KraneShares Dynamic Emerging Markets Strategy ETF
Q2 2020 Earnings Call Transcript

Published: 12 Nov 2019

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to the KEMET’s Second Quarter Fiscal Year 2020 Earnings Conference Call. At this time, all participants’ lines 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 first speaker today, Richard Vatinelle. Thank you. Please go ahead, sir.

[Richard Vatinelle:]

Thank you, Prince, and good morning, everyone. This is Richard Vatinelle, Vice President and Treasurer. Welcome to KEMET’s conference call to discuss the financial results for the second quarter of fiscal year 2020, which concluded on September 30, 2019. Joining me today on the call is Bill Lowe, Chief Executive Officer; and Greg Thompson, Executive Vice President and Chief Financial Officer. As a reminder to you, a presentation is available on our website that should help you follow along in the financial portion of the presentation. Before we begin, we would like to advise you that all statements addressing expectations or projections about the future are forward-looking statements. Some of these statements include words such as expects, anticipates, estimates, beliefs, plans, intends, projects and indicates. Although they reflect our current expectations, these statements are not guarantees of future performance, and they involve a number of risks, uncertainties and assumptions. Please refer to our 10-Ks or 10-Qs and our registration filing statements for additional information on the risks and uncertainties. Now, I will turn the call over to Bill.

[Bill Lowe:]

Thank you, Richard, and good morning, everyone. In addition to reporting our quarterly results, we’re also excited to talk this morning about what we believe is a compelling strategy and strategic combination for our shareholders, customers, business partners, and our employees. Yesterday evening we announced an agreement to be acquired by Yageo, a leading global electronic component company, headquartered in Taiwan and listed on the Taiwan Stock Exchange, in an all-cash transaction valued at $1.8 billion, which includes the assumption of net debt. Shareholders of KEMET will receive $27.20 per share in cash, which is not subject to a financing contingency. Yageo is similar to KEMET with a complete product portfolio and capabilities on a global scale including production and sales facilities in Asia, Europe, and the Americas. Because of KEMET and Yageo’s complimentary product offerings, the combined company will be an industry leader in the $28 billion to $32 billion passive components industry and serve as a one stop provider of a robust portfolio of polymer, tantalum, ceramic, film and electrolytic capacitors, chip resistors, circuit protection as well as magnetics, sensors and actuators with revenues of approximately $3 billion. Our Board of Directors conducted a thorough process in evaluating this transaction with outside advisors over a number of months along with other potential opportunities to enhance value for shareholders. The Board determined entering into this agreement is in the best interest of the company and our stakeholders. First and foremost, this transaction will deliver this certainty of immediate cash to shareholders at a 30-day trading premium of 26% and a 90-day trading premium of 37%. It is also a premium of 14% over our 52-week high. Second, we are confident this transaction will position KEMET for long-term growth as we enter our second 100 years as a company providing quality products and service. Together with Yageo, we will have an enhanced global footprint and be better able to partner with longstanding blue chip customers worldwide through a combined 42 manufacturing plants and 14 dedicated R&D centers with an increased presence and attractive high growth segments and applications. This includes consumer electronics as well as in the high-end automotive, industrial, aerospace, telecom, and medical sectors. The Yageo team has made it clear their amortization for the KEMET brand and the quality of our operations and our success in capturing increased worldwide demand for customer designed higher margin electronic components and capacitors and our talented workforce. Further Yageo and KEMET each have a proven track record of completing major cross-border acquisitions and believe this transaction will generate enhanced value for customers and shareholders of both companies, as well as greater opportunities for employees. As I stated earlier and is in our joint press release, the transaction is not subject to a financing contingency. Yageo intends to fund the transaction with a combination of cash on hand and committed financing. We would expect to close the transaction in the second half of 2020, subject to customary closing conditions, which including KEMET shareholder approval and the receipt of required regulatory approvals in various jurisdictions in which we operate. Until then, KEMET and Yageo will continue to operate as independent companies. Following the close of the transaction, KEMET will become a wholly owned subsidiary of Yageo. This is an incredible opportunity for our company to capitalize on our momentum and provide an enhanced experience, superior service and broader selection of passive component technologies to our customers across the globe. We are excited to take this next step and I’m optimistic as ever about KEMET’s future. Now, let me turn the call over to Greg to go through the numbers on the quarter and then I’ll come back to you with some comments in the markets and our business units. We did have a great quarter meeting all of our goals and seeing less of an impact in the slowdown than our competition with historical margins continuing to improve built by our tireless efforts over the years to embed changes in our structure. Greg?

[Greg Thompson:]

Thank you, Bill, and good morning, everyone. I’m sure you’ve had a chance to review our press release this morning. So I will highlight only a few key metrics. I will start my review on Slide 4 and 5 of the webcast slides. Revenue for the second quarter was down 6.3% to $327.4 million compared to Q2 last year of $349.2 million, as we continue our efforts to reduce excess inventory in the distribution channel. GAAP net income was negative $15.3 million or $0.26 per share loss for the quarter compared to GAAP net income of $37.1 million or $0.63 per diluted share for the quarter ended September 30, 2018. This decline was driven by onetime items relating to litigation settlements. As detailed in our 8-K filed this morning, the company entered into a settlement agreement with the plaintiffs in the antitrust litigation. It originally filed on December 4, 2014, in which KEMET and more than 20 other capacitor manufacturers and subsidiaries are defendants in a purported class action complaint relating to the sale of capacitors in the U.S. KEMET has reached a settlement agreement subject to court approval and as agreed to pay an aggregate of $62 million to settlement, the class of plaintiffs. Pursuant to the terms of this settlement agreement, KEMET will pay $10 million within 30 calendar days of the date of the settlement agreement and the remaining amount within 12 months. As part of the settlement agreement, the company did not admit to violating any statute or law any wrongdoing. The company recorded a total charge for litigation settlements of $63 million in the second quarter. Non-GAAP adjusted net income was $39.3 million in the second quarter versus $50.8 million in the same quarter last year, a decrease of 22.6% due to lower revenues and much higher tax rate in FY 2020, which I’ll touch on a bit later. In spite of lower revenues, GAAP gross margin was up significantly compared to last year’s second quarter by 220 basis points from $32.5 million to $34.7 million due to continuing improvements and operational efficiencies in the Solid Capacitor segment. GAAP diluted EPS was $0.26 negative compared to $0.63 for the second quarter last year. Non-GAAP diluted EPS was $0.66, down compared to $0.86 in the second quarter last year. Again, this decline was due to the higher income tax rate in fiscal year 2020. Our adjusted EBITDA for the second quarter was up 3.5% to $75 million from $72.5 million in the same quarter last year. Now on Slide 6. The LTM adjusted EBITDA margins have steadily increased over the last two fiscal years from 17.4% at September 30, 2018, to 23.1% for the period ending September 30 2019. During our first quarter call, we discussed the structural changes that we have made over the last few years in terms of segmenting the ceramics product line to focus on value added applications with a design in focus vertically integrating the tantalum business to improve costs and focus on the newer polymer technology and of course acquiring TOKIN to expand our offering and strengthen our balance sheet. This quarter’s results continued to highlight that these structural changes make us a different company today than we were several years ago as we demonstrate continuing strong sustainable profitability performance in spite of the slowdown in the electronics industry. Non-GAAP SG&A expenses came in below our forecast at $42.2 million or 12.9% of revenue compared to Q2 last year of $45.3 million or 13%. Non-GAAP income taxes were $18.7 million at an effective tax rate of 32.2% compared to Q2 last year of $2.2 million at an effective tax rate of 4.1%. As explained in our last earnings call, the increase in the non-GAAP income tax effective rate is due to the release in Q4 of last year of our U.S. net operating loss valuation allowance and partial valuation allowance in Japan. This is a result of the significant improvements in our profitability along with our forecast for continued strong profitability going forward. The further increase in the company’s effective tax rate this quarter and in our projection for next quarter is a result of lower projected earnings for the year, which changes the mix of earnings by tax jurisdiction and increases the impacts from the permanent differences related to the Tax Reform Act provisions. Turning now to Slide 7. Capital expenditures during the second quarter were $36.3 million compared to $37.1 million in the previous quarter. This coming quarter, we expect to spend in the range of $45 million to $55 million for capital expenditures as we continue our plan capacity expansion focused on ceramics and tantalum polymer to support future customer demand along with investments in our IT infrastructure around the globe. We expect capital expenditures for the full year ending March, 2020, to be in the range of $120 million to $135 million excluding approximately $45 million to $50 million of customer funded capacity expansion related to the customer capacity agreements, which we’ve discussed over the last couple of earnings calls. Net inventories increased $12.1 million in the second quarter to $268.2 million compared to the previous quarter of $256.1 million due to higher ceramics work in process to support future demand and some opportunistic raw material purchases in our tantalum product line. Cash on hand was $192.7 million. Our cash balances and accounts receivable DSO were negatively impacted by approximately $10 million by Typhoon Mitag, which caused banking closures throughout Taiwan a few days before quarter end. We do process a significant amount of our cash collections in Asia Pacific through our Taiwan subsidiary. We generated $51.7 million of cash from operating activities during the second quarter. Turning to Slide 8. Net debt stands at $113 million at quarter end and net debt to LTM EBITDA of 0.4 is on slide eight. This slight increase from a Q1 net debt to LTM EBITDA 0.3 is due mainly to the increase in customer capacity agreement funding between quarters, which gets recorded as down on the balance sheet as well as the lower cash number as I explained earlier. During the second quarter, we made our semi-annual principal payment of approximately $12.7 million on the outstanding TOKIN debt and overall our financial position remains very strong. Now, I will turn the call back over to Bill to comment on the business groups.

[Bill Lowe:]

Thanks, Greg. And so turning into our business groups and starting with solid capacitors. Solid Capacitor revenue was up – sorry $1.8 million lower or down 0.8% versus the same quarter last fiscal year. So looking the two Solid Capacitor business product lines, the revenue for the ceramic product line actually increased $21.1 million or 24.1% versus the same quarter the previous year. The ceramic revenue increased in each channel and increased in each region as compared to the same quarter a year ago. These increases were driven by product mix and a favorable MLCC pricing. Growth versus the same quarter a year ago it was broad based across almost all ceramic segments. Our focus segments led the growth which includes automotive, industrial, defense and aerospace, medical and energy. Our focus for future growth in our ceramic product segment continues to be development, design-in and supply of ceramic capacitors requiring high performance, reliability based on more robust designs and materials. Many of these require larger sizes to handle higher current and voltage and power requirements as compared to the global MLCC market. Our ceramic revenue has remained at a high level as compared to the global MLCC market, which has experienced about a 23% reduction from the peak quarter in September of 2018 based upon the world cap reporting. We said previously that we are insulated but not immune from the global market dynamics because of our product focus and our business model. However, we are forecasting reduced ceramic revenue for the upcoming quarter due to general global market conditions that remains sluggish and specifically demand that is somewhat stagnant or declining in the automotive and industrial markets because of tariffs and other global market economic factors. We also plan on reducing ceramics inventory within our distribution network this quarter by shipping in lower volumes than our distribution partners will ship to their customers to help balance out the inventory in the channel. Given the global market conditions, we believe this is the right thing to do. Lastly, December quarter is a seasonally low quarter for automotive and historically we typically observe a reduction in the December quarter of 6% to 10% related to automotive, except in years where demand might be accelerating. Revenue for the tantalum product line decreased $22.9 million or 15.5% versus the same quarter last fiscal year. The decline in revenue was driven primarily by weakness in the distribution and OEM channels for our legacy MnO2 products with MnO2 declining approximately $15.7 million or 50%. Polymer revenue declined only $8 million or about 8% impacted primarily by the distribution channel and telecom segments saw some softness in EMS. Revenue for our specialty tantalum products increased slightly, almost about $1 million year-over-year driven by the strength in the military and medical segments. Our focus for future growth in the tantalum product segment remains on new product development and design-in success for applications requiring higher frequency, harsh environments, limited board space, and enhanced audio quality. These application requirements across many in segments, including tablet, PC, telecom, automotive, industrial and cloud. SCBG, the Solid Capacitor business group gross margin increased to 44.4% or 420 basis points higher versus the same quarter last fiscal year. This improvement was driven by product mix optimization, favorable pricing MLCC's and favorable manufacturing performance as a result of continued focus on recurring cost out initiatives, yield improvement and alignment of our manufacturing cost structure with lower volumes. Backlog in tantalum is stable with normalize lead times. Backlog in ceramics is approximately seven months with more normalized lead times for lower CV products but still constrained in many high CV large case sizes. We continue to add capacity to support this demand. Our film and electrolytic business revenue was $41.8 million. That's $8.8 million lower than the same quarter in fiscal 2019. Revenue slowed across distribution and OEM channels during the second quarter, mostly in EMEA, which is Europe and APAC regions driven by softening automotive market. Gross margin was 5% compared to 12.4% in the same quarter in the fiscal year of 2019. Decreasing volumes in the automotive market and the shift in product mix contributed to the lower margin in the second quarter. For magnetic sensors and actuators group, revenue for the quarter came in at $52 million which was $11.2 million lower than the same quarter in fiscal 2019. Gross margin came in at 14.9% which was a decrease of 530 basis points year-over-year. The decrease was mainly driven by lower demand for EMI flex suppression sheets primarily related to a slowdown on the smartphone market. We are experiencing a continued slowdown in demand for piezo actuator products using the semiconductor production equipment consistent with the overall semiconductor market situation as well as specific consumer related markets. In addition, we are subject to the year-over-year slowdown in the global server market. On the positive side, we continue to see strength and upward momentum in our metal wire business for the medical catheter guidewire market. Additionally, we continue to see nice growth as well through the distribution channels we develop and place more new products in the channel to position and grow our MSA longtail business, particularly phase one and two of our new choke coil series which was recently released through the distribution channel and is expected to expand the business for the foreseeable future. I'm pleased with the pipeline of projects we have in place for the future periods as we expand MSA has reached well beyond Japan. Looking at the channel now, for the distribution channel, POA generated about $131 million in revenue, which was down 12% compared to the first quarter 2020. POS for the quarter came in at $163 million, which is essentially flat to the prior quarter and this POS to POA alignment drove the channel inventory down just slightly. Before I turn the call back to Greg for our upcoming forecast, let me comment on what we see in the various market segments. We forecast global light vehicle sales to contract approximately 5% to 6% year-on-year, but we continue to see increases in content of electronic components. We are forecasting moderate growth in this segment for this year and we remain convinced that the content and automotive and mobility in general will continue to grow. Our backlog in channel sales, POS both reflect this the positive trends year-on-year. Demand in the industrial segment has also been impacted by the general slowdown of major economies, but we are still seeing pockets of growth driven by the accelerated investment and enhancement in factory and warehouse automation and our direct in POS sales to the segment for the quarter decreased in the low single digits year-on-year. Our business in the defense and aerospace markets continue to be robust as demonstrated by another quarter of growth in both our direct and distribution channels and we forecast this growth to continue into next year. In the telecom segment, we continue to observe soft conditions and legacy solutions and applications and a gradual ramp up and infrastructure and applications that support 5G rollout. We remain focused on the design and efforts as we expand our product offering into 5G solutions across all of our product groups. In the computing segment which for us includes devices that support cloud solutions as well as personal computing. We believe we have seen the bottom of the cycle. We see encouraging signs in the traditional service space as well as design wins with customers developing servers for edge computing and enterprise level solid state drives. Demand in the mature notebook and desktop PC market has improved year-on-year and we anticipate this to continue into next year. On our last earnings call, I share with you the introduction of METCOM, a metal composite power inductor line of products. This quarter we announced the expansion of our KC-LINK capacitor series with industry-leading offerings for fast switching, wide band gap, semiconductor applications, which are forecasted to grow significantly over the next few years. Our KC-LINK components will allow designers to increase power efficiency and density in applications such as 5G telecommunication base stations and onboard electric vehicles. Now, I'll turn the call back to Greg to discuss our outlook.

[Greg Thompson:]

Thank you, Bill. In our outlook, we expect our third quarter sales to be in the range of $285 million to $300 million, down approximately 8% to 13% from the quarter ended September 30, 2019. The lower revenue number reflects the distribution channel impact which Bill discussed earlier. That said, we believe our gross margin will continue to be strong and reflect the positive impact from our structural changes as we expect non-GAAP gross margin to remain between 30% and 32.5%. SG&A expenses should be $43 million to $45 million and R&D expenses in the range of $12.5 million to $13.5 million. Our global effective tax rate is expected to be around 35% to 39% for the third quarter. Now, I will turn this back to Bill for some closing comments.

[Bill Lowe:]

Thank you, Greg. As noted by Greg's forecast, we expect to continue to maintain our margins at historical levels and while we're not immune to the slowdown, as I said earlier, and some of those end markets and the inventory distribution channel, our expectation is to continue to perform better than our competition on both the top line results as well as margins. As I said in my opening remarks, by combining with Yageo Corporation, KEMET is set to begin another exciting 100 years in our journey to make the world a better, safer, and more connected place to live. I believe our commitment to innovation and serving customers around the globe is profoundly unique. The unique culture of this company will endure and along with the quality of our products will continue to make us a leading supplier of electronic components. Yesterday's announcement is an important acknowledgement of how the services and products we provide sustain an international demand of technological excellence. Now, we'll open up the call for questions. Thank you.

[Operator:]

[Operator Instructions] Your first question comes from Craig Ellis from B. Riley FBR. Your line is now open.

[Craig Ellis:]

Thanks for taking the question gentlemen and congratulations both on the announcement with Yageo and the strong financial results in the quarter. Bill, I wanted to start up just by following up on one of the comments you made in the prepared remarks around the Yageo transaction and some of the other things that the executive team and Board looked at it. I think you said that you looked at other opportunities beyond the Yageo transaction. Can you provide more color on what those were and why you ultimately decided to move towards Yageo?

[Bill Lowe:]

What we can say today is that I can kind of repeat what I said, but the Board did go through a thorough process of course with outside advisors for a number of months. And of course that included multiple advisors and fairness opinions, et cetera. All that will be – all the steps that the Board went through will be in our proxy statement that we filed, preliminary proxy statement that we filed probably early January, that’s required as part of that proxy process. So we’ll lay all that out and it would be very clear what the full process was that the Board went through, over a number of months, I will say, to come to this conclusion.

[Craig Ellis:]

Great. And then as a follow-up, just on the approval point related to the Yageo transaction, can you identify which major geographies will require approval major geographies will require approval? And in particular, I think, our clients will be interested in whether China is needed or not? So if you could speak to that too.

[Greg Thompson:]

Yes China will be needed. We're both in China. We will be in a…

[Bill Lowe:]

Yes it's a number of locations Greg…

[Greg Thompson:]

Probably around four locations including China, it'd be about my guess.

[Bill Lowe:]

Yes, as well as in the U.S. you would expect a CIFUS approval is also required.

[Greg Thompson:]

That's correct.

[Craig Ellis:]

Sure. And then moving on just to the financial guidance, Greg, what I wanted to do is understand in the revenue range that you provided, the $385 million to $300 million, how much impact is there from distribution inventory reduction versus the quarter that was just reported? And how long would you expect distribution inventory reduction to play out? Do you think you get it all behind you in this current quarter or is this going to be a multi-quarter effort to get inventory to the target level of the company?

[Greg Thompson:]

So Craig $285 million to $300 million is our revenue guidance. I thought you said maybe I couldn't – I didn't understand your first number. And I would say the majority of that decline is related to the distribution inventory impact. It came down there was a slight decline as Bill mentioned. But not as much as we think is required. Also geographically in Europe we see some overall slowdown. And automotive, while we've seen content increases, that is some slowness that we see. Relative to your specific question about the timing, I think, it's too early to tell, but we – it feels to us like it's probably more like a couple of quarters, not just this quarter that we would see slowness. But we'll see how it all develops this quarter and hopefully get the distribution inventories down to a healthy level where we would like to see, recognize and we made some impact on that in this quarter, but not as much as we think is needed, given what we see for the end demand right now.

[Bill Lowe:]

And I'm going to circle back to your previous question. I believe, and I don't have it in front of me, but I believe that 8K was filed this morning that has the list of countries that will – that we need approval for. So I would just ask you to check the 8Ks that had been filed pretty soon [ph] this morning.

[Greg Thompson:]

Yes, it has been filed.

[Craig Ellis:]

Yes thanks for that. And then Greg a follow-up on the answer that you provided, as you look at the trailing five quarter revenue range and issue, look at the signals that you are getting from your customers acknowledging that there's meaningful inventory reduction going on in the current quarter and potentially for another quarter to. Where do you think the natural level of underlying demand or consumption is for your products? Where in that trailing five quarter range, which you peg underlying consumption intensity?

[Greg Thompson:]

That's a tough one, Craig. There's a lot of puts and takes in there. I think we've seen a lot of interest with our new products, pricing has been very stable throughout that period. I think the guidance that we are looking at that we've given you for the second quarter we would hope with all those movements in pricing and some volume increases along with the additional volume we have coming on now, we should be looking up – we should be looking up from there. But as I said earlier, it remains to be seen how this will all play out through the distribution channel and how much progress we'll make in our – in the third quarter relating to it.

[Bill Lowe:]

I think we'll still see corrections happening in our fourth fiscal quarter in the distribution channel. I don't think we're going to be any substantially different than what you might've heard on the rest of the industry. It's probably the beginning of our fiscal year in April before we've – I think it's probably settled out a bit.

[Craig Ellis:]

That's fair. And then guys, lastly for me, before I hop in the queue, you're keeping gross margin at the historically high level. So congratulations on all the structural gains. If we have a multi quarter period of inventory production, is it possible to sustain these levels or how do we assess the gives and takes with things you can do on the continuous improvement cost reduction side versus some of the volume headwinds that are out there?

[Greg Thompson:]

Yes again a lot of the things that we've done are really kind of embedded in the margin, the yield improvements and while we may have less revenue here or there as a result of a slowdown or a distribution channel correction, those structural changes are embedded in the margins. That's what's helping to keep them up. And we continue, of course, the business groups continue to look for ways to improve margins. So our expectation is to stay in that range for the margins even as we're seeing corrections in channel over the next couple of quarters.

[Craig Ellis:]

Congratulations on that and again on the transaction. Good luck guys.

[Greg Thompson:]

Thank you.

[Bill Lowe:]

Thanks Greg.

[Operator:]

Next question comes from Matt Sheerin from Stifel, your line is now open.

[Matt Sheerin:]

Yes, thank you. And good morning guys. So I just wanted to go back to the transaction and the acquisition particularly on valuation if you look at the valuation, even with the numbers scrubbed here taking a step down due to the correction as everyone else has seen you're still looking at sort of 6.5 times, 7 times EBITDA. And given the fact that you've really transformed the company, set it up in a much better position than past cycles, particularly with the product mix, the supply chain integration, the balance sheet, I'm just wondering why the Board felt that that was sort of a fair valuation at this juncture, given that we're basically sort of the bottom of this cycle?

[Bill Lowe:]

Well, Matt unfortunately I have to go back and repeat a little bit what I said earlier on the first questions because all the detail that the Board has gone through over quite a number of months will be all laid out in the proxy statement that we filed right – probably right after the first of the year. And I think it'd be unfair to try to pick and choose various comments that were related to the full process that the Board went through here. And I think I would say wait until that comes out. And I think then you along with everyone else will have full picture of everything that the Board did over the course of a number of months to reach this conclusion.

[Matt Sheerin:]

Fair enough. Could you tell us whether is this something that the Board initiated or you had some interest, some outsiders, and then you got into sort of a full mode of vetting other suitors, is that how that happened? I'm just trying to figure out the timing of that.

[Bill Lowe:]

That is correct. We were approached earlier in this calendar year and then as you know as a result of that when that occurs, the Board under the fiduciary responsibilities, are basically required to start a process which the Board did. So yes, we were approached. We did not actively go out seeking.

[Matt Sheerin:]

Okay, fair enough. And then just on the sort of the regulatory issues, particularly your exposure to military, aerospace, some of the industrial markets have you vetted that just to make sure that there aren't any specific challenges or hurdles that you might have to overcome?

[Bill Lowe:]

As a, Greg mentioned, we do have to file for CFIUS approval. We're not expecting that to be a particular issue, but we do have to file for that approval that could take six months, seven months to get that through. One time or the other we'll have various components that are considered to be ITAR-related, but not on a consistent basis. So it's not a – it shouldn't be a major material issue to deal with. So that filing will occur. Our expectations are that we will work through that.

[Greg Thompson:]

And Matt, as you might imagine, we have a number of advisors that have helped us assess all that, who deal with these kinds of issues all the time. And all those kinds of things that you've mentioned and others similar to it had been looked at very…

[Bill Lowe:]

Very closely.

[Matt Sheerin:]

I'm sure. And on the – you said that the deal is expected to close in the second half of 2020. Is that your fiscal 2020 or calendar 2020?

[Bill Lowe:]

Calendar 2020.

[Matt Sheerin:]

Okay calendar 2020, okay. And just lastly…

[Bill Lowe:]

[Indiscernible]

[Matt Sheerin:]

Understood. And then you talked about on the capacitors of the tantalum versus the ceramic. Could you give us the percentage breakdown, ceramic versus tantalum?

[Bill Lowe:]

The revenue?

[Matt Sheerin:]

Yes.

[Bill Lowe:]

Hang on. So for the second quarter, tantalum was – and this is on the web slides, I believe.

[Greg Thompson:]

Yes.

[Bill Lowe:]

Tantalum is 38% of revenues, of total revenues and ceramics was 33% of total revenues. MSA was for the others, MSA 16%; F&E was 13%.

[Matt Sheerin:]

Okay. Okay, all right. Well, thank you very much.

[Bill Lowe:]

Thank you, Matt.

[Greg Thompson:]

Thanks Matt.

[Operator:]

Next question comes from Marco Rodriguez from Stonegate Capital. Your line is now open.

[Marco Rodriguez:]

Good morning guys. Thank you for taking my questions.

[Bill Lowe:]

Hi Marco.

[Marco Rodriguez:]

Good morning. Just wanted to kind of follow-up just a little bit here on the acquisition, maybe if you can talk a little bit more about CIFUS approval, when do you expect to file that submission if you will?

[Bill Lowe:]

I believe it's relatively soon. I can't give you a specific date, but, I think, that's one of the first filings that will probably occur over the next 60 days. And then it will be, as I said, the process there could take six months to seven months just as a part of that process. But I think that's one of the first ones that gets filed fairly quickly.

[Marco Rodriguez:]

Got you. And then can you maybe talk a little bit about the approval you will need in China for this transaction?

[Bill Lowe:]

Well, it's a standard antitrust filing, we both do business there. They have facilities there. We have facilities there. Again, just broadly, not knowing – not to isolate China, but broadly, we're not expecting any particular issues in any particular jurisdiction. I think we just have to work through the timing of the regulatory approvals of the various countries to get the process through.

[Marco Rodriguez:]

Got it. And then in terms of the charge taking here for the legal settlement on the antitrust, can you maybe just kind of walk a little bit through that? It's a fairly large dollar figure. I think that might be one of the higher ones compared to what you've done in the past in regard to the antitrust.

[Bill Lowe:]

It is well in total, of course, over time, the token accrual for antitrust liabilities was substantially higher than that, well over a hundred some odd million, about $110 million, I think. But on an individual basis you'd be correct that that is one of the higher ones. I can't really comment on any more than what we've said in our formal comments about that settlement, other than the fact that just to repeat, as Greg said, that from a payment perspective, from a cash flow perspective, we'll be paying $10 million fairly soon here in the next 30 days, the balance of it to be paid within 12 months, most likely towards the end of the 12 months for the remaining $52 million.

[Marco Rodriguez:]

Got it. And is that remaining $52 million, is that inside of accrued expenses on the balance sheet? Or is there someplace else?

[Bill Lowe:]

It will now be inside accrued expenses, as of this quarter it will be inside the accrued liabilities.

[Marco Rodriguez:]

Got you. And then just coming – turning to the overall business itself and the movements, I was wondering maybe you could comment a little bit about what you've seen thus far this quarter just as far as cadences of demand for product and things of that nature, from a general perspective?

[Bill Lowe:]

Well, I think, in Greg's outlook when we talked about the quarter with the – well we're pulling back some although that – that percentage quarter-over-quarter sequentially our sales will be down less than what we're seeing and hearing and some of our competitors and others in the industry. But it's still a part of that as the inventory correction distribution related not just as – not just to some of the smaller case ceramics, but in the MnO2 product, which fortunately for us, one of the reasons that, I think, our slowdowns a little bit less is that we are – our revenue in tantalum predominantly today is coming from polymer, not the MnO2 product. So, about 70% or so of our – or more of our revenue today, on a quarterly basis, is polymer, not MnO2. That helps us some, but there is general slowdown as well, that’s affecting some of the polymer. So it's a mix of that. And it’s just both – we see some of that in the smaller case size, some of this for us – I mean we do nothing but large case size, but our smaller of the large case has gotten normal lead times today, little more pricing pressure there than has been in the past because of the slowdown in the smartphone market, which gives the other manufacturers of small case ceramics an opportunity to continue to spread out a bit because they've got the capacity to do that. So that's just you put all that together and we’re seeing that – I think the forecast was 8% to 13% down on revenue sequentially, which again from an industry standpoint is on the low end of revenue change quarter-to-quarter.

[Marco Rodriguez:]

Got it. And last question here on the automotive side of the business the end market there for you guys, I was just wondering maybe you might be able to share any sort of comments that you may have had with customers or your partners. Obviously you guys have made it well-known that that the content aspects are increasing, which would definitely benefit you guys over the long run. But just wondering what sort of comments and what sort of things you've been hearing as far as that overall market, that demand outlook for like maybe the next six to twelve months? Thanks.

[Bill Lowe:]

Well, I think, in my formal remarks, I think, we are thinking it's going to – all the data we see as well as comments from to your point from our customers points to kind of a 5% to 6% decline in volume, or unit volume in the automotive sector at the moment. For us it's somewhat offset by additional content, but not a 100% offset by content at this point. So there's a little mitigating factor of additional content, but we think it's a five – at the moment it appears like it looks like 5% to 6% unit volume decrease year-over-year is what we're seeing and also hearing at the same time.

[Marco Rodriguez:]

Right. And so is that general comment around just next quarter or is that sort of a sustained level?

[Bill Lowe:]

We think that's – we see that – at the moment that's kind of over the next six to nine months from an automotive sector standpoint.

[Marco Rodriguez:]

Got it, understood. Thanks guys. I appreciate the time.

[Bill Lowe:]

Thank you.

[Greg Thompson:]

Thanks Marco.

[Operator:]

Your next question comes from Jon Lopez from Vertical Group. Your line is now open.

[Jon Lopez:]

Hi, thanks so much. I have a couple of quick ones on your ceramics business if you don't mind. The first one is could you just parse the calendar third quarter is the first time your ceramics business has declined in, I don't know, 2.5, three years measured quarter-to-quarter. Could you just parse out that decline in units versus prices?

[Bill Lowe:]

It would be primarily – so our pricing is holding firm. Now we do have, in terms of overall prices, there is some mixed difference. So as we continue to work down the distribution channel, distribution tends to be higher prices than OEM and EMS. So that is a component of it, but the largest would be would be volume adjustments.

[Greg Thompson:]

Mostly in this – and not in the – we're still somewhat maxed out on our high CV large case ceramics, we're still looking for getting some equipment in that will free up some additional capacity up based on our expansion. So where we're seeing the softness is on the smaller. What we'll consider smaller case size for us in the commercial chipset. So we're still running fairly full – we're not just fairly full, we're running full on the high CV side with longer lead times still – with lead times eight weeks to thirty weeks depending on the particular dielectric or our case size in high CV and fairly normal lead times eight weeks to fourteen weeks on the low CV. So low CV commercial chips is where we're seeing a lot of the softness.

[Jon Lopez:]

Got you. And so just on that topic, can you remind me, my recollection is that automotive comprises a pretty sizable portion of your ceramics business, is that still the case? Can you just give the ballpark on kind of what auto as a percentage of your ceramics business is?

[Bill Lowe:]

Yes I think we say it's around 65%, somewhere in that range.

[Jon Lopez:]

And have you given the rough split just distribution versus OEM with your ceramics business?

[Bill Lowe:]

We don't really – it's probably pretty close to what the rest of the businesses. Our overall distribution channel splits are right around 40% number.

[Jon Lopez:]

Got you.

[Bill Lowe:]

Of course it varies quarter-to-quarter, but it won't be substantially different within ceramics.

[Jon Lopez:]

Got you. And sorry, just thinking about that same dynamic between your calendar third quarter and your calendar fourth, I know you haven't given explicit guidance between the two segments, but we assume kind an average decline relative to your total guidance in ceramics, is that more of the same like mostly units or is there some pricing that's coming into the December quarter?

[Greg Thompson:]

The only thing I'll say about the pricing and without giving specific dollar comments is that we typically negotiate our OEM contracts in the fourth calendar quarter. So in the quarter that we're in we're in the process of doing those negotiations. And those prices go into effect for OEM somewhere in that first calendar quarter of next year. Not necessarily January 1 some do, but basically within that quarter. So we're in the process of the negotiations now. So I'm not really going to comment on where pricing will go calendar year versus calendar year, but that's in process. Again, the high CV product is still in very high demand and we are still tapped out on that at the moment while we're trying to get more equipment in to expand that. So it's different than the commercial ship for the smartphones, et cetera. If you recall, we don't sell into the smartphone market at KEMET.

[Jon Lopez:]

Sure. That's all super helpful. And I apologize, I'm not asking for sort of how the negotiations are going, I guess my question was just as you think about the trends in the December quarter relative to September, it sounded like September was mostly units, not much pricing measured sequentially. Is it sort of that same mix into the December quarter?

[Bill Lowe:]

I think it's probably the same. I think we're looking at the same type of mix. Yes, I don't think the mix will be substantially different.

[Jon Lopez:]

Okay. Sorry, just two more quick ones. Just at a high level, you referenced this tightness in high CV multiple times and it's been a trend. At the same time, my understanding is that high CV is generally an automotive, not as a rule, but there's more sort of high cap, high CV in automotive in other places. And if you look at some of your international peers there are some new factories that are coming online, excuse me, late this year, early next that appear to be sort of automotive focused. And just my question for you here is how comfortable are you with the supply demand situation in high CV as you look out over say 12 to 18 months?

[Bill Lowe:]

I think we are, I guess the fact that we are not slowing our expansion down should be a signal that says we still expect it to be very robust in the high CV market, especially in automotive. And you are right, there is some other capacity coming on, there's also capacity coming off. The competitors who announced, and that's been a year and a half ago now that they were going to go into life on a number of products. They're still actively doing that and just they've slowed the process down only because that’s just my comment, I don't know what their – you know, I don't sit in their room so I don't know what they're actually doing.

[Jon Lopez:]

Sure.

[Bill Lowe:]

But they are running – they want to – if I was me, I'd be running, wanting to run my factory as full as I can. And I think so therefore as the small case size has pulled back because of the smartphone market, they're continuing to run more large case size rather than extract themselves as quick as they said they would originally. So our expectation is – and they continue to say to the customers that they're going to go into life on those products. And so there are still products that will be pulled out of the market, or components pulled out of the market by those competitors that will – someone will have to fill that need. The need is not going away. So we see that dynamic as something that's unusual. That's in addition to whatever the market trends are with the needs for the automotive segment. So that's what we're looking at the moment.

[Jon Lopez:]

Got you, very helpful. My last question for you I apologize if I just kind of look at your ceramics business now, you're like $100 million, give or take. Yageo right now on their ceramics business, like $100 million, give or take. You guys actually appear like you have some relatively relevant, I guess, is the right term there crossover at least like end market wise and I know you're in market splits are across all your businesses. But I suppose my question is, as you look across these two businesses on the ceramic side, is there a significant amount of crossover? And if so, kind of how – what's the plan to sort of handle that?

[Bill Lowe:]

Well, first of all, we are competitors and of course this is day one, we just announced the transaction.

[Jon Lopez:]

Sure.

[Bill Lowe:]

I'm sure that there'll be more commentary coming from Yageo as the time progresses. But I am not going to comment on that today on day one of the – on day one of the announcement.

[Jon Lopez:]

No, that makes sense. Thank you so much for all the questions. I really appreciate it.

[Bill Lowe:]

Thank you.

[Operator:]

[Operator Instructions]

[Bill Lowe:]

Okay. If there's no other questions operator, then I think we can close the call and thank everyone for their attendance this morning. And we look forward to discussing further with you at our next earnings call in next year. Thank you.

[Operator:]

This concludes today's conference call. Thank you for your participation. You may now disconnect.