AVX's (AVX) CEO John Sarvis on Q3 2016 Results - Earnings Call Transcript

| About: AVX Corp. (AVX)

AVX Corporation (NYSE:AVX)

Q3 2016 Earnings Conference Call

January 26, 2016 10:00 AM ET

Executives

John Sarvis - CEO and President

Kurt Cummings - CFO

Analysts

Matt Sheerin - Stifel Nicolaus

Blaine Marder - Cramer Rosenthal

Jim Suva - Citigroup

Operator

Good morning. My name is Holly and I will be your conference operator today. At this time, we would like to welcome everyone to the AVX Corporation Third Quarter Earnings Release Conference Call.

[Operator Instructions]

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

John Sarvis

Thank you, Holly. Good morning. I would like to welcome you to the AVX conference call regarding the results of our third fiscal quarter that ended in December. I'm John Sarvis and with me today is Kurt Cummings, AVX's Chief Financial Officer, and we hope you've had a chance to review our earnings release and related disclosures that were issued this morning.

It was another challenging quarter for sales, which came in slightly below our predictions, and gross profit came in at that top end of our predictions based on continuing favorable product mix, margin management and good operating performance. Sales were $287 million and reflect the typical holiday seasonality impact and a muted but relatively steady product build schedule from our customers. The translation impact of the continued strength of the US dollar and the change in sales channel for the Kyocera Resale Connector products in Asia effective April 1st of this year and as we discussed in previous calls, reduced sales for both the three months and the nine months periods when compared to last year. The currency movement once again impacted the reported consolidated sales. We sell in various currencies around the globe and the reported sales in the quarter were negatively impacted by approximately $10 million when compared to the same quarter a year ago due to the strength of the US dollar. Similarly, reported sales for the nine months ended in December were negatively impacted by approximately $50 million when compared to the same period a year ago and due to the strength of the US dollar.

Orders for the industry did not pick up to any great degree and this has been noted by several other suppliers in the industry. The gross book to bill for the company in the quarter was 1.03 to 1 resulting in a 7% increase in overall backlog. Some of these maybe due to preordering in the advance of February's New Year holiday in Asia. As has been the situation throughout the past 12 months, customers continued to be cautious due to concerns regarding inventory and end market demand. Although channel inventories appears to have reduced somewhat during the quarter, which should allow for expansion particularly at distribution customers when the global market starts showing signs of more meaningful recovery.

In this quarter, the distribution channel represented 45% of our overall shipments, down 1% from the previous quarter. Most feedback we've received is that the channel is seeing moderate POS growth and the intentional reduction of inventory -- channel inventory levels is now complete. These represent positive signs for more rapid AVX sales growth when end market demand improves.

Global distributor POS has been slightly up in the short term but down year-on-year in the mid single digit range. As a result, our global distributor inventories most recently this quarter reduced around 3% from the previous quarter end. Contrary to the press clippings on the China economy, POS in the Asia region is running at double digit growth rate versus last year. To a certain extent our business is positively influenced by restocking in the region and a strong automotive business in China due to government incentives in place to buy energy efficient vehicles.

Europe POS has been essentially flat when measured in EURO but the Americas business is still solid, primarily due to the general weakness in the manufacturing sector which is being negatively impacted by the energy sector [glut] [ph] and lower exports due to the strong dollar.

Regionally and looking at our revenue split each geographic region faced similar market conditions. As a percentage of the total each region kept its relative position with Europe representing 29% of our sales, Asia region at 42% of overall shipments and the Americas at 29% of the AVX total.

The PC market including tablets declined during 2015 nearly 7% in units and the smart growth rate is down to mid double digit growth in 2015 with the potential deceleration to low double digit growth during 2016. While 12% growth is not bad, it represents a maturing market that used to be growing at [15%] [ph] plus annually. The overall PC market is expected to decline in 2016. There is a shift occurring with more of the smartphones converging into the tablet, PC, notebook market. Functionality, portability and larger screen features of smartphones is cannibalizing the demand for tablets and notebook PCs. Going forward we expect over 80% of the mobile hand phone market will be smartphones.

Korea Telecommunication infrastructure manufacturers maintained their activity this quarter, primarily for the Indian market build out and the China suppliers starting to build the latest round of 4G base stations after those expansion programs were delayed most of the calendar year. This should support the increase in smartphone sales in these countries as a new 4G platforms come online to support increased bandwidth requirements. The reduction in demand for the PC market has kept the storage market flat, but with projected increases in infrastructure we expect the enterprise storage market notably the solid state disk drive segment to grow to support the increase in bandwidth usage.

The past holiday period was very favorable for the consumer side of wearables. They seemed to be popular items, new solutions are coming out demanding smaller and smaller component with more functionality and a number of brands are expanding. These components and end solutions are all a part of the IoT, or Internet of Things. Wearables and other devices and appliances are being connected to the Internet via RF links. Earlier in the year China auto sales reduced to a low in July but since then largely due to government incentives for efficient vehicles, the market has grown each month and positively affecting our business whereas we noted in my distribution channel comments. Globally hybrid and electric vehicle demand is increasing which drives up the demand for high end components solutions involving limited battery drain and improving the overall efficiency of the electrification of the vehicle. These solutions are served by our advanced power components group which has recently increased production capacity to support this growth.

Japan, Russia and Brazil automotive sales contracted recently while the EU, China and USA were estimated to grow in the 5% range this year but it looks now like it's going to be closer to 2%. Within the medical market the pacemaker and the defibrillator markets are steady but maturing. Our revenue in this market segment is expected to be higher this coming quarter as customers who reduced inventories during the last few quarters come back for normal demand.

We are well positioned in other sectors of the medical industry, neuro stimulation, diabetes management and other therapies which we also expect growth opportunities. We are forecasting low single digit growth in existing products for the coming year. Going forward, we have significant new product development and the pipeline for the medical industry and are actively engaged with many customers who are developing new therapies which will need our technology. The design cycles are similar in the automotive industry and much of this will impact calendar year 2017 revenue.

We've seen some increased order activity in the military and aerospace markets during the last quarter. And over the course of next year we expect some incremental improvement in the release of program for production. The recent US budget deal includes $80 billion additional spending for 2016 and 2017. We hope this will free up additional program releases affecting our mil and aerospace business. Specific program releases are expected in several significant space programs as well for AVX has strong design position. The increased demand for communication and security is driving the need for more satellite launches. These satellites are using more sophisticated equipment for imagery and secured ground communication. Both our RF and robust high reliability components are required.

Sales prices are under moderate pressure as overall product delivery lead times have not changed for most components. This issue is also impacting incoming order levels as stable lead time assures the customer of available product and creates a buyer's market. The commodity product pricing fell in the 1% to 2% range during the quarter similar to long term historical pricing trends. We anticipate the AS trend to continue like this until demand picks up in a more meaningful way and puts pressure on delivery lead time.

We believe that the ceramic capacity utilization was flat and utilization in the 85% to 90% range, high capacity and smaller footprint remain as dominant product areas. In town products production rates this past quarter stayed steady above 90%. This quarter's AVX gross margin performance at 23% reflects continued solid operating performance as well as a favorable mix of value added component. SG&A expenses in the quarter came in at $31.2 million or 10.9% of sales. The SG&A increased in the quarter primarily due to higher legal cost.

The quarter results reflect a $4 million unusual charge related to the accrual for estimated cost for ongoing legal disputes involving intellectual property issues. Profit from the operations including the unusual charge came in at $30.8 million or $34.8 million excluding the charge at 12.2% of sales. Our earnings including the unusual charge came in at $0.16 per share for the quarter or $0.17 per share excluding the charge.

This quarter we paid $17.6 million in dividend payments and spent $3.6 million repurchasing AVX stocks on the market. For the quarter, we spent $14.9 million for facility improvement and equipment. Depreciation expense totaled $7.1 million and tangible amortization expense was $1.3 million. At the risk of repeating myself, the visibility going forward remains uncertain and the March quarter will be impacted by the Asian New Year holiday period. The order activity leads us to estimate that our shipments in the March quarter will be up into 3% to 4% range compared to the December quarter. If the distribution channel sees good end market demand and increased inventory position then the sales could be better than that. We would expect margins to come in again near the 23% range and as usual be impacted by product mix and sales price pressures.

Our customers remain optimistic about new product introductions but still inventory risks adverse at this point. We anticipate an increase in new electronic applications across all platforms and markets particularly in automotive. Our strategy has included introduction of an expanded range of interconnect and passive electronic products across more diversified range of vehicles and onboard electronics around the world. At this time, identifying complementary, high technology acquisitions that provide opportunities for non organic sales growth.

I would now like to open it up to questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Our first question will come from the line of Matt Sheerin with Stifel.

Matt Sheerin

Yes, thanks, good morning, Kurt and Johnny. A few questions for me, just starting off I appreciate your color Johnny on the various segments and demand trends, could you give us a breakdown of sales by end market and then also by product category?

John Sarvis

Sure. Matt, good to hear from you. The automotive market remain flat at 23%, the cellular was actually up a point from last quarter at 14%, computer down one point at 14%, consumer up a point at 10%, industrial remain flat at 12%, our medical was down at 8% down one point as we said earlier due to the inventories. Military remain flat at 4% and networking at 4%, telecom at 11%.

Matt Sheerin

Okay. And the breakdown by product category, passives and connectors?

John Sarvis

Okay. I'll break it down by category in the ceramic group; we're up two points at 16%, tantalum remain flat at 26%; our advanced group dropped three points at 26% from last quarter. So the total passive remains at 68%, the resale products remain flat at 21% and connectors flat at 11%.

Matt Sheerin

Okay, connector [solid] [ph]. So if the advanced product sounds like it was down more than the business with a percentage decline, but the gross margin was better and you talked about a better mix, so what were the other reasons why the mix helped you if the advanced product category was down?

John Sarvis

Well, in some of the other products and some of the Kyocera, our resale products as well as some of the ceramic components the product mix within those groups were actually better.

Matt Sheerin

Okay.

John Sarvis

It drove an overall improvement in the -- maintain the margin --

Matt Sheerin

Got it. Could you remind us on a year-over-year basis what your revenue that's gone away because of Kyocera taking certain of the connector products on a direct basis, what that number is?

Kurt Cummings

Matt, this is Kurt. We included that number under the income statement table in the release this morning. So the sales for the quarter a year ago that were not repeated this year was $11.6 million and for the nine months last year included $40.9 million of sales that are not repeated this year.

Matt Sheerin

Okay, so basically you have one more quarter of headwind there, right, and then the comps are back to apples to apples?

Kurt Cummings

Yes. As we've indicated the other big variable when you are comparing year-over-year is the strength of the US dollar reducing the reported number of sales that are denominated in euro and yen.

Matt Sheerin

Got it. And on the growth expectation, the 3% to 4% sequential growth, and you talked about could be better if distribution comes back in a stronger way, but are you expecting sell in to distribution to be in line with that 3% to 4% or it should be, should it be still lower as they work down inventory or take a more cautious approach?

John Sarvis

I think the 3% to 4% does include the growth in the distribution channel as we said earlier, Matt, we think the inventories are pretty much reached where they need to be now. And the end market will actually be the big driver there in the both in OEM and in distribution.

Matt Sheerin

Okay. And just a couple more, I mean your opening commentary you talked about sounds like you're seeing a bit of a rebound in demand on telecom infrastructure in China where things were in a pause mode for a few quarters. Are you starting to see that pickup?

John Sarvis

Yes. We are. And we've noted that in China as well as in India.

Operator

Your next question will come from the line of Blaine Marder with Cramer Rosenthal.

Blaine Marder

Hi, guys, good morning. So as noted by the prior caller, your tone at least is seems to be a bit more optimistic than say the past two or three quarters. You're citing somewhat of an improvement in orders. You just mentioned telecom infrastructure, what other areas would you say or would you cite for an improvement in orders? How about the EV market, the comp in China, anything else you might note?

John Sarvis

The medical as we noted we are seeing an improvement in our medical due to inventory improvements in the last couple of quarter, so this quarter and the succeeding quarter should show improvement in that area as well and some of the mil aerospace as we noted where we've seen some releases on some of those programs.

Blaine Marder

I see. Okay and then are you guys hopeful you're still looking at acquisitions, have prices moved at all, did they come down with the public equity markets or not yet or you're hopeful to do something this year?

John Sarvis

We are hopeful and we are continuing to look. I guess the price points in the market still seemed to be relatively robust and the expectation is still very high in terms of the value of the company. So but we are currently looking seriously into three to four different companies at this point.

Blaine Marder

Okay, and just lastly on the SG&A, it popped up in the quarter, you cited legal cost, do you expect it be this high in the $31 million range going forward?

Kurt Cummings

Blaine, it's tough to tell. We've got two cases that are active currently. We put as indicated in the accrual last quarter, we got two issues in Massachusetts behind us. Unfortunately there is an awful lot of activity and the lawyer seemed to be the big winners in this. So I am hoping to get that SG&A back closer to $30 million but it’s hard to predict.

Operator

[Operator Instructions] The next question will come from the line of Jim Suva with Citi.

Jim Suva

Good morning and thank you gentlemen. Can you talk a little bit about pricing of average selling prices, what it was this quarter and importantly kind of month to date or kind of this quarter how we should think about pricing, maybe benchmark versus relative norms?

John Sarvis

Right now as noted earlier we are running in the consumer commodity kind of products 1% to 2% price reduction. And typically we see that across the quarter and the last several quarters have been fairly consistent. And within the norm of normal business. So we are not seeing any rapid decline in selling prices more so again in the norm range.

Jim Suva

Okay, and then on the CapEx outlook can you help us on your CapEx spending plans?

Kurt Cummings

Yes, Jim. You saw that it popped over $40 million this quarter and that reflects some of the infrastructure and building expansion we are doing in Czech Republic, in Mexico as we mentioned on prior calls. I think it will stay at that level or maybe slightly lower for another quarter or two and then come back down as these build outs are complete.

Jim Suva

Okay, and in conjunction with those build outs, will they bring incremental revenues or is it a shift from higher cost in geographic location to lower cost? How should we think about the benefit that would come through the income statement at some point and when?

Kurt Cummings

It will be incremental particularly for some of the longer-term automotive projects. They take time to -- for design, sampling, build out until the automotive industry uses it in full production. So it will be a gradual rise in revenue starting next fiscal year. But it will not be a dramatic increase in output immediately.

Jim Suva

Okay, great. And then on the litigation, I know that the EPA one is behind us I believe. It sounds like are there these kind of two newer patent litigation items and, or have they just been accrued in the past a little bit and they just, the dollar amounts are so small they weren't pointed out as opposed today, could you help me understand that a little bit?

Kurt Cummings

Sure. The current charges we indicated does relate to those cases. And it isn't that you incrementally accrue for these things. You change your estimate as time goes on and more information is available. One of the cases is in litigation as we speak. So the adjustments were made based on the condition of the case as well as another case that will start in March. So it's a change in estimate as we learn more. And then as indicated in our prior 10-Q and 10-K, we also have a participation in anti trust reviews that are being done globally for the capacitor and resistor markets in both America and Canada. And again that takes up legal time and expense. So many of the environment issues are behind us as we disclose there are still some legacy issues there. But the more recent spending has been related to this IP cases and anti trust investigations.

Jim Suva

Great. And then my last question is finally on foreign exchange, if the dollar and rates were to remain constant where we are like for this calendar year outlook, or the next few quarters, what on a quarterly basis should we expect kind of a similar FX headwind going forward for the next few quarters? Or what should we expect, just assuming rates remain stable?

Kurt Cummings

I think the rates have remained stable for almost 12 months now. So the biggest impact to us was when you are comparing our current fiscal year to the prior fiscal year. Assuming the rates stay where they are and as you said stable then comparing quarters rolling forward from here should not have much impact from currency changes.

Jim Suva

Great. And you guys don't do it hedges so we don't have to worry about hedges rolling off, is that correct?

Kurt Cummings

We do short-term hedging usually one quarter in advance based on the intake of orders in order to match up with the eventual sale. But there is no large carryover from hedging at this point.

Operator

That would conclude today's Q&A session of the conference call. I'll turn the conference call back over to Mr. Sarvis for closing remarks.

John Sarvis

Okay. Well, thanks again for everyone's time. I think this coming quarter that we have as the lower higher expectations as was noted earlier and with the current inventory situations and the channel seemed to be pretty well balanced themselves out now. Our expectations for succeeding quarters I think is more positive than we had in the last several quarters. So again thank you and we hoped everyone surviving all the snow and ice even in the south we got a little so that's unusual. But hope everyone have safe travel and things workout from a weather standpoint. And also from a business standpoint.

Operator

Thank you again for joining in today's conference call. You may now disconnect.

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