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KEM > SEC Filings for KEM > Form 10-Q on 2-Aug-2013All Recent SEC Filings

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Form 10-Q for KEMET CORP


2-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This report contains certain statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Actual outcomes and results may differ materially from those expressed in, or implied by, our forward-looking statements. Words such as "expects," "anticipates," "believes," "estimates" and other similar expressions or future or conditional verbs such as "will," "should," "would" and "could" are intended to identify such forward-looking statements. Readers of this report should not rely solely on the forward-looking statements and should consider all uncertainties and risks throughout this report as well as those discussed under Part I, Item 1A of the Company's 2013 Annual Report. The statements are representative only as of the date they are made, and we undertook no obligation to update any forward-looking statement.

All forward-looking statements, by their nature, are subject to risks and uncertainties. Our actual future results may differ materially from those set forth in our forward-looking statements. We face risks that are inherent in the businesses and the market places in which we operate. While management believes these forward-looking statements are accurate and reasonable, uncertainties, risks and factors, including those described below, could cause actual results to differ materially from those reflected in the forward-looking statements.

Factors that may cause actual outcome and results to differ materially from those expressed in, or implied by, these forward-looking statements include, but are not necessarily limited to, the following: (i) adverse economic conditions could impact our ability to realize operating plans if the demand for our products declines, and such conditions could adversely affect our liquidity and ability to continue to operate; (ii) adverse economic conditions could cause the write down of long-lived assets or goodwill; (iii) an increase in the cost or a decrease in the availability of our principal or single-sourced purchased materials; (iv) changes in the competitive environment; (v) uncertainty of the timing of customer product qualifications in heavily regulated industries;
(vi) economic, political, or regulatory changes in the countries in which we operate; (vii) difficulties, delays or unexpected costs in completing the restructuring plan; (viii) equity method investments expose us to a variety of risks; (ix) acquisitions and other strategic transactions expose us to a variety of risks; (x) inability to attract, train and retain effective employees and management; (xi) inability to develop innovative products to maintain customer relationships and offset potential price erosion in older products;
(xii) exposure to claims alleging product defects; (xiii) the impact of laws and regulations that apply to our business, including those relating to environmental matters; (xiv) the impact of international laws relating to trade, export controls and foreign corrupt practices; (xv) volatility of financial and credit markets affecting our access to capital; (xvi) the need to reduce the total costs of our products to remain competitive; (xvii) potential limitation on the use of net operating losses to offset possible future taxable income;
(xviii) restrictions in our debt agreements that limit our flexibility in operating our business; and (xix) additional exercise of the warrant by K Equity which could potentially result in the existence of a significant stockholder who could seek to influence our corporate decisions.

Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations and could cause actual results to differ materially from those included, contemplated or implied by the forward-looking statements made in this report, and the reader should not consider the above list of factors to be a complete set of all potential risks or uncertainties.

ACCOUNTING POLICIES AND ESTIMATES

The following discussion and analysis of financial condition and results of operations are based on the unaudited condensed consolidated financial statements included herein. Our significant accounting policies are described in Note 1 to the consolidated financial statements in our 2013 Annual Report. Our critical accounting policies are described under the caption "Critical Accounting Policies" in Item 7 of our 2013 Annual Report.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles ("U.S. GAAP") requires management to make estimates, assumptions, and judgments based on historical data and other assumptions that management believes are reasonable. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. In addition, they affect the reported amounts of revenues and expenses during the reporting period.

Our judgments are based on management's assessment as to the effect certain estimates, assumptions, or future trends or events may have on the financial condition and results of operations reported in the unaudited condensed consolidated financial statements. It is important that readers of these unaudited financial statements understand that actual results could differ from these estimates, assumptions, and judgments.


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Business Overview

We are a leading global manufacturer of a wide variety of capacitors. Capacitors are fundamental components of most electronic circuits and are found in communication systems, data processing equipment, personal computers, cellular phones, automotive electronic systems, defense and aerospace systems, consumer electronics, power management systems and many other electronic devices and systems. Capacitors are typically used to filter out interference, smooth the output of power supplies, block the flow of direct current while allowing alternating current to pass and for many other purposes.

KEMET's broad line of tantalum, multilayer ceramic, solid and electrolytic aluminum and film and paper capacitors are manufactured using a variety of raw materials and are available in many different sizes and. Our product line consists of over 250,000 distinct part configurations distinguished by various attributes, such as dielectric (or insulating) material, configuration, encapsulation, capacitance level and tolerance, performance characteristics and packaging. Because most of our customers have multiple capacitance requirements, often within each of their products, our broad product offering allows us to meet the majority of their needs independent of application and end use.

In fiscal year 2013, we shipped approximately 32 billion capacitors and in the quarter ended June 30, 2013, we shipped approximately 9 billion capacitors. We believe the long-term demand for capacitors will grow on a regional and global basis due to a variety of factors, including increasing demand for and complexity of electronic products, growing demand for technology in emerging markets and the ongoing development of new solutions for energy generation and conservation.

We operate 23 production facilities in Europe, North America, and Asia and employ approximately 9,600 employees worldwide. Commodity manufacturing in the United States has been substantially relocated to our lower-cost manufacturing facilities in Mexico and China. Production that remains in the United States focuses primarily on early-stage manufacturing of new products and other specialty products for which customers are predominantly located in North America. For the quarters ended June 30, 2013 and 2012, our consolidated net sales were $202.7 million and $223.6 million, respectively.

In the first quarter of fiscal year 2014, the Company reorganized its business by combining its Tantalum Business Group and Ceramic Business Group into one business group, Solid Capacitors. Following the reorganization, KEMET's two business groups are comprised of: the Solid Capacitors Business Group ("Solid Capacitors") and the Film and Electrolytic Business Group (Film and Electrolytic"). These business groups are responsible for their respective manufacturing sites as well as all related research and development efforts.

Recent Developments and Trends

Net sales for the quarter ended June 30, 2013 showed a slight decrease of 0.1% compared to the quarter ended March 31, 2013. We continue to focus on specialty products, and during the first quarter of fiscal year 2014, we introduced 417 new products of which 168 were first to market, and specialty products accounted for 44.2% of our revenue over this period.

We continue to sell our products into a wide range of different end markets, including computing, industrial, telecommunications, transportation, consumer, defense and healthcare across all geographic regions. No single end market industry accounted for more than 30% and two customers, both of whom are distributors, each accounted for more than 10% of our net sales in the quarter ended June 30, 2013. No single end use customer accounted for more than 6% of our net sales in the quarter ended June 30, 2013.

We have continued to shift production to lower cost locations and to restructure our operations and believe our recent equity investment activity enhances our competitive position. These trends are described in more detail below.

Equity Investment

On March 12, 2012, KEMET Electronics Corporation ("KEC"), a wholly owned subsidiary of the Company, entered into a Stock Purchase Agreement (the "Stock Purchase Agreement") to acquire 51% of the common stock (which represents a 34% economic interest) of NEC TOKIN, a manufacturer of tantalum capacitors, electro-magnetic, electro-mechanical and access devices, (the "Initial Purchase") from NEC Corporation ("NEC") of Japan. The transaction closed on February 1, 2013, at which time KEC paid a purchase price of $50.0 million for new shares of common stock of NEC TOKIN (the "Initial Closing"). The Company accounts for the equity investment using the equity method in a non-consolidated variable interest entity since KEC does not have the power to direct significant activities of NEC TOKIN. In the first quarter of fiscal year 2014, we incurred a loss on our equity investment in NEC TOKIN of $3.4 million.


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Restructuring

We incurred $4.6 million in restructuring charges in the first quarter of fiscal year 2014 compared to $1.3 million in restructuring charges in the first quarter of fiscal year 2013. The restructuring charges in the first quarter of fiscal year 2014 included $4.1 million related to personnel reduction costs comprised of the following: $1.9 million related to the closure of a portion of our innovation center in the U.S., $1.1 million related to the reduction of solid capacitor production workforce in Mexico, $0.7 million related to the Company's initiative to reduce overhead within the Company as a whole and $0.4 million related to an additional Cassia Integrazione Guadagni Straordinaria ("CIGS") plan in Italy. The additional expense related to CIGS is an agreement with the labor union which allowed the Company to place up to 170 workers, on a rotation basis, on the CIGS plan to save labor costs. CIGS is a temporary plan to save labor costs whereby a company may temporarily "lay off" employees while the government continues to pay their wages for a maximum of 12 months for the program. The employees who are in CIGS are not working, but are still employed by the Company. Only employees that are not classified as management or executive level personnel can participate in the CIGS program. Upon termination of the plan, the affected employees return to work. In addition to these personnel reduction costs, the Company incurred manufacturing relocation costs of $0.5 million for the consolidation of manufacturing operations within Italy and relocation of equipment to Evora, Portugal.

Outlook

For the second quarter of fiscal year 2014, we expect net sales to increase up to 3% when compared to the first quarter of fiscal year 2014. We expect Adjusted gross margins will improve to between 13% and 15% and Selling, general and administrative ("SG&A") and Research and development ("R&D") costs to be consistent with the quarter ended June 30, 2013.

CONDENSED CONSOLIDATED RESULTS OF OPERATIONS



Consolidated Comparison of the First Quarter of Fiscal Year 2014 with the First
Quarter of Fiscal Year 2013



The following table sets forth the Condensed Consolidated Statements of
Operations for the periods indicated (amounts in thousands):



                                                           Quarters Ended
                                                 June 30, 2013        June 30, 2012
                                                           % to                  % to
                                                           Total                 Total
                                                Amount     Sales     Amount      Sales
Net sales                                      $ 202,723            $ 223,632

Gross margin                                      17,534     8.6 %     32,311     14.4 %

Selling, general and administrative
expenses                                          26,502    13.1 %     27,255     12.2 %
Research and development                           6,380     3.1 %      7,733      3.5 %
Restructuring charges                              4,610     2.3 %      1,264      0.6 %
Net loss on sales and disposals of assets              -       -          104        -
Operating loss                                   (19,958 )             (4,045 )

Other (income) expense, net                       10,224     5.0 %     11,937      5.3 %
Loss before income taxes and equity loss
from NEC TOKIN                                   (30,182 ) (14.9 )%   (15,982 )   (7.1 )%
Income tax expense                                 1,580     0.8 %      1,771      0.8 %
Loss before equity loss from NEC TOKIN           (31,762 ) (15.7 )%   (17,753 )   (7.9 )%
Equity loss from NEC TOKIN                        (3,377 )  (1.7 )%         -        -
Net loss                                       $ (35,139 ) (17.3 )% $ (17,753 )   (7.9 )%


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Consolidated Comparison of the First Quarter of Fiscal Year 2014 with the First Quarter of Fiscal Year 2013

Net Sales

Net sales for the first quarter of fiscal year 2014 were $202.7 million compared to $223.6 million in the first quarter of fiscal year 2013, representing a 9.3% decrease primarily due to a 9.8% decrease in average selling prices. The decrease in average selling prices is due to a shift in product line mix. The effect of the decrease in average selling prices was partially offset by a 4.0% increase in unit sales volumes. In addition, net sales for Film and Electrolytic's machinery division decreased by $7.5 million from $8.1 million in the first quarter of fiscal year 2013 compared to $0.6 million the first quarter of fiscal year 2014.

The following table reflects the percentage of net sales by region for the quarters ended June 30, 2013 and 2012:

Quarters Ended June 30,

              2013            2012
Americas            29 %            27 %
EMEA                36 %            36 %
APAC                35 %            37 %
                   100 %           100 %

The following table reflects the percentage of net sales by channel for the quarters ended June 30, 2013 and 2012:

Quarters Ended June 30,

                  2013            2012
Distributors            46 %            46 %
EMS                     16 %            15 %
OEM.                    38 %            39 %
                       100 %           100 %

Gross Margin

Gross margin as a percentage of net sales decreased from 14.4% in the first quarter of fiscal year 2013 to 8.6% in the first quarter of fiscal year 2014. The primary contributor to the decrease in gross margin percentages was an increase in raw material costs for Solid Capacitors as well as the additional reserve of $3.9 million for inventory held by a third party. In addition we incurred a decrease in gross margin due to a decrease in average selling prices driven by the shift in product line mix.

Selling, General and Administrative Expenses

SG&A expenses were $26.5 million, or 13.1% of net sales for the first quarter of fiscal year 2014 compared to $27.3 million or 12.2% of net sales for first quarter of fiscal year 2013. The $0.8 million decrease in SG&A expenses primarily consists of a $2.1 million decrease in payroll and related fringe benefit expenses that resulted from headcount reductions taken as part of overall cost saving initiatives. Partially offsetting this decrease was a $0.8 million increase in NEC TOKIN investment related fees and a $0.6 million increase in information technology software maintenance expense.

Research and Development

R&D expenses were $6.4 million or 3.1% of net sales for the first quarter of fiscal year 2014, compared to $7.7 million, or 3.5% of net sales for the first quarter of fiscal year 2013. The decrease primarily resulted from headcount reductions achieved by leveraging the technology and licensing agreement in place with NEC TOKIN.

Restructuring Charges

We incurred $4.6 million in restructuring charges in the first quarter of fiscal year 2014 compared to $1.3 million in restructuring charges in the first quarter of fiscal year 2013. The restructuring charges in the first quarter of fiscal year 2014 included $4.1 million related to personnel reduction costs comprised of the following: $1.9 million related to the closure of a portion of our innovation center in the U.S., $1.1 million related to the reduction of solid capacitor production workforce in Mexico, $0.4 million


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related to an additional CIGS plan which will cover a maximum of 170 employees for up to 12 months in Italy and $0.7 million related to the Company's initiative to reduce overhead within the Company as a whole. In addition to these personnel reduction costs, the Company incurred manufacturing relocation costs of $0.5 million for the consolidation of manufacturing operations within Italy and relocation of equipment to Evora, Portugal.

The restructuring charges in the first quarter of fiscal year 2013 included termination benefits of $1.1 million primarily associated with converting the Weymouth, United Kingdom manufacturing facility into a technology center and manufacturing relocation costs of $0.2 million for relocation of equipment to China and Macedonia. The total termination benefits expected for the Weymouth facility conversion are $2.6 million and are expected to be completed in the third quarter of fiscal year 2014.

Operating Loss

Operating loss for the first quarter of fiscal year 2014 was $20.0 million compared to operating loss of $4.0 million for the first quarter of fiscal year 2013 primarily due to a $14.8 million decrease in gross margin for the first quarter of fiscal year 2014 as compared to the first quarter of fiscal year 2013. Additionally, restructuring charges increased $3.3 million in the first quarter of fiscal year 2014 as compared to the first quarter of fiscal year 2013. These expense increases were offset by a $1.4 million decrease in R&D expenses and $0.8 million decrease in SG&A expenses in the first quarter of fiscal year 2014 as compared to the first quarter of fiscal year 2013.

Other (Income) Expense, net

Other (income) expense, net was an expense of $10.2 million in the first quarter of fiscal year 2014 compared to an expense of $11.9 million in the first quarter of fiscal year 2013. During the first quarter of fiscal year 2014, we recognized a $0.6 million foreign currency exchange gain as compared to a $1.8 million loss on foreign currency exchange in the first quarter of fiscal year 2013, primarily due to the change in the value of the Euro and Mexican Peso compared to the U.S. dollar. In addition, we recognized a $1.4 million charge related to the write off of a long-term note receivable. Interest expense for the first quarter of fiscal year 2014 decreased $0.4 million compared to the first quarter of fiscal year 2013 due to higher capitalized interest related to the construction of the consolidated Film and Electrolytic production facility in Italy.

Income Taxes

Our income tax expense for the first quarter of fiscal year 2014 was $1.6 million compared to income tax expense of $1.8 million for the first quarter of fiscal year 2013. Income tax expense for the first quarter of fiscal year 2014 is comprised of $1.5 million related to income taxes for foreign operations and $0.1 million of state income tax expense. There is no U.S. federal income tax benefit from the first quarter of fiscal year 2013 loss due to a valuation allowance on deferred tax assets.

Income tax expense for the first quarter of fiscal year 2013 was comprised of $1.7 million related to income taxes for foreign operations and $0.1 million of state income tax expense. There was no U.S. federal income tax benefit from the first quarter of fiscal year 2013 loss due to a valuation allowance on deferred tax assets.

Equity loss from NEC TOKIN

In the first quarter of fiscal year 2014, we incurred an equity loss from our investment in NEC TOKIN of $3.4 million as NEC TOKIN is still recovering from the effects of the July 2011 flooding that occurred in Thailand in its capacitor business unit.


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Business Groups Comparison of the Quarter Ended June 30, 2013 with the Quarter Ended June 30, 2012

Solid Capacitors

The following table sets forth Net sales, Operating income and Operating income as a percentage of Net sales for our Solid Capacitors business group for the quarters ended June 30, 2013 and 2012 (amounts in thousands, except percentages):

                                            Quarters Ended June 30,
                                          2013                   2012
                                              % to Net               % to Net
                                    Amount     Sales      Amount      Sales
Tantalum net sales                 $ 94,139              $ 109,199
Ceramics net sales                   55,262                 51,545
Solid Capacitors net sales          149,401                160,744
Solid Capacitor operating income     12,808        8.6 %    25,518       15.9 %

Net Sales

Solid Capacitors net sales decreased 7.1% during the first quarter of fiscal year 2014 compared to the first quarter of fiscal year 2013. The decrease in net sales was driven by a decrease in average selling prices of 10.3%. The decrease in average selling prices is due a decrease in higher priced tantalum products across all regions. Tantalum net sales decreased 13.8% from $109.2 million in the first quarter of fiscal year 2013 to $94.1 million in the first quarter of fiscal year 2014 while lower priced Ceramic net sales increased 7.2% from $51.5 million in the first quarter of fiscal year 2013 to $55.3million in the first quarter of fiscal year 2014. The overall Solid Capacitors decrease was partially offset by a 3.6% increase in unit sales due to increased demand in the Americas and EMEA, which was partially offset by a decrease in demand in APAC as shown in the following table:

Quarters Ended June 30,

                                         Change in
              2013            2012       Units Sold
Americas          35.2 %          33.7 %        8.2 %
EMEA              34.4 %          33.7 %        5.7 %
APAC              30.4 %          32.6 %       (3.4 )%

Operating Income

Operating income for the first quarter of fiscal year 2014 was $12.8 million compared to operating income of $25.5 million in the first quarter of fiscal year 2013. The $12.7 million decrease was primarily attributable to a decrease in gross margin of $11.5 million driven by higher priced raw materials, the shift in product line mix to lower priced products and an inventory write down of $3.9 million. In addition, restructuring charges increased $2.9 million in the first quarter of fiscal year 2014 compared to the first quarter of fiscal year 2013. These decreases were partially offset by a $0.5 million decrease in SG&A expenses and a $1.1 million decrease in R&D expenses when comparing the first quarter of fiscal year 2014 to the first quarter of fiscal year 2013.

Film and Electrolytic

The following table sets forth Net sales, Operating loss and Operating loss as a percentage of Net sales for our Film and Electrolytic business group for the quarters ended June 30, 2013 and 2012 (amounts in thousands, except percentages):

                          Quarters Ended June 30,
                        2013                   2012
                            % to Net               % to Net
                  Amount     Sales       Amount     Sales
Net sales        $ 53,322               $ 62,888
Operating loss     (8,043 )    (15.1 )%   (6,208 )     (9.9 )%


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Net Sales

Net sales decreased 15.2% in the first quarter of fiscal year 2014 compared to the first quarter of fiscal year 2013. The decrease in net sales is driven by a decline in average selling prices, a decrease in end-market demand and adjustments to our customers' inventory stocking levels. Capacitor net sales were unfavorably impacted by $0.1 million related to foreign exchange. The Film and Electrolytic machinery division's net sales decreased by $7.5 million from $8.1 million in the first quarter of fiscal year 2013 to $0.6 million in the first quarter of fiscal year 2014. The decrease in the Film and Electrolytic machinery division's net sales is primarily due to a decrease in unit sales volume.

Operating Loss

Operating loss for the first quarter of fiscal year 2014 was $8.0 million as compared to an Operating loss of $6.2 million in the first quarter of fiscal year 2013. The $1.8 million increase in segment operating loss is primarily attributable to a $3.3 million decrease in gross margin in the first quarter of fiscal year 2014 compared to the first quarter of fiscal year 2013 due to decreases in average selling prices and overall market demand. In addition, restructuring charges increased $0.3 million in the first quarter of fiscal year 2014 compared to the first quarter of fiscal year 2013. These were partially offset by decreases in SG&A and R&D expenses of $1.5 million and $0.1 million, respectively when comparing the first quarter of fiscal year 2014 to the same . . .

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