Arrow Electronics - Q2 2015

Transcript

Operator (participant)

Good day, ladies and gentlemen, and welcome to the Arrow Electronics Inc. second quarter 2015 earnings conference call. My name is Lisa, and I'll be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. If at any time you require operator assistance, please press star followed by zero, and we will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Steve O'Brien, Director of Investor Relations. Please proceed, sir.

Steve O'Brien (VP and IR)

Thanks, Lisa. This is Steve O'Brien. I'll be serving as moderator on today's call, and I'd like to welcome you to Arrow Electronics' second quarter 2015 conference call. With us on the call today are Mike Long, Chairman, President, and Chief Executive Officer; Paul Reilly, Executive Vice President, Finance and Operations, and Chief Financial Officer; Andy Bryant, Chief Operating Officer, Global Components and Global Enterprise Computing Solutions; Eric Schuck, President, Global Components; and Sean Kerins, President, Global Enterprise Computing Solutions. As a reminder, you can access our earnings release at investor.arrow.com, along with the CFO commentary, the non-GAAP earnings reconciliation for the second quarter, and a webcast of this call. We will begin with a few minutes of prepared remarks, which will then be followed by a question-and-answer period. I'll now hand the call to our Chairman, President, and CEO, Michael Long.

Michael Long (President and CEO)

Thank you, Steve, and thanks to all of you for taking the time to join us today. In the second quarter, we delivered strong results that were ahead of the midpoint of our expectations. We continue to execute well despite the unfavorable currency environment and the uneven economic conditions. Both segments delivered sales growth and expanded operating margins. Our cash flow and returns were strong, and we returned substantial capital to our shareholders through our buyback program. In the second quarter, we delivered 9% overall sales growth on a constant currency basis and 3% adjusted for both acquisitions and currency. Our growth was led by our Europe Components business, which grew at a very strong 11% rate, adjusted for acquisitions and changes in foreign currencies, making the ninth consecutive year-over-year growth. Our Asia Components business grew 11% year over year and 4% adjusted for acquisitions.

Lastly, our Americas core business grew 3% year-over-year, which we believe was ahead of the economy. Enterprise Computing Solutions delivered growth in the segment as a whole, growing 9% on a constant currency basis and 2% adjusted for acquisitions and changes in foreign currency. For those that look at our results as a reference point for IT spending, our billings for the first half of 2015 grew 5% year-over-year, adjusted for acquisitions and changes in foreign currency. As we've done in the past, we encourage you to measure our ECS business on a multi-quarter basis to normalize for differences between our quarter-end dates and those of our suppliers. In the second quarter, our Enterprise Computing Solutions business experienced strong growth from our software portfolio, led by security.

In Enterprise Computing Solutions, we continue to focus on selling comprehensive solutions while enabling customers to migrate to cloud-based managed services when and where it helps them achieve their objectives. Our solutions are flexible. We continue to evolve with the accelerating pace of change in the IT industry. We have a number of efforts underway to increase the markets we serve. In Global Components, we're engaging with inventors and next-generation OEMs, with a focus on enabling wireless connectivity for their products. We're pleased to report robust design activity in all three regions during the second quarter. This performance is the result of our prior investments in sales and engineering talent. In Enterprise Computing Solutions, we've established a leading position in software with great emphasis on security and big data, as well as hybrid cloud automation and orchestration. We continue to increase our capabilities in these areas.

Our knowledge and solution selling are benefiting our customers as they face increasing complexity in their own IT infrastructure. We continue to further leverage on our sales growth while investing in our business for future growth. During the second quarter, adjusting for acquisitions and changes in foreign currencies, we grew Global Components operating income at over 1.5 times the rate of sales growth. We also expanded our Global Components operating margin for the 8th straight consecutive quarter on a year-over-year basis. And for the first half of 2015, we're on track to reach our goal of 5% Components operating margin. Our ECS operating margin expanded year over year and set another new all-time record for a second quarter. And last but not least, for the 7th consecutive quarter, we again increased our return on invested capital compared to the prior year.

At 10.8%, our ROIC was up 30 basis points year-over-year. Regarding the current state of demand in the electronic components industry, we expect little change in the environment heading to the back half of 2015. Conditions remain better for us in Europe than the headlines about the economies might suggest. In the Americas, modest growth continues. While this may be a surprise for those expecting an improvement or a re-acceleration, from our vantage point, the lackluster background has been persistent for two years. In Asia, we've seen a recent deceleration in the demand growth, but we expect growth to continue, albeit at more modest levels. We believe our broad base of small to mid-market customers across the regions reduces the variance in our performance compared to other industry participants, who may have sizable contributions from a small group of customers.

We also believe lean inventories and short lead times will continue to moot the fluctuations and cycles we experienced in the increasingly distant past. In summary, we'll remain mindful of the industry backdrop, but believe our own data from tens of thousands of customers provides the best guideline for operating our business. Last quarter, I discussed how we operate our business to assure consistent returns to our shareholders and minimize the risk from foreign exchange fluctuations. Again, this quarter, we've shown our ability to deliver consistent results despite the depreciation of the euro. I thought it would be helpful to you if I address how we navigate through this current period of semiconductor industry consolidation. Our suppliers value our engineering and design capabilities, which allows their products to be sold on their technical merits.

Our suppliers also continue to value the variable expense sales model we deploy on their behalf in the mid-market. To date, merger activity has resulted in a net increase of the products which we can sell. Suppliers are giving us more products to help drive their growth, which will also help drive our growth. As suppliers merge, we believe Arrow will be a constant that helps the new company grow market share, mind share, and maintain their selling motion. We see no disruption to our business from supplier consolidation, and we'll continue to deliver compelling value to our customers and suppliers long term. As we proved once again in the second quarter, we're able to produce strong results independent of the market environment, and we look forward to continuing this. Paul will now provide more details on the second quarter results and our expectations for the third quarter.

Paul Reilly (Executive VP and CFO)

Thanks, Mike. Second quarter sales of $5.83 billion grew 9% year-over-year, adjusted for changes in foreign currencies, and grew 3% year-over-year, adjusted both for acquisitions and changes in foreign currencies. Second quarter sales included an approximately $160 million contribution from two acquisitions, which were not originally factored into our guidance range. Excluding that benefit, consolidated sales were above the midpoint of our guidance range, with Global Components and Enterprise Computing Solutions both approximating the midpoint of their ranges. In Global Components, sales of $3.7 billion grew 4% year-over-year, and 3% year-over-year, adjusted for acquisitions and changes in foreign currencies. In the Americas, our sales were flat year-over-year, but Americas core sales were up 3% year-over-year and quarter-over-quarter within traditional seasonality.

Our performance in the Americas continues to be affected by the lackluster economic environment, with first half GDP growth in the United States estimated to be below 2%. In Europe, sales adjusted for acquisitions and changes in foreign currencies increased significantly, advancing 11% year-over-year, the third quarter in a row of double-digit growth. We experienced strength across the entire region. Sequentially, core sales in Europe grew 2% quarter-over-quarter, which is toward the high end of normal seasonality. Sales in Asia grew 11% year-over-year as reported and grew 4% year-over-year, adjusted for acquisitions and changes in currencies. Core sales in Asia grew 15% year-over-year and 9% quarter-over-quarter, for the high end of traditional seasonality.

Total second quarter book-to-bill was 1.02, and the overall components market remained stable, with lead times and cancellation rates operating in normal ranges. Second quarter Enterprise Computing Solutions sales were $2.13 billion, up 1% year-over-year as reported, and up 2% year-over-year, adjusted for acquisitions and changes in foreign currencies. On a six-month basis, ECS sales grew 4% year-over-year, adjusted for acquisitions and changes in currencies. In the Americas, sales grew 9% year-over-year and were down 1%, adjusted for acquisitions and changes in foreign currencies. Sales for our core ECS Americas distribution business were flat year-over-year and grew 25% sequentially, in line with normal seasonality.

During the second quarter, a strong mix of software and services relative to higher ASP hardware had a dampening effect on our reported sales and lowered the year-over-year growth trend in our business. In Europe, sales in constant currency advanced 8% year-over-year. Europe ECS sales grew 18% quarter-over-quarter, adjusted for acquisitions and changes in foreign currencies, which is above traditional seasonality. The growing and evolving requirements on data centers, our strong execution, and our solution selling efforts all drove the strong ECS revenue growth. Our consolidated gross profit margin was 13.2%. Year-over-year gross margins were flat. On a sequential basis, gross margins decreased 50 basis points due to the normal seasonally higher contribution from ECS within our mix.

Total company operating expenses decreased 4% year-over-year, adjusted for the impact of acquisitions, and increased 2% year-over-year on a reported basis. Operating expenses were flat as a percentage of sales year-over-year. Operating income was $238 million, an 11% increase year-over-year, adjusting for changes in foreign currencies. Operating income margins advanced year-over-year as well, increasing by 10 basis points to 4.1%. Global Components operating income margin of 4.8% increased 20 basis points year-over-year. For the first half of 2015, Global Components operating income margin was 4.94% and would have been 5%, excluding our Q2 acquisition activity in Asia. Global Enterprise Computing Solutions operating income margin was 4.9%, up 10 basis points year-over-year. Our effective tax rate for the quarter was 27.1%.

Net income was $149 million, up 12% year-over-year on a constant currency basis. Earnings per share were $1.54 on a diluted basis. Diluted earnings per share advanced 7% year-over-year and grew 16% year-over-year on a constant currency basis. Excluding the 5% contribution from acquisitions, earnings per share grew 12% year-over-year on a constant currency basis. Cash flow from operations was $461 million. Trailing twelve-month cash flow from operations was $609 million, or more than 120% of our GAAP net income. For the first half of 2015, cash flow from operations was $219 million, or 95% of our GAAP net income.

Both the trailing twelve-month and six-month performance is well ahead of our goal of delivering 70% of our GAAP net income as cash flow from operations. Consolidated return on working capital for the second quarter was 27.7%, up 50 basis points year-over-year, and overall return on invested capital was 10.8% year-over-year, up for the seventh consecutive quarter, and significantly outpacing our long-term weighted average cost of capital. We repurchased $78 million of our own stock in the second quarter, approximately $307 million over the last twelve months, and approximately $1.3 billion over the last five years. Authorization remaining under our existing share repurchase programs is $119 million. This is a high-level summary of our financial results.

For more detail regarding the business unit results, please refer to the CFO commentary published this morning. Now, turning to our guidance. We believe that total third quarter sales will be between $5.55 billion and $5.95 billion, with Global Components sales between $3.65 billion and $3.85 billion, and Global Enterprise Computing Solutions sales between $1.9 billion and $2.1 billion. We expect earnings per share on a diluted basis, excluding any charges, to be in the range of $1.40 to $1.52. Our guidance assumes an average tax rate in the range of 27%-29%.

Average diluted shares outstanding are expected to be approximately 95.5 million shares, and the average U.S. dollar to euro exchange rate for the third quarter to be $1.08 to €1. The U.S. dollar to euro exchange rate we are using for forecasting purposes declined 3% from $1.11 in the second quarter, and 19% from $1.33 in the third quarter of 2014. We calculate this depreciation of the euro has resulted in a 1% negative impact on sales growth compared to the second quarter, and a 5% negative impact on sales growth compared to the third quarter of 2014.

We calculate this depreciation has resulted in a -$0.01 negative impact on EPS growth compared to the second quarter, and an -$0.08 negative impact on EPS growth compared to the third quarter of 2014.

Steve O'Brien (VP and IR)

Thank you, Paul. Lisa, could you please open up the call to questions at this time?

Operator (participant)

Ladies and gentlemen, if you have a question, please press star followed by one on your phone. If your question has been answered or you would like to withdraw your question, press star followed by two. Your first question comes from the line of Mark Delaney with Goldman Sachs.

Mark Delaney (MD and Senior Equity Analyst)

Good afternoon, and thanks very much for taking the questions. The first question, I was hoping maybe you could give us some perspective, and I know you talked a little bit about this already, but what you think is enabling Arrow to do quite a bit better than a number of the other companies in the tech supply chain? I think it's been a few quarters in a row now that the company's been able to do better. You know, I know you talked a little bit about just the size of your customer base. Any other factors that you may be able to help us with, including maybe if you know, if you think you're taking any market share as well?

Michael Long (President and CEO)

... Sure, Mark, thanks. As you know, we've been investing in sales for quite some time, sales and engineering. We started a year ago, investing and increasing our sales force and our engineering force in China. We followed up, and we did that in Europe and also in North America. And so what we've seen is, really, this quarter, a record of design wins that are coming in, which are, as you know, pretty much future promises for designs, which gives us comfort in the outlook, and also an increasing customer base as a result of that. I think on the, on the enterprise computing side, much of the cloud work we've done to, be available to our customers, either on-premise, off-premise, or some sort of hybrid, with, with SKUs and services, has also helped us.

Frankly, I think, you know, to a lesser extent so far, but maybe, to a little bit more extent in the future, some of the consolidation of the semiconductor industry will allow us to have new lines to sell that maybe we didn't have before. So when you put those things together, what I would have to say is there's no home run in that. You know, there's singles, doubles, and triples, but they've allowed us to stabilize our performance, I would say, over the last year in a good way.

Mark Delaney (MD and Senior Equity Analyst)

That's helpful. And then, if you could just help to frame up what's needed to achieve the guidance in the third quarter. Maybe you could just help us with backlog coverage as you look into 3Q, and, you know, you know, related to that, on the bookings trends. You know, again, given, you know, Arrow is doing a lot better than, you know, many of the companies in the supply chain, but given the weakness that some of those other peers have reported, I mean, have you seen anything at all on the monthly orders that you think maybe explain some of the weakness that others have reported?

Michael Long (President and CEO)

Sure, Paul?

Paul Reilly (Executive VP and CFO)

Yeah, sure. Thanks, Mike. So Mark, you know that the third quarter always comes down to the month of September. That's traditionally what we see in our ECS business, and we see it especially in components because of the summer holiday period in Europe. With that said, book-to-bill at 1.02, we don't see any meaningful change in lead times. Cancellation rate is pretty consistent with what we've seen in the past. And when we look at that 90-day backlog, pretty consistent also what we've seen in the past. So, you know, when we look at those factors, we feels that pretty solid about our guidance going forward.

Mark Delaney (MD and Senior Equity Analyst)

Thank you very much.

Operator (participant)

Your next question comes from the line of Brian Alexander with Raymond James. Please proceed.

Brian Alexander (MD and Senior Equity Analyst)

Okay, thanks. Good afternoon, guys. Wanted to ask about inventory. Paul, up 10% year-on-year, 12% sequentially. I think days of inventory were up, maybe three days year-on-year. So given your outlook is seasonal, particularly in the components business, what's driving the inventory increase? And to what extent is Arrow using its balance sheet to drive market share gains, particularly in Europe, where performance has been really strong? Thanks.

Michael Long (President and CEO)

Yeah, Brian, I'll take the first part of that and let Paul take the second part, and hopefully not step on each other. As far as using the balance sheet for the inventory, for sure, we want to make sure that we've got the products that are going to ship for those new designs that our sales force has been getting. So what we're seeing is a little bit of uplift, of sort of registered type components in here, which you know, are higher margin, and we think that will serve us well going into the second half.

By the way, if you go back, and I think, look at 2009, you saw us do the same type of things that allowed us to weather, you know, that economic downturn in a better way also. So we're trying to continue with some of those inventory strategies, and there's a lot more underneath this that Paul can get into.

Paul Reilly (Executive VP and CFO)

Right, Brian. So, remember that we have two acquisitions that we have all their inventory at the end of the quarter, but we don't have a full quarter sales in ATM and Data Modul. So, that added about $120 million of inventory alone. And that obviously has a bit of a distortion on the calculation of the days of inventory that we have on hand. So, the days change isn't really that, you know, a little bit different than the number that you quoted, because you didn't have all the facts, but, like we have them, but that actually is impacting the calculation also.

Brian Alexander (MD and Senior Equity Analyst)

If we compare to 2009, if I go back and look at gross margins in the components business back then, it looks like the next couple of years, you gained about 200 basis points in gross margin. Is that the right kind of frame of reference for the strategies that you're putting in place now? Do you expect it to have, you know, meaningful impact on gross margins for Global Components?

Michael Long (President and CEO)

Well, we believe so. I'm not sure we're banking on that extent that we got the last time, but we certainly believe that as electronics do start to get tighter over a period of time, that you will see some pricing increase. But I do believe right now that's a little bit of a ways off. But that is, in essence, getting ourselves ready for the next upturn. And remember, we've been in this, what we consider this cycle we're in now, we believe we've almost been in it for two years. So we aren't really too worried about what we're seeing coming because we're viewing it as more of the same.

Operator (participant)

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

Jim Suva (MD)

... Great. Thank you very much. I have two questions. The first is, you know, your outlook is, is very, encouraging, and it looks quite normal. A lot of the other chip companies and OEMs have, have noted, you know, softness. And so can you just kind of help us bridge the gap of your understanding of the strength of what you're seeing there at Arrow versus kind of the, the rest of the world? Or maybe I'm just gonna, you know, caught my ear of the, the negative of some of the other companies out there. And then my, my follow-up is, can you just help us better understand the SG&A or OpEx outlook? You know, Arrow's done a, a good job at making several acquisitions recently.

And so for either a run rate or a percent or dollar amount, are we at a level now, or should we be building in some additional increase in SG&A or OpEx just to make sure we fully account for the integration of all these acquisitions? Thank you. And again, congratulations.

Michael Long (President and CEO)

Thanks, Jim. I'll take the first part of that. I actually believe that what you're seeing of some of the reported suppliers that are out there today probably has more to do with the wireless business than it does with the overall broad market. In fact, I would say that a vast majority of what I've seen have been few very large customers that tend to put a little bit of pressure on those suppliers, which give us the negative outlook. So far, we've seen pretty good strength in aerospace and defense. We've seen it in automotive, we've seen it in lighting, and we've also seen it somewhat in medical devices, sort of the decline slowing there.

So overall for us, we're still seeing sort of business as usual with the trend that China has slowed somewhat. And hopefully, that gives you what we see as some of the differences. Plus, we're dealing with a whole lot more customer base than many of the suppliers that did report, and that does help us. Paul, would you take the expense piece?

Paul Reilly (Executive VP and CFO)

Sure. So, Jim, my expectation is we'll see expenses flattish in the third quarter. We'll see a trend upward that's just variable cost tied to the surge we'll see in the ECS business. You know, some of these acquisitions that we've done recently, whether it's immix, as an example, or ATM, or even Data Modul, we're looking at those as opportunities to accelerate growth in markets and less so around changing the cost structure, if you will. But you're right, if we're not able to accelerate the growth, bringing the product lines to them, bringing them to new geographies, then we'll have the opportunity to take a step back and integrate them, really throughout the support systems. You know, we don't want to touch sales and engineering, but through the support systems to get some of those synergies.

But in the short term, I'd say we're not gonna see a meaningful change downward or upward in our expense structure.

Operator (participant)

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

Steven Fox (MD)

Thanks. Good afternoon. A couple questions for me on components. First of all, in terms of the deceleration you're seeing in Asia, I assume a lot of that's tied to China. Can you just sort of talk through how that came about in the quarter and, you know, what kind of inventory levels you think are in that region, and how you're attacking it? And then, secondly, you highlighted some of, you know, continued design success, and you also mentioned the wireless focus. So I was hoping you could sort of quantify the design win growth and also just talk about the wireless strategy into some of these industrial customers a little bit more detail. Thanks.

Michael Long (President and CEO)

Sure. The first piece around Asia Pac, what we've seen is really a growth rate in lighting, industrial power, and transportation year-over-year. All but one of those has been double digit growth. What we have seen is a decrease in the wireless numbers there, and because of the percentage, that's where we see a little bit of the slowing in Asia Pac so far. Eric, would you like to add anything else to that?

Eric Schuck (President and Global Components)

I would just add one thing, Mike, to that point, and that is, with the investments that we've made in the sales and engineering, the strong, focus that we have on the small and mid-sized account base, it's really enabled us to leverage the broad portfolio of products that we have in our line card. So Steve, you brought out one of them, a wireless connectivity. That's certainly a technology that we see taking off in Asia as well as the other regions. And certainly, we're using, not just our position in semiconductors, but also passive electromechanical and connector products to continue to drive growth into that small and mid-sized customer base.

Operator (participant)

Your next-

Michael Long (President and CEO)

The second piece of your question was around the design win activity, and what we've seen is a very robust activity in the second quarter. Approved registrations were up strong double digits year-over-year, and that accelerated from about 3% in the first quarter. We saw a growth in all three regions with design activity. And as you know, the growth isn't always linear because there's some lag between the design itself and the actual production of the product. But as we have said before, and has really panned out, when the design activity happens, then you're, you know, one or two quarters away from that stuff starting to ship, and it, it ends up being a good deal for us.

We continue to focus on that number, and we're seeing pretty strong results right now.

Operator (participant)

Your next question comes from the line of William Stein with Truist Securities. Please proceed.

William Stein (Semiconductor and Artificial Intelligence Equity Research Analyst)

Great. A couple questions. First, I'm wondering if you can remind us what is not in core components in the Americas. I think there's something in there that's helping the growth, and can you just remind us what that is?

Michael Long (President and CEO)

Sure. Well, I think you're talking about some of our specialty businesses. And those are the ones that actually, when we look at it, are, you know, small, don't have as big of an impact, and we're trying to give you all the color on the big parts of our business that drive it. So that might be, in the RF space, it might be aerospace and defense, those types of businesses.

William Stein (Semiconductor and Artificial Intelligence Equity Research Analyst)

Okay. And then, following up on the last question and maybe dovetailing with a couple of others, it sounds like you believe that consolidation among your suppliers may be helping, and you talked about accelerating design wins. There's also been some change with regard to at least one of your microcontroller suppliers, where they eliminated a third distributor maybe a year and a half ago. And I'm wondering if you're seeing an effect from that specifically, or maybe to ask it more generally, are you seeing a share shift among your suppliers? Is any of the new design acceleration, is any of that sort of concentrated among a smaller number of your suppliers? Thank you.

Michael Long (President and CEO)

I would say that, you know, whenever you've seen a distribution network shrink from 3 to 2, yes, we have had benefit. Yes, we have had benefit from those things specifically. We manage them very close. They. You have to remember, they make up a microcosm of our total sales because we have so many suppliers. So, they, that alone does not drive our performance. But when you look at it across the multitude of product lines, right now, we think we're positioned very well for even more of that to take place over the next year.

William Stein (Semiconductor and Artificial Intelligence Equity Research Analyst)

Great. Thank you.

Operator (participant)

Your next question comes from the line of Ananda Baruah with Brean Capital.

Ananda Baruah (MD)

Hi, thanks, guys, for taking the question, and congrats on the results and on the guide. I guess one for each side of the house, if I could. The first is with regard to the electronic components. You guys made commentary during the prepared remarks that you see an increase in the products on your portfolio that you're able to go to market with. And I was just hoping to get a little bit more broader context on that, you know, particularly in the context of you talking about ongoing consolidation from your suppliers. And is it fair to take this as a share gain on your part, or is it more of a broader industry dynamic? Thanks. And I have a follow-up.

Michael Long (President and CEO)

Eric, would you like to take that one?

Sean Kerins (President and CEO)

Yeah, sure, Michael. So, we've certainly seen a tremendous amount of consolidation announced so far, in calendar year 2015. As Mike pointed out in his commentary, it's really contributed, a net benefit to the products that we have in our portfolio. Not surprisingly, many of those supplier moves have been part and parcel around rounding out their own technology portfolios to take advantage of growth markets. So some specific areas where we've seen the benefit in expanding our own portfolio through that consolidation process, are in the areas of wireless connectivity, sensors, networking products, and the like. Many of the essential building blocks that are a requirement to participate in the growing Internet of Things marketplace.

In terms of share gain, Mike, again, referenced the investments that we've made in both sales and engineering resources over the past 18 months, and we truly believe by further execution and getting leverage with those incremental resources, that with the expanded portfolio of products, it'll have a net benefit in our ability to grow moving forward.

Ananda Baruah (MD)

Got it. Very helpful. And then I guess my follow-up is, can you just talk about how your service business, sorry, server business did during the quarter relative to your expectations? And I guess any thoughts on server refresh going into the second half of the year. There's been mixed data points on the server front, so would love to get your context. Thanks.

Sean Kerins (President and CEO)

Sure, Amitabha. Well, I can tell you that in Q3, our server business came in as expected. We grew, you know, in the low single digits. We continue to see, you know, customers take some time to evaluate hardware purchases, especially in light of newer architectures as they emerge, things like converged infrastructure, hyperconverged, and even flash. But I think we're well positioned, you know, in the server space going forward. And again, as we pointed out, we see, you know, guidance within normal seasonality for the third quarter, and, you know, our server business will be part of that for sure.

Ananda Baruah (MD)

Thanks a lot, guys.

Operator (participant)

Your next question comes from the line of Louis Maffea with CLSA. Please proceed.

Louis Maffea (Analyst)

Okay, two questions on similar lines. When you mentioned that you're winning business consolidation, could you mention if you're winning it for very large competitors on the component side or from more smaller ones? And I have a follow-up.

Michael Long (President and CEO)

I would say that when you go from three to two, and two people get it, you're probably winning it from the person that ended up opting out. And, you know, that's the business that people end up focusing on. You know, it's funny, but if you take a typical year, it's probably less than 1% that swings between the two big guys in the marketplace, you know, back and forth one way or another. So that's really never been our focus. Our focus has been to expand the account base, expand the product line, and increase our sales and increase our services.

So that's, you know, I could die, you know, at retirement and, you know, not have a huge swing of market share if that was the only way to do it. So it's gotta be the market, it's gotta be customers, it's gotta be new products.

Louis Maffea (Analyst)

Okay, my follow-up on ECS, it looks like you had very different results in Europe and the Americas, both from a—you know, overall from a revenue growth standpoint, but also from a product standpoint, obviously, when you take out currency and acquisition. Maybe if you could just go in, you know, why there was very good strength, proprietary, regular service, storage, software services, so on in Europe, but then not seeing really that same type of strength in the Americas.

Michael Long (President and CEO)

Yeah, sure. I'll have Sean go ahead and address that one. He's got it right in front of him.

Sean Kerins (President and CEO)

Sure, Lou. So you're right, there was a little bit of a difference. In Europe, we saw a good balance across the whole portfolio, and I think they grew very nicely. We saw a pretty good balance in North America as well. Probably, a slightly greater mix to software and services than we would have expected as compared to hardware. Your question or the question earlier about the server business. Again, hardware is... There's a lot happening in the hardware segment, you know, at this point in time. Customers are evaluating these new technologies I described. And even though our hardware pipelines continue to be healthy, sometimes those evaluation cycles take a bit longer than we might expect.

So we didn't see quite the close rate in hardware in the second quarter in the Americas that we had hoped for, but we certainly see that the hardware, you know, business will be important to us going forward. And again, it is part of what we project in Q3 and beyond. So I think we're well positioned with the traditional technologies as well as the newer architectures that are emerging, you know, fairly quickly.

Louis Maffea (Analyst)

Sure. Let me ask you in a little bit of a different way. Does it seem like here in the US, that customers are pausing as they're evaluating these new technology, whether it's converged, hyper-converged, the 10-second deliciousness storage, flash, and so on? And maybe that in Europe, they're just sticking with the standard, and they've held off for so long, given their poor economy, that they're just updating older stuff in comparison, and maybe as folks generally think, the US is six months or a year ahead of Europe, that that's what we're seeing now.

Sean Kerins (President and CEO)

You know, Lou, there might be some of that. You know, we probably have a slightly larger exposure to some of the newer technologies here in North America than we do in Europe. I'm not sure the buying patterns are dramatically different. I think, you know, each customer makes this evaluation cycle, you know, in a very different way. Some stay with the current architecture, some evaluate, and it takes some time. Some test and convert, you know, more quickly than others. So I don't think that there's a line in the sand that you might draw between Europe and North America in that regard.

Michael Long (President and CEO)

You know, Lou, you're also dealing with sort of a different law of bigger numbers in the US than you are in Europe too, because there's still plenty of room to gain share and rotating for our business in Europe, which is helping them versus the very, very strong market share that we have in the US. So there's a little bit of that play that would go in there. So those percentages, even though skewed, you know, would have an impact on that.

Operator (participant)

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

Shawn Harrison (Electronics Manufacturing Services)

Hi, everyone. Congrats on the results. Wanted to dig in a little bit on the comment on just the, the building of inventory versus the, the tremendous free cash generation you had this quarter. Should we expect, you know, similar cash generation in the back half of the year if you built inventory to support some near-term demand, and you would see that roll off into the back half of the year? Or should we expect kind of a, a different dynamic with inventory?

Michael Long (President and CEO)

Sure. I think we'll see the same amount of cash flow in the back half of 2015 that we generally saw in the back half of 2014. Just to remind you, if you go back and look at our transcript, we had a couple of items go our way in the fourth quarter. So it's not a direct compare, but we'll be positive in the second half of the year also. We expect to have very good performance for the full year.

Shawn Harrison (Electronics Manufacturing Services)

Okay, and this is a follow-up. Your largest competitor here in the, I guess, North America and globally cited I don't know if the term self-help, but a cost reduction program when looking at their M&A over the past five years that they completed. Do you see something similar of having to go back and look at the M&A that you completed and lean out cost? And is there an opportunity there, or do you think you've integrated it fully enough that you're already seeing the benefits?

Michael Long (President and CEO)

... Well, I would, I would say that we have a few that we've just purchased. As you know, you can go back from March, we bought some businesses, and, we're, we're working constantly on that type of thing and not letting the costs get out of control, so we have to go back and, and sort of reintegrate or rethink it. Right now, our focus has been on growth. We've been pretty successful with that. We will be touching up on the cost side over the course of the year. I'll let Paul highlight that to you a little bit. But for the most part, we're more comfortable on the growth side right now. Wouldn't be expecting to launch any massive cost cuts.

Paul Reilly (Executive VP and CFO)

Right, Sean, as I mentioned, we think our expenses will be flat in Q3 compared to Q2. Generally speaking, we'll see a bit of an uptick, seasonal uptick in the fourth quarter. But, you know, kind of the way I think of this is you haven't seen any meaningful negative impact on expenses in our investments we've talked about, because we're always working on efficiency. And really, what we're doing is we're self-funding many of these investments in sales and engineering talent by being able to be more efficient in other functions.

Operator (participant)

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

Amitabh Passi (Senior Technology Equity Research Analyst)

Hi, guys. I only had a couple questions. Mike, I guess the first one for you was, I think one I probably ask you every quarter. Just in your components business, the difference between the Americas and Europe, you cited sluggish GDP growth in the Americas. You know, Europe hasn't been that robust as well, yet we continue to see this divergence. I think in the past, you've explained it as part of the business or part of the demand being export oriented, but with APAC decelerating, is that an incremental concern? So I just wanted to get your thoughts again on sort of the disparity between the Americas and Europe on the component side.

Michael Long (President and CEO)

Sure. I would say that in Europe, we have a couple of things that have been going with for us. We had our computer conversion that you were aware we did. And after that, subsequent to that, we were able to add more sales and engineering and have more design wins. The European team has done a good job of being externally focused and adding accounts. Their design activity was one of the higher that we have seen given that they've had the longest run with salespeople.

And frankly, they've had some help from the aerospace and defense market and the automotive market, which are two very good markets and good growth rates for us, as well as lighting over the course of the year. The U.S. has been a little more sluggish and a little more choppy. I think there's still been a constant that we've had going on for years. There's still a transference of business going to Asia Pac out of the U.S., so the U.S. fights that piece of it constantly. But really, the sluggish economy, to me, would be to blame.

We've seen pretty good growth in aerospace this year, and but when you start going down, you know, quarter-on-quarter, between the verticals, you've got some up, some down, and they just play off of each other, and that's been the struggle for the last year or so in that marketplace. I'm not overly concerned with Asia Pac, because most of the slowdown has been that wireless infrastructure. And you know, we play in so many more markets other than that, that I still think we'll be able to grow through that. Maybe it'll be a little less, but needless to say, we will still see the growth. So we're not down on the economy. We just think that we could, we could stand to have a little better backdrop in North America.

The European economy is better than what we see printed in the press, and Asia is a general slowdown, primarily where we're not participating.

Amitabh Passi (Senior Technology Equity Research Analyst)

And then just as a quick follow-up, you've obviously, we've seen healthy levels of M&A activity of late. Just curious, is this a pace you think you can sustain? Just any update on pipeline opportunity set looking forward?

Michael Long (President and CEO)

You know, we're always looking. We just finished a couple, so you know, we're digesting those now, one in Asia Pac, and as you know, we've sort of increased the numbers in Asia Pac as the Asians get better at doing these acquisitions and managing them and making sure that they are successful for us. And then we finished another one. But as far as acquisitions go, I wish I could tell you, but there's no rhyme or reason what the pipeline manages, what we end up doing. It's all based on valuations, it's based off of returns, and can we bring benefit to the shareholders? And so that really doesn't have anything to do with pipeline other than we're constantly talking to a lot of people.

Operator (participant)

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

Sherri Scribner (Director and Equity Research Analyst)

... Oh, I squeaked in under the wire. I just wanted to ask a little bit about the ECS business. The midpoint of your guidance for the third quarter suggests that revenue is up 6% year-over-year, which is pretty strong considering the lack of growth over the past couple of quarters. Just wanted to get a better sense of what you're seeing there, is that, that shifts back to more hardware, which has more revenue away from software and security. Just wanted to get some more detail on that, and then I have a follow-up question.

Sean Kerins (President and CEO)

Yeah, Sherri, Sean Kerins here. I think what you're probably seeing in our guide is the immix acquisition, which would not have been in our numbers in the third quarter of last year. As you know, immix is a specialist in the federal marketplace, so, you know, Q3 is along with Q4 now, certainly part of the big buying season in the federal sector.

Sherri Scribner (Director and Equity Research Analyst)

Okay, that makes sense. And then just thinking about that shift you were talking about for this quarter, where hardware has been relatively softer, the buying pattern is longer. Do you think that impacts your fourth quarter, the typical sort of budget flush that we see in the fourth quarter? What are your expectations for 4Q, given this sort of, you know, slower demand environment and the shift to software and security? Thanks.

Sean Kerins (President and CEO)

Yeah, I wouldn't overemphasize, you know, that comment. I think, you know, we still saw billings growth in hardware, both for server and storage, so we're encouraged by that. I think, again, hardware pipelines are generally healthy. Some of the sales cycles and some of the evaluation decisions take longer than we might like, but I don't think it will introduce a material impact on our Q4 at all.

Operator (participant)

I would now like to turn the presentation back over to Mr. Steve O'Brien for closing remarks.

Steve O'Brien (VP and IR)

Thank you, Lisa. In closing, I will 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. If you have any questions about the information presented today, please feel free to contact me. Thank you for your interest in Arrow Electronics, and have a nice day.

Operator (participant)

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.