KEMET Corporation (NYSE:KEM)
Bank of America Merrill Lynch 2012 Leveraged Finance Conference
December 04, 2012, 11:30 AM ET
Per Loof -- CEO
Bill Lowe -- EVP and CFO
Welcome everyone. Thank you again for being with us. I'm thrilled to present KEMET Corporation. With us today, we have Per Loof who's the company's CEO and Bill Lowe who is the company's CFO. So without further ado, Per and Bill have some prepared comments and after that, we'll have some time for Q&A.
Okay. Thank you very much for giving us the opportunity to talk about us. For those of you who don't know us, we've been around a long time. We were part of Union Carbide and were founded in 1919 actually. We've been listed since 1992. And we are a global manufacturer of all things capacitors pretty much and we basically price ourselves of being able to offer 95% of all different types of capacitors.
We have 22 locations in 10 countries. And we have places in Mexico and China and Indonesia, in various places in Europe and of course in the United States. We're about 10,000 people totally, 600 people in the US, 5,000 or so in Mexico and the rest divided pretty evenly between Asia and Europe. We have a global sales force that covers all of these areas.
We divide our business into three segments. Based on capability and technology the tantalum capabilities which are used in computers, are used in telecommunications, mobile devices of various sorts and a lot of it in automotive as well. And not forget the military/aerospace applications as well.
The ceramics which in our case is heavily specialty oriented but still in the same type of applications. And then finally in the film and electrolytic business which is in large regard in the industrial space of the – from an end-use perspective.
We pride ourselves of having a pretty good global reach and having production in low cost areas and we're in the process of finalizing that activity by moving more of it to either Asia and also low coast areas in Europe in places like Bulgaria and Macedonia. And then we have sales operations and service operations across the globe.
From a market overview, we thought we'll put this slide in because we are a cyclical in a cyclical environment. And as you can see from this slide, the blue one is the distribution business, the red is EMS and the green is our OEM customers. As you can over the years, our EMS and OEM business varies but slightly whereas the distribution business goes up and down and that's really why you see the cyclicality of our business being so profound or so large.
As you can see, we are now in a down-ish environment together as – probably when you talk to our colleagues in the component industry, they're in a similar situation, but of course it is a cyclical business and when this comes back, the business comes back with more.
If you look at how we [divi-up] the business from the various segments, and this is what we did in fiscal '12. Fiscal '12 is the year that ended in March this year. Industrial is about a quarter of our business. Consumer is very small, only 10% and we like it to be that way. Computers, and that's mainly laptops and mobile devices of various sorts, it's about 15%. Telecom, mainly base stations and infrastructure about – was shy of 20%. Transportation, which is basically automotive, a little shy of 20% as well. And then defense and medical about 11%.
If you look at the channels, 43% of our business is through the OEM channel, 42% through distribution and about 15% through EMS. And if you look at where we sell our products, EMEA is a large part of our business, almost 40% of our business; Asia a little less than that and America, a little more than a quarter of our business.
Who do we sell to? Well, we sell to all the who's who in electronics whether that be in transportation or whether that be in electronics or medical or other industrial channels. We also of course work with the EMS and the OEM companies like Flextronics, Jabil, Quanta and others and of course the distribution partners, the big ones for us are Arrow, Avnet and TTI.
We have been on several years of restructuring our business and ensuring that we have a footprint that's low cost, and the latest in that process has been the opening of a plant in Skopje, Macedonia. And this is interesting for us because it's in the middle of Europe, it's in a part of Europe -- Macedonia is not a member of the European Union, but they have a very well educated workforce and they have nice incentives for companies to come and make direct investments in there.
Actually, the current Prime Minister, he wrote his doctoral thesis on foreign direct investments, so he's very keen and has been pushing for companies to come and invest in his country. And we took that opportunity a couple of years ago and we opened our facility there in October of this year. And we are very pleased so far with the capabilities we have and the good workforce that are there and of course the fact that it's right in the middle of Europe.
The next piece of this restructuring is in Italy where we have currently three plants and one is actually shot as we speak, but we are building one more facility in Italy to ensure that we can actually run that place in an efficient manner as well. And that should be finished by the middle of next year and we should be able to have that fully operational in less than 12 months. And that basically completes the various types of restructuring activities that we have been engaged in.
In Europe, there are facilities in the UK. One is closed, one is closing and they are moving to either Macedonia or to Portugal where we have a facility. We have activities in Finland that's being – where we are working and so forth. And the Italian facility is where we are now taking the three facilities into one. And at the end of the day, 586 people of them will be there when it's all said and done.
But the basic message here is that by the end of next year, we will have completed all of our restructuring efforts for basically all of our businesses. And you're going to see that when you look at our use of capital that the capital spend that we had to lay out to be able to do this will basically be completed.
The other big to do that we've been involved with has been ensuring that we – and dealing with our supply chain. And we took a first step about a year ago when we did acquire a facility in Tennessee to help us make our foil for us and we're very pleased with that. It's a year and a half now when we made that acquisition and it's now fully integrated within KEMET and we are now getting most of our aluminum foil from this facility in Tennessee.
And that has helped our cost structure. It also helped us on the engineering side as well. This facility actually also sells to some other customers always as well (inaudible), but basically the reason we acquired this facility is to ensure that we can actually have the supply that we need of aluminum foil.
We have also looked at the sourcing of tantalum, and I know there's been a lot of conversations in the media about sourcing of tantalum and where it comes from and so forth. And we have been in the process of trying to figure out a way to source tantalum from the DRC. And it's been very important of course that we are in compliance with the legislation being in the current and what's coming down the pike, but it's even more important that we're in compliance with the needs of our customers. And as you can imagine, our customers are even stricter in dealing with this than with legislation actually calls for. But we are committed to ensuring that we abide by all the rules and we are doing that of course. And we are ensuring that the OECD and so forth are there to help us ensure that we can do that.
We also in that vein acquired a powdered manufacturing facility in Nevada, so we now make our own powder. And this was previously a supplier to us and we bought that for $75 million and then $10 million of royalty payments. And we paid $30 million at closing and then we're paying $45 million. I think there's about $40 million left to that to pay over a 30-month period. And it's located in Carson City, Nevada. That closed in March of last fiscal year.
Basically how this works is that we -- the mine that we don't own or several mines, it's not just one supplier, they provide them the ore that we use and then that ore is converted to something called a KTaF which is a salt-looking like material that's being reduced from the ore that we take out of the mines. And then we convert that KTaF to powder in our Niotan facility. And then finally we make the wire or the capacitors that actually we then sell to customers.
Now we're in a position to ensure that we have control over all of these four steps in the process. And of course the reason we're doing this is to ensure that we have security of supply but also making sure that we can stay competitive going forward. There is some interesting R&D potential here as well in terms of working with the powder as well, so it actually gives us quite a nice edge in terms of being very competitive in this space.
As a result that this slide sort of points to, we are now in a position to control that entire space and that entire supply chain for us. And I think we're the only one that is completely vertically integrated overall of our competitors and stabilizes how we conduct business going forward. And of course it does something to the bottom line as well. And in next fiscal year, we estimate that this actually brings an additional $40 million to the bottom line of our tantalum business.
We talked a little bit about Congo and of course as we are doing this, we are committed to being socially responsible of course. And what we are doing is we are helping to fund new schools. And you can see a picture of the old – well, some of the new ones there and some of the old ones in terms of the schools and the hospital that we are building and we are putting 1.5 million into this little village called Kisengo in the Katanga Province in Southeastern Congo.
You have heard the discussions what's going on today in particular in Goma in Northeastern Congo in the North Kivu province and that is actually over 500 kilometers, almost 500 miles from where we are. So it's a big distance from where these activities are going on and we have seen no impact on our situation at this point.
And finally, the last bit of the puzzle here is our intention to acquire NEC TOKIN. And we announced that in March of this year that we in this process to gain a 34% interest in this company with a 51% voting interest. NEC TOKIN is a wholly-owned subsidiary of NEC Corporation and they manufacture tantalum capacitors plus also a number of other devices; electromagnetic materials, electromechanical devices, piezoelectric components and so forth.
And their revenues last fiscal year ended March 31, 2011 was JPY64 billion or $755 million. And we are, as we speak, in the final month of approvals from the Chinese regulatory authority Ministry of Commerce and we expect that to close and to get approvals in this month and then close that activity in the beginning of February.
So, I will hand it over to Bill to give you a little bit of an overview of how this transaction actually happens.
Thank you, Per. The first step we're waiting for final regulatory approval. Now we assume at this point that we will close this transaction in the first calendar quarter of next year, possibly the month of February will be the likely month it would occur in. So in the first step, the investment is a $50 million investment for a 34% equity position in the company with a 51% of voting control.
And if you fast-forward then to a period in August of 2014, we actually can do one of three things because it's a call option. So at that date as we evaluate the situation both of global economy and how things are going, we could choose to do nothing and wait for the next period or we could make an investment of $50 million additional and raise our equity interest to 49% while maintaining our volume interest at 51%.
And I would like to note that the -- as you make these investments in NEC TOKIN, the way the cash flow works is basically the cash does go in NEC TOKIN itself. NEC TOKIN will then pay off debt that it has between itself and its parent company NEC.
And then the other option we could do at that same date on August 2014, we could choose based upon the way the third step works which is a computation of six times trailing 12 months EBITDA, determined it takes the company to 100% ownership in the 2014 timeframe. If we choose to do step 2 of course by just doing the 49%, we would then go to our next timeframe to go to 100% in some future date. So really the first critical date for you to focus on is May of 2014 -- August 2014.
The reason I mentioned May, the bonds – we get asked questions about how we're going to finance the transaction. What we're saying at this point is we're maintaining flexibility on that. For those of you here at the Leverage Conference today who are probably involved in our bond issue, you know that our bonds have a non-call period. That non-call period does end in May of 2014. So we have flexibility to step back and we can see what should this transaction look like on a balance sheet once we have in fact taken the company to 100%.
Just a quick overview of NEC TOKIN's revenues broken down as Per already talked to you about the space of a plan. There's -- about 40% of it was capacitors, tantalum capacitors that NEC TOKIN has. I think you can see the other areas breakdown between the electric mechanical devices around 11% and EMC is over 30%.
They do have manufacturing locations in a variety of places. They have a few actually in Japan itself. They also are in China, Vietnam, the Philippines and Thailand.
Looking briefly then at financial metrics on our balance sheet, KEMET has worked over the last several years to improve and has a strong balance sheet. We ended the last quarter in September with $160 million of cash in our balance sheet. Our working capital as far as our DSO days on cash receivable and payables are matched up at 42 and 41 days. We've done a good job of maintaining that.
And from a debt perspective, basically all of our debt is long-term debt, the bonds at 10.5% coupon which are due in 2018 and do not carry a maintenance column as you're very well aware. The company also has a revolver. It's $50 million currently undrawn at this time.
And then to conclude before we go to questions as just a reminder that our goals are to have consolidated gross margins of the company of 25% as a company as well as an operating margin or EBIT margin of 10%.
And with that, I think we have time, Ana, to go to questions.
That's great. Thanks very much. I'm going to start out with maybe the most obvious question which is the cycle and where you believe you are in the cycle which is largely macro driven. So just remind the audience on your last earnings call, you did guide to a sequential decline in revenue and gross margin driven by demand weakness but did state that you believed it was the bottom and that you would see improvements in the first quarter of the calendar 2013.
You did show us a slide with the kind of historical trends and what you're seeing now in the distribution channel. It seems like there was weakness for you up until now from the demand side has been on the distribution channel, so it'd be interesting to hear what makes you confident about the uptick potential in the first quarter of calendar '13? And also just to provide us some sort of – the kind of visibility you have of your distribution channel?
Well, let me try and answer the last question first. We have very good visibility as to what the status is of our distribution channel. We can see the inventory of all of our distribution partners. We of course are having intense conversations with them almost on a daily basis as to what they see, how things are going. And it's now going the same in all the regions. It's clear to most of us that the European scene is a little different from the others and it's not doing as well for obvious reasons.
We feel pretty good about the US. We're seeing some strengthening in the US. We also feel reasonably good about Asia, even though it's a bit of a varied picture, I think the Chinese mainland is a decent picture. I think Taiwan is a little bit more complicated at this point and Europe of course I just touched on. So what we are seeing, we're not changing our tone from what we said at the earnings call in terms of what's going to happen this quarter.
We think we're going to be in sort of a stable to up environment. I think most of our distribution partners are talking on just data point, are talking next year up 3%, 4% sort of is what they're saying. So I think we kind of – but you can look at the macro data just as much as well as we can, but I think there is some hope that we're sort of seeing the bottom of it from a volume perspective at this point.
To touch more on your three different segments, I think you have a little bit of a different performance trajectory in the three segments. I believe F&E has really done the weakest and would like some insight on why that is? Ceramic where you have I think the highest concentration of specialty products seems to be more stable which is intuitive. And then Tantalum actually seems to also be performing relatively well given the environment, so just -- in particular some more insights on what's driving the weakness in F&E?
Yeah. The weakness in F&E is in the fixed costs infrastructure we have with, with that organization and clearly the demand picture in Europe hasn't helped. It's also a very European-centric business because it is really aligned with the industrial markets and those are huge there. But what the to do there has been to restructure the business, moving out of the more expensive areas and moving into more cost effective areas. And notably, Bulgaria, Macedonia, Indonesia, China and so forth. And we are at the beginning of the end of that cycle. As I said, the Macedonia facility is completed and we are in the process of moving equipment into Macedonia and getting those qualified. It takes a little while because the customers will need to have the capabilities qualified over some period.
The final puzzle to be laid down here is the Pontecchio facility in Italy where we can actually close out three facilities in Italy and move to one. And then basically we will have a specialty-oriented engineering focused facility in northern Italy sort of similar to what we have in Greenville here in the United States. So at that point we should be looking at a margin situation that looks pretty much like the tantalum business. It won't be as rich as ceramics, but it will be marching towards what we can do in tantalum.
So at that time, 12 months from now, we should be looking at a much, much healthier business. And it's taken a long time but of course we're also in the process of making product as we are moving things around and of course the demand picture hasn't helped or you can say it helped a bit because it's easier to move things when the volume requirements are not there. But in 12 months from now, we should be looking at a much, much, much better picture. And you would see the improvements as the year progresses.
Are there any questions from the audience?
Just two quick questions on the revenue profile of the business and the first is, can you talk about unit level pricing trends across your business segments? And the second question is, as you segment your revenue base, are there certain parts of your revenue that you deemed to be more recurring in nature, whether there's a replacement cycle involved or long-term contracts or something else that you think it makes it more recurring in nature?
Okay. In terms of – I didn't hear you quite clearly, but the first part of your question was really on the pricing side of the business, what's happening to pricing, right?
On the unit side?
On the unit side, yeah, that's right. And what I think we are seeing is there is some flexibility of volatility in the pricing side but I think we have seen -- in the ceramic business, we've seen some pretty decent price stability and also in the tantalum side. In the film side, we may have been a little bit aggressive and we may have to readjust our prices a little bit and I think that's actually going to help our performance. But for the most part during this down cycle, the pricing pressures have been less than we have seen in previous cycles. And I don't know if that's because the industry's a bit more consolidated than it was the last time around and we may be a bit more holding our fire power a little bit more than we did in the past. So I think that's been pretty decent.
In terms of -- Bill, you want to comment on this as well or…?
No, you seem to be doing good.
On your second question in terms of where these things are going and which markets are doing well, I think we – I did comment on the European scene and there are two things there. First of all, of course, the weakness of southern Europe is affecting the entire region. We don't sell a lot into places like Spain and we sell almost nothing into Greece. Our Italian business is large but not huge, but the investments in green technology which we were a big part of has slowed down some, particularly since incentives from governments have decreased. I think the appetite for capital expenditures is less now that it used to be and therefore that's affecting of course the machinery and so forth where we have a large investment. So I think the industrial markets in Europe have been relatively weak and that has affected us.
On the other hand automotive has been pretty strong and continues to show strength not just in the US but also in Europe and we don't do much in Japan. We do a little bit in China, but particularly Europe and the US in automotive has been pretty strong. In telecommunications, we do not have a huge handset business but in the infrastructure side we have seen it weakening but now coming back with some strength. So I think the telecommunications side is showing some strength. In the computer side, the computer business, we have seen laptops been weakened and some of that maybe due to the economy but some of it maybe structural.
The fact that we're all using iPads and we used to buy laptops every two years, now we're buying every three years maybe. So I think the Taiwanese business, which is largely where we have our laptop business, has been weakened some. So that sort of – and on the regional basis, as I said, I think the US as we see interesting opportunities in the US and we see the distribution business in the US being very healthy. And that's good because that goes into the new Google, on the new Apple that are being built in garages around the country. So there is some (inaudible) help and strength to that part.
Is there another question at the back?
I think I misunderstood but you said in your three step possible acquisition of NEC TOKIN, the first step you have enough cash. The next step you have enough cash, the 50 million item and the big step is in 2018 which is when your debt comes due?
I think where your question is do we have enough cash for the second step and what we're going to do for the third step?
I think as I mentioned in my formal remarks is that we haven't said exactly what that will look like, but we do have flexibility after May of 2014 with the existing debt that we have on our books. So we'll be able to step back and look, do we keep the bonds in place, do we take the bonds out and do something else holistic, do we involve for instance some Japanese partners in this -- Japanese acquisition, it may make sense to do that. So we're just going to say at this point, we're remaining flexible and I think that's the right answer at this point is to say that we'll look at all the options and we'll make sure that the balance sheet has the opportunity to be as strong as it can and look as good as it can when we put these two companies together.
One more thing. I don't have your balance sheet in front of my, but your sales are running 900 million or, do you have inventory receivables plant anything where you could put on some bank debt besides your revolver…?
Yeah, we do have a revolver that we secure with our receivables around the globe and it's a $50 million revolver that's in place today that would – now again, when we merged together – bringing NEC TOKIN ever since, we of course have a greater capacity there, but today we have a $50 million revolver that we're using receivables in.
Again, I don't know your level of inventory receivables but at 900 million of revenues all you can get is a $50 million revolver?
Well, over the course of – it really depends from banking process of where that inventory is located. And in some countries, it's really not easy for them to secure.
So if TOKIN runs 755 on a revenue base, are their gross margins at your 25% benchmark level?
No, they're not.
So what would they roughly be?
So we said their EBITDA…
What we have disclosed is their sale…
I'm trying to figure out what we said and what we didn't say?
We disclosed that the revenue was 700 million and their EBITDA was around 70 million in that same period. We have not disclosed all of their operating margins separately, their subsidiary of NEC and they haven't disclosed those separately as well, so either have we.
Those numbers were for current LTM or what…?
That was the March 11 fiscal period that we disclosed when we announced the transaction in March of this year.
We're out of time…
Yes, I think we're out of time. So Per and Bill, thank you so much for being with us.
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