KraneShares Dynamic Emerging Markets Strategy ETF
Q2 2015 Earnings Call Transcript

Published: 30 Oct 2014

[Executives:]

Richard Vatinelle - VP and Treasurer Per-Olof Loof - CEO William Lowe Jr. - EVP and CFO Wilfried Backes - Director

[Analysts:]

Matt Sheerin - Stifel, Nicolaus & Co. Marco Rodriguez - Stonegate Securities

[Operator:]

Good morning. My name is Arnica and I will be your conference operator today. At this time, I’d like to welcome everyone to KEMET Reports Preliminary Fiscal 2015 Second Quarter 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'll now turn the conference over to Richard Vatinelle.

[Richard Vatinelle:]

Thank you, Arnica. Good morning and welcome to KEMET’s conference call to discuss the financial results for our second quarter of fiscal year 2015. Joining me on the 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 that address 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-Olof Loof:]

Thank you, Richard and very good morning everyone. Our Q2 performance exceeded our expectations in all respect. Margins exceeded our forecast, generating an operating income that improved almost $6.8 million from Q1, with revenue at $215.3 million, surpassing the top end of our forecast and up approximate $2.4 million from the previous quarter. If we compare to Q2 a year ago, our EBITDA performance of $25.9 million now improved $8.1 million. Most importantly, this quarter we were pleased to report that our consolidated adjusted gross margin increased a resounding 340 basis points to 21.5% from 18.1% the prior quarter. We expected to be at this level as we would exit next quarter Q3. However, with the additional revenue, a decent product mix as well as cost improvement programs being ahead of schedule, this gave us the opportunity to reach this goal a quarter early. Our objective is now to hold that level through Q3 as originally planned. We still have a way to go to hit our timeless model, but gross margin at 21.5% and operating profit at 7.5% is moving us closer. Bill will walk you through our forecast a little later. Looking at our market segments, compared to last quarter, telecom was up as was medical and our defense business increased as well. Computer, consumer, industrial and automotive, each declined slightly compared to the prior quarter. From a channel perspective, distribution revenue was down about $5 million and OEM and EMS combined were up $8 million compared to the previous quarter. The very nice EMS increase was driven by our strength in telecom primarily, but also by a shift of some business from distribution to EMS. Our OEM business increased as well quarter-over-quarter with defense and medical being particularly healthy, automotive is still in a very good spot even though it was down ever so slightly, primarily due to the summer season in Europe. I am now going to turn over to Bill to have him go through the numbers and come back to you with some additional color on the business units. Bill?

[William Lowe Jr.:]

Thank you, Per and good morning, everyone. I'll begin my review on Slide 4, which is normally where I start on this deck if you're following along on the website and as a reminder again, the prior period results including this in the presentation have been adjusted to reflect discontinued operations. Net sales of $215.3 million were up 1.1% compared to the prior quarter of June 30 of $212.9 million and up 3.3% compared to net sales of $208.4 for the quarter ended September 30, 2013. Our non-GAAP gross margin as a percentage of sales increased 340 basis points as Per said to 21.5% compared to 18.1% in the prior quarter. And our non-GAAP net income was $0.08 per basic share and $0.07 per diluted share, and adjusted EBITDA this year was $25.9 million, up from $20 million for the prior quarter ended June 30 and significantly up from last September of $17.8 million. Our GAAP net income for the quarter from continuing operations found of Slide 3 was $0.17 per basic share and $0.15 per diluted share. Turning now to Slide 7, the total cash capital expenditures during the quarter were $6.8 million. Our expectation for the full year remains unchanged in the range of $20 million to $25 million for CapEx. Next quarter we expect it to be in a similar range of $6 million to $7 million. Cash flow generated from operations this quarter was $13.7 million and cash in the bank at September 30 was $64.5 million, down from $71.6 million last quarter. Included in the cash payments this quarter was a $10 million payment to Niotan related to the deferred purchase price of the powder facility. Regarding the performance of NEC TOKIN, revenue in Q2 came in at $129.7 million and EBITDA for the quarter was $12.4 million under J-GAAP terms. Our share of the net income was $200,000 and their cash balance remains healthy at 109.7 oku Yen or which in today's exchange rate is approximately $102 million. I'll conclude with remarks about our forecast for the next quarter. We expect a slight pullback in revenue within the range of $204 million to $210 million. The slight decline from Q2 is driven mainly by exchange rates, some non-capacitor product shifts in calendar year and holidays. However, our expectation is to hold our adjusted consolidated gross margin in the range of 20% to 22%. As Per said in his opening remarks, we ended this quarter essentially one quarter ahead of our margin goals, so holding steady, even with less revenue, we would exit the December quarter in around the same position in margins that we told you during our last earnings call. Now I'll turn the call back over to Per to discuss a few of the markets in our business units. Per?

[Per-Olof Loof:]

Thank you, Bill. Let me start with our solid capacitor group. Revenue versus the prior quarter was up $3.2 million to $163 million and gross margin improved by 380 basis points, driven by our vertical integration efforts in the tantalum product line and an increase in sales revenue from the medical and defense segments in both tantalum and ceramics. This was another solid quarter from this business group. I am optimistic what we can do going forward. We have exciting product launches in the pipeline and polymer, insolvent capability in ceramics and of course continued development of our specialty products across the spectrum. This coupled with further cost improvements I believe will allow us to see further margin gains by this Group. Our film and electrolytic business group revenue decreased slightly to $52.3 million from $53.1 million prior quarter. The decrease is attributable to lower revenue over the summer period within Europe. Margins improved by 180 basis points versus last quarter and this improvement was a direct result of our restructuring activities. I have said for a couple of quarters now that we expect the F&E operating performance to improve throughout this fiscal year. Next quarter will not be an exception from a margin perspective. However Europe in general continues to be sluggish and our revenue expectation for this region is that it will be flat. It should normally increase, but the region is held back by the euro decline. As Bill pointed out, NEC TOKIN did really well and did turn in a profitable quarter. I am pleased to see that the cost cutting activities that we commenced several quarters ago are now starting to bite and the further relocation of manufacturing tantalum from Japan is also having a very positive effect on NEC TOKIN's P&L. NEC TOKIN is as KEMET ahead of its plan. This is really nice to see. This is NEC TOKIN's first profitable half year since 2010. Now to our regions; in EMEA, the revenue for Q2 was $69.9 million, up 3% year-over-year, but as expected down 10.4% from Q1. This decline was driven by lower shipments to our distribution channel as they continue to make adjustments to their inventory levels. During the quarter automotive and industrial demand remained relatively flat. A lot has been said about Europe from slow recovery to a somewhat worrisome geopolitical scenario. The euro decline will affect us this quarter as I said, but on the topline primarily for the F&E business, but only with a minor impact on the bottom line since we do enjoy an almost natural hedge in this segment. The solid capacitor group could be affected a bit, but with the dollar strengthening against the Mexican peso, it may provide some offset to the euro decline against the dollar in this segment. We are right now in full swing with our negotiation season and we are so far pleased with the outcome across the Board. We're particularly pleased to see an increase and the successful design drive in our F&E business. As we are coming out of a lengthy refitting maneuver, we're now totally focused on improving our revenue. In local currency, Europe will be up this quarter as it should coming off the summer, but again the euro decline will take its toll on our topline in the region. I am seeing some positive signs however in the region as a current book-to-bill in EMEA is more than 1.2. In the Asia Pacific region, component sales were up a very nice 5% quarter-over-quarter to $73.2 million and this U.S. was also up 5% versus Q1. I am noticing good moves in Asia at this point. The current quarter started a bit slow, most likely due to holidays, but has now picked up steam. We see the telecom, automotive as well as the device markets doing better and we expect a decent Q3 even though the Christmas build is somewhat over. Even though our consumer business is relatively small, we now have an increasing number of products designed in, in devices that will go on sale over Christmas. I can also see an increase in design and activity in the industrial market, including alternative energy capability. Since we now have manufacturing resources in film, analytics as well of course as in [pat] (ph) and polymer in Asia we will be able to respond much quicker as well as being significantly more competitive due to an improved cost portfolio. It's been a long time coming, but it is here now. Our current book-to-bill is 1. Q2 revenue in the Americas region finished up a very strong 9.4% over the prior quarter's $72.2 million versus $66 million. We saw military focus as well as the medical business perform well in the quarter. Also our automotive business did well in the U.S. These positive signs in our OEM channel did more than outweigh the slowdown in industry. As I said, inventory correction is on the agenda among our distribution friends, more so than the slowing U.S. Americas will experience a slight decline this quarter, but we do expect a healthy pick up again in the beginning of Q4. Currently our book-to-bill is positive, slightly above 1. To sum up the quarter, telecom, military and medical where the segment starts, the disti business declined 6% quarter-over-quarter, but this was more than compensated by the OEM and the EMS channels. EMS was up 16%. Our sale of anodes improved quarter-over-quarter and this is nice to see. It shows that the corporation between KEMET and NEC TOKIN is moving along nicely. This helps KEMET but also NEC TOKIN by lowering the cost of tantalum material as well as being able to restructure the anode production. As has been said, our efforts to restructure our business as well as investing in our vertical supply chains are now really making its way to the bottom line. Our focus remains -- margin improvement is our agenda. In closing, let me say that it's gratifying to see the hard work of our employees pay off this quarter with the results we published. Continuing global uncertainty remains a challenge. However, we're focusing on improving our margin, designing and manufacturing high quality components for our customers and providing an unparallel customer experience while of course achieving profitable financial results for our shareholders. As always, thanks to our hardworking employees that continue to make the extra effort to improve our performance and enhance our customer's experience. This concludes our prepared remarks and we will be happy to respond to any of your questions.

[Operator:]

(Operator Instructions) Your first question comes from Matt Sheerin with Stifel.

[Per-Olof Loof:]

Hello Matt.

[William Lowe Jr.:]

Good morning, Matt.

[Matt Sheerin - Stifel, Nicolaus & Co.:]

Yes thanks. Good morning, guys. A couple of questions for me. First on the really nice margin expansion you saw, you talked about the vertical integration of the tantalum supply chain. Was that -- was that the primary reason or what were the puts and takes of that margin expansion Bill?

[Per-Olof Loof:]

Well -- Bill you can comment -- I think the margin expansion, it was clearly in the vertical integration, but also product mix helped as well and also the restructuring efforts in the F&E business. Bill you may want to put…

[William Lowe Jr.:]

Yes, I think in the order that Per probably laid that out is probably how it came through the numbers Matt. Vertical integration first, product mix and then we mentioned the 180 basis point improvement in F&E as well.

[Per-Olof Loof:]

Which was all restructuring

[William Lowe Jr.:]

Which is all restructuring.

[Matt Sheerin - Stifel, Nicolaus & Co.:]

And it sounds like on the mix side it sounds like the medical, the more advanced the value added products helped you, but distribution typically is also a strong margin business for you and that was down. So as you look -- you talked about sort of flattish fundamentals this quarter, but as you get into the March quarter, when in theory distribution should start to refresh inventory again, should that help you even more on the mix side?

[Per-Olof Loof:]

It will; you're correct. Of course the more complicated products is [Niotan] (ph) or from a margin perspective of course, but so is disti. So I think these kind of outweigh each other in a way. And we can also see in our backlog that the backlog in Q4 is filling in very nicely. So I think you're correct, we're going to see, yes there is a bit of a -- we're kind of flattish to down a little bit this quarter. Some of it actually based on as the euro declined and that will affect us quite a bit actually particularly in our F&E business, but also some non-capacitor material sales that we've been doing that's going to end this quarter. So those two are affecting the top decline, but in Q4 we will see that returning.

[Matt Sheerin - Stifel, Nicolaus & Co.:]

Okay. And then on the improvements you saw in F&E it sounds like the manufacturing shift to the one big facility in Italy has gone well, may be an update there and also are you getting benefits from the stronger dollar in terms of translation back on the cost side, so that, that have helped your margins at all?

[Per-Olof Loof:]

If I take the last question first, the F&E business almost has a natural hedge, not totally, but almost. So the effects of the euro decline for the F&E business is almost zero. On the other business, the capacitor group, that will be affected of course by the euro decline for some of our European businesses. However, since the Mexican peso is behaving sort of like the euro, that gives us a bit of a hedge as well. So as the peso declines as you know we have a lot of our business in manufacturing activity in Mexico that will help us on the margin side and on the manufacturing side, we are not done completely, with moving things and enjoying the P&L effect. So what we've done -- what is finished is all the heavy lifting facilities, moving machinery and that sort of thing. So we will continue to see improvement in this segment as we go forward. And also we're designing in better products and more products in the segment. We are now off the moving things around business and really focusing in on trying to design in quality products to our customers. And Bill you may want to add some comments.

[William Lowe Jr.:]

No, I think that's fine.

[Matt Sheerin - Stifel, Nicolaus & Co.:]

Okay. That was helpful. And then just lastly concerning NEC TOKIN, I know that that transaction has been pushed out and we know that there is a window there coming next year, but in terms of it seems like they're doing well. Are there anything that you two companies can do together in terms of cross selling, for instance supplying tantalum into their supply chain, those types of things before the transaction or the relationship goes to the next level?

[Per-Olof Loof:]

As I was trying to indicate in my prepared remarks, we are providing tantalum materials to NEC TOKIN. So we're selling them our tantalum material and that of course is helping their bottom line clearly. And both aren’t just the material purchase, but also since we will be making anodes for them they can actually restructure their anode production activities as well. So that is helping them and has helped them in that aspect. Also we are cross-selling their products and we've had a lot of interest from our customers across the globe in this segment. It's very small revenue numbers yet, but we're selling small amounts of products to design in shops for these capabilities. So I think that's going to be a good thing for us as we go forward.

[Matt Sheerin - Stifel, Nicolaus & Co.:]

And is there an economic benefit to you in terms of selling the tantalum powder into NEC other than your equity share there…

[Per-Olof Loof:]

There is a little bit of benefit to that as well.

[Matt Sheerin - Stifel, Nicolaus & Co.:]

Okay. All right. Thanks a lot.

[Per-Olof Loof:]

Thanks Matt.

[William Lowe Jr.:]

Thanks Matt.

[Operator:]

Your next question comes from Marco Rodriguez with Stonegate Securities.

[Per-Olof Loof:]

Hi Marco.

[Marco Rodriguez - Stonegate Securities:]

Hi guys. Thanks for taking my questions. Just wanted to kind of talk a little bit more about the F&E restructuring, how much more of a basic point improvement do you guys kind of see that progression as we move through the remainder of this year. I know you obviously discuss the next quarter and how we be thinking about '16?

[Per-Olof Loof:]

I'll let Bill put some additional color on this as well, but we've given you a timeline as to how this will impact and there are several activities that hasn’t happened yet on the cost side. As I said to Matt earlier that much of the heavy lifting has happened, but a number of the people have yet to leave the company. So this is going to happen over the next two three quarters. And so you're going to see continued improvement quarter-over-quarter as we have said in our previous remarks. So it's pretty much running on schedule.

[Marco Rodriguez - Stonegate Securities:]

Okay. Understood and then coming back to your earlier question on the strength you guys saw on the capacitors, what was going to drive the volume update that you had there sequentially and year-over-year?

[Per-Olof Loof:]

The volume -- could you repeat your question on the capacitor side and solid capacitor group you mean.

[Marco Rodriguez - Stonegate Securities:]

Yes, yes. It looks like you saw some pretty good strength there from a revenue standpoint above what my expectations were. I am just trying to understand what was kind of driving that area there?

[Per-Olof Loof:]

The strength we saw was in the EMS and OEM segment and it was driven by telecom and by medical as well as defense. And that's where the improvements came from a revenue perspective. And as I said also our disti business was down a bit but was more than compensated by the OEM strength. So that was good to see.

[Marco Rodriguez - Stonegate Securities:]

Sure, great. And did you see revenue that got pull forward into the quarter from December?

[Per-Olof Loof:]

Revenue pull forward from December into September you mean?

[Marco Rodriguez - Stonegate Securities:]

Yes.

[Per-Olof Loof:]

May be a little bit I think we were -- to be really honest we have more product designed in and stuff that goes over that's been sold at Christmas and I think we saw more activity in some of those areas that we had expected. So may be a little bit.

[Marco Rodriguez - Stonegate Securities:]

Got it. Okay. And then kind of shifting here NEC TOKIN may be you could give us a little bit more of your thoughts here as it relate to timing on the remaining options as far as the further investments. Obviously, you’ve announced that you delayed them a little bit, but if you can just kind of provide any more color on your thoughts there?

[Per-Olof Loof:]

Bill please come in and help me on this as well, but I think we've said, we have moved out the core period some and so we now have further time to do it and as we've said before we will make this further investment as and when we see it prudent to do.

[William Lowe Jr.:]

I think that's fair, that's the key that we're prudent. So as we evaluate all the reasons why we should pull the trigger, please give us more time to do that and we think we will get adequate time to do that between now and next April and we would call [it out] (ph).

[Marco Rodriguez - Stonegate Securities:]

Got it. And just last quick question here related to cash flow, just can you give us a sense as what your expectations are for the rest of the year from cash flow from operations and in relation to that is the American deferred payments, although it's done now, do you have one more left.

[William Lowe Jr.:]

We have one more Niotan payment left. It's a bit approximately somewhere between $7.5 million and $8 million that will occur probably in late December, early January. That's probably other than our bond interest which we actually make this week I think. That's next to our largest payment and that would be our last payment with Niotan. Operationally from a cash flow perspective, I think I would hold to the same comments we said earlier in the fiscal year about how this year would look cash flow wise, which is that the pressure on cash would occur in the first couple of quarters, maybe all the way through December with the Niotan payments and then we would have -- we would start to see cash starting to build as we got into the fourth fiscal quarter and then into the first quarter of next year. So I expect to see positive cash flow from operations and I expect the cash as an absolute number to start to see it building as we are going through Q4, but still kind of flat line if you will through the December quarter.

[Marco Rodriguez - Stonegate Securities:]

Got it. Thanks a lot guys.

[Per-Olof Loof:]

You're welcome.

[Operator:]

(Operator Instructions) At this time there are no further questions.

[Per-Olof Loof:]

All right. Well, thank you very much for joining us this morning, and your interest in our company and we're looking forward to telling you a good story again in January. Thank you.

[William Lowe Jr.:]

Thank you.

[Operator:]

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.