KraneShares Dynamic Emerging Markets Strategy ETF
Q1 2018 Earnings Call Transcript

Published: 2 Aug 2017

[Executives:]

Richard Vatinelle – Vice President and Treasurer Per Loof – Chief Executive Officer Bill Lowe – Executive Vice President and Chief Financial Officer

[Analysts:]

Matt Sheerin – Stifel Josh Nichols – B. Riley Marco Rodriguez – Stonegate Capital

[Operator:]

Good morning. My name is Lushanda, and I will be your conference operator today. At this time, I would like to welcome everyone to the KEMET's First Quarter Fiscal Year 2018 Earnings 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. [Operator Instructions] Thank you. I would now turn today’s call over to Mr. Richard Vatinelle to begin. Please go ahead, sir

[Richard Vatinelle:]

Thank you, Lushanda, and good morning everyone. Welcome to KEMET's conference call to discuss the financial results for the first quarter fiscal year 2018 ending June 30. 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 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, 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 Per.

[Per Loof:]

Thank you, Richard, and good morning everyone. Are we online now?

[Operator:]

You’re live.

[Per Loof:]

Okay, thank you. All right, sorry folks. This is Per. We had some issues with the phones, not sure where and why, but hopefully this works. So, operator, please monitor and make sure that that everybody can hear us. So, I will go ahead and start again. I don’t know exactly where we were cut off. So I will start again. So, it was a very exciting quarter and beginning of our new fiscal year. The TOKIN acquisition occurred early in the quarter, April 19 to be exact, and we're off to a great start together. Our pro forma sales this quarter, counting sales from both organizations effective April 1 were $291 million. After a rather long gestation period, as I would say, we were excited to welcome TOKIN to KEMET early in the quarter. And although we were not able to account for the TOKIN sales until that date April 19, consolidated revenue of $274 million generated over $43 million of EBITDA and non-GAAP earnings per share fully diluted of $0.33. Yes, I will repeat we’re off to a great start. While, we may have received some help from a decent market. We have only just begun to implement the significant actions related to cost savings, which we have previously described to you. We're still focused on achieving those savings and the team will be working to make those a reality over the next couple of years. This transaction clearly puts us in a much better place as a company. We have three main objectives over this past year

[Bill Lowe:]

Thank you, Per, and good morning everyone. I will begin my review on Slide 3, if you're following along on the website. And as Per said, net sales for the quarter of $274 million or up 38.7% from the prior quarter of $197.5 million and up 48.2% for the same quarter last year. GAAP net income was $221.4 million or $0.467 per basic share and $0.384 per diluted share after giving effect purchase accounting on the TOKIN acquisition, which closed on April 19. Please note that our first quarter financials reflect the 19-day period, during which TOKIN was still accounted for on a 34% basis. For comparison purposes, our revenue on a pro forma basis combining KEMET and TOKIN for the full quarter was $291 million. This pro forma revenue number excludes approximately $6 million of inter-company sales between KEMET and TOKIN, that are now excluded after the acquisition. Before I move onto the non-GAAP results, I want to comment just briefly on $136.4 million gain associated with the TOKIN acquisition. First, $72.7 million of this gain relates to marking to market at the time of our acquisition, our regional 34% equity interest. The balance of $63.7 million is the preliminary gain associated with the acquisition itself. I want to stress that this amount is preliminary. The calculation of this amount is complicated and involves not just the existing assets and liabilities but encompasses all the aspects of purchase accounting. This transaction was unique, we all know that. And as you know, it was quite favorable to KEMET and our balance sheet. Since this is a one-off transaction, I know that many of you may not be so focused on this gain, but we wanted to make it clear that the final amount could vary and be adjusted in the future period from this preliminary figure. Now, onto our non-GAAP results. On Slide 4, our non-GAAP gross margin percentage increased 270 basis points to 28.1% compared to 25.4% last quarter and up 470 basis points, compared to the prior quarter ended June 30, 2016 of 23.4%. We exceeded our forecast on margins by about 100 basis points, we had a very strong mix of products in our Solid Capacitor group and in both product lines within tantalum and ceramics. And this, of course, now includes the polymer tantalum business from the TOKIN facility in Thailand. Our non-GAAP adjusted net income was $19.2 million or $0.40 per basic share and $0.33 per diluted share compared to the $7.8 million last quarter and $3.3 million in the prior year, or $0.07 per basic share and $0.06 per diluted share. Non-GAAP SG&A expenses of $36 million were up compared to $25.8 million in the prior quarter ended March 31, 2017. They are pretty much flat as a percentage of revenue quarter-over-quarter at 13.1% of sales. And slightly below our low-end of our forecast for the quarter. R&D expenses were $9.3 million, which was in line with our forecast. Our adjusted EBITDA for the quarter was $43.3 million an increase of 59.2% over last quarter. Moving to Slide 5, capital expenditures during the quarter were $7.3 million compared to $10.6 million in the prior quarter. We now expect our total CapEx spending for the year to be in the range of $50 million to $60 million. As we are selectively adding capacity in our plants. This capacity increase will be seen in all of our product lines and business groups. We previously forecasted a range of $45 million. So this is an additional increase of $10 million to $15 million in CapEx, potentially this fiscal year. Regarding our cash balance on Slide 5, we exceeded our forecast and finished the quarter at $225.6 million, adding $114.7 million from last quarter. Of course, the vast majority of this increase is result of the integration with TOKIN. We expect our cash balance to be in the range of $225 million to $240 million at the end of the September quarter. And note, we will be making our first quarterly mandatory principal payment on the term loan this quarter of approximately $4.3 million. And finally on Slide 7, our LTM adjusted EBITDA margins have increased for six consecutive quarters from 11.6%, December 2015 to 14.7% this quarter ended June 30, 2017. So now, I will turn the call back over to Per for comments on the markets, the business units and the upcoming forecast.

[Per Loof:]

Yes, thank you, Bill. Let's look at our performance by market segment. The combined entity will of course, now look a little different from legacy KEMET. And on a percentage basis, we first look at the computer segment, that is at 21%. The industrial segment and the defense and medical segments remain relatively stable at 25% and 9% respectively. Telecommunications and consumer segments both coming in at 15%. The Realia Business [ph] that we sold was almost 100% automotive, and therefore, the combined automotive segment is now at 15%. Mainly, KEMET, but not only. Turning to our business groups, the Solid Capacitor group revenue compared with the prior quarter increased $33.1 million or approximately 22% at $182.1 million. The revenue increase was of course significantly impacted by the addition of the TOKIN capacitor business. As well, however, has good improvements in the disty channel and the EMS segment. Gross margin in Q1 was approximately 34.2%, an improvement of 330 basis points over the previous quarter. This margin is a result of the addition of the TOKIN capacitor business, as well as continued progress in our cost savings effort and an increase in our product development activities, which are helping our mix. Order rates were robust in Q1. And therefore, we’ve entered Q2 with a very solid backlog. Revenue is ahead of where we were at the same time last quarter. And book-to-bill is currently at 109%. It was 122% as we exited Q1. We expect revenue to be strong but not to increase significantly over Q1 for this segment. Our Film and Electrolytic group revenue was $48 million, similar levels of Q4 fiscal 2017. Revenue in Europe continued to increase, but the decrease in Asia was due to a delay in a plant production ramp by one of our OEMs. Orders continue to show strength as evidence by book-to-bill of 1.18 for the quarter and it is 3.36 today. Gross margin improved to 220 basis points and is now at 10.8%, compared to 8.6% in the previous quarter. Improvement in gross margin is the result of previously implemented restructuring actions, mainly in the aluminum, electrolytic business. The main focus now while many of the restructuring activities are complete is to increase revenue. As I'm just looking at the active project list, I'm confident that we will see improved revenue levels in the coming quarters. From magnetics, sensors and acturetic group, the revenue was $43.9 million for the quarter, TOKIN revenues from magnetic sensors and actuators for the entire quarter was $11.8 million for the 19-day period, which we course did not consolidate. Gross margin in Q1 was 21.3% and trending positively as the result of improved mix and accelerated cost down activities. Book-to-bill was 114 for the quarter and is at 1.10 today. We expect revenue to remain strong. Please note that the full quarter revenue was $55.7 million and we will likely see some improvement in our top line this quarter. And secondly, of course, this group was not reported in previous quarters by KEMET. Now to the regions. Europe closed with $66.5 million, up 8% over last quarter, higher than we expected and up by 9.9%, compared to the same quarter last year. While automotive and industrial business grew slightly due to strong demand, our channel revenue was up by 10% quarter-over-quarter and 20% year-over-year. POS was closed strong at $41.5 million. We see strong and broad demand in all our technologies, driven by ceramics, actually. And we have been able to gain some market shares. We have also increased our channel inventory slightly strong end customer demand. Our European business remain healthy and bookings do not show any weakening at this point. Asia revenue for fiscal Q1, closed at $170.4 million, an increase of 36.5% over the last quarter. This was of course largely due to the addition of a TOKIN Corporation into our group. The market in Asia is positive and bookings remain strong, driven by automotive and consumer market segments. The POS revenue for the quarter was $45.4 million, up 11% from the previous quarter. For continued POS growth in Asia we are focusing on developing new local customers, to grow a larger customer base. And this effort is already showing some very encouraging signs. The combined Q1 revenues for Japan, Korea and fourth region closed at $35.4 million, this includes both TOKIN and KEMET. The Japan, Korea market remains positive with bookings and billings from grid infrastructure devices, air-conditioning, semiconductor manufacturing equipment and consumer gaining leading the way. In the Americas, revenue was up by 13.1% versus the previous quarter ending at $64.7 million. POS was better than expected at $40.1 million, which is up 11% versus the previous quarter. The Americas continues to have a strong book-to-bill. All channels are positive with EMS and OEM channel being the strongest. The Americas continues to see growth in all channels. So the design efforts in specialty products and targeted segment campaign. Distribution revenue was up by 5.8% versus the previous quarter and improved 21.5% versus the same quarter last year. POS was up by 7.8% compared to last quarter and inventory in the distribution channel increased by 4% and continues to remain stable and very healthy relative to POS. We maintain our focus and efforts to drive POS growth and demand with our channel partners. While also, of course, maintaining balanced inventory levels and revenue patterns. The highlight for this quarter was our strong performance in the high service and used to be called the catalog distribution business channeled with record POS with two major channel partners. This was driven by strong demand worldwide and supported by robust campaigns for a new product introductions and increased investment in digital market. So finally, let me turn to the forecast for next quarter. We are forecasting sales to be in the range of $295 million to $305 million for Q2, compared to the pro forma sales of $291 million for Q1, including, of course, the 19 days of April that was not accounted for in KEMET books. We're expecting to be up as much as 4.8% on the high side and approximately 1% on the lower side. Gross margin as expected to be in the narrow band of 28% to 29%. And this will represent another quarter of an increase in our gross margin percentage, up possibly another 100 basis points over our June quarter. SG&A is expected to be in the range of $38.5 million to $40.5 million. And R&D will be approximately $11 million. Interest expense will drop to approximately $6.5 million. Although taxes were lower this quarter than our forecast, we continue to focus approximately $2.5 million of tax per quarter. We are, as I said, off to a great start with TOKIN. And as always, I'd like to thank our hard-working people that make the extra effort every day to improve our performance and enhance our customers experience. Operator this concludes our prepared comments. And we’ll be happy to respond to any of your questions.

[Operator:]

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

[Per Loof:]

Hello Matt.

[Bill Lowe:]

Good morning Matt.

[Matt Sheerin:]

Yes, hey good morning Per and Bill. Obviously, very strong results here. In particularly, the gross margin which I want to get into, a little bit. As you said 100 basis points better than what you were expecting. And you talked about mix. You didn't talk about ASPs and pricing. And I know that when you were at our conference in June, Per, you talked about some selective price increases. How much are ASP increases playing a role here? And in your guidance for gross margin flat to up again. How much does that play into that?

[Bill Lowe:]

It doesn't really. I mean, we did have done some selective price increases. But there – on the overall basis, they're very small. And there is, I'd say, now we're seeing the market that is a bit more stable from a pricing perspective. But to say that we're going to go undue price increases is probably not, that’s not what we're accounting on. So there's no real price increases in these pattern. So the improved margin is the result of two things. One an increased product development activity, which of course, we have newer – many more new products which tend to be have a positive impact on margins. And of course, the cost down activities, which are not coming together. And of course, we have about a quarter delay before we actually see them hit the P&L. As I am sure you’ll realize. So these are – it's basically mix due to new products and cost down activity. So that's creating the margin improvement.

[Matt Sheerin:]

Okay. So if you do the math on that and flow that through and I think you've given guidance for fiscal 2019, of approximately $160 million of EBITDA give-or-take. Given these is much better gross margin, looks like that number is going to be – going to look a relatively small. So the question is, are these margins sustainable here going forward?

[Bill Lowe:]

We continue to count on some erosion. This is the electronics business so that’s going to happen. But we are also confident that our cost down activities and our efficiency improvements in our plans will continue to offset that. So we – right now, with the market that we're seeing and many people are predicting that the market will stay strong – strong-ish anyway this calendar or maybe evident into calendar 2018. So we think these margins are sustainable as we move into the next segment here.

[Matt Sheerin:]

Okay. And on the capacity as you talked about, could you put out sort of a revenue number around that, as you add that capacity? What's the annual revenue contribution of capacity that you will be putting into place?

[Per Loof:]

Well, we don’t actually. We've given you some revenue numbers, in your conference in terms of what we thought we were going to do for the next couple of years. And we stick into that. Clearly, this last quarter was better than I think many predicted. And we see strong demand as we speak. So we will actually need to put some additional capacity in play here, in particular to serve some of the more complicated markets such as automotive. But we don't really have a number to provide to you on exactly what that will entail.

[Bill Lowe:]

Again, you can see as even in this quarter, next forecast revenue was up potentially.

[Per Loof:]

$50 million so if the trend continues what we are seeing is with CapEx will be need into really keep us at that revenue level or above as we see as the market moves. So it's kind of built into that both of these overall forecast that we give you.

[Matt Sheerin:]

And I know that your lead times on certain of your MLCCs and the tantalum products are 20 weeks plus. Obviously, that's driving strong bookings, particularly in distribution in EMS. So how long do you think that issue will last and will these capacity ads bring you some relief in terms of lead times?

[Per Loof:]

I think the capacity, as what will positively impact lead times from a customer perspective. But I think how that – what's going to happen to the demand perspective particularly in the disty channel, we are watching that very, very closely of course. And we're maintaining and ensuring that POS and POA levels are balanced. So that we don't get into a situation, where we are over inventory in the channel and as we look at the POS right now and compared that with POA, we are right where we should be.

[Matt Sheerin:]

Okay, and just lastly from me. Just concerning that your distribution sales were up, I think you said 20% year-over-year, obviously, end markets are not growing. I guess the question in terms of POS through distribution. I guess one thing that's difficult for you to figure out or it's whether or not those distribution orders are double ordering, right? And whether that's sell through is actually being consumed?

[Bill Lowe:]

No, I mean we know what the POS numbers are, of course. And we know what the inventory levels are. So we're seeing the POS happening and as you know, there was some inventory corrections going on last calendar that impacted the POA. But from a POS perspective, we are seeing strong POS. We saw almost 8% improvement quarter-over-quarter in POS levels. And we have a slight increase in the distribution inventory, but it is very healthy relative to our POA – POS sales. So we are of course, cognizant of what can happen if we over inventory and we're very careful not to. And we're having very clear conversations with our channel partners to ensure that we are not over inventoried.

[Matt Sheerin:]

Okay, great. It has been very helpful. Thanks so much.

[Bill Lowe:]

Thanks, Matt.

[Per Loof:]

Thank you.

[Operator:]

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

[Bill Lowe:]

Hello, Josh.

[Per Loof:]

Good morning, Josh.

[Josh Nichols:]

Hey, how’s it going?

[Bill Lowe:]

Good.

[Josh Nichols:]

Obviously, really strong quarter here. Nice to see what the first quarter with TOKIN. You did mention a little bit about some interest that the balance sheet is pretty strong. I'm doing some M&A potentially, could you provide a little bit more color about areas or segments you might be looking of getting into or regions?

[Bill Lowe:]

I think we – clearly we have just begun and we don't have a list at this point. We have just said we'll be looking at this as we go forward, since we do not have the opportunity the ability to do so. But clearly, what we're looking at is mainly non-capacitor businesses. And to augment our magnetics and sensors business. And also focus will be probably Asia. We will use our new talents we have to TOKIN to help us in that endeavor.

[Josh Nichols:]

Then could you talk a little bit about the tantalum supply. Just curious how things are going with revenue trending up and sales increasing?

[Bill Lowe:]

You mean the tantalum, the ore supply, or power supply or is that what you're referring to?

[Josh Nichols:]

Yes, as far as what you have – as far as your vertical integration, right.

[Bill Lowe:]

Yes, the vertical integration continues to be positive for us from a cost perspective, and also on the security of supply. So we have seen – we're seeing no constraints on that at all. And we have several places we get the ore from and places we have control over our supply chain that gives us the sense of that we can actually control this pretty well. So we're not seeing any constraints in that process. We continue to produce between 70% and 80% of the powder ourselves and the rest we do with our partners. And we think that’s a healthy balance between what we do internally and what we get from our partners, and we need to – we want to keep that percentage coming from the outside, so no issues from our perceptive.

[Josh Nichols:]

That’s great to hear. And then aside from some potential M&A. Now with cash balance you're quite healthy here. Could you talk a little bit about the company's capital allocation strategy going forward?

[Per Loof:]

Well, we’re going to – as I said before, we are going to take a look at the – I’m going to look at the cash. It’s nice to see all this cash and – on our books, of course, and we're going to use our cash wisely. We are increasing our CapEx spending a little bit particularly to help with the new product development activities, and also to increase capacity in some selective segments. And we are paying down our debt, as you know, we are paying down 5% every year now over debt, and we think that's a healthy way to improve our debt position. And over the next couple of years, I'm sure we will be thinking about exactly how we will move in this area. And Bill, if you want to comment some more?

[Bill Lowe:]

No, I think that's a good recount.

[Josh Nichols:]

That’s good. And then last question. Just for housekeeping. What was the balance on the antitrust liabilities at the end of quarter?

[Bill Lowe:]

Around about $73 million or so, in dollars.

[Josh Nichols:]

Sounds great. Thanks guys.

[Per Loof:]

Thanks Josh.

[Bill Lowe:]

Thanks Josh.

[Operator:]

Our next question comes from the line of Marco Rodriguez with Stonegate Capital.

[Marco Rodriguez:]

Good morning guys. Thanks for taking my questions here. Just a couple of quick follow-ups. I'm not sure if I caught this on the call, but the CapEx spend for the fiscal year here; can you kind of give us a little bit better understanding as far as the cadence of how that's going to be spent throughout the course of this year? And I think I heard you say it's going to be spent across all business lines. Just kind of confirming that as well.

[Per Loof:]

Yes, it's going to be consumed over all business lines. That's correct. And it will probably a little more in the later half of the year. So I think we're – we’ll be spending at $40 million – a rate of $40 million a year now for the first half and then will increase that a little bit over the second half.

[Bill Lowe:]

Yes, the back half will be heavier loaded as we start to get these projects going. It takes a little while to get them in place, we just made the decision to do this increase. So back half of the fiscal year.

[Marco Rodriguez:]

Got you. And once you start to add in this additional capacity, I mean, how quickly is that going to be turning to revenue?

[Per Loof:]

It's going to be turned into revenue relatively quickly because there will be selected machinery that’s going to be put on the line to enable us to use what we have, the kilns for instance, that we have today can be used for all product lines. So that's really how we are deploying the capital to ensure that we can do that.

[Marco Rodriguez:]

Got you. And a follow-up question in regard to very healthy increase that you guys saw in gross margins just by segment. I know I heard you talk a lot about product mix and then cost reductions. Just kind of wondered if may be you can talk a little bit more as far as which bucket might have been bigger for like the Solid Capacitor versus the Film and Electrolytic.

[Bill Lowe:]

I think on the Solid Capacitor side, the mix is driving a lot of this improvement, and the mix comes from new products being introduced. And of course, the TOKIN business here comes in with healthy margins, as you can imagine, and that's helping as well. And putting the two companies together, we are seeing already some really interesting development activities. That I think will further consolidate the improvement in our margin. So we're looking at nice – continued nice margins. I'm not saying we're going to improve the margins in this segment, but we're looking to see additional revenues that producing additional bottom line numbers.

[Marco Rodriguez:]

Got you. And can you quantify how much of a lift you got from TOKIN on the margin side?

[Per Loof:]

I don’t think we do that. Bill, right?

[Bill Lowe:]

No, it’s mixed in with SEBG from a tantalum side. Of course that the MSA or the magnetic sensors and actuators are a separate segment reported separately so you could see that independently, and in the balance, of course, is in the Solid Capacitor business group.

[Marco Rodriguez:]

Got you. And last question here just on the new business line, the electromagnetics. If you could maybe talk a little bit about that gross margin there 21%, is that a fairly normalized number there for you guys or how should we think to that in terms of modeling?

[Bill Lowe:]

Well, it is a healthy number, of course. But this is pre-doing what we have said we're going to do relative to cost down activities.

[Marco Rodriguez:]

All right.

[Bill Lowe:]

You can see that – you should expect that number to improve over the next couple of years for sure.

[Marco Rodriguez:]

Got you. Thanks a lot guys. I appreciate your time.

[Per Loof:]

Thanks Marco.

[Bill Lowe:]

Thanks Marco.

[Operator:]

[Operator Instructions] And there are no questions at this time.

[Per Loof:]

All right. Well, thank you for joining us this morning. We are excited about where we are at, and repositioned the company nicely. And after a long period, we finally were able to put the KEMET and TOKIN together and we're very excited about what we can do together. So thank you for your support and thank you for joining us this morning, and have a great day.

[Bill Lowe:]

Thank you.

[Operator:]

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