Arrow Electronics - Q2 2017
August 3, 2017
Transcript
Operator (participant)
Good day, ladies and gentlemen, and welcome to Arrow Electronics' Second Quarter 2017 earnings conference call. My name is Jamie, and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we'll conduct a question-and-answer session. If at any time you require assistance, please press star zero. This event is being recorded for replay purposes. Now, I'll turn the conference over to your host for today, Steve O'Brien. Please proceed.
Steve O'Brien (VP of Investor Relations)
Thanks, Jamie, and thank you all today for joining us for Arrow Electronics' Second Quarter 2017 earnings conference call. With us on the call today are Mike Long, Chairman, President, and Chief Executive Officer; Chris Stansbury, Senior Vice President and Chief Financial Officer; Andy King, 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, 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 will now hand the call to our Chairman, President, and CEO, Mike Long.
Mike Long (Chairman, President and CEO)
Thank you, Steve. Thanks to all of you for taking the time to join us today. We're well on our way to delivering the most successful year in Arrow's history. I'm pleased to report record second quarter sales of $6.5 billion, gross profit of $824 million, operating income of $267 million, and earnings per share of $1.78. Over the past few years, you've heard us talk about investing in growth. We've been getting ahead of the changes we've seen coming in our industry and the broader technology environment. We've invested in our digital platform. We've invested in our cloud capabilities. We've invested in sustainable technology solutions. We've invested in engineers and technical salespeople, and we've invested in our IoT capabilities and our ability to sell solutions that cross the entire enterprise. We will continue to invest to ensure the long-term growth of our business. These investments are bearing fruit.
We are providing solutions that encompass the full lifecycle of our customers' products from sense to sunset. The investments we've made are rapidly expanding our customer base and deepening our relationships with existing customers. At the same time, we've largely self-funded our investments through back-office efficiencies, automation, and pruning areas that have diminishing returns. I'm pleased to report that both our digital and cloud are on track to being billion-dollar run-rate businesses by the end of the year. Digital and cloud margins are already strong, and we'll continue to invest heavily in these businesses. We are confident that our digital platform cannot be reasonably replicated. Our ecosystem of online resources for innovators includes trade publications, reference libraries, live technical support, and crowdfunding. These resources, in turn, funnel back to our transaction and fulfillment engines that were purpose-built in-house and therefore seamlessly integrated with our core distribution businesses.
No other company in the world has the resources or capabilities to build this integrated digital platform for the future. We're further distancing ourselves from the competition in cloud. Here, too, our cloud marketplace and enablement tool, ArrowSphere, was developed internally. This allows Arrow to seamlessly integrate cloud solutions into our MSP customers' selling motions. It's our long-standing belief, has been, that hybrid infrastructures architectures, inclusive of on-premise, data center, private, and public cloud, are the pragmatic approach. The market is increasingly validating this belief. Changes in the competitive landscape have resulted in Arrow becoming recognized as the only distributor serving the complete IoT market space. We are adding a meaningful number of non-traditional VARs and MSP customers who are focused on IoT. PYMNTS.com recently named Arrow one of the top 10 IoT implementers. We're ranked alongside companies like Dell, HP Enterprise, Microsoft, and Apple.
Again, this quarter, we saw growing momentum from IoT customers buying components, utilizing our supply chain and manufacturing services, purchasing compute, storage, and cognitive tools for their data, and looking to Arrow for sustainable end-of-life solutions for their products. Looking ahead, we're seeing growing demand for the edge-of-network computing. We see tremendous potential for autonomous solutions for smart cities and industrial IoT, and we are aligned well for this trend. Turning back to the second quarter, in the current market conditions, Global Components again experience strong demand. Second quarter Global Components sales, we're $4.46 billion, up 16% year-over-year. We captured double-digit growth in all three regions. Lead times were mostly consistent with last quarter across our line card. Extended lead times persist in discrete, embedded, and passives. By and large, we continue to see normal purchasing behavior by our customers.
Our current organic growth rates are unprecedented and largely did not capture business shifts from suppliers or any distribution channel actions. Our growth was a functioning of adding customers at a greater share of purchases from existing customers. We're extending our reach up and down the supply chain. As we stated last quarter and so many times in the past, when our sales growth approaches 10% or more, we must make working capital investments that have short-term effects on our cash flows and returns. This is an organic investment in our business, which is the top priority for our cash. Organic investments have consistently produced the highest returns for Arrow over time. Global Enterprise Computing Solutions' second quarter sales of $2 billion were in line with our expectations. As we stated last quarter, incremental VAR and MSP signings were not a meaningful contributor to the second quarter.
Our infrastructure software and cloud businesses posted strong growth. Software continues to outpace our expectations. Traditional storage remains challenged, but at a rate of decline for servers as they improved again. Newer technology architectures, including new forms of storage, continue to grow at robust rates. In closing, as promised, we are on track to make 2017 the most successful year in our 82-year history. We delivered record performance in the second quarter and the first half of 2017. I look forward to updating you on our progress in the coming quarters. I'll now hand the call over to Chris to provide more details on our second quarter results and our expectations for the third quarter.
Chris Stansbury (SVP and CFO)
Thanks, Mike. Second quarter sales of $6.47 billion were above the high end of our prior guidance range. Sales increased 9% adjusted for changes in foreign currencies and 8% year-over-year as reported. The stronger dollar relative to the euro and British pound reduced our sales growth by approximately $57 million, or 1%, compared to the second quarter of 2016. Assuming rates remain stable, we have annualized any meaningful currency headwinds. Second quarter global component sales of $4.46 billion grew 17% year-over-year adjusted for changes in foreign currencies and 16% year-over-year as reported. Global component sales were above the high end of our expectation for the third quarter in a row. We had record second quarter sales in all three regions. Asia again produced exceptional growth. Asia sales increased 21% year-over-year, marking the fourth straight quarter of double-digit growth.
In the Americas, sales grew 15% year-over-year, driven by robust customer growth from our digital platform and from growth in sustainable technology solutions. We also had strong growth in our core business this quarter. In Europe, sales grew 16% year-over-year adjusted for changes in foreign currencies. Europe sales have grown year-over-year for 17 straight quarters adjusted for acquisitions and changes in foreign currencies. Global Components second quarter book-to-bill was 1.14, which is well above 1.03 in the second quarter of 2016. Second quarter Global Components operating income grew 10% year-over-year adjusted for changes in foreign currencies. Operating margin declined 30 basis points year-over-year due to mix of business in all regions. Second quarter Enterprise Computing Solutions sales were $2 billion, mostly in line with our prior expectation. Billings grew year-over-year, driven by infrastructure, software, and cloud.
Billings recognized as agency sales comprised a greater portion of our mix than we forecast. This allowed ECS second quarter operating margin to reach 5.6%, a record level. Returning to consolidated results for the quarter, total company operating expenses only increased 2% year-over-year, despite our strategic investments and our significant sales growth. As a result, operating expenses decreased 50 basis points as a percentage of sales on a year-over-year basis. Our effective tax rate for the quarter was 28.4%. As we outlined last call, this rate was toward the higher end of our long-term expected range. For the first half of 2017, our effective tax rate was 27.6%. Second quarter net income was $160 million, up 5% year-over-year. Earnings per share were $1.78 on a diluted basis, above the midpoint of our prior guidance range. Second quarter earnings per share grew 8% year-over-year.
Second quarter operating cash flow was a use of $112 million. While it is unusual for second quarter cash flow to be negative, this use of cash corresponds to our organic investment in inventories to support our rapid growth and timing of collections on stronger sales than we anticipated. We repurchased approximately $55 million of our stock in the second quarter, approximately $277 million over the last 12 months, and approximately $1.4 billion over the last five years. Entering the third quarter, authorization remaining under our share repurchase programs is approximately $409 million. During the second quarter, we successfully issued $500 million of 10-year notes at favorable terms. We used the proceeds to meet an upcoming maturity and retire a portion of our higher coupon debt. We calculate quarterly pre-tax interest expense savings of approximately $1.5-$2 million.
This is a high level of our summary of our financial results. For more detail regarding the business unit results, please refer to the CFO commentary that was published this morning. Now, turning to guidance, we believe that total third quarter sales will be between $6.325 billion-$6.725 billion, with global component sales between $4.4 billion-$4.6 billion, and global enterprise computing solution sales between $1.925 billion-$2.125 billion. We expect third quarter 2017 operating expenses to decline as a percentage of sales compared to the third quarter of 2016, similar to what we have posted thus far this year. As a result, we expect earnings per share on a diluted basis, excluding any charges, to be in the range of $1.74-$1.86. Our guidance assumes an average non-GAAP tax rate of 27%-29%.
We expect our effective tax rate for the third quarter and for the full year to be within our longer-term range. For the third quarter, we expect average diluted shares outstanding of $89 million, and the average U.S. dollar-to-euro exchange rate we're using for forecasting purposes is $1.15 to the euro. This is the average rate through the month of July.
Steve O'Brien (VP of Investor Relations)
Thank you, Chris. Jamie, could you please provide the instructions for the Q&A portion at this time?
Operator (participant)
For questions, please press star one on your phone. If you would like to withdraw your question, press star two. To begin, please press star one. Your first question comes from the line of Shawn Harrison. Please go ahead.
Shawn Harrison (Financial Analyst)
Hello. Can you hear me?
Mike Long (Chairman, President and CEO)
Yes. Yes.
Shawn Harrison (Financial Analyst)
Oh, sorry about that. Anyway, congrats on the results. Two questions, if I may. The first just being on the components business. The share gains that you have ramping into the back half of the year, if you could break out maybe what falls into the September quarter guidance versus the December quarter. And then the second question would just be on the legacy IT kind of storage and server markets. Would you expect that to bottom either in the third quarter on a year-over-year basis, or is that a fourth quarter event, if at all?
Mike Long (Chairman, President and CEO)
Yeah. First off, regarding the shifts, we don't expect a lot in the third quarter. And we're still calculating what the fourth quarter will look like, but that's where you would see sort of the full run rate basis of what's coming over. And part of the reason is we don't exactly know what will be shipped by the legacy partners of those changes. So we're prepared to take on whatever we can, but at this point, we're not expecting that to be material for us in the third quarter. Sean, would you like to give the sort of range on the storage piece?
Sean Kerins (President of Global Enterprise Computing Solutions)
Yeah, sure. Shawn, as you may have heard or seen, we saw the rate of server decline improve nicely in the second quarter. The rate of storage decline did not really improve, but it didn't get much worse. And when you dig into storage, I think we're still in the midst of a multi-quarter transition from old tech to new tech. And just to give you a little color on that, if you think about converged, hyper-converged, and solid-state storage technology, all of that is still growing for us well into the double digits, now comprising as much as 60% of our total storage category. I think roughly a year or so ago, that number looked more like 40, 42%. So we're making progress towards the crossover. I do think in some segments, some of the year-over-year compares will get a little bit easier. We'll have to see.
But I think the crossover is still out in front of us, but I'm pleased with the progress we're making toward it, especially with the newer technologies.
Shawn Harrison (Financial Analyst)
That's great, Sean. Thanks so much.
Operator (participant)
Your next question comes from the line of William Stein. Please go ahead.
William Stein (Semiconductor and Artificial Intelligence Equity Research Analyst)
Great. Congratulations on the good results and outlook. I'm hoping you might have some comment as to where you think we are in the semi-cycle now. Demand appears to be very robust. And in particular, we're also seeing these shortages in passives that you mentioned, Mike. And I'm wondering how you think that is affecting sort of the altitude and duration of this cycle and what it means for the next few quarters.
Mike Long (Chairman, President and CEO)
Yeah. It's interesting, but our customer surveys still show that customers would like to have a little more product than they're getting. So that's one good thing. The second good thing is the book to bill continues to push on, which would indicate that we're going out with this demand sometime into next year, as it looks right now. And the backlogs are starting to firm up for us with dates of shipment. So all in all, I would say that this isn't a one-region phenomenon. As you saw, we had virtually records in all three regions with shipments for the quarter. And the other thing driving it is we have sort of an unprecedented rate of new customers coming into the business right now. And most of that driven by new IoT-type solutions.
And the second piece that goes with that is obviously some of the cloud solutions and that type of thing. So right now, we're still bullish that we're not looking at anything in the next quarter or so, at least, for this. We keep an eye on it. Our cancellation rates are normal, so we're not seeing an increase. And if that's the first place that you tend to see a change when the cycle is coming to an end, and right now, we're not seeing that.
William Stein (Semiconductor and Artificial Intelligence Equity Research Analyst)
Mike, on the passives, if I can just ask one more, is that causing perhaps shortages and inability to ship complete kits, or are customers able to sort of get what they want by paying up a little bit more on the passives side but not having an issue getting full kits?
Mike Long (Chairman, President and CEO)
I would say right now, customers are largely getting what they want. When I talk about they would like to have a little more inventory, I think that's anybody would be comfortable if you had three months' inventory sitting on the shelf. But when you're down to two, you kind of would like to have that extra month. And I think that's where we are in the cycle. We are by no means in what I would say an across-the-board allocation. We're not in customers not being able to find what they want, and we're not in line-down situations. So all in all, right now, there's pretty good balance in the market, but the market continues to be strong.
William Stein (Semiconductor and Artificial Intelligence Equity Research Analyst)
Helpful color. Thanks, Mike. And congrats again.
Mike Long (Chairman, President and CEO)
Thank you.
Operator (participant)
Your next question comes from the line of Steven Fox. Please go ahead.
Steven Fox (Analyst)
Thanks. Good afternoon. First off, maybe you could talk a little bit more about the cloud services business. The billion-dollar threshold would be pretty important, it sounds like, versus, say, I think you were at $400 million last year. Can you talk about what is driving the growth more than other things? I think you mentioned good profitability, but is it sort of self-funding itself at this point, and what kind of growth is reasonable to expect off of a billion-dollar run rate? And then I had a follow-up.
Mike Long (Chairman, President and CEO)
Yeah. The first thing about self-funding, self-funding is an interesting thing, says it's throwing off the operating income that would totally fund that business. And what I would tell you is that I would hope not because that would suggest that it's in a mature level, and that's all we can get from it. So the truth is no. We're going to continue to drive this. And as you could see, where we were last year and where we are this year, that's a plus for us. Now, what I can say is Arrow Inc is funding this, so it is being funded out of our own earnings. And that is a positive when it comes to the company because this is ultimately a higher-margin, higher-profit business than the traditional business.
As far as how the complexion of that business looks, I'm going to let Sean explain it to you because it's really been his baby with his team, and I think it's hats off to that group for being able to build this internal.
Steve O'Brien (VP of Investor Relations)
So Steven, let me give you a little more color on your question about what's driving it. I think, and you're right, we did see significant growth again in the second quarter. The run rate improved substantially. We feel pretty good about the billion-dollar target we've set for ourselves as we exit 2017. And I would tell you that I think it's coming from three things. One, we continue to add cloud offerings to our line card, right? Suppliers and cloud offerings. And we continue to do the investment necessary to complete the API integration work to make those offerings available to our selling partners and solution providers. Secondly, we continue to bring on non-traditional channel partners at a pretty good rate. And I'm thinking about managed services providers and others that are really good with recurring revenue business models.
In both cases, that's really just improving our ability to participate in more opportunities. And then thirdly, I would say we are starting to see the hybrid cloud model become more accepted. We are working with partners to create opportunities to attach cloud offerings to things that they're also selling on-premises at the same time. And we think as that hybrid cloud model continues to play out, we're really in a great sweet spot to take advantage of it.
Steven Fox (Analyst)
Great. I appreciate all that color. And then just as a follow-up, you kind of addressed this in another question, but in terms of looking at a Book to Bill that's at 1.14, which is pretty high versus your historical standards, can you provide any more color around sort of the traditional aging of the backlog, how far out we're going, why that would be not an uncomfortable level suggesting some excesses? Thanks again.
Mike Long (Chairman, President and CEO)
Andy, would you like to take it?
Andy King (President, Global Components)
Yeah. Steven, I mean, the Book to Bill ratio does, as you indicate, imply that our backlog is growing. And the interesting thing is our backlog is growing right across the coming quarters. As Mike said, as those orders firm up, it's not just coming from one geography. It's coming from all geographies. It's not just coming from one end market. It's coming from multiple end markets and verticals. So there's no significant change whether this is becoming front-end loaded or back-end loaded. People are just increasing their commitments as they see those products pull through to the market, I think.
Steven Fox (Analyst)
Great. Thank you very much.
Operator (participant)
Your next question comes from the line of Matt Sheerin. Please go ahead.
Matt Sheerin (Analyst)
Yes, thanks. I just wanted to ask some questions around the gross margin, specifically in the components business. In the CFO commentary, you talked about some margin pressure due to mix in the Americas and in Europe. So I wanted to get some more color on that. And as you begin to ramp some of the new supplier wins, which will start with fulfillment business versus demand creation, would you expect that to be another headwind on margins as we go through the next, well, beginning of the December quarter, I guess?
Mike Long (Chairman, President and CEO)
Thanks, Matt. There's a lot of stuff going on in here, so I'll try to bring it to you. The first thing is a lot of the business, and you see our growth, has geared towards the fulfillment business. So the bigger portion of the business coming in for the quarter was fulfillment and Asia. So those were two mixed change and region change. Our design win activity is also up year-over-year, just not at the same pace as the overall sales growth. And a lot of that has to do with some of the new customers that have come in around IoT and those things yet, which are design win, but just haven't shipped yet. And so what you'll see over time is that GP decline slowing. And in fact, we are seeing that slow now.
If you take the implied third quarter guide, it really shows you that the sales growth and the operating income growth in the end are close to or at the same number, which suggests we're already seeing some benefit of things that have been worked on for the last six months. That's number one. Number two, we are still investing in cloud and digital. While those income levels will exceed the corporate average, we are investing to grow those businesses right now, as demonstrated that both of them were on a billion-dollar run rate by year-end. We fully expect them to continue to contribute more each year. As I said, not mature businesses, so they are certainly places that you would appreciate and any other investor would appreciate us investing in.
So all in all, there's a lot of what I would say between fulfillment business and region mix driving the GP the wrong way. The normal activities that we've done in the past are driving it back up the right way, just not at the same pace yet. We would expect another six or seven months for that to start to materialize as we get into some of the new customers, which will come over in December and start working on their designs. So hopefully, that's as clear as I can get on that.
Matt Sheerin (Analyst)
Yeah. Fair enough. That was helpful. And then just on your growth, obviously, 16%+ year-over-year growth in components is well above market and in sales. And I'm trying to figure out how much is that share gains, and where are you taking share from? Is it the smaller regional distributors? Is it your big competitor because of any issues they may be having? And then just as a follow-on, on the pricing environment, given extended lead times, as you said, and things like passives and discretes, every few years, you get a better cycle, and you get some advantageous pricing. Are you seeing that, or do you expect that at all to happen?
Mike Long (Chairman, President and CEO)
What we're seeing right now is the largest growth for us are deeper commitments with current customers. And that comes through our solution sale. The next area that we're seeing big growth is obviously in the digital platform, which didn't exist at these rates. So if you look at that growth rate, that also is another implied projection of market share growth for us, and that's happening all over the world. The next one is we did an investment in engineers and salespeople, and they are out there generating new accounts for the core. And as those accounts come in, what you're really seeing is they start to come in with the fulfillment business first, and then you start working on the projects with them. So that is the big reason for the share shift.
Now, how much of that business existed with the competition for us, I can't really tell you, but I can tell you it wasn't all new business because if it was, maybe the increased market share wouldn't be there. Obviously, in the fourth quarter, you will see big market share shifts, and that will be due to customer changes and supplier changes. But for right now, it's really driven by the solutions we're offering.
Matt Sheerin (Analyst)
Okay. Great. And just on the pricing environment?
Mike Long (Chairman, President and CEO)
The pricing environment, I would say, is remaining relatively stable, comparatively speaking. If you look at some of the very large deals that maybe we did not take in the past that were supply chain deals, those are a little less than what we would have normally had if you looked at what I would call an average account in here. But they also take a lot less of our skills to move that product from A-B. And I would say we see that more than we see really competition between people trying to book deals.
Matt Sheerin (Analyst)
Got it. Okay. Thanks a lot, Mike.
Mike Long (Chairman, President and CEO)
You bet.
Operator (participant)
Your next question comes from the line of Adrienne Colby. Please go ahead.
Adrienne Colby (Analyst)
Hi. Thanks for taking the question. I wanted to ask about the ECS operating margins. You saw some improvement again this quarter, although the rate of improvement has slowed. And I'm just wondering how we should be thinking about the opportunities for margin expansion going forward if it'll sort of be at a similar cadence or there's a bigger step up happening now that the cloud business is at a billion-dollar run rate?
Steve O'Brien (VP of Investor Relations)
Yeah. So in the near term, what's happening with our margins is obviously the shift from hardware to software and the impact on the bottom line. That shift, while continuing, is slowing. So I think that does give us some tailwinds, but the rate of growth does slow over time as it relates to that shift. On cloud, to the point Mike made earlier, we have decent margins on that business today, but we are investing heavily because it's a growth area for us. So longer term, the goal would be that that could be a growth platform as well. But our focus right now is really on driving growth there and making sure that we have a complete solution in place.
Adrienne Colby (Analyst)
Great. And then just as a follow-up, I'm wondering if in light of the strong demand you're seeing and the working capital needs you've described, if your cash flow expectations for the full year have shifted? I think you'd been talking about operating cash in the range of $450 million-$550 million this year.
Steve O'Brien (VP of Investor Relations)
Yeah. I think we said that at the beginning of the year just as a rough guideline. We're obviously not guiding the full year. I would just echo what Mike said in his comments, and I did as well, which is our priority for capital allocation has always been organic growth first. This is really the core of organic growth. I think the growth rates that we're seeing, while we're thrilled with, we didn't obviously project at the beginning of the year. So as long as we see this kind of unprecedented growth and share shift, we will stay focused on those investments to support our suppliers and customers. So I would expect that versus what we said earlier in the year, yes, it would be lower.
I don't want to put a number out there right now because we're still looking for internal efficiencies where we can to help offset some of those investments we need to make in inventory and receivables. I do think the one takeaway here is you've got to think about a six-month cycle from the buildup of inventory at the front end to support the sales growth all the way through the growth ramping and then the collections on the other end before we get to a normal run rate. So until we get through this rapid growth, I think that's the kind of stuff you guys should be modeling.
Mike Long (Chairman, President and CEO)
Yeah. I'd like to maybe add to this a little bit. We are in an unprecedented and very good position, one that we've never been in as a company before. When you consider the growth areas of digital, the growth areas of cloud, the growth areas of sustainable technology, of IoT, and the investments we are making, those are four viable, very large markets that can produce years and years of operating income for Arrow. Having that, most companies don't even get one thing to invest in that could be that big for them. We're looking at four right now. There is not going to be anything that we do to back off of our investments to make sure that we capture each one of those markets in a way that we should and the way that you would expect us to.
Operator (participant)
Your next question comes from the line of Mark Delaney. Please go ahead.
Mark Delaney (Analyst)
Yes. Congratulations on the nice results, and thanks very much for taking the questions. First question is a follow-up on component margin outlook. Typically, the second half of the year, just given regional mix shift, the margins in the component segment decline. I'm just curious with the strong backlog and some of the other efforts you already discussed on the call, is there a potential for that dynamic to be different this year?
Steve O'Brien (VP of Investor Relations)
Yeah, Mark. I know we've talked about this in different investor forums and conferences and whatnot. We believe that even with the significant share shift in fulfillment that starts as fulfillment and the impact of that on the fourth quarter, that because of the strong operating leverage that we can drive, that you will see year-over-year improvement in global components in the fourth quarter. Our belief in that remains. I think if you look at the implied leverage that we're putting forth in our guidance, you can kind of model off of that. I think that puts us relatively flattish on overall Arrow operating income margins in Q3. But in Q4, we would expect to see an improvement because of just the sheer volume of the shift with very little OpEx investment.
Mark Delaney (Analyst)
Yeah. That's a thoughtful question. Then for a follow-up question on the ECS business, the September quarter guidance implies revenue is up slightly sequentially and typical seasonality is down mid-single digits or so. Maybe you can just elaborate a bit on what you're seeing in the third quarter that's helping to lead to that better growth rate for ECS sales? Thank you.
Mike Long (Chairman, President and CEO)
Yeah. You bet, Mark. So I think if you look at the midpoint of our Q3 guidance, we're kind of right in line with last year's sales results. And remember too that in the last 3-4 quarters, our mix has shifted quite sharply to software and services because at the same time, we are expecting further billings growth in Q3. And I think we'll start to see our own competitive wins begin to roll into the business at an increasing pace across the course of the second half.
Mark Delaney (Analyst)
Thank you.
Operator (participant)
Your next question comes from the line of Param Singh. Please go ahead.
Param Singh (Analyst)
Yeah. Hi. Thank you. Wanted to ask questions actually following up what prior analysts had asked. One is on the book to bill 1.14, right? So the delta between what you're guiding and the book to bill has actually increased over the last couple of quarters. If I just look at last quarter's guide as well, you guided to 1.14, and you actually came up 10% Q&Q, which is well above your guidance range for the components business. So is the guide here for 3Q very conservative, or what's the missing piece here that's leading to the big delta between guidance and?
Mike Long (Chairman, President and CEO)
Yeah. It's actually one we haven't talked about, and I usually hate it when you guys ask me the questions, but one is increasing our inventory. We have to go out and use our cash to increase inventory and make purchases to make inventory available. And with the lead times right now being a quarter, 12 weeks, maybe a hair more, that would suggest you'll start seeing more of those shipments in the fourth quarter as we get that inventory in. So that's really the missing link you're seeing is that we actually have to build inventory to support all these nice wins in the sales that we have, and that's also one of our uses of cash.
Param Singh (Analyst)
Right. So I mean, you had similar commentary last quarter where more wins were supposed to come into 3Q, and your results actually were up 10% sequentially. So what was different in this quarter versus how you're guiding?
Steve O'Brien (VP of Investor Relations)
Yeah. It's any form. I mean, I guess the question you're asking is how much of the transfer business is coming in in Q3 versus Q4. And the answer is that we're guiding what we can see right now. It's not an exact science. That's the challenge we have here. We don't exactly know when our customers' inventory positions kind of liquidate down. We don't exactly know when other suppliers into that market liquidate their inventory positions and what impact that has on the supply chain. So we make our best estimate as to what we think that's going to look like, but that can change, and we just continue to monitor it closely.
Param Singh (Analyst)
Okay. Thanks, Andy. And then for my follow-up, the inventory increase year over year, how much of that is due to the new supplier win that's going to kick into 4Q versus the share gains, the organic share gains that you talked about?
Mike Long (Chairman, President and CEO)
We haven't broken out our inventory to distinguish the difference. Customers order a dollar is a dollar. So for us, we haven't—we don't have our salespeople saying, "Is this a brand new piece of business?" All we can do is look at it sort of by product line. And maybe we can put that together for the call-in later or at another time, talk about it. But we haven't thought of it that way. So thanks for that.
Param Singh (Analyst)
Okay. Just one last question, actually, which is kind of a follow-up to Mark's question. If I look at the ECS business on a billings basis, right, so taking out the software impact, which is larger in your second quarter, how would the numbers look Q&Q for ECS? Would it still be down a little bit sequentially, or is it better than seasonal, similar to as reported?
Steve O'Brien (VP of Investor Relations)
Param, is your question surrounding the impact of the share shift?
Param Singh (Analyst)
So what I want to gauge is your sequential guide, like you talked to Mark about, was better than seasonal. Now, how much of that is simply because of revenue recognition of software versus the other pieces? That's what I'm trying to differentiate here.
Mike Long (Chairman, President and CEO)
Your decline of hardware is slowing. I think that's what you said. Why don't you take that, Sean?
Sean Kerins (President of Global Enterprise Computing Solutions)
Yeah. Sure. So as we've talked about it, right, software and services are becoming a bigger piece of our mix. So you've correctly interpreted that. Obviously, that has an impact on the reported sales number. But our billings growth will improve again in the third quarter. I think sequentially is pretty much in line with what we would call normal seasonality, although I would remind you that we've kind of gotten away from that because our business mix has changed over time as we've made acquisitions and we've diversified where we play.
Param Singh (Analyst)
Okay. All right. Thanks a lot, guys. I really appreciate you taking my questions.
Operator (participant)
Your next question comes from the line of Adam Tindle. Please go ahead.
Adam Tindle (Investor Analyst)
Okay. Thanks. Good afternoon. Mike, I just wanted to see if you could maybe start by just reflecting on the overall industry dynamics. It's arguably been long enough to where it seems as if we're potentially experiencing a linear change in terms of your share gain, whereas this has historically been more of a mean reverting dynamic where gains were offset somewhat by losses, particularly in the components business. So maybe if you could speak to what has changed to drive this and should this continue on a linear path in your view?
Mike Long (Chairman, President and CEO)
Yeah. I would say that my expectations are that it would. There is really no mean regression given that the majority of the new opportunities coming in here are IoT. And when you consider what we are selling now is everything from sort of the sensor to the sunset, the business analytics, the storage, the cloud services are all going along with these new deals. And as a result of that, we're seeing more and more and more opportunities. It's interesting that our computer product suppliers are one of our largest sources of IoT opportunities for the components group. So we can work with them to build the appliances that will work with what those suppliers are trying to offer as far as cloud services go or analytics or things like that. That's really number one.
Number two, we've got engineering capability out there that no one else has and hasn't been close to. If you remember, we invested in this several years ago and continue to invest. Now we're operating with engineering centers all around the globe, 24 hours a day, seven days a week to answer questions that anybody, any engineer may have, and we can help them through their design. The other area that has been a growth area for us that I think is really one that would be hard for anybody to catch up with, and that's the crowdfunding opportunities that have come in here from new startups. That has largely propelled the digital business in a way that is different from most digital businesses, which are out there just gutting it out, fighting for current market share every day.
We have already had about 2,000 significant wins that have come to us in the core business from the digital business. That comes from having a fully integrated system that works together that keeps everything from being manual. We have dramatically changed our go-to-market with our customers. We've changed our go-to-market for the suppliers, and we're continuing to invest in areas that bring new customers in. I would probably suggest that you're going to continue to see this go for quite some time, and certainly through 2018.
Adam Tindle (Investor Analyst)
Okay. That's helpful. Maybe just touching on returns. So working capital has increased, and returns on working capital are down meaningfully in the components business, but arguably suppressed depending on what you believe this will bring. So wanted to understand, number one, do you think the willingness to build working capital has enabled you to gain share? So help us understand the why. And number two, how quickly can returns on working capital get back to historical levels so we can understand the payoff and visibility into that? Thanks.
Mike Long (Chairman, President and CEO)
Yeah. I'll let Chris answer, but the short answer here is that when the company starts to grow at rates that it's growing now, you're building inventory, you're setting up new accounts, you have a receivable, and everything is in a growth mode. So your inventory growth and your inventory purchases are outpacing the sales because you haven't matured. And that's the reason for the use of cash. You do get that back, obviously, as you collect, but you get it back some 90 days later if you were to say from the day you place that purchase order. So you will use cash anytime you grow this business more than 10%. In fact, it used to be 3% or 4% for those of you that remember, 5%. We've found a way to get 10% growth and still throw out cash.
But as I said before, as long as I have places organically to put cash so this company can put up the growth rates that you're seeing now. And by the way, I might add, while they are down, this is not indicative of a mature business anymore. This is indicative of a growth business. So we are seeing more operating income. We are seeing investments, and we're seeing returns on those investments, just like we said. I can tell you right now, if this was a mature business, we'd be running it entirely different, and you'd be seeing an entirely different return profile. But that decision is only 90 days away at any time. So that's the important thing, Chris.
Chris Stansbury (SVP and CFO)
Yeah. No, I think Mike really answered it. But the reality is we obviously don't have the operating income base loaded in here yet, Adam. And I think that as you model that out, the returns come back in line. I'd also remind you, because this is organic growth as opposed to, say, an acquisition where you pay an acquisition premium and you're buying a stream of revenue and receivables, the investment we're making here is not in an acquisition premium. It's in really building the working capital side of the business as we grow organically. So I think this is more timing than a trend.
Adam Tindle (Investor Analyst)
Okay. That's what I was just trying to get at. I know the business is changing pretty meaningfully. Digital has grown pretty significantly. So I mean, there has not been a structural change to your working capital requirements?
Chris Stansbury (SVP and CFO)
No. Not at all. Again, I would continue to focus all the analysts really on the cash conversion cycle, which has been impacted in the short run. But because of the way the balance sheet metrics, the days calculations are impacted by the agency accounting rules in the ECS business, it tends to distort the days calculations on some of those metrics. Really focus on cash conversion. You still get to the same place in the short run, but I think that also helps clean up some of the questions between things like inventory payables and receivables.
Operator (participant)
Your next question comes from the line of Jim Suva. Please go ahead.
Jim Suva (Stock Analyst)
Thanks very much. A lot of time has already been spent on the components business, which you gave a lot of clarity. So I want to ask on that. So I'll focus on the enterprise computing business. Am I correct if we look at your guidance that you're basically calling for a floor in your organic growth rate where I think you've had organic growth rates decline for about five quarters? And am I right on your outlook that that would call for a floor bottom?
Steve O'Brien (VP of Investor Relations)
No, I wouldn't say that, Jim. We wouldn't call that floor. As I said, we see continued growth in the second half, partly as a function of our organic efforts, but also partly as a function of some of the new business that's coming our way as a result of some of the competitive realignment we've seen in the marketplace with a handful of competitors. And we think that, again, it wasn't meaningful in the second quarter, but it will be more meaningful across the course of the second half.
Chris Stansbury (SVP and CFO)
So I would call it two parts. I would just add to that, Jim, that you got to be really careful looking at net sales because of the shift from hardware to software. And so we've been pretty open about what that impact has been.
The other thing, obviously, in the results to date has been the shift within storage from traditional forms to new forms. That's been a bit of an anchor on growth, and we're now at the point where those start to cross over. So I think to come to the conclusion on a net sales basis that we've kind of hit a ceiling on where we are, be careful with that.
Jim Suva (Stock Analyst)
Okay. That's very fair. Then my follow-up is regarding the profitability, the dollar amount of the computing dollars coming in. Looks like we're down year-over-year, but your security, your software, your cloud billing run rate and stuff appears very encouraging, but the dollars are down year-over-year from a profit perspective. Is that just mostly because of the decline of servers and storage, or how should we think about why the profitability actually isn't up year-over-year given your traction that you've done so well with your ArrowSphere and your Arrow go-to-market and your cloud efforts? Thank you.
Mike Long (Chairman, President and CEO)
Yeah. No problem, Jim. I understand the question. So again, in Q2, we saw a sharper mix of software and services than we anticipated. And again, our billings were up modestly in the quarter. But just from a sheer volume perspective, there were a handful of deals that rolled into the September quarter. Part of that was due to the industry constraints around solid-state disk drives. That's fairly well known. And the other was in our federal business where it's not uncommon this time of year to see big deals roll from one month to the next. Other than that, I would say the quarter kind of played out more or less the way we expected.
Jim Suva (Stock Analyst)
Thank you so much for the details and clarifications. It's greatly appreciated.
Mike Long (Chairman, President and CEO)
You bet, Jim.
Operator (participant)
At this time, there are no questions. I'll hand it back over to Steve O'Brien.
Steve O'Brien (VP of Investor Relations)
Thank you, Jamie. In closing, I will review Arrow's safe harbor statements. 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, and the company undertakes no obligation to update publicly or revise any of the forward-looking statements. 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.