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AVX Corporation (NYSE:AVX)

F3Q 2014 Earnings Call

January 28, 2014 10:00 a.m. ET

Executives

John Gilbertson - Chief Executive Officer

Kurt Cummings - Chief Financial Officer

John Lawing - President and Chief Operating Officer

Analysts

Jim Suva - Citi

Matt Sheerin - Stifel, Nicolaus & Company

Ruplu Bhattacharya - Bank of America Merrill Lynch

Operator

Good morning. My name is Jodie and I will be your conference operator today. At this time I would like to welcome everyone to the AVX Corporation third quarter earnings conference call. (Operator Instructions) I would now like to turn the conference over to Mr. John Gilbertson, CEO of AVX Corporation. Please go ahead, sir.

John Gilbertson

Thank you, Jodie, and good morning. I would like to thank you for attending the AVX conference call regarding the results for our third quarter that ended in December. I am John Gilbertson, with me today are Kurt Cummings, AVX's Chief Financial Officer; and John Lawing, AVX's President and Chief Operating Officer.

I hope that you have had a chance to review our earnings release that was issued this morning. The December quarter sales were $346.2 million and reflected the seasonality of a constrained holiday period. This season lacked a big consumer product and enthusiasm was not high going into the season. The consumer segment was particularly conservative and this hit the commodity products the most. This continued caution created and aggressive inventory management stance by many of our customers. Inventories during the holiday season were under tight control and customers were reluctant to build any inventory in the market channels.

Everyone was worried about inventory build and the recent GDP figures highlighted this inventory increase. In addition, some of the phone models slow movement through the channel increased caution across the entire spectrum and caused push offs of new model builds from major suppliers. Yet, our overall backlog did increase 1.7% from the end of the September, reflecting preparation for spring releases of new products and we are seeing a pickup now in the phone business related to new models. But customers would not take early shipments in the December quarter. The January month-to-date activity is currently running a positive gross order book-to-bill of 1.2 at this point. I will remind you that the Chinese New Year is coming up and we do get preorders prior to that period.

Some of our distributor customers appear to seeing slowing increasing demand although they continued to maintain conservative inventory positions and only order for business that is immediately visible. Current lead times allow distribution to run very high turns. Our shipments to the distribution channel increased almost 3% from the September and this continues to be a positive sign. In this quarter the distribution channel represented 45% of our overall shipments. This was up 4 points from the previous quarter. We generally have a strong share in this key channel and we except that their demand will increase during the calendar year. This should lead to an inventory replenishment cycle if the end market demand strengthens and lead times move out.

Europe distributors appear to be recovering at a quicker pace. At we have indicated previously, at the current level of distributor inventory a strong improvement in end market demand could cause immediate constraints on supply. Limited inventory should also help stabilize sale prices going forward. Regionally, Europe increased to 27% of our total sales, up 3 percentage points this quarter and continues with a strong January. The Americas stayed steady at 29% and Asian sales were 44% of the total. Europe is slowly starting to see improvements. Looking at some of the market segments, the cellular market, the issue again centered around concern regarding end-product inventory in the channel as I mentioned earlier and how it would move during the holiday season.

Some models were pushed out to later in the New Year and more of a wait and see strategy dominated this quarter's market in cell phones. Smartphones are still growing but not at the rate of last year. The movement in cell phones is definitely to larger screens which should generate a newbuild cycle. In the handset market, we estimated the total market last year at approximately 1.8 billion units for a growth rate of 3.7% year-on-year. Smartphone are estimated to have just topped the 1 billion unit level and therefore standard handsets would be in the 800 million range.

Most recently, the Chinese handset and telecommunication infrastructure manufacturers are picking up their activity and could drive the Smartphone growth rate up to the new 4G platforms that are booming in China. The 4G buildup appears to have surprised suppliers in China and they are requesting more product to meet a new schedule. We mentioned this last quarter. But we as well as many of our customers underestimated the demand that has shown up in January. The lead time in high-end components for the 4G buildup are moving up significantly. The December quarter which is normally pushed up by personal computers and TV sales were weaker than normal. Tablets were stronger but PC and TV production from our perspective were lackluster this year and our customers appear to be getting that news earlier than published reports.

We estimated last quarter that PCs would finish in the 320 million unit range and now think that number would be closer to 315 million and reflect about a 10% drop year-on-year. On tablets we had estimated it would come in about 205 million units and they will probably come in closer to at least 220 million units for close to a 50% increase year-on-year. Tablet activity was a good news but there is some confusion in the market as to which brand or platform is the best buy. From some early indications we think this will clear up more in the New Year with some shake outs in the offering. The new hot item appears to be wearable products, but that is just opening up at this time.

The traditional serve it market is still good across the spectrum although some suppliers are not doing as well as others. The big story continues to be cloud storage growth which will add to demand to support hardware increases all of next year. Medical and defense markets were reasonable but not strong. We are seeing more F-35 aircraft orders and this is helping across many product lines. In automotive, all the news continues to be good. We are seeing growth in all regions and product lines associated with automotive. Our auto customers continue to be optimistic and continue to hold up Europe for us. The U.S. market remains good and that should continue to flow into the new calendar year.

In other transportation areas, the upgrade of the rail transport in the industrial segment market is more sluggish than anything and growth continues to be forecasted but as of yet not seeing what was anticipated, particularly in emerging markets. In aerospace, both the military and commercial continues to increase electronic content and this is adding volume. At this point we believe this segment will be stronger next year than it has been this year. I mentioned it last quarter but it still holds true as we are hearing a common theme across all markets calling for improvements next year than this year. We will just have to wait and see what results in the first and second quarter.

In the pricing, sales prices are still under pressure and broad product delivery lead times have not yet extended. But in general, we were satisfied with our margin performance this quarter which was aided by decreased reliance on commodity type products and greater share in our value added products. This was a quarter where margin management was critical. The yen remains low and opportunistic spot buying activity continues in this type of product. This always puts pressure on the commodity product pricing which fell 1% range during the quarter. It's still in line with or slightly better than long-term historical pricing trends. We anticipate that this trend will continue unless end-market demands picks up in a more meaningful way.

We believe that the ceramic capacity utilization was flat to up slightly during the quarter, taking into account the holiday schedule as more of the component mix shift to smaller case sizes and more high capacitance products to support increasingly sophisticated consumer electronics. Delivery times have generally remained steady, we would estimate that ceramic capacitor industry utilization remains in the 75% to 80% range depending on the product type. Again, the higher capacitance product segment continues to see high utilization levels even though it is seeing pricing pressures while we are the top of our capacity for this type of product.

In the tantalum product, we maintained high production this quarter based on a healthy demand in this product line. We are seeing some competitors appear to price their products for cash flow only in the lower ranges of products. This today has impacted industry margins significantly but not hurt sales to the larger customers. Buying for revenue is something that we have seen in the past and eventually it subsides if other pressures counteract. Right now we feel that prices can be held in a reasonable range if we pick and chose what business to participate in.

This quarter's AVX gross margin performance of 19.6% reflects continued solid operating performance and a favorable mix of value-added components. We continue to examine all of our costs, especially overhead, in order to enhance gross margins. SG&A expenses in the quarter came in slightly better at $32 million or 9.3% of sales. The profit from operation was $35 million or 10% of sales. Our earnings came in at $0.19 per share for the quarter with a strong margin improvement performance enhanced by favorable income tax movement.

This quarter we paid $15 million in debt and dividend and we spent $4 million repurchasing AVX shares on the market during the quarter. For the quarter we spent $6 million for facility improvements and equipment and depreciation expense was $10 million. The settlement with the EPA regarding the Harbor in Massachusetts was finalized and the initial installment paid in October. Our overall financial position continues to remain strong. The visibility going forward remains uncertain and the backlog movement in this past quarter leads to estimate that our shipments in the March quarter will increase in the 2% to 3% range.

Activity in the new calendar year should track general economic conditions and anticipated demand improvements. But nothing leads us to believe that we will see a large step up in the next quarter. We would expect margins to come in near the 18% to 19% range but as always, this will depend on sales level, selling prices and the mix of the products sold. The issue today remains the uncertainty across the board as our customers are still optimistic but careful about taking on risks associated with inventory. Near-term is dependent upon the general macroeconomic concerns and how that plays out. We have seen increased design activities from many handheld device makers, as the need for extended battery life and enhanced functionality continues. We anticipate an increase in new electronic applications in the spring of this year.

I would now like to open it up for any questions.

Question-and-Answer Session

Operator

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

Jim Suva - Citi

Thank you, John and Kurt, and congratulations on your results. Quick question. Can you run through just the end market percent of sales, computer and network and all that, for us as well as then your segments such as tantalum and ceramics? And then after that I have a follow-up question.

John Gilbertson

Yes, good morning to you Jim. Thank you. If you look at the segment, automotive was 21%, cellular was 13%, computer was 14%, consumer was 9%, industrial was 13%. Medical was 8%, military was 4%. Network was 4%, and telecom was 14%. It's pretty flat to last quarter Jim. If you look at the markets analysis by product divisions, ceramics was 15%, tantalum was 28%, the advanced products was 25%, the resale business was 17% and the connectors were 15%. Okay.

Jim Suva - Citi

Yes. And then as a follow-up. For the EPA settlement, can you help us better understand the payment timing schedule? What you've paid so far and the future payment schedule?

Kurt Cummings

Sure, Jim. This is Kurt Cummings. As you will recall the settlement was $366 million and we paid $133 million in October. The next scheduled payment would be about $110 million scheduled for September but as we have indicated previously, we can prepay the future payments at any time.

Jim Suva - Citi

Okay. And the rationale between prepaying versus not prepaying, is it basically NPV or looking at the interest rates? Or looking at, you have other uses of cash that you could do whether it's acquisitions, or how should we think about your timing for the cash flows for that versus, I don’t know, are acquisitions on the horizon?

John Gilbertson

Well, acquisitions are always part of our strategy but the amount of cash we have would not be impacted by the Harbor settlement. So that would not influence our acquisition strategy. As you mentioned, there is an interest element but there are also tax considerations on sticking to the original schedule or prepaying any amounts.

Jim Suva - Citi

Okay. Great. My last question. On taxes going forward, anything that could move that number or is it pretty consistent of what happened this quarter? How should we model cash -- I am sorry, taxes on a long-term basis?

John Gilbertson

Well, one thing is certain with taxes, it's never consistent. But the 30% range is our normal tax rate at this point. And then each quarter you may have some onetime items that affect the overall rate.

Operator

Your next question comes from the line of Matt Sheerin from Stifel, Nicolaus.

Matt Sheerin - Stifel, Nicolaus & Company

John, it looks like the gross margin, obviously pretty strong, considering the 7% or 8% decline in revenue sequentially, and it sounds like that was more a mix issue than anything with relatively strong distribution and also as you said, more specialized product. It looks like from your breakdown of end markets, it looked like the wire cellular or wireless business was actually down sequentially and also PCs were weak. So is that sort of the takeaway there that the commodity products were weaker and the mix helped you?

John Gilbertson

Yes, that exactly right, Matt. And we did a lot more margin management on, I guess I would call it, we walked away from some very low margins business particularly in Asia during the quarter, and that helped us a little bit. But there is no question that the activity in the cellular market was very uncertain. Everybody was extremely cautious. I have never seen normally at the end of a quarter we can forward ship items, particularly to distribution or some big customers. But in the cellular business it was inventory management, inventory management and more inventory management. So they were concerned about not only the inventory they had but the sell-through of the finished product and they wanted to see what the Christmas or the holiday season was. So that was an issue there is no question about it.

Matt Sheerin - Stifel, Nicolaus & Company

Yes, it's helpful. And you're guiding gross margin down, it looks like 100 to 200 basis points or so, and is that really a function of mix there? Because you do have sequential growth coming and distribution, it would seem seasonally, it should be up for you.

John Gilbertson

Yes, I do think. But I think right now the new models are not coming on at quick in the cellular business as you would anticipate at this time. So this time last time we were seeing some build schedules that we are not seeing now. I believe that we will see that later in the quarter than we anticipate. In other words, it will move out into the after March before we see a bigger build in the cellular business. So I think that volume, when there is volume down, I have said a couple of times, in this handset business, it affects prices and margin and the rest of the business because it's not eating up its normal capacity. But I think there is several projects online that will help move it up early in the spring.

Matt Sheerin - Stifel, Nicolaus & Company

Okay. Great. And your commentary, John, on the fact that in distribution, inventories are running very lean and that any kind of push on the demand front across more than just auto and industrial would seem to be holding up, would lead to lead times and possible allocation overnight which we've seen in past cycles. But is that, I mean do we need multiple markets to pick up here and do you have any visibility? You sound a little bit more cautious than you did last quarter.

John Gilbertson

Yes. I didn’t want to sound that cautious but I think the thing that surprised me a little bit, Matt, was the lack of not being able to move anything in that December quarter. I mean the December month we normally can refurbish some of the inventory at places and help us in that December quarter. That just didn’t happen this time. So it added a little conservative bent to my thoughts there. But in truth, if we look at the distribution market, they are seeing a little improvement in POS. And normally, that POS would bring a little bit more inventory replenishment cycle. But we are not seeing that yet. We are seeing some, particularly in Europe, the distribution market there is picking up a little bit. Their POS, albeit from a very low base a year ago, Europe is surprisingly strong and we are seeing distribution be stronger in Europe than we are in the U.S.

Matt Sheerin - Stifel, Nicolaus & Company

Okay. And then lastly, just a question on SG&A for Kurt, it was up a couple of million. Is that $32 million level something that we should expect this quarter or will it be down?

Kurt Cummings

Matt, I think that was on the higher end of our expectation some of it being specialized expenses in the quarter. I would think the $30 million to $31 million range should be manageable at this level of sales.

Operator

(Operator Instructions) Your next question comes from the line of Ruplu Bhattacharya from Bank of America.

Ruplu Bhattacharya - Bank of America Merrill Lynch

My first question relates to tantalum and you've been pretty good at being opportunistic in buying tantalum when the prices have been low. So I was wondering are you buying tantalum now and can we think of that as being a tailwind to margins going forward? Because if we look at the spot prices today, at least compared to a year ago, they're much lower. So do you think that can be a tailwind to your margins in the future?

John Gilbertson

Yes, I do. I think it can. A couple of issues there. As you are probably aware you are asking a question that’s, you are familiar with the market. There has been, the supply issue has been very limited here in about six months. We have been opportunistic [ph], buying on the market to replenish at a lower price and that should help us going forward. The activity in the tantalum market from an ore standpoint is very low and that’s keeping the spot prices down. But I would say that is a temporary thing in my opinion. We are going to see those pick up. Right now it's the raining season in most of the areas where the mines are and there is very little ore coming out. So the opportunity to buy and having the cash and the financial resource to do it, now is a good time to be buying tantalum product. And we will see rises in the second half of next year almost certainly unless the economy should take a dive.

Ruplu Bhattacharya - Bank of America Merrill Lynch

Okay, thanks, John. That was helpful. Just wanted to ask you on Nichicon. You were qualifying your product so they could use your tantalum. Has that been qualified? Is the integration on Nichicon complete now?

John Gilbertson

We are about 60% or 70% of that movement of product through there. I think at the end of this quarter we should be at a level where we can. Some of that product, as you may be aware, went to automotive, particularly in Japan. And it's difficult to get them to qualify a product longer, it generally takes longer than you think it's going to and this would take a little bit longer than I thought it would. But we will probably have that completed by the end of March.

Ruplu Bhattacharya - Bank of America Merrill Lynch

Okay. And just when you look at these end devices, John, when you look at the new phones that are coming out, do you think that your content on smartphones and tablets is increasing and is there any way to quantify that content growth?

John Gilbertson

Okay. It's difficult to quantify that but we do know, anytime you make it more complicated, for instance larger screens, you get let's say, more noise in the circuit which requires more of our components. So as they go to larger and larger screens which they are all going to do from what we can see from sample size, it's going to require more content. Now on the negative side, obviously as tablets not as functional sometimes as personal computers, so in personal computer we do lose some content in that direction. We would rather sell a laptop, for instance, than we would a tablet. So that hurts on that side. But the complexity of the tablets will increase the component usage.

Ruplu Bhattacharya - Bank of America Merrill Lynch

Okay. Great. No, that makes sense. And one for Kurt. For this quarter, the tax rate came in quite a bit lower than what we had expected. What was the reason for that?

Kurt Cummings

Ruplu, there are many things around the world that can affect that. But some of it relates to the expiration or periods when the tax accruals can be, or tax returns can be challenged in various countries. So it happens periodically as those periods expire. But as I said earlier, it's a very hard rate to predict for a global business.

Operator

Your next question comes from the line of Jim Suva from Citi.

Jim Suva - Citi

A quick follow-up. I think on the Q&A when I asked about the use of cash, Kurt, I think you mentioned that the EPA settlement and future payments don't impact your cash level or maybe I misunderstood that. Have you like accrued for that in some type of a reserve fund for it or just can you help me clarify, understand that statement a little bit?

Kurt Cummings

I apologize if what I sad wasn’t clear. It certainly would affect our cash level but what I meant to say was, given the amount of cash that we do have and certainly borrowing capacity if we wanted to do that, we have the ability to pursue our acquisition strategy. And the strategy is not impacted by the amounts we would owe related to the Harbor.

Jim Suva - Citi

Perfect. All right, I got that now. That's very clear. And then my second follow-up question is, I think you said, if I'm correct, ASPs were down about 1%. And am I correct that you kind of expect down 1% per quarter to continue?

John Gilbertson

Yes, Jim, that’s pretty much in line with what we traditionally see. And again whey volume drops, we do see more pricing pressure than obviously when things are good. And we would expect that 1% range again next quarter.

All right. Thank you very much. We appreciate your time in listening to us for the quarter review and we look forward to seeing you in the next quarter conference call. Good bye.

Operator

Thank you. That concludes today's conference call. You may now disconnect.

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