KraneShares Dynamic Emerging Markets Strategy ETF
Q2 2019 Earnings Call Transcript

Published: 30 Oct 2018

[Executives:]

Per Loof - Chief Executive Officer Bill Lowe - Executive Vice President, Chief Financial Officer Robin Blackwell - Corporate Communications, Investor Relations

[Analysts:]

Maynard Um - Macquarie Josh Nichols - B. Riley Matthew Sheering - Stifel Marco Rodriguez - Stonegate Capital Management Robert Shohet - RLS Financial Group

[Operator:]

Good morning. My name is Barbara and I will be your conference operator today. At this time, I would like to welcome everyone to the Kemet Reports Preliminary Second Quarter Call Fiscal Year 2019 Results conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Ms. Robin Blackwell, you may begin your conference.

[Robin Blackwell:]

Thank you, Barbara. Good morning everyone. This is Robin Blackwell, and welcome to Kemet’s conference call to discuss the financial results for the second quarter fiscal year 2019, which concluded on September 30, 2018. Joining me today on the is Per Loof, Chief Executive Officer, and Bill Lowe, Executive Vice President and Chief Financial Officer. As a reminder to you, a presentation is available on the website which will help you follow along in the financial portion of the discussion. 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, believes, estimates, and other variations of such words. 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, our 10-Qs, and our registration filing statements for additional information on the risks and uncertainties. Now I’ll turn the call over to Per.

[Per Loof:]

Thank you, Robin. Q2 results are strong and we are proudly presenting the results. This is the 11th consecutive quarter of quarter-over-quarter growth. In our view, Q3 will be another strong quarter with expected additional revenue growth and continued margin expansion. We’re bullish into calendar ’19. Revenue for this quarter was $349.2 million, up 6.6% over our June quarter and up 15.8% compared to Q2 last year. GAAP gross margin was strong at 32.5%. Non-GAAP came in at 33.1%, up 370 basis points from last quarter and up 480 basis points from a year ago. GAAP diluted EPS was $0.63 and non-GAAP diluted EPS was $0.87, up $0.32 from last quarter and up $0.42 from a year ago. Regarding refinance, we have previously reported of our intention to refinance our debt in Japan, and as announced yesterday, Tokin Corporation, our Japanese subsidiary has entered into a new term loan facility of ¥33 billion, which is approximately $296 million, funded by a syndicated bank group in Japan led by Sumitomo Mitsui Trust Bank Limited. We expect the closing and funding of the new term facility, which of course is subject to customary terms and conditions, to occur on or around November 7, 2018. The proceeds from the new term loan facility will be used together with cash on hand to prepay in full all of the outstanding amounts under our existing term loan credit agreement dated April 28, 2017. The refinancing will decrease Kemet’s interest expense by $21 million or $0.35 per diluted share compared to the current run rate on an annual basis. The company will also pay down an additional $28 million in debt, and Bill will discuss the details later. We are now positioned even better to take advantage of acquisition opportunities due to the flexible terms of this agreement. Both Kemet and Sumitomo Mitsui Trust Bank view this as the beginning of a long term relationship which will broaden and deepen with time. This is the second debt financing since the acquisition of Tokin in April 2017 and represents a combined annual interest savings of $31 million and a decrease of debt by $92 million. Kemet is in a strong financial position with the refinancing of our long term debt complete and the resulting substantial decrease of cash interest payments to $6.1 million per year. We have $263 million of cash and cash equivalents as of September 30, 2018 and net debt approaching zero. As announced this morning, Kemet’s board of directors has declared a return of value to the shareholders in the form of a quarterly dividend of $0.05 a share of its common stock, representing a planned annual dividend of $0.20 a share. The initial dividend will be payable on November 26 for shareholders of record as of November 16. Future dividends will be subject to be determination declaration and discretion of Kemet’s board of directors as well as complies with Kemet’s existing credit facilities. As of September 30, 2018 Kemet had approximately 57.4 million shares of common stock outstanding. The dividend represents an annual use of cash of approximately $11.5 million. Regarding tariffs, thus far the impact of the tariffs has had minimal overall effect on Kemet because very little of our Chinese production is delivered to the U.S. or even outside China. Our joint venture with Jianghai has not been affected. We entered into this joint venture as a vehicle to reduce our material costs to enable us to compete more favorably in the Chinese market, therefore this capacity has always been intended for the Chinese market only. Our American and European customers are mainly served from facilities outside China in Mexico, Eastern Europe, Portugal, Vietnam and Thailand. The tariff effect on an annual basis if nothing else changes in the world is $10 million, which we are passing onto our customers so far with no issues. If tariffs increase another 15%, this will be another $15 million we will have to charge our customers. I believe many of us hope that we can come to an agreement with China relatively quickly. The tariffs are not helping, even though the overall impact on Kemet is small. Regarding pricing, while shortages in MLCCs are very prominent, there are in fact many other component categories in high demand with extended lead times. This has led to a market environment more favorable to pricing adjustments, so as contract tiers expire we are working with our customers with our customers to adjust prices. This will help us continue to support existing customer programs while also providing an acceptable ROI on the expansion plans that we have underway. The impact will continue to feather in over time as new contracts are rolled over. While we are not releasing specific numbers, most of the impact will be seen in 2019. ASP declines are to date non-existent; however, our cost on actions are of course continuing and we expect to achieve additional margin improvements through these efforts. Long term contracts - the current environment has created the unexpected benefit of what one could call a recurring revenue stream for Kemet. We have now entered into one long-term contract with a customer guaranteeing additional capacity above and beyond that which they currently purchase from us. This particular customer has a current run rate of 6 billion pieces annually, and through the agreement Kemet is to provide an additional 6 million pieces annually for the next 10 years. It will take two years for this capacity to be installed, so actually this from Year 2 through Year 12. This customer is funding the capacity with a $36 million interest-free loan. Kemet owns all assets and IP and can use this additional capacity for other customers if this customer does not consume. Annual production pricing will be based upon market prices, as always. We are in final discussions on the same type of agreement with two more customers. If all of these agreements are solidified, 27 billion pieces or 37% of all Kemet annual MLCC capacity in fiscal ’21 will have been sold for the next 10 years, with expansion costs funded by customers interest free. This recurring revenue stream has been unattainable in our industry thus far and requires a high level of confidence and trust between the parties. This is telling of the type of relationship we have with our customers and we always strive to be the emotional favorite. Our view of the global ceramic supply chain indicates a continued shortage of passes for at last two years likely extending into calendar ’21. To fill today’s gap in MLCCs will take a $3 billion investment, and this is without any additional demand growth beyond today’s level. Supply is particularly in automotive and would require thousands more of MLCC per vehicle due to the electrification activities and the increase of electronics driving up dramatically the number of components per vehicle. This situation is exacerbated due to the several large Japanese manufacturers having decided to move out of the large case size market. Because of the voltage requirement in the automotive market, it is not easy for our customers to change to smaller case sizes. This tightness will likely continue to evolve exponentially as we move towards the electrification of transportation, not just vehicles. Other segments driving the shortage are industrial and electronics. The ceramics supply constraint is causing changes in our industry. The long-term capacity contracts are one example. Another is customers looking for alternative solutions and redesigning their boards. This has created an unexpected benefit for tantalum polymer as we are seeing customers considering tantalum polymer who would never before have considered legacy tantalum as an alternative. The switch to tantalum polymer is not the immediate savior to the MLCC shortage as tantalum polymer capacity is also tight. Kemet is the largest producer of tantalum products and our backlog as of yesterday in tantalum was $294 million. Due to the resurgence in the tantalum market, we will be adding 30% additional capacity in tantalum polymer over the next two years. The R&D teams of legacy Tokin and Kemet have broadened and deepened the tantalum polymer technological capabilities, and we are now able to produce small case sizes which enables additional opportunities for MLCC substitutions. As MLCC prices rise, the cost differential between ceramics and tantalum polymer will become less of an issue, thereby enabling customers to make decisions based on the technology which is best suited for their applications versus pricing. We’re confidence in our vertical integration strategy in tantalum which allows Kemet to be cost competitive, therefore it is imperative that all of us in the tantalum supply chain continue our efforts to maintain the highest standards of audits to ensure the conflict-free status. As we look at the tech landscape a few years out, the next shortage may be in film due to the electrification of the transportation sector. Regarding capex, the ultimate objective of our investment strategy is to ensure that Kemet remains technologically relevant as we have been for the past 99 years. We aim to continue to be as we next year celebrate our 100th year birthday. Our investment decisions of today are based upon our view of future worldwide trends and customer needs. As a result, we are adding an additional $30 million of capex this year for capacity expansion alone, bringing the total capex for this fiscal to $130 million. We could be convinced to do the same next year if our longer view projections of demand and cash generation hold true. This additional capex is above and beyond the customer funded expansion. Customers - many of us received calls from customers expressing their thanks for standby by our contracts, delivering on time and offering the highest quality of parts and customer service. Our goal is to be the emotional favorite to our customers, employees, communities and investors. Before I hand over to Bill, Bill just sent me a note saying I may have said 6 million additional parts - of course, I meant 6 billion additional parts. Thank you, Bill. Now I hand it over to you.

[Bill Lowe:]

Thanks Per. Good morning everyone. I’m going to cover a few of the financial numbers that Per has not already covered with you. Let’s start with EBITDA. Our adjusted EBITDA for the quarter was $72.5 million, that’s an increase of 44.7% from the $50.1 million in the same period in the prior year. This is an increase of $16.3 million over our first quarter that ended this past June, and that’s a 29% increase since September over June. The LTM adjusted EBITDA margins have steadily increased from 13.6 to 17.4% since December 31, 2016. Now turning to Slide 4, our non-GAAP SG&A expenses were in line with our forecast at $45.3 million and were up compared to the $42.2 million in the prior quarter. Our expectation next quarter is in a similar range between $45 million and $46 million. Taxes this quarter were $2 million, which was below our stated forecast. We expect the range next quarter to be between $3 million to $3.5 million. Although revenue will be up again next quarter, as Per said, we expect the mix to be more in the U.S. and Japan, where we have NOLs which will minimize our taxes. Now let’s move to Slide 8. Capital expenditures during the quarter were $24.5 million compared to $16 million in the prior quarter. We expect our capex spend will continue to grow quarter over quarter as we ramp up our efforts to increase capacity. This coming quarter, we expect to spend in the range of $25 million to $35 million. In prior earnings calls, we did indicate that we expect capital expenditures, including IT and corporate spending related to the Tokin acquisition for the full year ended March 2019 to be in the $80 million to $100 million range. As Per also mentioned, we’re revising our range today to be somewhere between $120 million and $130 million. Our view and our customers’ view of the required demand over the next several years requires us to increase spending to be able to supply their needs, as Per described earlier. We did grow cash in the past quarter and finished with a cash balance of $263 million. During the quarter, we also paid $4.3 million toward reducing our term loan in accordance with our amortization schedule. Our total debt now stands at approximately $317 million. Yesterday we announced the signing of a new debt agreement, as Per mentioned, through our Japanese subsidiary, Tokin. It’s a six-year ¥33 billion credit facility, which is approximately USD $296 million, funded by a syndicated group of banks in Japan led by Sumitomo Mitsui Trust Bank Limited. The proceeds will be used to repay our existing term loan credit agreement which we’ll pay in full using some of our own excess liquidity. The new term loan facility does consist of a ¥16.5 billion, and that’s about $148 million, term loan tranche A payable in 12 semi-annual principal payments and a ¥16.5 billion, again approximately $148 million, term loan B tranche payable in a single payment at maturity. Both loans will require semi-annual interest payments with the interest rate based on a margin over TIBOR. The margin for Term Loan A is 200 basis points and the Term Loan B is 225 basis points. TIBOR is currently at approximately 13 basis points - I’ll repeat that number, 13 basis points. The new term loan facility will lower our interest cash payments with a savings of approximately $21 million annually. It will also result in an EPS increase of approximately $0.35 per diluted share compared to the current run rate on an annual basis. More details on the new credit agreement can be found in the 8-K we filed yesterday after the market closed. Initially our expected cash interest per year, and I want to emphasize these are per year, not per quarter, is estimated to be approximately $6.1 million and the amortization of fees will add approximately $1.3 million to cash interest expense each year over the loan, so initially our GAAP interest expense will be approximately $7.4 million per year made up of both cash interest and non-cash amortization of the fees associated with the debt. The average interest expense including amortization over the life of the loan will be approximately $6.3 million per year or approximately $1.6 million per quarter compared to our current $7.1 million per quarter. In conjunction with our refinancing, we’ll use approximately $40 million of cash to pay down debt and pay fees associated with obtaining the debt. Included in that number is also the premium of approximately $3 million that is required in paying off our current term loan. I think everyone will agree that it’s well worth it. As is always the case in paying off a debt early, the unamortized costs of our previous loan will be written off on our GAAP statements in this December quarter as a one-time non-cash charge. We expect this charge to be approximately $15.8 million. We will exclude that charge from our non-GAAP interest expense and we expect non-GAAP interest expense excluding this one-time charge in the December quarter to be a blend of the old loan and the new, and will fall somewhere around the $4.4 million number for the quarter. The March quarter will see interest expense at $1.9 million or so with the full impact of our refinancing in place. A couple last points to make on the new loan. First, a reminder that the floating rate is based on TIBOR, not LIBOR, and a reminder again TIBOR rate is 13 basis points and typically doesn’t change very much, unlike LIBOR which is notably higher and is expected to go even higher depending on the Fed’s actions. This rate is not really affected by what the Fed does here in the United States, and we do not have quarterly maintenance covenants related to the loan. Some of you might be wondering what the impact on our financial statements will be from borrowing in yen versus the dollar. The company will be entering into two currency swaps, one related to the loan at fair value hedge and another which is a net investment hedge that will essentially offset the income statement impact of the currency movements related to the loan value and the related fair value hedge costs as long as we keep the swaps in balance. We can do the net investment hedge because we have investments in yen-based assets in Japan. It basically moves in the opposite direction of the fair value hedge. On the balance sheet date, the liability will be adjusted to the currency rate at that date, and the other side of that entry, if you’re wanting to know the actual accounting, is basically the other comprehensive income account on the balance sheet as well. Essentially, we’ll have little, if any noise in the financial statements associated with this loan. Now I’ll turn the call back over to Per.

[Per Loof:]

Thank you, Bill. You can follow along on Slides 13 to 17 in the presentation during this section. Turning to our business groups, solid capacitors revenue increased $21.7 million as compared to the prior quarter, or approximately 10.1% to $235.5 million. Total revenue increase was significantly impacted by continued strength in the distribution channel and incremental growth in OEM and EMS. Gross margin in the second quarter was 40.2%, an improvement of 300 basis points over the prior quarter. This result was driven by increased revenue, a favorable mix, and improving cost performance. The book to bill remains positive and we entered this quarter with a solid backlog and expect to see revenue increase marginally over second quarter performance. On a year over year basis, second quarter 2019 revenue increased $44.2 million as compared to the same quarter in fiscal year 2018, or approximately 23.1%. Gross margin percentage improved 550 basis points year over year and was driven by continuous improvements, as I said, in product mix, manufacturing performance, and also impacted of course by annual cost down initiatives. Our film and electrolytic business revenue was $50.6 million, $4.3 million lower than the prior quarter and $2.6 million higher than the same quarter in fiscal year 2018. Revenue slowed in both our distribution channel and web channel during the summer quarter, mostly in EMEA and APAC regions. Gross margin was 12.4% compared to 6.2% in the previous quarter. Improving manufacturing performance and good capacity utilization contributed to the better margin in the second quarter For the magnetic sensor and actuator segment, revenue for the quarter came in at $63.1 million as compared to $58.8 million in the previous quarter and up $0.8 million from the same quarter in fiscal 2018. Gross margin at 20.2%, an increase of 20 basis points from the prior quarter. The increase was a result of a number of factors, which include favorable product mix and broad market stability led by an increase in demand for noise suppression sheets for smartphone applications, continued stability in the demand for piezo actuators for semiconductor equipment and piezo transducer products for fish finder applications. Now to the regions, Europe closed with $77.7 million, which was up 4.1% versus the previous quarter and up 16.7% compared to the same quarter a year ago. POS continues to be strong for the EMEA region, which closed at $55.2 million or 1.4% increase from the prior quarter, and a 33% increase from the same quarter year over year. Distribution inventory increased by 13.6%, in line with the POS growth and customer backlog. We continue to see strong markets across Europe. The automotive industry continues to report strong demand and continues to experience difficulties in buying the required volumes, especially MLCCs. Book to bill is stable at 1.18, and for the Christmas quarter we expect to remain relatively flat compared to the second quarter with a chance to see a bit of growth. In the Americas, revenue closed at $82.3 million, a 14.1% increase from the previous quarter and a 33.4% increase compared to the same quarter last year. The increased demand is being seen across all segments and all channels. The POS for the quarter was up 8.7% compared to the previous quarter and 48.6% compared to the same quarter last year. This was the eighth consecutive quarter of growth with our channel partners in the Americas and book to bill remains positive. In Asia, revenue closed at $138.4 million, which was a 4% increase from the prior quarter and a 7.6% increase compared to the same quarter last year. POS closed at $66.7 million, slightly down by 1.7% from the previous quarter due to a capacity constraint, and up 35.8% compared to the same quarter last year. The markets in Asia remain positive and book to bill is positive. We continue to see solid demand from automotive, consumer and cloud computing segments. Q2 revenues for our fourth region, Japan-Korea, closed at $50.8 million, an increase of 6.2% versus the prior quarter and an increase of 13.6% compared to the same quarter last year. This was due to our piezo actuator product line for semiconductor manufacturing equipment [indiscernible] material product line for medical instruments. Book to bill turned slightly negative in the quarter, however backlog is strong and we do expect Q3 to be about the same as Q2. POS in Japan and Korea is very small in this region but was down by 13.4% compared to prior quarter, however increased 17.3% compared to the same quarter last year. Our distribution business, as you can imagine, remains strong, healthy and growing. POA generated $144.4 million in revenue, representing a 5.7% increase compared to the prior quarter and a 34.4% increase as compared to the second quarter of fiscal year 2018. POS coming in at $187 million grew 3% for the quarter and 38% compared to the second quarter of fiscal year 2018. Inventory in the channel grew 8% over the quarter to $154 million to support the additional POS growth. We continue to work with our distribution partners to ensure that they do not build unnecessary inventory and help them focus their investments on components that are in high demand. Lastly, let’s have a look at our performance by market segment. On a percentage of revenue basis, the telecommunications segment was up to 14%. The industrial, computer, consumer and defense medical segments remained stable at 26%, 21%, 14% and 10% respectively. The automotive segment at 15% was slightly down compared to last quarter, and you can find these percentages on Slide 16. Let’s talk a little bit about market conditions. Global markets show continued strength in all regions, but we see the pace of grow in Asia slightly lower due to the China-U.S. trade tensions. Our core customers as well as new ones are asking Kemet to step up and significantly increase capacity so that they can grow, particularly in automotive, telecom and industrial markets. Our customers also grasp the capital-intensive nature of the capacitor business and the dynamics that led to the current shortage. We’re hearing this across all channels and all regions. Kemet data illustrates market strength and demand resulting in continued capacity constraints. Unlike what Texas Instruments reported, companies like Intel and others see their data reflective of our view that Kemet has supporting, we think, continued long term growth. Overall, the semiconductor segment grew 13% year over year and recently [indiscernible] TTI said current booking levels reflect a supply chain driven breather before things take off again in 2019. We’re looking at this market with a long view while keeping a daily eye on market shifts and trends. Kemet is a nimble team, able to pivot directions in real time. Our 13-week book to bill is positive at 1.12. From April 2, 2018 to April 29, 2018, our backlog has increased by approximately $277 million, growing from $652 million seven months ago to a total of more than $929 million today. This is up almost 42% in less than seven months, and our backlog continues to grow. Regarding the forecast for the upcoming quarter ending December 31, the market remains robust. While we had added capacity, we are still constrained and running full. More capacity will come online in the March 2019 quarter. Some price increases will affect the December quarter, but the majority begin in January. With this as a backdrop, we expect sales to continue to increase and be in the range of $350 million to $360 million, non-GAAP gross margin to increase again and fall between 33.5% to 34.5%, SG&A around $45 million to $46 million, and R&D in the range of $11 million to $12 million, taxes approximately $3 million to $3.5 million. Interest expense excluding the one-time charge that Bill covered is expected to be approximately $4.4 million, as Bill was saying. The full benefit of refi will occur in our March 2019 quarter. We are extremely proud of our continued strong performance, 11 quarters of quarter over quarter growth and a 12th on the way, and the collaborative internal culture we have been able to create. With unity comes strength, and I thank all of you within Kemet. Thanks to our investors who take the long view of the business, just as we do. This type of unity philosophy internally and externally has enabled us to remain technologically relevant for the past 99 years, and now onto the next 100. Thank you very much. That concludes our prepared remarks, and we will now open up for any questions that you might have.

[Operator:]

[Operator instructions] Your first question comes from the line of Maynard Um from Macquarie.

[Maynard Um:]

Hi, thank you. Congratulations on the results and the refinancing. If I heard correctly, the gross margin improvement was a function of mix, yield improvements, and cost down initiatives. I just want to make sure I understand the comment. Can you just walk through which pieces were the biggest drivers, and also just confirm that there weren’t pricing benefits in the quarter itself?

[Per Loof:]

There was some pricing benefits, but a few million dollars in total were pricing benefits. The rest actually attributed to product mix, and of course we strive to refresh our product line-up and typically newer products carry a better margin than older products, for obvious reasons. So the product mix was helping, and of course the cost down initiatives, as I said, continue as we are used to price erosion so we continue with the cost down activities. I think the fact that prices stayed stable, we did have a little bit of an impact due to some price increases but very small, and the product mix was very favorable, so that’s what contributed to the improvement in margin. I don’t know, Bill, if you want to comment some more?

[Bill Lowe:]

I think that’s right. The price increase was a very small portion of it. More to come starting in January.

[Per Loof:]

There won’t be a lot in the December quarter either because as we’ve said before, we will not discuss pricing or change prices while we have an ongoing contract, of course, so these are all discussions that we have with our distribution partners and our OEM and EMS customers, and we’ll do the math as the contracts expire.

[Bill Lowe:]

And the OEM contracts all begin January 1, so that contracts for the OEMs, which is about half the business, starts January 1 anyway.

[Per Loof:]

It’s very important to play this game in an open and reasonable manner, so the words we’re using is we’re raising prices strategically and sustainably.

[Maynard Um:]

Great. Then in terms of the price increases, how do we think about that going into the March quarter? We’ve seen a big step up in this quarter and that wasn’t driven by pricing. There’s obviously no costs associated with price increases. Could we see another similar type of step up coming into the March quarter, or are there some offsetting things on mix or other things for that quarter? How should we start thinking about that in terms of the--

[Per Loof:]

Are you talking about the December or the March quarter?

[Maynard Um:]

The March quarter.

[Per Loof:]

You know, what happens in March, of course, is that the consumer segment - you know, cell phones and games and these sort of things, kind of taper off a little bit, but on the other hand, industrial and automotive kind of kick in. The cost performance of these various segments are pretty similar, so I would imagine that the decline in consumer and some other segments in the after Christmas quarter, first of all they kick right back in after March but will basically even out with what we see in other segments, so I think we will continue to enjoy margin expansion even in March.

[Maynard Um:]

Okay. Any sense in terms of how to think about the magnitude of increase from pricing?

[Per Loof:]

Well, we haven’t shared these numbers. I don’t know, Bill, if you want to comment on this as well? We’ve been a little tight lipped on the size of the increase.

[Bill Lowe:]

We’re just trying to [indiscernible] competition standpoint, we’re trying to be a little silent on those, but let’s just say that the next fiscal year for sure, they will be a significant impact to--

[Per Loof:]

Let’s call it a not insignificant impact.

[Bill Lowe:]

A not insignificant impact in the ceramic business. We’re really talking about mostly the ceramics business here, so it’s the ceramics product line within the solid capacitor business segment that we’re referring to, and it will be not insignificant in fiscal ’20.

[Maynard Um:]

Great, then Per, you talked about the next potential shortage coming in film and electrolytics. Could you just expand on that a little bit in terms of what the key drivers are, where we are in terms of that, and in terms of any impact on pricing that you’re seeing today or when we should expect that?

[Per Loof:]

First of all, that’s sort of a long view. I don’t think that’s going to be an issue over the next quarter or two, or not even next year. If you do the math and think about what’s happening with the electrification of the entire transportation sector and how much--you know, we’re now in maybe a few million cars produced, and if that goes to 20 million in five, six years, that will require a significant investment in our business, other businesses too, and in film capacity which currently is used to supplying a couple million, and suddenly that goes up 10 times and that capacity is not around as we speak. So we’re looking at what to do with that scenario in mind, so that’s really what I’m talking about. Just as an example, a line to build the capacitor for the inverter, which of course every electric vehicle has one or two, is about 40 meters or 120 feet long, and a line like that can produce maybe 100,000 pieces a year, so you can just do the math on that and you can see why I worry about the supply situation in a couple years time.

[Bill Lowe:]

Maynard, sorry - we just had a note, we might have a problem with the phone. Can you hear us?

[Maynard Um:]

I can, yes.

[Bill Lowe:]

Okay, sorry.

[Per Loof:]

I hope that helps.

[Maynard Um:]

That helps. Just a last question in terms--I just want to confirm that there’s been a lot of concern about the automotive market and the end market there. I just want to frame that up and sort of confirm with you guys that we shouldn’t be looking so much as the end market because it’s more a function of the content growth, so should we just view that as being noise, and as long as we have that core underlying content growth, that it doesn’t really affect you as significantly as it does maybe a traditional supplier?

[Per Loof:]

The way we look at this is we don’t expect the number of cars produced in the world is going to increase much, just the number of electric vehicles and hybrids are going to expand greatly and the electronic content in these vehicles are expanding dramatically as well, so that just increases the number of componentry in each vehicle and that’s where the growth is coming from, from our perspective.

[Maynard Um:]

Great.

[Per Loof:]

You could argue that there are additional people buying cars, so you could see in markets like India and China and Asia in general, you could see the automotive market increasing as well, but we are not using that as part of our thinking of where to invest and how to position ourselves going forward.

[Maynard Um:]

Great, thank you.

[Operator:]

Your next question comes from the line of Josh Nichols of B. Riley.

[Josh Nichols:]

I’m guessing you’re feeling pretty good, another strong quarter. I was going to ask, it’s nice to see the company start to create this kind of recurring revenue stream with these long term--the first, I guess, long term contract with customers. Could you provide a little bit more detail? You mentioned you’re in negotiations with two other customers, what type of impact that could have on the business if those contracts were to get executed?

[Per Loof:]

Well, what I said was if you do the math on this, and they’re about--you know, so we would be adding another, let’s call it 7 billion pieces between those two customers potentially to the 6 billion we just did, so in total we would have added 13 billion pieces of capacity annually that are funded by these interest-free loans from the customers, but also the way this works is that we pay the loan back based on how much they consume on top of what they already consume, so basically for all of these customers, they’re doubling what they’re going to buy from us. If you do the math on that, that will in two years time, if all this comes to fruition, 37% of our MLCC capacity will have been spoken for, for the next 10 years.

[Josh Nichols:]

Great. Margins have been expanding continually. Can you talk a little bit across the segments what you’re seeing as far as lead times and order rates, broadly speaking?

[Per Loof:]

Well, I gave you--we haven’t actually talked about backlog in the past, but I felt I gave sort of a story in itself to see how backlog has increased since the beginning of the fiscal, by $277 million actually to be more precise. That is an indication, and if you look at the backlogs in our MLCC business, it’s more than a year. In our tantalum space, it’s seven months and in the other segments it’s a couple quarters as well, so the backlog situation is very strong and continues to build. We believe that what we’re seeing actually requires us to step up and put some more capacity in play, but we are always worried about that and we look at this on a daily basis, basically, to make sure that we are investing correctly as we move forward.

[Josh Nichols:]

Great, then last question from me, just looking at capital allocation, with the cash the company has been generating and the very favorable refi, good to see the new dividend policy implemented. How does the company think about long term targeting its payout ratio on this?

[Per Loof:]

Bill, you want to take that?

[Bill Lowe:]

Well, I think we’ve just initiated the dividend program, Josh, and the board was pleased to be able to do that for our shareholders. I think as we go forward, we’ll evaluate whether the dividend rate increases. That’s usually the typical pattern, right - I mean, you’ve got to start somewhere. We think we’ve started at the right level for the company and the shareholders, and we’ll continue to evaluate that as we go forward, as we should. We’re pleased to start after--as Per said, we’re celebrating our 100th year anniversary and we’re pleased to start our dividend program.

[Per Loof:]

It took us 100 years to get there.

[Bill Lowe:]

But you know, I think we’ll continue to evaluate what’s the proper amount for the return to our shareholders and whether there’s other ways that we can return value as well.

[Josh Nichols:]

Sounds good. That’s it for me. Thanks for taking the questions. I’ll hop back in the queue.

[Per Loof:]

Okay, thanks Josh.

[Operator:]

Your next question comes from the line of Matthew Sheerin of Stifel.

[Per Loof:]

Hello Matt.

[Matthew Sheerin:]

Yes, hello. Good morning guys. Just a couple follow-ups from me. On the margins this quarter, I know you talked about mix. We do understand that there’s been some pricing through distribution and you should see that in the December quarter. Is that playing out yet in distribution pricing, or still not?

[Per Loof:]

No. As I said, there is a little in this quarter and there’s a little more in next quarter, but we’re talking a few millions.

[Bill Lowe:]

Single digit millions.

[Per Loof:]

Single digit millions, less than five.

[Bill Lowe:]

The point of that is as we get through December, the bigger numbers come in next calendar year, so we’ll see continued impact from pricing next year versus this year.

[Matthew Sheerin:]

And the margin expansion you’re seeing next quarter, I guess that’s also a function of mix and some higher volumes. I know last year in the December quarter, you had a surprisingly strong margin partly because of contributions from the Tokin business, the consumer and mobile phone business that they’re in, so there’s some seasonality. Is that going to play out too, which is why in the previous question, Per, you talked about gross margin in December sounds like sort of flattish, where you get benefit from pricing in the capacitor business but an offset in the consumer business?

[Per Loof:]

Well, consumers are capacitors too, to some degree, but [indiscernible] as well and antennas and these sort of things, yes. But you know, I think the product mix looks very favorable in the segments for next quarter, so we see margin expansion, and I think in March when the pricing increases will start to play out, I think we could expect some additional expansion of our margins in March as well.

[Matthew Sheerin:]

If we think about fiscal ’20, which is a couple quarters away, and you’ve got favorable pricing, it sounds like you’re looking at at least a 10 to 15% capacity addition in all your capacitor areas, and the leverage off of that plus the ASPs, you could be looking at gross margins well into the mid 30s or higher. Is that fair?

[Per Loof:]

If the world doesn’t go nuts somehow and if we get over these trade issues that we’re having right now, I think that’s absolutely in the cards.

[Matthew Sheerin:]

Given the balance sheet now, you talked about you’re basically down to no net debt to speak of--

[Per Loof:]

We have a little. We have a little.

[Matthew Sheerin:]

You have a little bit - sorry. You have a little.

[Per Loof:]

It’s not zero, okay?

[Matthew Sheerin:]

Okay, well you’re certainly in better shape than you’ve been ever as I can remember, so thinking about going forward here, what’s the thinking in terms of expanding the portfolio through acquisitions?

[Per Loof:]

Well, we have said we have opened up. [Indiscernible] you may know is heading up our M&A practice, and we’ll continue to look at how we can play that out in a favorable fashion. Of course we want to grow, we want to grow organically and we want to grow through acquisitions, and we have a number in our head what we want the company to be a couple years from now. We’re not going to share that, but clearly growth is important. I don’t know, Bill, if you want to--

[Bill Lowe:]

I would just add that we previously said that we see some of that growth coming in the Asian area of the world, and this relationship now with Sumitomo is very important. It give us a foothold there to help us expand in that market if we decided to need more leverage, to work with our new partner in that part of the world in, we’d assume, rates that are similar to what we just did. I think that’s the direction we’ve been thinking about.

[Per Loof:]

Yes, I think you would agree, Matt, that it was worth waiting for this Japanese deal to come through. It took a few months longer than maybe would have done elsewhere, but I think it was worth waiting for.

[Matthew Sheerin:]

Yes, it sounds like that. You just said the book to bill was above 1. Is it similar to where it’s been, well over 1 in distribution still?

[Per Loof:]

Well, depending on the segments, it’s sort of--for the company, it’s 1.12 total and it varies a little bit by region and products and so forth. But the distribution is right in there with everything else, so it’s--and as you can tell, the backlog continues to grow and that, I think, is a good sign that customers believe that they have an opportunity to use our products for their products as well, and they look to be able to expand as well.

[Matthew Sheerin:]

Okay, all right. Thanks a lot.

[Per Loof:]

Thanks Matt.

[Operator:]

As a reminder, if you would like to ask a question, please press star and the number one on your telephone keypad. Your next question comes from Marco Rodriguez of Stonegate Capital Management.

[Per Loof:]

Hello Marco.

[Marco Rodriguez:]

Hi guys, good morning. Thanks for taking my questions. Just a couple quick follow-ups - most of my questions have been asked and answered. In terms of the additional capacity or the addition capex that you’re spending this fiscal, I don’t know if I caught it, but is that going to be spent across all three of your product lines or is it going to be in one particular area?

[Per Loof:]

The majority of our capex expansion dollars are going to go into tantalum polymer and MLCCs.

[Marco Rodriguez:]

Got you, okay. Then in terms of the acquisition landscape, to kind of follow up on the prior question, can you maybe talk a little bit more about what you’re seeing out there in terms of valuations?

[Per Loof:]

Can you hear us?

[Marco Rodriguez:]

Yes, can you hear me?

[Per Loof:]

Yes, sure. Sorry, go ahead.

[Marco Rodriguez:]

I was wondering if you could maybe talk about the M&A, the acquisition landscape, what the valuations look like for you guys out there.

[Per Loof:]

That’s a good question, but it’s also one that’s difficult to answer. I think I’ll pass on that one.

[Marco Rodriguez:]

Got you. Lastly, just on the dividend, the new dividend you guys initiated, can you maybe walk through the discussions you had to basically drive that decision versus maybe perhaps share buybacks?

[Per Loof:]

Well, we thought that conversations with some investors, particularly non-U.S. investors but also U.S. investors, felt that a dividend strategy and policy was a preferred route and something that will continue to give. I mean, the buyback is a one-time activity maybe, and we haven’t ruled it out, we just haven’t gotten to what we’re going to do with that. But we thought that a dividend strategy was the better one to pick because it shows also that we feel confident that we have a strategy and the strategy is working out, and we have the wherewithal to give some back. I don’t know, Bill, if you want to continue?

[Bill Lowe:]

I think to your point, it’s not off the table. It’s a continued dialogue at the board level on the share buyback, and I think this quarter with the refinancing, the decision to do the dividend, you take things one step at a time and see where you go. We’ll see what the future holds.

[Marco Rodriguez:]

Got you. That’s all I’ve got, guys. Thanks a lot, appreciate your time.

[Per Loof:]

Okay Marco, thanks.

[Operator:]

Your next question comes from the line of Robert Shohet of RLS Financial Group.

[Robert Shohet:]

Good morning, gentlemen. Thank you for a truly exceptional quarter and a fabulous year.

[Per Loof:]

Well, thank you.

[Robert Shohet:]

I wanted to address the last point raised by the gentlemen before me with regard to stock buyback and shed a little light, perhaps a different perspective as an investor and a financial advisor for people that I manage money for. Because you are a micro cap stock, unfortunately even when--even in non-volatile times, there’s a lot of predatory manipulation of stock pricing going on. I won’t get into [indiscernible] nonsense or anything like that, but I’m just referring to the way that stocks of companies, viable, profitable, growing companies like yours are being traded now, where it’s basically we can short them at will and drive the valuations down to nothing because we can, and they do it for sport and primarily to make money. It’s one thing for those companies that deserve to have their valuations dropped, but in your case it’s been frankly nothing less than obscene, given the extraordinary growth and consistency of your earnings growth and profitability not just from a standpoint of managing the business well but also seeking out new markets as you’ve done, looking to strategically increase capacity and sales and earnings, and manage the finance side so well with your refinancing of debt. Unfortunately the shorts and the algorithmic trading realize that right now, it just doesn’t matter what companies do, they can drive share prices down, and unfortunately that affects all of us as investors, executives of the company, and so on. While dividends, I think, are a wonderful step and do in fact demonstrate consistency of earnings and belief in the future of the company and all that’s very positive, they do nothing really to address the fact that you can beat earnings by 40 or 50% quarter after quarter and watch the stock literally get almost cut in half from one quarter to the next, which is absolutely ridiculous. The reason primarily is because there’s no one stepping in to buy shares or the threat isn’t out there to formally buy shares. What I’d like to suggest to you as a professional, having seen this time and time again with many different companies, is that to put in place a program like this so that when the value gets very low, as it has been recently and unrealistically so, and if you actually go back and look at the pattern, it’s to sell off your company stock sharply for weeks following a fabulous earnings announcement - it’s a pattern these institutions follow - this will nip a lot of that in the bud. There won’t be the tremendous dislocation in share price quarter after quarter, which frankly scares away potential investors who can’t take this level of volatility even for a fabulous company like yours. I really would strongly urge that you consider this, not just from the standpoint of providing value back but literally protecting the value of shareholders and the value of your company against this form of manipulation that is so prevalent now.

[Per Loof:]

I have no comment to that. I think your analysis is correct - it’s clearly annoying, if I may use that word, to see the stock be manipulated by the algorithms and the shorts when the company is actually performing reasonably well, and the discussion of buybacks is not off the table and we will continue to look at that to see if that is a way forward, and how much and how quickly and so forth. But we thought we’d start with a dividend now as a way to pay back some to our investors, and we will continue to have the conversation internally to see when the right moment is to maybe consider something like you suggested.

[Bill Lowe:]

I think your comment--thank you for your comments. I think your comments will be very helpful to the board of directors as well.

[Per Loof:]

That’s what I think too.

[Bill Lowe:]

We appreciate your feedback and your input.

[Robert Shohet:]

Thank you, gentlemen.

[Operator:]

There are no further audio questions.

[Per Loof:]

Okay, so with that, we thank you all for being with this morning, and we appreciate the support. We’re looking forward to Q3 and hopefully we’ll have another interesting conversation towards the end of January. With that, we sign off from Fort Lauderdale.

[A - Bill Lowe:]

Thank you.

[Operator:]

Thank you for attending today’s conference call. You may now disconnect.