KraneShares Dynamic Emerging Markets Strategy ETF
Q4 2016 Earnings Call Transcript

Published: 3 May 2016

[Executives:]

Per-Olof Loof - Chief Executive Officer Richard Vatinelle - Vice President & Treasurer Bill Lowe - Executive Vice President & Chief Financial Officer

[Analysts:]

Nikhil Kumar - Stifel Nicolaus Josh Nichols - B. Riley & Co

[Operator:]

Good morning. My name is Nan and I’ll be your conference operator today. At this time, I’d like to welcome everyone to the KEMET Reports Fourth Quarter and Fiscal year and 2016 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. [Operator Instructions] Thank you. I would now like to turn the call over to Richard Vatinelle, Vice President & Treasurer. Please go ahead, sir.

[Richard Vatinelle:]

Thank you, Nan, and good morning everyone. This is Richard Vatinelle. Welcome to KEMET’s conference call to discuss the financial results for the fourth quarter of fiscal year 2016 ending March 31. Joining me today on the call is Per Loof, Chief Executive Officer, and Bill Lowe, Executive Vice President & Chief Financial Officer. As a reminder to you, a presentation is available on the Web site that should help you follow along in the financial portion of the presentation. Before we begin, we would like to advise you that all statements addressing expectations or projections about the future are forward-looking statements. Some of these statements include words such as expects, anticipates, 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, our 10-Qs and registration filing statements for additional information on the risks and uncertainties. Now, I will turn the call over to Per.

[Per-Olof Loof:]

Thank you, Richard and good morning everyone. It's been an interesting and somewhat exciting start to our fiscal year. As you may have noted this morning, in addition to our earnings release, we also filed an 8-K along with a press release detailing a settlement in principal by NEC TOKIN of the U.S. civil case in California, related to the antitrust issues. For KEMET, this is important news because it removes one of the more significant unknowns and barriers to getting our acquisition completed. Certainly the fact that NT will need to make these payments and the amount of the payments is not a welcome debate. However, having the amount set and its schedule of payment established over time allows us the ability to still implement our strategies upon combination. We believe we are now one step closer to being able to complete this acquisition now and are working with our fellow joint venture shareholder, NEC Corporation, to bring it to a conclusion later this year. Although we are still waiting for a few more governmental jurisdictions to report their finding, this is a significant milestone towards concluding this long process. I know, all of you are anxious to hear the details of exactly when and how we will combine with NEC TOKIN. While we do have an understanding with our partner concerning our strategy, we are not at liberty yet to announce the mechanics of this transaction. Believe me, when I say that we want to provide it as soon as we can. It is in KEMET's best interest to do so and once we are at a point to provide the details, we would expect the closing to occur rather quickly thereafter. Just to reflect a bit on our journey with NEC TOKIN over many years. We have endured a devastating flood in Thailand which wiped out NT's entire tantalum capacity. A new plant has been built and has been operational now for a little over two years. The 9.0 quake and tsunami that hit Fukushima in Japan a few years back also it NEC TOKIN. Both the Sendai as well as the Shiroishi facilities are in the same Prefecture and close to the ocean. And of course for the last two years, NEC TOKIN has been dealing with the investigations from several jurisdictions regarding the Japanese capacitor cartel, including the civil cases in the U.S. As I said, NT has now taken a huge step forward giving us clarity as how to close this transaction. Having said all that, I just want to reflect a bit on what NT has been able to do since we became involved and I took over the chairmanship of the joint venture. For their fiscal 2012, which is the year ending March 31, 2013, our fiscal '13 of course, NT's revenue was $361 million, down at the time of course due to the Thai plant just coming back into play. This year revenue was up compared to 2013 by $124 million as $492 million. During the same period, operating income improved $53.8 million to $22.6 million this last fiscal and adjusted EBITDA improved from $9 million in 2013 to $73.6 million this last fiscal. Cash improved $40 million to $104 million at the end of this last fiscal. During this period, as the numbers show, we have been able to move some and close other facilities and have cut costs significant. When we merged the two companies, more cost-cutting and additional synergies will of course come into play. Now let me make a few comments about our quarter and fiscal year financial results before I will turn over the call to Bill. Our revenue for the quarter came in at $183.9 million which was within the top quartile of our forecasted range. With the disti inventory correction behind us, we saw an increase in our sales as we came back up to the level of POS within the distribution channel. Gross margins improved once again to 22.8%, driven by our solid capacitor business group. As a whole, the business is doing very well except for one product line. The electrolytic product line within the F&E group has been disappointing. It has not performed at an acceptable level and it needs to step up this next fiscal. The F&E group contributed $5.7 million more EBITDA this year than last, which is an improvement certainly, but the film group was the driver of this entire EBITDA within F&E. We are seeing Europe picking up, which is a good sign for everyone but in particular for us, since it is a positive sign for our F&E business. F&E is very heavily towards European customers. From a full year standpoint, our total revenues were $734.8 million, down $88.4 million compared to last year's revenues of $823.2 million. Approximately $31 million was due to change in exchange rates. Approximately $24 million was due to the inventory corrections that we have talked about in the distribution channels and the remaining amount is attributable to unfavorable macro conditions. Having said all that, we do believe that we grew or maintained market share in all of our products line which gives me confidence looking forward. Overall in fiscal year 2016, we reported to you more or less what we forecasted. We reported positive non-GAAP earnings per share each quarter. We increase gross margins, EBITDA margins also increased and our cash balance increased slightly more than we forecasted ending at $65 million. We think that fiscal year 2017 that we just started will remain a challenge. In particular, the macroeconomic environment is still not what we would like it to be. Having said that, we are confident that revenue will improve slightly this current fiscal year and EBITDA margins will continue to improve by more than 10%. Furthermore, we do believe that the NEC TOKIN acquisition, as I talked about, will be completed this fiscal year and that should be a significant event and a potential game changer for KEMET, providing increased shareholder value. We are excited about this prospect and while the journey has been long and sometimes very frustrating, it will be worth it in the end. With that, I will turn it over to Bill for comments on our financial results for the quarter.

[Bill Lowe:]

Thank you, Per and good morning, everyone. I am going to begin my review on Slide 3, if you are following along on the Web site. As Per said, net sales for the quarter were $183.9 million, which is up 3.8% compared to the prior quarter of $177.2 million. The GAAP gross margin percentage was higher by approximately 90 basis points from 21.9% to 22.8% and our GAAP net loss was $15.2 million or $0.33 per basic and diluted share compared to a net loss of $8.6 million or $0.19 per basic and diluted share for the prior quarter of December 31, 2015. However, as you review these numbers, please note that excluding the non-cash equity loss from NEC TOKIN of 11.6 million, the loss would have been $3.5 million or $0.08 per basic and diluted share. Moving to Slide 4, our non-GAAP gross margin percentage, as Per said earlier, increased by 100 basis points to 23.2% compared to 22.2% in the prior quarter. And our non-GAAP adjusted net income was $0.04 per basic and diluted share and adjusted EBITDA for the quarter was $23 million, down just slightly from $23.5 million in the prior quarter. Non-GAAP SG&A expenses of $23.5 million were up compared to the $19.8 million in the prior quarter of December and our expectation for this next quarter is a similar amount of approximately $23 million. Let's skip forward to Slide 11. Capital expenditures during the quarter were $6.3 million and $20 million for the year. For this coming quarter we expect to spend in the range of $6 million to $8 million and capital expenditures for the full year 2017 will again be in the $20 million range. Regarding the performance of NEC TOKIN, revenue in the fourth quarter came in at 13.5 Oku yen or approximately 114 million. Our share with our financial results for the quarter was an equity loss $11.6 million and their cash balance remains healthy at approximately $104.4 million and their EBITDA for the quarter in U.S. dollars excluding legal fees was $16.5 million. As noted on the 8-K and press release we filed this morning, NEC TOKIN did accrue an additional $37.25 million this quarter for the settlement of the class action lawsuit to which Per referred to earlier. Including the net loss from the equity affiliates this quarter was KEMET's 34% share of that impact. As forecasted in our previous call, we grew available cash in the fourth quarter, ending the year at $65 million, which was a $21.8 million improvement over last quarter at December 31. Year-over-year this represents an increase of $6.9 million. We also paid down the revolver this fiscal year of $9.6 million over the course of the year with $4.1 million of that paid in the fourth quarter, bringing the balance back to approximately the same as we began the fiscal year. And speaking of the revolver, the bank has increased our total revolver from $60 million to $65 million, effective yesterday. This excludes the [springing] [ph] feature which we also have that’s $15 million. This next fiscal year once again we expect to grow cash, approximately $25 million to $30 million by the end of the fiscal year. We expect the balance to drop in the mid-$40 million range at the end of this first quarter since we pay our bond interest, which we paid just yesterday on May 2. As a result of this favorable cash forecast, the board of directors has approved a bond repurchase program initially up to $20 million. Just note, the cash balances in my projections here do not include the reduction that may occur related to any purchases of outstanding bonds. Now I will turn the call back over to Per to discuss a few of the markets and our business units. Per?

[Per-Olof Loof:]

All right. Thank you, Bill. Let's have a look at our performance by market segment. On a percentage of revenue basis, the computer and industrial segment show an increase at 15% and 23%. The consumer, defense and medical segments remain stable at 8%, 6% and 7% respectively. The telecom and automotive segments at 21% and 20% were slightly down compared to last quarter. Turning to our business groups. In the solid capacitor group, the revenue versus the prior quarter was up $4.7 million or 3.5% at $140 million. The increase in revenue in Q4 was focused in our distribution channel. This is a good sign and in case inventories have moved into more balanced position relative to demand. Revenue in the OEM and EMS channels were down quarter-over-quarter but in line with seasonal expectations. Adjusted gross margin for Q4 was 29.3% or up 1.7% versus the previous quarter. This represents our best gross margin performance of the fiscal year for this group. Progress in our cost and mix initiatives continues to drive a favorable results. Moving into Q1, orders rates and backlog continue to improve driven primarily by strength in the solution channel and improving picture also in the OEM and EMS groups. This is an indication that the period of inventory correction and distribution is behind us. Our film and electrolytic business, revenue was $43.9 million compared to $41.9 million last quarter, an increase of $2 million. Revenue from Europe was responsible for most of the increase with a smaller contribution from Asia. The increase was equally spread between direct customers and customers supported through our distribution channel. Orders received continued to improve during the quarter with an end of quarter value of 107. The increase in orders received was greater than 1 in each region and for all channels. Adjusted gross margin for this business was 4% versus 5% for the previous quarter and the impact of lower volumes during the previous quarter worked through the inventory sold this quarter. This impact was approximately 3% of revenue. Now to the regions. Europe finished the last quarter with $59.8 million or 14.1% up versus Q3. This rebound occurred across all channels and all segments. We also saw the inventory correction within our distribution channel coming to its end. The POS in our channel improved by approximately 6% versus last quarter. By the end of March, our book to bill rate in the OEM as well as in the distribution channel were all positive. In the Asia Pacific region, revenue was up at $68.9 million in Q4 and POS was virtually flat. Certainly the Chinese new year holiday had some impact. The Asia market has been flat for the last few quarters and it's challenging for China as GDP further contracted to 6.7% in Q4. For the distribution business, we believe that inventory corrections has been completed and we expect POS to grow in the next couple of quarters. We see some emerging applications in China that post strong opportunities for us. The sales campaigns we have in Asia will continue to focus on POS growth and improving KEMET's positions in their applications. Q4 revenue in the Americas finished down slightly over the period ending at $55.2 million, as we anticipated last quarter POS did return for a more normal sales rate and was up 9.4% over last quarter. POS this quarter is anticipated to be flat. The Americas book to bill is currently slightly positive. Distribution revenue was up 15.1% or $10.7 million with POS improving in every region, up 5.4% compared to last quarter. Inventory in the distribution channel stabilized and was down 1.1% quarter-over-quarter. We maintain our focused effort with our channel partners to drive growth and POS demand while reaching balance and the inventory levels and revenue patterns. Looking forward to next quarter, we see sales in the same range as $180 million to $185 million with a slight margin improvement. With SG&A and R&D consistent again next quarter, I believe we are looking at the quarter very similar to the one we just complete. Finally, looking out this year. Our focus is on maintaining and further our cost structure improvements, looking for growth in the right places and very importantly, we are working diligently to bring to a close our acquisition of NEC TOKIN. As I said at the beginning of our call, we are looking for additional EBITDA margin growth and with a forecasted slight improvement in revenue, this will translate to bottom line improvements for the fiscal year. As always, thanks to our hardworking people that continue to make the extra effort to improve our performance and enhance our customers' experience. And this concludes our prepared comments and we will be happy to respond to any of your questions.

[Operator:]

[Operator Instructions] And your first question comes from the line of Nikhil Kumar with Stifel.

[Nikhil Kumar:]

This is Nick Kumar for Matt Sheerin. So Per, can you talk about your guidance? You talked about improving trends from distribution but guidance calls for like a flattish top line. So can you talk about what you are seeing in terms of what you are baking in your expectations?

[Per-Olof Loof:]

What we are guiding to is a slight improvement in revenue for the year. And for the Q1, our first quarter, we are guiding in the sort of range where we were this quarter. Maybe with a slight uptick but basically in the range of where we were this last quarter.

[Nikhil Kumar:]

And if you have seen improvement from distribution, I mean is there a possibility you could exceed your guidance range? I mean is that being conservative there or just [indiscernible]?

[Per-Olof Loof:]

You know you always have to be somewhat conservative when you give these estimates but I think there was -- we are guiding in this range but if I would say something, I am cautiously optimistic about what I am seeing. And I said in my prepared remarks, I talked about Europe coming back and we see that. And, of course, for us having such a large share of our business in Europe that is a welcome sight for sure.

[Nikhil Kumar:]

Got it. And can you talk about book to bill quarter till date? I mean is it still above one, well above one or close to...?

[Per-Olof Loof:]

Quarter to date book to bill is very strong. Book to bill at the end of March was, for the total company, 1.07. But now it's...

[Nikhil Kumar:]

Okay. Got it. And in the F&E business, I mean the top line sequentially improved but still margins were weak and you talked about contribution from Europe as one of the reason. But like can you talk about what needs to happen for margins to improve in Q1 and Q2 going forward.

[Per-Olof Loof:]

Well, if you look at F&E for the year, still not at the level we need it to be. But it actually improved the EBITDA by almost $7 million on the course of the year. So we have seen some improvement. And as I said on my call, on my prepared remarks, the issue or the main issue in F&E is one product line, electrolytics. And that’s where the focus has to be and we will have to figure out what to do with that if it doesn’t improve. But we see some good signs. We are sold out in a couple of products in that product line and we now have invested in additional capacity in that particular segment. And we will see those machines coming on line now in this quarter and that should help the revenue as well as the bottom line. I don’t know, Bill, if you want to comment some more.

[Nikhil Kumar:]

Got it. Thank you. And on NEC TOKIN, if I remember last quarter I think you accrued about $50 million in total liabilities and still I think you have five or six jurisdictions to get clearance form. So can you talk about what needs to happen between now and of the year you are talking about. You know integrating, what needs to happen for that NEC TOKIN to be folded into KEM.

[Per-Olof Loof:]

What we announced today is the initial agreement in the U.S. on the civil side, which now is part of the accrual. So we now believe as we will always say, that the accruals that NEC has taken includes what we have done, which are three jurisdictions finished and the two civil cases in the U.S. And the rest is also accrued. So we think we have -- although actual may vary somewhat, but I think we are kind of in the range of where the accruals should be. I don’t, Bill, if you want to comment on that one?

[Bill Lowe:]

Just, you made the comment that we accrued 50 million -- they accrued 50 million last quarter. Actually just to make sure we have the numbers straight when the accruals occurred. The first accrual occurred actually March 31 of the prior year, at the end of the last fiscal year, which was approximately $30 million. Additional accrual was taken in December bringing it up to about $50 million. And that relates to, as Per said, all the various jurisdictions. The ones that have been, that are known to us. That have actually supplied an assessment as well as an estimate for those jurisdictions that have yet to respond with a formal assessment. So that, as Per said, we believe and NT believes that they have accrued the necessary amounts related to the jurisdictional finds that have occurred or will occur. And then the additional accrual taken this quarter relates to the civil case that Per detailed on the phone call.

[Nikhil Kumar:]

And you expect these to be, like settle favorably before you acquire NEC TOKIN completely. Right?

[Per-Olof Loof:]

Well, what we have said is we need clarity. That KEMET and KEMET's board needs clarity whether all of the jurisdictions will have concluded their investigations is a different matter. But a huge step towards clarity happened as a result of this agreement that’s been done in California.

[Operator:]

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

[Josh Nichols:]

Regarding the debt repurchase program, that’s good to see. Any plans that you could detail as far as does the company plan to use the majority of its free cash flow to repurchase debt and do you have any kind of debt to EBITDA longer-term target that you are kind of aiming at.

[Bill Lowe:]

Well, first of all, as we had said in our press release, the board has authorized an initial amount up to $20 million for debt repurchase at this time. They can always revisit that at a future date. The goal of course as we -- and we said this on our last call of course -- is as we have increased our liquidity as to reduce our debt structure in anticipation of a combination as we go forward with NEC TOKIN and, overall, getting our debt statistics, I mean the goal of course would be eventually to work our way down into the low 3 or below 3 into the 2s. I mean so we are now embarking upon that path of creating liquidity to lower -- to get our debt structure in line with where it needs to be.

[Josh Nichols:]

It looks like the solid state capacitor business has been benefitting a bit from product mix shift. It seems like to some tantalum capacitor with higher margin. What's driving that? Do you think that that’s a longer term trend or what's your view?

[Bill Lowe:]

Yes, I think it is a longer-term trend because the mix shift is to the newer products. So a capability that is coming on line that we are selling now to customers at the edge of capable technology. So that’s a good thing. So the mix is to the newer capabilities. So I think this is sustainable. I also think that we have, in both of these products line, done quite a lot in terms of reducing our cost structure and making it more efficient, which includes yields, for instance. You know the yield improvements in our tantalum business is quite remarkable over this past couple of quarters. So we are looking forward to that continuing and also we are not done with all the efficiency move and cost enhancements. So I think you can look forward to seeing that business continue to be a great contributor to our overall results.

[Josh Nichols:]

And speaking about some of the restructuring and operational efficiencies left to begin. Is the restructuring in F&E segment completed or there is still a little bit of work to be done in there to further improve margins.

[Per-Olof Loof:]

There is still some work to do and also some of the work has been done but hasn’t shown up on the P&L yet. There is a number sitting in the balance sheet that will start to flow through into the P&L starting this quarter. But there is further restructuring to be made and also as part of that, we have one particular product line inside the analytics business which is we have been sold out and we have been adding capacity and trying to add capacity and we have two lines that will come on board, starting this quarter which will improve the revenue performance and also with nice margins. So there is more to do and clearly the performance of the F&E group, in particular, is not where it needs to be. So a big focus on making sure that what we started actually gets completed. But the majority of the costs for the restructuring is already completed. I don’t know Bill if you want to add to that?

[Bill Lowe:]

I think that’s the main point from a cost standpoint. That the majority of this is behind us. There is a little bit to go but it's not in a material amount level.

[Josh Nichols:]

Good. So good to see that the distributor channel seems to have bottomed out and is rising. How would you categorize the distributor channels inventory levels compared to last three or four years as it stands today.

[Per-Olof Loof:]

Very low. So I think we have work with our channel partners which of course we view as an extension of our sales force of course. To ensure that we have a very healthy level of business both with regards to their inventories as well as the POS. And I think we are seeing some success in that. So the inventory levels are low and the POS is growing somewhat. So with that in mind and the correction is basically complete.

[Josh Nichols:]

So you guided to revenues flat to up a little bit for this year. So that’s kind of assuming that the distributor channel still stays relatively conservative as a low of level of inventory though compared to the historical levels but some room for upside if they change their view?

[Per-Olof Loof:]

You know we will see how that works out but, yes, we are guiding pretty conservatively.

[Josh Nichols:]

Okay. And then last question. Good to see one of the major hurdles, the NEC TOKIN acquisition is out of the way. Any major hurdles left? I know you said you expect to have it done later this year but what are the other major things need to be done to complete the acquisition.

[Per-Olof Loof:]

Well, there are still a few jurisdictions that are outstanding that we need to work through. And we need to work with our shareholder partner NEC Corporation, to complete the transaction and we have, as I said, an understanding how that will actually take place. And we will, as soon as we can, communicate to you the mechanics of how this will work.

[Operator:]

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

[Per-Olof Loof:]

Okay. Well, we appreciate that you are on the call this morning and thank you for your interest in our company and we are looking forward to this fiscal. And as I said and as Bill pointed out, there are a couple of things that are very important for us this year. One of them, of course, is completing the NEC TOKIN transaction and also to lower our debt. So with that, I thank you all very much.

[Bill Lowe:]

Thank you. Have a good day.

[Operator:]

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect.