Arrow Electronics, Inc. Q1 2008 Earnings Call Transcript

| About: Arrow Electronics (ARW)

Arrow Electronics, Inc. (NYSE:ARW)

Q1 2008 Earnings Call Transcript

April 23, 2008 10:00 am ET


Sabrina Weaver – Director Investor Relations

Bill Mitchell – President, Chief Executive Officer

Paul Reilly – Chief Financial Officer

Mike Long – Chief Operating Officer


Brian Alexander – Raymond James

Steven Fox – Merrill Lynch

Matthew Sheerin – Thomas Weisel Partners

Jim Suva – Citigroup

William Stein – Credit Suisse

Mark Moskowitz – JP Morgan

Louis Miscioscia – Cowen and Company


Welcome to Arrow Electronics conference call to discuss their first quarter earnings. (Operator Instructions) At this time I’d like to turn the call over to Sabrina Weaver for opening remarks and introductions.

Sabrina Weaver

Welcome to the Arrow Electronics first quarter conference call. I’m Sabrina Weaver, Arrow’s director of investor relations and I’ll be serving as the moderator on this morning’s call. Today’s call is also available via webcast. To access this webcast or future webcasts, please visit our investor relations website and click on the webcast icon.

With us on the call are Bill Mitchell, Chairman and Chief Executive Officer; Mike Long, President and Chief Operating Officer; and Paul Reilly, Chief Financial Officer. By now you all should have received of our earnings release if not you can access our release on the investor relations section of our website.

Before we get started I would like to review Arrow’s Safe Harbor statement. Some of the comments to be made on this morning’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 for such statements for a variety of reasons.

Detailed information about these risks is included in Arrow’s SEC filing. We will begin with several minutes of prepared remarks which will then be followed by a question and answer period. As a reminder, to members of the press you are in a listen only mode on this call but please feel free to contact us after today’s call with any questions you may have.

At this time I would like to introduce our Chairman, and CEO, Bill Mitchell.

Bill Mitchell

The first quarter was a challenging one for us and did not meet all of our expectations. We achieved record level first quarter sales and working capital to sales and after exceptional cash flow performance in our 2007 we again generated positive cash flow in the first quarter. Yet we saw increasingly challenging in the volatile conditions during the quarter particularly in the last few weeks. And primarily in our enterprise computing solutions business, this in turn created headwinds for our operating performance.

When we last spoke on February 7, we communicated that market conditions were cautious and the macro economic picture had become more negative yet business appeared to be stable. As the first quarter progressed, the turmoil and the financial markets increased to unprecedented levels and as a result we did not see the typical uplift at quarter end. This caused us to miss our guidance range for earnings per share.

In ECS, we saw mixed results with very strong growth in storage software and services offset by weaknesses in all areas of our server markets. Our customer base reacted to the uncertain economic backdrop with caution at quarter end. This in turn led to lower sales volumes and margins that in turn resulted in lower supplier rebates that impacted our results.

As we always do we took appropriate actions to adjust out cost structure to reflect existing market conditions. However, despite current market weakness we are going to continue to focus on prudent investing in this business for the long term. First quarter saw the launch of our mid market initiative the announce acquisition of Logix as well as the successful implication, implementation of our global ERP platform in our North American sun business.

In components we executed well in a market that continued with its cautious tone. After resuming year-over-year growth in the fourth quarter, conditions in North America remained generally stable. Our Asia pacific business saw strong double-digit growth and conditions in Europe were soft with less that seasonal performance on a constant currency basis.

Book to bill was above one globally with both North America and Asia packed above 1.05. And we achieved a strong increase in design registrations in North America year-over-year, a very positive sign the customers are still designing new products despite the macro uncertainties.

We also announced three strategic acquisitions in our components world. ACI to help strengthen us in our military aerospace offerings, Acheiva to help us in the ASEAN Asian region and Hynetics to strengthen our capabilities in the important emerging market of India.

Though we did not meet our expectations, the company is fundamentally sound both financially and from a market perspective. Our global scale and financial strength allow us to take advantage of opportunities to invest in both organic and M&A related growth during periods of market weakness. And this is precisely what we are doing. As we previously mentioned we announced four strategic acquisitions in the quarter. We will continue to invest in the long-term future of Arrow to increase our opportunities in higher growth markets to better leverage our global scale and to further diversify our revenue streams.

At the same time, we have taken steps to be more efficient in all areas of our business. I would note that we have done this on a consistent basis over many years and we will continue to do so to be able to maintain our cost and capability structures in tune with the prevailing market conditions. Our strategic priorities for the future are clear and have not changed. We will continue to pursue transformational opportunities in enterprise computing solutions, we will leverage our best in class capabilities throughout our global components organization we will install world class systems and processes to take us to an entirely new level of global operations and we will pursue significant growth opportunities across products markets and geographies.

And we will do this while continuing to manage the company in a prudent fiscally disciplined manner to increase profitability maintains positive cash flow and strengthen our already strong balance sheet. Paul Reilly will now give you our detailed review of the first quarter and then Mike will discuss our business unit performance in greater detail.

Paul 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 in the first quarter of last year. I will review our results excluding these items to give you a better sense of our operating performance. As always, the operating information we provide to you should be used as a complement 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. Sales for the first quarter were $4 billion, an increase of 15% year-over-year and a decrease of 9% sequentially. Pro forma for the impact of the KeyLink acquisition and the related procurement agreement reduced sales by 5% over last year. Global enterprise computing solutions increased sales by 55% year-over-year and decreased 31% sequentially to $1.1 billion in the seasonally soft first quarter.

Pro forma for the acquisition of KeyLink and the related procurement agreement our top line increase 6% over last years first quarter. This represents the 17th consecutive quarter or year-over-year growth for ECS.

Server weakness led to lower than anticipated volumes and lower rebates this quarter. And combined with a lag in return on investments and growth initiatives, our operating margin came under pressure, decreasing 140 basis points year-over-year to 2.8% yet further improvements in managing our asset base and the scale provided by our North American acquisitions allowed us to increase return on working capital by 28% year-over-year.

Global component sales of $2.9 billion increased 5% year-over-year and 4% sequentially. In this uncertain environment, we remain focused on cost containment we’re able to decrease our operating expenses to sales by 20 basis points year-over-year. We remain very close to the financial target for global components with an operating margin of 5.5% in the first quarter. That’s flat with the first quarter of last year in what is a more cautious environment this year.

Our working capital management also continues to improve as working capital to sale decreased 70 basis points year-over-year. In Asia Pacific, sales increase 20% year-over-year and were flat sequentially at $653 million, which is stronger than normal seasonality. Operating income increase by almost 47% year-over-year and combined with better asset management, return on working capital increased 200 basis points year-over-year in this year’s first quarter.

In North America, total sales of $1.2 billion were up slightly compared to the previous quarter and flat with the first quarter of last year. Sales in our core customer base of small and medium sized businesses increase 2% sequentially and 2% year-over-year while operating income for this customer segment grew 3 to 4 times the rate of sales growth sequentially and year-over-year.

We also increased return on working capital in this region by 18% over the same period last year. In Europe, sales of $1.1 billion increased 11% sequentially and increased 3% over last years first quarter. Excluding the impact of foreign exchange, sales increase 8% sequentially but decreased 9% year-over-year as markets have weakened compared to the first quarter of last year.

While year-over-year operating comps proved tough to beat, our continued focus on the broad small and medium sized customer base combined with ongoing efficiency initiatives allowed us to increase our operating margin by 70 basis points and grow earnings at twice the rate of sales sequentially. Our consolidated gross profit margin was 14.6% an increase of 70 basis points sequentially.

Gross profit margin declined 90 basis points year-over-year due to the increase mix of business and global ECS from 20% to 27% of our total sales as well as the impact of lower rebates and ECS. When you look at our core customer base of small to mediums sized customers and components gross margins were flat year-over-year. Operating expenses as a percentage of sales decreased 50 basis points year-over-year to 10.5%, the lowest first quarter levels since 2000.

Our operating expenses as percentages of sales in the first quarter were lower on a year-over-year basis despite and increase in ERP spending of $3.5 million demonstrating our ability to drive costs down while investing for the long term. The back half of 2007 we identified $40 million of cost initiatives in our North American components group from centralizing certain back office operations and creating a shared service environment.

We have messaged consistently that we continue to see opportunities to leverage our global scale and operate more efficiently. In the first quarter we identified an additional $7 million of annual cost savings within our components business in North America and Europe as well as our ECS business. Approximately $1 million of savings relating to these initiatives was achieved in the first quarter. This brings out total annual expense reductions announced in that last three quarter to $47 million as we manage our business prudently to achieve even higher levels of operating efficiency.

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

Operating margins decreased 50 basis points sequentially primary due to the afore mentioned rebate and ECS server buyer misses. Our effective tax rate for the quarter 30.5% and for modeling purposes, you should assume that our tax rate for the remainder of 2008 will be between 30% and 31%.

Net income was $97.9 million that was up 7% from last year and a decrease of 19% sequentially. Earnings per share were $0.80 and $0.79 on a basic and diluted basis respectively. This represents an increase of 7% compared to last years first quarter on basic and diluted basis and represents a record first quarter level.

So while our earnings per share were not where we anticipated, it would be this quarter, we did come in at a very respectable level of earnings given the economic backdrop. We believe have created a floor at our earnings through reducing our cost structure and increasing our variable costs and diversifying our revenue streams.

This marks our sixth consecutive quarter of positive cash flow generation with cash flow from operations of $40 million. Our consistent ability to generate cash has enabled us to self-fund many of our growth initiatives. And today’s financial markets that is a clear competitive advantage.

Our strong balance sheet and access to committed liquidity facilities provides us will a level of comfort that Arrow has the financial stability to perform and take advantage of market opportunities throughout the cycle. Focused management of working capital resulted in our return on working capital increasing almost 160 basis points year-over-year to the second highest first quarter level since 2000.

Return on investment capital significantly exceeds our cost of capital for the 17th consecutive quarter. We were able to decrease working capital to sales by 280 basis points compared to the same period last year. Mike will now discuss of performance and business trends and global ECS and global components.

Mike Long

Our enterprise computing solutions product saw mixed results for the first quarter. Storage software and services posted impressing double-digit year-over-year gains and we expect continued growth here given the strong underlying demand for virtualization and security solutions. Yet we experience year-over-year declines in both proprietary and industry standard servers as have been widely reported.

The uncertainty of the macro environment has caused IT extending to soften and as a result our customer base became more cautious with our server investments in the first quarter. Server weakness led to lower than anticipated volumes and lower rebates. And a lag on return on investments in a organic growth initiatives resulted in operating margin pressures. We find our level of operating margin this quarter to be unacceptable and belive we have plans in place to get us back to track in imporveing our profitability. One key element of our strategy in expanding our European footprint which we began to do two years with the acquisition of DNS.

We have continued to make investments in line card expansion and geographic expansion to increase our scale. This has impacted our progress toward profitability targets for this region but we’re on our way. On February 19, we announced the acquisition of Logix an interprise computing solutions provider in Euproe that we expand our pan European footprint into six new countires and diversity of our suite of solutions by almost doubling our existing line card in this region.

The acquisition represents a key step in our Eurpean expansion and will bring an extrememly talented management team and provide us with and necessary scale to improve our operating performance in this region. In addition, Andy Bryant, the new president of our enterprise computing solutions group will be spending a large amount of his time in Europe to ensure we bring our performance up to the next level.

Andy has over 25 years of distribution experience and one of the longest track records in enterprise computing solutions distributions, which makes him the perfect candidate to build a bond and further accelerate the success of our ECS business. We are all very excited about his decision to join us and I’d like to take the opportunity to formally welcome him to the team.

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

I am also extremely proud to report that on April 1 we achieved an important ERP milestone. The North America sun business of our enterprise computing solutions group transitioned smoothly and is now operating on the oracle platform with out any delay in processing orders or shipping or receiving product. For more than 18 months or project team has been planning, developing testing and training to make this vision a reality. This technology will create the infrastructure to produce best in class services to our partners and truly change the value proposition of ECS.

We are rolling out systems that will fundamentally change how we go to market with data analytics and intellectual property that has not been seen before in the market place. This global system takes profitability tracking the mid market from the dream to reality. We’re extremely proud of our ability to deliver ERP on budget and on schedule and we will now take those key leanings from the sun implementation to further improve our processes as we move forward with our implementation throughout our business units.

Our customer and vendor feedback on the conversion has been positive and we look forward to the gain changing benefits as global implementation will bring to our business. We’re laying the groundwork in investing in the long term to create some very exciting opportunities for our vendors our reseller partners and our shareholders.

In global components we executed extremely well in a cautious marketplace with sales at the High end of our expected range of $2.9 billion. In Asia-Pac, we achieved strong year-over-year growth in Taiwan, India Australia and New Zealand the ASEAN region.

We again outgrew the market despite seeing some softness in China. Our strategic expansion in Asian Pac continued in the first quarter as we closed the Hynetics and Shreyanics acquisition which is leading a components distributor in India. This provided us additional scale to increase our profitability in the Indian marketplace.

We also announced the acquisition of Acheiva, a value added distributor that will further strengthen our position in the ASEAN region and enhance our existing demand creation activities.

Acheiva’s management team is a highly experienced and will be and impressive addition to our bench dream as we move forward with our growth and profitability initiatives in this very important region. We anticipate this transaction will also be immediate accretive to earnings. In North America we saw a strong sequential increase in book to bill in the first quarter and design registrations showed strong double-digit year-over-year growth.

The while customers base maybe cautious in the short term they too are positioning themselves for the long term by designing new products to take advantage of anticipated future strengthening in the marketplace. Year-over-year softness in North America was driven primarily by weakness in the transportation end market.

Our defense and aerospace segment performed well again this quarter and in February, we announced and acquisition in the rapidly growing area with ACI electronics. ACI is one of the largest independent distributors of electronic components used in the defense and aerospace applications.

This acquisition further bolstered our number 1 position in North America defense and aerospace market and provided us with leading market share in many technology segments including military discreet. In Europe we saw conditions weaker in the first quarter. The European marketplace typically lags behind North America by two to three quarters and moderate conditions were expected.

In addition to and anticipated cyclical trends, the strength of the Euro began to impact the competitiveness of the regions export markets which created additional headwinds for us in Europe. Though this market weakness we’re moving forward with our ongoing efforts to broaden our existing customer base and drive for more consistent and productive operations throughout the region. Taking a look at leading indicators, our book to bill remained above one at 1.03 for the third consecutive quarter.

Levels strengthened in North American and remain stable in Asia Pac. In Europe our book to bill materially weakened and the outlook here is extremely cautious at this time. We are carefully monitoring the conditions in Europe as we move forwards. These times in pricing have remained stable with lead times still within normal ranges of 8 to 12 weeks. And importantly we saw no notable increases in cancellation rates.

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

Bill Mitchell

Overall we had mix performance this quarter in a cautious marketplace. While we achieved the high end of our guidance range in our components business, our performance in ECS did not meet our expectations and we will not accept the current levels of profitability.

We believe we have the right strategies in place and we have the right team in place to move forward with these strategies. We will continue to manage our company conservatively and prudently based on the changing market conditions while at the same time we will maintain our flexibility to take advantage of opportunities for organic market share growth and opportunities in M&A.

We will continue to generate cash, our balance sheet is in great shape and we remain committed to investment additions that will position Arrow for future growth. and vertical market initiative in geographic initiatives in Asia and Europe and further penetrating the small and medium sized marketplace and the global systems to leverage our scale worldwide to transfer the way we do business.

At the same time we will take steps to be more efficient in all areas of our business to make sure that we provide premium returns to our investors and we will continue to manage the tradeoffs between a conservative and largely defensive posture versus seizing the opportunities that are all around us short medium and long term.

As what this team has shown it can do, and that’s what we will continue to do. With the start of the New Year the macro economic environment is continued to be under pressure and the commentary seems to have moved away from will there be a recession to how long will it last. We have been monitoring our leading indicators very closely and we’re keeping a close watch on trends with our customers and suppliers and we will adjust as necessary to main and to increase our competitive position.

Looking ahead into the second quarter, we anticipate that our server business will continue to be under pressure worldwide and that the components market in Europe a high margin region for us may continue to soften in the second quarter. We believe that total second quarter sales will be between $3.85 and $4.15 billion with global component sales between $2.70 and $2.9 billion.

Global enterprise computing solutions sales between $1.15 and $1.25 billion. As a result of this volatile outlook, we expect earnings per share on a diluted basis excluding any charges and including estimated amortization of intangible assets of $0.02 to $0.03 a share to be in the range of $0.74 to $0.80 a share a decrease of 1% to 9% from last year’s near record level of second quarter earnings.

As I often say when I’m asked questions by the investment community I truly like the hand we’re playing. This is true today even in the midst of some of the most challenging conditions we have seen in years. We’re confident of our ability to perform in any marketplace given our financial strength, our leading market position and our broad customer and supplier base and our global scale.

I’d like to thank the entire Arrow team for their continued commitment as we move ahead with our strategic initiatives and build a future for Arrow we will continue to create value for our business partners and our shareholder and we manage prudently and wisely in the short term while continuing to invest in future growth and profitability.

Sabrina Weaver

Please open up the call to questions at this time.

Question-and-Answer Session


(Operator instructions) We will take our first question from Brian Alexander - Raymond James.

Brian Alexander - Raymond James

Yes, if I could just focus on the computer business here, your guidance for June, 9% sequential growth at the mid point that’s obviously below seasonality of 15% to 20% and it sounds like most of the weakness here seen in that business is server driven and my assumption is that that business is declining year-over-year but when I look at your largest vendors results they’ve already reported they weren’t very good in aggregate but they weren’t down.

So I guess we haven’t seen another one of you big vendors report yet but my question is how broad based in the weakness your seeing in the server business I think Bill you alluded to earlier that it’s across mid range in industry standard but can you give a little bit more color on the rate of decline you’re seeing between each of those platforms is it across vendors and then just remind us how big as a percentage of the computing business is the server category.

Mike Long

Brian we did see a server demand materially soften in the first quarter. That was noted by one of our major suppliers and we really anticipate that our server business will continue to be under pressure and as a result that’s we see a little bit less than normal seasonality in the top line for this second quarter.

The server business for us a round the 40% range so it does have an impact on our business overall and I believe it will have an impact. Now having said that as know in virtualization it takes more storage and more software so with those servers we do get an impact of good growth in software sales and in our storage sales and I would expect those to continue being strong.

But the server area is the area where we’re experiencing the weakness.

Brian Alexander - Raymond James

Mike you’re viewing as virtualization driven weakness for the industry as opposed to maybe a more aero specific issue with more of your exposure being proprietary which is lower than industry standard is that fair?

Mike Long

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

Brian Alexander - Raymond James

On the computing business, are any of your major vendors changing the rules of the game such that your profitability is going to be structurally lower than it has been or are these profit challenges really just short-term volume and rebate driven?

Mike Long

What I would say Brian is as you know I’ve been in this business longer than I probably care to admit the suppliers have not changed their rebate programs the best I can tell for around 15 years.

This has been an extremely stable model I expect it to be very stable. Our performance was not good in servers due to the economy and probably some of our own doing and the model is based on really consistent sales and sales growth. So when you have a down turn like we had in Q1, we not only lost the margin from the volume of the sales that we had but we did see lower rebates.

This was not due to any change that suppliers have given us in a rebate programs. Those programs have been very stable. We do know how to operate within those programs and I equate it to pure volume in the first quarter.

Brian Alexander - Raymond James

Typically in a situation like this Mike where volume is below expectations and you miss rebates you go back to your suppliers and renegotiate those levels so that in future quarters you can restore your profitability yet when I look at your June guidance from an overall perspective it kind of implies maybe a little bit of an increase in margins that’s more seasonal in nature but it does not imply that you get close to the run rate that you guys have been achieving so can you just kind of walk us through whether these rebates are permanently lost or how quickly can you get the margins back up to where you’re comfortable.

Mike Long

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

Bill Mitchell

I, just to emphasize the point that Mike’s made that no structural changes in the marketplace and this is where we’re due to volume and that’s a double whammy effect when you miss volume you miss margin and then you miss the rebates. We have ongoing discussions that are daily, weekly, monthly quarterly about the structure of the markets with our suppliers we have great relations with our suppliers, those discussions are ongoing but the market’s quite murky and quite cloudy right now and that’s what we’re trying to reflect in terms of our guidance.


We will take our next question from Steve Fox - Merrill Lynch

Steven Fox - Merrill Lynch

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

Mike Long

Steve here’s an opinion and it is an opinion. I think that what has happened is that the turmoil in the financial markets and you’re correct we do not have a large exposure to the financial market, we have some but it’s not a large exposure to the financial marketplaces.

What I think has happened, particularly in our enterprise computing business is that these are capital purchases long-term capital purchases and the market has gone conservative. That people are saying I’m going to wait, I’m going to see what’s going to happen it’s not particularly prevalent in my business yet but I’m worried and I am concerned and therefore I will push some things out and that’s what I fundamentally think that we are seeing.

That people just simply have gone cautious over the last quarter and got increasingly so in the face of the drumbeat of negative news that you read everyday in the financial press. And it’s true, so I made the argument last quarter and that we hadn’t seen any spill over from the financial turmoil’s in our marketplaces they appeared stable.

I think what’s happened and again it’s my opinion is that market’s got conservative they pulled back on capital expenditures in our part of the business that primarily would be related to servers, and I think that’s what we project going forward.

Steven Fox - Merrill Lynch

Just so I’m clear if I look at total sales growth year-over-year excluding acquisitions and excluding currencies what would that number be and then just to make sure I’m also clear in terms of the acquisitions you’ve announced in January and February, which ones were in the quarter which ones are in the guidance and which ones are yet to be in the guidance.

Paul Reilly

If you exclude the impact of foreign exchange we’re 1% to 2% up in sales year-over-year when you look at our guidance it does not include any of the announced but not closed transactions so that would exclude Logix as well as Acheiva. And then what we have is ACI was in for 1 month and Q1 they’ll be in for a full quarter obviously in Q2. Hynetics was in for an obviously Hynetics is a very small transaction relative to big Arrow was in for about 2 months in Q1 will be in for Q2

Steven Fox - Merrill Lynch

ACI was pretty small also, right $60 million?

Paul Reilly

ACI run rate last year was $60 million.


Your next question comes from Matt Sheerin - Thomas Weisel.

Matt Sheerin - Thomas Weisel Partners

I just want to follow up on the questions regarding the computing business you did talk about weakness in demand certainly and that looks like it’s in your guidance but could you talk about any market share losses that you may be seeing in that business you just put in a new president so you’re replaced the management team there.

They’ve also been reports about losses of some of our customers so could you talk about why you made the management changes, whether or not you are losing any big customers is that factored into your guidance and should we expect any changes to the structure of the business or the strategy going forward.

Mike Long

We did have a loss of a supplier Symantec that I think you were aware of that’s probably what you’re referring to. And really with that our portfolio solutions are really continually changing.

Symantec’s currently undergoing a series of changes in their channel strategy and why we no longer carry those lines we can provide our resellers with similar solutions from Convolt, McAffee and Blue Coat which are aligned we have engaged with we need lots of time to talk about our additions and we do have campaigns to replace that business. So we’ve not expecting any slow down from that in the second quarter if you will.

As far as customers go I think you probably heard there are ins and outs every quarter of customers that leave and customers that come and we’re not expecting any decline in our sales as result of any customer losses in Q2.

Matt Sheerin - Thomas Weisel Partners

And then the reasons for the management change.

Mike Long

Look I think there’s a piece here that we have a business that we don’t make any decisions based on any short term or quarterly performance if you will. This business is really evolved from a $2.5 billion North American operation to a $5 billion global enterprise in really a short period of time. And with that the transformation sometimes needs to change in leadership. And with Andy we believe we’re bringing on board a well trained well seasoned veteran. Andy has over 9 years of enterprise experience and 25 years in the distribution business and he has built an integrated European operation.

So I’d call it more of a normal transition if you will for an enterprise that’s growing this quick.

Matt Sheerin - Thomas Weisel Partners

Regarding components, on Europe you sounded pretty terrible about what you’re seeing there. You said the book to bill was weak. Could you tell us what the book to bill was and also how much do you think is just customers maybe going around the channel for better pricing or is it just a weakness you’re seeing across the markets.

Mike Long

Well, we’re seeing that the market’s clearly weakened both due to normal lag behind North America and due to the Euro stirring which is impacting their export competitiveness. We anticipate that the components market in Europe which is a high margin region for us will remain soft into the second quarter. And during this time we’ll continue to drive our results by broadening our customer base and really working ourselves towards more consistent and efficient operations in the region. So we’ll continue our plan in Europe but we do see a softening.

Matt Sheerin - Thomas Weisel Partners

And what was that book to bill Mike?

Mike Long

The book to bill has clearly gone below one.

Bill Mitchell

A quick follow up to that is that we have not seen any indications of anybody going around the channel I don’t think we’ve seen that any place in the world. In fact quite the contrary we’re seeing stronger relationships worldwide with virtually all of our suppliers the recognition of the value of the channel. I think what we’re seeing is just generally weaker market conditions in Europe right now and it’s very credible given the strength of the Euro the lag time with the US other economic factors that are we’ve seen before.

Matt Sheerin - Thomas Weisel Partners

And as you’re seeing that competitive environment softness across the board, are you seeing pricing pressure and when you are, are you getting any sort of margins support from the supplies are you on your own there?

Bill Mitchell

Well I think Matt what Paul said and is really the operative term is that on a like to like basis, across our north American and European component businesses, margins have been quite flat for some period of time so as the business competitive out there, absolutely. Is it getting more competitive, you bet, it always does.

But our margins on a like to like basis products into end markets and geographies have remained relatively flat. Are shift in margin as a company has been entirely due to mix shift between our business units that have different structure around them.


We will take our next question from Jim Suva - Citigroup.

Jim Suva - Citigroup

Can you talk a little bit about linearity and what I mean is starting points of when you started to see the fall off in March and kind of how the first three week of April has progressed and then importantly you know this quarter as we look at is a significantly back end loaded with sun and are we looking at another opportunity here for risk of you missing?

Paul Reilly

We did see as Mike mentioned and Bill mentioned the drop off in the month of March and the computer business in general the last month of every quarter is the biggest month so saying how the first three weeks of April is bit a fake out if you will because it’s not that much activity going on.

So we did see a drop off in March the strongest month of the quarter just like June, September and December are. I would say that while there is always the opportunity for macro economic conditions to change we’re taking a conservative view to what’s going to happen in the market place.

Bill Mitchell

There are some normal seasonal trends that play here. And they play our differently by region and they play differently by business unit. Clearly in our enterprise group we benefit in the fourth quarter from the year end closes for two of our largest suppliers, HP and IBM. The second quarter benefits from the year end close for sun.

And so we see some impact from that. Normal seasonal trends in our components business the first quarter in Asia is typically down a bit because of the lunar New Year. Ours was flat and up strongly on a year-over-year basis. Europe is typically up in the first quarter and then down in the second quarter in components due to fewer shipping days and lots of holidays that come on in Europe at that time we expect to see that.

North America typically is slightly down in the second quarter from the first quarter again due to fewer shipping days. So it’s probably a long way around to say there are a lot of things going on. There’s seasonality there’s year ends for customers and then there are market conditions. And the market conditions are overlaying at this point in time and are having some impact particularly as we said in our server markets where we do see some cloudiness and uncertainties and in our European components marketplaces where we see greater than normal seasonality.

Jim Suva - Citigroup

Exactly but just to clarify, does your guidance include a continued deterioration in the macro environment or stabilization or some type of pick up because I’m trying to assess the risk of a potential nother risk of miss versus is there some type of buffer if things continue to soften.

Bill Mitchell

Sure Jim let me see if I can take a shot at that one again it’s mixed. In Asia Pacific we think things are stable and we see normal seasonality more of a strong run there in Europe we see that there’s good chance for continued softness and we have certainly filled that into our outlook.

In North America we think it’s relatively stable but it’s been at a pretty low level for some period of time if you notice we’ve had essentially no growth in North American for a couple of years and so that’s stable but in a relatively low level.

In our ECS business as we say we see very strong business in software storage and our services business that’s about 60% of our business and so expect to be in the normal range there but 40% of our business in servers and we see weakness worldwide in both the industry standard as well as the proprietary servers.

There’s lots’ that’s been remarked about the secular shift from industry standard to industry standard from proprietary we certainly see that. But at the same time there’s just weakness across the server market and we have reflected that in our guidance.

Jim Suva - Citigroup

Inventory wound up I believe at 7% quarter over quarter and you’re expecting sales to decline next quarter. Can you talk about the inventory you plan to work it down did you get stuck holding the bag there and thank you very much.

Paul Reilly

In fact when you look at it over half of increase is due to changes in foreign exchanges as inventory we bought on for the ACI acquisition the rest of the inventory when you look at it inventory turns are up year-over-year and our components business by 20 basis points so no we didn’t get stuck, no we didn’t see a real issue there it’s just a combination of factors to be able to meet the market place in Asia Pac as well as I mentioned foreign exchange and actuations.


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

Will Stein - Credit Suisse

Can you comment on the leading or lag effect between the two businesses that you’re in. Do you see the server weakness as potentially a leading indicator for what could go on in semi demand or is the other way around or is there no good leading lagging effect there?

Mike Long

I personally don’t think that they, there’s a strong correlation we’ve never see it and we have no reason to believe. They’re really very different cycles the server cycle is driven by the capital expenditure cycle, it’s driven CIO’s in enterprise or small or medium businesses who are making decisions to create the kind of systems and solutions that they need to meet their market so it’s a much broader indicator of overall economic trends than would be the semi cycle.

The semi cycle as you know we have argued for some period of time has changed, we believe has balanced in its depth and its complexity. We think cycles are shorter and shallower we think that supply and demand remains in better that the channel is still in good shape overall from supplier through distribution through EMS companies through end customers but we simply don’t see a correlation there that’s really built on the specifics of individual markets and what they need in the way of new electronic gear.

Whether that be in the military aerospace field whether that be in the industrial controls, whether that be in automotive or transportation or consumer electronics all of them have some different rhythms to them. We participate broadly in those and that’s a good thing because it buffers us from a down turn in one particular one. But again I simply don’t see a strong correlation between the semi cycle and the our enterprise computing cycle.

One of the reasons why we invested in the enterprise computing cycle quite frankly was to make sure that we decreased the dependence of the semiconductors cycle for consistent earnings and we still think that’s the right decision.

Will Stein - Credit Suisse

I wanted to address this rebate issue again I think we all know that one of your big competitors stated that at least one of their system suppliers changed the rebate formula if you will at the beginning of the quarter and they kind of got caught in that. What we’re hearing from you is it hasn’t changed in 15 years. Is it perhaps because of different agreements or different supplier relationships or different geographic exposure or is this kind of clue what’s going g on in terms of the difference.

Mike Long

It could be a lot of factors. The overall macro rebate policies have not changed. From time to time there is a rebate that gets put in for the launch of a new product, how fast we can take that product to the mid market to the our community and sometimes there are incentives for those types of things.

That can get negotiated regionally if you will but it typically the same for every value based distributor. My guess is what you’re eluding to could be a mix or a change between he two companies and how they operate, what their sales volumes are by region but again we have seen a stable approach to rebates, haven’t seen significant changes in the rebates and believe that its’ truly a partnership with us and our suppliers haven’ seen that change in any way either.


We will take our next question from Mark Moskowitz - JP Morgan.

Mark Moskowitz - JP Morgan

Paul or Bill could kind of maybe comment on your overall suggestion that we’re goin got go into a market cont4raction at least for the n ear term but can you maybe comment about what type of takes you have within your model to maybe introduce some buffers and I know you probably dn’t want to include how explicitly they are a part of your guidance but can you increase feet on the ground your sales and marketing certain segments or certain regions where you do have opportunity right now and maybe chase some revenues to offset what’s going on in the server and the Euro component environments.

Bill Mitchell

It says first of all market conditions are clearly volatile and they’re clearly are not as postitive as they were a few months ago or six month ago. so that says let’s take the steps that we need to make sure we’ve got our costs in line, that we have our capabilities, properly deployed etcetera and that’s largely a defensive positions.

It says make sure that we put a floor under the profitability of the company we continue to generate cash, we continue to keep a strong balance sheet etcetera and that’s all good and we’re doing that. The opposite side of that says in down markets there are always opportunities and there are opportunities for organic growth and we have a number of terrific opporunitties across all of our business units and across all of our geogprahis and across all of our product segments to generate organic growth and so we are going to go after that.

We simply are not going to cut back on field facing sales related kinds of activities. We’re going to go after it and compete aggressively for the business that in fact is out there and we think we have a good chance of getting it. We do believe that the strategic initiatives that we have in place things like the mid market initiative in the ECS business which is all about generating additional sales to small and medium customers or these small customer initiatives within the global components group are attractive and continue to focus on those.

We do not expect to back off on our global ERP efforts; these are transformational activities that are truly important to the long term future of the company. We had our first big success this quarter and we’re on track on budget and on time to roll that out and we think that’s going to give substantial competitive advantage when it’s fully completed.

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

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

Mark Moskowitz - JP Morgan

Can you give us a sense on Paul in terms of the $47 million in annualized savings. Could a decent or meaningful amount of that devoted towards what Bill just commented in terms for front line support.

Paul Reilly

In fact we have seen many of that I break that down is $47 million in total, $40 million in which we had squeezed out of the business by the end of the year so you’re seeing some of those benefits for the $7 million in Q2.

The one thing that we definitely remain focused on, it’s interesting when we refer to creating a shared service environment if you will is our focus is making what you may call the back end of business more efficient, more effective, while not impacting customer facing a supplier facing a position.

So we don’t want to see fewer sales people we want to see more sales people we want to see more productive sales because that’s where the action takes place. So that’s really what we’re focused on is how do we get right sized internally in the back end without it impacting those forward focused people.

Mark Moskowitz - JP Morgan

I know folks like to focus on the very near term particularly in a given the negative environment that we’re facing but trying leave a silver lining I want to it’s kind of a loaded question but I want to get a sense in terms of your business development efforts are you guys actually seeing increased activity because of our strength and your market position and cash position that you actually have an increasing level discussion with potential take out candidates as part of your acquisition strategy?

Bill Mitchell

The answer is that we’re always looking at potential acquisitions. Our pipeline is quite full right now. We are having increased opportunities and we think those are attractive ones. We have a rigorous and disciplined process for looking at them and we’re I believe we’re quite good at identifying them and bringing them in and integrating them and creating the value from them.

But as you would expect, and again it sounds a bit like a cliché but it’s true in some downtimes, the strong can get stronger and the weak look for exit strategies and I think we’re part of the strong and we are going to continue to be looking for those opportunities and those pipelines are quite full right now.


We will take our next question from Louis Miscioscia - Cowen and Company.

Louis Miscioscia – Cowen and Company

I wanted to ask you I guessa bout the disconnect between servers and storage I mean in general are those are the two area that obviously most have talk about holding up the best and you’re mentioning obviously that storage is doing pretty well here but obviously you mentioned a number of times how servers are weakening so maybe you can give us a thought about the drivers behind storage and whether you think that will hold up as we go through the year.

Mike Long

When you virtualized your systems you’re really displaying the need to have less servers if you will but the requirements when you do that are more storage and more software so really if the demand can stay up in servers that will cause an explosion if you will in storage and software. So despite the fact that the market has slown on the server side, the ratio between software and storage is very high so that’s you still seeing a quite good demand it those areas. Does that help you?

Louis Miscioscia – Cowen and Company

When you look at virtualization do you have a feel for how many of your customers have actually deployed it because the sense it that obviously it’s a huge trend that’s going on right now but that a lot of companies are still in the deployment phase and you would actually think that given the incredibly ROI that they’re getting on that, that it would be something they would not defer and it would actually be getting rid of all that three year old, four year old equipment that’s out there given that the saving s they should get or maybe in the SM, small medium business space it’s just not as prevalent maybe as the bigger companies.

Bill Mitchell

First of we think here’s an enormous opportunity for us in the virtualization space. We think that less then 5% of our available customers have in fact virtualized their environments and we see that as a very strong positive for us.

We also think that when you get into a period of weakness thing you probably pull back on first is your server refer you’ll continue to move on storage and software kinds of things because you need that to run your business and as business come back and exactly as you say, we would expect the server part of the business to come back to it’s more normal growth levels and that will accelerate the growth in the software and storage part of the business.

So the really is a nice story in there that we will participate, we do believe the server market will come back, we’re not quite exactly sure when, when it does come back we will have very accelerated growth in the software and storage parts of our business and we’re showing strong growth there right now in spite of the weakness in the server market so that’s the silver lining that’s sitting in there that they will come back and it will be good for us.


And this will conclude today’s question and answer session.

Sabrina Weaver

Before and in today’s call for those participating in today’s webcast we will quickly scroll through slides 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 and this presentation will be available on our website. I’d like to thank all of you for taking the time to participate in our call this morning and as always if you have any questions, please feel free to contact Paul or myself. Thank you and have a great day.

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