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AVX Corporation (NYSE:AVX)

F3Q 2012 (12/31/11) Earnings Conference Call

January 25, 2011 10:00 AM EST

Executives

John Gilbertson – CEO and President

Kurt Cummings – CFO

Analysts

Matt Sheerin – Stifel Nicolaus

Joe Wittine – Longbow Research

Jim Suva – Citi

Operator

Good morning. My name is Chris and I will be your conference operator today.

At this time, I would 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 speaker’s remarks, there will be a question-and-answer session. (Operating Instructions).

I will now turn the call over to John Gilbertson, CEO and President. Please go ahead, sir.

John Gilbertson

Yes, thank you, Chris. Good morning. I’d 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, and with me today is Kurt Cummings, AVX Chief Financial Officer, and Peter Collis, our Worldwide Tantalum Operational VP.

I hope you’ve had a chance to review our earnings release that was issued this morning. The December quarter was a challenging quarter. The global economic uncertainty combined with an inventory level correction up and down the supply chain but affected the orders and sales pattern. The supply disruption in Thailand had some impact as availability of other products limited production at several of our customers. But these impacts were overshadowed by inventory concerns as many customers were reluctant to take any product beyond the immediate need.

The quarter revenues were most impacted by actions at major distributors to reduce their inventory levels and limit shipments at the end of the year. The OEM market channel saw less impact which we believe indicates likely improvement going forward, despite continued uncertainty regarding the general economy as you all well know. Inventory levels at all customers are being watched closely until the demand picture becomes clear. The feedback from our customers is that inventory correction will be complete by the end of the March quarter and demand should accelerate in the second half of the calendar year. January activity has been encouraging, but the unknown is if the inventory correction will persist into the June quarter.

Automotive, especially in Europe, continues to be strong. And as indicated in the last call, in many ways seemed to be acting apart from the rest of the users of components. Another major area, the phone market, continues with good news regarding the continual strength of smartphones, but has been offset by some weakness in the feature phones which many of our customers are moving away from in favor of the newer smartphones. In general, other end-market demand appears to have stabilized and in some categories to be increasing.

The sales in the quarter were $341 million. In this quarter, the distribution channel represented approximately 35% of our overall shipments, down from 38% in the last quarter and 42% in the quarter previous to that, reflective of the conservative inventory position I mentioned earlier. For the distributors, they appeared to be seeing stable activity with their customers and a continuing reduction in their months of inventory in some categories.

To summarize the market segment, automotive remained strong in all three regions, with Europe leading the way. As the electronic systems become more complex and smarter, we are seeing more components and increasing overall unit growth. Some of our acquisition efforts are concentrated in the automotive sector, especially in Asia. Power film capacitors associated with power storage in hybrid and electric vehicles and transient voltage suppressors in the vehicle electronic systems are creating opportunities for additional new products in automotive.

As mentioned earlier, the mobile handset market is continuing to see a shift from feature phones to smartphones at a more rapid rate than anticipated. Already at 26% of the overall handset market, up from 21% a year-ago, the smartphone will most likely continue to be the main growth driver in cellphones. The increase in functionality of these smartphones increases the need for AVX components. Smartphones typically have twice the number of components than a traditional cellphone, but also are putting more pressure on bandwidth requirements.

The increase in demand for more bandwidth at the network operator is driving the need to upgrade existing wireless broadband and telecom infrastructure. Everyone is pushing for more bandwidth, and this should result in growth for this market in the next couple of years. This will increase the component count as the need for features and efficiencies converge. The latest base station utilizes more sophisticated electronic solutions to support the increase demand in bandwidth. We anticipate traditional defense spending to be restrained this next year, although at the current time we have not seen a significant impact. Some projects are active like the unmanned aerial vehicles and increased satellite activity.

In the consumer market, the 3D television has not created the growth in the market as originally expected. At the 2012 CES Show in Vegas, it was reported new TV with both 4K and 8K resolutions were very impressive. These newer features could expand the use of current product offerings.

In the medical area, we have seen some recent improvements in this area. Pacemakers continue to show growth, while defibrillators are moderating. Growth in the newer neuro stimulation devices for pain continues strong. AVX has a strong presence in these devices through our high-reliability miniaturized capacitors and other components. We believe that we will continue to see the number one – to be the number one component supplier by a wide margin in the medical business.

In the personal computing market, the year of the tablet resulted in nearly 50 million units sold in calendar 2011 versus 18 million units last year. Ultrabooks are now the new buzz word and appear to be a serious competitor to the tablet. This small light weight PC will have more powerful processors, giving it more horsepower than most tablets. AVX’s low ESR tantalum polymer devices are improving the power efficiency of these products resulting in longer battery life.

Oil and gas exploration was the driver in the industrial market this past year and grew 20% for us. Deeper drilling, both vertically and horizontally are allowing many options for tapping into these energy sources. For temperatures above 200 degrees Celsius and high humidity, AVX high-reliability products are a must. The traction market such as high-speed rail lines in China is expected to see a strong growth in the second half of calendar 2012 once some of the recent rail problems are resolved in this growth market.

As a percentage of the overall revenue in the quarter for the region, Europe continues strong with the automotive markets continuing to be the player in that region. Other end markets in Europe are less robust. Europe represented 27% of the total, a single point than last quarter, while Asian sales decreased one point to 45%, and the Americas sales increased to 28% of the total.

The commodity product pricing decreased between 1% and 2% during the quarter in line with long-term historical pricing trends. Pricing was also impacted by a seasonal affect in the December quarter as it is usually when we see more shipments of consumer product during the holiday season. The uncertainties in the strength of the end-market demand may continue to put pressure on selling prices going forward.

We believe that capacity utilization eased during the quarter. We would estimate that ceramic capacitor industry utilization is near the 75% to 80% depending on the product line. The tantalum capacity utilization is somewhat as well, now in the 80% to 85% range. Our strong material inventory position and low cost to manufacturing continues to give us an edge in that market. We believe we have partially offset the weakness in worldwide tantalum unit usage with increased market share.

Inflationary pressures have affected the price for many of the materials and the currency movement during the quarter affected both our top-line and our bottom-line numbers. Currency was more of an influence on revenue than in previous quarters. During the quarter, we lowered production levels in order to manage our finished goods inventory.

The quarter’s gross margin performance at 23% reflected continued solid operating performance. We continued to address all of our costs, especially overhead in order to hold up gross margins. During the quarter, we also deemphasized some marginal businesses based on selling prices.

SG&A expenses in the quarter decreased when compared to the previous quarter and came in at $28.1 million which is 8.2% of sales. The manufacturing plants continue to operate efficiently despite lower output, and this has helped margin, as well as control SG&A.

The profit from operation was $50.2 million in the quarter and close to 15% of sales. Our earnings were $0.22 for the quarter. During the quarter, we continued to generate positive operating cash flow estimated at $50 million.

The December quarter distributor POS, point-of-sales trend appears to have remained steady, which is a good measure of the continuing strength of the end-market demand. I hesitate to mention visibility concerning the next quarters, but it should track the general economy. As mentioned earlier, our distributor customers have indicated that the supply chain inventory correction should be completed next quarter with our sales in the channel increasing at the correction to match their POS numbers.

As this correction continues, at this time, we would estimate revenues in the March quarter to be flat-to-up 1% to 3% range compared to the December quarter. We would expect margins to come in at the 22% range depending on the sales level and mix.

In the quarter, we paid $12.7 million in dividend, which reflect the most recent quarterly rate approved by the Board of Directors in October. We spent $2 million repurchasing AVX shares on the market during the quarter. Our overall financial position continues to remain strong with $1 billion in cash and security investments at the end of December or approximately $6 per share of outstanding stock. We spent $10.6 million for facility improvements and equipment expansion in the quarter or $38.5 million for the first three quarters. Depreciation expense totaled $11.4 million for the quarter.

As we have said before, we had many things in our favor in the electronic industry. Our customers continue to design end-market products with increased sophisticated electronics in virtually every industry we serve. This is evident in the expanding smartphones, ultrabooks, netbooks, and tablet markets, the telecommunication infrastructure, as well as in automotive and commercial transportation. We have the financial strength to continue to address our customer needs for electronic solutions in order to create those exciting customer industrial products and participate in strategic acquisition opportunities, several of which are under active investigation.

On the acquisition front, we are currently actively working three projects with one in the due diligence phase. We expect to continue to seek more opportunities during the next 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 Matt Sheerin with Stifel Nicolaus.

Matt Sheerin – Stifel Nicolaus

Yes. Hi, John and Kurt. So first question, John, you talked about looking at sort of flat-to-up revenue in the March quarter, and also talked about the distribution and inventory correction continuing, so do you expect sell into distribution for you to be down again offset by sequential growth in OEM business, or is distribution going to flatten out as well?

John Gilbertson

Matt, what we’re seeing right now is more activity in the distribution market, and we expect that in – starting in February and March that activity pick up. What’s happened in the distribution channel is, their months of inventory – when the slowdown occurred their months of inventory went up and what they have done is not taken any new inventory replenishment in order to drive that months of inventory down, and that is what has happened. The inventory or the request to us has gone down more than their POS in order to get their inventory to a number that they’re more comfortable with, but we anticipate seeing a low improvement in the OEM. But a larger improvement in distribution channel.

Matt Sheerin – Stifel Nicolaus

Okay, so you expect distribution sales to be better. And you’re looking at margin of 22% I think you said with revenue flat-to-up. Why would margins be down, is that a mix issue?

Kurt Cummings

Matt, this is Kurt. I think you are right on the mix issue. But we’re also seeing some of those higher material cost flowing through. There has been some moderation of metal prices recently, but the inventory purchased during the previous quarter has kind of come through. So I expect some affect from higher costs.

Matt Sheerin – Stifel Nicolaus

I know you’re seeing AS – continued ASP pressure in some of the commodity areas that you talked about John, is that another reason?

John Gilbertson

Right. We’re having a couple of things that impact us there. The March quarter is not always good for prices, because you have the cellphone guys sort of retooling, if I can use that word. They’re waiting to see the sell-through distribution to service providers and they generally start new projects that period. So their activity is not as strong in that March quarter to the supplier, so that tends to have more available capacity in the March quarter. So there is more pricing pressures. We’ll see more pricing pressures in this next couple of months until it starts settling out a little bit more for that June quarter.

Matt Sheerin – Stifel Nicolaus

Okay. And you sensed that margins are going to bottom here then for you in the March quarter.

John Gilbertson

I feel comfortable that they will bottom for us in the March quarter.

Matt Sheerin – Stifel Nicolaus

Okay. And if I can just lastly ask you to – as you do every quarter go over the percentage sales by end market and then also by category.

John Gilbertson

Certainly. Automotive again it’s up another point; it’s now 19% of our business. And that automotive market if you look this time last year was 16% – 15%. So we’ve probably increased our automotive penetration by about a point every quarter. I think that average might be that. So it’s at 19% right now. Cellular was 14% of our business. Computer was down a little bit; it was weaker than I think we anticipated and perhaps the market did, it was a 12% drop from 13% last quarter.

Consumer, 9% of our business; industrial, 14%. Medical, again I mentioned that is very good for us; it was 8% of our total revenue and we haven’t seen 8% since the first quarter of FY ’10. So that seems to see some life in it. Military, 5%, that’s been flat for the last six quarters; networking 4%; and telecom 15%.

By product type, ceramic was up to 12%; tantalum was 24%; advanced products was 25%; resale business was 26%; and connectors was up another 2 points from the previous quarter to 13%. So the connectors are doing very well.

Matt Sheerin – Stifel Nicolaus

Okay. And I’m sorry, if I can just one quick follow-up on the strength in auto is, what’s the mix in your auto business connectors versus passive components?

John Gilbertson

If you look at our – I’d say 80% of our – just a rough guess Matt, 80% of our connector business is automotive. What we’re seeing an increasing leverage to that automotive business in the connector markets for both tantalums and for ceramics. So we’re going to see more ceramics business in automotive this year than we did last year same way with tantalum.

Matt Sheerin – Stifel Nicolaus

Okay, that was helpful. Thanks a lot.

Operator

Your next question comes from the line of Joe Wittine with Longbow Research.

Joe Wittine – Longbow Research

Hi, it’s Joe Wittine calling on behalf of Shawn Harrison. Can you hear me okay?

John Gilbertson

Yes, Joe. We got you.

Joe Wittine – Longbow Research

Thanks. So John you gave some pretty good color on what’s happening in the markets. I’m hoping if you can give us maybe some additional comments on the book-to-bill ratio, both for the December quarter, and then what you are seeing in the month of January, and just to be clear, when you think the bottom was, or will be in bookings particularly to distributors?

John Gilbertson

Okay, good question, Joe. Joe, I don’t have right in front of me the book-to-bill for the quarter, but it was negative. Now, a better answer to your question is, it was negative. And it was positive in September, it was negative in December and it was – in November it is negative and December, so that was somewhat of a concern, and it was negative most of the quarter. Now, January – we’re into January pretty good and it’s running positive. So right now it’s 1.05. I looked at it this morning before I came here. So that is good.

Now, as to the quarter, seasonality – I think the low point for distribution was in the December quarter and that it will improve in the March quarter. Now that doesn’t mean that the low point for the company could be in that period, because of the seasonality of the March quarter. But I think that we will see the low point was probably occurred in that December timeframe for distribution, and we should see improving condition in distribution going forward.

Joe Wittine – Longbow Research

Okay, very helpful, thanks John. And then maybe along similar lines, anything to point out as far as inventory at distribution amongst the different geographies; I know you guys are obviously very overweight Asia. But anywhere you’re still seeing the inventory correction I guess, or saw an early conclusion to it between geographies?

John Gilbertson

No, I would say those geographies which is – is a little bit surprising, it came down together. We don’t normally see that in the distribution channel. Of course, sometimes –to call some of the activity in Asia, distribution is not the same model I would say as in Europe and in the US. But in general we saw that downturn come together. Normally we will see one region in distribution get more conservative than other, but they all three pretty much went down. That’s – they didn't go down, they became more conservative in that period. Their POS was respectable in that December quarter as you can see from some of their reports.

Joe Wittine – Longbow Research

Kurt, then this is a follow-up on the SG&A line. We saw cost coming down a decent amount in the December quarter, was that just selling expenses coming down; I didn’t hear of any kind of cost cuts that were over and above. And how should we expect SG&A the trend as we go forward? Should hang around this kind of $28-million level over the next few quarters assuming sales are flattish.

Kurt Cummings

You are right. Some of it was relatively to the level of sales, but we’ve been very careful about spending as well in order to try to maintain the strength of the profitability. Going forward, I think that’s a fair dollar amount to use. As the revenues rise it will come up some, but your assumption is okay.

Joe Wittine – Longbow Research

Okay. Thanks a lot, guys.

John Gilbertson

Thank you, Joe.

Operator

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

John Gilbertson

Good morning, Jim.

Jim Suva – Citi

Good morning and Happy New Year to you and your team there. The question I had is on pricing. With raw materials in the past few years haven’t gone up, and I think many of the companies in your sector has seen better-than-normal expected product pricing, what should we kind of expect for pricing for your products in March and going forward as we see kind of 2012 unfolding?

John Gilbertson

Jim, we had two factors going there, and that is the competitive nature of the industry particularly in electronics and that need to always lower their price, okay? They have got the issue pressure from the end market very competitive. That’s still in place. But there is a new parameter there in play and that’s these material prices. If you take somebody like one of the large automotive guys, they are a lot more sympathetic than they were five years ago to price increases, because they are seeing themselves. All these – particularly any noble metal is gone through the rough. People are much more understanding about those things.

I don’t see the pricing pressures going forward that we saw five or six years. We will see again those trends; certain months will be more pressure. December quarter again because consumer is such a big influence is always more price pressure. But I think June will be a good pricing quarter for us. We’ll see some pricing pressures in the March quarter, but I think June will be good. If obviously we’re talking about the general economy, if that’s the stage where it’s at, I think we’ll see a good pricing environment for the calendar 2012.

Jim Suva – Citi

And just one – you have to help me quantify what you mean by good. Are we talking kind of like down a couple of percent, or what – do you actually mean up as in price increases, it seems tough to increase prices?

John Gilbertson

Typically, I think we’ll have quarters flat-to-down, flat-to-down. If we get into another shortage of components if the economy would do a more V shape recover, I think there is – recovery, I think there is opportunity there for pricing. In fact, I think pricing will go up if we see a better improvement in the second half of the year.

Jim Suva – Citi

And then as a follow-up, I think in your prepared remarks, you had mentioned about some strength in Europe. Can you maybe just you know talk a little bit more details on that as compared to similar the other OEMs in the area whether it’s Alcatel-Lucent, Ericsson, or the automakers seeing softness in Europe? Can you just help us kind of bridge the gap of where you’re seeing the strength versus some recent commentary of Europe softness?

John Gilbertson

I think the issue we said a little bit on the last call, and just to kind of restate that, it’s automotive for us in Europe. Everything we’re seeing as a positive nature is related to automotive and those automotive suppliers. The general market in Europe is not that strong outside of automotive. Actually we’re seeing more weakness there, so there is concern in the non-automotive sector. You know certainly many of the German automotive producers are doing very well and they are exporting a lot of that market to Asia and the Middle East, and they are very strong, and I would say they are very bullish. They were bullish this time last year and there was some concern about were they were going to do it and they did it and did more than that. And I would say they are more bullish today than they were before.

But if you look again at other sectors, let me talk a little bit about the energy storage things, which had a good year last year, they’re not going to see as much of that this year. Germany is saying they are not going to have that – they built too much solar stations last year and they’re not going provide the subsidy in Germany, so that market which is industrial market we call it in our segments is going to be under pressure. The same thing with trains; we’ve seen weakness in the train business and the traction business. So I think that will be under pressure all year as that area is under more pressure than the rest of the world.

Jim Suva – Citi

Thank you very much, and we’re looking forward to 2012.

John Gilbertson

Great Jim, thank you.

Operator

At this time, you have no further questions. I will now turn the call back over to management for closing remarks.

John Gilbertson

All right, we again want to thank you. As we all know, it’s been a rapid paced year. And I look forward to 2012; I do think there is positive things there. And we look forward to seeing you in the next quarter. Thanks again.

Operator

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.

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