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Executives

William Lowe – EVP and CFO

Analysts

Amitabh Passi – UBS

Kemet Corporation (KEM) UBS Global Technology and Services Conference November 14, 2012 11:00 AM ET

Amitabh Passi – UBS

Okay. Thank you everybody, we’ll go ahead and get started. My name is Amitabh Passi, I’m the Supply Chain and Networking Analyst at UBS. And it’s my pleasure to welcome KEMET. And presenting on behalf of KEMET is Mr. William Lowe, the Chief Financial Officer. Thanks Lowe.

William Lowe

Thank you and good morning everyone and thank you for attending the KEMET’s presentation today. I’m going to start out, just a little bit of a company overview for those who may not know us very well, would be around quite a while.

We do have global manufacturing sites around the world. We have about 22 manufacturing locations in about 10 countries, a little over 10,000 employees. And we have a global sales force, it’s broken up by region in the America and India and Asia.

We have three business segments that we report, we report in a Tantalum business unit as Ceramic as well as our Film & Electrolytics business group. The purpose of this slide really is to show, there is some cross over and the market segments, primarily between Tantalum and Ceramics, so you can see between the computer and gaming and health in the TV area and as well as some of the military and aerospace products that we make cross-over between both Tantalum and Ceramics. And then Film & Electrolytics business unit, primarily big focus on industrial automotive and then renewable energy products.

Just again, looking at our global reach, we have a production base as I said, that’s around the globe, a large concentration in Mexico and China. We also have major sales locations throughout, both the US, Asia and throughout Germany – and sorry, throughout Europe.

Looking into the market overview, I want to start with a slide that we’ve actually put for the first time on our last earnings call to demonstrate, we’ve talked over the last several quarters about what has moved our revenue up and down a little bit and directions over the last several quarters, as primarily we talked about the distribution channel. And what I would demonstrate by this chart really is, you can see in the blue line which is the top-line here, how much it has moved up and down dramatically over the course of, quite a few quarters, compared to say our OEM channel or our EMS channel, they’ve certainly not been flat but they certainly haven’t moved up and down as much as the distribution channel.

We think that either the blue line as you see, as it declined into the last quarter, we expect again to see a bit of a de-stocking still occurring through this December quarter. And as we said in our earnings call, we expect potentially we expect to see – they started coming back as we get into our final fiscal quarter ended March of next calendar year.

From a – looking at the revenue, breaking it down between the segment, the channel, our regions and then our business groups, looking at last year’s revenue broken down this way, you can see that we have from a segment standpoint about 19% of our revenues in transportation, that primarily is light vehicle. About 11% last year in Defense and Medical, that’s fairly consistent usually runs around 10% or 11%.

And then Telecom, which is primarily base stations for us, that’s around 19%, computer at 15%, consumer at 10% and then Industrial & Lighting at 26%. And channels again, you saw on our line short, distributions around 42% last year, OEM around 43% and EMS at 15%.

From a regional standpoint fairly evenly split, last year Americas around 28%, the European region at 38% and Asia at 34%. And then again our largest business group, the Tantalum Business Group, and they were about 42% of our revenues last year, Ceramics business group around 22% and Film & Electrolytics at 36%.

I’m not going to go through all the customer list here but just a point that we do a strong customer relationships on the OEM side with a lot of names that all of you would recognize immediately when you look at this chart. As well as our distribution channel with where our largest distribution goes through those folks as well as the EMS channels with Flex and Foxconn and JBL, I think just presented before I came on today.

We’ve been focused a lot over the last couple of years on restructuring and moving into a low cost locations in Europe and I want to cover a little bit about what we’re doing there and what our status is. We just recently opened a facility in Skopje, Macedonia, this last month in October, that facility is – we’re moving – we have moved equipment in there from other locations within Europe to have a low cost manufacturing facility to serve Europe as we’re doing our restructuring.

In addition, we currently have three facilities in Italy, we are constructing a new facility where we will close the three facilities we have today. And move into one facility in Pontaccio Italy, it’s actually just down the road a little bit from one of our facilities so it’s fairly close by on one of them. We expect this instruction to be completed and our stuff to be completed with that Film & Electrolytics Group some time next summer and move into this new facility and lower our fixed overhead, with 586 people are remaining in Italy when we’re completed this construction.

The other things we’re focused on has been reducing our cost of materials. We bought up a foil facility in June of 2011 and that is really for securing our long-term supply of quality aluminum foils for our business.

And the largest one really is in our Tantalum business unit, we’ve had significant increases over the course last several years in our raw material which is Tantalum powder. And again this is our largest business group, Tantalum powder was our largest raw material purchase that we make within the company.

We are sourcing, so we set out to really vertical integrate our supply chain, to do that we needed to do three things, we needed to be involved in sourcing, the Tantalum Light or directly from a mine. We needed to be involved in the K-Salt production which is the second step in the process of taking the ore to return it to powder and then also to convert K-Salt to powder itself. So, I’ll talk about those three steps that we’re in the process of doing.

We have been involved consistently with the SEC and Congress over the last couple of years relating to the section of the Dodd-Frank Act that deals with sourcing minerals from the Congo. And we’ve been amongst the leading companies to assure that those continuous improvement of quality of life and the DRC as a result of our relationship with the mine there in the Congo. And we did work with the SEC and support finalizing the final rules as it relates to the regulations around the Dodd-Frank section of 1502.

As a part of this – the process, we purchased a powder producer that was actually one of our suppliers called Ni-Tan. They were a leading manufacturer of Tantalum powders. We purchased them for $75 million we did pay them $30 million at closing. And we’ll be paying them over the course of the next 30 months basically, we made another payment this last August of $5 million, and essentially the payment terms that we’ll pay $10 million every six month until we reach the $75 million, that’s over a 30-month period and that is interest free as well. This is located in Carson City, Nevada. We closed the acquisition in March of this year so we are fully operational there and working to fulfill our supply chain.

So, when you look at this slide on how this supply chain is vertical integrated, we have not purchased a mine but we have expect worked to engage miners and supply contracts to supply timid with the ore, where we take title for the ore at the mine’s site before it’s shipped out as to go to the K-Salt facility. The ore is then as I said converted to called K-Tap or K-Salt. And then it’s converted to either powder or Tantalum powder wire and the wire is actually also used in production as well.

So we have vertical integrated the entire source of our supply chain, in an effort to reduce our costs in this raw material that we use in the Tantalum business group. It does not gives us the ability to manufacture the majority of our Tantalum powder requirements in-house. We think that we’ll be manufacturing around about 80% of our needs in-house as we go forward. We’re in the process again as I’ve said of getting the pipeline completely full. We expect that in fiscal ‘14, which begins next April, compared to our first quarter this year, we’ll reduce our cost approximately $40 million, compared to where we have been on annual basis, starting in Fiscal ‘14.

We are seeing savings per day, and we’ve eliminated that on our last few earnings calls. We expect compared to the first quarter of this year, which we did in June, we said that in this quarter that we’re currently in and in December, we’ll see about $5 million savings compared to the first quarter, about $7 million in the March quarter next calendar year and then up to the full amount of $10 million a quarter as we enter into the first fiscal quarter of next year which ends next June. That’s significant savings for the company and a significant reduction in our variable cost to produce our Tantalum product.

We are also taking very seriously our social responsibility in the Congo, where we have a relationship with the mine. We have provided some funds to put a new hospital in place, as well as a new school for the children in the village where this mine is located. And you can see in these pictures, what the existing hospital look like before our funding into the new facility, and the new facility is under-construction. We’re also providing funding for – training for doctors in the area as well, who will also be at the hospital.

And then last from a restructuring standpoint or I would say, from an M&A standpoint, we have entered into an agreement this past March, to acquire 34% economic interest in NEC token, with the 51% of voting interest. NEC token is a wholly owned subsidiary of NEC Corporation. And they manufacture Tantalum and other capacitors, electromagnetic materials, electronic components as well as electro-mechanical devices and access devices.

Revenue wise, NEC token in the period ended March 31, 2011 as we reported back in March, we announced the transaction there, revenues were approximately $755 million, and the EBITDA which I’ve provided in this slide, which we also indicated was around $70 million. We are awaiting regulatory approval today from MOFCOM which is the Ministry of Finance in China. We’ve already received approval from the European Union for the transaction.

And again, looking at the steps of this transaction, once we’re able to close this transaction, we will acquire the 34% ownership for $50 million, except two of the transaction, we have a call option in August of 2014, where we have the ability to do a couple of different things, one is we could step up our interest for another $50 million to 49% or we could choose that call option date to go to 100% on the basis of the same methodology as you see in the step three, which is basically six times, 12-month trial in EBITDA in that date.

Just looking at the overview of what NEC token looks like from again, from a revenue perspective breaking down the various product lines. Capacitors were around 40% during this fiscal period ended March 2011, the EMC area about 35%, the device in EM devices about 11%. The (inaudible) was around 7% and access devices around 5%.

They do have manufacturing in a variety of locations and some are low cost locations including China, Thailand, the Philippines, Vietnam and then they have three locations within Japan itself in Sendai, Toyama and Shiroishi.

I want to spend just a brief moment on our financial metrics, primarily focused on the balance sheet at the moment. As we ended the quarter in September, we had about $160 million of cash on-hand we also have a $50 million revolver that remains un-drawn, although we did issue a letter of credit to an OEM as a part of an OEM transaction that we’ve completed in the last couple of months, related to additional capital spend.

We have – the debt is on our balance sheet, is bonds that are doing 2018, they’re non-call for, their non-call period ends May of 2014. There are no maintenance covenants related to those bonds. And again, the due date is May of 2018.

From other metrics standpoint, we’re pretty much our – from a working capital standpoint, our AR and AP days are fairly well aligned 42 and 41. Inventory has been up a little bit lately, we are expecting to see some decline in our inventory balance between now and in the fiscal year, primarily related to the Tantalum business group. As I said, we were in the process of filling the pipeline from a vertical integration strategy point of view.

We at the same time simultaneously have continued also by powder, from our powder suppliers. So, as we get at that fall, we’ll find that we’ll be able to balance our inventories little better, from a raw material standpoint. So we do expect to see some benefit to cash flow over the course of the next couple of quarters, as it relates to the inventory balance in our Tantalum business group.

And just a final point, our targets for the company is to have gross margins on a consolidated basis of 25% and an operating margin of 10% is the goal. We have announced the number of actions over the course of the last two earnings calls related to reducing our fixed cost in the business to adjust where we see the world economies today.

We are not seeing a catalyst for any substantial change on the upside at the moment. And so, we’re making sure that we are running the business with our lower fixed cost to adapt to where we are for the next quarter or two from a revenue base.

And so, with that I’ll wrap it up. And if there are any questions, I’ll take those.

Question-and-Answer Session

Amitabh Passi – UBS

Excellent, thanks Will. If you have any questions, please get and raise your hand. Maybe I could just start off, you’ve got quite a few restructuring actions going on. Can you remind us at the end of fiscal ‘14, what is the cumulative savings you’re anticipating from the supply chain, vertical integrating in supply chain, the F&E restructuring and the additional restructuring actions?

William Lowe

Right, I’ll do it two ways. One is, the vertical integration again I said, the savings on an annual basis is $40 million. The actions that we’ve announced over the last two earnings calls totaled around $25 million annually. And we said on the call that actually our goal is to – if in fact revenue is $200 million range is to be breakeven at the net income line so that we are generating good cash flow even at depressed revenue levels where we’re at today, based upon where the world economies are that those actions will generate that kind of results to the bottom line.

Amitabh Passi – UBS

So, is the total in the $40 million from?

William Lowe

$40 million from the vertical integration and a $25 million annual savings from the other actions that we’ve taken over the course, beginning in August and we’re in the course of still doing some of those actions. So they are kind of phased in. But on an annual basis, as we get into the first quarter of next fiscal year, that number is $25 million.

Amitabh Passi – UBS

Okay. And then for fiscal ‘15, is it again $65 million?

William Lowe

Well, we haven’t projected fiscal ‘15, that’s why we’re talking about – into the next fiscal year, fiscal ‘14. And by the way when we talk about these savings numbers, we are comparing them to what our run rate was in the first fiscal quarter of this year. So, when we say $20 million – the $40 million for integration and $25 million all the other actions, we’re looking at it as we compare to where we were in the June quarter ended this fiscal year.

Amitabh Passi – UBS

Okay. Just maybe any update or thoughts in the competitive environment, what are you seeing from a pricing perspective across your three major segments (inaudible)?

William Lowe

I think we said on our last call that it’s been – it’s fairly, I only use the word normal, but a fairly normal environment as far as pricing goes, I mean, I think we’ve said there is some pricing pressure in our Ceramics area. However, we have concentrated a significant portion of our efforts to increase the specialty area of our Ceramics business unit. And the margins in that business unit have held between 29% and 34% of gross margins. We expect to hold in that range. We don’t see a change, as for is the normal, I think that is the normal pricing that’s going on in the marketplace every day, there is nothing abnormal going on or extraordinary that’s happening with ASPs.

Amitabh Passi – UBS

Okay. The one other concern of investors recently, I think of the last two to three quarters you’ve had couple of quarters in the negative free cash flow, I think you have $50 million payment coming due to NEC token, help us understand the cash dynamics as we look at the business over the next two, three, four quarters?

William Lowe

We’ve indicated that over the course of the next several quarters, we would continue to see some use of cash. This quarter particularly we do have our bond interest that we’ll pay effective what we already paid is due on November 1 or 2, I’m not sure exactly which day it was, but it has been paid. So we’ll see a use of cash there, we will continue to see with these actions we’ve taken, as you know how it works typically the cash that’s part of – for instance severance program continue to get paid out typically over a period of time. And so the benefits from a cash flow basis of these actions we’re taking we won’t see until we almost roll into next fiscal quarter.

So, we will see, we will continue to see some use of cash between now and end of the fiscal year. And then we expect to see some of that will be offset with this inventory reduction, we’re focused on reducing inventories. We indicated in the call that one of our actions that we’re taking is to that the Tantalum business group is exiting ever Portugal, which will actually generate additional savings in the next fiscal year, about $1.5 million a quarter.

But in addition to that we said that we thought that that would save about $5 million or $6 million in inventory or generate $5 million or $6 million inventory reduction between now and March 31. So, a portion of our inventory reduction will come from just Tantalum exiting the Portugal facility. We’re not closing that facility, where still operations are but Tantalum is exiting.

Amitabh Passi – UBS

Just from NEC token, there was some capacity at a facility in Thailand, do you have any sense of where we are in terms of normalizing production there, is it back to 100% lower?

William Lowe

Well, while we’re waiting for approvals, of course we’re pretty much hands off.

Amitabh Passi – UBS

Okay.

William Lowe

And so, information regarding their facilities, their production really has to come from them, at this point.

Amitabh Passi – UBS

Okay. Maybe just a question on supply chain, inventories across the supply chain, how would you characterize that?

William Lowe

Yeah, they don’t seem to be in excess, although we are still expecting to see some de-stocking happening from distribution this quarter as you saw our line graph there, we think that’s going to continue to decline slightly this quarter. In fact, the majority of our forecast that we forecasted our revenues to decline slightly between September and December is coming out the distribution channel.

And then we said we thought that that in the March quarter we would see that start to recover. So, there are certainly, I think they may be de-stocking a little below where their point of sale that is, but again that’s up to, and we decided we can’t control that channel, as we said on the earnings call. So, when they want product, we’re going to certainly sell it for them. But it doesn’t seem, it doesn’t feel like there is an excess amount of inventory out there.

Amitabh Passi – UBS

Okay. We have a question back here.

William Lowe

Yes.

Unidentified Analyst

(Inaudible).

Amitabh Passi – UBS

What would be the growth rate on a sector basis for you guys excluding NEC consolidation if that were to happen and what are the profit margins in that business after you get them with your?

William Lowe

That’s a good question. I think when you look at Tantalum, there is, two things going on in Tantalum, there is the standard M&L 2 Tantalum product that has been declining on an annual basis over time and probably continues to decline slightly over time as we go forward.

However on the other side of that coin, is a product that we make – that’s in more demand today and we’ve been adding capacity over time which is the polymer capacitor, a combination of polymer and Tantalum that we make. That particular product has been increasing in demand and we’ve been adding capacity as we go forward, so one side of the business has been declining a bit while the polymer production, we’ve been converting equipment to run polymer over time. The second half of your question was?

Amitabh Passi – UBS

Well, both growth rate going forward on the secular basis for Tantalum, the mix that you point out, something declining, something growing and then what’s the profitability potential cent per cent?

William Lowe

Yeah, the probability questions the part I forgot. Last quarter, Tantalum gross margins were around – they’ve been hovering the last couple of quarters between 15% and 17%. And if you run the numbers, with their buy-ins where they have been holding over the last couple of quarters, with the change that we’ve talked about with the $40 million, the gross margin then would go above 25% for that business unit at revenue levels that we reported in the last couple of quarters. So, that’s about 10% margin change from where they were at the low point.

Amitabh Passi – UBS

So, an operating margin, if you make the 25% growth is what on analyst is offering top of markets?

William Lowe

Well, that puts some water around our goal, which is around 10% or 11% operating margin.

Amitabh Passi – UBS

Okay. Suppose that happens and I assume the secular growth rate at Tantalum is below 10% in revenue in aggregate business, right?

William Lowe

Okay.

Amitabh Passi – UBS

Well, I’m asking you, is it?

William Lowe

Well, I think the numbers I’ve seen from those who track that would say that the overall rate is below 10, it’s probably between 5% and 7% rate.

Amitabh Passi – UBS

Okay. So, this business from investor standpoint, why is an attractive business?

William Lowe

Why is Tantalum an attractive business?

Amitabh Passi – UBS

Yeah, that’s a good portion of your business.

William Lowe

It is a good portion of our business and I think that as we develop more, again as we develop more additional new products which is always in the pipeline, as well as I think polymer is going to take off more than it has in the past, we see bigger growth in polymer in excess of decline of the standard M&L 2 product. So, we do consider to see that.

And again that – there is only three companies that make the polymer product in the world today at the moment, it’s us, UC Token and Samuel I believe. And so, that is why, there is fairly tight demand on that and I think the rate on that might be greater than what the overall blend is. And so, it’s a matter of where your – what products you have that’s going to grow. And I think we’ll grow that faster than the general cagier rate.

Amitabh Passi – UBS

And lastly, if you were to consolidate NEC token down the road, what kind of incremental operating profit does that give you?

William Lowe

Well, what we’ve said previously and I’ll just repeat that, is that we thought we believe that once we have taken on 100% and we didn’t put a timeframe on that we felt that the combination of that of the business would generate we said $300 million to $400 million of EBITDA together. We believe we can reach that – get to that point. Now that’s not on day one, that we consolidate. But that was our view that the two businesses together in a normalized timeframe would be generating $300 million to $400 million of EBITDA.

Amitabh Passi – UBS

Excellent. I think with that we’re almost out of time. We’ll have a breakout session downstairs in the conference room. Thanks Will.

William Lowe

Okay. Thank you very much.

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