the impact of foreign exchange, sales were down 10% year-over-year and increased 29% sequentially. The fourth quarter for ECS once again demonstrated the leverages scale we have in our model when revenue growth occurs, with operating income growing almost 2.5 times faster than sales on a sequential basis.

Focus management of working capital resulted in a record low level of working capital to sales, and in an increase a return on working capital of more than 250% sequentially, and almost 20% better when compared to last year's fourth quarter.

Global component sales of $2.5 billion decreased 13% year-over-year and 18% sequentially, for a decline of 9% year-over-year and 14% sequentially, excluding the impact of foreign exchange.

Despite the realities of a difficult marketplace, our gross margin increased 10 basis points sequentially. And we believe our focus on creating value for our supply chain partners will allow us to perceiver through macro economic challenges. However, lower demand coupled with the fact that sales accelerated at a faster pace and on a more profitable North American and European businesses, and our expenses reductions caused our operating margins to decline on both the year-over-year and sequential basis.

We continued to work to ensure our cost structure is inline with the market realities. Please refer to the appendix of our slide presentation for breakdown of revenue by geography.

Our consolidated gross profit margin was 12.7%, a decrease of 120 basis points year-over- year, primarily due to an increase in the mix of business from Asia and ECS, as well as weakness in North American and European components.

On a sequential basis, gross margin decreased 40 basis points, driven principally by increased mix from our ECS business. Our core customer base is small and mini-size customers showed a more positive trend, with gross margins flat in Europe and North America sequentially.

Operating expenses at the percentage of sales increased 30 basis points year-over-year and decreased 20 basis points sequentially to 9.6%, the second lowest fourth quarter level since 2000. And it has been our consistent message, we remained committed to ongoing EBIT to improve efficiencies across our organization and to lower cost in our business.

As Mike discussed earlier, we've initiated a number of additional cost reduction programs to offset the weakening demand while at the same time investing our business for the long-term.

Operating income was $126.6 million, a decrease of 38% year-over-year and 11% sequentially. Operating income as a percentage of sales decreased 150 basis point year-over-year due to mix and lower gross profit. Sequentially our operating margin was down 20 basis points.

Our effective tax rate for the quarter was 30.2%. From modeling purposes, you should assume that our tax rate for the first quarter of 2009 will be between 30 and 31%. Net income was $72 million, down 40% compared with last year and down 14% sequentially. Earnings per share was $0.60 on both the basic and diluted basis. This represents a decrease of 39% and 38% compared to last year's fourth quarter on a basic and diluted basis respectively.

In accordance with Generally Accepted Accounting Principles, we will continued to evaluate the recorded value of our intangible assets including goodwill, the filing of our Form 10-K. And impairment charge whether it's required now or in the future, will not result in any cash expenditure will not affect our cash position, cash flow from operations, availability under our credit facilities or any of our covenants.

This quarter marked our ninth consecutive quarter of positive cash flow generation, cash flow from operations of $275 million, more than $50 million ahead of last years strong performance. As Bill mentioned, for the year we generated $620 million in cash flow from operations.

Our balanced sheet remains strong with conservative debt levels. Debt-to-capital is near record low levels and a debt to EBITDA ratio of less than two. Importantly, we have no maturities coming due until the fourth quarter of 2010, but we will have more than enough cash flow generation to fund this.

In today's challenging economic times, we believe our financial strength and conservative balanced sheet are competitive advantage that will allow us to weather the storm and maintain our industry leading position.

In addition to our cash, our access to $1.4 billion in committed liquidity facilities provide us with flexibility, and will enable us to take advantage of opportunities that may present themselves as a result of the global economic downturn.

Focus management of working capital enabled us to achieve a near record low level of working capital to sales of 13.8%. Despite a difficult operating environment that has impacted our profitability, we continued to post strong levels of cash flow into our outlook across the capital, which we believe demonstrates our commitment to creating shareholder values through all economic cycles.

One last comment to help you with your modeling. We expect our ERP expense in 2009 to be between 50 and $60 million. From a cash flow point of view, ERP will have a negative impact of more than $100 million on cash flow.

William E. Mitchell

Thanks, Bob. In closing the current macroeconomic environment is clearly impacting our and virtually all companies in our universe and their financial results. However, I want to emphasize that we'll continue to manage the company prudently. We're going to focus on superior execution to ensure that we stay ahead of the current in these uncertain times.

Despite the near-term challenges that may arise out of ongoing market volatility, I believe that our company is well positioned to convert these market challenges into future opportunities. I would also point out that in times of economic stability, we generate more cash not less, and that serves to strengthen our financial position.

As Mike outlined, we are taking aggressive actions to align our cost structure and strategic investments with the current market conditions. More than 175 million in cost savings and operating efficiencies that we've identified and committed to through these actions. We'll provide a catalyst for long-term growth when market demand recovers. Till that time we remained focused on protecting the financial performance of the company, as well as the investments that will lead to future growth and market share gains.

I also want to emphasize that if we are still investing in the ERP and our vertical markets, our new geographies and then our people, selective acquisitions as the strategic accelerator.

It should come as no surprise that the first quarter is off to a tough start as global business conditions have continued to deteriorate. We remained confident about the long-term health of our business model, but acknowledge the reality in which we are currently operating.

In that vein there are number of headwinds that we will be faced within the first quarter, including a stronger U.S. dollar compared to the first quarter of 2008, and the costs associated with our ERP initiatives which Paul just laid out. We don't expect any cash flow impact from these increased expenses. Needless to say, our visibility remains extremely limited and we will continue to take a prudent approach to our guidance by providing you with wider than normal revenue and EPS ranges to account for the uncertainty in the marketplace.

So looking ahead, we believe the total first quarter sales will be between 3.0 and $3.6 billion, the global component sales between 2.0 and 2.4 billion, and global enterprise computing solution sales between 1.0 and 1.2 billion. This is well below normal seasonality and reflects our view of the weakening markets that we serve.

So result of these weakening conditions, we expect earnings per share on a diluted basis and excluding any charges to be in the range of 32 to $0.44 per share. Our guidance assumes that the average euro to U.S. dollar exchange rate for the first quarter is 1.3 to 1, and this compares with an average exchange rate of 1.49 to 1 in the first quarter of 2.8. Greer?

Greer Aviv

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). We'll take our first question from Matt Sheerin with Thomas Weisel Partners.

Matthew Sheerin - Thomas Weisel Partners

Yes, thanks and good morning. My first question is just in regard to your component guidance and where... I mean, I appreciate that visibility is limited. But you are just about half way through the quarter and your guidance basically implies down 2 to down 18%. So what has to happen in the next six weeks to get to the low-end versus the higher end of your guidance?

Michael Long

Matt, this is Mike. As we said before, we've seen a decline in book-to-bill after the December quarter. And we did see some cancellations and push outs. We need to see a more rationale purchasing with demand being real if you will in the near-term.

Right now the lead time as we said before are on the low-end of normal, so the ability to get product to customers is there, if we do see a change in the demand environment. Does that answer your question?

Matthew Sheerin - Thomas Weisel Partners

Yeah, well let me ask another way. So, if... the current weekly run rate you're seeing now and maybe just if you adjust that for the Chinese New Year, and if that continues at that run rate, would that basically hit the low end of your guidance? So in order words, would you need daily run rates to increase significantly to get to the mid range or high end?

Paul Reilly

Hey Matt, it's Paul. Interestingly, first Chinese New Year which makes us a bit more complicated for us an estimation. In fact, the more we see, the more we learn. Folks in Northern China are just came back from their two plus week holiday yesterday. So it's difficult to understand what's going to happen in China, in light of the very extended holiday period.

Our guidance is always given to you with our best thoughts of what's going to happen, with a range that we think we can deliver on. We can't call what's going to happen in the rest of February and the rest of March, and we give you our best shot of what we think today.

Matthew Sheerin - Thomas Weisel Partners

Okay. I appreciate that. And then, just looking at the, your ERP system, if you could just update the... how that's going, what, where you've implemented it so far, any hiccups. And then on the expense side there you said 50 to 60 million in expanses. How much is that up incrementally from last year and if you can give us an idea or the expenses for next year going to go down?

William Mitchell

Yeah. Matt, it's Bill. Let me first of all talk about the ERP and what it is. In April of last year, we converted in our ECS business the Sun business and that's gone very successful and we delivered a number of really good quarters out of that business after that. And so that's been a real success.

We have done like at the first of February with our IBM business, which is our biggest business in our computer products group. That's so far so good. We're 10 days into it. And then so far so good, and we expect to continue with that.

We would expect to have ECS completed by the end of 2009 and to have ourselves fully converted. We are right in the midst of beginning to transition the components parts of the business, our first go live start in the second quarter, and those transitions will then carry-forward through most of 2010.

One of the things I would point out to you and it may not be obvious in upon inspection is that some of the savings that in fact we are able to generate now have come about because we have been working on repositioning our company, simplifying our company, redesigning our company through our ERP efforts. It's a lot less about in selling computer systems and a lot more about making sure you have efficient systems in process. So we've been working this for quite a while. And in fact many of the savings that we can see were in fact the benefits that we've been able to pull forward from our ERP work. So we're beginning to see some of the benefits, those are starting to come through, we... but there are still to come.

Paul, I'll let you talk about the financial piece of it.

Paul Reilly

Great, thanks Bill. Matt, when we said that we're looking at 50 to $60 million of expenses, this year expense charge, that will be about a 10 to $20 million increase over full year 2008. Cash flow impact will be a bit less this year than it was last year. Next year, 2010 will be big year for us. And the components business, which obviously is much larger for us, so I don't think we'll see a significant decline in expense charges next year, though we did talk about reaping the benefits, deficiencies, et cetera and reductions spending in 2011.

Matthew Sheerin - Thomas Weisel Partners

Okay. That's great. Thanks a lot.

Operator

We'll take our next question from Brian Alexander with Raymond James.

Brian Alexander - Raymond James

I guess I'll start by picking up on the ERP question. At the Analyst Day, Paul, I think you guys talked about 65 to 75 million of the cash flow impact and a $45 million OpEx impact in 2009. And now if I heard you it's more than 100 million cash flow and 50 to 60 million of expense in '09. And it sounds like the '08 numbers came in higher than you expected.

So, if the question is, is the project still on time and on budget with what you said at the Analyst Day and this just reflects an acceleration or is it becoming more costly and timely than you expected?

Paul Reilly

Brian, let me take a shot at that. We have not seen a material change in either timing or at costs. In fact, we're seeing the ability to get the benefits sooner. So in fact we have pushed or pulled some spending up into this year and we did the same type of thing in 2008.

From the cash flow side, what's interesting is we were able to buy some licenses. I mean it's very technical type of thing that we were able to pay-off over several year periods. So that would account for the majority of the cash flow increase in 2009 or drag. We thought we would spend that money in 2007 and we are able now to postpone it until 2009.

Brian Alexander - Raymond James

Okay.

William Mitchell

Brian, it's Bill. It's an interesting question. Bottom-line what Paul says is exactly correct. We are on speck, in scope and on budget and on time. We have been able and this has been an added benefit for us. We have been able to see where much of the work that we've been doing to modernize the company, to strengthen the company, to make it simpler, to make it more efficient and factor things that we can implement in advance of the computer system. The computer system will make it easier, make it simpler, we'll get additional benefits. And that's where some of the $175 million in benefits have come from. And we've never promised for a while, so we know where it is, we know where to get it and that's a good last thing benefits that we're starting to read from this program. There is a lots more to come there.

Brian Alexander - Raymond James

Great. And then just on the restructuring that you've announced today, how much of the 175 is incremental to what you've announced previously? What is the timing of that savings by quarter and if you can help us with that. And then, I guess finally do you think that these savings will allow you to still achieve the earnings for which I think Paul, you've talked about of around 220 a share, and that was in a different environment obviously.

But if I'd extrapolate, in the quarter guidance you've given it would seem like it would be difficult to achieve that, but perhaps with these savings you still think that's doable? Thanks.

Paul Reilly

Great. Thanks Brian. So, looking at the cost savings we announced $57 million in total last year. So this is additional expense items, cost savings that get us to a total of 175. So effectively round numbers and other $120 million of actions. So that's what we're talking about here. It's not this plus last year, it's an accumulation of those numbers.

It's very interesting. We have... I would say about half actually in Q1 the quarterly run rate. The challenge as we go through this is that when you tell from an accounting point of view someone that you are going to have them exit the organization, then they stay for two weeks or for a month to transition to work. We wanted an orderly transition, while they still get charge to the P&L.

In addition, in Europe and many countries, you have to go to the informal work councils and picture idea to them. And it's a process where they go through, they review it, they approve it and as they get can execute it on.

So, while we pull people, so... that we think we have executed on. In North America, there maybe some people working out of the organization. And in Europe, we've already gone to the work councils. There is an actual time lag, and those people would be leaving the organization early in Q2.

So, well along on execution. We have hard plans behind all of this. It's not a number that we are shooting for, we have plans that we are going to deliver on. As far the... that the floor that... you are right, that was a very different time. First difference being that, that was in a 10% downturn. We're all seeing now macro economic conditions that are suggesting that the downturn will be much greater than 10%.

So, the other point I would also mention is that was when the exchange rate was 12 to 15% higher in Europe, so we're getting a bit of a drag on that also. So, in this environment $2 is going to be not being deliverable because the sales drop-off is being greater. But we do remain committed so our long-term view on that, as well as our long-term view on our operating income targets.

Brian Alexander - Raymond James

Okay. Thanks, Paul.

Operator

We'll take our next question from William Stein with Credit Suisse.

William Stein - Credit Suisse

Thank you. First, just want to make sure, just a clarification on the last comment that the $2 floor on EPS is likely not achievable in this environment, did I hear that right?

Paul Reilly

Well, that's correct, that was built on a 10% downturn. And we'll see a more dramatic decline in revenues, both on reported for Q4 year-over-year, as well as what's happening in Q1.

William Mitchell

Well, it's Bill. Just a quick comment to that. We are absolutely committed to remain... to retain in the profitability of the company, to make sure that we generate cash, that we retain a strong balance sheet, that we gain market share and that we keep the company in strong shape. You have read all of the outlooks from people that are in our space and in our universe. They are projecting anything from 15 to 35% down kinds of things. And as we go through and do the math, and you will certainly do that.

Given the savings that we can generate and the revenue levels that we see will be extremely difficult for us to meet that $2 target. Having said that, we are absolutely committed to maintain the profitability of the company, to maintain our return on invested capital, to maintain strong cash flow and continue to invest prudently in the long-term future of the company.

William Stein - Credit Suisse

Okay. Another question. I feel like the elf in a room is real peace, there is a number one component distributor in Asia. They are number three globally. They essentially called and end to the downturn in Q1.

I'm curious as to what they are seeing that you are not. Any opinion as to what they might be able to see here to call bottom in Q1? Their comments I believe it was yesterday, where they passed the low point in terms of daily and weekly ship rates in Q4 and then Q1 should be a bottom from a quarterly revenue perspective. Any comments about that will be helpful. Thanks.

William Mitchell

Well, I'll take a shot at that. First of all you know that we don't comment on what other say. All we can do is comment on what we see, and we call, we see and quite frankly we say that we don't see a bottom yet but we don't see that for the first couple of quarters in probably through 2009.

Sitting here, I hope they are right, because if we will come out of it stronger and more rapidly because we have a broader global footprint. We have more business that's available to us. While we're very, very strong in Asia, we've been outgrowing that market for a number of years. And so, if they are correct, we're going to be the ones that are going to benefit from that and so I hope that's true.

All we can do though well is call it as we see it, given the indicators that we see all around the world. There are many of them and that's what we're trying to do.

William Stein - Credit Suisse

To ask another way, are you seeing any turn in the business in Asia in particular?

William Mitchell

Mike, you want to take that?

Michael Long

What we saw, what was a deterioration in the business condition starting around mid-November and that was particularly from increased cancellation rates. Our Taiwanese business did outperform our expectations in December. And since the first quarter market our conditions have continued to deteriorate or soften. And since we've seen is the consumer in the automotive markets being the largest in the slowdown. It is early to determine the impact of the Chinese New Year on the quarter as Greater China itself is just starting to return. And we have employees that are still out on holidays and have actually encouraged them to take time off during this time.

And as a result, our visibility is low and difficult to assess the impact on the holiday. Most of our customers, suppliers and competitors they are all forecasting lower Q1s and Q4 and mostly due to the less days from the Chinese New Year and the impact of the downturn. So I wouldn't say yes that we are in a position to call anything at the bottom.

William Stein - Credit Suisse

Okay, great. Thank you.

Operator

We'll take our next question from Steven Fox with Banc of America-Merrill Lynch.

Steven Fox - Banc of America-Merrill Lynch

Hi, good morning. A couple of questions. Just first, clarification on the $175 million, are you saying that there is half of the remaining 120 million that you just instituted is going to realized in Q1 and at least 60 million or was that half of the 175?

William Mitchell

See we're trying to say, was if you take the quarterly run-rate which is about $42.5 million, we have achieved in the first quarter about half to a little more than. And we're executing the plans to make sure that we get close to 100% in Q2 and with full run rate on sQ3.

Steven Fox - Banc of America-Merrill Lynch

Got it. Has then can you talk a little bit about cancellations rate in more detail specifically this quarter, has the cancellation rate remained high through today or is it started to dissipate?

Paul Reilly

We continued to see cancellations today. And as you heard, right now lead times are on the low-end of normal. And what we're seeing is that our customers have depleted their inventories. We've seen a slight build at the manufacturer level. And what we would expect is that eventually as the customers work though their inventories and generate cash for themselves then we would see some buying. We have not seen that happen yet, and we'd hope that would happen in the near future. But again we don't see any indicators that show us that customers will start increasing their demand.

Steven Fox - Banc of America-Merrill Lynch

Okay. And then on your own inventories, your total were sort of flattish if I assume part of that is mixed related. If you just look at the component inventory turns in your business, I assume they went down, where are they relative to your comfort level at this point?

Paul Reilly

Yeah. When you look at it, in fact there is a couple things impacting inventory. So foreign exchange makes it lower, the acquisitions make it higher. We are down in absolute dollars compared to the fourth quarter of 2007.

In our components business, we saw a slight decline in inventory turns. That's not unusual when it's a downturn inventory, it takes a little bit longer to catch up. They are still well in excess of where we were in the last tech rack. So we feel we're in good shape.

I'll let Mike talk about how he feels about comfortable, uncomfortable with the level of inventory right now. But remember Steve, we always managed the working capital to big pool. So if we may increase inventory, we may also be able to increase payables with suppliers, so that net working capital is not impacted.

Steven Fox - Banc of America-Merrill Lynch

Okay.

Michael Long

Yeah. I would say right now we are relatively comfortable with the levels of inventory we had. And again, remember we said we were managing the company based of what we see in the facts not speculation to what might happen in the market.

So we're managing our inventories inline with the market and inline with customer demand. And that's why you are not seeing massive fluctuations at this point in time. You have seen a reduction in the inventory as Paul said, but we are not doing anything crazy. We stand prepared to be here when the demand turns and that's our expectation to continue to have the inventory to provide the service that our customers need.

Steven Fox - Banc of America-Merrill Lynch

Great. And then very quickly, Paul do you have a head count number for the end of the year, from the end of the year?

Paul Reilly

I don't have it with me, but definitely we can get that information for you.

Steven Fox - Banc of America-Merrill Lynch

Okay. Thank you.

Operator

We'll take our next question from Shawn Harrison with Longbow Research.

Shawn Harrison - Longbow Research

Hi. Good morning. Getting back to the restructuring savings, maybe we could just look once that full run-rate is achieved, the breakout between the global components business and ECS what percentages of savings will fall on each?

Paul Reilly

We don't have the information, we're not going to disclose the information by business segment. I would say though that it's more tilted towards the components businesses in general. But we're looking at this also around the efficiencies that come out of ERP. So we'll see greater efficiencies in ECS this year.

I actually am pretty enthused by the ERP rollout because when there is the recovering of broad economy and revenues go back up, we'll get a tremendous amount of leverage out of the new system and not be in a situation where we have to bring back costs at the same pace that we may have done in the past.

Shawn Harrison - Longbow Research

I guess is a follow-up to that then, the 105, 75 million savings, is there a way to quantify maybe how much of that is permanent, so that when you do see revenues come back up what we can expect will still be not in the model going forward?

Paul Reilly

Yeah. Well, it's hard to project on what case the revenues will come back. Let me give you an idea of the areas that we've made these cuts in. So when we look at it in employment head count area, it's over $110 million. So that's a big number, there is furloughs, incentive reduction and benefit cuts that are $25 million plus. We're able to do better in freight now, professional fees, less temp help because obviously we don't need it, we can use our own people. Reduction in IT, reduced CNE meetings by 5 million, warehousing facilities down by 5 million. So facilities and warehousing, that's gone forever.

CNE meetings we're sitting in our teleconference room right now as opposed to flying around the world, flying around the country, we had that all. And as many locations now at Arrow, that's cutting back in CNE permanently. We made that investment.

IT, we're thinking smarter and better. Right now we have to run two through systems. We're rolling out of new ones, plus we've got to maintain the old one. We'll get rid of the old one eventually that's a permanent savings.

Sent help because we're more efficient, that will be permanent savings. How we're managing freight that will be permanent savings also. So it's tough for me say what's going to happen in the future around personnel course, because it was dependent upon on the pace of what revenue recovers. But I would say that our expectation is that we have permanent costs in that area as the business also.

Shawn Harrison - Longbow Research

Okay. And then getting back to working capital and cash generation in 2009, given that you are managing total working capital, is there a number of days that you'd like to see come out of the cash cycle during 2009 that we can maybe look for an additional cash generation?

Paul Reilly

Yeah, it's a good question. We track it as working capital as a percentage of sales. So, we're looking for a number that's between 13 and $0.14 for every dollar of sales. That's our target. That's what we're driving towards. That's what we're for. So we feel that that's an opportunity to not only get cash flow out of efficiently managing our inventory now, or our working capital now, but also to be able to better than we were in 2008.

Shawn Harrison - Longbow Research

Okay. Then just two quick follow-ups. I guess baseline capital expenditures excluding the ERP system in 2009, and then just kind of your thoughts on cash usage here and over the next six to nine months beyond the restructuring?

Paul Reilly

Well, I would say on CapEx it runs historically ex-ERP, somewhere between 50 and $65 million. So that's really CapEx excluding ERP. As far as cash utilization going forward, I think we're very similar to most of the U.S. companies and international companies. We're looking to hold cash at the moment. We're committed to our investment credit rating. And we're going to make sure that we have the right balance, as Mike and Bill said, between expense reduction, but inventing in the business.

Shawn Harrison - Longbow Research

So, in these near-term or cash as the opportunities come up then look at those, but nothing on the... at least immediate horizon?

Paul Reilly

Correct.

Shawn Harrison - Longbow Research

Okay. Thank you

Unidentified Analyst

Okay.

Operator

We'll take our next question from Jim Suva with Citigroup.

Jim Suva - Citigroup

Great. Thanks very much. Now looking at this level of run-rate and economic outlook that you have seen at the $2 to 2.54 is kind of off the books so to speak. Looking at your guidance, is it fair to say $1.40 to 50 is a good rate, or since Q1 is typically the lower should we kind of be looking at above 50 to 75?

Paul Reilly

Hey, Jim, its Paul. If you do the math on the mid-point of our guidance for the first quarter, it's above 150 and we don't have full run rate for expense savings yet. So, I would suggest its north of above 50.

Jim Suva - Citigroup

Okay. And then on the cancellations, any commentary on, are they more on the component side or the system side or both?

Michael Long

Yeah, we've seen the cancellations remember on the component side primarily. And remember coupled with that, we did see a slight negative book-to-bill going into the quarter. And we are trying to see a sign that shows that that's reversing, but we haven't seen it yet.

On the computer side, the demand for us has been relatively steady given the marketplace. And again, we have not seen the wild fluctuations in that business that may be people have seen in laptops and accessories and other discretionary items.

Remember the mid-range business is a mission critical business, and while we know that it is based on capital spending, we haven't seen the violent swings that some of the other industries have seen. So hopefully that will give you a little clarity that the big cancellation rates have been on the component side.

Jim Suva - Citigroup

Okay. And there is a quick follow-up on the component side, you are guiding down 18 to 2% range, it seems like a lot of the chip vendors were guiding down significantly much more. What's normal seasonality in your components business and are we at risk of having a little bit too high of guidance there? But I guess, since we've only got six weeks left in the quarter, do you feel pretty confident in that?

Michael Long

We gave the guidance based of what we see today. And again visibility is limited. Remember the suppliers are basing their declines off of a smaller customer base than we have. So, the suppliers' customer base is really is more around if you would say a general comment, the wireless industry and the networking industry or things that are built in, what I would call a very a narrow market. Where if you look at the strength of Arrow, we have many small customers running right up to what we would call our large core accounts, and that marketplace has declined less than what we've seen with the OEM manufacturers.

Jim Suva - Citigroup

Okay. And what's normal?

Paul Reilly

Jim, I'll come back with the information. I don't have it right in front of me. But you're right. This is outside the range of normal seasonality for the first quarter.

Jim Suva - Citigroup

Great. Thank you very much, everyone.

Operator

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

Carter Shoop - Deutsche Bank Securities

Good morning. I have a question on lead times. I was hoping that you have to quantify what your lead times now are in a components division and how that compares to where they were in January, and then also to where they were on the last earnings call back in October?

Michael Long

We were seeing lead times in the normal 12-week. If you go back to the tail end of last year, those lead times have come in substantially for many reasons. Obviously, there is still been some building going on by the manufacturers into the first quarter, the quick slowdown pace of the market.

And again, there is a difference in passive components versus active components, but all in all easily been three week shaving off of that lead time. We are not really hurting at this point in time. If a customer would come in tomorrow, I'm sure we have a good chance of filling that order.

Carter Shoop - Deutsche Bank Securities

Okay. That's helpful. And then, one of the areas that you've discussed is performing relatively well is lighting. Can you discuss what the year-over-year growth rates were in the LED business in the December quarter and how that compared to the September quarter?

Michael Long

I don't have the exact number for the December quarter. But in 2008, our lighting sales doubled, and we would expect them to double again this year.

Carter Shoop - Deutsche Bank Securities

Okay. That's helpful. And then, in regards to component inventory returns, you gave us a little bit of color on the fact that they declined sequentially. Can you disclose what that actual number is and how that compares to kind of peak inventory returns and components?

Paul Reilly

Carter, I think the round number on that is... we were down about 15% in inventory returns and components from the fourth quarter of last year. Yet that at the level we are today is approximately 40% better than the down cycle, so that we last went through. So, not from the peak of performance, but still 40% ahead of where we were in the last down stroke.

Carter Shoop - Deutsche Bank Securities

Great. Thank you very much.

Operator

We'll take our next question from Brendan Furlong.

Brendan Furlong - Miller Tabak and Company

Good morning guys. Thank you. A couple of quick questions on the balance sheet, and looking into Q1 in terms of I guess the inventory dollars and accounts receivable, what are you guys planning from that?

Paul Reilly

I am sorry, Brendan, could you give that once for me, again?

Brendan Furlong - Miller Tabak and Company

I am sorry. On the balance sheet, inventory in terms of dollars into Q1 and accounts receivable, what are your thought... what's your thought process in terms of AR into Q1?

Paul Reilly

From an AR point of view, we monitored based upon DSO. So we don't necessarily set a dollar amount. So, we would expect to see an improvement in DSOs in the first quarter. But we're talking about a day, which is a meaningful number in dollars, but we're looking an improvement there. It's very interesting. We didn't seen a significant change in paid patterns in the fourth quarter and that encourages us. And we expect to see that to hold true in the first quarter also.

So, from receivables point of view, some improvement from DSO point of view, but we don't manage it based upon how many dollars we're willing to commit through receivables.

Brendan Furlong - Miller Tabak and Company

And your inventory, you are hoping to take down again, I assume in Q1?

Paul Reilly

It's not a matter of taking inventory down as much as we want to make sure we have the right level of returns and the right quality of inventory. So, historically what we've done is we focused on trying to make the slower turning inventory return faster versus the hot move is. So, I wouldn't expect it to see a significant change in our inventory position going forward absence anything around revenue levels.

Brendan Furlong - Miller Tabak and Company

Okay. And then just a follow-up on this beat the dead horse on the component inventory sales. The... a lot of the semiconductor companies are also kind of saying they are seeing a little balance in terms of orders. But you are saying no. If can you, and if I missed this I'm sorry, on the cancellations that you are seeing, et cetera, is that all coming out of Asia? Is there a geographic spread on what you're seeing in the components and how is U.S. and Europe versus Asia, is it all just Asia canceling?

Michael Long

First of, let's remember that the direct manufacturers again are dealing with the narrow customer base. They have bigger provisions and the consumer industry if you will, the cell phone industry if you will, and also directly into automotive, a little balance for them could be a hiccup in the consumer industry or in the wireless industry.

We don't have anything that moves us that quickly. Again, if you take the rest of the industries that we deal within the 140,000 customer base we have, we are still seeing cancellation rates in every region of the company. We're seeing them in North America, we're seeing them in Europe and we're seeing them in Asia. And again, too close to call what will happen after the Chinese New Year. If you're equating that balance back for the direct manufacturers, I would certainly hope to see that and I would welcome that. But right now we don't see it.

Brendan Furlong - Miller Tabak and Company

Great. Thank you.

Operator

(Operator Instructions). We'll take our next question from Brian Alexander with Raymond James.

Brian Alexander - Raymond James

Yeah. I guess just one follow-up, a big picture question. If I just look at the components business, your operating margins at 3.6%, grants it is a very difficult environment and you are reducing your cost structure. But they're similar to where they were in 2003 despite the fact that your sales are about 50% higher.

I realized that Asia is higher percentage of the mix now versus then, but I don't think that would explain the whole issue. So, can you just talk about what are the structural changes you might have occurred over the last several years and why you are still comfortable in the long-term operating margin target for that business, given that we haven't improved over six years despite 50% higher sales?

Paul Reilly

Hey, Brian its Paul. Let me try to give some directional information on the performance of the businesses. So, in the fourth quarter, our North American components business operated with operating income percent at a... what I would say is a strong level. And that's reflected the fact that we've been able to recognize the change in the business which is built more around value-added services, differentiated gross profit, yeah differentiated cost also, but yet more for us more proper business for us. You're right also that we've seen a growth in the Europe... in the Asia-Pac business, which dilutes down our margin. We're not at the levels that we've set as targets.

The third thing I would point to is around Europe, and two factors there. We haven't seen the same pace of growth if you will in Europe. So that means it's less as a mix for all the components which drags down the operating income percent.

But the other thing is that I would say in retrospect we focused a tremendous amount of effort in making sure we got back to best-in-class operating income percents in North American components. So within the last year and a half or so we've been doing that also in Europe. But the big issue is Europe has resistance, so we really can't get those cost out fast enough until we get ERP rolled out there.

So Mike and Bill both mentioned we have some plans in place that are pretty exiting to be able to now take the most cost out even though we don't have ERP rolls out there, but it's going to take us some more time to really get them back on track if you will reflective of all the great work that's been done in North America to drive their operating income percent back up.

William Mitchell

Brian, I'll take you back to again to some of things that we talked about in the... our Analyst Day last year, it seems like a very long time ago. One of the things we did laid out was the roadmap for getting to our long-term targets. You certainly have seen a decided lift that's come on in the fourth quarter and continuing now. But that roadmap is still correct. We can certainly get there even in spite of increasing impact of Asia, increasing impact of ECS both of which are lower gross margin regions. But we get them where we want them to, will be at the right operating margin region.

We have run into headwinds with foreign exchange, we haven't gotten the benefits of the ERP. But we do see that roadmap is still a good one and that's what we're continuing to follow for the long-term.

In the short-term we will continue to manage the company as prudently and wisely as we possibly can get. But, for the long-term it is still on that long-term roadmap that we've projected some months ago. It seems like a different era for sure.

Brian Alexander - Raymond James

And then just a follow-up on industry standard servers, Mike, I think you mentioned that, that was the weakest part of the computing business in the quarter. So would you say that's more a function of the market demand, do you think that's more a function the vendor line card that you have perhaps some of your key venders lost share or is there any other story within there that suggests you're deemphasizing that product line due to poor returns, just want to make sure I understand the performance there?

Michael Long

We actually believe that pause if you will. We still believe that hardware swap outs towards virtualization will happen. No matter what data you look at, if we look some at IDC and it still fights with only 5% Brian of those servers worldwide have been virtualized off with virtualization software in this point. So, there is still a lot of opportunities ahead of us and that really translates to a great opportunity for us as this business starts to pick backup, especially because we're the number one distributor of VMware.

With the current economic environment impacting us, the spending, the discretionary portions of the budget, it's more likely that this is a slowing in getting pushed out versus a missed opportunity. And that's how I would characterize it.

Brian Alexander - Raymond James

So Mike --

Michael Long

But again it's not something that somebody has to do right away to be able to turn your system on mild.

Brian Alexander - Raymond James

Right. So it's still a strategic product line for you?

Michael Long

Absolutely. I think it's still a huge opportunity for us going-forward. And I fully believe that the pause in discretionary spending is what's sort of put the lid on it for now.

Brian Alexander - Raymond James

It makes sense. Thank you.

Operator

It appears we have no further questions left in the queue. At this time, I'd like to turn the conference back over to the presenters for any additional or closing remarks.

Greer Aviv

Thank you. Before ending today's call, for those participating in today's webcast, we will quickly scroll through the slide referenced in our webcast that contain a reconciliation between GAAP and adjusted results. This reconciliation is also included in our earnings release, and both the release in this presentation will be available on our website.

I would like to thank all of you for taking the time to participate in our call this 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.

Operator

Thank you, ladies and gentlemen. Once again, that does conclude today's conference. We thank you for your participation.

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Source: Arrow Electronics Q4 2008 Earnings Call Transcript
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