安富利 (AVT) 2016 Q3 法說會逐字稿

I would now like to turn the floor over to Vince Keenan, Avnet's Vice President of Investor Relations.

Good afternoon, and welcome to Avnet's third quarter FY16 business and financial update. As we provide the highlights for our third-quarter FY16, please note that in the accompanying remarks, we have excluded certain items, including intangible asset amortization expense, restructuring, integration, and other items and certain discrete income tax adjustments from all periods covered in our non-GAAP results.

When we refer to constant currency or the impact of foreign currency, meaning the impact due to the change in foreign currency exchange rates when translating Avnet's non-US dollar-based financial statements into US dollars. When we refer to organic sales, we have adjusted the prior period to include the impact of acquisitions and other items. In addition, when addressing return on capital employed, return on working capital, and working capital velocity, the definitions are included in the non-GAAP section of our press release.

Before we get started with a presentation from Avnet management, I would like to review Avnet's Safe Harbor statement. This call contains certain forward-looking statements, which are statements addressing future financial and operating results of Avnet. There 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 third-quarter FY16 highlights. Following Rick, our Chief Financial Officer, Kevin Moriarty, will review some additional financial highlights and provide fourth-quarter FY16 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 is Gerry Fay, President of Electronics Marketing. Unfortunately, Patrick Zammit, President of Technology Solutions, will not be joining us today due to a death in the family. With that, let me introduce Mr. Rick Hamada to discuss Avnet's third-quarter FY16 business highlights.

Thank you, Vince and hello everyone. Thank you all for taking the time to be with us today and for your interest in Avnet. In our March quarter, our revenue was within our expected range, even as our sequential decline was slightly below our normal seasonality, given an expected drop in select high-volume supply chain engagements at EM Asia and weaker-than-expected demand in certain legacy technologies at Technology Solutions.

Revenue of $6.2 billion declined 10% sequentially, as compared with our normal seasonal range of down 9% to down 5%. On a year-over-year basis, organic revenue decreased 7.2% in constant currency, as TS was down 13.6% and EM declined 3.3%.

Gross profit margin increased 57 basis points sequentially and 44 basis points year over year, with both operating groups contributing to these improvements. Operating expenses declined $12.4 million, or 2.3% year over year, due to ongoing expense efficiencies, including our Avnet Advantage initiative and the translation impact of the stronger US dollar, partially offset by the impact of acquisitions.

In our March quarter, we realized roughly $3 million of expense savings from our Avnet Advantage initiative, which, when combined with the realized benefits from the first half of FY16, equals a cumulative total of approximately $57 million of annualized savings fiscal year to date toward our revised commitment of $60 million as we exit FY16.

Given that we are accelerating several projects, we now expect to exit our fiscal year with $70 million of annualized savings. Our decline in revenue lead to a 10.9% year-over-year decline in adjusted operating income dollars and a 10-basis-point decline in adjusted operating income margin.

Adjusted earnings per share of $1.01 decreased $0.03 from a year ago. Given the overall revenue trends through the past two quarters, we have initiated focused expense-management actions, where our revenue declines have created gaps to expectations. Even as we adjust to the current market conditions, we are continuing to invest in areas of growth, highlighted at our Investor Day last June, including the Internet of Things, embedded solutions, and third platform technologies.

In addition, we continue to advance our digital transformation with the launch of a significantly enhanced Web portal EM, and the ongoing development of our Avnet Cloud Marketplace. These digital platforms represent a growing foundation for our future as we embrace new technologies and business models that reflect changing customer preferences.

As expected, [our counter] cyclical balance sheet resulted in another quarter of strong cash flow from operations, as we generated nearly $600 million over the trailing 12 months. In addition to strong cash flow, we strengthened our capital structure with the issuance of 10-year notes and continue to invest in our equity through our disciplined share repurchase program.

Now, I would like to turn the commentary over to Kevin Moriarty, to provide more color on our financial performance. Kevin?

Thank you, Rick and hello, everyone. I would like to start with some commentary on EM. Strength in our western regions offset some of the expected decline in select high-volume supply chain engagement in Asia, as revenue declined 2% sequentially, as compared with our normal seasonal range of down 1% to up 3%. Revenue grew a better than seasonal 17% and 6% from the December quarter in our EMEA and Americas region, while our Asia revenue declined 18%.

Revenue of $4 billion declined 3.3% year over year in constant currency, as a 9.4% increase in EMEA was offset by declines of 12.3% and 3.6% in our Asia and Americas region. The strong, sequential growth in year-over-year growth in EM EMEA represents the 12th consecutive quarter of year-over-year growth in constant currency.

Gross profit margin increased sequentially due to the geographic mix shift to the western regions, and increased modestly year over year as an improvement in the Asia region was offset by a decline in EMEA. Operating income declined 7.1% year over year to $183.3 million, driven by the translation impact of the stronger dollar and declines in our Americas and Asia region. Operating income margin declined 15 basis points year over year, primarily due to a decline in our Americas region, where we had planned for and have incurred additional expenses related to the ERP implementation that went live in early April.

Even with the varied growth by region, foreign currency headwinds and quarterly fluctuations and high-volume supply chain engagements, the EM team has done a solid job aligning resources, as operating income margin on a trailing 12-month basis has approximated 4.6% over the past six quarters. In the March quarter, working capital and constant currency was essentially flat with the December quarter and increased 7.9% in constant currency year over year, primarily due to an increase in inventory.

The year-over-year increase in inventory was driven by an increase in EM Asia to support specifically identify demand for the June quarter, an increase in EMEA related to organic growth, and an increase in the Americas region to support the previously mentioned ERP go live. As a result of the decline in operating income, return on working capital declined 222 basis points from the year-ago quarter.

Now, turning to TS. TS revenue came in at the low end of our expectations, as all three regions experienced weaker-than-expected demand in select areas of legacy data center products, which resulted in organic revenue declining 22% in constant currency, as compared with the typical seasonal range of down 19% to down 16%. As a result, revenue of $2.1 billion declined 13.6% year over year organically in constant currency, with all three regions experiencing double-digit declines.

Year-over-year growth in networking and services was offset by declines in storage, servers, and software. Gross profit margin increased year over year in all three regions, driven by portfolio actions and product mix. Operating income dollars declined 18.5% year over year, and operating income margin declined 11 basis points, as the gross profit margin increased and a reduction in operating expenses offset some of the impact of the revenue decline.

Despite the double-digit decline in certain legacy technologies, TS delivered significant growth in areas where we have been investing, such as our all-flash array storage business, which grew over 40%, and our converged infrastructure solutions business, which we were up nearly 20% from the year-ago quarter.

Working capital decreased 7.6 -- 7.7% year over year, or 6.7%, excluding acquisitions and the impact of changes in foreign currency exchange rates. And return on working capital decreased 219 basis points from the year-ago quarter.

Given the March results and the aforementioned declines in certain legacy data center products, we have initiated expense reductions that will reduce annual expenses by approximately $25 million. During this period of transformation in TS' end markets, we will continue to redirect investments into higher growth.

Our recently introduced Avnet Cloud Marketplace, which offers a growing portfolio of solutions from cloud service providers, flexible payment options, and a powerful cloud management tool set, is gaining traction with our partners and independent software vendors, bringing innovation to the IT ecosystem. Going forward, we intend the balance investment with profitability, as evidenced by our recent performance, as TS' trailing 12-month operating income margin was 3.3% the past two quarters, nearing our long-range target of 3.4% to 3.9%.

Now, turning to cash flow from operations. In this slower growth environment, we continue to generate strong cash flow from operations, as during the March quarter, we generated $213 million and have generated $596 million for the trailing 12 months.

During the quarter, we returned approximately $146 million to shareholders via our disciplined share repurchase program, as we capitalized on the pullback in equity markets early in the calendar year and repurchased 3.7 million shares during the March quarter. For the first nine months of the fiscal year, we have returned approximately $400 million to shareholders through dividends and our share repurchase program.

In addition, we improved our capital structure with a well-received debt offering of $550 million of 4 5/8% 10-year notes. The debt offering allowed us to lock in a favorable rate while increasing our percent of fixed-rate debt. Some of the proceeds will be used to retire the $300 million of 6 5/8% notes that are due in September of this year.

We ended the quarter with just over $1 billion in cash, which, when combined with our strong cash generation and credit facility availability, provides us with ample liquidity to fund the profitable growth initiatives that Rick highlighted earlier.

Now, turning to our outlook. Looking forward to Avnet's fourth quarter of FY16, we expect EM sales to be in the range of $3.9 billion to $4.2 billion and TS's sales to be in the range of $2.05 billion to $2.35 billion. Therefore, Avnet's consolidated sales are expected to be in the range of $5.95 billion to $6.55 billion.

Based on this revenue forecast, we expect adjusted diluted EPS to be in the range of $0.95 to $1.05 per share. This guidance does not include any potential restructuring and integration charges or the amortization of intangibles. The guidance assumes 131 million average diluted shares outstanding and an effective tax rate in the range of 27% to 31%.

In addition, the above guidance assumes an average US dollar to euro currency exchange rate of $1.13 to the EUR. This compares with an average exchange rate of $1.11 for the EUR in the fourth quarter of FY15.

With that, let's open the lines for Q&A. Operator?

Thank you. Ladies and gentlemen, we will now be conducting the question-and-answer session.

(Operator Instructions)

Lou Miscioscia, CLSA.

Thank you. Maybe if you could go into the component weakness in Asia and just how long is that from a transitional standpoint? Obviously, sort of the same question on the TS side. Obviously, you called out servers and storage. Any visibility it that is going to change this year, or do you think that trajectory of weakness, maybe you could give the magnitude of it, that would be helpful too, we'll continue?

Let Gerry start with EM, Lou, and I'll comment for Patrick on TS.

Sure, thanks, Lou. First of all, as you know, we usually talk about our high-volume supply chain business in Asia.

So sequentially, that was down 15% sequentially and down almost 44% year over year. So that was one of the big downs on the revenue side.

If you look at our core business, actually core was down 11% sequentially. We saw weakness in the industrial market, and where we saw some strength was in alternative energy for us. And so, when we look at the Asia market, it continues to be weak from an industrial-based perspective.

And Lou, jumping over to TS, on the outlook here, so our guidance for the fourth quarter would tend to indicate we see a similar situation that we saw this quarter as far as the year on year compares. We're tracking the specific segments of the server and storage business that are exhibiting the areas of decline. And, of course, redirecting and trying to steer our investment towards where the opportunities and areas for growth are today, because they are out there in the overall portfolio.

We're just underexposed to some of those key areas at this time. We do not typically offer a multi-core outlook. But as I said, for the fourth-quarter guidance that was provided, we see at least a revenue midpoint we provided is very similar year-on-year compares to what we experienced and what we've seen here in the March quarter.

Are you getting any feedback for why sales are weak? And I said that obviously you highlighted the Cloud Marketplace. Do you think it is because of the cloud taking businesses away, SMBs and even enterprises are moving off of their own data centers to the cloud? And then maybe if you could just give us a little bit more detail about your Cloud Marketplace and how it's doing?

Sure. So, Lou, I think there's multiple factors contributing to the March quarter results. First of all, I'm not sure the general macro environment is the greatest. There's a -- obviously, a variety of our key partners that have reported some results similar and in line with the type of experiences we're talking about in the legacy technologies as part of the overall story.

Second, the specific areas of exposure we have in these legacy technologies. The storage was a continuation of a trend from what we saw in the December quarter.

And in the server space, even though we see conversion infrastructure growing it's the standalone server space that's got the declines year on year. And in addition to seeing what's happening with conversion infrastructure, we're seeing growth in the hybrid arrays and flash array area as an offset to the overall storage story.

So there's still, I believe, a tremendous amount of private cloud and hybrid cloud investment taking place. However, we are very excited about what's happening with the Avnet Cloud Marketplace as an option to offer the opportunity for our [VARs] to enable their customers to implement new consumption models, subscription or consumption based, to tap into a variety of platform infrastructure and software-as-a-service solutions.

Based on -- there's small numbers and high-growth with our cloud market place today, but based on the total traction and activity we're seeing there, can't call that it's a major offset. But we think there's a direct line of sight from what's happening in the legacy environment and traditional on-premise environment to what's happening here.

But I would absolutely put us in the camp that says we are big believers in the cloud and we believe the future for TS is in the cloud. And we're very excited about getting that digital platform established as a very key element of the digital distribution models of the future.

Okay, thank you.

Brian Alexander, Raymond James.

Just on the revenue outlook for EM, which appears to be below seasonal, could you talk about a little bit more about the outlook? Your comments about book to bill being at or above parity in each region seem to be somewhat contradictory to the outlook.

So, is that all related to the SAP implementation in North America? Are you just being conservative on the outlook or could you just be a little bit more specific there?

Sure, Brian, it's Gerry. What I would say if you look within our seasonal range in Q3 in the core business, due to the sequential growth in the Americas and the EMEA market, we ended the quarter at 1.02 to 1 book to bill. This was the first quarter in a year we've been above parity.

Quarter to date we continue to be above parity. In the Americas, I think if you look at what we're seeing in both Americas and in Asia, we're continuing to see weakness in the industrial and the automotive market, whereas in Europe, we continue to see strength in those two areas. So anything related to the ERP implementation is baked into our forecast at this point. So that's how we see the market at this point.

Gerry, just to follow-up on that, could you quantify the impact to your guidance related specifically to the SAP implementation. Both in terms of revenue and the margin drag that you're expecting for the June quarter? And when do you think that will no longer be a drag on earnings?

So how I would look at this, Brian, so if you think about the ERP expenses today that we have to make sure we've got a smooth transition, are running about $5 million to $6 million a quarter. That's to support the additional staff we need to support customer service in the transition.

We won't see much in the way of expense reduction in the June quarter, and that will start to taper in the September quarter and it should be all out by the end of the calendar year. So we will see a decreasing impact to margins as we get to the end of the calendar year.

Okay. And then maybe just for Kevin, when do you expect the cash conversion cycle to normalize? The increase we saw year over year in DSOs and DIOs, I think you touched a bit on inventory. When do you think the cash conversion cycle will normalize, and how are you thinking about cash flow trends going forward?

Sure. Thanks, Brian. First, I'd point to two primary factors, both associated with our Technology Solutions business in the most recent quarter. The first is tied to the linearity of our sales this quarter, and the second contributing factor was tied to our revenue mix.

And the dollar amount of [net treat] of products, which the net treat of products for sales reporting, we treat them as net. But when you look at the AR, the full customer billing is included, so that was one of the contributing factors this quarter.

When I think about our [forge], the current quarter, cash flow from operations, I would range in the $150 million to $200 million range in what I've been highlighting on a trailing 12-month basis, we will stay within the neighborhood of $400 million to $500 million during this growth cycle.

Okay. Thank you very much.

Shawn Harrison, Longbow Research.

Just getting back into TS, if we could discuss two factors. Back of the envelope math is if hardware is 50% of TS and all in TS was down in the teens, that would imply that server storage, et cetera, were down 20%-some-odd. Am I right in that math on a year-over-year basis?

And then second, just the linearity, was it the quarter started off slow and you never saw the back-end improvement that is typical? Or did you just see projects not close at the end of the quarter?

No, Shawn, it's Rick. I'll start with the linearity. I would tell you my impression of linearity was that January started on track, and we had a little hangover remember from Q2.

I'd say February was a little bit of a dip, and actually March was more in line with what we expected. So it really wasn't an end-of-quarter story, to tell you the truth.

On the breakdown of the hardware, software, and services, keep in mind when we share those percentages we're doing that at gross billings. We're doing that at the gross revenue level.

And when we report, Kevin mentioned that there is a portion of our transactions that apply for net treatment, resold service, maintenance contracts, some large software ELAs, et cetera. So when we say it was 50% and you well, your net revenues were $2.2 billion, so that means your hardware is $1.1 billion, you start off in the wrong comparison there, because there's a growth revenue part of this story that it's not part of our reported numbers, so to speak.

I didn't mean to confuse anybody on this thing, but it's been the consistent way that we've reported along the way. What's been happening is that the gross to net conversion has been going up as we've continued to grow our software and services business.

Absent my poor math there, is there is a way you can provide us the range what servers and storage were down year over year, the legacy products?

Yes, let me give you a breakdown in storage as an example, Shawn, because we have shared in the past that storage represents the largest component that's larger than servers dollars as far as a component of our hardware business. But now I'm going to speak about the storage solutions in general.

If we take a look at our total storage solutions, today the balance with got there is about 60% of that revenue is what we would call the legacy all-spinning disk storage deferred environment, which is declining our calculations somewhere north of 20%, low 20%s. About 40% of our revenue is in the hybrid and all-flash arrays, and we have hybrid arrays growing 15% and all-flash arrays growing north of 40%.

But net-net, that whole storage package for us is down year on year because of that mix today. So just trying to give you a flavor for the way we break it down. And remember we're talking about total storage solutions, that includes the hardware, the software, and the services as part of a storage solution, which is the way we're looking at the overall tracking within our business.

Hopefully, that gives you some more color on how we're breaking that down and looking by -- as we talked about on the call, making sure we are steering more and more of investment resources and focus to where the areas of growth and reassigning and redeploying those resources from the areas of decline.

That's very helpful, Rick. And Kevin, as a brief follow-up, the $25 million of new expense actions as well as the $10 million of incremental from Avnet Advantage, when will the full $25 million be in the numbers and how does the new $10 million breakout as well?

Sure. I'll start with, on the $25 million and I would say that's aligned to areas, Shawn, where under-performance to our expectations we'll begin to see some of that in our June quarter. But to your broader question, completed by the end of the calendar year. And then on the other $10 million similar type of framework, Rick, I would say another $2 million to $3 coming up in our fourth quarter and then continuing through the balance of the calendar year.

And is it more weighted toward TS than EM?

Yes.

Okay. Thanks, Kevin.

Thanks, Shawn.

Steven Fox, Cross Research.

Thanks, good afternoon. Just following up on that detail on the $25 million savings. So, is this mainly people related and when you say you're out getting resources into some of the growth areas can you be more specific on what that means? And then I have a follow-up.

I would share with you that primarily people from other areas where we're looking to be reducing investments outside of that category. But clearly when Rick commented in his comments around the digital transformation and cloud marketplace, really reallocating investment to those areas is of high importance for us right now.

Just to be clear, Steve, that is a net number that's coming out and there is a variety of other re-allocation activities taking place as we align to where areas of growth are and future growth are.

And not to belabor the point, but when you say re-allocating investment, you mean you're moving salespeople into different areas to focus more on the growth areas or is that --?

Not just limited to sales, Steve, it could be materials management people, it could be marketing -- product marketing people, it could be inside sales, it could be outside sales, it could be business development, it could be solutions, architects, and sales experts. There's of number of moving parts to the transformation to the solutions focus.

Okay. And just from a bigger standpoint, the detail in terms of how the legacy business breaks out is really helpful, and I'm sure you have similar pressures on the server side. But this is still a significant piece of your business declining at a rapid pace.

So without even getting into what the markets are doing, you guys are getting out of bed and you're looking down 5%, down 10% to start with. So how do you overcome that in a fairly quick amount of time, besides the restructuring issues and accelerate the go-to-market beyond maybe with the market is already at?

Steve, the traditional playbook overall, obviously, there's organic activities and there's inorganic activities as well. We're looking, we have the capacity and the ability to step up, invest, and take advantage of growth opportunities. There's a significant amount of work that's got to take place organically in the -- again the reallocation and redistribution of existing resource towards these areas of growth.

But we'll also proactively be looking for new partnerships, engagements, perhaps new other acquisition investments that could help accelerate our progress along here as well. As you know, we don't ever try to forecast those along the way, but it is well-known we do have the capacity to step up when we see good opportunities to do that. And just in general, M&A remains an important part of our overall profitable growth plans.

Great. I appreciate all that color. Thank you.

Ananda Baruah, Brean Capital.

Thanks for taking the questions, two for me. Along the same lines, to that end, to what extent -- to the comment you guys made [in pay] remarks. I'm paraphrasing, that there is underexposure to key server areas and maybe key storage areas.

Have you guys -- is the way you view it today is it more a function of not having exposure or line cards to all that you would like to have line cards to? Or is it more a function of not having optimal distribution of the line card which do you have?

And how does your cloud services portfolio actually fit into this as well? And I have just one quick follow-up, thanks.

Ananda, the way I would think about it is, it is not just about line cards. Today, we believe we're well-positioned in some key areas of growth. We talked about conversion, infrastructure. We've talked about hybrid and all-flash arrays as an example.

So some of these areas, we think we're well-positioned. Other areas, perhaps in the total packet, networking is good, could we up our game in security? Could we up our game in analytics?

And that's not just about line card, it's about making sure that we have the relevant value propositions, the ability to enable our ecosystems to take advantage of these opportunities and grow, help train and get them up to speed on how they help their customers with these problems. The same ecosystem enabling value and services we've brought for years in a variety of other traditional areas, as well as some vertical areas in markets like healthcare, et cetera.

So that's what we're talking about is building the value proposition in those areas. We've got some good critical mass where we're starting from today. We got some work to do, we think, to get aligned with some of the current areas of growth, which by the way, we think some others have some better mixes and offerings on.

When it comes to the Cloud Marketplace, now that's another move out towards the digital future where we're trying to take advantage of evolving procurement and consumption models and putting our ecosystem in a position to be able to go provision, either by consumption or a subscription models, to add to their total IT environment. And they can make the choices on what's physical, with virtual, what's on-prem, what's off-prem, what's going to be a CapEx opportunity versus what they would want to convert to an operating expense opportunity.

So it's not just about line cards; it's about building the value propositions in these relevant areas. We've got a solid base in a couple of key areas today. We'd like to opt our game in a couple of others as part of this transformation story.

That's very helpful. And then just quickly as a follow-up, did you see -- what impact, if any, did you see to Europe, European spending? I'm thinking primarily on the TS side, but to the extent that this is turning to EM, I would love to hear it. In Europe, post events in Belgium, as you went through the quarter? Thanks.

Ananda, I can't really point to any particular impact due to those events, those tragic events. If I offered some color commentary though, I would tell you, as we have highlighted in the script, our components team in EMEA continues to perform very, very well. 12 consecutive quarter, year-on-year growth in constant currency. We disrupted some nice momentum we had going with our TS business in Europe, and if you just go one click down on where some of the regional flavor was there, actually the area of biggest gap to our expectations was in the north, primarily in the UK.

Again, I don't want to make any political commentary on whether this has to do with the Brexit rumors or not, et cetera. But just for us on our scorecard, as Europe came in and where we saw the biggest gap to our expectations, the central region for us in the computer business, eastern region and actually the southern region still performing to what we expect. It was the north region primarily in the UK that was the gap.

Interesting. Okay, appreciate the input. Thanks.

Mark Delaney, Goldman Sachs.

Yes, good afternoon and thanks very much for taking the questions. The question is on the OpEx levels, just trying to better trend understand some of the moving pieces and maybe we could start on the March quarter.

The SG&A dollars increased about $9 million quarter to quarter, even as revenue was down about 10% sequentially, a $5 million to $6 million was maybe from the ERP system. But I'm a little confused about SG&A rising when some of the Avnet Advantage cost savings were going through. So if you could help me understand that, it would be helpful.

Hi, Mark, it's Kevin. So sequentially what I would point to is -- the first element is we had two acquisitions that were in the full run rate for the quarter. That added expenses sequentially.

We also had our employee merit program at the beginning of the calendar year. We talked earlier about the Evolve project, so all of those would have been additive. And then net of the productivity from the Avnet Advantage program.

Okay, that's helpful. And then I'm trying to just make sure I understand all of the different moving pieces around OpEx as we go forward. So I think, if I understood this properly, $70 million from Avnet Advantage as you exit FY16 and you may get closer to another $10 million from some of the incremental TS savings that you announced. How much more should we think about as you go from FY16 to either the end of FY17 or the end of calendar 2017?

I'm assuming -- it sounds like they're gross targets. So maybe you can help us understand what the net and how much of that gets reinvested.

And actual SG&A dollars decline, if hypothetically revenue is flattish in 2017, can SG&A decline? Or should we think about maybe more flattish absolute SG&A dollars as you move through the year?

I would point to some amount of net, and I will continue to update. As you know, we don't give much more than a one-quarter outlook. But clearly, as revenue stays in this category or area, we will continue to make the right decisions to ensure our cost base supports the revenue that we are generating.

Okay. And then just last one for me. Do you expect to participate more high-volume programs as you move through the year?

I know in the EM segment, I understand that was an area of weakness. But later in calendar 2016, would you expect to see better revenue from that specific type of engagement?

As Kevin said, we wont' give much of a forecast outside of one quarter at this point. But if you look at where we're projecting that business to be, we project that business will be down both quarter over quarter and year over year in Q4.

Thank you.

Sherri Scribner, Deutsche Bank.

Thanks. I was a little confused by some of the gross and net comments in the TS piece, but it seems like with more net business, with that business it sounds like software and whatnot growing. It seems like there's going to be a challenge to revenue growth as that proportion continues to change, added to that declines in the legacy business, which still represents more than 50% of the revenue in the different segments.

Is that a fair way to think about that? And when do we get to some balance there where the net is less of an impact and the legacy is less of an impact?

Sherri, I think it's a fair assessment, and another way that we look at it is contrasting what the trends are with the revenue line versus the trends and the gross profit dollars as well. So, again, we'll continue to try to be as open and transparent as we can on what's happening with the commodity mix. You're right, as software and services continues to grow, that will probably increase the amount of the net treated transactions, causing more of this differential between the gross and the net revenues.

The issue, the other side of the coin is, if we take gross hardware revenues and compare it to a net revenue number, it over-exposes it. It over calculates. It sets an expectation that hardware is a bigger proportion of our sales than it really is, which is why we like keeping to the consistent gross revenue comparison. Simply when we offer that high-level commodity break down of hardware, software, and services.

Okay. And as you shift the business, related to my question about gross margins, I know you manage the business' operating margin, but the gross margin was pretty strong this quarter.

How should we think about gross margins going forward? Is there a positive impact to gross margins, as you move to more net? And generally has some of the cost savings impacted the COGS line or is it all coming out of the SG&A line? Thanks.

I think the way I'd think about it at this point, Sherri, is that yes, continued growth in the gross and net treated area will be a headwind, a positive for gross margin overall. And based on all the actions, there's really not much impact on the COGS part of the equation.

Okay, thanks.

Jim Suva, Citigroup.

Thanks very much. Understanding the changes that are going on with the cloud, legacy business are emerging and continuing. Are you guys changing your capital allocation strategy?

What I mean by that, are you looking at buying back more stock? Or are you looking at [making] more acquisitions? And if so, are those acquisitions more focused on like skill sets or software?

Or in the past, you been very successful at rolling up other distributors. So how should we think about capital allocation in this new era of computing?

Yes, Jim, this is Rick. I'll take a stab, maybe Kevin might want to weigh in a little bit. I believe we're being highly consistent with our general capital allocation priority scheme. Obviously, the dividend is now at the top of that list.

Investing in growth has always been second; that comes both organically and possibly with acquisitions. And then third, we have that very disciplined approach to repurchasing our equity, which we intend to continue with as well.

When it comes to the acquisition targets, I think we have commented in the past that the main drivers, the era of consolidation and geo-expansion, while maybe not 100% done, we're not clear is going to be really the big drivers of M&A going forward. So setting expectations that you would expect more acquisitions to be selective, strategic acquisitions that actually add skill sets, was the term you used, add more critical mass to some of these emerging areas of value creation, such as digital platforms, et cetera.

That's probably more what you should expect from us going forward, as we continue to build out towards our vision of the future in leading and digital distribution. The plays of consolidation will still present themselves; there will still be some great opportunities to do so.

We love adding that onto the core business. And when they meet our total culture, strategy and economic hurdle rates, we will still execute on those as well. But as far as where I think we're proactively looking to stimulate and go find new opportunities to deploy capital, it's in support of these very, very, we believe, critical, long-term growth strategies.

Thank you very much.

Thank you, Jim.

Matt Sheerin, Stifel.

Yes, thank you. Just a question in your Tech Solutions business regarding the PC components on hard disk drives business, which I know has been a drag in recent quarters. You haven't called that out, so wondering if that's stable or is that weak as well?

Matt, it's Kevin. It's actually been relatively stable this quarter. And included in our guidance is a stable revenue outlook.

Right, and actually for the March quarter, Kevin, I think it's fair to say from an expectations point of view, the business was where we wanted it to be.

Yes.

Is that because you've restructured in such a way that you're targeting the right markets that meet the right returns and margin goals?

We are happy with the returns in margins from that business today. It's just still -- just under 10% of TS global revenues, Kevin?

Yes.

Okay. In the electronics marketing, you talked a lot about the supply-chain engagement being a drag on revenue in Asia. It looks like it's going to be down a lot again. But just talk about the strategy there.

I know initially, basically, the justification was low margin, but you're high velocity, so good returns. Now at the lower volumes, I would imagine that the returns are lower as well, and I know there's a lot of customer concentration there we can get whipped around quarter in quarter. What's the strategy with that business going forward?

Matt, it's Gerry. Great question. As you know, this is opportunistic business for us, so we continue to assess it and we'll continue to do that. To your point, I think it's pretty well known in the marketplace that the business is slowing down and based on the numbers that I just put out, you can see it continues to slow.

So we will continue to look at it. And at this point at which it doesn't meet our metrics, we will exit the business.

Okay, and just lastly, on the Latin America on the commentary in the CFO commentary, you talked about weakness there and certainly not the only one. Has that market bottomed or stabilize at all or is that going to continue to be weak?

Kevin?

Matt, I would comment that I would think it would be consistent with some of the broader trends that we've been experiencing in the other parts of the business in the near term.

Meaning what? Meaning it's going to continue to be soft?

Yes.

Okay. All right, thanks a lot.

Thanks, Matt.

Param Singh, Merrill Lynch.

Hi, guys. Thank you for taking my question. So wanted to understand that EM strengthened EMEA. How much of that is coming from either the pick up in design activity and how have you seen that trend over the past few quarters?

Is that an indication of any future pick up in demand or in acceleration? And then I have a follow-up.

I'll start, I'll talk about the market first, then I'll talk about demand creation. We normally don't talk about the demand creation by region, but I'll talk about it globally. When it comes to Europe, I would say, I think Rick teed it up nicely.

The only market we saw weakness in, in the components section was in the UK. Other than that, we still see strength and particularly in Germany where we're very strong.

Regarding the end markets, we still see strength in industrial and automotive. I would say less so in comms and military and aerospace. As Rick said, Q3 represented the 12th consecutive quarter of year-over-year growth and those compares are going to continue to get harder. But my hat's off to our European team for continued strong performance and their market leadership there.

When it comes to demand creation, actually our demand creation metrics continued to improve, which bodes well for business in the future. Our demand creation revenue was up 4% versus the prior year and registrations are up 17% but, design was up 6%.

In Q3 alone, we generated close to 80,000 new registrations. So we continue to make investments in this space. We think it's a kay and a differentiator for us. And then with some of the other strategy Rick's talked about, particularly focused on the Internet of things and getting suppliers' IP in the hands of our customers, demand creation continues to be a key strategy for us.

Quite a colorful clarification on that. Do you have a way to clarify what's IoT-related, because at the end of the day, this still falls in industrial demand picking up short of it right?

How we look at it, we look at the three main building block technologies of IoT, which are sensors, processing, and communication protocol devices. That's a proxy for us for IoT, because those are the three main building blocks.

And of course we have ways to identify projects that are specific to IoT So that's how we measure IoT inside of Avnet today. As it gets more legs and more and more projects get identified as specific to IoT, we'll be able to give a little more clarity.

Param, we're actually working on that associated with a lot of our visibility and communication around IoT. And Gerry's got a very good line of sight here, but we also, with our new Vice President of IoT started on January 1, and looking how it bridges over to the analytics portion of our TS business and how we want to count that as part of the overall IoT revenue or market stream, so to speak.

We're actually working on designing and defining those metrics so that we can come back to this group on a more consistent basis with some metrics around that. So stay tuned, definitely work in process, as it is with a number of players across the industry overall. But a definitely big play for us in the short, medium, and long term.

Great. Thanks, Gerry, Rick. So as a follow-up, I wanted to follow-up on another question from an analyst earlier in the call. Now how much of that year-over-year TS margin decline was related to your hard disk drive business versus revenue decline?

And then how much was offset by your average Advantage program over the past year? If you could break that down, that would be really helpful.

Param, I'm not sure we're going to have that detail immediately available overall. As we commented earlier, the Avnet -- what we call our Avnet Global Computing Components business as part of TS, was pretty much on the plans and expectations we had for that portion of the business for the March quarter.

So it didn't really contribute to the overall result. The overall results for TS were much more in the key areas we've already identified and talked about.

As far as all the moving parts, we do understand there's a lot going on there with a long-term Avnet Advantage, some transitory incremental expense actions we've announced in reaction to the market realities. The incremental investments here in the short term for this, making sure we had a very successful and well-trained organization ready for a new ERP go live.

We don't put all these projects in place to try to confuse anybody, But I tell you what, I would recommend following up with Vince or Kevin maybe after the call here. We'll see if we can get more specific about some of the breakdown.

But there's a lot of moving parts going on, a lot of things going on in our business. Overall, long-term trend, we know where we've got to be from an OpEx to net GP perspective. And we know where we've got to make sure we're investing for the future, no matter what the overall environment is. Those are two big key themes I'd ask you to keep in mind.

Thanks a lot, really helpful. Appreciate it.

Thank you. There are no further questions at this time. I would like to turn the floor back over to Management for any closing remarks.

Thank you for participating in our earnings call today. Our third-quarter FY16 earnings press release and related CFO commentary can be accessed in downloadable PDF format at our website at www.ir. Avnet.com under the Quarterly Results section. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.