Avnet - Q3 2016
April 28, 2016
Transcript
Operator (participant)
Good afternoon, and welcome to Avnet's third quarter fiscal year 2016 business and financial update. As we provide the highlights for our third quarter fiscal year 2016, 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, we mean 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 the 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 fiscal year 2016 highlights. Following Rick, our Chief Financial Officer, Kevin Moriarty, will review some additional financial highlights and provide fourth quarter fiscal 2016 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 fiscal 2016 business highlights.
Rick Hamada (CEO)
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%-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 from the first half of fiscal 2016, 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 fiscal 2016. 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 led to a 10.9% year-over-year decline in adjusted operating income dollars and a 10 basis points 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 at 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 countercyclical balance sheet resulted in another quarter of strong cash flow from operations, as we generated nearly $600 million over the trailing twelve months. In addition to strong cash flow, we strengthened our capital structure with the issuance of 10-year notes and continued 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?
Operator (participant)
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 engagements 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 regions, while our Asia revenue declined 18%... Translation impact of the stronger dollar and declines in our Americas and Asia regions. Operating income margin declined 15 basis points year-over-year, primarily due to a decline in our Americas region, where we have 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 in high volume supply chain engagements,
Kevin Moriarty (CFO)
... 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 in 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 identified 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%-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 decline. 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 increase 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's 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 to balance investment with profitability, as evidenced by our recent performance, as TS's trailing twelve-month operating income margin was 3.3% the past two quarters, nearing our long-range target of 3.4%-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 twelve 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 4.625% ten-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 6.625% 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 fiscal 2016, we expect EM sales to be in the range of $3.9 billion-$4.2 billion, and TS's sales to be in the range of $2.05 billion-$2.35 billion.
Therefore, Avnet's consolidated sales are expected to be in the range of $5.95 billion-$6.55 billion. Based on this revenue forecast, we expect adjusted diluted EPS to be in the range of $0.95-$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%-31%. In addition, the above guidance assumes an average US dollar to euro currency exchange rate of $1.13 to the euro. This compares with an average exchange rate of $1.11 to the euro in the fourth quarter of fiscal 2015. With that, let's open the lines for Q&A. Operator?
Operator (participant)
Thank you. Ladies and gentlemen, we will now be conducting the question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Please limit your question to one question and one follow-up. Our first question comes from Louis Miscioscia from CLSA. Please go ahead.
Louis Miscioscia (Analyst)
Hey, thank you. Maybe if you could go into the component weakness in Asia and just how long is that from a transitional standpoint? And obviously, the sort of the same question on the TS side. Obviously, you called out servers and storage, any visibility if that's gonna change this year, or do you think that that trajectory of weakness, and maybe if you could give the magnitude of it, that'd be helpful too, will continue.
Rick Hamada (CEO)
Yeah. Let Gerry start with EM, Lou, and I'll comment for Patrick on TS.
Gerry Fay (President of Electronics Marketing)
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, that was down 15%, sequentially, and down almost 44% year-over-year. So that was one, one of the big, you know, downs on the revenue side. If you look at our core business, it actually, core was down 11% sequentially. We saw a weakness in the industrial market, and where we saw some strength was in alternative energy for us. And so, you know, when we look at the Asian market, it continues to be weak from a industrial-based perspective.
Rick Hamada (CEO)
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-quarter outlook, but as I said, for the fourth quarter guidance that was provided, we see at least the revenue midpoint we provided is very similar year-on-year comparison to what we experienced and what we've seen here in the March quarter.
Louis Miscioscia (Analyst)
Are you getting any feedback for why sales are weak? And I see that obviously, you highlighted the cloud marketplace, and I guess, do you think it is because of the cloud taking businesses away, so SMBs and even enterprises are moving off of their own data centers to the cloud? And then, after that, maybe if you could just give us a little bit more detail about your cloud marketplace and how it's doing.
Rick Hamada (CEO)
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 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 converged infrastructure growing, it's the standalone server space that's got the declines year-on-year.
In addition to seeing what's happening with converged infrastructure, we're seeing growth in the hybrid arrays and all-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 the, there's small numbers and high growth with our cloud marketplace today, but based on the total traction and activity we're seeing there, can't call that it's a major offset where we think there's a direct line of sight from what's happening in the legacy environment and in a 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.
Louis Miscioscia (Analyst)
Okay. Thank you.
Operator (participant)
Our next question comes from Brian Alexander, from Raymond James. Please go ahead.
Kevin Moriarty (CFO)
All right. Just on the revenue outlook for EM, which appears to be below seasonal, can you just talk about a little bit more about the outlook, your comments about book-to-bill being-
Brian Alexander (Analyst)
... 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, or are you just being conservative on the outlook, or could you just be a little bit more specific there?
Rick Hamada (CEO)
Sure, Brian, it's Gerry. What I would say is, 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.
Brian Alexander (Analyst)
So 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?
Rick Hamada (CEO)
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-$6 million a quarter. That's to support the additional staff we need to support customer service and 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.
Brian Alexander (Analyst)
Okay, and then maybe just for Kevin, when do you expect the cash conversion cycle to normalize? You know, the increase we saw year-over-year in DSOs and DIOs, I think you touched a bit on inventory. So when do you think the cash conversion cycle will normalize, and how are you thinking about cash flow trends going forward?
Kevin Moriarty (CFO)
Sure. Thanks, Brian. So first, I'd point to two primary factors, both associated with our technologies and 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 treated products, which the net treated products, for sales reporting, we treat them as net. So 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 the current quarter, cash flow from operations, I would range it in the $150 million-$200 million range.
What I've been highlighting on a trailing twelve-month basis, we will stay within the neighborhood of $400 million-$500 million during this, during this growth cycle.
Brian Alexander (Analyst)
Okay. Thank you very much.
Operator (participant)
Our next question comes from Sean Harrison from Longbow Research. Please go ahead.
Shawn Harrison (Analyst)
Hi. Just getting back into TS, if we discuss, I guess, two factors. Back-of-the-envelope math is if hardware is 50% of TS, and all TS was down in the teens, that would imply that, you know, server storage, et cetera, were down 20-some-odd%. Just, 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, the back-end improvement that is typical, or did you just see projects not close at the end of the quarter?
Rick Hamada (CEO)
No, Sean, it's Rick. I'll start with the linearity. I would tell you my impression of the 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%, you say, "Well, your net revenues were $2.2 billion, so that means your hardware is $1.1 billion." You kind of start off in the wrong comparison there, because there's a gross revenue part of this story that it's not part of our reported numbers, so to speak. So, didn't mean to anyway confuse anybody on this thing, but it's been a consistent way we've reported it 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.
Shawn Harrison (Analyst)
I guess, absent my poor math there, is there a way you can provide us kind of the range, what servers and storage were down year-over-year, legacy products?
Rick Hamada (CEO)
Yeah. Let me give you a breakdown in storage as an example, Sean, because we have shared in the past that storage represents the largest component, and it's larger than servers, raw dollars, as far as a component of our hardware business. But now I'm going to speak about the storage solutions in general. And if we take a look at our total storage solutions, today, the balance we've got there is about 60% of that revenue is what we would call the legacy, all-spinning disk storage environment, which is declining our calculation somewhere north of 20%, low 20%. And then 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 there. 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. So hopefully, that gives you some more color on how we're breaking that down and looking at, as we talked about on the call, making sure we're steering more and more of investment resources and focus toward the areas of growth and reassigning and redeploying those resources from the areas of decline.
Shawn Harrison (Analyst)
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, I guess, when will the full $25 million be in the numbers, and how does the new $10 million break out as well?
Kevin Moriarty (CFO)
Sure. I'll start with the to your-- on the $25 million, and I would say that that's aligned to areas, Sean, where the underperformance 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-$3 million coming up in our fourth quarter and then continuing through the balance of the calendar year.
Shawn Harrison (Analyst)
Is it, is it more weighted toward TS than AM?
Kevin Moriarty (CFO)
Uh, yes.
Shawn Harrison (Analyst)
Okay. Thanks, Kevin.
Kevin Moriarty (CFO)
Yes.
Rick Hamada (CEO)
Thanks, Sean.
Operator (participant)
Our next question comes from Steven Fox from Cross Research. Please go ahead.
Steven Fox (Analyst)
Yeah, thanks. Good afternoon. Just following up on that, detail on that, on the $25 million savings. So is this mainly people-related? And, when you say you're allocating resources into some of the growthy areas, can you just sort of be more specific on what that means? And then I have a follow-up.
Kevin Moriarty (CFO)
I would share with you that primarily people, some 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, high importance for us right now.
Rick Hamada (CEO)
Yeah, just to be clear, Steve, that is a net number that's coming out, and there is a variety of other reallocation activities taking place as we align to where the areas of growth are and future growth are.
Steven Fox (Analyst)
Not to belabor the point, but when you say reallocating investment, you mean you're moving salespeople into different areas to focus more on the growth areas, or is that-
Rick Hamada (CEO)
Yeah, not just, not just limited to sales, Steve. It could be materials management people, it could be marketing, product marketing people, it could be, it could be inside sales, it could be outside sales, it could be business development, it could be solutions architects and sales experts. I mean, there's a number of moving parts to the transformation to the solutions focus.
Steven Fox (Analyst)
Okay. And then just from a bigger standpoint, the detail in terms of how the legacy business sort of 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 at 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 sort of accelerate to go to market beyond maybe what the market is sort of already at?
Rick Hamada (CEO)
Yeah, you know, Steve, it's the traditional playbook overall. Obviously, there's organic activities, and there's inorganic activities as well. And we're looking—we have the capacity and the ability to step up and 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 toward these areas of growth. But we'll also proactively be looking for new partnerships, engagements, perhaps new other acquisition investments that can 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 plan.
Steven Fox (Analyst)
Great. I appreciate all that color. Thank you.
Operator (participant)
Our next question comes from Ananda Baruah from Brean Capital. Please go ahead.
Ananda Baruah (Analyst)
Hey, guys, thanks, thanks for taking the question. I guess, two for me. It's sort of along the same lines. To what-- to that end, to what extent, you know, and this is to, to the comment that you guys made in the prepared remarks that, I'm paraphrasing, that there is underexposure, to key server areas and maybe key storage areas. How do you guy... The way you view it today, is it, more a, more a function of not having exposure, or line card, to, to all that you would like to have line card to? Or is it more a function of not having, you know, sort of, I guess, optimal distribution of the line card, which you do have?
And then how does your cloud services portfolio actually fit into this as well? And then I have just one quick follow-up. Thanks.
Rick Hamada (CEO)
Yeah, Ananda, the way I would think about it is, it's not just about line card. See, today, we believe we're well-positioned in some key areas of growth. We talked about converged infrastructure. We've talked about hybrid and all-flash arrays as an example. So there are some of these areas we think we're well-positioned. Other areas, perhaps in the total package, 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 ecosystem 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 enablement 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 propositions in those areas. Got some good, got some good critical mass where we're starting from today, 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, 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, but either via consumption or subscription models, to add to their total IT environment, and they can make the choices on what's physical, what's 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 card. 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 up our game in a couple of others as part of this transformation story.
Ananda Baruah (Analyst)
That's, that's very helpful. And then just quickly, as a follow-up, did you see what impact, if any, did you see to European spending? I'm thinking primarily on the TS side, but to the extent that this is pertinent to EM, I'd love to hear it. In Europe, post the events in Belgium as you went through the quarter. Thanks.
Rick Hamada (CEO)
Yeah, 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 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 1 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.
Ananda Baruah (Analyst)
Interesting. Okay, I appreciate the input. Thanks.
Operator (participant)
Our next question comes from Mark Delaney from Goldman Sachs. Please go ahead.
Mark Delaney (Analyst)
Yes, good afternoon, and thanks very much for taking the questions. The question is on the OpEx levels. I'm just trying to better understand some of the moving pieces, and maybe we could start on the March quarter. The OpEx, the SG&A dollars increased about $9 million quarter to quarter, even as revenue was down about 10% sequentially, and I guess $5 million-$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'd be helpful.
Rick Hamada (CEO)
Kevin?
Kevin Moriarty (CFO)
Hi, Mark, it's Kevin. So sequentially, what I would point to is, the first element is we had 2 acquisitions that were in the full run rate for the quarter, that added expenses sequentially. We also had our employee merit program beginning 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.
Mark Delaney (Analyst)
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 fiscal 2016, and then maybe it's 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 fiscal 2016 to either the end of fiscal 2017 or the end of calendar 2017? And I actually mean, those sound like they're gross targets. So maybe you can help us understand what the net and kind of how much of that gets reinvested and just, you know, can actual SG&A dollars decline?
If hypothetically, revenue is flattish in 2017, can SG&A decline, or should we think about being more flattish, absolute SG&A dollars as you move through the year?
Kevin Moriarty (CFO)
I would point to some amount of net, and I'll 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.
Mark Delaney (Analyst)
Okay. And then just, last one for me. Do you expect to participate in 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, you know, later in calendar 2016, would you expect to see better revenue from that specific type of engagement?
Kevin Moriarty (CFO)
Yeah, again, as Kevin said, we won't, you know, 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 as in Q4.
Mark Delaney (Analyst)
Thank you.
Operator (participant)
... Our next question comes from Sherri Scribner from Deutsche Bank. Please go ahead.
Sherri Scribner (Analyst)
Hi, 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 gonna 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?
Rick Hamada (CEO)
No, 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 in 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. And 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 overexposes it, it overcalculates.
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 breakdown of hardware, software, and services.
Sherri Scribner (Analyst)
Okay. As you shift the business, it's sort of related to my question about gross margins. I know you manage the business as an operating margin, but the gross margin was pretty strong this quarter.
Rick Hamada (CEO)
Right.
Sherri Scribner (Analyst)
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.
Rick Hamada (CEO)
Yeah, I think the way I 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.
Sherri Scribner (Analyst)
Okay, thanks.
Rick Hamada (CEO)
Mm-hmm.
Operator (participant)
Our next question comes from Jim Suva from Citigroup. Please go ahead.
Jim Suva (Analyst)
Thanks very much. Understanding the changes that are going on with the cloud and the legacy business are, you know, emerging and continuing, are you guys changing your capital allocation strategy? And what I mean by that, are you looking at buying back more stock? Are you looking at making more acquisitions? And if so, are those acquisitions more focused on, like, skill sets or software or... You know, in the past, you've been very successful at rolling up other distributors. So how should we think about capital allocation in this kind of new era of computing?
Rick Hamada (CEO)
Yeah, Jim, this is Rick. I'll, I'll take a stab. Maybe Kevin might want to weigh in a little bit. So, 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 a hundred percent done, we're not clear it's gonna 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, as you said, the term you used, add more, critical mass to some of these, emerging areas of value creation, such as digital platforms, et cetera. That would. 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 in digital distribution. So, the, the plays of, you know, consolidation will still present themselves. There'll still be some great opportunities to do so. We love adding that onto the core business and, and those, those, 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, what we believe, critical long-term growth strategies.
Jim Suva (Analyst)
Thank you very much.
Rick Hamada (CEO)
Thank you, Jim.
Operator (participant)
Our next question comes from Matt Sheerin from Stifel. Please go ahead.
Matthew Sheeran (Analyst)
Yes, thank you. Just a question in your tech solutions business regarding the PC components and hard disk drive business, which I know has been a drag in recent quarters. You haven't called that out, so I'm wondering if that's stable or is that weak as well?
Kevin Moriarty (CFO)
Matt, it's Kevin. It's actually been relatively stable, this quarter, and included in our guidance is a stable kind of revenue outlook.
Rick Hamada (CEO)
Right. Actually, and then 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.
Kevin Moriarty (CFO)
Yes. Mm-hmm.
Matthew Sheeran (Analyst)
Is that because you've restructured it in such a way that you're targeting the right markets that meet the right returns and margin goals?
Rick Hamada (CEO)
Yes, we are happy with the returns and margins from that business today, and it's just still just under 10% of TS global revenues, Kevin?
Kevin Moriarty (CFO)
Yes. Yep.
Matthew Sheeran (Analyst)
Okay. And 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 gonna be down a lot again. But just talk about the strategy there. I know initially, basically, the justification was low margin, but 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, where you can get whipped around quarter to quarter. So what's the strategy with that business going forward?
Gerry Fay (President of Electronics Marketing)
Hey, Matt, it's Gerry. Great question. As you know, we keep—you know, this is opportunistic business for us, so we continue to assess it, and we'll continue to do that. And to your point, you know, 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 the point at which it doesn't meet our metrics, we will exit the business.
Matthew Sheeran (Analyst)
Okay. And just lastly, on the Latin America and the commentary in the CFO commentary, you talked about the weakness there and, certainly not the only one. Has that market bottomed or stabilized at all, or is that going to continue to be weak?
Rick Hamada (CEO)
Okay, 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.
Matthew Sheeran (Analyst)
Meaning what? Meaning it's going to continue to be soft.
Rick Hamada (CEO)
Yes.
Matthew Sheeran (Analyst)
Okay. All right. Thanks a lot.
Gerry Fay (President of Electronics Marketing)
Thanks, Matt.
Operator (participant)
Our next question comes from Param Singh from Merrill Lynch. Please go ahead.
Param Singh (Analyst)
Yeah. Hi, guys. Thank you for taking my question. So, you know, wanted to understand, that EM strength in EMEA, how much of that is coming from, you know, the pickup in the design activity, and have you, how have you seen that trend over the past few quarters? And is there, is that an indication of any pickup, future pickup in demand or an acceleration? And then I have a follow-up.
Gerry Fay (President of Electronics Marketing)
Okay, well, I'll talk about the market first, then I'll talk about demand creation. We normally don't talk about demand creation by region-
Param Singh (Analyst)
Regional level.
Gerry Fay (President of Electronics Marketing)
But I'll talk about it globally. So when it comes to Europe, I would say, I think Rick teed it up nicely. The only market we saw weakness in, in the component section was in the UK. Other than that, you know, 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, you know, Q3 represented the twelfth consecutive quarter of year-over-year growth, and, you know, those comparisons are going to continue to get harder. But, my hats 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 continue to improve, which bodes well for business in the future.
Our demand creation revenue is up 4% versus the prior year, and registrations are up 17%, with design wins 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 key and a differentiator for us. And then, you know, with some of the other strategies Rick's talked about, particularly focused on the Internet of Things and getting our suppliers' IP in the hands of our customers, demand creation continues to be a key strategy for us.
Param Singh (Analyst)
One kind of clarification on that. I mean, do you have a way to clarify, you know, what's IoT related or, you know, because at the end of the day, it still falls into industrial demand picking up, sort of, right?
Gerry Fay (President of Electronics Marketing)
Yeah. 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 kind of 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.
Rick Hamada (CEO)
Yeah, Param, we're actually working on that, associated with our, you know, 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 1st, 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, you know, 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, so, in the short, medium, and long term.
Param Singh (Analyst)
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 Avnet Advantage program over the past year? If you could break that down, that'd be really helpful.
Rick Hamada (CEO)
Yeah, 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 a 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 the 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'll tell you what, I would recommend follow up with Vince or Kevin, and 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 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.
Param Singh (Analyst)
Thanks a lot, Rick. Really helpful. Appreciate it.
Rick Hamada (CEO)
Thanks, Param.