Arrow Electronics - Q4 2017

Transcript

Operator (participant)

Good day, ladies and gentlemen, and thank you for joining the Arrow Electronics' fourth quarter and year-end 2017 earnings conference call. My name is Latoya, and I will be your moderator 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 assistance, please press star followed by zero, and an operator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. It is with great honor introducing our host for today, Vice President, Investor Relations, Arrow Electronics, Steven O'Brien. Please proceed.

Steven O'Brien (Head of Investor Relations)

Thanks, Latoya. Good day and welcome to Arrow Electronics' fourth quarter and year-end 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, some of the figures discussed on today's call are non-GAAP. You can access our earnings release at investor.arrow.com, along with our 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.

Michael Long (Chairman, President and CEO)

Thank you, Steve, and thanks to all of you for taking the time to join us today. I'm pleased to report a strong finish to what was unquestionably the most successful year in Arrow's history. For the fourth quarter, we achieved record sales of $7.6 billion, gross profit of $930 million, and operating income of $340 million, and an earnings per share of $2.51. For the full year, 2017 sales of $26.8 billion, gross profit of $3.4 billion, operating income of $1.1 billion, and earnings per share of $7.56 also reached record levels. Our view for the next five years out is the most visionary and transformational in our history. We will enable customers to adapt to change. Our customers will rely on us to help them with a multitude of new technologies coming their way. We'll make it even easier for customers to buy from us. That means making it easier for them to buy from us digitally, from a salesperson, or through their value-added reseller or managed service provider. With our unparalleled data and the use of intelligent technology, we will increasingly anticipate customers' needs before they do. We're going to continue to expand our services. This will bring us even closer to our customers. We'll provide technical support and unmatched collection of online reference material. We provide engineering help or even have our engineers take over product design. We manage supply chain and aggregate disparate sources of supply, and we'll control bill of materials and take products all the way from idea to production. We will not leave any market underserved in terms of the products or services we offer. Our digital team is reaching the entry-level market with self-service design. Our field application engineers will continue serving the mid-market, and last month, we announced the exciting acquisition of eInfochips. The deal bolsters our already robust internal engineering capabilities with 1,500 more engineers. These engineers have the expertise from chip design level all the way to hardware, software, and cloud-based solutions. eInfochips brings us the skills to satisfy large engineering commitments. Industrial automation, edge computing, cloud, connected devices and home automation, smart cities, and growing electronic content for transportation are some of the biggest opportunities of our lifetime. To lead in these areas, you must offer system solutions. Being a point provider of parts, devices, or manufacture is not being a leader. It does not make it easy for customers, and our vision is much more comprehensive. We delivered unprecedented growth in 2017. This growth validates our strategy and inspires us to push forward to 2018 and the years ahead. This growth builds trust with our suppliers, and we are casting the widest net for our customers and offering the most comprehensive services and solutions on our suppliers' behalf. We have lived up to our commitments to suppliers, and we continue to aim to exceed them. Turning back to our results, our business model continues to perform as we expect it to. Our broadened supplier engagements brought in new sales and new customers. Our investments in working capital drove sales and profit growth. We delivered profit leverage on our sales just as we anticipated. We expected 2017 to be a great year for growth in the semiconductor industry, and indeed it was. Early indicators suggest 2018 should be a good year for growth for the industry. Global Components again experienced strong demand in the fourth quarter. Sales were $4.95 billion, up 24% year-over-year, and we're at the high end of our expectations. We captured double-digit growth in all three regions. Extended lead times persist in discretes, standard logic, embedded, and passives. In aggregate, lead times were mostly consistent with the prior quarters of 2017. Our cancellation rates remain normal. Our book-to-bill was 1.12 for the fourth quarter, up from the third quarter and up from 1.09 in the fourth quarter of 2016. Global Enterprise Computing Solutions' fourth quarter sales of $2.69 billion grew 10% year-over-year, and we're above our expectations. Our software-based solution strategy continues to work well. We're constantly pursuing new technologies and architectures for our customer. This quarter, our infrastructure, software, and cloud business again posted strong growth. We reached the turning point for storage, with newer forms driving growth in both regions. For the second quarter in a row, our performance in Europe was very strong, with sales growing 19% year-over-year. Americas sales grew 5% year-over-year. In closing, as promised, we made 2017 the most successful year in our 83-year Arrow history. It delivered record performance in all four quarters, and we expect this momentum to continue into 2018. I look forward to updating you on our performance and our progress in the coming quarters. I'll now hand the call over to Chris to provide more details on our fourth quarter results and our expectations for the first quarter.

Christopher Stansbury (SVP and CFO)

Thanks, Mike. Fourth quarter sales of $7.63 billion were above the high end of our prior guidance range. Sales increased 18% year-over-year and 15% adjusted for changes in foreign currencies. The actual exchange rate for the quarter was $1.18 to EUR 1, in line with the rate we had previously used for our forecast. Fourth quarter Global Components sales of $4.94 billion increased 24% year-over-year and increased 21% adjusted for changes in foreign currencies. Global Components sales have been at or above the high end of our expectations for six quarters in a row. We had record fourth quarter sales in all three regions. In the Americas, sales increased 25% year-over-year, driven by our core, our digital platform, and our sustainable technology solutions. In Europe, sales increased 35% year-over-year and increased 24% adjusted for changes in foreign currencies. Europe sales have grown year-over-year for 19 straight quarters, adjusted for acquisitions and changes in foreign currencies, as we continue to gain share in the marketplace. Despite a challenging year-over-year comparison, Asia again produced strong growth. Asia sales increased 16% year-over-year, marking the sixth straight quarter of double-digit growth. Asia sales increased 14% year-over-year, adjusted for changes in foreign currencies. Fourth quarter Global Components operating income increased 32% year-over-year and increased more than our 24% sales growth. Operating margin increased 30 basis points year-over-year. In short, we've started to capture the leverage we've been anticipating for this business. Fourth quarter Enterprise Computing Solutions sales were $2.69 billion, up 10% year-over-year and above our prior guidance range. Sales grew 6% adjusted for changes in foreign currencies, and billings also grew at a mid-single-digit rate year-over-year, adjusted for changes in foreign currencies, driven by infrastructure software, cloud demand from new VAR and MSP customers, and a return to growth in both regions for storage. We also experienced strong demand for proprietary servers. Fourth quarter Enterprise Computing Solutions operating income grew 3% year-over-year. As we stated in the past, we're focused on driving operating profit dollar growth for this business, and we're pleased with the return to growth. Stronger hardware sales, including storage and both proprietary and industry-standard servers, negatively impacted operating margin compared to prior fourth quarters. Therefore, we did not capture a margin benefit from agency accounting for certain types of software and services. Operating margin decreased 40 basis points year-over-year. Returning to consolidated results for the quarter, total company operating expenses increased 9% year-over-year to support our strategic growth. Despite some increased spending, operating expenses still decreased 70 basis points as a percentage of sales on a year-over-year basis. The effective tax rate for the fourth quarter was 23.9%. Our effective tax rate was 310 basis points below the low end of our prior target range of 27%-29%. This was due to favorable tax rulings whose outcomes and timing were uncertain entering the quarter. Compared to the low end of our prior target range, the lower-than-anticipated effective tax rate contributed approximately $9 million to net income and $0.10 to earnings per share. Fourth quarter net income was $224 million, up 23% year-over-year. Earnings per share were $2.51 on a diluted basis, above the high end of our prior guidance range. Fourth quarter earnings per share grew 25% year-over-year. Fourth quarter operating cash flow was $123 million. Operating cash flow was well below normal fourth quarter levels due to our working capital investments. However, our cash conversion cycle was unchanged year-over-year after being slightly elongated during the first two quarters of 2017. Inventory days declined by one day compared to the fourth quarter of 2016, when our business started to capture significant growth. Return on invested capital increased 120 basis points year-over-year, increasing for the second quarter in a row. We're starting to capture higher returns on our organic investments in the business. We repurchased $25 million of our stock in the fourth quarter, approximately $161 million over the last 12 months, and approximately $1.3 billion over the last five years. Entering the first quarter, authorization remaining under our share repurchase program is approximately $359 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. Turning to guidance, we believe that total first quarter sales will be between $6.4-$6.8 billion, with Global Components sales between $4.7-$4.9 billion, and Global Enterprise Computing Solutions sales between $1.7-$1.9 billion. We expect first quarter 2018 operating expenses to decline as a percentage of sales compared to the first quarter of 2017, as we have posted in the recent past quarters. We expect interest expense to be approximately $48 million. The increase compared to fourth quarter is due to slightly higher interest rates on our short-term borrowings, as well as some temporarily higher cash and debt balances related to the purchase of eInfochips. We expect an increase in non-cash depreciation expense of $6 million or $0.05 per share after tax due to the go-live of our Americas ERP system. 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 23.5%-25.5%, down from our prior range of 27%-29% due to U.S. tax reform. However, under U.S. tax reform, we will pay approximately $196 million on taxes on our more than $3 billion of unremitted foreign earnings and increasing installments over the next eight years. Overall, we see the impacts of U.S. tax reform being approximately neutral to cash flow over the next eight years and positive thereafter. For the first 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 $1.22 to 1 euro. This is the average rate through the month of January.

Michael Long (Chairman, President and CEO)

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

Operator (participant)

Ladies and gentlemen, if you'd like to pose an audio question, please press star one on your phone. If your question has been answered or you would like to withdraw your question, please press star two. Questions will be taken. Please proceed when you're ready. Press star one to begin. Your first question comes from Matt Sheerin with Stifel. Please proceed.

Matthew Sheerin (Managing Director and Senior Equity Research Analyst)

Just a question on the guidance. Obviously, you've had a strong quarter in both components and computing. If you look at the sequential guide, it looks a little bit perhaps below seasonal for the components business and at or slightly below where you were last year on computing, but obviously, you're coming off of a strong base. Anything to read into that, Mike, in terms of what you're seeing?

Michael Long (Chairman, President and CEO)

Actually, there's nothing to read into it at all. Our book-to-bill is still strong. Our backlog is still growing. Into the first quarter, we're still seeing the same type of book-to-bills we saw before. We're not seeing cancellation rates. As you know, I'm not sure what it is with us in the first quarter, but we always sort of struggle to get there in the first quarter. But we really just came off of a quarter where all cylinders are firing on the engine, and we don't really see it as being down. We don't really see that same sort of seasonality issue that we're seeing, and we think we're going to have a great year. We think we're going to have a great first quarter.

Matthew Sheerin (Managing Director and Senior Equity Research Analyst)

Okay. And then just related to that, you did talk about ERP go-live in Q1 in North America, and that's on, I know, on the component side. Is there any of that factored into the guidance in terms of potential hiccups or anything on the sales side there?

Michael Long (Chairman, President and CEO)

Yeah. I guess the good news to report, Matt, is that we did it in the fourth quarter. We converted our systems over. The systems are running right now as we expected them to. We're not expecting any down trouble or any problems with inventory or bookings and billings. It looks like things have come off pretty well for us. We had a little bit of a slowdown in terms of salespeople getting to know the system and the speed by which they could operate. That's all getting worked out here early in the first quarter. But other than that, the system is right where we expected to be. I don't want to say non-event because we had an awful lot of people for an awful lot of long time doing a lot of work around getting this system, making sure it was up. The good news I can tell you is we just completed the journey. North America was the last journey, and so we're really happy to have that behind us, and now we feel like we can just turn things loose. I think you're just going to see the growth continue, Matt.

Matthew Sheerin (Managing Director and Senior Equity Research Analyst)

Okay. Just lastly, if I can just fit in another question just regarding the pricing environment. As you pointed out, Mike, there are still shortage issues in a bunch of areas, passives and some of the discrete semiconductor areas, and some of the suppliers are seeing some leverage. I would imagine, particularly if you've got the right inventory, that you're seeing some better pricing environment. Is that helping margins at all?

Michael Long (Chairman, President and CEO)

We're starting to see some firming, and there's really some other good news around this. If you remember, we talked about registration activity needing to grow, so we're not just shipping sort of bill of material and commodity parts. I'm happy to report we've just come off of a very successful design activity quarter. In the fourth quarter, that brings us back to par for where we were, and now we can grow from there. As that number continues to grow, we fully expect to get the margin with that, and that is our opportunity. The short-term profits from hard-to-get products, while they're nice, as you know, they're not lasting. They sort of cycle with the marketplace. They cycle with production. Frankly, I just sort of discount that as a win when we get it, but strategically, that's really supply-demand. So the real trick here for us is more design wins, more designs with customers, more engineering, and that's what's going to raise our margin.

Matthew Sheerin (Managing Director and Senior Equity Research Analyst)

Got it. Okay. Thanks very much.

Operator (participant)

Your next question comes from Param Singh with Merrill Lynch. Please proceed.

Param Singh (Equity Research Analyst)

Hi. Thank you for taking my question. Firstly, on the ECS side, based on the revenue guide, it looks like you're announcing high single-digit revenue growth with recovery in storage. Do you think that revenue growth will persist? Do you expect to see that kind of trajectory going forward? Also, based on the guide, it would imply that you're seeing somewhat flat operating income in ECS despite the revenue growth. What's your expectation for margin there? I mean, you've been running above your historical targets. Do you expect to get back to that range now that hardware is picking up?

Michael Long (Chairman, President and CEO)

Yeah. First off, we do expect growth. We're planning for growth this year in the ECS business. I think last year, we really thought that the storage piece would cross over in the third quarter. It actually happened in the fourth quarter that we saw the growth, but we're not calling that bad. That was a long-term outlook when you graph things on a piece of paper. What's exciting and what actually drove us down was there was a pretty good budget flush on hardware, and that changed our mix a bit, but I still read into that as good news. We believe we're still seeing growth in software, all forms of software, services, and our cloud. And I guess I'll let Sean sort of answer the profit piece going forward because he's a little closer to this mix change than I am.

Sean Kerins (President, Global Enterprise Computing Solutions)

Sure thing, Mike. And Param, just to kind of round out part of Mike's comments as to our growth outlook, bookings are up nicely so far this year in Q1, and we did exit Q4 with backlog up nicely year-on-year as well. Clearly, we saw a mix shift to hardware in Q4 that was even better than we anticipated, which does create some gross margin pressure. But we think as the year plays out, we think both top line and profit dollars will continue to grow.

Param Singh (Equity Research Analyst)

Got it. All right. Thank you, guys. And then as my follow-up, the component side, I mean, as you mentioned, you've been seeing consistent growth. Your book-to-bill has been pretty strong. You've been at the high end or above your component guidance in the past few quarters. I mean, it just feels that the guide has always been conservative. Why would you guide something which is down 3% sequentially when you're seeing a strong book-to-bill like that? Or is there some missing piece? I mean, because everything you've mentioned so far with the lead times, with the activities, with the end markets has been very positive, and it's hard to believe that you would see that kind of sequential decline.

Andy King (President, Global Components)

Hey, Param, it's Andy. I'll take that one. Yeah. Over and above what Mike said in his comments, really, we don't see a significant change in the sort of macroeconomic conditions or the demand patterns we're seeing. What you're seeing is fundamentally a sort of shift in mix. The products that we sell and the regions in which we sell them continue to change over time. Asia, as you know, has grown dramatically for us over the last couple of years and is now the largest region for us in components. And of course, Q1 for them with the Chinese New Year is always sequentially lower than Q4. So there's nothing behind this, Param. It's really just a mix issue, and we continue to see positive momentum as we go through into the first quarter of 2018.

Michael Long (Chairman, President and CEO)

Param, this is Mike. What I could add to this is that our customer survey that we put out, it's interesting because with all of the talk in the marketplace, for some reason, we're just not seeing the same thing that others are about this slowdown. Our North America customer survey showed that we had a record low number of customers saying they had too much inventory. And conversely, the percentage of customers saying they did not have enough inventory was also at record high levels. So our customers are thinking that they're producing product, and they're still worried about product shortages. And frankly, as you can tell from our inventories, we're staying ahead of that and keeping our inventory levels where we are to support them, and I think that will carry through. But I wouldn't read anything into the guidance. I don't necessarily see the demands the same as they were given the growth, especially when you're coming off of the huge growth we had in Europe and the huge growth we came off of in China. They were the two big drivers, and they're both planning on being up significantly year-over-year. That's where I think we are.

Param Singh (Equity Research Analyst)

Okay. Got it. And just really quickly, did you have any cash payments for U.S. tax in this quarter, or is it starting 1Q18?

Sean Kerins (President, Global Enterprise Computing Solutions)

I'm sorry. What are the cash payments for?

Christopher Stansbury (SVP and CFO)

Tax.

Param Singh (Equity Research Analyst)

Yeah. The U.S. tax payment that you had, yeah, was any of it cash, or was it all non-cash?

Sean Kerins (President, Global Enterprise Computing Solutions)

No. That was all non-cash, and that won't start till this year.

Param Singh (Equity Research Analyst)

Got it. Thank you so much, guys.

Operator (participant)

Your next question comes from Adam Tindle with Raymond James. Please proceed.

Adam Tindle (Managing Director and Senior Equity Research Analyst)

Okay. Thanks, and good afternoon. Just wanted to start with Chris. In Q4, we saw a much higher delta between gross profit dollar growth and operating expense growth on a year-over-year basis than we've seen in quarters past, resulting in nice leverage, as you mentioned. I know you still want to invest in the business, so I'm trying to understand as we enter 2018 how we can think about gross profit dollar growth versus expense growth or leverage in general. Was there something extraordinary about Q4? You talked about firing on all cylinders. Or do you think the kind of leverage we saw in Q4 is kind of the way to think about 2018?

Michael Long (Chairman, President and CEO)

Yeah. Adam, if you think about some of the conversations we've had over the course of the last year, we felt it was really important to get back to leverage and that even with not having all the design activity on the new business in, that we had the ability to drive that kind of leverage in Q4, and we're glad that we did. I think as we go into 2018, the focus is definitely, and you can see it in the guide, on continuing to drive GP faster than we're growing OPEX. And to Mike's point a few minutes ago, as we get more design win activity coming through GP, that will help as well. But that is definitely a focus for us.

Adam Tindle (Managing Director and Senior Equity Research Analyst)

Makes sense. Just as a follow-up on cash flow, working capital has been elevated, and I know you're growing at a significant rate. Just wanted to see how you're thinking about working capital metrics entering 2018, whether it's on a cash cycle or as a % of sales. Is there a goal you're driving towards to where we might see a meaningful cash flow uptick, or is there still enough growth opportunities to where we might not see the $600 million-$700 million or so of operating cash from years past?

Michael Long (Chairman, President and CEO)

Yeah. Great question. It's really going to depend on how the overall environment grows. As we said before, if we're growing over 10%, then we will have to make investments in working capital. But that aside, I would say that the balance sheet exiting Q4 is pretty much run rate balance sheet, and we don't have all the sales in yet that we've won over the last year to support that. So that will help returns. The way we're looking at it, we're really focused on the cash conversion cycle, not just any one element of working capital. And I would expect that we could improve that as we go forward.

Adam Tindle (Managing Director and Senior Equity Research Analyst)

Got it. Thank you.

Operator (participant)

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

Shawn Harrison (Managing Director and Senior Technology Analyst)

Hi there, everybody. Wanted to just, I guess, dovetail into Adam's question specifically on the leverage you saw in the components business for the fourth quarter. I think you grew EBIT at 1.3 times the rate of sales growth. Can you maintain that type of leverage on the component sales growth throughout 2018? Can you do better than that? I know the target typically is more 1.5 times, but anything on that aspect of the business would be helpful.

Christopher Stansbury (SVP and CFO)

Yeah. I wouldn't commit to a specific number at this point because I think from quarter to quarter, the timing of how we make investments in our strategy could change. I would say, broadly speaking, though, that that focus remains in terms of growing the OI at rates faster than we're growing sales. And the guidance that we've given in the past on that, I would stick to.

Shawn Harrison (Managing Director and Senior Technology Analyst)

Okay. And then two brief follow-ups, if I may. You had another line card win here. It looks like coming on board. But when does that begin to ramp for you in 2018 on the components business? And second, anything you could give on chips in terms of the new profile, price paid, any accretion for 2018 would be helpful.

Michael Long (Chairman, President and CEO)

Oh, you're talking about eInfochips?

Shawn Harrison (Managing Director and Senior Technology Analyst)

Yeah. Well, yeah. And then it looks like you guys won Silicon Labs as well. So maybe when does that business ramp on for you too? But eInfochips, the cost of the business, revenue profile, any accretion, and then also the Silicon Labs, when does that ramp in for you?

Michael Long (Chairman, President and CEO)

That starts ramping in after February, and the eInfochips will start ramping now. The idea between that one is, you know, I mean, the purchase, and you can see the earnings. While it's a very profitable company and very nice earnings to the overall Arrow, it's not quite as material. And our focus there is going to be growing that over the next several quarters. And it actually is filling a need that we had a hole. So the nice part of that is we do expect some early wins for that that could make it pretty viable for us going into the second half of the year. I would say, honestly, with that one as it's coming in, we're getting going. We're going through the sales cycle. We're introducing our engineers to their engineers. I would look for more out of that in the second half of the year versus the first half.

Shawn Harrison (Managing Director and Senior Technology Analyst)

Perfect. Thanks, Mike. And congratulations again on the quarter.

Steven O'Brien (Head of Investor Relations)

Thank you.

Operator (participant)

Your next question comes from Mark Delaney with Goldman Sachs. Please proceed.

Mark Delaney (Managing Director and Senior Equity Research Analyst)

Yes. Good afternoon. Thanks for taking the questions. First question's on the ECS segment, which I realize grew nicely on a year-over-year basis. Appreciate the comments and the prepared remarks on which areas were growing fastest. But hoping you could help us understand maybe what was the upside surprise relative to guidance. Was there any one or two product categories in particular that had driven that upside versus guidance? And related to that, yeah, and just related to that, would you describe any of the upside in ECS to maybe some pull forward of Americas' purchases given the tax law and the opportunity to maybe expense CapEx in the fourth quarter while the U.S. statutory rate was still higher?

Michael Long (Chairman, President and CEO)

There you go. Go ahead, Sean.

Sean Kerins (President, Global Enterprise Computing Solutions)

Hey, Mark. So let me start where you finished, which is by no means did we see any pull forward business that impacted our Q4. In general, if I look at Q4, the drivers for growth were pretty balanced. As Mike mentioned, we saw a more typical year-end budget flush in Q417 than we did in Q416. But as we also mentioned, our software-based solution strategy continued to serve us well. And for us, that's all about exercising our install base and getting our selling partners into the next big demand trend. And we think we've got a pretty good handle on what they are. And those are the places in which we're investing, things like security, things like analytics, and certainly things like hybrid cloud. But we also benefited from net new customer relationships as we saw our competitive wins start to roll into the business at more scale in the quarter. So that was very helpful also. And then lastly, as we pointed out, we did see renewed momentum with storage, and that was largely driven by the adoption of kind of the next generation architectures, which we think now well more than 50% of our total storage mix really bodes well for the future.

Mark Delaney (Managing Director and Senior Equity Research Analyst)

Thanks for that, Sean. For a follow-up question on the new U.S. tax law, I'm just curious if that changes Arrow's capital allocation strategy at all, maybe because of increased flexibility of where your cash is domiciled.

Michael Long (Chairman, President and CEO)

We certainly like the increased flexibility around where we can use the cash. But if you look at capital structure or just capital allocation priorities, it really doesn't change things. But the overall change in tax rate was not material enough for us to consider doing that. So we believe in the way that we've structured the companies the right way, and we're going to stick to that as we go forward.

Mark Delaney (Managing Director and Senior Equity Research Analyst)

Thank you.

Operator (participant)

Your next question comes from Steven Fox with Cross Research. Please proceed.

Steven Fox (Equity Research Analyst)

Thanks. Good afternoon. I was wondering if you could decompose the organic growth in the components business a little bit more. The 21%, it's a very healthy number. It seems like there's a bunch of factors. So if you sort of started with a baseline of market growth and just sort of added on some of these competitive wins plus IoT demand, etc., if you can give us a better feel for how you're growing, that'd be helpful. And then I had a follow-up. Unique tickets.

Michael Long (Chairman, President and CEO)

Yeah. If you kind of think about it this way, Steven, if you look at the overall semiconductor market through the channel, that's probably going to come in in 2017 at the high single digits, low double digits kind of number. And then if you add into that the balance of it was fundamentally us outperforming the market, a chunk of that, and we've kind of already told you a sort of run rate number that's going to come in at around $200 million a quarter from the competitive wins. And the rest is the investments that we've made in growing our business in the areas like IoT, like digital, like our engineering services capability. So that's kind of how it all breaks down into those three major buckets, if that answers your question, Steven.

Steven Fox (Equity Research Analyst)

Yeah, it does. And then maybe just to build on that answer a little bit, if you just look at then the IoT and the engineering services portion going forward, do you guys have a sense for how much that could help above and beyond market growth maybe in 2018? And would that be a discernible number to operating margin mix where we'd see a benefit to margins year over year just from that?

Christopher Stansbury (SVP and CFO)

Well, let me take the second one first, Steven. If we talk about engineering services, as Mike said, as we look at exporting out the elnfochips capability, we'd certainly expect to see some of that as we go into the second half. But we're sort of really in early connection mode there, but we like the opportunity. As far as IoT is concerned, then we've seen IoT hardware be above the average growth rates for our business for some quarters now. And we're starting to see the kind of associated services, both upstream and downstream from that hardware, kind of ramp through our opportunity funnel. So I think, yes, our expectation is that would be accretive.

Steven Fox (Equity Research Analyst)

Great. That's helpful. And then a real quick one, if I could. On the cloud services business, can you just give us a sense of where you came out versus your billion-dollar run rate target for this quarter?

Michael Long (Chairman, President and CEO)

Yeah. If we basically take out of December, we exceeded the $1 billion run rate. So we're on track. It's still growing at a strong rate. It's going to be exciting. And since you asked about that, we might as well tell you that digital is well over the $1 billion mark at this point in time too, $1.1 billion, $1.2 billion, right in there. So both of those activities are ramping and going very strong.

Steven Fox (Equity Research Analyst)

Great. Thank you so much.

Operator (participant)

Your next question comes from Adrienne Colby with Deutsche Bank. Please proceed.

Adrienne Colby (Associate Analyst)

Hi. Thanks for taking my question. I was hoping you could provide some additional color on your expectations for the enterprise computing business in Europe. How sustainable is the double-digit growth rate into 2018?

Sean Kerins (President, Global Enterprise Computing Solutions)

I'm sorry. Say that again.

Adrienne Colby (Associate Analyst)

Just wondering in terms of the enterprise computing business in Europe, how sustainable a double-digit growth rate is?

Sean Kerins (President, Global Enterprise Computing Solutions)

Well, we've got a healthy outlook in Europe, both in Q1 and then from a planning perspective for the full year. It's hard to call it precisely, but I think so far this year, out of the gate, we're seeing some good momentum. As I said earlier, for the business overall, also good backlog exiting Q417.

Adrienne Colby (Associate Analyst)

As a follow-up, could you talk about how you're thinking about the upcoming implementation of, I think it's GDPR, the General Data Protection Regulation in the U.K.? I think it goes into effect later this year. Wondering if you're starting to see an uptick in demand on the security side of the business.

Sean Kerins (President, Global Enterprise Computing Solutions)

Yeah. So far, we're monitoring that closely. We see spots in our pipeline that would indicate we might see some demand from that, but I think it's a little bit too early for us to tell.

Adrienne Colby (Associate Analyst)

Thank you.

Operator (participant)

Your next question comes from Jim Suva with Citi. Please proceed.

Jim Suva (Managing Director and Senior Technology Analyst)

Thank you very much, especially all the good answers so far and detailed questions. When we talk with investors, there's some investors who focus on margin % and others who focus on margin dollars. And so when we think about, as CEO and CFOs, you run your company, can you help us and investors better understand about how you kind of lay out the strategy of Arrow Electronics for growing one versus not growing the other? Because if my math is right, maybe it's wrong, I think the gross margin % year-over-year is down pretty big, but the dollars are up. And operating margin % are kind of flattish, but the dollars are up. Can you help us understand how you strategize and lead your teams when you evaluate those different metrics? And what's most important to you?

Michael Long (Chairman, President and CEO)

Yeah. So let's go back to the initial comments I made in the beginning, is that we're going to make it easier for customers to purchase any service from us that they want. And so by saying that, Jim, what happened this year is the supply chain activity, which would be a lower gross margin activity, grew at a much faster rate than the engineering design activities, which are now starting to catch up. So if you look at it, the supply chain type activities are going to bring in the high GP or the high dollars, if you will. And the engineering activity is what will help raise the gross profit. The biggest change in the business over the year that caused that to go down was that our mix of design wins and design win activity shipments versus supply chain got out of skew because we had a bunch of wins, as you know, early on in the year that were starting to pick up and gathered steam all year. So it's not an either/or here. It's actually both by business. You'll also notice or you'll see that we built up and purchased elnfochips to even do more design activity, 1,500 more engineers than what we had before in that one business. So that will push our gross profit up over the course of the year. As we said, probably you'll see some of it more in the second half than in the first. The additional services that we will continue to launch will be GP percent based, more than dollar based. So that's really the difference in the business. It's all good. Our job is to get it all. Our job is basically to bring technology to our customer base in the easiest form and allow them to get their products to market. And if we do that, we're going to satisfy the suppliers, we're going to satisfy the customers, and we're going to grow faster in the market. And that's what the goal is.

Jim Suva (Managing Director and Senior Technology Analyst)

Well, thank you so much for the detailed answer. That actually fully explains it, and I appreciate the additional insights. Thank you.

Michael Long (Chairman, President and CEO)

You bet.

Operator (participant)

Your next question comes from William Stein with SunTrust. Please proceed.

William Stein (Managing Director and Senior Equity Research Analyst)

Great. Thanks for taking my questions. First, Mike, you mentioned that your surveys among customers, I think there was a very varied answer to the status of their inventory. I think it's fair to say the extended lead times in some categories that you highlighted certainly influenced that. And I'm wondering how you expect that issue resolves itself over the years, over the rest of this year, I should say. Do you see more capacity coming online? Do you see potentially customers adjusting designs to specify in shorter lead time products? In other words, redesign parts or some other resolution?

Michael Long (Chairman, President and CEO)

Well, it's interesting because while parts are hard to get, I would say that overall we've had a pretty successful supply chain this year of getting customers what they need. And there's been very few line down situations at the customer base where the product hasn't found its way there. So if I start with that, I expect this to persist through the first half of the year easily. The current book-to-bill indications are that it's going to stay the same. I do not expect a lot of on-line capacity to come on because, frankly, I don't know where it's going to come from. That's the big thing. You don't just flip a switch, and you don't just flip a switch in a year to get capacity because everybody is buying their capacity from the foundries. So if they don't have it, then there's none to be had. If there is anything to come online, I certainly haven't really heard about it. So I'm going to probably go out on a limb here and say this market is going to continue through the first half of the year easily. And we'll see what comes out of it in the second half. But right now, the manufacturers are bullish. They're bullish everywhere in the world. We're seeing pretty unprecedented growth in Europe. North America returned to growth, and that was a North America survey, which even makes it more buoyant that it was a fourth quarter survey going into the year. So those manufacturers are feeling good. And overall, it's going to be us continuing to manage our supply chains and our inventory. And frankly, we've had orders on factories for 12, 15, 18, 20 weeks on all of these products to make sure our customers are covered. Hopefully we got it right.

William Stein (Managing Director and Senior Equity Research Analyst)

Well, that helps. It suggests, of course, extended lead times without additional capacity and growth expected. It's sort of hard for all that to play out collectively. But I'll go on to maybe my follow-up. Can you remind us what the long-term margin targets are in the components segment and sort of what the path is to get into that range? Thank you.

Michael Long (Chairman, President and CEO)

Yeah. They still haven't changed. It's interesting. They still haven't changed from the 5% we had out there. We haven't gone back on that. What's been interesting with that is we were starting to gain on that and bring that home. And then, of course, there were some significant changes in the market about how business came to market. And we capitalized on a lot of supply chain business, which is great business, but brings us in at just sort of under those levels. And now with the engineering business, we have to build it back up. The funny thing is we see exactly the same path we did before. So that's not a difference. I guess the good news is the company is a whole heck of a lot bigger than it was and stronger and earning more, which is a plus. But you're just going to have to wait a little while for that to happen.

William Stein (Managing Director and Senior Equity Research Analyst)

Thanks, Mike. Good luck.

Michael Long (Chairman, President and CEO)

By the way, if I do do that, I haven't had one of you come to tell me what I get for it.

We'll think about that. Thanks. Yep.

Operator (participant)

Your next question comes from Lou Miscioscia with Pivotal Research Group. Please proceed.

Lou Miscioscia (Equity Analyst)

Okay. The questions and requests from us never end. So sorry about that, Mike.

Michael Long (Chairman, President and CEO)

That's okay.

Lou Miscioscia (Equity Analyst)

Here are maybe some easier ones. Obviously, on the ECS side, you talked about strong server growth. Can you pin that to anything, or is it really just tied to the global economy just doing well? And then I guess tied to that, what about Intel's problems with their chips? I mean, are customers saying anything? I mean, there was some concept and thought that maybe that customers would hold off for a period of time until they understood what a better fix was possibly out there.

Michael Long (Chairman, President and CEO)

Yeah. First off, I'd say I don't think anybody's holding off of anything right now. And as we said before, there was a good budget flush that sort of returned to what we would call historical days. Sean, you guys had a lot of product growth. Why don't you go ahead and go through it with them and show them? Because it was really across the board, there was a lot of growth.

Sean Kerins (President, Global Enterprise Computing Solutions)

Yeah, Lou, you nailed it, right? It wasn't just storage. It was also servers. But if I look across all the categories in which we participate, billings rough year-over-year. And I think the drivers include not just the year-end budget flush and some of our customer wins, but also some of our initiatives to stimulate demand in our installed base. And I think one of the takeaways from the uptick with hardware is that it validates, at least in part, that the on-premise deployment model is certainly not dead.

Lou Miscioscia (Equity Analyst)

Okay. And then shifting over to the semi side a little bit, could you maybe separate out the extraordinary growth into, again, what might be just more the normal economic positive situation, and then the areas that are Internet of Things and digital and other things that are more new growth areas, just trying to understand how we're getting the different levels of growth coming in?

Michael Long (Chairman, President and CEO)

Yeah, sure. There's been obviously a mix change in-house of how we do business with everything. And Andy, you want to go ahead and go through that with them so he can?

Andy King (President, Global Components)

Yeah. As I mentioned earlier, Lou, I think that we're kind of going to end up at a market growth globally. It's somewhere in the high single digits, low double digits. And the rest of that of the growth that we experience is clearly market growth above that or market share gains above that. A chunk of that has come from the supply chain wins that we've talked about in previous calls. And the rest of it, you can really much point to those things you just mentioned, the investments we made in digital and IoT to capture the kind of value and growth that those markets could provide for us. So we sort of see it in those three buckets. And the second two are still momentum behind us.

Lou Miscioscia (Equity Analyst)

Okay. Thank you. Good luck on the new year.

Michael Long (Chairman, President and CEO)

Thank you. Yeah. Lou, maybe I can maybe help you a little bit. If you think of IoT's passing the $1 billion-dollar rate, digital's passing the $1 billion-dollar rate, so that can tell you a little bit how the new business has started to come in here and sort of the rate and pace. It's a pretty good clip.

Lou Miscioscia (Equity Analyst)

Thanks.

Operator (participant)

I will now turn the call over to Mr. O'Brien for closing remarks.

Steven O'Brien (Head of Investor Relations)

Thanks, Latoya. 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, 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, thank you for your participation. This concludes today's conference. You may now all disconnect. Enjoy the rest of your day.