Avnet - Q4 2013

Transcript

Operator (participant)

Ladies and gentlemen, please stand by. Our presentation will now begin. I would now like to turn the floor over to Vince Keenan, Avnet Vice President of Investor Relations.

Vince Keenan (VP of Investor Relations)

Good afternoon and welcome to Avnet's Q4 fiscal year 2013 business and financial update. If you are listening by telephone today and have not accessed the slides that accompany this presentation, please go to our website and click on the icon announcing today's event. As we provide the highlights for our Q4 fiscal year 2013, please note that in the accompanying presentation and slides we have excluded restructuring, integration, and other items including certain income tax adjustments for all periods presented. When discussing organic growth, prior periods have been adjusted to include the impact of acquisitions and divestitures. In addition, when we refer to the impact of foreign currency, we mean the impact due to the change in foreign currency exchange rates when translating Avnet's non-U.S. dollar-based financial statements into U.S. dollars.

And finally, when addressing working capital, return on capital employed, and return on working capital, the definitions are included in the non-GAAP section of our presentation. Before we get started with the presentation from Avnet management, I would like to review Avnet's Safe Harbor statement. This presentation contains certain forward-looking statements which are statements addressing future financial and operating results of Avnet. Listed on this slide are several factors that could cause actual results to differ materially from those described in the forward-looking statements. More detailed information about these and other factors is set forth in Avnet's filings with the Securities and Exchange Commission. In just a few moments, Rick Hamada, Avnet's CEO, will provide Avnet's Q4 fiscal year 2013 highlights. Following Rick, our Chief Financial Officer, Kevin Moriarty, will review some additional financial highlights and provide Q1 fiscal 2014 guidance.

At the conclusion of Kevin's remarks, a Q&A will follow. Also here today to take any questions you may have related to Avnet's business operations are Phil Gallagher, President of Technology Solutions, and Harley Feldberg, President of Electronics Marketing. With that, let me introduce Mr. Rick Hamada to discuss Avnet's Q4 fiscal 2013 business highlights.

Rick Hamada (CEO)

Thank you, Vince, and hello everyone. Thank you all for taking the time to be with us and for your interest in Avnet. While the sequential growth trends across our portfolio were somewhat inconsistent over the first three quarters of fiscal 2013, we did close out the year on a more positive note as both EM and TS delivered growth at or above normal seasonality, and notably this trend was evident in all of our regions. At EM, where growth was below normal seasonality in the March quarter, our June quarter revenue came in above both expectations and normal seasonality. In our TS business, after a very weak September quarter to start the year, we had three consecutive quarters of normal sequential seasonal growth, and in the June quarter, our EMEA region realized normal seasonal growth after trailing our other regions for multiple quarters.

As a result, Avnet organic revenue in constant currency increased 5% sequentially to $6.59 billion, which was in line with our normal enterprise seasonality for our third consecutive quarter. On a year-over-year basis, reported revenue increased nearly 5% in constant currency, and organic revenue growth just crossed over into positive territory at roughly 0.5%. Gross profit increased 2% sequentially to $771 million, while gross profit margin declined 30 basis points, with both operating groups realizing a sequential decline. On a year-over-year basis, gross profit dollars increased 1.6% even as gross profit margin declined 33 basis points, primarily due to the decline in the EMEA region at both operating groups. The expense management actions we implemented during the year added additional leverage as adjusted operating income grew three times faster than revenue sequentially, and adjusted operating income margin increased at both operating groups over the March quarter.

In our June quarter, adjusted operating income grew 14% sequentially to $222.7 million, and adjusted operating income margin increased 28 basis points to 3.4%. On a year-over-year basis, operating income decreased 4.8%, and operating income margin declined 33 basis points as a decline at EM was partially offset by an increase at TS. Below the operating income line, results were negatively impacted by higher-than-expected foreign currency losses and other items amounting to approximately $6.7 million pre-tax or approximately 3 cents per share after tax. This compares with the below-the-line expense of $4.1 million in the year-ago quarter and income of $4.1 million in the March quarter. As a result of these factors, adjusted EPS increased 8 cents or 9% sequentially to 98 cents.

On a year-over-year basis, adjusted EPS was down just 1% from the year-ago quarter as the decline in profitability was partially offset by the benefits of shares repurchased. Return on capital employed increased 154 basis points sequentially to 12.1% due to the increase in profitability and an improvement in working capital velocity. After our disappointing September quarter, working capital velocity improved year-over-year for the next three quarters and was a contributing factor to our strong cash flow generation in fiscal 2013. Cash flow from operations was $267 million for the quarter and $696 million for our full fiscal year. Our cash flow from operations continues to be strong due to our improved profitability combined with our disciplined management of working capital in response to the slower growth environment.

For our full fiscal year, working capital declined approximately $90 million, excluding the impact of acquisitions and foreign currency, driven primarily by a $241 million reduction in inventory. Even though we are beginning to see various positive signals on our dashboards, there are still questions regarding the pace of recovery by region and in-market. With the substantial majority of our previously announced restructuring initiatives complete, we plan to build on this performance and leverage future growth into improved margins and returns across our portfolio. Now let's turn to the operating groups. In the June quarter, electronic marketing sequential growth was above expectations with all three regions contributing. Reported revenue grew 4.6% sequentially, while organic revenue increased 4.7% in constant currency as compared with our normal seasonal range of flat to up 4%.

At a regional level, sequential organic revenue increased 5.5% in the Americas region, grew 3.3% in constant currency in EMEA, and was up 4.3% in Asia. On a year-over-year basis, reported revenue increased 5.5%, while organic revenue was up 2.6% in constant currency, which represents the first positive year-over-year organic growth in eight quarters. In addition, all three regions grew mid-single digits year-over-year on an organic basis when you exclude the impact of the Americas decision to exit the commercial components business in Latin America. EM's gross profit margin decreased 34 basis points sequentially due to lingering competitive pressures with all three regions experiencing a decline.

On a year-over-year basis, EM's gross profit margin declined 61 basis points primarily due to increased competitive pressure in the EMEA region, partially offset by an improvement in the Americas related to our previously mentioned decision to exit the commercial components business in Latin America. The sequential increase in revenue and the benefits from cost reductions initiated during the year drove operating income up 8.2% sequentially to $175.4 million. Operating income margin increased 15 basis points sequentially with improvements in the Americas and Asia regions partially offset by a decline in EMEA. Operating income margin declined 66 basis points year-over-year primarily due to our previously mentioned declines in our gross profit margins in our EMEA region.

While the environment of relatively short and stable lead times in the electronic component supply chain has led to some competitive pricing pressure, the EM team did a good job managing working capital velocity as both improved sequentially and year-over-year. Since the weak September quarter, EM has improved working capital velocity by 0.5 turns and reduced its cash cycle by nearly 8 days, with over 9% of that improvement attributable to a reduction in days of inventory. To put this in perspective, EM inventory turns are at a level last seen in the Q1 of fiscal 2011 when the component supply chain was dealing with long lead times and shortages during the peak of the V-shaped recovery. Our effective working capital management helped drive return on working capital up 200 basis points sequentially.

However, ROWC was down 185 basis points year-over-year due to lower profitability in our western regions, partially offset by an improvement in APAC, where return on working capital was up for both the June quarter and the full fiscal year. While we are somewhat encouraged that our book-to-bill ratio remained above parity in all three regions for the third consecutive quarter, customers continue to take advantage of the relatively short and stable lead times that have characterized the past year and have placed orders consistently with this ready availability. Although growth returned to more normal seasonal patterns this quarter, it remains difficult to discern any longer-term trends given the mixed demand signals by end-market. We do expect that if demand in our served markets continues to improve, we will experience some increase in lead times, which has historically led to a recovery in gross profit margins.

Going forward, we will continue to focus on the profitable growth opportunities in each region and expand margins and returns as we enter fiscal 2014. As a wrap-up to our EM section this quarter, I did want to quickly acknowledge our recent announcement regarding our upcoming leadership transitions for this business. Harley, who, in my humble opinion, has led our EM team to a position of clear industry leadership, will be handing over the reins to Gerry Fay effective October 1st. We will provide a further update on this transition as part of our Q1 call, but for now, we have our focus and attention on our Q1 performance while planning for a smooth and effective transition as we have done for a number of key roles around here over the past two years. Now, I'd like to move on to TS.

Technology Solutions delivered another solid financial performance as operating income margins and returns increased both sequentially and year-over-year, aided by a third consecutive quarter of normal seasonal growth on the top line and continued attention to expense management. Reported revenue increased 4.7% sequentially to $2.6 billion, and organic revenue grew 5.4% in constant currency as compared with a normal seasonal range of up 3%-7%. At the regional level, our Americas region grew 6.9% from the March quarter, while EMEA was up 3.3% in constant currency and Asia increased 3%. When compared with the year-ago quarter, reported revenue was up 3% while organic revenue declined 2.4%. On a year-over-year basis, growth in storage, services, and software was partially offset by a decline in service.

After two quarters of improving gross profit margin, TS gross profit margin declined 25 basis points sequentially due to competitive pressures yet remained flat as compared to their year-ago quarter. The expense management initiated during the year has had a meaningful impact on TS as they were able to leverage their sequential top-line momentum by growing operating income 3.5 times faster than revenue. Operating income grew 16.6% sequentially, and operating income margin improved 29 basis points led by our Americas region and, to a lesser extent, our EMEA region. On a year-over-year basis, operating income margin increased 15 basis points with improvements in our Americas and Asia regions, partially offset by a decline in EMEA.

In Asia, where we have consciously increased our focus on margins and returns, operating income margin increased 58 basis points year-over-year, and return on working capital was up 457 basis points, with our ASEAN region driving much of that improvement. This increase in TS operating income margin, when combined with an improvement in working capital velocity, drove return on working capital up 437 basis points sequentially and 245 basis points year-over-year. Even though margin levels for our full fiscal year 2013 are below fiscal 2012, the cost reductions and portfolio decisions implemented to focus on profitable growth opportunities are having a positive impact as we exit the fiscal year. In our Americas region, the investments we've made in professional services and converged solutions are resulting in incremental growth and higher gross profit margins.

In our EMEA region, where our team has had to deal with a tough macro environment for the past two years, the addition of Magirus has strengthened our competitive position in key technologies, including virtualization, storage, and converged solutions, enhancing the value we can deliver to our partners. As we mentioned at our analyst day back in May, at the start of fiscal 2014, we combined our reverse logistics and IT asset disposition businesses with TS Professional Services Organization to form a new services organization within TS. This move will allow us to leverage our VAR network to enhance the value we deliver to our trading partners and accelerate their growth in these higher-margin segments of IT spending. While fiscal 2013 started out with a very challenging September quarter for TS, our global team has done a good job responding to market conditions and driving consistent improvement in financial performance.

As we told you on our Q1 earnings call back in October, the actions we initiated were designed to get TS back to prior-year operating margins by our June quarter. I am proud to report that TS met this short-term goal and is ready to resume progress toward our long-term goals as we enter fiscal 2014 with some momentum in our served markets and a strong focus on our organic growth strategies. Now, I would like to turn the commentary over to Kevin Moriarty to provide more color on our financial position and some reporting changes for fiscal 2014. Kevin.

Kevin Moriarty (CFO)

Thank you, Rick, and hello, everyone. After the disappointing setback we experienced in the Q1 of fiscal 2013, our team has done a good job adjusting to market conditions and closed the year with a strong performance on both the top and bottom line.

As a result of the portfolio actions we took and the actions we completed, we enter fiscal 2014 in a stronger competitive position across our portfolio. In addition to this strong performance, the effective working capital management through a difficult 2013 resulted in cash flow from operations of $696 million that strengthened our already solid balance sheet while allowing us to invest in strategic acquisitions and our share repurchase program. Before I provide guidance, I would like to address some changes that will impact how we report our results in fiscal 2014. As highlighted at our May 1st analyst day, at the beginning of fiscal 2014, we combined our reverse logistics business, Avnet Integrated, with technology solution service offerings into a newly created organization within TS called Avnet Services.

Avnet Services will combine existing services organizations into one dedicated global team with a unified strategy focused on software, lifecycle, and education services that complement our existing solutions and suppliers service offerings. In addition, we have decided to combine our regional computing components business into a single global organization within TS called Avnet Global Computing Components. Bringing these regional businesses together under a single global organization will allow us to work with suppliers more strategically, to take advantage of Avnet's global scale and scope, including optimizing inventory levels and support resources across regions. Collectively, this global organization, which focuses on commercial hard disk drives, microprocessors, and memory modules, generated approximately $1.2 billion in sales in fiscal 2013. As a result of these changes, roughly $450 million of annual revenue that had been previously reported in electronics marketing will be consolidated within TS beginning in fiscal 2014.

Finally, as previously communicated, beginning in fiscal 2014, we will exclude the amortization of intangibles from our adjusted numbers consistent with the practice followed by many technology companies. In fiscal 2013, amortization of intangibles totaled $32.3 million, which would represent approximately a $0.16 positive impact on adjusted earnings per share if it had been excluded. For fiscal 2014, we currently expect to amortize roughly $32.5 million of intangibles from prior acquisitions, and approximately 80% is related to acquisitions in technology solutions, with the balance attributable to electronics marketing. We have also provided some historical information related to the amortization of intangibles in this slide presentation and in the CFO review issued earlier today to assist with your analysis. These three reporting adjustments are reflected in the outlook provided in our press release, and we will account for these items when reporting our adjusted results in fiscal 2014.

Now, let's turn to our outlook. Looking forward to Avnet's Q1 of fiscal 2014, we expect EM sales to be in the range of $3.7 billion-$4 billion, and sales for TS to be between $2.35 billion and $2.65 billion. Therefore, Avnet's consolidated sales are forecast to be between $6.05 billion and $6.65 billion. This sales guidance takes into account the previously mentioned transfer of some services and computer components business, which I previously mentioned from EM to TS, amounting to approximately $100 million for the current quarter. When adjusting for these transfers, acquisitions, and the impact of foreign currency, the midpoint of guidance for EM and TS would represent a sequential growth rate of -0.9% and -0.84% respectively, as compared with a normal seasonal range of +1% to -3% for EM and -5% to -10% for TS.

Based upon that revenue forecast, we expect Q1 fiscal year 2014 earnings to be in the range of $0.83-$0.93 per share. This above EPS guidance does not include any potential restructuring charges or any charges related to acquisitions and post-closing integrations, and, as previously discussed, now excludes the amortization of intangibles. The guidance assumes $139 million average diluted shares outstanding used to determine earnings per share and an effective tax rate in the range of 28%-30%. In addition, the above guidance assumes that the average euro to US dollar currency exchange rate for the Q1 of fiscal 2014 is 1.32 to the euro. This compares with an average exchange rate of 1.25 to the euro in prior year Q1 and 1.31 to the euro in the Q4 of fiscal 2013. With that, let's open up the lines for Q&A. Operator.

Operator (participant)

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation that you type on your line is in the question queue. You may also press star two if you would like to remove a question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, please press star one on your telephone keypad if you have a question at this time. And our first question comes from the line of Sherri Scribner with Deutsche Bank. Please proceed with your question.

Sherri Scribner (Director and Senior Sell-side Equity Research Analyst)

Hi. Thank you. I just wanted to get a sense of the seasonality and the expectations for the September quarter.

It looks like for EM, you're expecting seasonality to be at the low end of the range. I assume that's primarily related to the upside this quarter. Then looking at TS, it looks like the expectations for seasonality to be at the higher end of the range. Can you give us some detail on what you're expecting there and if I'm right in terms of the EM business?

Rick Hamada (CEO)

So Sherri, it's Rick. I think we've said that for TS, it'd be normally down 5-10, and Kevin reported that if you adjust based on the moving parts, they're about down 8.4, I think, at the midpoint. So actually, TS might be a little below that midpoint, whereas EM was closer to it overall.

So basically, the general outlook for our business is pretty much in line with "normal seasonality," and we've had certainly some we talked about the mixed signals. There have been some encouraging ones along the way. The positive book-to-bill above 1 for three quarters of EM, the fact that it's geographically balanced across all three regions, the fact we've now had three normal sequential seasonal performances on a growth basis for TS, these are all encouraging signs. But at the same time, as you know and heard from many of our not only competitors but also some of our partners in the overall tech world, there's been some mixed signals regarding the health of the IT spending, the recovery in the broad industrial markets we serve, etc. So all of that is factored into what we've put together for you there.

So Phil and Harley, if you want to add any particular color for components or computers, we'll go from there. But hopefully, that gives you a little bit of color commentary of what we're trying to do.

Phil Gallagher (President of Technology Solution)

Hey, Rick. I'll jump in. This is Phil. Thanks, Sherry. Just at a really high level, when we're only looking a quarter out, we're feeling pretty confident. Asia-Pac was definitely normal seasonality. The Americas is going well, so we feel pretty good there in addition. And the one that we're pleased with the progress we're making very pleased, matter of fact, with the progress we're making in Europe. We're still just a bit cautiously optimistic with some of the outlook in Europe. So if there's any issue with TS's being off a bit, it's more around Europe than it is anything else.

Sherri Scribner (Director and Senior Sell-side Equity Research Analyst)

Okay.

And just quickly on the operating margins, we're not really in the targeted range yet. I know that we need to see some growth to get those operating margins back, but do you anticipate that we'll see that in fiscal 2014?

Phil Gallagher (President of Technology Solution)

Yes. So Sherry, if you look at the two businesses here so short-term goal for TS was to get back on year-on-year margin by the June quarter, which they were able to achieve. Now, we've got to get back to the long-range goals in that range of 3.4%-3.9%. With our EM team, Harley and team, we were trying to get back to at least 5% by the June quarter, came up a little short. But obviously, we're looking to continue to set our sights on getting back in that range. Growth would help.

On a down quarter heading into Q1, flattish to slightly down or up, a little bit of leverage challenge there. But I believe we are looking for the second half of FY 2014 for EM to get back into the minimum 5% range.

Sherri Scribner (Director and Senior Sell-side Equity Research Analyst)

Okay. Great. Thank you.

Operator (participant)

Our next question comes from our line of Mark Delaney with Goldman Sachs. Please proceed with your question.

Mark Delaney (Managing Director and Senior Equity Analyst)

Great. Thanks very much for taking the question. I know one of the goals that you articulated at the analyst day was to focus more on margins. So I'm trying to just get a better sense of some of the steps the company can take to improve margins given that gross margins for a June quarter are at one of the lowest levels in quite a long time.

So maybe as a scenario, I mean, if you just assumed seasonal growth rates across the entire business from here, would you expect to eventually get back to your target operating margin levels, or are there further steps that you need to take either in terms of designing work or cost-cutting or something else that will get you back to your target margin levels?

Rick Hamada (CEO)

Yeah. Mark, I'll have two seconds. Maybe ask Kevin to jump in. But I would tell you, if we have normal seasonal patterns from here, we feel good about the trajectory back towards those ranges we've spoken about. There are still wildcards: what's going on with the gross margin, what's going on with the lead times, what goes on with the year-end IT spend and the budget flush, etc. So lots of moving parts, but the growth will certainly help. We don't rely exclusively on that.

I think at this point, what we're saying is that the contribution from the expense reductions that we've talked about in the previous quarters. We have expense management always ongoing, reallocating resources, trying to align resources to growth, trying to move on the design win mix of our business. All those issues are normal course of business expense management. But at this particular point, we're not anticipating further specific expense reduction as part of the equation. But that lever, if needed, will always be there. I know, Kevin, if you want to talk about the rest of the levers.

Kevin Moriarty (CFO)

Yeah. Thanks, Rick. I would just amplify, Mark, that obviously, continue to improve SG&A efficiency, grow GP dollars faster than expenses, and continue to optimize from our acquisitions. Obviously, M&A focus on higher margin opportunities, effective portfolio management with constant evaluation of appropriate actions taken.

The point brought up earlier about the sustained economic recovery and growth is also important. But I think that's kind of our key tenet as we look at how we get back to the targeted goals. Okay. Thanks for that. And then for my follow-up, I'm hoping you can be a little bit more specific on some of the mixed signals that you're seeing in terms of bookings and customer conversations. So I understand that the book-to-bill was positive across all three regions within your EM segment this past quarter. When you think about your guidance for next quarter within EM, are you actually seeing anything impact your actual order rates that gives you pause, and maybe there's been a decline in actual orders? Or are you just trying to factor in some general hesitancy when you speak with your customers? Harley, can I jump in? Yeah.

Harley Feldberg (President of Electronics Marketing)

Hi, Mark. This is Harley Feldberg. Let me comment a little bit as well as you kind of took us a little bit back to, I think, to Harley and Sherry's question as well. When we gave our revenue guidance for Q1 of, I believe, down 0.9%, just below 1%, our intent was to send a message that we view it as normal seasonality. Our records suggest normal seasonality minus one, excuse me, +1% to -3%. The intent of that number was to suggest normal seasonality. I just want to be clear on that. You may have a different view of the numbers, but that was our intent. There's really nothing that I can give you that has changed our view for the long term as reflected by the positive book-to-bill in all regions.

But I was reading an example that might be a good one to depict mixed signals this morning. Many of you may have seen the release out of Europe on the PMI numbers for Germany. And I haven't read that in detail. It just came out this morning. But if you look through it, what you'll see there is an interesting dilemma in that the overall number looks encouraging, but when they dissect it, what they said was that the majority of the growth, in this case, was for domestic spending, and their export-related data was mixed, specifically out of a concern for slowdown in China and obviously, the balance of Europe is up. So for me, that's an example when we say mixed signals. There's a positive in the PMI, but one level down, you see a mixture of what the data means. Great.

Mark Delaney (Managing Director and Senior Equity Analyst)

Thank you very much.

Operator (participant)

Thank you. And our next question comes from the line of Brian Alexander with Raymond James. Please proceed with your question.

Brian Alexander (Senior Managing Director and Director of Equity Research)

Okay. Thanks. The first is just a clarification. To get to your September outlook, Rick, are you assuming EM margins slide back to around the 4.2% level given the regional mix shifts that you're likely to see in the quarter with Asia becoming a bigger piece in September? And then to get back to 5%, which I know we've asked about already, but are you counting on any gross margin recovery to get there, or is it all going to be expense leverage? And if it's really expense leverage, what quarterly revenue for EM do you think you need to achieve to get back to that level? It seems like maybe $4.3-$4.4 billion a quarter, but just wanted to confirm that. Thanks.

Yeah.

Rick Hamada (CEO)

So, first of all, Kevin, on the sequential gross margin expectations for EM there, again, midpoint of 1% down on the revenue. Is it roughly flattish, Harley? Roughly flattish is what we okay. Yep. And then, Brian, it's not 100% on the expenses. We'll look at all the levers. And at this point, the expectation is that the margin erosion we've seen is abating a bit. And as we said, historically, we've seen in the past, as momentum picks up, generally, lead times start to move out. And at that point, we generally tend to see a recovery in the gross margins. Now, we haven't factored in a major move there along the way, but we have factored in some expectations regarding not continuing to have a major decline there to deal with. Otherwise, that would probably put more pressure on the expenses.

And then from the quarterly revenue, again, the midpoint, as Harley said there, down 0.9%, I think that all of that commentary is based on that expectation of revenue. And then upside, of course, should have very rich drop-through, which would help with the leverage and the expansion of the margin expectation. I guess the follow-up, why do you think you're seeing the additional margin pressure sequentially in EM if your revenue basically came in above seasonal and lead times were stable through the quarter? Is that typical for this part of the cycle, or is this atypical? I'll ask Harley to chime in, Brian. But I think it's that last part of your statement that has our attention, which is that lead times have remained stable.

The fact they're short, stable, and predictable encourages customers to order on a much shorter cycle there, less longer-term supply chain engagements, and there's less complexity to try to sort through on their behalf. But I think that that's the issue that at this point in the cycle, normally, we'd see lead times start to move out yet, and that's not what we're seeing at this point. I know, Harley, anything to add there?

Harley Feldberg (President of Electronics Marketing)

Yeah. Thank you, Rick. Hi, Brian.

Brian Alexander (Senior Managing Director and Director of Equity Research)

Hey, Harley. How you doing?

Harley Feldberg (President of Electronics Marketing)

First off, I would be a little bit more assertive than Kevin was, maybe considering my personal circumstance. I could be a bit more of a risk-taker. But I actually think it is possible for us to increase, albeit modestly, increase both gross margin and upmargin even in the first half of our fiscal year, which is not difficult.

I say that because of a combination of many different factors, from revenue deselection to expense synergies to a belief based on our booking activities in our last couple of quarters that we are starting to see the beginning of a healthier environment in the broad industrial base where we do tend to make our richest margins. The bookings tell us that the PMI data in Germany, to a degree, reinforces that. But it didn't really impact our June results to a substantial degree. So June backwards is obviously factual. June forward is somewhat more subjective. But the indicators do suggest to us and reinforce that we are seeing an improving environment in the segment of the market that we need to really be stronger to allow us to raise gross margins.

So in addition to Rick's point about lead times, those two factors, continued improvement in the broad industrial base, and the market showing enough growth I think the total market showed some growth that you might have seen back to positive year-on-year territory in the June quarter. Those two factors should contribute to an ability for us to enhance our gross margins. And of course, the drop-through would be significant, as Rick said.

Brian Alexander (Senior Managing Director and Director of Equity Research)

Thanks for the risk-adjusted answer.

Harley Feldberg (President of Electronics Marketing)

You got it.

Operator (participant)

Thank you. And our next question comes from the line of Matt Sheerin with Stifel Nicolaus. Please proceed with your question.

Matt Sheerin (Managing Director)

Yes. Thanks. I just want to go back to the gross margin issue again because it certainly looked a lot tougher than we had expected and certainly compared to Arrow. And they've certainly been seeing similar pricing pressure. But it looks like it got incrementally worse for you.

And then, Harley, you used the term possibly deselecting revenue and being obviously more careful about managing your margin versus volumes. And I know there's a fine line there. But are you looking at that in any specific area? And then as part of that, as you see backlog building on and not lead times, but backlog seems to be a little bit firmer across the supply chain, wouldn't that help pricing at all?

Harley Feldberg (President of Electronics Marketing)

Hi, Matt. Yes. It is my belief that that backlog, obviously turning into shipments, should improve pricing if indeed, as you heard Rick say earlier, one of the byproducts of that is expanded lead times. It is very difficult to enhance gross margins with very low lead-time environments. Now, I am of the opinion that the improving environment we're seeing today is primarily driven by how low inventory overall is in the aggregate supply chain.

So in many ways, I believe that's what's driving the improved booking environment and should continue to show modest growth over the next couple of quarters overall. The gross margin one, I'm not sure I agree with your data on your comparative data to us and our largest competitor in that neither of us, I believe, publishes group gross margin. I'm not sure how to validate that. I'm not sure that data is accurate as far as gross margin. It has been a difficult situation. Again, as I've said multiple times, we need that growth to return in the broad industrial base. And we are seeing encouraging signs. So I do see a more positive environment moving forward. One area of gross margin, if I could, that got a lot of attention was Europe. And I think we singled it out as well as in our comments.

And specific to EM, as I think many of you are aware, that is the region where we, as Avnet, have the largest share. So we've seen quite a bit of aggressive pricing going after we believe going after us as the largest share owner in that region. And that does make for a highly competitive market. Growth, of course, will help alleviate some of that.

Matt Sheerin (Managing Director)

Okay. Thanks for that detailed answer. I appreciate that. And on the shift of some of the commercial components business from EM to TS, it seems like every few quarters, you swap business back and forth. And so is this the commodity PC-related businesses like disk drives that don't really belong in EM? And is there still a significant embedded component business that's left there?

Rick Hamada (CEO)

Yeah, Matt. It's Rick. Yeah. So we don't mean to confuse you.

Just the component this computing components business, which is primarily microprocessors, hard disk drives, memory. It had actually been in Europe and Asia, consistently been in the TS business. We made it part of the embedded business here in the Americas under EM. And that's the last portion that is now coming out of EM under this now Avnet Global Computing Components umbrella. All of those components that are sold as part of embedded solutions, OEM systems, etc., that remains part of our embedded systems business. So yes, you're right. This is strictly the volume commercial-oriented sale of those particular commodities and products.

Okay. So $100 million is coming out of North America this quarter, approximately. Approximately.

Matt Sheerin (Managing Director)

Yeah. Okay. And then so that leaves you. I think you mentioned a $1.2 billion or $1.4 billion business in the commercial components. Could you give us an idea of margins?

I imagine it's well below margins on both sides of your business. But could you give us an idea there and what kind of targets you have that are reasonable targets for you to reach in that business?

Harley Feldberg (President of Electronics Marketing)

So you're right, Matt. It's $1.2 billion. It runs lower gross margins than our sort of core businesses on either side. It runs marginally less operating margin profile. And generally speaking, particularly the business we're focused on retaining has an outstanding return profile. For lower-margin business, which is higher risk, we obviously set the bar higher from a return expectations point of view. And by the way, that same analysis over the past couple of years has led to some of these discussions and decisions around revenue deselection.

Matt Sheerin (Managing Director)

Okay. All right. Thanks a lot.

Harley Feldberg (President of Electronics Marketing)

And our next question comes from the line of Jim Suva with Citigroup. Please proceed with your question.

Jim Suva (Managing Director)

Great. Thank you very much. In your prepared comments, you mentioned strength in storage services and software, year-over-year growth. Can you help us quantify some of the percents on that that you're seeing and then maybe how that compared to last quarter or sequentially? Just trying to figure out if some of those buckets are accelerating, still growth stable, or growth that's decelerating.

Phil Gallagher (President of Technology Solution)

Yeah. Yeah. Hi, Jim. This is Phil. How you doing? Well, clearly, the storage has been the story of the year, I think, frankly, for many of us and continues to be for us. On a year-over-year, it's safe to say it grew in the higher teens, okay, from a revenue standpoint. So very, very positive. We're seeing in services, and some of this is resold as well as Avnet branded, although it's not all included in the numbers yet.

We're seeing really good growth there as well in the, let's call it, the mid- to high-single digits, okay? And software continues to grow nicely. Another way to look at it is we have a stated strategy to continue to outgrow or increase our diversification in our portfolio around services and software. And if you look at our mix today, the question hasn't been answered. I think it helps answer your questions. Hardware is roughly 59% of our total mix today, where software and services makes up the balance of 40%, okay, which is a pretty significant shift from several years ago for sure. It's not the emphasis on hardware by any stretch, but more of an emphasis on really driving the value add around the hardware.

Jim Suva (Managing Director)

Great.

And then as a quick follow-up, relative to, say, last quarter, I believe last quarter, each of those three buckets were also pretty strong. Are we seeing accelerations in some of those three buckets, or still kind of stable, impressive, good growth, or deceleration? Just kind of gauge about the magnitude of the change.

Phil Gallagher (President of Technology Solution)

Yeah. I would say it's been pretty consistent. I think it's the best word to use there, Jim, again, particularly storage. And keep in mind, storage today, if you look at storage, you think it's hard. Storage is driving a lot of software, right? You look at the acquisitions that a lot of our storage suppliers have made, a lot of it's been in the software space. So you start to become a bit of a mix. But when you look at storage in general, that's been very, very consistent.

And of course, we have a focus not only on the Avnet not only on resold services but the Avnet branded services, which we'll continue to elaborate on in the future. But I would say consistent would be the word. It's been very consistent, very steady as we continue to drive the mixing portfolio.

Jim Suva (Managing Director)

Great. Thank you so much for the details.

Phil Gallagher (President of Technology Solution)

Thanks, Jim.

Operator (participant)

Our next question from the line of Steven Fox with Cross Research. Please proceed with your question.

Steven Fox (Managing Director)

Thanks. Good afternoon. Just two questions from me. First of all, on the $100 million per quarter in revenues that basically shifts between your two businesses, what's the operating profits associated with that? And then secondly, I thought I heard you talk about some gross margin pressures in TS, but I wasn't clear on what was driving that, whether it was mix or actual something in the marketplace, etc.

If you could just sort of expand on that, I'd appreciate it.

Rick Hamada (CEO)

Yeah. So Steve, let me start. I'll turn it over to Phil on the gross margin issues of TS. On the $100 million revenue transfer, I think we just talked about that this components business is generally characterized by lesser gross margins than our core businesses. But I think I used the term marginally below what you would expect from some of our businesses across the portfolio. And then the offset there, of course, is the exciting returns that keep us interested in this business. So don't think we quantified it exactly, but it's not a 50 basis point or 1% operating business. Somewhere in between there, hopefully, you can triangulate and figure some of that out, so. Phil, on the TS gross margin?

Phil Gallagher (President of Technology Solution)

Yeah, Steve. We did mention in the script.

Really, margins overall have been moving in the right direction, where we have a bit of a headwind. This past quarter was in Europe, more specifically. And it's specifically to a region. We can't really say it's specific to a product mix, frankly. I think it's just, and we've been making progress in Europe. So I want to make that input as well. And in the last several quarters, just saw a bit of a setback this past quarter. I don't think there's anything other than the market in general in Europe that's been struggling with growth. And with that, you get a bit more competition in the marketplace going after the business that's there. But there's nothing specific more than that. And we feel confident moving forward will be fine.

Steven Fox (Managing Director)

Okay.

So just to follow up on that, if it's regional in nature, I mean, are you comfortable saying that your product if you were I know you sell in a bundle nature in a lot of cases, but you're saying that there are no sort of gross margin pressures on either your products or services on an individual basis. But when you get the deals in Europe, you have to give up a little bit more in aggregate?

Phil Gallagher (President of Technology Solution)

It's probably not a bad summary. Yeah. I'd say that's probably not a bad summary. We're not seeing an across-the-board product issue in margins. A lot of these big deals, as you know, that come down on the TS side in the enterprise are project-based. They can be really large projects, and they can get pretty competitive.

I didn't mention we did have an increase in Europe in the past quarter in processors and some of that, but that was relatively minimal to the grand scheme of things.

Steven Fox (Managing Director)

Okay. Thank you very much.

Operator (participant)

Thank you. Our next question comes from the line of Louis Miscioscia with CLSA. Please proceed with your question.

Louis Miscioscia (Managing Director)

Great. Could you give us any kind of color on the slowdown or negative growth in the servers, whether you think that that's going to go out X number of quarters? And I guess tied to that, in the virtualization market, I think a couple of or the biggest virtualization company had weak transactional virtualization growth. If you could comment that you're also seeing that.

Harley Feldberg (President of Electronics Marketing)

Yeah. Let me make a comment on the servers. We did note in the script that we saw some modest negative growth in the servers in total.

But frankly, we don't see any major concern on that moving forward. As you and all the analysts know, the servers in general have become a lesser part of the overall business, and particularly the industry standard servers. They're very competitive and can typically not meet the margin hurdles. So our focus is to continue to drive value around the server-based marketplace, continue to drive it in the converged infrastructure opportunities we have. But overall, and again, when I say modest, in the grand scheme, the negative growth was not that great. And ironically, actually, sequentially, again, modestly, we were actually up in proprietary. So it's kind of interesting, all right? But in general, in total servers, we were down a bit. And the second part of the question was virtualization.

Actually, quarter-over-quarter and year-over-year, we continue to see growth in and I'm not talking any specific supplier, but in the virtualization space, we actually saw continued growth. Is there a decent expansion going with virtualization outside of the market leader, or is it mostly the market leader you're referring to? Again, I don't want to get into too many suppliers. I would say the market leader for us is still the market leader. But there's certainly guys coming into that space, as you alluded to, that are trying to be a little bit more disruptive. And we're obviously working with those suppliers as well. We have them on the line card.

Louis Miscioscia (Managing Director)

Okay. Thank you. Uh-huh.

Operator (participant)

And our next question comes from the line of Shawn Harrison with Longbow Research. Please proceed with your question.

Shawn Harrison (Stock Analyst)

Hi everyone. A lot of clarifications, I guess.

Going back to the restructuring program, are all the savings in the numbers right now, or how much incrementally, if, excuse me, if not, you would see maybe into the September quarter?

Kevin Moriarty (CFO)

Hey Sean, it's Kevin. Of the freeze-to-net program here in the Q4, it's $40 million. That was an annualized number. So of the $10 million per quarter, roughly half or $5 million we recognize in the Q4. So the actions are substantively complete. So we would expect roughly a $5 million carryover benefit in our Q1.

Shawn Harrison (Stock Analyst)

Okay. Second, maybe I missed this question, but the overall book-to-bill ratios through July and August, how have they been at EM regionally versus kind of what you typically see this time of year? I guess that's for you, Harley.

Harley Feldberg (President of Electronics Marketing)

Excuse me. This is Harley.

Book-to-bill has remained encouraging and positive in all three regions through what is essentially five weeks of the quarter.

Shawn Harrison (Stock Analyst)

Okay. And then just two quick follow-ups. The inventory turn's really good this quarter. Does that continue? And then second, I believe there was an acquisition announced recently, MSC, excuse me. But is that in the guidance? And if not, when do you expect that to close?

Harley Feldberg (President of Electronics Marketing)

Okay. Yeah. So the first question was on inventory velocity. And in a way, I guess an additional point back to our conversation about what's happening in the market, the inventory velocity that we achieved in June was quite encouraging, and I give the team a ton of credit for it.

In tandem, part of it is driven by the nature of the business that what has driven the business over the last year, which, as we've talked in the past, to a higher degree than is typical, has been from high-volume fulfillment type of business. All of the large channel partners have mentioned and seen that. Therefore, that type of business warrants much higher velocity. Indeed, as we believe we should continue to see improvement in our broader industrial base over the next couple of quarters, then it's likely that velocity will come down a bit. Our goal in the September quarter will be to match our revenue growth with a bit of additional inventory looking for similar velocity. But again, that velocity, the point I want to make is that velocity is also impacted by what customer sets are driving it.

So I guess in a nutshell, would I trade a little bit of velocity for higher margins? I think the answer to that is clear. Relative to the acquisition, MSC Gleichmann was the company you're referring to. We're very excited about it. Due to the somewhat complicated nature of the way we're acquiring the company, Kevin, correct me if I'm wrong, but I don't think you'll see anything from us from a revenue perspective this year, this calendar year.

Kevin Moriarty (CFO)

No, that's correct. Yeah.

Harley Feldberg (President of Electronics Marketing)

Okay. So there should be nothing in your guidance for this quarter and next.

Shawn Harrison (Stock Analyst)

Okay. Very helpful. Thanks, Harley.

Operator (participant)

Ladies and gentlemen, as a reminder, if you wish to ask a question at this time, please press star one on your telephone keypad. Our next question comes from the line of Amitabh Passi with UBS. Please proceed with your question.

Amitabh Passi (Senior Technology Equity Research Analyst)

Hi. Thank you.

Just a couple for me. Kevin, can you just clarify your September quarter expectations for gross margin, OpEx, and other expense at the corporate level?

Kevin Moriarty (CFO)

Yeah. On OpEx, I'll start there. When you look at our Q1, we expect SG&A to increase sequentially roughly $10 million on the top. And that's composed of a number of different items. One is the sequential impact of our stock-based compensation. That's a normal Q1 item for us. And that's roughly $11 million when you look from Q4 to Q1 of an increase. In addition to that, we have an FX headwind of approximately $2 million-$3 million. And in addition, a sequential increase of cost tied to a recently completed M&A of roughly $1 million or $4 million annualized. Now, these increases are reduced by some of the Q4 restructuring actions, the carryover benefit I previously mentioned of roughly $5 million.

When you net all that out, we are expecting a sequential increase of approximately $10 million on the OpEx line sequentially.

Amitabh Passi (Senior Technology Equity Research Analyst)

Then anything unusual on the other expense line?

Not that we're planning on, no.

Okay. Then just one follow-up for me. Just any updates on your appetite for buybacks? I think you've really not participated the last couple of quarters. Just curious how you're thinking about the capacity that you currently have available.

Kevin Moriarty (CFO)

Yeah. I'll tell you how it is, Kevin, again. I'll start. You are correct. We did not buy back any shares in Q4. We do still have the approximately $224 million remaining on the previously announced program. As we have highlighted in the past, we have a disciplined approach on the buyback, and we buy what is compelling value based on our intrinsic value.

We will continue to evaluate the price relative to our internal projections, and we will continue to follow our disciplined approach.

Harley Feldberg (President of Electronics Marketing)

Yeah. Amitabh, I would just add we've had a schedule in place throughout the past two quarters. Based on all the new information, which we've now shared with you today, etc., we'll take a look at our own internal analysis of the projected intrinsic value, probably adjust our estimates accordingly, and let you know next quarter if we hit and trigger anything along those lines. We do like, as Kevin said, we like investing in our equity when we feel there's a very compelling value there. Just like any other M&A, if you want to think of it that way. Think of it as internal M&A, and that's the way we approach it.

Okay. Got it. Harley, all the best.

Thank you.

Operator (participant)

And our next question comes from the line of David Ryzhik. Please proceed with your question.

David Ryzhik (Analyst)

Hi guys. Thanks for taking my question. Going back to storage, do you see any change in the tone of demand ahead of new products from the likes of EMC and NetApp? Can you give me more clarification on that?Well, in anticipation of, for example, the refresh of the VNX family for EMC, any change that you're seeing right now in demand ahead of that?

Harley Feldberg (President of Electronics Marketing)

No. Not specifically. I think EMC getting big into NetApp, investing in flash SSD storage is coming on strong for them. They make a lot of investments in that space. But nothing specific to your question. Do you think that overall there's pent-up storage and/or data center infrastructure demand in the second half?

Yeah. That's a tough yeah. That's a tough call.

We really look at it quarter-on-quarter because everything's so project-based. We've not seen some of our suppliers have announced that they've seen push-outs at the end of the quarter. We've seen the cycle getting a little bit tougher and the sign-off at the end of the quarter getting a little bit tougher, but we've not seen a big carryover quarter-on-quarter. That said, in polling the value-added resellers and just doing a roadshow not too long ago, there is optimism in this quarter around both data center, storage, networking that we're cautiously optimistic about. But we don't really look beyond the September quarter at this point in time. July looked okay for us. So that's about how we're seeing it right now. But I wouldn't say there's big pent-up demand.

Rick Hamada (CEO)

Yeah. Dave, I would add. This is Rick.

After two quarters in a row of hitting essentially normal seasonal sequential guidance, there wouldn't be any indications to us there that there's a signal of pent-up demand. But it is curious to us, as Phil mentioned, that some of our key OEM partners have mentioned on their March and June quarter calls that they saw some signs of delays and push-outs, etc. By the way, very similar to the commentary we shared back in the June/September quarters of 2012. So we are noticing the same set of comments of phenomenon. But whether it's a mid-market versus large enterprise issue, we're not sure. But for our dashboards and what we're looking at, no indications of "pent-up demand" as we close out the year.

David Ryzhik (Analyst)

Great. Thanks, guys.

Kevin Moriarty (CFO)

Thank you. Hi. This is Kevin. I just want to clarify one thing on the MSC acquisition.

It really ties to the regulatory approval of the transaction in terms of whether or not we'll see any sales in the Q2 or not. So again, we'll keep you updated. It really gets to the regulatory approval of the transaction.

Operator (participant)

Thank you. It seems there are no further questions at this time. I'd like to turn the floor back over for any closing comments.

Rick Hamada (CEO)

Thank you for participating in our earnings call today. As we conclude, we will scroll through the non-GAAP to GAAP reconciliation results presented during our presentation along with a further description of certain changes that are excluded from our non-GAAP results. This entire slide presentation, including the GAAP financial reconciliations, can be accessed in downloadable PDF format at our website under the quarterly results section. Thank you. Thanks, everybody. Ladies and gentlemen, this does conclude today's teleconference.

Operator (participant)

You may disconnect your lines at this time. Thank you for your participation.