KraneShares Dynamic Emerging Markets Strategy ETF
Q4 2015 Earnings Call Transcript

Published: 5 May 2015

[Executives:]

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

[Analysts:]

Matt Sheerin - Stifel Marco Rodriguez - Stonegate Capital Eran Grumberg - Abbett & Co

[Operator:]

Good morning. My name is Philus and I will be your conference operator today. At this time, I would like to welcome everyone to the KEMET Reports Preliminary Fourth Quarter and Fiscal Year 2015 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. Richard Vatinelle, Vice President and Treasurer. You may begin your conference.

[Richard Vatinelle:]

Thank you, Philus. Good morning and welcome to KEMET’s conference call to discuss the financial results for a fourth quarter fiscal year 2015. Joining me on a call today is Per Loof, our Chief Executive Officer and Bill Lowe, Executive Vice President and CFO. As a reminder to you, a presentation is available on our website that should help you follow along with the financial portion of our 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 involve a number of risks, uncertainties and assumptions. Please refer to our 10-Ks, 10-Qs and registration statement filings for additional information on risks and uncertainties. Now, I will turn the call over to Per.

[Per Loof:]

Thank you, Richard. And good morning, everyone. It has been a successful yet challenging fiscal year for KEMET. It was a year when we hit all of our internal targets. Our focus in fiscal 2015 was to improve our operating margins and therefore operating income and EBITDA. And we accomplished those tasks. While the Europe did take a bite out of our third and mainly our fourth quarter revenue causing us to end the fiscal year approximately $10 million behind the prior year. I am pleased to say that our adjusted operating income increased approximately $30 million with an improving adjusted gross margin of 430 basis points. This turnaround wasn't easy and I commend my staff and all the employees of KEMET for the dedication to making all of these plans work. And the turnaround is not just completed. Fiscal 2016 just got underway and is also slated as a margin improvement year for the company. If I look at our adjusted EBITDA track record for the past three years, we finished fiscal 2013 at $62.7 million, fiscal 2014 at $70.7 million and this most recent year at $91.7 million. As I alluded to, our expectation is for this trend to continue. As cost reductions will take full effect during the course of this current fiscal year. But not only cost reductions, the shift in mix is helping as well. This product makeshift will have even greater impact on our bottom line performance as we move further into fiscal 2016. Our focus on specialty products and deciding actions we can see are producing the desired results. Let me address the fourth quarter for a moment. Like many others have said it was tad challenging. Sales were impacted by both by the euro and the slight downward adjustment of inventory level with our distribution partners. This has been noted by many. For us specifically and additionally as specific rollout change for a few customers affected us well. This is reflected as a two percentage point decline in our defense and medical segment primarily was in defense. As our defense customers wanted to move ahead with deliveries in Q3 a bit more aggressively than usual. While our primary selling currency is the US dollar, about 30% of our revenue is sold in euros. The negative impact to our top line from strengthening US dollar to the euro was approximately $5 million, represented a largest portion of our miss to our forecast this quarter. The euro weakness against the dollar also contributes to a negative impact of approximately $2 million on operating income for the quarter. Fore the entire year, the top line impact of the currency moves was as I said $10 million and the bottom line saw negative $4 million effect. Thus EBITDA would have been $95 million without the currency changes. The rollout shift we experienced within our defense and medical segment declining about 2% represents the rest of the decline, approximately $5.1 million in revenue also significantly impacting our margins. Let's briefly look at our market segments before I turn the call over to Bill. On a revenue and percentage basis, telecommunication, computer and consumers were basically flat. Industrial driven primarily by Europe for us was down. Almost exclusively euro related. Defense was down but not indicative as a trend. We mentioned in last earnings call that we expected the sales of particular customer would decline this quarter based upon their normal buying pattern and that happened. Automotive continue to show strength and was up compared to Q3. We are seeing good design activity across segment and across all three regions. And in total, the order impact in Q4 was $50 million higher than in the December quarter about 8%. With the positive book-to-bill at the end of the quarter stronger than we anticipated. The book-to-bill today is over1.3. From a channel perspective, distribution revenue was down about 3.7% or $3 million. However, product sale was positive relative to last quarter meaning that our disti friends continue to work their inventories down. Inventories at the distribution channel still remain under scrutiny. My assumption after discussion with our partners is that we now will begin to notice that the inventory correction is coming to a close. These corrections started in Q1 last fiscal and continued throughout the year. Our disti partners are telling us if they are not happy with the current inventory levels and the trick for us of course in conjunction with our partners is to manage the channel inventory such that it fully support the POS demand ensuring a steady supply to the channel in order to maximize efficiencies both in the channel and for us at KEMET. We are currently rolling out a few new tools that will help all of us manage this better. Thus enabling us to better balance our disti business both inside a quarter as well as between quarters. OEM was down $4.5 million compared to the previous quarter including the military shift outside the military business, the business grew but not enough to offset the drop. A large portion of our OEM business is in Europe. Therefore this segment is impacted by the euro decline. Our EMEA business in local currency actually grew nicely in the fourth quarter. The weakness we've seen now for some time in the European industrial market may be helped by devalue of euro in my opinion. Thus in the long run the currency correction may prove to be beneficial for us. F&E as a percent of revenue was up and pretty flat on a dollar comparison quarter over prior quarter. And with that I'll turn it over to Bill to go through the numbers and come back to you with some color on the business units after Bill. Bill?

[Bill Lowe:]

Thank you, Per. And good morning, everyone. I am going to begin my review on Slide 5 if you are following along on the website. And discuss the fiscal year numbers first and then follow up with the review of our fourth fiscal quarter. Net sales for the year were $823.2 million which was down 1.3% compared to the prior year of $833.7 million. As Per said the strengthening US dollar to the euro were accounted for $10.4 million of that decline essentially all the decline on a yearly basis. And approximately 50% of that impact occurred in our fourth fiscal quarter. Our GAAP net loss was $14.1 million, or $0.30 a share both basic and diluted to compare to a net loss of $68.5 million or $1.52 loss per basic and diluted share for the prior fiscal year ended March 31, 2014. Our non-GAAP gross margin as a percentage of sales increased 430 basis points to 20.2% compared to 15.9% in the prior year. And operating margins were impacted by the weakening euros as we said in dollar terms by $4.6 million or negative 50 basis points on the year. Our non-GAAP adjusted net income from continued operations was $0.15 per basic share and $0.13 per diluted share and adjusted EBITDA for the current year was $91.7 million, up $21 million from $70.7 million for the prior year. Now turning to Slide 3 and addressing some fourth fiscal quarter numbers. Net sales for the quarter were $193.7 million and were down 3.8% compared to the prior quarter of December 31 of $201.3 million. The weakening euro to the dollar accounted for $4.8 million or 2.5% of that. Our GAAP net income for the quarter was negative $0.44 for basic and diluted share. And that includes our share of our joint venture partners' net loss for the quarter and the change in the value of the NEC TOKIN options. Our non-GAAP gross margin as a percentage of sales decreased 350 basis points to 18.9% compared to 22.4% in the prior quarter. And operating margins were impacted by the weakening euro and dollar terms by $2 million or negative 100 basis points for the quarter. Our non-GAAP net loss for the quarter was $0.04 per basic and diluted shares and adjusted EBITDA for the quarter was $18.2 million, down from $27.6 million for the prior quarter ended December 31. Capital expenditures during the quarter were $4.8 million; capital expenditures of $22.2 million for the full year came in within our forecasted range of $22 million to $25 million. And unrestricted cash in the bank at March 31 was $56.4 million since we flat from the December quarter of $55.6 million. Included in our cash payment this quarter, I'll remind was our last payment for the Niotan acquisition of $7.7 million which was paid in the first part of January. Regarding the performance of NEC TOKIN, revenue came in at $118.8 million. During the quarter NEC TOKIN re-cost or recorded a liability of $30 million related to the various antitrust investigations in which they were involved. And that we have disclosed in previous SEC filings. Our share of their financial results for the quarter was a net loss of $2.1 million and their cash balance remains healthy at $103.5 million. Now I'll turn the call back over to Per to discuss few of the markets in our business. Per?

[Per Loof:]

Thank you, Bill. I'll start with the solid capacitor group. The revenue was as prior quarter was down $7.1 million or 4.7% to $145.7 million. This revenue decline was driven primarily by exchange rate effects in Europe, continued softness in the distribution channel for MnO2 two products and seasonal pull back in key OEM accounts. On a positive note our channel and polymer revenue was up 14% compared to a year ago. This has been an area of focus for us and we are pleased to see this progress. I see this product line as a growth engine for our business going forward. Adjusted gross margin remained above our timeless model target at 26%, but off the Q3 pace as a result of low revenue and unfavorable seasonal mix wing from our specialty value added products mainly in military as I said previously. Cost continued to improve and help to offset a portion of the unfavorable mix and revenue impact. Our Film and Electrolytic business grew revenue -- group revenue was essentially flat at $48 million from $48.5 million last quarter. However, and I don't want to sound like a broken record but in local currency the business was actually up. Revenues were impacted by weakening euro to 17.3% versus previous quarter. Within Film and Electrolytic, the euro based revenues represent in excess of 70% of sales. Adjusted gross margin was down versus a prior quarter also driven by actions to reduce inventory. We reduced our inventory in this segment by $8.8 million in the quarter which resulted in a $3.4 million unfavorable impact on adjusted gross margin. The fact that costs are improving is very positive of course even though these costs reductions must run through inventory before benefiting the income statement. We expect the actions in our fourth quarter to provide benefit to our financial results in the first fiscal quarter ending June 30. Now to our regions. In EMEA, at a lower euro rate the revenue for Q4 was $66.9 million which was basically flat versus last quarter. Thus the business grew in local currency. Within our distribution channels we've seen reasonable resale activities as well as reasonable restocking activities. Our automotive and our industrial OEM business remained stable in Q4 and the book-to-bill is positive at this time in the quarter. Looking ahead to next quarter we do expect our European business at a similar level as in this quarter. In the Asia-Pacific region, revenue was down 2.3% quarter-over-quarter to $68.6 million that was up 5% if compared year-over-year. In the first calendar quarter there is always an impact because of Chinese New Year celebrations as we all know. Overall, it was a positive year for the region with solid results both in terms of top and bottom line and the book-to-bill is positive in these areas as well. China manufacturer and PMI for the first quarter of 2015 came in negative below 50 points reflecting not only the impact of the Chinese New Year but also a general slowdown in the Chinese economy. Q4 revenue in the Americas region finished down over the prior quarter $58.2 million versus $63.7 million, all related to the shift in military business. Up US this quarter was flat, however, we anticipated being slightly up next quarter. For fiscal 2015, the Americas grew variable margin year-over-year and also contributed 70% more operating income this year versus the previous year. The Americas team continues to focus on designing specialty products and adding to operating income. And to sum up, we are pleased with our results for the year. I can't say that we are totally pleased with how the fourth quarter ended but currency moves combined with other seasonal changes provide strong headwinds. We believe the efforts of cost reductions in fiscal 2015 will position us well as we roll into fiscal 2016. And we do expect continued margin improvement that will contribute to an improving bottom line and cash flow. And in regards to our first quarter of fiscal 2016, we are forecasting sales to be flat to slightly up within the range of $190 million to $195 million. However, an unpredictable FOREX situation mainly the euro could continue to affect this range up or down. Our average euro rate this past quarter was around 1.14 so based on where the euro has traded the first month of the quarter we could see a slight negative impact quarter-over-quarter. But not what we saw last quarter. And now it seems to be settling down. The expectation is for margin improvement F&E sales remain flat. We do expect to see an improved bottom line in our first quarter of the fiscal year. And as always thanks to our hardworking employees, they 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] Your first question comes from the line of Matt Sheerin with Stifel.

[Matt Sheerin:]

Yes, thanks, good morning, guys. Just a couple of questions regarding the gross margin decline. I know you had guided it down a little bit, I mean that pretty much just explained FX, the military customers so that the mix hurting you. Was there anything else there? Are you seeing incremental pricing pressure particularly from Japanese customers? Anything going on with F&E that also hurt your margins. And then of course distribution was part of that too right.

[Per Loof:]

Yes. I think, no, we are not seeing adding pricing pressure; shift was the part of it as we talked about. The euro was part of it, also the inventory draw downs particularly in the F&E segment contributed to that as well as these effects roll into inventory and will be released next quarter, so that basically explains the whole difference.

[Matt Sheerin:]

Yes, go ahead.

[Per Loof:]

Now if you look at -- for our adjusted operating income, a year-over-year was basically flat. Last year's revenue was $22 million higher.

[Matt Sheerin:]

Got you. And on the --so as you look to next quarter you sounds like you are talking about you are returning the profitability on a non-GAAP basis. Is that military business coming back so you will see the mix improve in your favor?

[Per Loof:]

No, the military business is not -- I mean we still have some military business but the one we are talking about is really a Q2 and Q3 and the Q4 business typically. What happen this time is they pushed a lot into Q3 rather than Q4 which was a bit more than we had anticipated? So that added to that. But we are going to see improving margins in this quarter based on the business improving and we are seeing many of the cost reductions that have been implemented are actually coming on to -- we are actually to see them on the top line over the P&L. I don't -- if you want to comment Bill on that.

[Bill Lowe:]

No. I think that's correct.

[Matt Sheerin:]

Okay. Then on NEC TOKIN, you talked about a loss -- was that primarily due to legal cost and other things related to the investigation. Could tell us what sort of a pro forma operating metrics look like there?

[Per Loof:]

Well, I mean if you take away the accrual they took on -- relating to this investigation then the legal fees they will have -- they would had a profitable quarter and a profitable year. The operating performance of NEC TOKIN, not counting these other actions is actually positive and actually better than we had in our budgets and better than we had anticipated going into it so from that perspective we are pleased with the performance of the improvised --

[Matt Sheerin:]

Is there any visibility into any sort of settlement regarding this tantalum investigation?

[Per Loof:]

I mean, I think we are getting closer to clarity. Do we have it at this point? No. But the company did take $30 million accrual relating to these investigations. I don't know Bill if you want to continue.

[Bill Lowe:]

No. I think the Per is right. We just -- we still need -- still more time needed to make the full assessment. I think we are waiting on that. There is no clearer than the accrual that they took, there is no more clarity at this point.

[Operator:]

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

[Marco Rodriguez:]

Good morning, guys. Hey, thanks for taking my questions. Just kind wanted to follow up in regard to the -- I guess the additional restructuring efforts on the business itself. I think last time you guys talked about taking a total of about $30 million restructuring charges, and obviously saw about 3, almost 3.5 this quarter, is that still a valid number and how should we be thinking about when those charges come through this fiscal year?

[Per Loof:]

That still a valid number and I would say they are going to come -- they are going to be basically I would assume most of it done in this calendar. So you are going to see some in Q1, some in Q2 and some in Q3.

[Bill Lowe:]

And it's, to follow up the Per's comments, they are on the quarters; most of what we talked about is already accrued on our books. So of the total 80% is probably accrued and so we will see the cash flow impact of that quarterly somewhere in kind of more so in the first quarter and the second quarter front end loaded. And then the accruals will probably happen, the additional accrual and it will, probably some will happen in the first quarter and some maybe in the second quarter. So first and second quarter for additional accruals. Probably first and second quarter for the majority of the cash but the cash is actually spread throughout the fiscal year.

[Marco Rodriguez:]

Got it, okay. And the margin improvements, can you give us a little better of sense how you these additional restructuring efforts and the impact onto the operating margin and gross margin? How should we be thinking as far as flat revenue environment? How they kind of move up through the quarters?

[Per Loof:]

Well, I think first of all the -- some of those activities within the F&E segment will start to come in this -- coming quarter. As I said they rolled into inventory this past quarter which affected the P&L performance. And so they will come out of inventory and affect the P&L this quarter and we are going to see that happening further. There is some-- there has been some delays and which we've talked about before and particularly moving one plant, restructuring one facility due to demand that we had from a particular customer. That grew required us to keep the plant open longer than anticipated. So that's going to take till Q3 till that is finalized. But I think you are going to see improved performance not just from the restructuring efforts that we are taking but also from a makeshift. We are seeing in the tantalum environment, we are seeing a relatively stable overall business. But within the tantalum business you see a shift from lower margin MnO2 products to better performing polymer products. And as I said we grew that -- the polymer segment in the last quarter, we grew that 14% over next and we continue to see the polymer segment being a bigger part of the pie as we move forward. Also in a more specialty products are coming online and those makeshifts I think are going to be positive impact to our bottom line performance. So we expect the year to improve over this year, even the fact that euro is of course impacting us to a degree. How much it will impact that is of course at this point hard to tell but last year we ran the entire year a lot higher than we ended for sure of course so that's going to have an impact to us. I don't know, Bill if you want to comment more that to.

[Bill Lowe:]

No.

[Marco Rodriguez:]

Okay. So that just coming back to your specialty product aspects. What percentage of your revenues in Q4 and fiscal 2015 were specialty and how should we be thinking as far as a percent of revenue of those products will represent in fiscal 2016?

[Per Loof:]

Yes. I think we are seeing -- we are growing, it is in the 30% range today. The way we define specialty or application specific capabilities. And I think you are going to see that several percentage point improvement of that particular segment as we move forward. So we expect in the tantalum business unit for instance our specialty products to improve as a percent of the sales as well as in the ceramic side. So I think there is a mixture of cost avoidance activities and cost restructuring that's going to impact the margins positively as well as the shift in mix to better margin capabilities because it is a higher value product.

[Marco Rodriguez:]

Got it. And so if just kind of back of the envelop here so if we had -- do have a flat revenue environment once again in fiscal 2016, the restructuring, the additional restructuring at F&E, the $20 million you are going to be improving there, that gives you about a 200 basis points improvement year-over-year from an operating margin standpoint, the makeshift what do you -- I mean what kind of range wise would you think that would add to that improvement on the operating margin. I think it maybe a 100 basis points, something little bit less, any kind of color you can provide there.

[Per Loof:]

I think you are looking at the 100, more than a 100 actually.

[Operator:]

Your next question comes from the line of Eran Grumberg with Abbett.

[Eran Grumberg:]

Hi, thank you for taking my questions. The pull forward in the military sales went into Q3 instead of Q4, was that unexpected or different than whatever you discussed at the last earnings call. I am just trying to understand if they caught you by surprise.

[Per Loof:]

Well, it didn't catch us by surprise. I mean these things are -- but it was different from prior year that's what I am saying. The fact that we pulled and more of came in earlier than later was of course what the customer wanted so but it was different what we had in our initial plan, and it was also different from last fiscal. That's all I am saying.

[Bill Lowe:]

Yes. I think we highlight on the last call. It did occur and that we said we thought that would have an impact on this quarter as we came into it, yes.

[Eran Grumberg:]

Okay. Can you talk little about where things stand with NEC TOKIN and your plans to buy in the balance of the business? I understand that you are still waiting on the litigation to resolve itself but maybe if you can just remind me of any obligations you have with regard to put and call arrangements.

[Per Loof:]

What we've said of course we are in continuous discussion with NEC, our joint venture partner. And the objective of this particular exercise is not changed from a KEMET perspective nor from NEC perspective. The objective of both partners is to consummate this deal as originally planned. Now clearly it has put the investigations have put a delay into going forward and we need to wait to see what the impact of this has. And as we've reported this quarter the company did take an accrual for $30 million related to these activities this quarter. But what that means is we have a bit more clarity now than we had a couple of months ago. But we still need to wait for further clarification before we are ready to take the next step. And we are in lock step with NEC on this. So we are clearly committed to make this happen. And we have a committed partner who also going to make this happen. So that's where we are in terms of our situation with NEC TOKIN.

[Eran Grumberg:]

And I apologize, I don't have the documents in front of me but are there expiration dates on either the put or call that are coming up imminently?

[Per Loof:]

Yes. There are expiration dates on those. But we've said between and we move them out once and we decided jointly that let's not move -- let's not worry about these things at this point but having an understanding that we will continue to -- we will make the moves when we have the clarity that we need to move forward. And I think both NEC and us want to have that clarity before we take the next step for obvious reasons. So I wouldn't actually from a practical perspective, the fact where the call is and where the put is, I wouldn't worry about those deck because they are not really impacting the way these things go forward. I don't know Bill if you want to continue --add some more comments

[Bill Lowe:]

I think it is pretty clear Per what just said from the practical standpoint yes.

[Eran Grumberg:]

So the dates are effectively put on abeyance pending whatever the outcome is from the legal stuff?

[Per Loof:]

On a practical matter that's pretty well put. I mean we will wait for clarity and during this period you can imagine we are having good conversations with NEC and how we are going to move this thing forward. And they are as anxious as we are to make sure that we have full clarity before we take the next step.

[Bill Lowe:]

We have not filed any formal documentation at this point. But at the Per's comments from a practical standpoint the parties are continuing to have discussion about the consummation of the transaction as soon as we are able to have full clarity. So that's what going on in reality and but we have not filed any formal new documentation in that regard.

[Eran Grumberg:]

And then one final question. The high yield notes that are currently callable that's not think I am -- there was discussion about refinancing in conjunction with ORG transaction. Can you talk about any plans or thoughts you have with the notes?

[Bill Lowe:]

I would say we are still continue to monitor the market and it is not just the my -- it is a combination of monitoring the market in conjunction with the other factors that are affecting that such as the NEC TOKIN transaction itself is to-- the timing is to when the company will actually become engage back into the market to refinance the notes. So it is a combination of factors. So we are -- that subject is a constant subject with us here.

[Operator:]

[Operator Instructions] We have a question from the line of Marco Rodriguez with Stonegate Capital.

[Marco Rodriguez:]

Hey, guys, sorry, and just one real quick question here regard to cash flows. Can you give us a sense as far as your expectation on cash flows for next year and also CapEx?

[Bill Lowe:]

Yes, CapEx next year probably in the same range as this year, I said that we finished the year right around $22 million or so. I'll expect this to be in the same general range this next year. Of course this last year we've spent-- we had a lot of cash that exceeded for the purchases of Niotan. That will repeat of course so from a cash flow basis which you are looking at is our interest expense and it remains relatively unchanged. CapEx of $22 million, cash tax is typically $6 million to $8 million from that perspective. Those are the major components as well as we talked about the severance already that we spent this year around $10 million. And it is fair to say we are expecting to see continued improvement in the operating income again this year. There is one more expense I did forget and that is the -- we announced the purchase of Intel Data, so we will continue to make the payments related to that. We didn't actually disclose that. That purchase price was not material amount. Not a big number.

[Marco Rodriguez:]

Got it. And are you expecting the Bill cash on the year?

[Bill Lowe:]

Yes. I am.

[Operator:]

At this time, there are no further questions.

[Per Loof:]

Okay. If there are no further questions, thank you very much for coming on the call. And we'll talk to you on the call again in about three months. So thank you very much and have a great day.

[Bill Lowe:]

Thank you.

[Operator:]

Thank you. That does conclude today's conference. You may now disconnect.