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Avx Corporation (NYSE:AVX)

Q3 2013 Earnings Conference Call

January 24, 2013, 10:00 AM ET

Executives

John S. Gilbertson - President and CEO

Kurt Cummings - VP, CFO, Treasurer, and Secretary

John Lawing - VP of Advanced Products

Analysts

Matthew Sheerin - Stifel Nicolaus & Company, Inc.

Jim Suva - Citi

Brett Reiss - Janney Montgomery Scott LLC

Operator

Good morning. My name is Sabrina and I’ll be your conference operator today. At this time, I’d like to welcome everyone to the Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

I’d now like to turn the conference over to John Gilbertson, President and CEO.

John S. Gilbertson

Good morning. Thank you, Sabrina. I like to thank you for attending the AVX conference call regarding the results for our third fiscal year quarter that ended in December. I’m John Gilbertson and with me today are Kurt Cummings, AVX’s Chief Financial Officer and John Lawing, our Vice President of the Advanced Products Group. I hope you had an opportunity to review our earnings release that was issued this morning.

The December quarter sales came in lower than we anticipated particularly as a result of continued cautious inventory management by our customers, including the distribution channel and our decisions during this difficult quarter to protect margins as much as possible. There were additional revenue opportunities, but a much lower margin in this current market situation. We were able to increase our backlog late in the quarter as some movement was seen in the distribution market, but these orders were not for delivery in the third quarter.

Our 90 day backlog increased significantly for the first time this year. The book-to-net bill was 1.07 to 1 in the quarter. But our backlog increased by 5% during the quarter and now it’s higher than any quarter in calendar 2012. Sales came in at $339.9 million reflective of continued economic uncertainty and inventory management. Market conditions during the quarter are always under pressure due to the mix of the consumer products that we receive at this time of the year. But we saw much more market price pressures during the quarter than normal.

As we’ve mentioned previously when orders moderate there tends to be more spot pricing and several of our competitors were booking orders at very marginal prices. Yet in general we were satisfied with the margin performance considering the typical mix of commodity component sales during the holiday period and the limited overall sales level.

The inventory situation particularly in distribution, stayed during the December quarter. Our shipments to distribution decreased 1.7% from the September quarter, which is unusual. At this time, we will say we’re still on a period of inventory moderation. And this quarter, distribution channel represented approximately 40% of our overall shipments.

Distribution demand will improve, but it is difficult to say whether we will see that in the March quarter. We will have to wait until later in the new calendar year after macroeconomic picture improves. Again we feel comfortable with our acquisition in this channel, when inventory requirements improve. Regionally Europe remains a question market, but Asia here is the key. As a percentage of our overall sales, Asia sales decreased one point to 48% of overall and the America stayed steady at 27% of the total. Europe represented 25% of this total sales, up one point from last quarter and considering all the press on this region, this was a respectable performance as our connector business continues to improve.

Looking at the market segment, we obviously saw seasonal growth in the cellular handset market with the increased bill of smartphones. One customer on this segment moved out a new model introduction to the next quarter and this limited this quarter, but it will help next quarter’s activity. The story here is to continue to be an important supplier to as many handset producers as possible as market share mix is shifting so dramatically among the providers.

Smartphones grew about 30% this year with a growing shift to larger screen sizes and this could impact tablets later. In the television market, it was good as would be expected during this quarter, but not a strong growth as last year. Overall, the LCD segment was about flat year-to-year. Next year estimates the growth will be about 5%, but a shift to manufacturers from Japan to China. There are also some indications based on sample request that next year we can see much more dramatic changes in the television segment electronic functionality.

Computers are confused in terminologies as the desktop and laptops were under pressure, while the tablets and eReaders continue to blossom at many suppliers. The units of PCs probably dropped about 3% to 4% as a structural shift continues to tablets. Most other market segments held their own with some early signs that the military market maybe weakening more.

Automotive and aerospace continues to be the driver of volume. Our exposure to Germany is holding much of our connector market activity and these customers are still optimistic about car sales in conversations with us. Automotive electronic is forecasted to grow in the 7% to 8% range. We are continuing to see communication and IT infrastructure, the routers, switches, base stations etcetera transitioning to faster devices.

Accessing this dramatic increase in data requires faster IT infrastructure equipment to satisfy the new smartphones and this is demanding more memory storage in IT infrastructure appears to be moving up steadily. The medical market at present time look like flat to up about 2% year-on-year. The two robust areas continue to be satellites and automotive and we expect a good year for those areas. Smartphones and tablets should further help the coming year. But complexity is a major improvement as the electronic becomes more complex and requires more passive components.

On the pricing front as we mentioned earlier, we saw a continual pressure on pricing as uncertainty continues and much more spot-buying activity in the market. This always puts pressure on the commodity product pricing which fell in the 2% range during the quarter, although this inline with long-term historical pricing trends.

The uncertainty is in the visibility of the end-market demand will likely continue to put pricing pressures across the board until end-market demand increases. We believe that the ceramic capacity utilization decreased slightly during the quarter as more of the component mix shift to smaller case sizes and more high capacity products to support more sophisticated consumer electronics.

Lead times have remained steady. We would estimate that ceramic capacitor and after utilization remain near that 78% to 80% range depending on the product type. The higher capacity product segment continues to see high utilization levels even though it is seeing pricing pressures, this is driven by some competitors trying to replace decreases in demand for the lower end components with higher end products.

In tantalum products we maintain production this quarter based on a healthy demand in this product line. Our strong material inventory position and low cost to manufacturing continue to give us a hedge in that product type. We work more overtime in this product segment than in any other during the quarter. We continue to maintain our inventory of tantalum material by taking advantage of favorable spot-buying opportunities.

As previous announced we’re excited about the plan acquisition of Nichicon’s tantalum component division with design and production facilities in Japan and in China and a special product’s capability and strong customer ties in Japan and throughout the Asian regions we expect to grow the overall business. We look forward to integrating the operation into the AVX Tantalum Group. This will further enhance our position in the automotive segment and bring a new product as we don’t currently offer to the smartphone segment. Also this will add another manufacturing operation in China where our sales are growing and it remains close to one of our existing facilities.

With this acquisition which is expected to close next month, our strong material purchasing advantage and worldwide sales and marketing network we will reinforce our clear number one global Tantalum component supplier position. During the quarter inventory balance remained relatively steady. The quarter’s gross margin performance at 18.4% represents continued solid operating performance, but was impacted by lower sales and prices. We continue to examine all of our costs especially overhead in order to address gross margin.

SG&A expenses in the quarter came in at $29.2 million, 1.6% below last quarter and 8.6% of sales. The profit from operation was $33.6 million at 10% of sales. During the quarter we continued to generate positive operating cash flow estimated at $40 million. Our earnings were negatively impacted by increases in provision for tax, income taxes and mentioned in our call last quarter and came in at $0.12 per share.

The visibility going forward continues to be uncertain into the next quarter, but we expect to see increasing business that tracks a general economic improvement as we progress through the calendar year. Based on our input from our customers, at this time we would estimate the revenue in the March quarter could increase in the 2% to 3% range compared to the December quarter that the end-market demand increases and our customers gain confidence in the global economic improvement.

To date in January, the gross book-to-bill is running a healthy 1.25 to 1. We would expect margins to come in near the same range and obviously this will depend on the sales level and product mix. This quarter we paid $12.7 million in dividends and we spent $1.8 million repurchasing AVX shares on the markets during the quarter. Our overall financial position continues to remain strong. We spent $10.4 million for facility improvements and equipment expansions in the quarter, as depreciation expense totaled $11.2 million for the quarter.

The issue today continues to be uncertainty across the board as our customers are waiting for the next move in the general economy. The near term is depending on general macroeconomic concerns and how that plays out. The start to the fourth quarter has been positive today. We had the financial strength to continue to address our customer needs for electronic solutions in order to create the exciting consumer and industrial products that will drive future growth opportunities. We will also continue to look for additional acquisition opportunities that will enhance our technology and product portfolio.

I’d now like to take this opportunity to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Matt Sheerin with Stifel Nicolaus.

Matthew Sheerin - Stifel Nicolaus & Company, Inc.

Good morning, John and Kurt, and Happy New Year. So, the first question John, regarding your commentary on backlog, on book-to-bill, those trends all seemed to be pretty positive. You’re guiding – I don’t know if it's cautious guide or not up 1% off of a fairly low base here. Are you just being cautious or you’re really not seeing trends in end-markets that give you any visibility and to either inventory replenishment or any kind of growth here?

John S. Gilbertson

Good morning, Matt. Matt, a couple of things happened, the answer straightforward is I am little cautious, once burnt you’re little shy to hit that stove again. But if you look at the September quarter things were starting to improve pretty good in that September quarter, and apparently what we were seeing was some bill of inventory at the OEMs particularly to get ready for the holiday season, they put a lot of inventory in place. So, that was – that bullishness that we saw on the September quarter did not keep up as we moved into the December quarter. Some of that related to the volumes of some of the smartphones, although they grew dramatically, they didn’t grow to the level that some customers thought they were in the December quarter, so they slowed down as the quarter progressed.

And one major customer actually pushed out a model until the first calendar quarter. So, I would say, at this point I’m more cautious than I am negative. Actually we’re pretty optimistic. If you look at that number, you can look at our book-to-bill and we've been building book-to-bill each quarter over the last three quarters and we have to go back to see this level of backlog. We have to go back to March of – I’d sort of say December, it’ll be the September of ’11. If I looked at this morning, we haven’t had this backlog since September of ’11. So, I’m bullish, but also a wait and see attitude.

Matthew Sheerin - Stifel Nicolaus & Company, Inc.

That’s fair. And on the – and obviously we’re seeing some other suppliers and a very big smartphone manufacturer that looks like big swings in the seasonality and of course you’ve got a lot of mobility exposure there, and I don’t know if that’s the new normal or not where you see big swings inventory build that those customers and then big cuts. Are you still seeing the same things?

John S. Gilbertson

Yeas, Matt we are. It's a good way to see it. I think the new normal is overused, but that’s exactly what we’re seeing. We’re seeing expectations of certain models moving through and build of inventory and then if the model didn’t go then they’re very hesitant to take any more. And we’re also seeing as I tried to highlight in the narrative, a real mix around month-to-month of who’s a player and who’s not a player in the smartphones. It depends on models. It's becoming much more model sensitive. You used to have pretty much standard models quarter-to-quarter, but not we’re seeing dramatic model changes within the quarters. So that’s making it difficult to predict what you’re going to do.

Matthew Sheerin - Stifel Nicolaus & Company, Inc.

And is that more difficult for you in terms of being designed in on certain products or they are more, do you have more commodity products in those end-markets, so that it doesn’t make as much a difference?

John S. Gilbertson

We’re seeing more of the high-end components in the smartphone, okay. And we’re seeing that issue of where somebody wants to expedite those at the early point of a model launch, we’re very anxious to get all those components in and in truth they probably over order and then when that model comes out based on how it moves through, they become more conservative on it. But we’re seeing much more complex components go into the smartphones. And the other thing that several of these suppliers have been heard on, I think maybe two quarters ago, we heard more of this, was not being able to get a critical component and then not being able to launch their phone when they said they were going to, and that hurts them in the marketplace. So, they’re very sensitive to not having that component available when they’re going to launch a new model.

Matthew Sheerin - Stifel Nicolaus & Company, Inc.

Okay, that’s helpful. And then just my last question, regarding that Nichicon acquisition; should we expect any significant restructuring and obviously you’re really not going to do much or plan much until the deal was done; but in terms of anticipation of any charges or any big changes to that business that could take time to turn that around?

John S. Gilbertson

No, we’ve looked at that Matt and Kurt over here is shaking his head also. We don’t see any restructuring issues related to that. It's pretty clean. Now, as we mentioned several times in the past, we’ve got some changes to make in their process, but we also got some material that needs to be re-qualified and worked through. So, we expect the real impact on them to improve their profitability’s two to three quarters based on the qualification of new material and our new lower price material getting in there. But truthfully that acquisition is going pretty good and it's been accepted. What we’re nervous about was particularly protecting some of those Japanese automotive accounts and that has gone real well. So, we’re very positive at this point.

Matthew Sheerin - Stifel Nicolaus & Company, Inc.

Okay. That’s helpful, and thanks a lot, John.

John S. Gilbertson

Thank you, Matt.

Operator

(Operator Instructions) Your next question comes from the line of Jim Suva with Citi.

Jim Suva - Citi

Thank you, and congratulations to you and your team there at AVX. Pretty volatile times we’re living in right now today. When we think about this mix shift to tablets, can you kind of help us compare on contrast AVX’s dollar value or content of say tablets versus PC, is it similar or is it higher, is it lower. How should we think about that? And then also then just a clarification quarter, on the EPA can you help us understand in terms of the cash flow timing so we can build that internal model? Thanks.

John S. Gilbertson

Good morning, Jim, yeah. I thought you’re going to ask the more difficult question is, how is our tablets going to do emerging into smartphones, so that’s the question that we’re debating around here a lot. What’s going to be a tablet and what’s going to be a smartphone? But the basic answer is we do better in a tablet. The mix of our product I don’t have that dollar value, obviously based on everybody doing like a different way. But if you put a touch screen on any device it puts more noise on the circuit and we get more components in there to, you might say filter it. But in truth the more tablets we see the higher our component usage goes up. So, and we get more components in there and we get more higher value components as we see more touch screen. So the more touch screens we see the more functionality there is, we’re going to see more component usage. So, for us a tablet – a $600 tablet has more dollar value – I’m sorry to make a number, but it's a pretty good number, it maybe is that 18%, 20% number as opposed to just a personal computer, but that’s just a guess. Let me let Kurt handle the EPA finance issue.

Kurt Cummings

Good morning, Jim. If you’ve been following the issue, the EPA opened up for public comments on the settlement through the middle of the later part of December. And right now we’re waiting for the EPA to issue its public responses to those comments and then seeking court approval for the settlement. So, at this point I really can’t predict when that will occur. The timing of the ultimate payments is the same as we’ve discussed in the past with approximately one-third going out after approval and then another chunk a year later and the final payment a year after that. So the sequence hasn’t changed, but the timing of the initial payment isn’t unknown.

Jim Suva - Citi

Okay, that makes sense. And then the reason why I didn’t ask about the transition of smartphones to tablets and what AVX’s positions were, but maybe I’m incorrect because I assumed that a tablet is kind of just like a big smartphone, but maybe there is a structural difference. You had mentioned that going from PC to tablets is a benefit given the touch surface where it helps you out, but from smartphones to tablets I just assume that was kind of comparable, is that accurate? And then finally the last question is your end-market percent if you can break that down then I'll cede the floor to the next caller.

John S. Gilbertson

All right, Jim, my instinct there is that because of the size constraint because of all the functionality on a handset smartphone, it is much more component driven than eventually perhaps a tablet would be, okay. In the early phases of a tablet as you’re well aware any new design always uses a little bit more components as time goes on, it diminishes. But I believe that when we get through with this, when you set a tablet down versus a fully functional smartphone you will see more components in that smartphone. And when they merge, I’m not sure and we’re having a lot of discussion about that and I’m not really sure we have a consensus on that.

Moving to the issues as far as market segment, automotive was 20%, cellular was 16%, computer was 13%, consumer was 9%, industrial 13%. Its interesting on industrial, we’re seeing more wind projects than we’ve solar projects. The medical was 7%, military was 4%, networking was 4% and telecom was 14%. Okay? Hello Jim?

Jim Suva - Citi

Thank you.

John S. Gilbertson

All right.

Operator

(Operator Instructions) Your next question comes from the line of Brett Reiss with Janney Montgomery Scott.

Brett Reiss - Janney Montgomery Scott LLC

Good morning, gentlemen. Are you seeing anything from your customers that are going to reinvigorate television sales, I thought I heard a comment very briefly in your narrative.

John S. Gilbertson

Right. That is correct. And if you look at – if you’re knowledgeable about the television sales it’s been sort of a spotty history, they’ve gone to size and then they over bill to different areas. So it’s been kind of up and down. But what we’re seeing not from necessarily any knowledge, but what we’re seeing from sample request from television manufacturers is they’re going into more functionality. The TV screen doing more things. So they’re asking for samples right now that indicate we could see next year different format or a different functionality of television than we saw during this season. I think they felt that they needed more bells and whistles than they had this Christmas season and they’re out very vigorously trying to put more bells and whistles in those. What those are, we don’t know because they never tell us. We only can judge it by the samples that they request.

Brett Reiss - Janney Montgomery Scott LLC

Right. But that’s something often to the future because with some of the channel checking I did with the CES conference, the feeling was the ultra high-def TV were wonderful. But the pricing it’s just not going to get units moving, is that your observation?

John S. Gilbertson

Yes, that’s exactly the observation and if you get the inputs from those, from that meeting it was – I won’t say glooming, but – gloomy, but it sure went robust. So I think what they’re saying is not necessarily new formats for television, but the television being able to do more things or more than just a television set. Now, what that would involve, I’m not sure I understand, but from the sample request they’re asking for components that they don’t normally ask for. So they could be experimenting around, but I think they feel as a result of their performance in the year that they have to come up with something with a little significant twist to this next season.

Brett Reiss - Janney Montgomery Scott LLC

Great. Thank you for taking my questions.

John S. Gilbertson

Okay. Thank you very much.

Operator

At this time there are no …

John S. Gilbertson

All right. We – is that the last of the calls, Sabrina?

Operator

Yes, sir.

John S. Gilbertson

Thank you very much and we appreciate your time and we will look forward to seeing you in the March quarter. Thanks again.

Operator

This does conclude today’s conference call. You may now disconnect.

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