KraneShares Dynamic Emerging Markets Strategy ETF
Q4 2018 Earnings Call Transcript

Published: 17 May 2018

[Executives:]

Robin Blackwell - VP, Corporate Communications & IR Per Loof - CEO Bill Lowe - EVP & CFO

[Analysts:]

Matt Sheerin - Stifel Nicolaus Josh Nichols - B. Riley & Co.

[Operator:]

Good morning. My name is Melissa, and I will be your conference operator today. At this time, I would like to welcome everyone to KEMET's Fourth Quarter Fiscal Year 2018 Earnings Conference Call. [Operator Instructions] Thank you. Robin Blackwell, Vice President, Corporate Communications & Investor Relations, you may begin your conference.

[Robin Blackwell:]

Thank you Melissa, and good morning everyone. This is Robin Blackwell. Welcome to KEMET's conference call to discuss the financial results for the fourth quarter and year end of fiscal year 2018 which concluded on March 31, 2018. Joining me today on the call 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 KEMET website, which will help you follow along with the financial portion of the discussion. Before we begin, we'd 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, plan, intend, 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 Per.

[Per Loof:]

Thank you, Robin and good morning everyone. This past quarter actually marked our ninth sequential quarter revenue growth. And if I were to summarize fiscal '18, the highlights will be as follows

[Bill Lowe:]

Thank you, Per and good morning, everyone. I am going to begin on Slide 3 if you are following along the website. I'll repeat some of the statistics that Per gave you, in case you missed that early on in the call. And so as Per said, net sales for the quarter were $318 million, which is up 3.8% compared to the prior quarter of $306.4 million. Strong performance by our Solid Capacitors Group and specifically our ceramic product line was a big contributor enabling us to exceed the top end of our guidance. GAAP net income was $2.4 million and our non-GAAP adjusted net income was $26.4 million in the current quarter compared to $52.9 million and the $7.8 million respectively in the same quarter in the prior year. And you should note, the prior year GAAP number reported had a positive effect from the sale of the EMD unit which was embedded in the TOKIN organization in that quarter. Our GAAP gross margin percentage improved by 240 basis points from 25.4% in the prior year to 27.8% in the current quarter, and the non-GAAP gross margin percentage was slightly higher at 28.2%. Our adjusted EBITDA for the quarter was $48.5 million, an increase of 78% from the $27.2 million in the prior year. For the quarter, our non-GAAP net income was $0.46 per basic share and $0.45 per diluted share. Adjusted EBITDA decreased slightly from the prior quarter as depreciation expense was affected by purchase accounting true-up related to the TOKIN acquisition. The LTM adjusted margins though have increased steadily from 13.6% to 15.9% since December 31, 2016, these details can be found on Slide 15. Now turning back to Slide 4, our non-GAAP SG&A expense of $43.8 million were above our estimated range for the quarter but were down slightly compared to the $44.5 million in the prior quarter, our expectation for this next quarter is SG&A in the range of $41 million to $42 million. Tax at this quarter were $3.1 million and we continue to forecast a range next quarter between $2.5 million and $3 million as this quarter had some minor effect from the Tax Reform Bill. Regarding tax reform, the company is still working to determine the impact of the toll tax, but we expect to offset this this tax with our NOL versus paying cash over the eight year period as allowed by the new law. We also revalued the tax benefit associated with the NOL and the offsetting valuation allowance to reflect the new lower corporate tax rate going forward, but it had no impact on our income statement. On Slide 5 and 6, from a full year perspective, revenues were up 58.3% to $1.2 billion compared to $757.8 million last year at March 31, 2017; primarily driven by growth across all channels and segments, a favorable Euro-Dollar exchange rate and of course, the impact of the TOKIN acquisition. Our gross margin was up significantly from last year at 370 basis points increase to 28.4% from 24.7%, and U.S. GAAP net income for the fiscal year ended March 31, 2018 was $254.5 million or $4.34 per diluted share compared to net income of $48 million or $0.87 per diluted share for the fiscal year ended March 31, 2017. For the fiscal year March 31, 2018, non-U.S. GAAP adjusted net income was $102.7 million or $1.75 per diluted share compared to non-U.S. GAAP adjusted net income of $23.9 million or $0.43 per diluted share for the fiscal year ended March 31, 2017. We move to Slide 11; capital expenditures during the quarter were $34.1 million compared to $13.1 million in the prior quarter. As stated in our last earnings call, we did expect capital expenditures for the full year to be in the range of $50 million to $60 million. We finished the year slightly higher, as Per said, it was $65 million capital expenditures as we ramped up our investment and additional capacity. This coming quarter we expect to spend in the range of $25 million to $35 million and capital expenditures for the full year including IT and corporate spending related to the TOKIN acquisition will be in the range of $80 million to $100 million. Additional capacity as Per mentioned will be in the $60 million to $70 million range. As mentioned before, we'll be adding capacity to meet the increased demand for our products in the market. We finished the quarter with a cash balance of $286.8 million, quite a bit ahead of our forecast. During the quarter we did pay $4.3 million towards reducing our term loan in accordance with our amortization schedule. And good news on the rated agency front, both S&P global ratings and Moddys have upgraded our ratings. In March, S&P global ratings upgraded KEMET from B to B+ and in April Moody's upgraded our rating from B3 to B1. And as we mentioned in the past, this next six months will have to see increased demands on cash related to certain TOKIN liabilities that will be paid during this period. In our first fiscal quarter ending this June, we expect to pack approximately $29 million against the antitrust liabilities which will lower the accrual to a balance of approximately $49 million. Will pay an additional $4 million throughout the remainder of the fiscal year, primarily in the fourth fiscal quarter. So the first quarter will be a heavy use of cash between CapEx, antitrust and incentive payments related to fiscal '18 but we will generate very good cash flow this next year. Our total debt now stands at $324.6 million versus $388.2 million from the beginning of the fiscal year. We generated approximately $120 million of cash from operations versus $71 million in the year before and the $191.3 million EBITDA versus $105.2 million in the prior year. And now, I'll turn the call back over to Per.

[Per Loof:]

Thanks, Bill. You can follow along on Slides 16 to 20 in the presentation deck during this section. Turning to our business segments; Solid Capacitors revenue increased $7.8 million as compared to the prior quarter or approximately 4%, to $202.8 million. The total revenue increase was significantly impacted by continuous strength in the distribution channel and incremental increases in the OEM and EMS channels as well. This was somewhat offset by seasonal decrease in the EMS channel. Gross margins in the fourth quarter was approximately 37%, an improvement of 50 basis points over the prior quarter, this result was driven by continued improvement in cost and also somewhat favorable mix. Order rates continue to be robust and we enter this quarter with a solid backlog and expect to see revenue increase over the fourth quarter performance. On a year-over-year basis, fiscal year 2018 revenue increased $196.1 million as compared to fiscal year 2017 or approximately 34% to $771.2 million. The revenue increase was significantly impacted of course by the additional net sales of $133.8 million resulting from the TOKIN acquisition, continued strength in our legacy products as well, and in the distribution channel across all regions and incremental revenue increases in the EMS channel. Gross margin in fiscal year 2018 was approximately 36%, an improvement of 530 basis points over the previous year. This was driven by continued improvements in manufacturing performance impacted by annual cost initiatives, and of course, the TOKIN acquisition. Our Film & Electrolytics segment revenue was $55 million, which is 7.2% above the prior quarter. The increase in revenue was primarily driven by higher demand in the distribution channel and OEM [ph] customers in the Asian markets. Gross margin was 5.9% compared to 8.3% in the previous quarter and unfavorable product mix contributed to the lower gross margin in the fourth quarter. Fiscal year 2018 revenue was $201.7 million, which increased approximately 10% to fiscal 2017. This increase in revenue year-over-year was due primarily to increases in the distribution channel across AsiaPac and EMEA regions. Gross margin in fiscal 2018 was 8% compared to 6.8% in the prior fiscal year. For the Magnetic, Sensors & Actuators segment, revenue for the quarter came in at $60.3 million, almost flat compared to the prior quarter. Gross margin at 16.9%, a decrease of 11.3 percentage points from the prior quarter. This decrease is a result of an additional fair value adjustments for the acquisition of TOKIN. Contributing to the decrease in margin were lower production by our China factory due to the Chinese holidays and unfavorable product mix as we forecasted on our previous call. Major factors that impacted this mix was due to temporary decrease in demand for antenna units for portable gaming machines, and a seasonal decrease in demand like suppression sheets for the Smartphone market. Demand for PSO Actuators and -- for semiconductor equipment and PSO transducers for fish finders continues to remain strong and stable. Total revenues for the fiscal year 2018 were $227 million, gross margin at 21.7% which is a much better performance than we had anticipated at the outset of the year. Now to the regions; Europe closed strong with $75.9 million, which is up 10.6% versus last quarter and up 23.3% compared to same quarter last year. We continue to see strong demand across industries led by the automobile and industrial segments driven mainly by the distribution channel. U.S. closed very strong at $53.8 million, a 26.5% increase from the previous quarter and 32.3% same quarter year-over-year. We experienced a slight drop in distribution inventory in this versus last which kind of confirms the strong end customer demand situation. Year-over-year European revenue grew 16.7% of revenues of $277.6 million. Automotive and distribution were the main drivers of this growth in addition to somewhat favorable exchange rates. We have been able to secure and win several new designs in our major businesses, and particularly in our major -- with our major automotive partners. Additionally, our new MSA business added $2.1 million in revenue in Europe, and looking at POS, year-over-year Europe grew 24.5% to $181 million. Increased demand in MLCCs resulted in the strongest growth in the second half of the year. Turning to the Americus; revenue grew to $67.7 million, up 4% compared to the prior quarter, and up 18.3% compared to the same quarter last year. Revenue for this fiscal year grew 12.2% over the last year with all segments showing growth. It was also another strong quarter for POS, it was up 10.4% compared to previous quarter and 30.8% compared to the same quarter last year. This was the sixth consecutive quarter of revenue growth with our channel partners. Fiscal year 2018 POS growth was 17.9% over fiscal year 2017. And book-to-bill remains strong across the board but particularly in distribution and EMS. For Asia, revenue closed at $119.8 million, down by 3.6% from prior quarter due to the impact of the Chinese New Year holidays. POS was $57.5 million, up 10.5% from the previous quarter and up 45% compared to the same quarter last year. Fiscal 2018 was a good year for Asia. Total revenue closed at $480 million, up 66% compared to last fiscal year. Total POS for this fiscal year was $201.9 million, up 30.8% compared to last fiscal year. The market in Asia remains positive, bookings remain strong in all channels, and the supply chain continues to tighten. We continue in any case to drive design wins and focus on cross-selling and growing POS. Our revenue in the fourth quarter for Japan and Korea, our fourth region closed at $54.7 million, an increase of 13% versus the prior quarter. The book-to-bill ratio remained very positive with strong demand in automotive, medical and the semiconductor manufacturer equipment. Total revenue for the fiscal year was $183.2 million. So let's have a look at our performance by market segment. On a percentage of revenue basis, the industrial segment shows an increase to 28%, computer, automotive, telecommunications, medical and defense segments remains stable at 20%, 16%, 13%, 5% and 4% respectively. The consumer segment was at 14%, slightly down compared to the prior quarter. All key segments continue to show strength and in automotive, it's been a solid increase in both number of cars produced and new vehicle registrations across all regions. Looking ahead, we believe the electrification of automobiles will bring further opportunities for KEMET. Q4 also confirmed the positive signs in the computer and consumer segments driven by sustained high demand of solid state drive devices, as well as game counsels and actual laptops, in general. Industrial was basically flat with a positive outlook from Europe where the recovery we witnessed in 2017 is predicted to continue and even gained further momentum in 2018. Regarding telecomm, there is excitement for the 5G deployment in China where we do expect the first standard addition of the 5G protocol to be launched around June. This will be another key driver for demand for our products. Lastly, positive growth is expected from our military segments, thanks to a trend of new designs and overall increase in spending. Now we just take a look at our distribution business on a global basis, and please refer to Slide 21 for this section. For fiscal '18, POS increased 35% year-over-year, and POA grew 26% year-over-year. Inventory is up only 20%. Our district friends [ph] tell us that they do not have enough product on their shelves. The POS number support approximately $125 million of POA revenue, well within our warehouse [ph]. Inventory in the distribution channel remain basically flat compared to the previous quarter. In KEMET's past, we have experienced cyclical movements in revenue, over the past four years we have managed of all revenue study. Moody's attributes this to KEMET's ability to manage inventory and sales in the distribution channel. We continue to drive POS growth for the channel partners, while maintain balanced inventory levels of revenue patterns. The focus this time with extended lead times is to ensure that our partners do not overstock and that we help them focus their investments on high runner components. As we look at the distri [ph] business today, we continue to expect it to be strong with a constrained supply environment. Results compared to Q3, POS increased 16% and book-to-bill is at 1.24%. While POS -- POA increased 7% over Q3, our POA to book-to-bill is at 1.63%. Just to note, inventory has actually dropped 0.5 percentage points in Q4 from the previous quarter. Regarding TOKIN, April 19 marked the one-year anniversary of the acquisition of TOKIN. The integration is going according to plan and we expect to see the synergies we have previously announced. The sales force is aligned across all -- Asia, Europe and the U.S., in the Japan and Korea markets we go to market as TOKIN and we are in the process of reaching out to customers showcasing the entire KEMET product portfolio. We are the leader in tantalum polymer which of course is the future for tantalum. And we are also ensuring that we expand our product portfolio in sensors, actuators and inductors to address the need in particular of our distribution channels. With the acquisition of TOKIN, Solid Capacitors dropped from 75% of our total business to two-third. The new sensors portfolio within MSA positions KEMET to benefit from the increasing demand in sensors. So, now on to our forecast. Before I provide you the specifics about the first quarter ending June 30 let me make a few comments about our expectation for the full fiscal quarter to provide a longer term view versus just 90 days. We continue to see robust market demand for our products throughout the entire fiscal year. Our expectation for fiscal '19 sales is to grow 4% to 6% of our fiscal 2018 with sales growth limited primarily by the variable of how quickly additional capacity will come online. Margins should continue to remain stable in 27% to 29% range throughout the year. SG&A expenses should range between $39 million to $42 million per quarter, and we are planning to ramp up around these spend approximately 25% to run $11 million to $12 million per quarter which we will expect to pay dividends in the future periods. Taxes will be approximately $2 million to $3 million per quarter. And as we said, previously CapEx spend will be in the range of $80 million to $100 million. For capacity expansion, IT integration relate to the TOKIN acquisitions and of course, our maintenance CapEx as well. We do expect to see strong cash generation in fiscal '19. Now finally for the quarter ending June 30; we expect sales to be in the range of $310 million to $320 million, gross margins between 27.5% to 29.5%, SG&A between $40 million to $42 million, R&D in the range of $11 million to $12 million, and taxes support from $2 million to $3 million. We are forecasting another strong quarter and a great start to the new fiscal year. Book-to-bill excluding distribution remains slightly above $1.2 million and distribution backlog continues to increase creating total book-to-bill numbers at our levels, maybe not even worth mentioning. We are shipping everything we can make and we are working diligently to increase our capacity. We do not believe the industry is adding too much capacity and based upon both market demand and various changes in certain competitors portfolio of product or should I say removal of certain products from the market, we see continued tightness even with capacity expansion as announced across the industry. In closing, I'd like to send a big thank you to the KEMET leadership team and our almost 16,000 people in 34 countries for their persistence, commitment, and continued pursuit of excellence everyday which has made it possible to report these exceptional results for the quarter and year end. Thank you. Operator, this concludes our prepared remarks and we'll be happy to respond to any questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Matt Sheerin from Stifel.

[Matt Sheerin:]

Obviously, you're coming off of a terrific fiscal '18 and your outlook seems extremely optimistic based on the metrics that you've been talking about. Just one thing on the book-to-bill and distribution which is obviously inflated; and I know that you're talking about good sell-through meaning that this consumption. But how can you tell whether your direct customers are using distribution more than normal? Obviously when things are in short supply, there is double ordering and no denying that, right. So how do you track that? And why the distribution customer is growing so much faster than your direct customers; is it the end markets or is it just because you're seeing more and more use of distribution because that's where the inventory is if there is any?

[Per Loof:]

I think that if there is any inventory anywhere, it's with this department. So of course, that is a way to try and get to product when they can't find it any other way. On the other hand, when we talk to our disty friends, we -- there is -- yes, there is some double ordering, I am sure but when we look at it, it's not significant from what we can tell. So I think the -- what we are shipping are going into production and you know, the fact that the book-to-bill ratio is in distribution or sort of somewhat off the charts. That is one thing, but of course, when you look at how the products are being used, I do not think that we are in a situation where this is double booking. And I think this is just an increase in demand across the board and I think people were not prepared for this, -- off guard and that's what's creating it. I mean, you just look at the MLCC demand or the MLCC usage in cell phones; I mean, from cell phones a couple of years ago towards now it's a 2X and if you look at MLCCs in automotive and combustion engines, it's 2,500, let's say and electric vehicle maybe 10,000 to 12,000. And of course, these are just creating this demand situation I think to some extent is real. So when I'm saying that this is not bubble*, it's a trend, I really believe that.

[Matt Sheerin:]

And if you look at your guidance, it's basically kind of flattish sequentially but you're seeing all this demand, is that really just because you're still capacity constrained and the bulk of the capacity won't come until -- when would that be September quarter, we'll see some of that?

[Per Loof:]

We'll see some across but it will not really be significant until towards the end of Q3 and in Q4. So we could ship a lot more if we had the product of course, and when we talk to our disty friends, they want more on the shelves, not because they want the inventory to grow but they have opportunities to ship them.

[Matt Sheerin:]

And your gross margin guidance for the year is actually down or flat to down I guess from last year; and is that because -- are there mix issues or higher depreciation costs? And were you not going to really get the leverage until the volume start to kick-in later in the fiscal year into fiscal '20? And then just in line with that on the pricing side, I would think -- I mean, I know you're seeing some favorable pricing, so I would think that that would also have a favorable impact on your gross margin?

[Per Loof:]

You could argue that our gross margin projections* are little conservative but we like to be conservative in this of course. And regarding pricing, we want to make sure that we are not doing this opportunistically but rather where the there is* sustainability in the pricing. So playing around with pricing has a tendency for those of us who has been around this business for a while to come and bite* you where you don't want to be bitten. So I really think we need to be careful with our price increases but clearly, there are opportunities that should have a positive effect on the margins as well.

[Matt Sheerin:]

Bill, are there other drivers that we should think about with gross margin and COGS as we get into the next year where there would be input cost, tantalum or any other issues in addition to the CapEx?

[Bill Lowe:]

No, I don't think so. I think when you mentioned tantalum, I think we have the spot chain well under control; I'm not expecting to see anything that's significantly -- that would affect us in a negative way in that regard. And certainly year-over-year there is a little bit of effect from getting the values correct on the TOKIN acquisition that did have some depreciation expense effect on a year-over-year basis but nothing material that I would expect to see in there.

[Per Loof:]

And we will have some higher costs due to all the new equipment going in, of course.

[Bill Lowe:]

The depreciation will ramp up as that comes online, that would be true too.

[Per Loof:]

Even though that's below the gross margin line, we are increasing R&D expenses by 25% as well.

[Matt Sheerin:]

And just lastly for me, just on the debt; Bill, I know you've been talking about the opportunity post the fiscal year to do some -- look at refinancing, any update there?

[Bill Lowe:]

Same comment. We would like to get the 10-K filed. I think get that behind us and I think we'll move forward and looking at doing that. I think that was -- with the upgrades we've gotten from both rating agencies and our position, our balance sheet today, we expect to move forward on that relatively quickly after we've gotten the 10-K behind us.

[Operator:]

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

[Josh Nichols:]

Just a question -- now the company is actually getting close to having net cash position. I guess what are the company's plans on that front given that -- I know Matt asked about the debt refi, but you had over $30 million of interest expense this year and what's the company's capital allocation strategy?

[Per Loof:]

I mean, clearly, we have been over the years in a pretty constraint cash position, so the fact that we have some cash now gives us a bunch of degrees of freedom that we didn't have before. And of course we are deploying some of that cash in additional capacity and CapEx expansion, and you know, as you saw we added almost $35 million of CapEx expense in the last quarter and of course that was driven by the need to put more capacity in play. So that's one way we will use our cash. Also, as we have said we are interested in doing additional M&A activity and there is some cash that we can use for that as last quarter we talked about two small investments we've made and you can expect more of that to happen as we go through the year. So with that, we will do that and probably as Bill has -- we've talked about Bill and I, that we will use some of the cash to pay the debt down a little bit before we go refi. So there are several ways we can allocate the cash but clearly, we're going to make it work for our shareholders. Bill, you want to add something?

[Bill Lowe:]

No, I think that's right. And as we enter this next fiscal year and we'll be talking amongst the management and the amongst the Board as to what's the best way to direct that to increase shareholder value.

[Josh Nichols:]

And then last question, you mentioned some potential M&A, could you talk a little bit about the company's objectives; is it really looking at some topline growth to acquire things that are margin accretive, or EBITDA or cash flow -- I mean, could you talk a little bit about what you're looking for? And then also, any particular areas or regions of interest?

[Per Loof:]

We're looking at increasing our capabilities outside of the capacitor space we've said and also clearly, Asia is a focus. So it's really difficult to talk about these things before they become a reality, as I'm sure you can realize.

[Operator:]

[Operator Instructions] Your next question comes from the line of [indiscernible].

[Unidentified Analyst:]

Already answered. Thank you.

[Per Loof:]

Thank you.

[Operator:]

There are no further questions at this time.

[Per Loof:]

Well, thank you for attending the call today and look forward to your* continued support of our company and we really are looking forward to a great fiscal '19. So thank you very much and have a great day.

[Bill Lowe:]

Thank you.

[Operator:]

This concludes today's conference call. You may now disconnect.