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Bill Lowe - EVP and CFO

Analysts

KEMET Corporation (KEM) Deutsche Bank 21st Leveraged Finance Conference October 1, 2013 6:40 PM ET

Unidentified Analyst

I am [Andrew Draznin]. I cover technology here at DB and I am happy to welcome KEMET. We have Bill Lowe and Richard Vatinelle here. So thank you guys very much for coming and I guess we’ll go to the presentation and then leaves some time for Q&A. Thanks.

Bill Lowe

Thank you and welcome everyone. Thank you for attending the KEMET presentation today. We will spend some time going through quite a few slides, talk about where we’re at and a few of the items we talked about in our last earnings call, as well as give you a little bit of an update since it’s October 1, as what we expect things to come out here on the September quarter, that's a bit of an update from where we were on the last call and then we leave some time for Q&A.

Talking a little bit about the market first, you know that we have combined over the last quarter or so our tantalum and ceramics product lines into the solid capacity of business group. And most of you who were familiar with the story know that that group serves a variety of end markets that doesn’t overlap that much with film and electrolytic business group, primarily overlaps a little bit in automotive, does not overlap in the other items, such as computer, mobile phones, gaming, a military, aerospace.

We look at last quarter on how things look from a channel standpoint, there are similar to what you’re seeing in the past with distribution being at 46%, EMS at 16%, and OEM at 38%. And then the regions, again the similar story of what you see in the past and we are happy to continue to have our regions generally well balanced, the Americas at 29%, Asia at 35%, and EMEA at 36%. And the segment, two largest segments continue to be industrial, lighting and automotive. And automotive continues as you know more or less around the globe to remain relatively steady and strong both in the Americas and within Europe.

When I look just graphically at the global capacitor market and trend both the world and how KEMET has trended, and you just see that the lines are fairly well matched up on both the times when the market has been up and when the market has been a slight decline. As you know the last several quarter and look at KEMET’s revenue and we’ll see that again in a minute, our revenue has been relatively flat over several quarters indicating we are at the bottom of our cycle here for a number of quarters where the pickup projected from World Cap data projected to come sometime in calendar ‘14.

I wanted to focus just a second on laptop shipments (inaudible) for KEMET, our product that goes into many different products, the one of the products that uses more of our components would be a laptop versus say a tablet. And the laptop shipments have been down, have dropped down to around 187 million projected for this year in 2013, from a 202 in 2012 and that market is expected to come back in 2014 not at the rate that it’s been in the past, but building slowly over the course of the next couple of years and I think we’ll start to see that as we get into next calendar.

And I think if you want to focus on how KEMET might be progressing with that is to listen to some of the other actual computer manufacturers as they start to talk about what their laptop sales are and if their laptop sales start to increase, you would expect to see that KEMET would also benefit from that in our revenue and in our profit.

There is a number of things we talked about in our last several calls regarding our strategy and what is going to be driving our financial performance over the next several quarter, and I am going to spend some time speaking to those items which is vertical integration, our conclusion of the F&E restructuring which will give you update on that, some of the growth opportunities we have as well as some of the private label partnership item is going on with NEC TOKIN.

First of all, there is a number of things that we have done on our top level that’s been in our way trying to change the game here of late and that has been focusing on selling higher margins specialized component solutions, and I think we’ve seen that in our ceramic product line as well as expanding our portfolio with NEC TOKIN.

For those of you who don’t know there are several product lines with NEC TOKIN that are not capacitors, we will look at those in a few minutes. KEMET does not produce those particular components and through PLP arrangements both on the capacitor space and those non-capacitor components, we are working with them to supply their product into some of our markets and then vice versa, supply for lot of products into their markets where they don’t have the same products that we do.

We have been working on the vertical integration to supply -- ensure our supply of tantalum and we have made some senior management changes which I will cover in a second related to that. We have been decreasing a number of manufacturing sites and we are working on leaning out our processes and improving our yields.

From a senior leadership team perspective, we recently announced that we appointed Chuck Meeks to be the Executive Vice President, In-Charge of the Solid Capacitor Business Group. He was previously leading the Film and Electrolytic Group. The Bob Willoughby has now been appointed and Bob is basically just like a man when he was there. And then we brought, we put John Drabik as a Senior Vice President of Global Sales replacing Marc Kotelon.

The tantalum supply chain that we talked about for a number of quarters, which is really KEMET's desire to stabilize both the prices and the reliability of our supply chain, when it comes to our tantalum business group, starts with the ore itself. The second process in the chain is converting that ore to K-salt and then to powder and approach to a capacitor and then into electronic devices.

If you know we purchased Niotan, which is now referred at KEMET Blue Powder, which is our powder company in Carson City, Nevada. We constructed and built and are running a K-Salt facility in Mexico and we have entered into several contracts with multiple mining operations to supply us with ore.

I'm going to try to gather the comments on the tantalum vertical integration with our inventories and that we put this on our actually our website, I think the last quarter and I'm going to talk about it at the day because I really don't believe it will change what we expect for the fiscal year.

One of the reasons that our inventories where we used to 217 last quarter -- at the end of the quarter at 217 million. While it is on the process of working on a vertical supply chain, we had a slight hiccup last quarter and I think we talked about in the earnings call, we’re while using a third party producer of K-Salt as we were preparing to start the ramp up of our own facility and by getting a permits to actually bring ore into Mexico, that particular third-party had a major hiccup in his quality and KEMET had to make a decision to simply cut off that supplier and go in to the spot market, buy powder, buy K-Salt to keep the supply chain running while we obtain the proper permits in Mexico to actually run the K-Salt at our own facility.

As a consequence, that sucked up about $22 million of cash of the balances in the inventory. Now what we expect and what we will see as we report this particular quarter, we’ll see that in a minute is that inventories actually went up during the quarter, in the interim quarter, have come back down as we projected in Q2, we projected that 217 to be essential flat. I think we will see those between 215 and 217. So we will be on target with that. We further expect that inventories in Q3 will drop to about 205 and the projections for Q4 is 195, driven by both tantalum flushing through this higher cost inventory [bump] spot market and our Film and Electrolytic business as we sell out the buffer inventory that we were building to allow us to move in to Kentucky which I'll talk about in a minute.

So the impact of that little hiccup last quarter as we were quite, and in the fourth quarter of last year was as we were on our path, savings of about $5 million a quarter in December of last year. Of course we fell backwards, margins in our Solid Capacitor Business Group dropped, affected our P&L. What we're expecting now is that recovery in the second quarter, I think we announced on the last earnings call that we expected the margins to improve slightly in the Solid Capacitor Business Group from around 17% to 18.5% to 19% this quarter, improving another 250 basis points in the fourth quarter and that’s something what we're going to see as a report as a typical quarter, getting that back on track heading towards ultimately around the $8 million so per quarter savings from versus just going on the market as we use to and buying powder.

When we look at thermo-electrolytic, we start crystal ball for product capabilities to remind you, first of all what the products are in this particular business group, which the main uses of a thermo-electrolytic capacitors falls in the motors, drives, power supplies, voltage conversion, circuits, thermometers, voltage and coal suppression and power cracker corrections.

They do have a unique cell filling characteristics that prevent some from felling in catastrophic ways. And additions the package can be engineered to provide a full safe solutions. And we believe these capabilities are certainly needed now and will continue to be needed in the future. We design capabilities one of our strengths is our ability to design the products that make unique customer requirements for the automotive, wind power, solar power, medical devices, lighting and the electrical distribution in measurement area.

After we are done with the restructuring and the manufacturing operations we do plan to keep our R&D centers close to our customers to maintain this competitive advantage. So we've been doing for the manufacturing optimization standpoint and the two key initiatives for fiscal ‘14 has been continue to creation of lower cost plants to support Europe and America that involves a Skopje, Macedonia for Film Capacitors and Evora, Portugal for Electrolytic capacitors.

Additionally as you know we are working on consolidating three Italian film plants into one single plant. Monghidoro, the facility there, in Italy has operations have now ceased. Vergato will be moved into Pontaccio in early fiscal ‘15, first quarter and Sasso Marconi will begin to move basically this month and will take the next two quarters during fiscal ‘14 to move into and Pontaccio by the way is actually just a few miles down the road from Sasso it’s not a very long distance.

These will also maintain our Asian plans to support the areas which are NT in China, Batam, Indonesia, the film capacitors, and [Shijo] China for electrolytics. The Pontaccio facility has been completed. The facility is now available for equipment and we’ll begin doing that this fall. There are some additional payments we made to our contractors over the course of the next couple of quarters, but the building is ready for equipment.

So basically our construction is complete on September 14, only remains just was exterior landscaping. The completion of our tidal generation system which is really energy efficient system for the plant that allows it to run off of one system on other natural gas so otherwise dependent on what would be cheaper at the time will be installed in fiscal ‘15. The acceptance, testing and final permitting and documentations are being done and building has been transferred to KEMET.

So we’re expecting the transfer of all of our operations to be complete by the second quarter of calendar 2014. And you see that scheduled dates here below that on the various bullet points.

Picture of our Macedonian plant, the Macedonian plant has been up and running for a while it has been recently certified ISO 9000 for automotive and is currently available in running automotive parts. And quick snapshots of the Pontaccio plan, again ready to be moved into here in the next several months.

Spending a few on NEC TOKIN just as an update reminder that we entered into that agreement and we announced it back in 2012 and we closed it essentially here in last February on February 1st. They do manufacture other capacitors electromagnetic materials and [piezo] components along with electro mechanical devices and access devices. There is always some confusion it seems on the steps of this transaction, so I do want to spend, if you bear with me for few minutes to talk about the steps for this transaction because it impacts what’s your impression is of our cash requirements and liquidity over the course of the next 12 months.

We signed the agreement on February 1st and we paid $50 million where 34% economic interest for the 51% voting interest. And there are two other steps that would complete this transaction to working it with 100%. It was in the form of two call options beginning effectively next August.

The first step would be if we chose to do so, would be to make an investment of $50 million to take our equity interest to 49% or if we exercise both call options simultaneously take on just 100%. I think it is important to note that KEMET is not obligated to do either. KEMET will evaluate the situation in August of next year as to what the capital markets are that’s on, we like the performance of KEMET is at that time, what the performance of NEC TOKIN is at that time and determine what is the best step for KEMET to take.

Primarily we believe that our preference of course would be to be able to grow 100% of all of the things line up correctly. And I think the important thing to know and I think the misconception is that we have the requirement to make an investment of $50 million in August of next year and that simply is not true.

We have the call option and we will determine at the time what is the right option for the company to take whether it’s stand still and do nothing at the time based upon the economic environment or to go 100% depending on the environment and performance of both companies.

So again what is the major technology is excluding capacitors and these are products that KEMET does not manufacture, which is a EMC devices, which are electromagnetic compatibility, the EMD which is electromechanical devices and that products that act as low power switch to activate a circuit or device such as motor. The access control the devices and piezo devices which are products that transform electric energy into mechanical energy or the reverse. We have multiple manufacturing sites throughout Japan and Sendai, Shiroishi and Toyama, as well as operations in China, Vietnam, the Philippines and Thailand.

I wanted to break out a little bit about financial information for you if you looked at our last 10-Q, you saw a portion of these items or these categories, but we do not break out the cash component from other assets. So while we're not showing any more information other than the cash, I this is important especially in the leverage conference to show you that as of June 30th, the amount of cash on hand in their banks were slightly over $69 million. We expect that their cash flow grow between June 30th and September 30th. So when we report results here at the end of October, we would expect that their cash would grow about $69 million for this quarter.

From a growth opportunity standpoint, I have mentioned briefly our private label partnership and cross licensing. And that's giving us the ability to expand our markets and product offerings for both companies. And really is a partnership between two of the world's premier Tantalum manufacturers to achieve true scale in operations allowing us to manage our raw material sourcing, as well as to maximizing our efficiencies and best practices in both plants. It creates significant cross selling opportunities for tantalum TaMnO2 business, as well as our polymer business and film capacitors.

It is really complementary from a geographic reach, strong KEMET presence in Western Hemisphere and excellent NEC TOKIN position in Japan and Asia. It benefits from international management team since it is separated to the region’s specific business needs and combined R&D capabilities and university relationships. And we enjoy flexibility to pursue these growth opportunities through the continued R&D investments in both Japan and the U.S. and enable us to diversify beyond capacitors in the passives market.

Financial metrics, I want to put up here this from a sales perspective over the last several quarters, but I also wanted to put the bar, which is the estimate for the second quarter. We said on our earnings call that we expected revenue to be flat to up 3%. I think what we would project today, would say we’ll be on the high end of the 3%. And I think that’s, for those of you who know the cyclical nature within our fiscal year of the company typically September might be slightly down due to a two-week shutdown in Europe. So being up in September actually is a bigger positive than what you see here. So we're projecting that we will be on the top-end of our projection for revenue for the quarter.

And then looking quickly, the snapshot of the balance sheet, a couple things I want to point out again that sometimes I hear a few questions from investors that I believe is somewhat of a misconception. We have cash in bank at June 30th of $69 million. That does include restricted cash as defined by U.S. GAAP but it’s not restricted from a company standpoint. We’re able to -- those funds are comingled with the rest of our cash and is available to be spent on general operations, general CapEx etcetera.

There has also been some comments I heard today as to the change in our cash balance over the course less 12 months and the uses of that cash. And I want to remind everyone that the reason that of course that we borrow the additional 110 million from many of you in the room from our bondholders was to spend in on exactly items with that the cash is going out the door for, now talked about two of those, that both of those today and that's the $50 million investment NEC TOKIN. And over time, over the course of the last year, we've paid out between $40 million and $60 million to purchase Niotan which is the KEMET, now refer to as KEMET Blue Powder, which was the Niotan acquisition.

So keep in mind that's with the funds we borrowed for, that's with the funds we spent for and the cash balance is at $69 million at June. I’ll talk about what we expected to be here in September in just a minute.

In summary then, over the course of time, we've executed a number of initiatives to lower our -- to adjust really where we were at from a lower revenue standpoint precipitated by the weaker economic activity we’re seeing, although fortunately we’re starting to see some slow growth. We’re expecting the vertical integration from raw material to benefit us and building to about $8 million benefit per quarter by quarter two and you can look back at the chart I reviewed earlier about how that progresses to get there.

And building from the hiccup, we had last couple of quarters that issue has been fixed, our K-Soft facility is running full and as planned our powder company internally with all the K-Salt that we need. We are expecting the F&E restructuring will drive a lower breakeven point each quarter during fiscal ‘14 and beyond. We expect to start to see adding value from the private label partnership I discussed towards the end of this fiscal year and growing in fiscal ‘15 as we are starting to see the market now with product.

And we’re expecting our inventory levels to decline to 195 million by March 31 generating $22 million of cash to return back to the bank as we work the inventory through from the spot buys we had to make in the last four or five months. We expect to have sufficient liquidity in the near and medium term, expected to meet all of our cash needs including the debt service and we expect cash to build again during the fourth fiscal quarter ended March 31.

I want to cover quickly on this summary kind of where we are on our book to bill, I know these are numbers that everyone likes to see on our calls. I am providing these numbers to you as of September 25 as I put together the presentation. All of the numbers are positive. All the number in whether it’s the regions, whether it’s the channel or whether it’s in the business units are positive. The Americas are positive at 1.21, with Europe at 1.10 and Asia at 1.01, distribution at 1.13, EMS right at 1 and OEM at 1.12. And then if you break it down by the business groups, solid capacitors is 1.12 and F&E is 1.05. It’s been a while since we have seen all of the book to bill numbers (inaudible) positive, I think that’s an indicator as I mentioned and we’re starting to see a pattern of slow growth across each of the regions in our business.

Again referring to cash balance and I check this as of yesterday, doing a conference on October 1 is a bit difficult when your quarter ends a day before. The cash in bank and this is without any accounting adjustment that always inevitably occur as you close the books, the cash in bank we expect to be in the range of $72 million to $75 million and that is after the revolver draw of 21. Near term cash needs in November we have an $18 million bond interest payments to make.

Our expectation is that cash will remain relatively flat to slightly usage into the December quarter, $5 to $8 million most likely and then build back up in March. The cash in bank actually was around $73.6 million and again there is always accounting adjustments that take place for checks [that work out] during the last few days that have to be adjusted, so will provide you a range of 72 to 75.

Those who can do the math from last quarter, well last quarter without the revolver draw, says that we ended up around $54 million or so. Prior to revolver draw that is in the range we projected, we said that we will try to manage the cash to somewhere around the 20 -- no more than the $20 million drop, hopefully holding somewhere along 12, we came in slightly between there somewhere around 14 or so.

So right in the range that we said would be. We expect again with the inventory drawdowns next quarter with margins increasing, supplying, better profit margin in the bottom line, revenue increasing we expect that to start offsetting the cash needs in the next quarter and then building cash in the March 31 quarter.

Like I already mentioned the revenue range, we expected to be up 1% to 3%, we again expect to be around at the top end of that range. We also said solid capacitor throughput increase about a 100 basis points this quarter and we still expect to grow another 250 basis points in December. We expect F&E operating improvement this quarter and in September to improve between $3 million and $3.5 million over June. And again, I have already mentioned inventory numbers going from $217 million in June to between $215 million and $217 million in September dropping to $205 million approximately and then $195 million in March. And that concludes my formal remarks in the presentation, and now open the floor for questions.

Question-and-Answer Session

Bill Lowe

Yes.

Unidentified Analyst

Are you comfortable just about the competition and [Audio Disturbance]?

Bill Lowe

No, I mean market share stood relatively steady and I think going back at the trial we show how the global market is behaving. You can see we’re behaving exactly the same way it's more almost a parallel line up and down and across. But no market share, we have been maintaining market shares in every area.

Unidentified Analyst

And competition was?

Bill Lowe

Competition is a competition and it is always competition everyday out there. I don't think it's being different than it has been. Yes.

Unidentified Analyst

You showed slide early on laptop sales, what percentage of your products coming from laptop sales?

Bill Lowe

We put that into our computer, in our computer segment and it's probably the majority of what's in there. That’s somewhere around I think a 10% kind of number. There is some other, it's not the full 10, the exact number is probably somewhere between the $5 million and $8 million, $7 million, 7% on a number of that category.

Unidentified Analyst

Alright. What do you think the positives that there will be growth from laptop sales?

Bill Lowe

Well, we are again that data is put together by third-party appointments I mean that’s not KEMET data. So that’s what we've gone from the marketplace and those that gather the data and what they expect to happen in the PC market. That’s why I said, it will be good to pay close attention to what you are hearing from some of those other companies you follow that make the PCs. Let’s see what they are saying about their growth in that area and then you can translate that to benefits to KEMET.

Unidentified Analyst

[Audio Disturbance].

Bill Lowe

Well, we're still in 2013. And certainly we're seeing the numbers down where we are today. So we haven't seen that upturn yet.

Unidentified Analyst

[Audio Disturbance].

Bill Lowe

The lead times are fairly normal, we do not extend, lead times are not extended today. I mean quite certain, these products may have a different lead time than the other, but they are not extended.

Unidentified Analyst

[Audio Disturbance].

Bill Lowe

Ultimately from our, or let’s just talk about from a capacitor standpoint. One of the things that’s changed for NEC TOKIN overtime as you are aware is that they were part of the, they had a facility in Thailand that was a part of the flood. That changed their direction or what they were producing from a capacitor standpoint. Prior to the flood, they were producing not only polymer capacitors, but lot of standard tantalum TaMnO2 parts from that facility. What they chose to do post flood and this was their decision KEMET was not a part owner at the time was to, in the new facility to downsize the facility by almost two-thirds, so that facility is about one-third the size it was prior to the flood and then only produce tantalum polymer capacitors in that facility.

And so and they are and that's what they are doing. Now from a capacity and the sales standpoint, we until we are 100% owner, we cannot cross pollinate our sales forces, we are not able to obtain customer data or pricing and vice versa. So we are still competitors when it comes to certain capacitors certainly. There are capacitors though small case size that they make that we do not make that we will as I talked about the PLP arrangements, we will be buying from them and then selling into our market. And there are certain capacitors now because of their change in philosophy that we make that they no longer make that they are able to buy from us to sell into the Japanese and Asian markets.

So that will continue while own a 100%, now once we go 100%, it would be like any other location would be combined we’ll be able to make strategic decisions about what we do with capacity and facilities, but until then really going to the sales forces we weren’t able to combine and take advantage of that. But from an R&D perspective, we are able to put our R&D groups together, we were able to put, we’re able to come together with distribution, logistics, HR, there is a number of other areas, where we come together what we can bring value to both companies in the bottom-line especially certainly in raw material when we had fully implemented vertical integration savings particularly, those raw material savings that can benefit NEC TOKIN as well.

Any other questions? Alright. And if there are no further questions, I want to thank you for your attendance. And have a good day.

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