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Vishay Intertechnology (NYSE:VSH)
Q3 2019 Earnings Call
Oct 29, 2019, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Peter Henrici

Good morning, and welcome to Vishay Intertechnology's third-quarter 2019 conference call. With me today are Dr. Gerald Paul, Vishay's president and chief executive officer, and Lori Lipcaman, our executive vice president and chief financial officer. As usual, we start today's call with the CFO, who will review our third-quarter 2019 financial results.

Dr. Gerald Paul will then give an overview of our business and discuss operational performance, as well as segment results in more detail. Finally, we'll reserve time for questions and answers. This call is being webcast from the Investor Relations section of our website at ir.vishay.com.

The replay for this call will be publicly available for approximately 30 days. You should be aware that in today's conference call, we will be making certain forward-looking statements that discuss future events and performance. These statements are subject to risks and uncertainties that could cause actual results to differ from the forward-looking statements. For a discussion of factors that could cause results to differ, please see today's press release and Vishay's Form 10-K and Form 10-Q filings with the Securities and Exchange Commission.

In addition, during this call, we may refer to adjusted or other financial measures that are not prepared according to generally accepted accounting principles. We use non-GAAP measures because we believe they provide useful information about the operating performance of our businesses and should be considered by investors in conjunction with GAAP measures that we also provide. This morning, we filed a Form 8-K that outlines the various variables that impact the diluted earnings per share computation. On the Investor Relations section of our website, you can find a presentation of the third-quarter 2019 financials and metrics.

Now I'll turn the call over to Chief Financial Officer Lori Lipcaman.

Lori Lipcaman -- Executive Vice President and Chief Financial Officer

Thank you, Peter. Good morning, everyone. I am sure that most of you have had a chance to review our earnings press release. I will focus on some highlights and key metrics.

Vishay reported revenues for quarter three of $628 million. EPS was $0.21 for the quarter. Adjusted EPS was $0.26 for the quarter. During the quarter, we continued our cash repatriation program.

We repatriated $115 million to the United States and paid withholding and foreign taxes of $18 million. These taxes had been accrued upon enactment of U.S. tax reform in 2017. The payment of these taxes is reflected as an operating cash flow on the statement of cash flows.

Also during the quarter, we recorded restructuring charges of $7 million related to the cost-reduction program we announced in July. I will elaborate on these transactions in a few moments. Revenues in the quarter were $628 million, down by 8.3% from previous quarter and down by 19.5% compared to prior year. Gross margin was[Audio gap]9%.

Operating margin was 8.1%. Adjusted operating margin was 9.3%. EPS was $0.21. Adjusted EPS was $0.26.

EBITDA was $91 million or 14.5%. Adjusted EBITDA was $99 million or 15.7%. Reconciling versus prior quarter, adjusted operating income quarter three 2019, compared to operating income for prior quarter based on $57 million lower sales or $55 million excluding exchange rate impacts, adjusted operating income decreased by $21 million to $58 million in Q3 2019 from $79 million in Q2 2019. The main elements were: average selling prices had a negative impact of $7 million, representing a 1.1% ASP decrease; volume decreased with a negative impact of $22 million, equivalent to a 7.1% decrease in volume; variable cost decreased with a positive impact of $4 million, primarily due to improved manufacturing efficiencies and cost reductions, which more than offset cost to adapt direct labor and foundry capacities to near-term volume expectations; fixed cost decreased with a positive impact of $4 million, primarily due to general belt-tightening measures, as well as the realignment of incentive compensation accruals for the period year to date September.

Reconciling versus prior year, adjusted operating income quarter three 2019 compared to operating income in Q3 2018, based on $153 million lower sales or $144 million lower excluding exchange rate impacts, adjusted operating income decreased by $80 million to $58 million in Q3 2019 from $138 million in Q3 2018. The main elements were: average selling prices had a negative impact of $12 million, representing a 1.9% ASP decline. Volume decreased with a negative impact of $59 million, representing a 17.4% decrease. Variable costs increased with a negative impact of $7 million, primarily due to temporary manufacturing inefficiencies and cost to adapt direct labor and foundry capacities to near-term volume expectations.

Other variable cost inflation was virtually offset by cost reduction. Fixed cost decreased with a positive impact of $4 million primarily due to general belt-tightening measures, as well as the realignment of the incentive compensation accruals for the period year to date September, which more than offset inflation. Inventory effects had a negative impact of $5 million. Selling, general, and administrative expenses for the quarter were $92 million, lower than expected, primarily due to belt-tightening measures, realignment of incentive compensation accruals for year to date September and other individually immaterial items.

For quarter four 2019, our expectations are approximately $95 million of SG&A expenses and approximately $385 million for the full year at constant exchange rates. During the third quarter, we continued our cash repatriation programs, which included movement of cash from some second- and third-tier subsidiaries to higher-tier subsidiaries. During quarter three, we have received $115 million in the United States and paid withholding and foreign taxes of $18 million. This brings the totals year-to-date to $189 million received in United States with $38 million of withholding and foreign taxes paid.

Substantially all of these amounts have been utilized to pay down the revolver to settle certain intercompany debt, to finance the capital expansion projects and to pay the tax reform transition tax. Recall that while such amounts are no longer subject to U.S. federal tax due to U.S. tax reform, they are subject to foreign, withholding and other taxes and some state income taxes.

There are approximately $100 million of additional earnings available for repatriation with taxes accrued. We are still evaluating the timing of such repatriation, but do not expect it to be in 2019.We had a total liquidity of $1.5 billion at quarter end. Cash and short-term investments comprised $788 million. No amounts were outstanding on our revolving credit facility.

During the quarter, we did not repurchase any of our outstanding convertible debt instruments. The authorization to repurchase additional convertible debt instruments will expire in a few days, but we expect it to be renewed by our board. Such transactions would be made in open-market repurchases or through privately negotiated transactions, subject to market and business conditions, legal requirements, and other factors. Our debt at end -- at quarter end is comprised of the convertible notes due in 2025 and the remaining convertible debentures due in 2040 and 2041.

The principal amount or face value of the converts totaled $621 million, $600 million related to the new notes and $21 million related to the remaining debentures. The carrying value of $496 million is net of unamortized discounts and debt issuance costs. As I said, there were no amounts outstanding on our revolving credit facility at the end of quarter three. No principal payments are due until 2025, and the revolving credit facility expires in June 2024.

As announced in July, we are implementing global cost-reduction programs, intended to lower cost by approximately $15 million annually when fully implemented and provide management rejuvenation. Some of these projects have already started, but in most cases, our strategy in the first phase is to seek volunteers to accept a voluntary separation early retirement offer. Accordingly, the amount of restructuring expenses recorded for these programs during Q3 is only $7 million. We expect to incur restructuring charges related to these programs totaling $25 million, and expect the cost reductions to be fully achieved by December 2020.

The year-to-date effective tax rate on a GAAP basis was approximately 30%. The year-to-date normalized tax rate was slightly above 26%. For the quarter, this mathematically yields a GAAP tax rate of approximately 31% for Q3 and a normalized rate of approximately 25%. Our GAAP tax rate includes adjustments to remeasure the deferred tax liability related to incremental foreign taxes payable upon repatriation, such as foreign currency effects.

A similar remeasurement will occur quarterly until such amounts have been repatriated. The remeasurement adjustment was an expense of $2.6 million for the quarter and an expense of $2.0 million year to date. Our year-to-date GAAP tax rate also includes the unusual tax benefit related to the settlement of some of the convertible debentures from Q1 and tax expense on a tax basis foreign exchange gain resulting from the payment of an intercompany loan previously deemed permanent in Q2. We continue to evaluate the provisions of the U.S.

tax law, particularly aspects of the GILTI and BEAT taxes. Our consolidated effective tax rate is based on an assumed level and mix of income among our various taxing jurisdictions. A shift in income could result in significantly different results. Total shares outstanding at quarter end were 144 million.

The expected share count for EPS purposes for the fourth quarter 2019 is approximately 145 million. For a full explanation of our EPS share count and variables that impact the calculation, please refer to the 8-K we filed this morning. Cash from operations for the quarter was $76 million. Capital expenditures for the quarter were $30 million.

Free cash for the quarter was $46 million. For the trailing 12 months, cash from operations was $362 million. Capital expenditures were $204 million, split approximately for expansion, $111 million; for cost reduction, $25 million; for maintenance of business, $68 million. Proceeds from the sales of property and equipment for the trailing 12 months were $48 million, which primarily represents the sale of our former manufacturing facility in Santa Clara, California.

We have leased back the property under a short-term arrangement to raze the buildings. Free cash generation for the trailing 12-month period was $205 million. The trailing 12-month period includes $53 million cash taxes paid related to cash repatriation, $38 million, and U.S. tax reform, $15 million.

Vishay has consistently generated in excess of $100 million cash flows from operations in each of the past 24 years and greater than $200 million for the last 17 years. Backlog at the end of quarter three was $1.127 billion or 4.5 months of sales, still high compared to our historical average of approximately three months. Inventories decreased quarter over quarter by $12 million, excluding exchange rate impacts. Days of inventory outstanding were 87 days.

Days of sales outstanding for the quarter were 51 days. Days of payables outstanding for the quarter were 29 days, resulting in a cash conversion cycle of 109 days. Now I'll turn the call over to our chief executive officer, Dr. Gerald Paul.

Gerald Paul -- President and Chief Executive Officer

Thank you, Lori, and good morning, everybody. As expected, Vishay's financial performance also in the third quarter has been negatively impacted by a low demand predominantly from distribution. Still high inventory levels in the supply chain keep burdening orders and revenues. Manufacturing capacities had to be further reduced, causing temporary inefficiencies for some product lines.

Vishay in the third quarter achieved a gross margin of 24% of sales, a GAAP operating margin of 8%, an adjusted operating margin of 9% of sales, GAAP earnings per share of $0.21 and adjusted earnings per share of $0.26. We continue to show a strong generation of free cash, which was $46 million in the quarter, and this includes the taxes paid for cash repatriation of $18 million. Let me talk about the economic environment as we see it. Also in the third quarter, global economy for electronic components remained on a reasonable level in general, but continued to show areas of relative weakness like automotive globally and industrials in China.

Inventories in the supply chain, after having reached a record high in the second quarter, started to come down noticeably. Lead times for most of the product lines have normalized. Backlogs remain high at this point, but are on the way to come down to more historical levels. Book-to-bill ratios remain substantially below one, actually 0.72 in the third quarter.

The price decline for commodity products has returned to normal rates, which, of course, is no surprise. Commenting on the regions. Geographically, markets also in the third quarter continued to develop rather differently. Economic conditions in the United States continued to be favorable, supported by strong industrial, military and also automotive sectors, and the POS remains at high levels.

Europe is weakening, impacted mainly by a softening of the automotive and industrial market segments. Generally, there is too much inventory in the supply chain in Europe. Despite ongoing economic uncertainties, Asia seems to have bottomed out with some signs for a recovery. Talking about distribution.

POS of global distribution in the third quarter declined by 4% versus prior quarter and was 14% below prior year. Regionally, we see a rather different picture. Sequentially in Europe, POS declined by 7%, reflecting a more difficult market situation. POS in the U.S.

went down by 5%, but remained at a good level. POS in Asia has stabilized. Despite an overall weaker POS, inventories in the third quarter came down noticeably, and let me emphasize that in a broad way. In Q3, inventory turns of distributors declined slightly to 2.4 as compared to 2.5 in prior quarter and to 3.5 in prior year.

In the Americas, it was 1.5 inventory turns after 1.5 in the second quarter and 2.3 in prior year. In Asia, 3.3 turns after 3.2 in the second quarter and 4.5 in prior year. In Europe, 2.9 after 3.0 and 3.8 in prior year. Let me come to the various industry segments.

First, automotive. Automotive customers predict vehicle sales to decline this year and do not expect a major turnaround for 2020. Nevertheless, our sales should remain healthy, continuing to be driven by electrification and by the implementation of programs for electromobility. Industrial markets continue to show a mixed picture.

Industrial automation, oil and gas, power transmission sectors remain healthy in general, whereas power supplies and lighting continues weak. Military and aerospace markets remain solid and growing. They are supported by higher governmental spending in military, mainly, of course, in the United States. Medical markets continue to grow steadily.

The introduction of 5G is expected to drive substantial growth in fixed telecom in the midterm, whereas mobile phones remained weak. Computing shows some improvement with an expected growth of 2% this year. Consumer markets are weakening in general, which, in particular, relates to the white-good sector. Now let me come to[Audio gap]business development in the third quarter.

Sales came in slightly above the midpoint of our guidance. We achieved sales of $628 million versus $685 million in prior quarter and $781 million in prior year. Excluding exchange rate effects, sales in the third quarter were down by $55 million or by 8% versus prior quarter and down versus prior year by $144 million or 19%. We have seen a book-to-bill ratio of 0.72 in the third quarter, 0.55 for distribution after the 0.55 in the second quarter, 0.90 for OEMs after 0.86 in the second quarter, 0.60 for actives after 0.56, 0.83 for the passive after 0.81, 0.76 for the Americas after 0.72, 0.64 for Asia after 0.57, 0.78 for Europe after 0.79.

In summary, there is a normalization of backlogs in a broad form and this continues. Backlogs in the third quarter continued to shrink to a high level, still a very high level of 4.5 months, down from 4.9 months in the second quarter, 4.4 months in semiconductors and 4.5 in passives. Let me remind you that historical levels are approximately at three months. Distribution inventories reduced by $36 million in the quarter, whereby all regions and virtually all commodity product lines were concerned.

Price decline has restarted, predominantly in semiconductors. For all Vishay, we have seen minus 1.1% prices versus prior quarter and minus 1.9% versus prior year. Tariff errors are included. For semiconductors, these were minus 2.1% versus prior quarter and minus 4.3% versus prior year.

For the passives, minus 0.1% versus prior quarter and plus 0.5% versus prior year. Some comments on operations. In the third quarter, we again were able to offset the negative impacts on the contributive margin by cost reduction and by innovation, despite costs related to adaptation of direct labor and of near-term foundry capacities. SG&A costs in the third quarter came in at $92 million, which was below expectations primarily due to general belt-tightening and the adaptation of bonuses.

Manufacturing fixed costs in Q3 were $125 million. Total employment at the end of the second quarter was -- at the end of the third quarter, sorry, was 23,100, down by 2% versus prior quarter due to lower production output requirements. Excluding exchange rate impacts, inventories in the quarter decreased by $12 million. Raw materials basically made that, they were down by $12 million, whereas WIP and finished goods were flat.

The inventory turns in the third quarter remained at a fairly good level of 4.1. Capital spending in Q3 was $30 million versus $50 million in prior year. $18 million was spent for expansion, $1 million for cost reduction and $11 million for the maintenance of the business. For 2019, we continue to expect capex of about $150 million, which reflects lower short-term market requirements.

Concerning the cash flow. We, in Q3, generated cash from operations of $76 million versus $71 million in prior year. Q3 of last year was burdened by cash taxes paid for cash repatriation of $65 million. Q3 of this year was burdened by $18 million.

We generated cash from operations of $362 million on a trailing 12-months basis, including $38 million cash taxes paid for cash repatriation. We generated in the third-quarter free cash of $46 million versus $21 million in prior year. Q3 of last year was burdened by cash taxes paid for cash repatriation of $65 million, Q3 of this year by $18 million. We generated free cash of $205 million on a trailing 12-months basis, including $38 million cash taxes paid for cash repatriation.

Coming to the product lines and starting with resistors and inductors. With resistors and inductors, we enjoy a very strong position in the industrial, auto, mil, and medical market segments. Vishay's traditional and since years, most profitable business also feels the impact of high inventories at distributors. Sales in the third quarter were $227 million, down by $15 million or by 6% versus prior quarter and down by $23 million or by 9% versus prior year, all that excluding exchange rate impacts.

Book-to-bill in the third quarter was 0.86 after 0.88 in prior quarter. Backlog remained at 4.6 months, which is still very high. Gross margin for resistors and inductors remained at 29% of sales. Manufacturing capacities now are adapted to present requirements.

Inventory turns in the third quarter remained at a good level of 4.2. There's a low price decline in this product line, minus 0.3% versus prior quarter and minus 0.5% versus prior year. We have slowed down the expansion of manufacturing capacities for MELFs and thin film resistor chips, but we remain ready for serving increasing market requirements in the future. Coming to capacitors.

Our business with capacitors is based on a broad range of technologies with a strong position in American and European market niches. We enjoy increasing opportunities in the fields of power transmission and of electro cars. Sales in the third quarter were $98 million, 11% below prior quarter and 14% below prior year, which excludes exchange rate effects. Book-to-bill ratio in the third quarter was 0.76 after 0.68 in prior quarter.

Also commodity capacitors see backlog normalization and inventory correction. Backlog reduced further to a still high level of 4.3 months. The gross margin in the quarter was at 22% of sales versus 24% in prior quarter as a result of lower volume. Inventory turns in the quarter were at normal, 3.4.

Selling prices were increased vis-à-vis prior year and vis-à-vis prior quarter by 0.6% versus prior quarter and by 2.8% versus prior year. Several capacitor lines keep benefiting from major governmental programs in China and from the ongoing strength of the military markets in the United States. Opto. Vishay's business with Opto products consists of infrared emitters, receivers, sensors and couplers as well as of LEDs for automotive applications.

The Opto business, since a few quarters, suffers badly from high distribution inventories and unfavorable product mix and a general weakness of our main product line, predominantly in Asia. But we now believe that the business has bottomed. Sales in the quarter were $51 million, 16% below prior quarter and 33% below prior year, which excludes exchange rate effects. Book-to-bill in the third quarter was 0.86 after 0.70 in prior quarter.

The backlog increased to 4.4 months. Gross margin in the quarter came in at 22% of sales after 27% in the second quarter, much below historical levels, for the most part, due to substantially lower volume. The line has good inventory turns of 5.3 in the quarter as compared to 5.6 in the second quarter. Price decline is accelerating, minus 2.7% versus prior quarter and minus 6% versus prior year.

We expect the business to come back to more historical levels of profitability after this normalization phase. Coming to the diodes. Diodes for Vishay represents a broad commodity business where we are largest supplier worldwide. Vishay offers virtually all technologies, as well as the most complete product portfolio.

The business has a very strong position in the automotive and industrial market segments, but suffers very substantially from too high inventories at distributors. Sales in the quarter were $124 million, 13% below prior quarter and 33% below prior year, which excludes exchange rate effects. The normalization of backlog progresses and explains the very weak book-to-bill ratio of 0.57 in the quarter after 0.52 in the second quarter. Backlog reduced to a still very high level of 4.9 months from 5.5 months in prior quarter.

Gross margin in the quarter came in at 17% of sales, down from 20% in the second quarter. A further reduction of the sales volume in combination with costs to adapt direct labor burdened results. Inventory turns remained at a good level of 4.2 as compared to 4.3 in prior quarter. We are back to historical rates of price decline.

We have seen minus 2.6% versus prior quarter and minus 3.9% versus prior year, whereby tariff errors are included. We definitely expect diodes to continue their success story at recent -- of recent years to the full extent after the normalization of the inventories in the supply chain has been finalized. Coming to MOSFETS. Vishay continues to be one of the market leaders in MOSFET transistors.

MOSFETs, over the last years, developed a strong and growing position in automotive. Also, MOSFETs now see the impact of inventory reductions in the supply chain. Sales in the quarter were $127 million, 2% below prior quarter and 12% below prior year, excluding exchange rate impacts. The book-to-bill ratio in the third quarter remained at 0.54.

The normalization of backlogs also for the MOSFETs continues. Backlog has reduced to a still high level of 4.0 months after 5.3 months in prior quarter. The gross margin in the quarter came in at 24% of sales as compared to 25% in the second quarter, which includes costs for near-term foundry capacities adaptation. Fairly good inventory turns we have seen for MOSFETs of 4.0 in the quarter as compared to 4.2 in the second quarter.

Price decline is at normal levels, minus 1.5% versus prior quarter and minus 3.9% versus prior year. We continue to expand internal and mid- to long-term foundry capacities, preparing ourselves for substantial increases of demand, in particular, in automotive in the midterm. Let me summarize. After a record year 2018, our business continues to be in a phase of correction and normalization.

We have seen all this happening before. The electronics industry business is, may I say, notoriously cyclical. Automotive and Far East markets in general are less favorable than in recent years and still high inventory levels in the global supply chain should impact our business for another two quarters. On the other hand, there is no reason to doubt the growth potential of electronics.

The fundamentals have not changed at all. Vishay, as a very well-established broad line supplier, will benefit from all moves toward electrification going forward. We currently are managing the slowdown by adapting all operational parameters as we have done this in the past. On the other hand, our increased machine capacities will enable us to participate in the next economic upturn to the full extent.

We are well on the way to implement our announced restructuring and rejuvenation program that aims at an annual reduction of personnel fixed costs of $15 million when fully implemented by Q1 in 2021. Having to expect the continuation of the inventory burn off in the channel, we, for the fourth quarter, guide to a sales range of $580 million to $620 million at gross margins of between 23% and 24%. Thank you very much. Peter?

Peter Henrici

Thank you, Dr. Paul. We now open the call to questions. Stephanie, please take the first question.

Questions & Answers:


Operator

[Operator instructions] Our first question comes from the line of Matt Sheerin with Stifel.

Matt Sheerin -- Stifel Financial Corp. -- Analyst

Yes. Thank you, and good morning. Dr. Paul, in terms of the bookings in the -- or the backlog in semiconductors versus passives, it looks like the passive component side of the business is holding up a little bit better.

Is that because that seems to be lagging the semiconductors which got hit earlier? Does it have to do with end market exposure? Could you just talk about that?

Gerald Paul -- President and Chief Executive Officer

Yes. I believe that the share of commodity products in semiconductors in the case of Vishay is much higher than in the case of passives. Our passives business consists of quite a nice share of specialty products, where backlogs never went down so much. The nervousness of getting these specialty products was not as high as we have seen that in the other lines, in the more commodity-oriented lines.

And -- so the passives really behave differently. It's not that they lag. It never -- the reason is much less to do that. That's the answer.

Matt Sheerin -- Stifel Financial Corp. -- Analyst

Understood. And it also looks like the pricing is starting to get hit in the semis and not on the passive side. Are you expecting, as you get into the new year, particularly with new OEM contracts, that you're going to see more normal price declines in both areas of the business?

Gerald Paul -- President and Chief Executive Officer

Now as you know, our main price decline happens at the commodity components, really, and this is predominantly semiconductors. We are in midst of negotiations for the next year. And I can tell you, yes, there will be some concessions to be made, but nothing special. So it's just a return of normal conditions as we see it.

Matt Sheerin -- Stifel Financial Corp. -- Analyst

OK. And the -- the capacity expansion, it sounds like you're pulling back on some production areas, but you're also continuing to add capacity. Could you tell us areas where you are adding capacity, what product lines?

Gerald Paul -- President and Chief Executive Officer

Yeah. There are quite a few, even. So as a matter of fact, I don't want to go through all my lines, but predominantly inductors. They have a major success in the market, which really is independent from this economic cycle at the moment, and we can hardly add capacity fast enough.

Power inductors, that's the most prominent example. But we also have to think of MOSFETs. We believe that the growth in automotive, with our MOSFETs will be quite substantial going forward. And we have to take care of capacities, inside capacity, as well as foundry capacities.

I think these two segments, they represent the places, so to speak, where we continue to look for more volume. Otherwise, we are in a good position. We have invested a lot in the last two years.

Matt Sheerin -- Stifel Financial Corp. -- Analyst

OK. Thank you very much.

Gerald Paul -- President and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Harlan Sur with JP Morgan.

Harlan Sur -- J.P. Morgan -- Analyst

Good morning. Thanks for taking my question. On your broad-based segments, specifically, industrial and automotive, I know that these businesses are at depressed levels. But off of a low base, these two businesses are typically up sequentially in Q1, but you still have some inventory work-downs.

And so if you look at your backlog visibility for Q1 and maybe four, three, and six months customer forecasts, do you think you'll get some positive seasonality in Q1 of next year?

Gerald Paul -- President and Chief Executive Officer

Well, we feel that in Q1 -- really the -- everything is determined by the inventory burn off these days, right? As a matter of fact, we see the inventory coming down, which was good news, as a matter of fact, in the third quarter. And this will continue in the fourth quarter, and we do believe that also the first quarter will still be impacted. To the extent the future, it all depends also on the development of POS. We believe that we will see a real change of the direction in quarter two.

Harlan Sur -- J.P. Morgan -- Analyst

Got it. Thank you for that. Thank you for the insights there. And then SG&A, your prior view, I think, on Q4, SG&A was $98 million, now you're anticipating $95 million.

Is that just continued discipline and belt-tightening? Or are you getting some acceleration of the global cost reduction program sooner?

Gerald Paul -- President and Chief Executive Officer

No.

Harlan Sur -- J.P. Morgan -- Analyst

And -- go ahead.

Gerald Paul -- President and Chief Executive Officer

Global cost reduction program is still innocent for that, so to speak. We are just starting to -- well, we are in midst of defining, it's not an impact. So we just save money, to say it clearly. We have seen sales coming down and the company's disciplined, I believe.

We started to save money, as a matter of fact, and we continue to do so.

Harlan Sur -- J.P. Morgan -- Analyst

And do you have an initial view on SG&A for 2020?

Gerald Paul -- President and Chief Executive Officer

Yes. We do. We do. We will have less than the inflation, but we may want to -- somebody helps me.

So as a matter of fact, we believe SG&A in the area of $400 million, and this includes the inflation, the annual wage increase.

Harlan Sur -- J.P. Morgan -- Analyst

Got it. Thanks. And then just my last question...

Gerald Paul -- President and Chief Executive Officer

This is -- we have -- we don't have a finalized budget yet. This is the direction approximately.

Harlan Sur -- J.P. Morgan -- Analyst

Got it. OK. I appreciate that. Then my last question, if I look back at the cyclical downturn, let's say, 2015, 2016, your current diode and opto revenue run rates are bottoming, probably at about those same levels as the last cycle.

But gross margins for diodes this cycle, they're about 400, 500 basis points lower. Opto margins about 600, 700 basis basis points lower versus last cycle. What are the biggest differences? Is it just that utilizations this cycle are just much lower as customers brought off inventories?

Gerald Paul -- President and Chief Executive Officer

As a matter of fact, on MOSFETs -- you have not mentioned MOSFETs because MOSFETs have changed in the other direction. They are substantially better.

Harlan Sur -- J.P. Morgan -- Analyst

That's right.

Gerald Paul -- President and Chief Executive Officer

Opto is a special case. Diodes, I cannot see that. I believe diodes, principally speaking, they -- it's a specialty included. We have -- we had to reduce people this quarter and this costed money, as a matter of fact, and this is part of the P&L.

Diodes, we are very, very confident. They also improved their earnings power substantially over the years and continue to do so. We are -- I am not satisfied with -- really what I'm not satisfied with is the development at our opto line. They suffered from lower volume, but also -- they suffered more than they should have.

They are focused very much on China and had some specific problems in China there. We believe that this line will turn around as we go because they are forcing now more the sensors in coupler area and on the way to do that. So they suffered more is no question, but this is the only line, I would say, that they suffered more historically.

Harlan Sur -- J.P. Morgan -- Analyst

OK. Great. Thank you, Dr. Paul.

Operator

Your next question comes from the line of Karl Ackerman with Cowen.

Karl Ackerman -- Cowen and Company -- Analyst

Hey, good afternoon, everyone. Thanks for taking my question. A few, if I may. Dr.

Paul, if we were to fast forward two quarters ahead, in which case you could get some inventory distribution partners will be at equilibrium, should we expect ASPs to stabilize or increase from here? I guess what should we expect from an end market mix or specific product growth initiatives that should drive an upward inflection in margins and ASPs?

Gerald Paul -- President and Chief Executive Officer

Sorry. I may not have understood completely, acoustically. So what was it? So as soon as the dust will be down, you said, right? Two quarters ahead or something? Sorry it's just a --

Karl Ackerman -- Cowen and Company -- Analyst

Correct. As we work through this inventory challenge at distribution partners, what's your indication for ASPs and margins, I guess, beyond the simplicity of working-down inventory. What do you see from the end market mix or specific product growth initiatives that you're driving up inflection from there?

Gerald Paul -- President and Chief Executive Officer

I see no reasons that the mechanics after this normalization will be different from the mechanics which were there before this upturn, which was partially leading to higher inventories. I believe that we are going to see very stable pricing in the wide field of our specialty products. And you already see that also happening now. Like it always happened in the past, it's obviously quite constant.

And then, of course, you will see some price decline on the commodity side, which also is starting to show. And this price decline we are used to. We are able, since many, many years, we show it even -- we discuss it quite often that our variable margin remains constant, we can defend it despite this price decline, despite inflation, by cost reduction and innovation. So I see -- I'm not concerned at all, we return to normal conditions, and we are used to these conditions, of course.

Karl Ackerman -- Cowen and Company -- Analyst

That's it. Thank you. I know your outlook calls for a sequential decline in -- toward the fourth quarter, but do you expect any end markets to be up sequentially in the fourth quarter? In addition to that, some of your peers in supply chain have spoken about modest improvements in actually China automotive, particularly on the electric vehicle segment, as well as health [Inaudible] for power-related devices, industrial systems and servers. I was hoping you could describe what you're experiencing in those areas.

And also, what you're seeing across network infrastructure, specifically as we look into fourth quarter and Q1? Thank you.

Gerald Paul -- President and Chief Executive Officer

You are talking China, in particular or in general.

Karl Ackerman -- Cowen and Company -- Analyst

For automotive, broadly, but China automotives, in particular. Yes.

Gerald Paul -- President and Chief Executive Officer

OK. Well, in particular, automotive in general, from a standpoint of vehicles produced is down. And China, to my understanding, is down, especially much. On the other hand, it's the old story, but it's down in terms of pieces, in terms of pieces of automotive cars produced does not mean necessarily for the electronics supplier that he sees the same downturn.

This has always been the case. And also now, we -- you see we do quite well in automotive and this, of course, is the consequence of the fact that more and more electrification takes place in automotive. And this is true for China also. In particular, as I believe, even, in particular in China, because I believe this local supplier start is relatively in small models and want to become more sophisticated.

So I am not concerned. I think this growing electrical constant -- context -- content will help us also to do quite well, despite the production rates of automotive may not grow every year and maybe they are stagnating for the next years, which is the common belief. China is not doing very well at the moment in total, but also, this doesn't have to stay the same way. You can be also modestly optimistic that they will come back to higher growth rates.

OK? This -- so I'm not concerned about automotive, neither in China, nor globally. It will continue to be our area of strength for Vishay. Hello?

Karl Ackerman -- Cowen and Company -- Analyst

And sorry. Just some of clarification on -- curious on what you're seeing with regard to network infrastructure and in addition to server, as some of your peers had called out. Thank you.

Gerald Paul -- President and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Shawn Harrison with Longbow.

Shawn Harrison -- Longbow Securities -- Analyst

Hi. Good afternoon, everybody. Dr. Paul, do you think that once the inventory positions with distribution normalize, be it the first quarter or sometime thereafter that you also see your backlog get back to that normal three and a half to three months level.

Is there anything -- I guess, the question is that we should bring from distribution versus trends versus your backlog normalizing?

Gerald Paul -- President and Chief Executive Officer

There was never a doubt on that. During the last two years where it boomed, we knew from the very beginning, from the time it -- we started to grow quite heavily in the year 2017. We, from day one knew, and not only we say, everybody knew, that this was partially driven by nervousness, not getting -- not being able to get enough products. There is absolutely no doubt that this business, which always typically has a three-months backlog will go back to this level of three months backlog.

When this fear is out in the lead times as they have done it already have normalized. No question about it. The backlogs will go back to normal.

Shawn Harrison -- Longbow Securities -- Analyst

And, I guess, a larger-picture question. And the concern looming out there is kind of this made-in-China component initiative and there's general theories on whether they will try to start more at the high end of the market, the mid end, more commodity products and obviously, a risk for semiconductor and component suppliers. What -- how -- maybe you could talk about that risk that you see out there and whether there's any potential threats to the business over the next 12 months or a couple of years from growing Chinese competition, domestic Chinese competition?

Gerald Paul -- President and Chief Executive Officer

We are Chinese also. So as a matter of fact, if you refer -- and I must have a bad connection today, if you refer to our competitiveness in China vis-à-vis local suppliers, and this is what I understood, we are also producing in China, as a matter of fact. So I'm not concerned there also. At the moment, we go together with all the suppliers to China.

We see the negatives of an economy that doesn't grow so much anymore as it used to be. But I think there are also reasons why it's not so growing so much these days. And I believe part of the reasons may go away. And we will -- for us China remains to be a center of our efforts in sales.

It's the biggest market that exists for us. So we will continue to go there, and we are quite optimistic and confident that we can compete there also in the future.

Shawn Harrison -- Longbow Securities -- Analyst

Thank you.

Operator

Your next question comes from the line of Ruplu Bhattacharya with Bank of America. Your line is open.

Gerald Paul -- President and Chief Executive Officer

Hello?

Ruplu Bhattacharya -- Bank of America Merrill Lynch -- Analyst

Hi. Can you hear me now?

Gerald Paul -- President and Chief Executive Officer

Yes.

Ruplu Bhattacharya -- Bank of America Merrill Lynch -- Analyst

Hi. Thank you for taking my question. Dr. Paul, you mentioned that there's about two quarters' worth of inventory that needs to be burned off.

Did I understand correctly that most of that inventory is in Europe? Or is it geographically equally distributed across the region?

Gerald Paul -- President and Chief Executive Officer

No. This is a broad distribution of too much inventory? No, no. It's not the case. So it's broad.

It's broad.

Ruplu Bhattacharya -- Bank of America Merrill Lynch -- Analyst

OK. And then did I understand correctly that pricing is getting more stable? And do you see that continuing because if you still have two quarters of inventory, would that not put more downward pressure on pricing?

Gerald Paul -- President and Chief Executive Officer

No. First of all, the prices on specialty products, stable like they always have been. The pricing of -- for commodity products, which were rather stable in -- during the last two years of kind of shortage. They now start to go down, like they always do.

It's a -- there's a continuous price decline on commodity products. And we see it now returning, but we have learned to cope with that, as a matter of fact. The times of inventory decrease is not -- does not necessarily mean that there's more price pressure as a matter of fact.

Ruplu Bhattacharya -- Bank of America Merrill Lynch -- Analyst

OK. And for my last question, do you have a view on industry supply versus demand? I mean, your competitors have also added capacity. So do you have a view of how much total capacity exists now in the in the system? And how does that compare to demand? And would that impact pricing over the next six months, a year?

Gerald Paul -- President and Chief Executive Officer

You referred to the high-capacity increases of -- in our industry of the last two years, I suspect, right? Which is --

Ruplu Bhattacharya -- Bank of America Merrill Lynch -- Analyst

Yes.

Gerald Paul -- President and Chief Executive Officer

Of course. There is a lot of capacity put -- being put in place, no question about it, and Vishay is one of the ones. But I believe, and that was always the policy, to be ahead of the demand at any point in time. We have to serve our markets when the markets want to have the volume.

And I believe that the economy will turn up. I think we will need this capacity in a very foreseeable future, and this is true for my competition, of course,also. I do not see a direct connection. Of course, theoretically, it should exist.

But I do not see a direct connection between the machine capacity available and the price pressure. I admit you can argue, but probably, I would -- no, I have not seen that. You can always find cases where somebody wants to fill this line. And we are also not innocent sometimes.

But overall, this is not a driving momentum, no.

Ruplu Bhattacharya -- Bank of America Merrill Lynch -- Analyst

OK. All right. Thank you for taking my question.

Operator

Thank you. There are no additional questions at this time. I'll turn it back over to management for closing remarks.

Peter Henrici

Thank you. This concludes our third-quarter conference call. Thank you for your interest in Vishay Intertechnology.

Operator

[Operator signoff]

Duration: 55 minutes

Call participants:

Peter Henrici

Lori Lipcaman -- Executive Vice President and Chief Financial Officer

Gerald Paul -- President and Chief Executive Officer

Matt Sheerin -- Stifel Financial Corp. -- Analyst

Harlan Sur -- J.P. Morgan -- Analyst

Karl Ackerman -- Cowen and Company -- Analyst

Shawn Harrison -- Longbow Securities -- Analyst

Ruplu Bhattacharya -- Bank of America Merrill Lynch -- Analyst

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