KraneShares Dynamic Emerging Markets Strategy ETF
Q2 2016 Earnings Call Transcript

Published: 29 Oct 2015

[Executives:]

Per Loof - Chief Executive Officer William Lowe – EVP and Chief Financial Officer

[Analysts:]

Alvin Park - Stifel Nicolaus Ana Goshko - Bank of America Kevin Kuzio - First Eagle Investment Management

[Operator:]

Good morning. My name is Angie and I’ll be your conference operator today. At this time, I’d like to welcome everyone to the KEMET Report Preliminary Second Quarter Financial 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 conference over to Mr. Lowe, Executive Vice President and CFO. You may begin.

[William Lowe:]

Thank you, Angie, and good morning everyone. This is Bill Lowe. Welcome to KEMET’s conference call to discuss the financial results for the second quarter of fiscal year 2016 ending September 30. Joining me today on the call today is Per Loof, our Chief Executive Officer. And we’re speaking today from our facility in Pontecchio, Italy. As a reminder to you, a presentation is available on the website that should help you follow along in the financial portion of our presentation. And 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 involve a number of risks, uncertainties and assumptions. Please refer to our 10-Ks, 10-Qs and registration filing statements for additional information on the risks and uncertainties. Now, I will turn the call over to Per.

[Per Loof:]

Thank you, Bill, and good morning everyone. The quarter finished better than projected and it’s good to see that the work over many quarters is now showing up on our bottom line. We still have actions to complete, but over the next six months or so, our [recruiting] [ph] exercise will in essence be done. Those who follow our company will note that we are right where we said we would be at this time, actually slightly ahead of schedule. Adjusted gross margins improved 180 basis points quarter-over-quarter, exceeding our forecast of a 100 basis point improvement, with revenues down ever so slightly compared with the prior quarter at $186.1 million, falling within our forecasted range of $185 million to $190 million. Our non-GAAP EPS came in at $0.09 per diluted share. And as I said, our second quarter continued along our established glide path of continued margin improvements even in a time of flat to declining revenue trends. Both OEM and our EMS channels were slightly ahead compared to last quarter and totaled about $3 million. However, the distribution channel is consistently and stubbornly continuing to correct its inventory levels, now down quarter-over-quarter by $4 million. We have not seen yet after several quarters that [POA] [ph] level that corresponds to the business [Indiscernible] distribution partners are seeing. I do believe that many in the channel are trying to read the tea leaves in the market and since lead times continue to be rather short for some products then they are trying to play it safe. A slowing China’s economy, geopolitical uncertainties as well VW news are keeping folks somewhat more careful. However, we continue to see both our OEM and EMS revenue more or less firm. On our last call, I said that we expect to see this business trend continue for possibly another two quarters. And that prediction has been unfortunately so far fairly accurate. As we enter our third quarter, we see continued weakness in our distribution revenue, but I do believe barring any unforeseen macro events that this current quarter will mark the end of the channel corrections. Based upon the POS data that I see, even from this quarter, I do believe our last fiscal quarter ending March 2016 will reflect an increase in the distribution channel revenue over level expected in December. POS in the Americas and Asia was up this past quarter, while Europe was seasonally lower. Therefore, clearly inventories in the distribution channel continue to be an area of focus for us and we work deliberately with our partners to reach a balance between POS demand inventory levels and revenue patterns. As I said, we do see both OEM and EMS to be relatively flat in comparison with the previous quarter. In general, we see both of these channels to remain flat and stable over the near-term, including automotive and industrial customers. Regarding our segments this quarter, telecom was slightly down [indiscernible] of our revenue. The industrial segment moved up to 24% of our business, while automotive, computer and consumer segments were all stable at 22%, 14%, and 8%. respectively. Medical and defense segments were also stable at 7% and 5%. Therefore with those comments in mind, our revenue expectation for the December quarter, unless the dist inventory corrections finishes earlier, of course, we will see revenue growth, we expect to be in the range of $180 million to $187 million. Margins, we expect, will continue its path of the past. Remember, we did say in our last call that margins will improve 100 basis points per quarter, we already improved 180 points towards our 200 point goal for September and December quarters. With that calculation in mind, a 30 to 40 basis point improvement I believe is in the cards. I will now turn it over to Bill to go through the numbers and come back to you later with some additional color on the business units. Bill?

[William Lowe:]

Thank you, Per. And I’ll begin my review on slide 3 if you’re following along in the website. Net sales of $186.1 million, which was down just slightly, 0.8% compared to the prior quarter of $187.6 million. The GAAP gross margin percentage improved 180 basis points from 21.2% to 23% and our GAAP net income was $7.2 million or $0.16 per basic and $0.14 per diluted share compared to a loss of $0.81 per basic and diluted share for the prior quarter in June 30, 2015. Moving to slide 4, our non-GAAP gross margin percentage, as Per said earlier, increased the same, 180 basis points to 23.3%, compared to the 21.5% in the prior quarter. Our non-GAAP adjusted net income was $0.09 per basic and diluted share. Adjusted EBITDA for the quarter was $24.4 million, up $4.2 million from the $20.2 million in the prior quarter. SG&A expenses of $21.1 million were lower by almost $3 million from our June quarter, reflecting both our efforts at reducing overhead and some timing differences quarter-to-quarter. Our expectation for the December quarter is in the range of $21.5 million to $23 million for SG&A. If I skip forward to slide 7, capital expenditures during the quarter were $3.5 million and our forecast for the full year remains in the range of $20 million to $22 million. Total cash in the bank at September 30 was $39.2 million. Cash is generally on plan with where we expect it to be this time of the year and our expectation is it remains the same, in the range generally throughout the third quarter and our expectation is to continue to build cash up to our next bond payment, which occurs on November 1 throughout the remainder of the fiscal year. And as I said on our last call, we should end up with amounts similar to where we started this year, if not even slightly up. Regarding the performance of NEC TOKIN, revenue in Q2 came in at [144 million yen] [ph] or approximately $117 million. Our share of their financial results for the quarter was equity income of $200,000. Their cash balance remains healthy at $100 million and their EBITDA for the quarter in US dollars was $13.8 million. Now, I’ll turn the call back over to Per to discuss a few of the markets and our business units.

[Per Loof:]

Thank you, Bill. In the solid capacitor group, revenue versus the prior quarter was up $1.6 million, or 1.2%, at $141.3 million. The increase in revenue for Q2 was driven by improved demand in the OEM and in our channels for both tantalum and ceramic products. While, as we said before [indiscernible]. Adjusted gross margin for Q2 was 28.3% and this result is an improvement of 230 basis points quarter-over-quarter as our cost and mix initiatives continued to produce favorable results. Moving into Q3, starting backlog is lower than previous quarter, driven solely by weakness in our distribution channel and some seasonal weakness in EMS. These will put downward pressure on revenue and margins, but strong specialty product mix in conjunction with additional cost improvements is expected to help mitigate the impact. Our film and electrolytic business group revenue was $44.8 million as compared to $47.9 million last quarter, a decline of 6.4%. Current quarter revenue was impacted by reduced demand in China and America, while Europe remained essentially flat. Revenue from our distribution channel was lower, while the OEM and EMS channel was essentially flat as in the other businesses. Inventory in the distribution channel continued to reduce this quarter and as I said the de-acceleration of China’s economy has resulted in reduced demand which has impacted many companies’ outlook. As a result, many are taking a conservative view towards inventory and expenditures as a precaution. Adjusted gross margin for this business group was down slightly versus the previous quarter to 7.6% versus 8.4%, mainly driven by the reduced revenue level. Lastly, as I mentioned last quarter, we are completing the closing of one operation site and we’ll start moving operation from Germany to Macedonia during this upcoming quarter ending in December. And now to the regions, we finished our last quarter in Europe with $59.5 million, which was down 3.4% versus last quarter. The lower revenue levels within our direct business was expected due to the European channel slowdown and inventory adjustments within our distribution channel. Today, our book-to-bill ratio is again positive at both channels and we do see the overall European economy slowing down a bit also in the next quarter. However, we do expect our European business at a similar level as last quarter. In the Asia Pacific region, revenue was flat at $58.6 million in Q2. Operating income improved within the region from 12% specialty product sales. POS sales was flat in Q2 and going forward to Q3 we expect the number will be slightly up. China shows signs of slowing down and manufacturing PMI decreased to 47.2 in September which is the weakest showing since March of 2009. Other indicators such as export orders also declined. Q3 is a challenging quarter for Asia as China will take one full week off with their national holiday as December is the fiscal year end for most distributors and they will need to do inventory adjustment. However, we still target flat from Q2 to Q3. Q2 revenue in the Americas finished up over the prior quarter of $56 million ending at $58.1 million. In our last call, we expected POS in the Americas to be flat to slightly up for this year and this was the case as POS finished up 3% for the second quarter compared to the first. The book-to-bill rate is currently positive. Regarding our joint venture with NEC, we continue to remain optimistic and we will have more clarity soon on a number of jurisdictions in [indiscernible] NEC company. As you know, the US announced their findings on September 2 and imposed a $13.8 fine payable over five years. NEC TOKIN accrued $30 million related to these potential liabilities in the quarter ended March 31, 2015. The accrual remains at $30 million, it has not been resolved at this time. NEC TOKIN and KEMET continue to see increased cooperation between the two companies with benefits for both. To sum up, the quarter was better on the bottom line versus forecast, with revenues in line with our range. Our F&E business continues to perform within expectation, while we’re continuing to fight a sluggish European economy making top line growth somewhat difficult. Until the dist inventories reach their bottom, revenue will remain relatively flat or a small decline, especially in the solid capacitor business group. Sales in the range of $180 million to $187 million, with slight margin improvement should put us on a profitable course for Q3. However, as we see some revenue pullback, the bottom line might see a slight impact, but profitable of course. We believe our cost structure is in the best shape it has been in years, possibly ever. Top line growth is somewhat dependent upon the world economic situation; however, we’re well positioned to take full advantage of the rise in revenue with our current cost structure. We remain optimistic that we might see a bit of a rise in distribution revenue in our March 2016 quarter based upon the POS and POA data that we are now seeing. And as always, thanks to our hardworking employees 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.

[William Lowe:]

Operator, we’re ready to take questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Alvin Park with Stifel.

[Alvin Park:]

Just heard from your commentary that book-to-bill was positive, could you be able to provide a little more color on that, specifically from different segments and product lines? And as well, if you could give any color on the quarter-to-date so far on the book-to-bill that you’ve been seeing in different segments of businesses?

[Per Loof:]

Book-to-bill currently in the quarter is 1.2, 1.25 range and basically positive in all of the channels at this point, varying a little bit between the regions and the businesses, but basically in that range. And also the POS sales for some of our distribution partners where we’ve seen the data seem to be fairly positive in the October month.

[Alvin Park:]

And concerning margin, I think in your guide of 180 to 187 for the upcoming quarter, I think you said flat margin improvement. Given your good margin improvement of almost 180 bps this quarter, do you have any more color as to how much margin improvement leverage you have remaining and how much you think there is left in the tank in terms of improvement?

[Per Loof:]

What we’ve said is we’ve said we expect to see 100 basis points a quarter and we expect to see – so that gets us 200 for the quarter ending September and December. And we did a bit quicker in September to 180, so therefore we guided to 30 to 40 basis points for the quarter, this current quarter. But also we’re guiding to – we’re continuing with 100 basis point improvement in the March quarter as well. So we’re not done and the idea here is that we will end the year with 25% gross margin [Indiscernible].

[Alvin Park:]

That’s your target. And lastly, in terms of NEC, I know you mentioned the accrual still remains the same at 30 million, but in terms of litigation, have you seen – could you be able to provide any color on any updates you’ve been seeing so far throughout the quarter and quarter-to-date?

[Per Loof:]

What happened in September was that the DoJ and NEC TOKIN agreed on a plea agreement and that was the $13.8 million in fines payable over five years. So the US side of this is done. We’re still waiting for the other jurisdictions to come out with a finding. We do expect them to be ready relatively soon, so within a few months or so, we should be seeing additional findings coming out from the other jurisdictions. It’s a little bit [Indiscernible] to always predict those correctly, but from what we can ascertain at this point is that these findings and these activities are coming to a close within a relatively short period of time.

[Operator:]

Your next question comes from the line of Ana Goshko with Bank of America.

[Ana Goshko:]

I just wanted to follow-up on the prior question on NEC TOKIN, so how many jurisdictions are you waiting for? I think in my notes I have China, Japan, Korea and the European Commission. So are we waiting for four decisions?

[Per Loof:]

They’re all important, of course, but Japan, Korea and EU are the ones that we’re waiting for that and then we’re also waiting for Taiwan, Singapore and Brazil. So there are actually a number that we’re waiting for. And we have some indications as to where they’re at and our current indications are that several of those will be done within the next couple of months. But again, I’m no expert in this for sure to try to tell exactly what will happen, but I would expect you will hear from them within the next couple or three months.

[Ana Goshko:]

And then is your game plan to wait until all of these decisions are in before you would proceed with consolidating and rolling in NEC TOKIN or is there – at some point where you feel that you may have comfort on outlook or you could be indemnified so you don’t have to wait until every single decision comes in with finality?

[Per Loof:]

I think, what I’ve said and I hold to this is that we will wait until we have clarity or reasonable clarity as to where this will come in. So I don’t think we need to wait for every single one of them, but we need to have reasonable clarity as to whether it will come in before we proceed. The US came out and that was an important one and that was done relatively quickly and we hope and expect that a few more will come in in the relatively near-term. So we don’t have to have everybody done.

[Operator:]

[Operator Instructions] Your next question comes from the line of Kevin Kuzio with First Eagle Investment.

[Kevin Kuzio:]

Bill, I’ve appreciated your tracking of the cash expectations for us over a quarter. I guess, I have a question related to the $100 million cash over at NEC TOKIN, is any of that available to KEMET at this point in the game?

[William Lowe:]

No, it is not available at this time. We own of course 34% equity ownership, [Indiscernible] of course as you know, if you have [indiscernible] to get cash out really as dividend, that’s not the path with us and our partner NEC is looking to do with this business. So we have said from beginning [Indiscernible] that until we consolidate, the cash on their balance sheet remains on their balance sheet and does not come to KEMET nor to NEC.

[Kevin Kuzio:]

Do you have a sense as to what the minimum operating cash is in the NEC business, just for my note?

[William Lowe:]

It’s not dissimilar to KEMET; they operate in a number of foreign jurisdictions which always means that you need to have sufficient cash to and those jurisdictions operate as well. So no, it’s less than the [Indiscernible] on the balance sheet [reserve] [ph] today.

[Operator:]

[Operator Instructions] At this time, there are no further questions.

[Per Loof:]

Thank you everyone for participating on our call today and we’ll talk to you at the end of next quarter. Thank you all very much. Have a good day.

[Operator:]

Thank you for participating in today’s conference call. You may now disconnect your lines at this time.