William Lowe – Executive Vice President, Chief Financial Officer
Kemet Corporation (KEM) Company Conference Call November 17, 2011 11:00 AM ET
Good morning everyone. Welcome to the UBS Tech conference. I think we should get started – the clock is running already. It’s my pleasure this morning to introduce William Lowe, Kemet Corporation to discuss his company a little bit, and then—sorry, and then we’ll have some time for Q&A afterwards.
Thank you and good morning. Thanks for attending the Kemet portion of the presentation today at the UBS conference. I’m going to just jump right in and skip over the cautionary statement, but advise you that we do want you to read that as you look through the presentation today.
For those of you who don’t know about the Company, the Company has been around quite a long time as part of Union Carbide. It was founded back in 1919 and we are a global manufacturer of multiple types of capacitors – tantalum, ceramic, film, paper and electrolytic. We have manufacturing sites around the globe and we have almost 11,000 employees as of our last September 30, and we have a global sales force that’s split up into regions between the Americas, Europe and Asia.
A little bit on the industry background – most of you are familiar with this, but if you’re not, primarily capacitors are a passive electronic component that stores, filters and regulates electrical energy. Some of the devices that our products go into sometimes contain several hundred or sometimes several thousand capacitors into one particular unit like a flat-screen TV or a smart phone.
Looking at our segment overview, there is an overlap between our segments - tantalum and ceramics, within the end markets, with the exception of at some of the downhole drilling will be primarily one area versus the other. In the film electrolytics, which we’ll talk about separately and the green technologies when we acquired these businesses back in ’07 and ’08, there is very little overlap between our tantalum and ceramics business with film and electrolytics compared to the other two.
We do have a global reach. As I said, we have major sales locations around the globe as well as manufacturing, so just to give you a quick look at where we’re located at. As you saw on earlier slides, the majority of our employees sit in North America and Mexico, and also a large contingent in Asia as well, China in particular. Looking at the market overview and if we look at our last quarter and use this, we’d like to think we’re fairly well balanced both geographically and within the channels, and actually within the business groups themselves. And so we’ll start with the channels. Our OEM channel last quarter represented about 45% of our business and distribution around 43%. So you can see between those two channels, we’re fairly balanced. Geographically, we’ve been more balanced over the last couple years with the acquisitions that we’ve made, and if you look at the last quarter again, Asia came in at 29%, the Americas at 31, and Europe primarily around 40%. Europe and Asia tend to go back and forth a little bit, and if you look back at the prior quarter, Asia would have been about 36% and that change would have occurred within the European location. So well balanced there, so generally when one region is up, another region is down. We feel that that helps smooth out our cycles within a calendar year or within a fiscal year. We used to be a little more volatile that way, and the geographics have changed that and helped us.
From a segment standpoint, we are light in the consumer segment and that’s on purpose. We don’t have a lot in that area. Most of what’s in our consumer segment we capture there is gaming—gaming consoles, and in transportation – that’s primarily light vehicle automotive. And in telecoms, it’s primarily base stations is where we capture. Our base station business is within telecom.
We do have strong customer relationships, and this is kind of a who’s who. But you know these companies very well. I’m not going to spend the time going through the names, but you can see that we do from an OEM standpoint have a variety of large OEMs in both automotive, the computer side, as well as base stations. And then from a distributor standpoint, all the large distributors that we use across the globe.
We’ve been focused over the last several years on moving away from base commodity products to specialty and growing our specialty business in the tantalum group, the ceramics group and the film electrolytic group as well; but primarily changing our focus in ceramics over the last several years, and we’ll talk about their margins in a minute as you see that change has occurred since the ’08-’09 time frame to today. There’s been a dramatic change in what that business looks like. And the bottom half of this slide really is the targeted specialty areas we’re looking at with alternative energy, it’s lighting, it’s medical, it’s military, it’s downhole drilling. Those types of things is where we’re really focused to get those parts out in the market that drive higher margins for us and are specialty related.
So let’s look for a minute—as we look forward what we’ve been involved with in alternative energy, the green energy, we do have products that go into electric drive vehicles, and we’ll talk about a new facility which we’ve just opened up in Simpsonville, South Carolina in the last few weeks. But we have products that go into wind, solar, thermal, storage, the smart grid, and of course from an efficiency standpoint as well.
From a green energy perspective, our customers are a wide group of customers. Again, you’re going to recognize the name and we haven’t got all them up here today, but you can see who we’re dealing with in the categories of not just the wind technology but in the electric drive vehicles as well, including even the industrial side like Caterpillar, for instance.
So recently we just announced that we opened a new manufacturing facility for a change. It was nice to come back and announce that we’re opening a facility actually in the United States. We’re putting the facility in South Carolina in an existing structure to produce de-sealing capacitors for hybrid vehicles. That production will start up in a month or two with our first part coming off the line in that period of time. We’ll eventually have four lines there. This is one line that we have up and we’ll be starting as we just opened the facility over the last month.
Again, looking at the green side, when you look at last year’s revenue, it was slightly over a billion dollars and when we talk about what we’ve been growing in the green space, how much does that represent from revenue base, it’s somewhere around $79 million—79, $80 million, which is not a bad start for us. It’s almost approaching a 10% kind of range of where our revenue base was this last year, so that is a growing area for us and it’s in primarily our film electrolytics group.
We do walk the talk at Kemet. We also have a charging station as well as electric drive vehicles at our facility in South Carolina as we’ve gone into this space.
The other thing we’ve talked about on our last few earnings calls is what we’ve been doing on our initiatives to lower our production base within our acquisitions we’ve made, as well as looking at acquisitions and vertical integration strategies going forward. Just recently, we announced that we had purchased a foil facility in Knoxville, Tennessee. This photograph shows a quick photograph of that facility. This is primarily to fulfill our own requirements internally. Production here is to be sent to a facility in Europe for further manufacturing. We also do have some external customers, of course, that came with this, but primarily this was a vertical integration play for us to help take costs out of our supply base as we continue to produce those products.
So we acquired in June. It’s now fully integrated within Kemet. We have secured a long term supply of quality formed aluminum foil to support sustainable business growth, and it’s vertically integrated to ensure long-term cost control and profitability.
In addition, we announced recently that we are building a facility in Macedonia—in Skopje, Macedonia. This relates to our restructuring in our film electrolytics group. As we’ve been moving production lines – we’ve talked to you about this before – we’ve been moving production lines out of Europe into China and Mexico. In addition, we also want to move some production lines to stay within Europe but in lower cost locations. This is a new facility that’s actually under roof at the moment and will be dried in, we say, by January 1, 2012, which is a month and a half from now. We expect to start installing manufacturing equipment next May in 2012.
Before I go onto the next slide, which is Making Africa Work, and that’s really about our supply base for our tantalum powder, I will mention that this morning we did put out a press release that talked more about our restructuring efforts in our film electrolytics group. It’s something we’ve talked to you about in the past but this puts a little more specifics around it as we’ve gotten some of our agreements completed and allows us to take the actions that we’ve been talking to you about regarding consolidation of facilities, specifically in Italy where we’ll combine three facilities into one. We’ve laid out for you in that press release what the costs will be, as well the savings to the Company over the coming fiscal years. And I would encourage you if you didn’t see that press release to please go online and take a look at it.
So we call this Making Africa Work because that happens to be where the tantalum powder is located that we’re looking at. These photographs, of course, are of our CEO, Per Loof, who visited the mine location a number of months ago. This is an important step for the Company to determine whether or not we will be able to purchase ore from this mine in the Congo. We are working diligently through all the processes that will require us to make sure that this is conflict-free, working with the SEC under the Dodd-Frank Act, making sure we’re clear there. Also, we also publicly committed to work on the OECD due diligence guidance pilot to improve the protocols associated with conflict minerals, and that’s just not tantalum. There’s many other conflict minerals as well, tin being a very large one that is much bigger than tantalum that is involved in this. There was an SEC roundtable just recently in October 18 to discuss the Dodd-Frank section that relates to this, and we did present at the meeting. So we are involved as we go forward, making sure as I said that if we end up using ore from this location, we’ve followed all the guidelines and we’ve dotted all the I’s and crossed all the T’s. But this is one way to help us get quality ore, good supply at potentially lower costs for the industry, not just Kemet going forward.
Quickly looking at the financial overview and our financial profile, looking at our trailing revenue for fiscal quarter 2012, which just ended in September. A little over a billion—about a 1.82 billion in revenue on a trailing basis, and $196 million of trailing EBITDA. The picture I like to also show over the last several years is what has happened with cash and what has happened with debt. Over the course of the recession we went through, we certainly started the recession with over $400 million of debt. Today, actually when we paid it off on Monday, just this week, we paid $37 million on a bond issue that was outstanding, a convertible bond that had a put date of the 15th, so we paid off the remaining $37 million of that bond on Monday, leaving us with $230 million of long-term debt which you’ll see in a minute when we look at the balance sheet is not due until 2018. So what we’re very proud of is over the course of the time of the last several years, we’ve taken our debt during a recession from 400 million essentially to 230 million while at the same time building cash from 39 million to 164 million before we made the payment on Monday.
This is our quarterly cash position. Again, we’ve been generating good cash throughout the period. The red color on this bar represents the restricted cash. That restricted cash is what we set aside to pay the bonds we paid on Monday, so as of today our restricted cash is very small. It’s about $2 million. It’s represented only by a VAT exposure we have in Holland that we are required under the laws there to keep that set aside for VAT liabilities, and that will be released, we think, in the next year and a half and will be unrestricted.
So looking at our operating trends, operating trends over the last several quarters with revenue growing to—peaking at 289, dropping back slightly to 265, and I’m not going to go into the details of that. If you want to know that, I think the best way is to read our transcript from the earnings call if you didn’t listen to it. There are specific reasons for that. We actually guided to that number, so that was a number that we did guide to for the quarter.
From a gross margin standpoint, we have been riding over the 25% mark until the last quarter. The Company’s goal was to reach 25%. We’ve done so for several quarters and then we did pull back a little bit to 23.5% last quarter. EPS last quarter was $0.43 per share. Our outstanding shares on the diluted side include warrants of about 8.9 million, so the fully diluted number is a little over 52 million. That’s the number we use to calculate the earnings per share versus the basic. Actually, the one we pay more attention to is the fully diluted one.
And then again coming back to the balance sheet, I’ll point to the cash first. The 127 is without the restricted cash, which is a separate line for restricted cash; and again, the restricted cash, all but about 1.7 million of that was probably used on Monday. Long term debt, as I said, is around 230 million which is due at 2018. We do have a revolver of $50 million. It’s an ABL type of facility that is undrawn as of today, and then other thing, we’ve been able to get our metrics in line from our days outstanding on our receivables down to about 39 days, which lines up fairly well with our days payable outstanding to 34 days as well.
Our total debt to LTM adjusted EBITDA is right around 1.4 for those of you who pay attention to that particular metric.
So I’ll make some final comments. Looking ahead, we still expect that there’s an overall growing market, 2011 – 2015 as we look at some of the specifics on the industry. Both the short term and the long term effect of the Thailand floods are unknown at this time. We made that comment on our earnings calls. We don’t expect there to be too much of an impact on Kemet during this quarter. We do not have a facility in Thailand, in case you were wondering. Kemet does not have facilities in Thailand, but those of you who are looking to see what might come our direction this quarter, it’s a little too early to tell. There is sufficient inventory in the distribution channel that we talked about on our earnings call. It was actually going to affect this quarter or next quarter. It’s going to take about two quarters for the distributors to work off their inventory, so there is an impact there. This means there’s also inventory in the channel for use from the fact that there could be impact from the Thailand floods, and all that is unknown really at this point.
We still think that the European and U.S. automotive markets are relatively strong. They’re running relatively stable over the last several months. In military, although there are some cutbacks in military, the smart systems continue to be required and that’s where our product plays a part. The smart grid continues to grow, and the alternative and green energy as well are taking a little bit of a pause right now. We expect long term that those will continue to grow as well. We continue to make sure that we’re well positioned in that field, not just in hybrid vehicles but in wind and solar as well.
And then lastly, we’ve said over the last several quarters, and the foil facility is a step in that direction, is that we believe that the industry remains fragmented. We believe that there is also vertical integration steps possible to help us keep our costs in line or lower than what they have been to date through vertical integration strategies, and again the foil facility represents that. And whether or not there is acquisitions that make sense to be a part of Kemet going forward, we’ve also made statements in regards to that as well.
So with that, that concludes my formal remarks on Kemet today.
Question and Answer Session
Thank you, Bill. We have a few minutes for questions. I guess there’s a question up here in the front? Sorry, there’s a mic coming.
Your competitor is being impacted by the floods; you aren’t. I would guess that means that given what’s going on in semi—I mean, in hard drives and other things, that the distribution inventory’s been sucked down pretty hard. Are you getting extra orders because of that?
Well, what we’re seeing is—I don’t think the distributors’ inventory has been, in your words – I’ll change the words – pulled down sufficiently to date. I think there’s still quite a bit of inventory in our distributor channel. We thought that that was two-quarter—put Thailand aside for a minute. We believed that that was a two-quarter correction, so there was plenty of inventory there. I still think there is sufficient inventory there. It may not take as long, but it will certainly go through this quarter.
We are seeing some orders, certainly. We said on the call we didn’t think there would be too much impact this quarter, and I think we stand by that comment. What needs to be seen – we have the same information you have. The NEC, to my knowledge, has not put out a press release that says exactly what the condition of the facility is and how long it will be offline. All those factors, I think will impact all of the rest of us in the industry on what we do over the course of the coming months.
The Foreign Press has quoted some of your employees over in international locations as saying you have been getting a lot of orders. So you’re saying that’s not true?
What I’m saying is this quarter we will not see a lot of impact. We are in fact buying raw material and making components that we expect will be probably impacted in the next quarter, the January to March quarter, okay? We think we’ll see that impact in that quarter.
Hi. Just to continue on that question, are you seeing an impact on pricing of your products given what’s going on in the channel?
Well again, I think it’s very early in that regard.
Bill, I’ll interject one while we wait for the mic to get back there. Forty percent of your business is tied to EMEA. Just wondering how your discussions have been going with customers in that region – any significant change in tone? Are you seeing any strains of credit constraints in the region?
No, without being specific to one customer, I would say that we have had fairly normal discussions with our customers. This is the time of year that we have our, from an OEM standpoint, we negotiate our contracts, and I assume that’s what you’re referring to—
That starts in October or so and we finish by the end of December. I would say they’re going well and nothing extraordinary to really talk about.
Yeah, I’m just following up. I’m not sure I heard you correctly earlier. At the time you were showing the slide with regard to your new facility in Macedonia. I think I heard you say you exited or are leaving manufacturing facilities in China and Mexico. Did you say you were pulling out of those two, or did you say you’re moving into those two?
No, we have been moving and we will continue to move some production that’s located within Europe to China and Mexico, and then some of that will move from one location in Europe to Macedonia.
Got you. For some reason, I thought I might have heard you said you were leaving those two, and I wasn’t sure—
No, no. Sorry.
If you had to make an estimate, what percent of capacitor supply do you think is in the flood-affected areas in Thailand for the industry?
Well, I’ll fall back on one of the industry experts who was on a call by another bank, so I won’t mention the other bank’s name, I guess, that said around 15%.
Bill, if I just look at the guidance for next quarter, gross margin is 19 to 22%. At the revenue guidance you gave for the December quarter, can you actually get to 25% and what are the levers, or would you actually need to see higher revenues to get to your 25% target?
Well, we’ve provided our forecast on the earnings call, and I think typically and traditionally we don’t update that unless we believe that there’s a change required. So I don’t know that I’d even make any more comment about that. I mean, the impact of Thailand, for instance, we said we thought was very minor, so to your point about what would change that, we don’t see that changing that because we don’t think that’s going to be significant this quarter. What’s driving that, of course, as we’ve said – the mix of our business and the distribution channel impact of correcting their inventories is driving our comments as to how we forecasted that quarter.
Okay, I guess my question was just at a more basic level, to get to your 25% goal for gross margin, what do you need to see occur in your business? Is it just a function of higher revenues, or do you have other levers that could get you there?
Well, if we thought that the—let me go back a second. We have said that we expect this correction is a two-quarter correction. It’s a distribution issue, not a demand issue. When you look beyond the distributors, the demand is certainly a little softer than it was six months ago, but the demand really isn’t that bad. And so we aren’t taking Draconian efforts to reduce fixed costs at the moment because we think it’s short term, and if we do something dramatic we’ll find ourselves caught short when this corrects after two quarters and we’ll have more difficulty meeting the demands of our customers at the demand level we’re seeing. So that’s why we’re not going to be seeing major pullbacks in fixed—if it was a longer period of time, we would probably take some actions as we did the last time it was a little longer, and you saw us pull down our—in fact, if you look back at the numbers, if you look back to a quarter in which we ran about $170 million of revenue, that was a breakeven operating income quarter. So breakeven operating income was about 170 million of revenue. Certainly it’s higher than that today because we’re running at higher volumes, but we would expect that we’d run at the same type of breakeven if we saw that this was going to be a bigger situation. We don’t see that at the moment.
Okay, any other questions? Maybe I’ll ask one final one and then we’ll break out. You’ve seen very strong year-over-year ASP trends. In fact, I think last quarter tantalum prices were up 37%, F&E 26%. Any sense of how you see non-tantalum trends ASP trends? I understand the tantalum aspect of it, but some of the non-tantalum product categories.
Non-tantalum ASP trends? I think we’ve said, and I don’t think we’ve changed our view on this—Per said on I think it might have been our last earnings call that we were seeing ceramics kind of flat to slightly down, but not significantly. And I think we’re seeing the same trends in the other business unit as well.
Okay. Bill, thank you so much. We’ll head to the breakout room. It’s in Carnegie Hall downstairs.