KEMET Corporation F1Q10 (Qtr End 06/30/09) Earnings Call Transcript

Jul.30.09 | About: Kemet Corporation (KEM)

KEMET Corporation (NYSE:KEM)

F1Q10 (Qtr End 06/30/09) Earnings Call Transcript

July 30, 2009 9:00 am ET

Executives

Dean Dimke - Director of Corporate and Investor Communications

Per Loof - CEO

Bill Lowe - EVP and CFO

Analysts

Darrius Norrid [ph]

Omar Semulot [ph]

Al Shan [ph]

Operator

Good morning. My name is Therese and I will be your conference operator today. At this time, I would like to welcome everyone to the KEMET Corporation first quarter conference call. (Operator instructions) I would now like to turn the call over to Mr Dean Dimke, Director of Corporate and Investor Communications. You may begin, Mr Dimke

Dean Dimke

Thank you Therese. This is Dean Dimke. Good morning and welcome to KEMET's conference call to discuss our first quarter financial results ending June 31 for fiscal year 2010. On the call with me today is Per Loof, our Chief Executive Officer and Bill Lowe, our Executive Vice President and Chief Financial Officer.

As a reminder to you, a presentation is available on our Web site that should help you follow along with the financial portion of our presentation this morning. Please go to kemet.com and click on the Investor Relations tab in the top right portion of our front page. Once there, please click on the first quarter conference call link. That will bring up a few slides that we will call to your attention when we are covering those topics.

Before we begin, I 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, but involve a number of risks, uncertainties, and assumptions. Please refer to our 10-K and 10-Qs for additional information on risks and uncertainties.

And now, I will turn the call over to Per.

Per Loof

Thank you Dean and good morning everyone. Our first quarter of fiscal 2010 ending on June 30, 2009 was a positive quarter for our company. Three factors primarily contributed to our positive progress. Firstly, a strengthened balance sheet through traditional debt reduction and a successful tender offer for 54% of our convertible notes. Secondly, improving product demand and also product mix, and thirdly a continued improvement in our cost structure, which has led to a significantly lower breakeven point across all our businesses. Today our breakeven point has improved slightly from last quarter.

Let me first give you the highlights of the quarter and then review each of these three factors that I have just mentioned. Revenue for the quarter was up 10% over fourth quarter fiscal ’09 at approximately $150 million. Consolidated gross margin was up to 14%. The Tantalum business gross margin increased to 19.3% and Ceramics posted a gross margin of 24%, which is their best performance in quite some time. For example, in the first quarter of last fiscal year which is June 2008 the Tantalum gross margin was 11.4% on $36.5 million more in revenue and Ceramics gross margin was 10.7% on a pro forma adjusted basis with $20 million more in revenue.

Our EBITDA this quarter was $9.9 million so, as I stated, we are very pleased with our progress and performance this quarter. That said these positive results were made possible by the efforts over the last 12 months not work isolated to just this past quarter and that is what gives me and our company great confidence going forward.

Firstly, our ongoing focus on strengthening our balance sheet through the reduction of both short term and long-term debt and these efforts were capped off with our successful tender offer with respect to our outstanding $175 million in aggregate principal amount of 2.25% convertible senior notes which are due in 2026. The tender offer enables us to retire 54% of the convertible notes, which equates to $93.9 million. Working with our partners Platinum Equity, we bought back the convertible notes at a purchase price of $400 per $1000 principal amount of notes plus accrued and unpaid interest up to but not including the date of purchase. In addition and as previously announced, our banking partner UniCredit have amended their covenants significantly reducing the risk of default by not being in compliance.

We issued warrants for Platinum to purchase 49.9% of our stock at $0.50 a share as a part of this transaction. Full details of the terms and conditions of this tender offer are included in KEMET’s offer to purchase and schedule TOI [ph] which have been filed with the Securities and Exchange Commission. With the completion of the tender offer, the previously announced restructuring of our short-term debt to our banking partner UniCredit and the previously announced paying off of our senior notes through the sale of some limited business assets, we have seen our total debt reduce by about $150 million which includes about $42 million in debt discounts and this has happened over the last four quarters. We are extremely pleased to have accomplished this during a time of credit tightening and dare I say some economic turmoil.

The second factor has been an increase in product demand as well as the mix of products we are selling with the focus on more specialty products, which of course have higher margins. Approximately a year ago we announced a change in our strategy, which moved us more in the direction of building upon our strength in the specialty products arena. The results we saw an increased margins in both Ceramics and Tantalum businesses is a direct correlation for this new business model.

Thirdly, like many if not most businesses today, we have been aggressively reducing our cost structure across all business groups, sales regions and corporates. In the past few conference calls, I have highlighted the many cost saving initiatives that we have undergone. As previously announced, these reductions are tripped over $60 million of annual costs out of our operations. These savings have served to significantly reduce our breakeven threshold.

I am now going to turn over the call to Bill Lowe for a review of our financial results. Bill?

Bill Lowe

Thanks Per and good morning everyone. I will begin our review on slide 3 if you are following along on the Web site, which is income statement highlights.

Our sales increased to $150.2 million from $136 million, which is an increase of 10.4% over our March quarter. Gross margin percent increased to 13.6% from a negative 1% versus the prior quarter and March. Gross margins increased significantly within our Tantalum and Ceramics group while Film & Electrolytic continues to struggle. As Per will discuss later, Europe and the segments in which F&E serves is lagging behind from a recovery standpoint. The combination of our R&D and SG&A were 14.6% lower when compared to the prior quarter. Our GAAP net income of $25.1 million includes a gain on the extinguishment of debt and our non-GAAP net income was a loss of $13.6 million versus a loss of $20.6 million in the prior quarter. The loss this quarter does include a non-cash exchange loss of $4.2 million compared to a $6.7 million gain in the prior quarter.

Turning now to slide 4, which is a reconciliation of GAAP to non-GAAP, I would like to provide some detail on the category of other income and expense on the income statement specifically on the press release. First as a result of the successful tender of 54% of our outstanding convertible notes, we reported a gain on the extinguishment of debt of $38.9 million. The major offset to this gain was a $4.2 million exchange loss. In addition we were required to adopt FSP APB 14-1 this quarter. Therefore there is an additional loan amortization cost of $2.3 million due to the adoption of APB 14-1. Our prior periods have been restated to conform to this presentation. On this particular slide we have broken out these components into separate line items. The income statement in the press release and what we will file in our 10-Q we will have it combined into one line. We will provide a footnote in our 10-Q to highlight this amount. Further going forward this amount will increase because we have loan cost amortization related to the new Platinum loans.

The Platinum loan amortization ranges from $1.5 million to $1.8 million per quarter to the balance of fiscal 2010 and will total approximately $5 million for this fiscal year. Additionally the accounting treatment for the warrants that we issued to Platinum to purchase up to 80.5 million shares of our common stock requires us to treat the warrants as an embedded derivative under FAS 133 and will require us to mark to market the warrant value quarterly and record any change through our other income and expense. We have also recorded a warrant liability on the balance sheet. When I review the balance sheet I will address this a little bit further.

So let us turn to the balance sheet now on slide 8. Highlighting a couple of other items first, we will start with a comparison of unrestricted cash balance of June 30 to March 31 which reflects a decline of $5 million but I would like to remind you that on April 1 we made a payment to UniCredit of approximately $10 million in principal and interest. Their far more competitive view would indicate that unrestricted cash actually increased from $29 million to $34 million during the quarter. Cash generated from operations on the cash flow statement was $4 million. We maintained net working capital relatively flat from the last quarter and our receivables DSO improved by decreasing 7 days from 81 to 74 even as our revenue increased 10%. We expect to continue to see improvement in our receivables DSO and we are focused on controlling our inventory as the economy recovers. In fact we hope to actually increase our inventory turns as we continue through the fiscal year.

Earlier I mentioned that I would address the adoption of APB 14-1 when I discuss the balance sheet. Continuing on to slide 8, we have indicated the make up of our total long-term debt. As a result of adopting APB 14-1 the convertible notes under this section were re-classified on a retrospective basis $26.4 million and at the June 30 date approximately $11.1 million remained. In addition, the resulting fair value process of the Platinum warrants required us to report a debt discount of $31.4 million. This total has been amortized or accreted to the interest expense. Each quarter this discount will decrease and effect will be that over time the discount will strengthen and the debt will increase to the amount due at maturity. So if you combine the two amounts that I have referenced to you of $11.1 million for the convertible notes and the amount for the Platinum discount, you can see the $42 million on the sheet reducing our total debt balance to $242 million. Short-term debt has also been reduced as a result of the change in the payment schedule at UniCredit when we have also recorded a warrant liability of $31.4 million in other long-term liability section of the balance sheet.

Capital expenditures this quarter were $1.4 million, we expect the second quarter capital expenditures to be in the range of $2 million to $3 million. Our adjusted gross EBITDA was $9.9 million compared to a negative $14.2 million last quarter. A reconciliation of EBITDA is on slide 6, and our first test of covenant under the new loan agreement is as of September 30, however we have already reached 90% of the required amount in this first quarter. Our net EBITDA after cash restructuring charges, which are a subtraction for covenant purposes, was $8 million. This new EBITDA calculation for our covenants was started with pretax income for the loan agreements, you will find that with only minor exceptions is essentially a combination of operating income and adding depreciation and amortization expense which result in the same value and is more in line with the way many of you calculate it.

At this point I will turn the call back over to Per and he will update you on the individual business groups and our markets. Per?

Per Loof

Thank you Bill. Starting with the Film & Electrolytic business group, we believe the markets now have bottomed down in the first quarter with revenues slightly below the previous quarter and we have begun to see a pick up in demand for these businesses in Asia. We are anticipating a pick up in EMEA and the Americas regions after the summer holidays. We are continuing to utilize where possible temporary headcount reductions to flex our costs down with a drop in demand. Currently the F&E group is operating at 44% capacity. The book to bill however at the end of the quarter was 108 and as of yesterday the book to bill operating for this business group was at 117.

Revenue dropped $1 million from the previous quarter to $45 million which is 30% of our total revenue. The customized design in activity is running out of pace of 35% greater than last year at this time and we are poised to respond to market recovery. We have secured approval of a new project HEV applications for (inaudible) and continental for example and a portable device charging station for power met that are currently running and our line for those products are at full capacity. Additional restructuring is planned for the future to improve the flexibility and overall cost of the manufacturing within this business without adding brick and mortar to kind of [ph] overall manufacturing footprint.

Turning to our Tantalum business, we saw an improvement in volumes over our Q4 fiscal ’09 and it appears that Q4 represented the bottom of the economic downturn for this business. Although we have entered into the traditional slow summer months in Europe, we are now starting to see the lower inventories in our distributor channels in all regions necessitating cautious replenishment. The automotive sector is down of course however we are seeing some turnaround in the American industrial sector and continued strength in Asia’s wireless and notebook sectors. This has been aided by the implementation of cost strategies initiated in the last two quarters. Sales revenue was $72.6 million for the Tantalum group up about 23% from the fourth quarter representing 48% of KEMET’s total revenue. Capacity utilization is at approximately 70% in total with the polymer demand continuing to be very strong; we now are bringing back staff in our Chinese and Mexican facility. The book to bill on June 30 was 110 and continues to show improvement.

In our Ceramic business, (inaudible) from the low point in the March quarter improving 7.8% to $32.9 million in our first quarter. Margins improved significantly as a result of the continued focus on product mix and manufacturing cost initiatives. The Ceramic business crossed the breakeven point in Q1 generating $2.4 million in operating income in the quarter. Inventories were reduced by 10.4% in Q1 and continued to be managed effectively and constant with our working capital initiatives across the Corporation. The book to bill for Q1 improved to 1.2 on the strength of increased bookings across all regions. Capital utilization remained at 50% in Q1 and is expected to increase to support higher shipments as we move into Q2.

Let us now look at sales on a regional basis starting with Asia Pacific. Orders received started to increase just after the Lunar New Year holiday. As at the end of Q4 last year of fiscal ’09, the book to bill rate closed at 1.2 and a positive trend that has been improving during this quarter and is now at 125. Asia order rate and shipment rate is bottom up from bottomed up [ph] in February, March ’09. The order grew by 22% over the previous quarter and sales grew by 40%. Book to bill closed as I said 1.2 for Q1 driven by China 3G telecom activities, wireless card and mobile phone market segments, the China green energy projects like lighting, wind power, hybrid buzz etc. and also the Taiwanese notebook and netbook bill client which is up quarter over quarter.

KEMET’s market share continues to grow especially in MNO2 Tantalum, Polymer Tantalum and screw-type Electrolytic capacitors. Customers have been placing more orders owing to positive local market segments. The recovery of notebook market and the upsurge of smartphone, notebook, 3G wireless products and (inaudible) project is of course leading the pack here. Orders from the EMS segment have been improving with urgent orders and delivery-pooling request for MNO2s and HICV MLCCs. Inventory levels for distributors is back to normal due to the inventory depletion.

Looking at sales in our Americas region, Q1 revenue dropped slightly from Q4 last year. Revenue was down about 2.5% however we are confident that Q1 was the bottom for the Americas market and now the recovery begins. Americas ended Q1 with a book to bill of 115; current book to bill is 120. Backlog grew nicely during Q1 and distribution POS performance even though it declined quarter over quarter the inventory declined even more causing turns to improve to 3.9. Customers are now more optimistic about future demands and we are seeing spot shortages. Customers have some concerns about the industry and our ability to quickly ramp up production since the inventory is very low throughout the supply chain. Meanwhile business continues to be very steady and the automotive business of course continues to be weak but the bottom is forming and the industrial business sector is starting to recover. The MS [ph] business is picking up speed as we approach the Christmas build and we expect our revenue to grow 3% to 5% in Q2 versus Q1.

Revenue in Europe for Q1 fiscal ’10 decreased by 4% compared to the previous quarter and the market continues to be very tough with most customers having a relatively short view of the market. Pressures on inventories remained one of the key issues. This is particularly true within the distribution segment where our POS business continues to be relatively flat. On a positive note for the EMEA region for Q1, book to bill was at 106 at the end of the month, end of June and also the month of June was particularly strong in all sectors. In June, we started to see these improvements even in our automotive business and some renewed confidence in inventory investment from some sectors of our distribution network. Q2 looks like it will continue to be a challenge for EMEA and the jury is still out on how the traditional summer vacations will affect overall business levels with the month of August expected to have the biggest impact. That said the quarter book to bill rate is currently about 130.

Reviewing the activities in the various market segments, we saw revenues increase across every segment in the quarter; Telecom came in at 22% of total sales about the same as last quarter. We saw a nice pick up in the computer segment and now at 16% of total business. The consumer segment remained at 10 consistent with where it has been for the past few quarters. The mil and medical combined businesses remained strong at 11% of our total sales the same as last quarter and up a few percentage points from a few quarters ago. Transportation remained at 16%, which may be an indication that we have seen the bottom while industrial lighting dropped a few points to 24% of our total sales based in large part on the state of the European economy.

In conclusion our initiatives over these past 12 months to reduce our cost structure, strengthen our balance sheet and change our business model to focus more on higher margin specialty products are all bearing fruit for our company today. More work remains, (inaudible) are always possible, we are feeling good about our efforts and the results we are delivering, and as I stated in our earnings release this morning, we believe this quarter marks a turning point in our company’s recovery. As always, I want to thank all of our employees for their hard work during this time period through all of these difficulties I and them have remained deeply heartened by our customer constituency. I want to convey a special thanks to our customers as we commence our nineteenth year of operation in the end as we all know nothing much happens without an order.

This concludes our prepared comments and we will now be happy to respond to your questions. Thank you.

Question-and-Answer Session

Operator

Your first question comes from Darrius Norrid [ph].

Darrius Norrid

Good morning gentlemen.

Per Loof

Good morning.

Darrius Norrid

I congratulate you guys on the much needed improvement you guys have done in the last few quarters.

Per Loof

Thank you.

Bill Lowe

Thank you.

Darrius Norrid

At the beginning of the call Per you said that you have great confidence moving forward in the business across most of your business lines, now that the tender is over and apparently all the capital improvement efforts are mostly done, is management now allowed to purchase shares of the company?

Per Loof

We will be allowed to do that I think in a week or so when the window opens.

Bill Lowe

Yes, when the attorneys review everything hopefully within the next week or so we will hear what the situation is.

Darrius Norrid

Okay. And my last question it really goes in with some of the analysts who are following your company, I was wondering if you guys have thought about asking some of them to drop coverage since their $0.20 price target is absolutely ridiculous.

Per Loof

Bill, you want to comment on that?

Bill Lowe

I think you will find that they are dropping coverage as we speak based on their criteria so I think you will stop seeing the write-ups of some of those you have seen in the past although I would say that generally though the company will look to find the appropriate coverage as we go forward for the company because I do believe we do need appropriate coverage and we will look to do that over the coming months.

Darrius Norrid

So you plan on expanding I guess as you “road show” going out on the road and attracting some more --

Bill Lowe

We will be looking at the possibility of doing it. I think it is important that the company has coverage and appropriate coverage I guess I should say and we will be looking to properly doing that yes.

Darrius Norrid

Wonderful, well thank you very much and again guys congratulations on your results.

Operator

Thank you. Your next question comes from Omar Semulot [ph].

Per Loof

Good morning Omar.

Omar Semulot

Great guys, how are you?

Per Loof

Yes Omar. How are you doing?

Omar Semulot

Good, good, congratulations guys it is a good job well done. First of all a few housekeeping as always, the cash restructuring charge for this quarter and maybe what you expect for next quarter.

Per Loof

Lowe, you want to get on talking about that?

Bill Lowe

Sure. Omar, would you repeat that, it was a little bit garbled for me so if you could repeat the question?

Omar Semulot

Yes the cash restructuring charge for this quarter and maybe what you expect for next quarter.

Bill Lowe

Cash restructuring charge this quarter the flow-through from prior actions was $1.9 million, now I addressed that a little bit on my formal comments when I talked about our gross EBITDA per covenant was $9.9 million but the net was $8 million [ph] so the difference is cash restructuring. Over the course of the next few quarters, I believe it will be somewhere around $1 million next quarter and about $600,000 to $700,000 in the following quarter after that.

Omar Semulot

Okay perfect. Do you have a run rate for what the interest expense would be for next quarter?

Bill Lowe

Yes we have that. We are just going to – second quarter interest expense which includes this new debt, this discount amortization that I referred to, we will see about $7.2 million next quarter. Of that $7.2 million approximately $4 million is the normal accrual for cash interest expense associated with our debt and balance $3.2 million would be the amortization of the debt discount which are perfectly non-cash items, non-cash in the current period.

Omar Semulot

I noticed that you guys did not give much guidance for next quarter; you did not also mention what the book to bill for the Tantalum business was for this quarter, could you maybe expand a little bit on that?

Bill Lowe

Yes, the year to date the book to bill for Tantalum right now is slightly above 120. We clearly believe that we are going to see some improvement in the second quarter and we have seen that in the July timeframe. However, as you know, we have a large share of our business in Europe, you know there are shutdowns and fab shuts during August normally and it is a little hard to ascertain at this point how that will affect our business in today’s environment. So therefore we are a little cautious with looking at our book to bill and just projecting that out across the quarter but what can I say is clearly Asia is going very strong at the moment in a number of segments and the computer demand seems to be coming up as well as across the Telecom markets. We do believe that the Americas have reached a bottom in the last quarter and there are indications that the same is true in Europe. However we do want to caution that with the August question mark, if I may use that description, but overall we are going to see some improvement on the revenue line for the quarter and it is just a little hard to ascertain the size of that at this point.

Omar Semulot

Would you say mid-single digits or you would not even venture into that?

Bill Lowe

I would say mid – if I were to give a number that is kind of where I would kind of place it.

Omar Semulot

Okay. AVX your competitor, they mentioned some problems with personnel manning, if you will, the existing facilities, in other words, there is plenty of capacity but the difficulty of finding people I guess or bringing them back was a problem. Are you experiencing these same problems?

Per Loof

No we are bringing back people in Mexico, we are bringing back people in China, and we have not experienced any issues with that. So that is something that fortunately we have not seen.

Omar Semulot

Okay. This will be my last questions then I will get back in queue, can you comment on your – you said that your breakeven would be lower now, can you put a number to that or –

Bill Lowe

I said last quarter that we were heading towards 175.

Omar Semulot

Right.

Bill Lowe

And I think you can share the $2 million of that at this point.

Omar Semulot

Okay. Thank you and I will get back in queue.

Per Loof

Thanks Omar.

Operator

Thank you. Your next question comes from Al Shan [ph].

Al Shan

Hi gentlemen, good morning. First of all thanks for all your good and hard work over the last year.

Per Loof

Thanks Al.

Al Shan

Couple of questions, number one, the balance sheet restructuring that we have done, is this largely complete what you had in mind in doing in that area, did it change, etc?

Per Loof

If you take our three businesses, we have spent the last number of years to restructure or re-orient and readdress issues in the Tantalum and the Ceramics business, and if you look at what we have been able to do in these businesses, we have actually come to a point now where our ability to flex the business with volume, it works, and the guys running Tantalum and Ceramics have been able to flex with volume which of course is very important in a cyclical business like ours. What remains to be done is to continue the second phase of our restructuring efforts in the Film & Electrolytic business and we have done phase I and we are about to start phase II of that process.

Al Shan

Okay but phase II is going to be more of an operational restructuring rather than a balance sheet restructuring and a financial restructuring.

Per Loof

It is going to be – exactly, it is not going to be stuck out but it is going to be moving things to places where our ability to flex with volume basically gives that business the same chance to do that as the other two.

Al Shan

Okay. Number two, the debt exchange we did with Platinum equity, did they get warrants on 80 million shares of stock or 40 million shares?

Bill Lowe

80 million, which would represent 29.9% effectively.

Al Shan

Okay so if they were to exercise it to $0.50 level, we would have a doubling in the number of shares outstanding.

Bill Lowe

Correct, that is correct, just about.

Per Loof

(inaudible).

Al Shan

Could you spend a few minutes and talk about the benefits, obviously there is a disadvantage to this in that we have lot more shares outstanding and then obviously there are some advantages to the debt restructuring, could you spend a few minutes and review that please?

Per Loof

Yes, I will do that and I will let Bill chime in as well. Firstly, to be able to retire a large share of our debt is of course an important part of strengthening of our balance sheet and of course that continues. Also we have now the ability to have working capital for a company as well as money for restructuring activities. And thirdly as a result of this we are able to improve our covenant structure with current lenders and covenants the whole principal payment schedule starts off have also been approved. Fourthly and finally, we are bringing in additional expertise in the various areas to our company, which I think will be very helpful. So over and all I realize the fact that we are going to double or almost double the number of shares outstanding if they actually do the warrant exchange but I think the benefits that this has far outweighs that particularly in an environment where credit as I am sure you know continues to be very tight and of course the last 12 months have been extraordinarily tight.

Al Shan

Right. Now do we see Platinum equity as a true real partner or are they a potential predator for the company?

Per Loof

We do not see them as a predator, we see them as a partner in our business and as you can imagine we have camped together for quite some time to get to this point. I feel we know these people very well. We are very much with them as individuals as well as business people and I think the partnership between us and Platinum is real good as well as giving us a platform to take the company to the next stage.

Al Shan

Okay and one last comment, we are going to end up with more shares outstanding and I understand the benefit of that and what we have done, at the appropriate time when our balance sheet is sufficiently healthy and if we are very undervalued at that time, we could do a stock buyback which would reverse the effects of the dilution that has occurred, again it has to be at the right time and assuming we have got the right balance sheet.

Per Loof

That is correct.

Al Shan

Okay. Thanks again Per to you and to your team for all the good work you have done.

Bill Lowe

Thank you.

Per Loof

Thank you very much.

Operator

Thank you. And at this time I do not have any further questions.

Per Loof

Okay. Having no further questions I would like to thank all of you for being on the call, thank you for the support of our company, and as I said we do believe we have seen a bottom and I think we are going to see a slow recovery here in our business as we get into our next quarter. And also I think you are going to see that our ability to do further restructuring has increased and that is also going to improve our company’s performance going forward. So at that note, thank you all very much and have a good day.

Bill Lowe

Thank you.

Operator

Ladies and gentlemen, thank you for joining today’s conference. Thank you for your participation. You may now disconnect.

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