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Avx Corp (NYSE:AVX)
Q2 2019 Earnings Call
Oct 28, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to AVX Corporation Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Mike Hufnagel, AVX's Chief Financial Officer. Thank you, sir. The floor is yours.

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

Thank you, Christie. Good morning. I would like to welcome you to the AVX conference call regarding the results for our second fiscal quarter. I am Mike Hufnagel, AVX's Chief Financial Officer. With me today is Jeff Schmersal, AVX's Chief Operating Officer; and Eric Pratt, AVX's Senior Vice President of Marketing. I apologize to anyone who is expecting to hear from John Sarvis, AVX's President and CEO. Unfortunately, Mr. Sarvis is unable to attend today's call.

We hope you have had a chance to review our earnings release and related disclosures issued earlier this morning.

Overall orders continued to decline in comparison to the previous quarter. Inventory levels remain high in the sales channel and the global economy continues to show weakness. The global economic environment remains uncertain as international relations and trade regulations continued to put pressure on the global economy.

POS at our distribution customers continues to be slower than expected and is negatively impacting the order rates. Currently, we do not expect orders to improve substantially, until later in the fourth quarter of our fiscal year. Product lead times continued to decline on commodity and standard tantalum products, but remain extended on certain high capacitance ceramics. We are continuing to bring on additional capacity for high capacitance MLCCs and these improved lead times are contributing to the reduced order rate.

Sales in the December quarter are expected to continue to reflect the increased inventory levels at our customers, as well as a tougher economic environment in all regions, resulting in a sales decline of approximately 6% compared to the September quarter. Our backlog has declined in light of market conditions, but remained strong and continues to support long-term growth.

As mentioned, markets continued to show weakness this quarter, once again being led by the slowdown in China's economy along with the slowdown in automotive sales and production in all regions. As a result of this, along with the higher inventory levels in the distribution sales channel, overall sales in the quarter were $377.3 million, a decline of approximately 6% compared to the June quarter.

During the quarter, our direct business to OEM and EMS customers increased by 2% to 64% of our total business. The distribution channel represents 36% of our overall shipments. Global POS was down to the previous quarter by 8% in the Americas and Europe. Asia was slightly up to the previous quarter.

Our overall distribution book-to-bill was negative as a result of the inventory build through the first half of the calendar year for commodity products. We have worked and will continue to work very closely with our distribution partners to reduce their inventory levels.

We expect contracting distribution shipments through the December quarter to further align inventory levels. We estimate that POS will be flat in the next quarter, facing the typical seasonality and a further inventory correction in North America and Europe. We expect that the POS in Asia will be similar to the previous quarter and inventories will continue to decline throughout the quarter. The overall book-to-bill for AVX in the quarter was 0.93.

Total bookings declined approximately 15% to the June quarter. The Americas were down 16% to the previous quarter, reflecting the high inventory levels in standard commodities at our distribution partners. In turn, the demand for advanced components in the high-rel market remained strong. Europe bookings were down a 11% to the previous quarter, reflecting a softer demand from the automotive industry. Asia bookings were also down 19%, whereas the overall Chinese market remained under pressure, due to the trade conflict and weaker consumer spending.

Regionally and looking at our revenue split, market conditions in the regions were relatively unchanged from the previous quarter. As a result, each region's share of the market was also relatively unchanged with the Americas at 29%, Asia at 29% and Europe relatively flat at 42% of our sales.

In general, the global economic environment remains unfavorable. Uncertainties in relation to international relations and trade regulations continue to put pressure on the global economy. The macroeconomic conditions continue to be under pressure with most major economies experiencing quarter-on-quarter contraction for many economic indicators. Global industrial productions slowed to 0.6% year-on-year. PMI remains in contraction territory at 49.1 for the fourth consecutive month.

I will now address the various market segments. Automotive represented 44% of our total revenue, 1% up from the previous quarter, as we continue to win market share in a general weaker automotive market with increased vehicle electronic content. The global automotive market continues to experience headwinds with light vehicle sales still down year-on-year after a strong 2018. One exception is the Japanese market, which is up 6% year-on-year. The Chinese market, which is the largest market with 31% of the global light vehicle sales, is down 8% year-on-year, but up 6% month-on-month. Overall, we expect light vehicle production and sales to be under pressure in the foreseeable future, but the electronic content in vehicles will continue to increase at a rate of a 11% per year.

We continue to experience strong design and R&D activities of our customers in virtually all electronic products we offer, like ADAS, infotainment, vision systems, instrument clusters, braking systems, body controls, electronic power steering and powertrain. On a positive note, this past quarter was our strongest program win record in these applications. We continue to invest in developing products such as sensors, modules, super capacitors, DC link capacitors, polymer capacitors and RF components that support these applications.

Global computing and consumer, which represents 16% of our total revenue, had both positives and negatives during the last quarter. Tablet shipments were under pressure whereas the worldwide PC shipments showed a modest increase in the third quarter to 68 million units. We also experienced a continuous positive development on cloud storage and online gaming opportunities and are confident that we will see further growth throughout the year in this segment.

Our networking and telecom revenue was stable at 11% of our total sales. We are seeing more component demand from increased satellite deployments from around the world for various commercial applications, such as 5G communications. The steady conversion for 5G continues to fuel new design opportunities and future growth. 5G technologies relying in large part on high capacity transmission using high-frequency short-length radio waves with short ranges. This results in higher component demand for our antenna, thin-film capacitors, RF components, MLCCs and filter products.

Our high-rel military and aerospace market remains strong. In both segments, we continue to achieve robust growth rates with two major aircraft manufacturers in the world maintaining a healthy backlog of new aircraft orders. The electronic content of these planes or avionics is following this growth and requires leading-edge components from AVX both now and in the future. Our backlog for these applications continues to be strong and we expect demand to be robust for the foreseeable future.

Defense spending is focused on three key areas; cyber security, smart technologies and agile forces. All three of these initiatives are built on leading-edge technology and increased demand for leading-edge electronic components. Our backlog for specialty and mil-spec components remains strong. We continue to expand in our technology in manufacturing capabilities to meet the growing demand. Our focus is maintaining our position as a strategic partner with our customers in the defense industry.

The high reliability implantable device medical market is a primary source of AVX's medical revenue. These devices include pacemakers, implantable defibrillators and neuromodulators for the treatment of pain or tremor conditions. In the most recent quarter, revenue growth for our end customers in these markets slowed from the typical 5% to 6% range to around 1%. Market price competition between the three major suppliers has held revenue down, while unit sales have increased in the low-single digit range. This allowed us to show growth in our business in this time period and we continue to hold a dominant position for the products we supply into this market and are working with their customers on their next generation of products and to include other AVX products into their devices. In addition, we have expanded our market penetration on our customer base to include manufacturers in other countries.

We have experienced a lot of headwinds from the slowing market due to the reasons discussed earlier plus a storming macro environment, where inflation, tariffs and trade disputes continue to be key issues. We trust in an overall long-term growth for our electronic components and interconnect sensing and control devices, based on R&D activities we are involved in, with several new customer applications, which will lead to future volume markets for electronic components like IoT, IIoT, 5G, smart home grids, smart cities and agriculture, robots, drones, wearables, 3D printing, healthcare and further electrification of cars compared to new auto applications in safety and health.

Our gross profit percentage was 21.1%, 4 points down to the previous quarter, reflecting a different mix of product shipments and some price pressure on low-cost commodity MLC, low CV and standard tantalum products. With expected margin pressure, we will continue to focus on margin management and cost reduction programs to improve margin.

Total SG&A expenses increased slightly this quarter to $42.1 million or 11.2% of sales, consistent with the prior quarter. Our overall effective tax rate for the quarter was 18.5%, including discrete items. Excluding discrete items, our tax rate would be approximately 21%. For the quarter, we paid $19.4 million in dividend payments and spent $34.8 million for facility improvements and equipment purchases. Depreciation expense totaled $19.6 million. Intangible amortization expense was $3.5 million. For the quarter, cash flow from operations was approximately $58.6 million.

As mentioned, we currently anticipate sales in December quarter to be down in the 6% range. We estimate that gross profit margin in the December quarter will be in the 21% to 22% range, reflecting some pricing pressure, particularly on commodity tantalum and ceramic products being offset by lower manufacturing costs related to cost reduction initiative. Total selling, general and administration expenses should come in between 9% and 10% of net sales and the blended tax rate should be approximately 22%.

We are facing a difficult market environment over the next couple of quarters. However, we are optimistic about our future prospects, as our design win pipeline continues to expand, driven by the introduction of innovative products designed to address stringent application requirements required in today's markets.

I would now like to open it up for questions.

Questions and Answers:

Operator

[Operator Instructions] And you do have a question from Matt Sheerin of Stifel.

Matt Sheerin -- Stifel Nicolaus -- Analyst

Yes. Thank you and good morning, Mike. Just a few questions. If I could just start, Mike, can I ask you and I know you gave some of the end market breakdown, could you be more specific in terms of the percentage of revenue for each of your key end markets?

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

Sure, Matt. Thank you. Automotive at 44%, cellular at 11%, which is up 1%, computer a 11%, consumer 5%, industrial at 8%, medical at 6%, military at 4%, networking at 3% and telecom at 8%.

Matt Sheerin -- Stifel Nicolaus -- Analyst

Okay. Great. And then could you also give the product breakdown by product type?

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

Yes. Sure, Matt. Ceramic Components at 23%, Tantalum Components at 16%, Advanced Components at 29% and Interconnect Sensing and Controls 32%.

Matt Sheerin -- Stifel Nicolaus -- Analyst

32%. Okay. So look like the -- it looks like then the Ceramic business was down pretty significantly sequentially. Is that correct?

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

The Ceramic -- it was down about 4% sequentially.

Matt Sheerin -- Stifel Nicolaus -- Analyst

4%. Okay. And is that -- could you talk about just in the ceramic area? I know you said there is still some extended lead times on the large case size for auto and specialty areas. Are you still seeing strength in some of those areas in terms of orders and overall demand?

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

Yes, Matt. The orders for the high CV ceramics and the Advanced Components, particularly as it relates to military, medical, et cetera, continue to be in high demand and the lead times on those still remain extended. So that demand is holding up. The problem is more in the commercial ceramics, where the demand is down due to the inventory issues, primarily at our distributors and in some of our customers.

Matt Sheerin -- Stifel Nicolaus -- Analyst

Okay. And I know you've talked about some of your competitors moving -- discontinuing certain product lines where you play. Are you still seeing visibility into that sometime next year?

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

Limited visibility into it. We continue to focus on, as we've told you before, the expansion in our polymer market and in on the high CV ceramics, where the demand is holding up. We expect that demand to hold up long-term.

Matt Sheerin -- Stifel Nicolaus -- Analyst

Okay. And speaking of the tantalum, which I know has been under pressure more than ceramics, down significantly year-on-year. What's the inventory situation at distribution now in terms of weeks? I know as high as -- I'm sorry months, I know it was six months at some point.

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

Yes, Matt. The inventories at the distributors are still in excess of six months and it's not coming down as quickly as we would like it to. Normal is, as we said in the past, is three to four months. So we expect that inventory issue to go on throughout the next quarter and into the fourth quarter.

Matt Sheerin -- Stifel Nicolaus -- Analyst

And is that primarily on the tantalum business or the commercial ceramics as well?

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

It's on the tantalum and the commercial ceramics.

Matt Sheerin -- Stifel Nicolaus -- Analyst

Okay.

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

Tantalum is getting a little bit better, particularly in Asia, but in the US, it's still -- US and Europe are still seeing a pretty healthy inventory.

Matt Sheerin -- Stifel Nicolaus -- Analyst

Okay. And then the gross margin, which was down, it looks like -- look like you can maintain it at these levels. You did talk to us about some restructuring or some cost-cutting programs. Could you be more specific about what you're doing? Are you taking capacity offline?

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

We've taken some capacity offline to be more aligned with market conditions where they are. So that's resulted in headcount reductions in certain factories at least in the short term until volume comes back. And those reductions certainly have contributed to some of the higher cost, but long term, we expect it to help us hold -- maintain margins where they are.

Matt Sheerin -- Stifel Nicolaus -- Analyst

Okay. And then what was the reason for the relatively inflated SG&A number? I mean, year-over-year, it was up a bit. I know you have some ongoing legal expenses. Was it related to that in some way?

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

I think partially it's related to legal expenses and partially it's related to -- it takes time to reduce some of these cost reduction programs. It will take some time, particularly in the European region, when you're trying to address headcount reductions. You can't just walk in there and tell people they're going tomorrow. It's a little bit different in the US. But it will take some time to bring that number down in line with the sales number.

Matt Sheerin -- Stifel Nicolaus -- Analyst

Okay. So you're flowing those costs right through the P&L and might be taking charges -- extraordinary charges?

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

Correct. Absolutely.

Matt Sheerin -- Stifel Nicolaus -- Analyst

Okay.

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

Normal business these days.

Matt Sheerin -- Stifel Nicolaus -- Analyst

Okay. And then on the 5G side and you talked about some steady demand there, but if you think about the content increase in 5G versus 4G in base stations for whether it'd be both tantalum, polymer and ceramics, what's that opportunity?

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

I'm going to pass that question on to Eric Pratt, our Senior Vice President of Marketing.

Matt Sheerin -- Stifel Nicolaus -- Analyst

Great. Hi, Eric.

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

5G opportunities as opposed to 4G.

Eric Pratt -- Senior Vice President of Marketing

Yes, hi. We continue to see the market grow with 5G both in infrastructure and devices. Certainly, China is leading the way with that. So there's a lot of opportunities in China. The mix of products being used in 5G also is in infrastructure. So that mix of product fits well with our portfolio. So we're seeing a lot on the base station side. Certainly, the antennas we do are going into 5G handsets and we're now seeing some growth there, but some of the projections are by 2023, 25% of the handsets now will be 5G. We're already seeing 5G-capable handsets. So we're still in the early stages of it, but over the next 12 to 24 months, we'll see a lot more momentum both with the 5G infrastructure and 5G devices.

Matt Sheerin -- Stifel Nicolaus -- Analyst

Okay. Okay. I think that's it for me. Thanks very much.

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

Okay, Matt. Thank you.

Operator

And there are no additional questions at this time.

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

Okay. Thank you, Christina. And thank you to those who joined our Q2 call. Johnny and I look forward to speaking with you again in January with our Q3 results.

Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.

Duration: 24 minutes

Call participants:

Mike Hufnagel -- Senior Vice President, Chief Financial Officer and Treasurer

Eric Pratt -- Senior Vice President of Marketing

Matt Sheerin -- Stifel Nicolaus -- Analyst

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