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AVX Corporation (NYSE:AVX)

F1Q09 Earnings Call

July 29, 2008 9:00 am ET

Executives

John Gilbertson - Chief Executive Officer and President

Kurt Cummings - Chief Financial Officer

Marshall Jackson - Executive Vice President

Analysts

Andrew Huang - American Technology Research

Ingrid Aja - Merrill Lynch

Jim Suva - Citigroup

Matthew Sheerin - Thomas Weisel Partners

Shawn Harrison - Longbow Research

Mark Hassenberg - Nottingham Capital

Operator

Welcome everyone to the AVX Corporation first quarter earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, the CEO and President, John Gilbertson.

John Gilbertson

I'd like to thank you for attending the AVX conference call regarding the results for the first quarter of this year that ended in June. I am John Gilbertson and with me today are Kurt Cummings, AVX's Chief Financial Officer, and Marshall Jackson, AVX Executive Vice President.

The sales in the quarter were $397 million and up over the previous year's numbers by almost 4%. The economic climate has been dynamic in the last couple of quarters, and this has obviously impacted the electronic segment.

The overall company backlog increased 5% in the quarter, and the gross book-to-bill was positive at 1.06 to 1. Backlog is also up from where it was this time last year.

We are seeing unusual strength in the July bookings, and that book-to-bill is running 1.14 to 1 at this time, which is obviously close to the month end. But June was weaker than normally expected in orders, and at this time it appears that we will ship in July at a similar level as we shipped in June, which is very unusual. But with the good activity in the normally slow month of July, we are projecting an increase in shipments for the September quarter.

The advanced products group performed well and maintains its position with 31% of our overall orders in the June quarter. The group has benefited from the integration of the American Technical Ceramics, which was purchased at the end of September. ATC sales in the quarter are up 5% over the previously year and are continuing to be stronger in the month of July.

Our distribution customers appear to have seen good demand during the quarter, but we have yet to see the expected replenishment of product as they remain cautious. Sales in quarter through this channel of distribution was 36% of our overall sales. Sales in the June quarter did not increase in this channel as we had expected, primarily due to the cautious buying activity in the distribution channel in Asia. We believe that the product inventory in this market channel is very lean, and we remain optimistic that we'll see increased quarters soon if the market demand holds up.

The mobile handset producers are still on target to achieve 10% unit growth this calendar year. The reported June quarter handset unit sales for that segment increased 11% over the prior year. Similarly, the reported computer unit sales increased 16% in the June quarter compared to the prior year. In both cases the growth rate was higher than what was seen in the prior year.

The medical and military markets also continue to show improving trends. The area that was the weakest, as might be expected, was in consumer and automotive, which use a high volume of components.

As a percent of overall revenue in the quarter, Asian sales declined slightly to 43% of the total in the June quarter, again an indication of the weakness in consumer this quarter. The decline also seems to be related to lower China local handset manufacturing in the region.

The Americas sales held steady at 29% of overall sales, and Europe increased to 28% due to strong connector sales in the region and the strength of the Euro.

The commodity product pricing became more competitive in the June quarter, and prices declined approximately 2% overall to the prior quarter. This is closer to historical trends than we have seen during the past several quarters. Obviously some of this is related to weakness in the consumer segment and low-end handsets.

The gross profit margin, excluding restructuring costs in the quarter, was 16%. Slightly lower sales and lower ceramics component production impacted the result, but more significant were the negative effects of the continued weak U.S. dollar, higher metal and material costs as well as rising utility and transportation costs.

We have initiated a number of cost saving initiatives to address headcount and overall cost in order to help mitigate these rising operating costs. We feel there are additional cost-saving opportunities to reduce these operating costs in the coming quarters as we further rationalize our manufacturing strategies.

SG&A expenses were $34.1 million in the June quarter or 8.6% of sales. Wage and general inflation have also impacted these costs, however I feel that we can also attack these costs going forward.

The profit from operations was $32 million, and we earned $0.18 per share.

The future market activity is difficult to predict with the current economic situation, but again, our orders thus far in July are encouraging. We would expect the September quarter sales to be impacted by seasonality during the summer holidays, but still expect them to be ahead of the June quarter results by 3% to 4%.

Margins are expected to remain steady next quarter depending on the inflationary pressures that appear to be growing across the world. As mentioned previously, it is our intent to implement additional cost saving programs during the next two to three quarters to help offset increases in operating costs.

This quarter we paid $6.8 million in dividends and repurchased $3.4 million of AVX stock on the market. Our overall financial position remains steady, with $807 million in cash and security investments at the end of June or approximately [$4.7] per share.

Interest income in the quarter was $6.6 million, which reflects the current interest rate environment.

Overall inventories increased 2% sequentially, most of the increase related to higher metal value and strategic raw material purchases to protect against rising cost.

During the quarter we spent $14.7 million for improvement and equipment expansion. Depreciation totaled $14.9 million.

We have made and will continue to make investments in our strategic product lines. We expect to spend between $50 and $60 million in capital this year.

There are uncertainties regarding the health of the general economy, as widely reported. However, we remain confident that we will be able to continue to introduce new products that serve our customer needs for greater functionality and attack aggressively our operating costs.

We will not lose sight of our main goal, to address our customers' needs. Evidence of this dedication can be seen in the 2008 Frost & Sullivan award for the company of the year in the world capacitor market that we recently received and recent customer appreciation awards from Rockwell Collins, Seagate and Arrow Electronics.

Brie, I would now like to open it up for questions.

Questions-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Andrew Huang - American Technology Research.

Andrew Huang - American Technology Research

So first can you comment a little bit about your guidance because normally you would expect to see some kind of European seasonality? Do you feel like that's going to come into play this year?

John Gilbertson

No, Andrew I don't. It appears that due to - use the word dynamics - in the financial markets and the concern in some of the customers, there was a lot of caution in that June quarter. And it seems that some of the activity that we would have normally seen in June has moved into July, so July is much stronger. Actually July has been stronger since - I went back four or five years - than we've seen. It's going to be the same shipment level that we saw in June the way it's going right now.

So apparently what's happened is some of this order activity that we would anticipate in the June quarter has moved into a later second quarter, the September quarter. And I think that we will see an increase in revenues in that 3% to 4% range.

Andrew Huang - American Technology Research

And then kind of sticking with the geography question, do you think that there's going to be any kind of slowdown? Like I know you were talking about, you know, the ramp in Asia in the September quarter kind of depends on how strong the consumer rebounds, but with the Olympics going on do you expect any kind of impact from that on either the positive side from a demand perspective or on the negative side from a productivity perspective?

John Gilbertson

I think that the Olympics did help the TV sales, but I think if you listen to LG, I believe, the other day, they said that the market was kind of saturated there. I think it was overhyped and it'll probably be, if the word is underhyped, it won't be the downturn after the Olympics are over; I think we won't see the impact on the downside as much as everybody anticipated.

But there will be some downside after the Olympics are over due to activity in that area. But I think that's yet to be determined.

Andrew Huang - American Technology Research

Okay, and then just one last question. I think in your prepared remarks you commented that you felt like inventories are pretty lean in the channel, but at the same time they weren't purchasing, I guess, in the June quarter. What's your conviction level that they kind of - or what drives your conviction that they need to kind of increase their purchases here?

John Gilbertson

I think if you looked at point of sales, their point of sales have been good. And look at and yourself know the results of the big three or four distributors there. Their sales or revenues have been good. Their point of sales have been good. Their inventory's down. We track what their point of sales is. It's up. And we track their inventory. It's down.

So their inventory replenishment I think has skipped a month or two month out, and again, back to your earlier question, to this September quarter.

So I'm pretty convinced we'll see more activity from the distribution channel.

Operator

Your next question comes from Ingrid Aja - Merrill Lynch.

Ingrid Aja - Merrill Lynch

I was wondering, you commented on how there were some orders that seemed to get pushed out into July, and I was wondering if you could describe if you saw any other change in customers' ordering patterns as a reaction to economic risk and anything you can point to directly to sales in Europe and the U.S.?

John Gilbertson

I think the biggest issue that perhaps surprised me and surprised a lot of our customers was the handset shift that apparently is going on now. If you look at the actual units [hand sales] it's pretty consistent, even a little bit better than last quarter. So apparently what's happened is we're seeing more low-end at that first and second tier. We're not seeing as much activity in the Chinese local manufacturers due to the government situation there, but we are seeing a larger percent of low-end phones moving to that first and second tier. And the issue there is those phones do not use as many components.

I think two things happened to us as far as pricing and revenues this quarter, probably three things that surprised us. But one's some capacity. We talked about capacity coming on in place in ceramic capacitors in the summer months, which it did, and we knew that would haven impact. But I think in addition to that impact we also saw the impact of a shift down to less complex phones which, again, didn't use as many components, and that hurt. And that also put some pricing pressure. And the third thing was the material costs or inflationary pressures were more than we anticipated in the June quarter. I think everyone is experiencing that in their own personal life. Okay?

Ingrid Aja - Merrill Lynch

Okay, so how is that affecting your capacity utilization rates? Do you have an idea of where they're running at then?

John Gilbertson

Yes. I think that that utilization number's dropped down into that 85, 86 range, and we were up and around the 90, 92 range. So we do see that because of this - fewer complex phones. Now there will be a movement - again, back to Andrew's question a little bit - there is more movement in August and September to these later 3G phones which will be coming out. And we're seeing activity there, which will help use more components. But that certainly wasn't a factor in the June quarter. We saw more low-end phones, less cameras, all the other things that you would see.

Ingrid Aja - Merrill Lynch

And then I was just wondering if you could comment on - there's been some reports that there's going to be some [inaudible] and price increases on the horizon. I wonder if you could comment on what you're seeing and what your expectations are?

John Gilbertson

I think that if you look at the issue of the two different product lines, you have a lot more components of ceramics in cell phones than you do in tantalums. Plus you have a lot more competitors in ceramics than you do in tantalums. So the tantalum marketplace has perhaps not been hit with this utilization issue as much. I think it may have dropped to, I'll say, 1 or 2 points as opposed to 4 or 5 points or more in ceramic in the utilization area.

And the story that I've also heard in the industry is that there is movement on prices in tantalums because of the limited availability of some of those components still, and there is. I read an article the other day that said AVX was raising its prices throughout the Asian region. I sure would like to be raising them the number that was quoted in the article, but, you know, there is a point that we're seeing some price movement in the tantalum product line upward.

Operator

Your next question comes from Jim Suva - Citigroup.

Jim Suva - Citigroup

A quick housekeeping item, then I'll have a follow up question. Can you let us know what the ATC sales were for the quarter? You'd mentioned they were up, I believe it was 5% year-over-year, but what was the dollar amount?

John Gilbertson

They're around about $23. And if we look at - somewhere around $23 million, Jim.

Jim Suva - Citigroup

And so then if I look at year-over-year June of this year versus June of last year and exclude that 23%, unless I'm missing some type of sale or something like that, it looks like your organic growth year-over-year was negative about 2.5%. That would lead me to believe that AVX at this point is losing a bit of share or organically you're not growing as fast as the market or maybe the market's slowing. Can you just kind of comment on some of those potential questions?

John Gilbertson

I think your number is in absolute dollars. You said percentage, but you meant dollars. And there is no question that the organic business did decline in the June quarter against the March quarter.

Now where we saw most of that was in the ceramics business, all right? And in general I think that ceramic business volume was down more than we anticipated and I think the industry anticipated. But again, I think that what we're seeing going into July is we're seeing a pickup of both AVX sales and, surprisingly, ATC is doing much better in July than they did previously.

And the big drain we have there - it's really hurt us last quarter in the ATC - is the semiconductor equipment business, which they have a big share of. But we also think disti will rebound in this next quarter.

Jim Suva - Citigroup

And then when you talked about, I believe it was ASPs down 2% quarter-over-quarter, were they down, if I remember right, around 1% last quarter? Is that about what they were?

John Gilbertson

Yes, Jim. Just a minute. Both of our memories have to refresh, but I think it was flat to 1%. But we've seen that flat to 1% for the last, I would guess four or five quarters. So it was a little bit more pronounced this quarter than normal, but it is still [inaudible] than that traditional levels. And there were more pressures on ceramics, again, than there were in tantalums.

Jim Suva - Citigroup

And last follow up on that, the down 2%, do you think that's sustainable which is typically normal in a very long-term view, but do you think given the macro uncertainties that there's, you know, a little bit more risk if we could go down, say, 2.5% to 3% quarter-over-quarter?

John Gilbertson

Yes, I'd have to say yes, Jim, because you threw in the macroeconomic situation. If indeed it gets weaker in the September quarter, those prices will drop to that 2.5%, 3.5% range.

Operator

Your next question comes from Matthew Sheerin - Thomas Weisel Partners.

Matthew Sheerin - Thomas Weisel Partners

So just to follow up on the distribution commentary, is the book-to-bill at distribution above 1 now and was it  I assume it was below 1 for the June quarter?

John Gilbertson

Oh, it's definitely above 1 now. They're looking through the numbers to see if it was below 1 in the June quarter. Kurt's saying it's pretty close to flat. We're just looking at a graph. So it's flat to down a little bit.

Matthew Sheerin - Thomas Weisel Partners

And then your comment on pricing, obviously when there's weak demand there's going to be more pricing pressure, particularly, as you say. We have seen capacity, more capacity overall come on on the ceramics side although it looks like you've been able to at least use the rising material costs as an excuse for some leverage with your customers over the last couple of years, which is why we haven't really seen much ASP erosion. But it sounds like now that's not really working anymore.

John Gilbertson

Well, I think part of the problem that the customers have is the same problem we have. They're seeing it from everywhere, okay? And if you look at this example going back five or six years ago, Matt, we were in business where you had one individual item that went up - say tantalum powder - you went in and said, look, tantalum powder went up X%. We need some help here. They were very reasonable. But now what they have is a line outside their door of all these issues, which they have themselves.

So we're in a state of flux right now, and the question is going to be how is that going to be handled in the pricing situation? You obviously know the inflationary issues. If everybody gets their inflationary costs passed through, then we're in a bigger mess.

I don't know the answer to your question.

Matthew Sheerin - Thomas Weisel Partners

And just in terms of the cost cutting, could you be more specific about headcount, how many costs, how much cost you plan to take out, what kind of impact do you think that'll have on gross margin over the next two or three quarters or as, you know, SG&A percentage?

John Gilbertson

Matt, we're obviously working on that, but we have been working on it, to be honest with you, for almost three quarters. We will take some restructuring charges next quarter in a reasonable range. But we have plans and we've been working on them to exit several businesses that are very low margin and exit several facilities that are very high cost. And these are ongoing, and we should finalize a lot in the next quarter.

So my answer to that is those businesses that are not marginal businesses that we get out will help us shore up that margin, and we think that the margin will improve as we move forward.

Matthew Sheerin - Thomas Weisel Partners

And then on the ATC, I know that over the first couple of quarters you had depressed gross margin because of accounting reasons, inventory recognition, etc. When will that return to the higher gross margin as a contribution to the company?

John Gilbertson

We think now, Matt, that it is in that state now. We've done most of our restructuring there; this last round of restructuring had some money in there for that. So we think that going into the September quarter we'll go through a natural period for ATC.

Matthew Sheerin - Thomas Weisel Partners

And just lastly, if you could just go over the end market breakdown revenue trends for each market?

John Gilbertson

Well, if you look at the computer, we saw, again 20% in computer. Military is about 7%. Industrial is around 13%. Auto's in that 12% to 13%. Network was 2%. Wireless was 12%. Telecom is 16%. Medical is 6%, and medical is improving. We think medical will move up another point as we progress through the year. And consumer was down a little bit below the 11% range.

Operator

Your next question comes from Shawn Harrison - Longbow Research.

Shawn Harrison - Longbow Research

First question, just another housekeeping, if you could break out the sales by major product type in terms of just the percentage number.

John Gilbertson

If you look at ceramics, about 13% of our business. Tantalum was about 19%. Connectors were up about 13%. The Resale business was 25%, and the advanced product segment was about 30%.

Shawn Harrison - Longbow Research

Okay. Within the Connectors business, remind me what end markets again you're serving?

John Gilbertson

Almost all of our end markets, Shawn, are in the automotive. Our biggest product is an engine control unit, a connector on an engine control unit, and that has been a very good business for us and it's increasing each quarter. And we are looking at - we're building a new factory for the North American business now in Juarez. We're expanding a factory, I should say. And we're looking at additional space in the Czech Republic for that Connector business.

Our Connector business is doing very well.

Shawn Harrison - Longbow Research

Okay, and you said that was principally European automotive was the strength this quarter?

John Gilbertson

Principally European automotive.

Shawn Harrison - Longbow Research

The second question just has to do with the capacity that came on line in the ceramic capacitor market. Are you hearing anything, are you seeing anything out there that would lead you to believe there's more capacity scheduled to come online in the second half of this calendar year?

John Gilbertson

I think the answer would be - I'd almost have to say yes, but I haven't heard anything. What I have heard which is unusual is people canceling capacity. I know of a very large block of capacity that was canceled. The building was built but the equipment was not installed. So that, I've not seen that happen before. But we are seeing any capacity that is still on the books is trying to be canceled, so maybe some of that later capacity that I thought would come out  more of it come on in the second half will not come on.

Shawn Harrison - Longbow Research

And this was mainly focused in on the HiCV products, correct, or was this more -

John Gilbertson

Yes, I think that's mainly focused on the HiCV.

Shawn Harrison - Longbow Research

And then my other question just goes back to the tantalum question. I read the same article you did about the pricing. But just in regards to your tantalum cost, the actual price of tantalum powder potentially going up, when would you see something like that begin to occur and maybe begin to affect margins?

John Gilbertson

Next year.

Shawn Harrison - Longbow Research

So the beginning of the calendar year?

John Gilbertson

Yes. These astronomical numbers that you're hearing, okay, from the miners and all that that's going around, I think that you'll see those big increases, if they do occur, not occur until next year. Now we have seen price increases from the tantalum suppliers existing today. But there are a lot of - miners talk about next year being an issue, but today we're not seeing that big jump and probably won't see it until next year.

But we have seen in this quarter and next quarter price increases related to it, but not at the level that you're hearing from the miners in Australia.

Shawn Harrison - Longbow Research

And do you think you'll be able to pass at least some of these increases through to customers?

John Gilbertson

It would be our intent to try to mitigate some of that increase.

Shawn Harrison - Longbow Research

And then just lastly, maybe Kurt you could try and quantify the sequential quarter-to-quarter impact we saw from higher raw material and higher, you know, just -

John Gilbertson

He loves that question.

Kurt Cummings

Shawn, I think I'm going to have to give a similar answer to last time, that with the currency, the mix of product, the movement in metals, energy, transportation and freight costs, there are a lot of different variables that affect it quarter-over-quarter. Currency is still a big one for us, but I do not have the ability to quantify each of the pieces for you. Metals cost, as I've mentioned before, come in on a delayed basis because they first go into inventory and then work their way through the process. So the quarter certainly reflected a higher metal cost than the previous quarters.

John Gilbertson

Shawn, I think we saw more currency. We felt more currency. We saw the material costs up, but each time we saw it, we felt that [a little bit's] currency. We are getting help, as you obviously know, by the dollar being weaker, but it's also the currency and some of the operating costs in Europe because, as you know, we have several facilities in Europe. That currency has increased pressure on us. So we felt the currency pain more than we felt the material pain, but they both hurt.

Operator

Your next question comes from Mark Hassenberg - Nottingham Capital.

Mark Hassenberg - Nottingham Capital

On the comments about the mix, the cell phone demand and fewer components and lower-end phones, is that a mix issue or is that a geography issue? Is that people buying less expensive phones because of the economy or is that because places like India are growing faster?

John Gilbertson

It's both, but I think what surprised us and some of our customers was they expected the region mix; they didn't expect buyers, say, in Europe and the U.S., to buy a lower-grade phone than they had been traditionally. I think they expected to see more high-end phones in Europe and the United States.

But with all this economic turmoil, I think buyers decided to trade down more than our customers expected in both U.S. and Europe. But in Asia we continue to see more and more of a mix, and they picked up more business by the Chinese government's action trying to control some of these local cell phone guys.

Mark Hassenberg - Nottingham Capital

And, you know, it might be an ignorant [inaudible] but is Apple having any effect? Is the iPhone having any effect on the overall mix of phones or what people are looking for in a phone?

John Gilbertson

The answer is yes, and I think that the market that they are perhaps - it's becoming a very big status thing in Asia. I was just over there last week, the week before, two weeks ago, and it's becoming a status thing in Asia. And if anything it is perhaps opening up the Japanese market as some of the buyers over there, consumers, are seeing the different things that can be done with this iPhone.

So I think the iPhone is going to have more of an impact on the design and that sort of thing than it is on the actual unit volume. So we're going to see a lot more design changes as the other suppliers try to mimic some of those features, which is good for us to see that iPhone become a target for everybody to go after. I think I read several articles about them being a larger and larger unit. I think the design would be an impact on that.

Mark Hassenberg - Nottingham Capital

You would think that competitively they'd have to respond.

John Gilbertson

And I think they will. They've certainly illustrated they can.

Mark Hassenberg - Nottingham Capital

I'm trying to remember things. In tantalum over the years there have been many threats of tantalum prices going up dramatically and, you know, the rhetoric and the pricing didn't always follow the same path. Is that correct?

John Gilbertson

That's absolutely correct. And there seems to be a lot of - always a lot of rhetoric before the actual result. So I think that we're going to see modest price movement in the tantalum powder, and we will have to wait and see. But you've got to understand that there are other dynamics that weren't in the market, say, in 2001. You bought essentially from two, two and a half suppliers in that period, and that's totally changed in the last five or six years. Now there's, you know, half a dozen, maybe more than that, suppliers out there who are buying for the business.

And there's different sources. But again, in 2000 you were talking about Australian only powder but now you're  ore. Now you're talking about China. There's areas of China, and there's several people there that are fully qualified and they'll put some restraints on that.

Mark Hassenberg - Nottingham Capital

Again, as I recall, in 2000, 2001, I mean, there were some suppliers that were really trying to, you know, take full advantage of the situation who were later penalized, weren't they, in terms of what their business model looked like?

John Gilbertson

That's correct. We benefited from some market share gains. I think today we're back to number one in the tantalum market.

Mark Hassenberg - Nottingham Capital

And just one other question. I mean, we're all talking about costs going up. Are you seeing any place in materials where costs are beginning to go down because of the economic situation?

John Gilbertson

Yes. I think that we're starting to see a little restraint in copper for instance, okay? Copper seems to be a little bit more readily available, so I think we need a couple more months to understand whether that's real or not. But we are seeing some moderation in price.

Operator

At this time I'd like to turn the floor back over to John Gilbertson for any closing remarks.

John Gilbertson

Thank you very much. We look forward to seeing you at the next conference call. Thank you.

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