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KEMET Corporation (NYSE:KEM)

Q4 2009 Earnings Call

May 19, 2009 9:00 am ET

Executives

Per Loof – CEO

William Lowe – EVP & CFO

Dean Dimke – Director Corporation & Investor Communications

Analysts

[Sabhir Zohere] – Severn River Capital

Matthew Sheerin – Thomas Weisel Partners

Joe Wittine – Longbow Research

[Omar Semulot] – Independent Financial Analyst

Unspecified Analyst

Operator

Good morning. At this time I would like to welcome everyone to the KEMET Corporation fourth quarter earnings conference call. (Operator Instructions) I will now turn the conference over to Mr. Dean Dimke with KEMET; please go ahead sir.

Dean Dimke

This is Dean Dimke, Director of Corporate and Investor Communications. Good morning and welcome to KEMET's conference call to discuss our fourth quarter financial results ending March 31, for fiscal year 2009. On the call with me today is Per Loof, our Chief Executive Officer and William Lowe, our Executive Vice President and CFO.

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

Before we begin I would like to advise you that all statements and address of expectations or projections about the future are forward-looking statements. Some of these statements include words such as expects, anticipates, plans, intends, projects, and indicates.

Although they reflect our current expectations, these statements are not guarantees our future performance, but involve a number of risks, uncertainties, and assumptions. Please refer to our 10-K and 10-Q for additional information on risks and uncertainties.

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

Per Loof

Thank you Dean, and good morning everyone. We continue to operate in a challenging environment as we all know. The short-term will continue to be turbulent and although we seem to see to quote the US Fed Chairman, Ben Bernanke, “a glimmer of hope. The world economy is still in a decline and the short and mid-term prospects are at best, uncertain.”

For many if not most companies, the worldwide deep recession continues to have a major impact on our industry and our business in virtually every segment. Our revenue for the fourth quarter ended March 31, 2009 dropped $54.7 million to $136 million, down sequentially 29% from $190.7 million in the quarter ended December 31, 2008.

Our gross margin in the quarter was virtually zero versus 12.6% in the third quarter. Adjusted for nonrecurring items our operating income in the fourth quarter fell to a negative $26 million from a negative $1.9 million in the third quarter. If we adjust for the business we sold in September, our sales declined from a year ago is approximately 40%.

We have actively been taking measures since last August to reduce operating costs. Starting with the leadership team, we reduced salaries by 10% for all salaried employees where possible in January. We eliminated our 401K match, we reduced our global work force by over 20% from 11,500 to around 9,300 today and these reductions began as early as last August.

We are currently manufacturing facilities at reduced rates to manage inventories. The Board of Directors also participated by reducing their annual compensation by 10% and meeting fees by 25%.

These restructuring and rationalization efforts and other cash measures have lowered our break-even levels significantly over the last three quarters. We now believe that the operating income break-even point for our tantalum business is approximately $75 million per quarter, ceramics $34 million, and film and electrolytic business $66 million per quarter.

For the company as a whole, assuming the same mix, our operating income revenue break-even level sits at $175 million per quarter. Now this bodes well for the company when the upturn comes assuming that we are successful with our current initiatives to reduce and restructure our balance sheet.

We did see some slight erosion in the market share in Q4 and this was attributed to a number of factors including our determination to maintain pricing and price increases that we previously negotiated in contracts for calendar 2009.

Additionally we were unwilling to participate in some tantalum price erosion specifically in the Asia region. In addition it can’t be ruled out that some customers had concerns over our short-term debt. Our working capital focus and our ability to refinance all of our short-term debt in this current debt market and at these rates, has in my view, now made the customer concerns almost moot.

The slight market share decline we experienced was mainly in our distribution channel as inventory reductions continued. However, this is really not a fact of our significant distributor position and we’re hopeful that this will be reversed once reductions are complete and we get back to a more true demand scenario.

Finally, our rationalization of the ceramics business away from low margin commodity business has of course has a sales volume impact. Cash preservation and thus working capital management was a key focus for us in this quarter with the objective to reduce inventories faster then the rate of decline to maximize cash.

Free cash flow from operations reached $16 million in the quarter. Unrestricted cash increased by approximately $14 million ending at $39 million, up from $25 million in the December quarter. This is largely a result of the release of working capital and of course our working capital management efforts.

Having said that we continue to see pressure on our cash in the short-term. We did make our semi annual payment to UniCredit on our long-term debt obligations on April 1, approximately $10 million, reducing our cash balance significantly immediately after the fiscal year end.

While I will discuss our segments and channels a bit later during this discussion I would like to make just a general comment. We do sense bottoming trends in some of our markets. However others may not have bottomed yet and may not bottom for another couple of quarters.

As a result we will have to continue to manage our working capital closely to maintain sufficient cash to operate our global business. We expect that our cash balance will decline between March 31 and June 30 as a result of continued low volume of revenue and operating losses and debt amortization repayments.

As I mentioned the UniCredit principal payment as well as other scheduled payments due typically reduce our cash reserves in our first quarter. Over the last three quarters we have made the strengthening our balance sheet the main priority. As you may remember we did pay down in full the senior note in September of $40 million.

We eliminated most of our short-term debt through the closing and funding of a new medium term credit facility amounting to €60 million with the UniCredit Corporate Banking. In addition on April 3 we entered into a second agreement to extend and restructure a short-term credit facility in the principal amount of €35 million with UniCredit Corporate Banking originally scheduled to mature on April 9, 2009.

This facility has been extended for a two year and three month period, and will now mature on July 1, 2011. We will repay this debt in three installments of €2 million each on January 1, 2010, July 1, 2010, January 1, 2011 and a fourth and final payment of €29 million on July 1, 2011.

During the term of this facility the outstanding balance will have an interest of six months LIBOR plus 2.5% and it will remain unsecured. On May 5, we entered into a series of agreements centered around a significant investment of our Platinum equity in the company which would, if successful, enable us to reduce our overall debt levels, provide incremental relief from UniCredit covenants and repayment schedules, and also give some very important incremental liquidity to help us get through the downturn and be ready for the upturn.

These agreements are conditioned upon among other things, the successful repurchase of at least 95% of our outstanding $175 million of convertible senior notes, pursuant to a tender offer which we launched on May 5. The notes are due in 2026, however, there is a put option for November of 2011 which is the date of course on which we are focused.

We do not believe that under current market conditions or at the pace with which we expect the markets to recover that we’ll be able to accumulate sufficient cash from operations to retire the notes at that time.

The proposed Platinum financing and related transactions represent the combination of a nine months profits whereby we and our financial advisor pursued a full range of financial and strategic targets. The Platinum financing and related transaction is for sure an essential building block for our company as we continue to see challenges ahead.

It will as I said not only reduce our debt but also provide much needed liquidity to help fund the necessary restructuring activities in particular in Europe, and investment in working capital to be fully able to fully participate in the upturn when it arrives.

In addition to the Platinum financing that will be available to us, our banking partner UniCredit has agreed again if the tender is successful, to amend the covenants significantly reducing the risk of default by not being in compliance. Furthermore again conditioned on the success of the Platinum financing UniCredit has agreed to defer the October principal payments of approximately €7 million and to extend the €35 million loan now maturing in July, 2011 to 2013 with no additional principal payments in the aggregate for the company.

As previously discussed if the tender is unsuccessful we will need to be extremely vigilant of our cash position and related working capital investments and we will be subject to increased loan amortization this year and more difficult financial covenants under our UniCredit facilities. And of course we will need to retire approximately $135 million of debt unrelated to our convertible note prior to the put date on the $175 million [inaudible] in November of 2011.

The tender offer will expire at 11:59 Eastern time on June 2, 2009 unless extended. Holders of notes who are validly tender and do not validly withdraw their notes on or prior to the expiration date will receive $300 for each $1,000 of principal amounts and notes purchased in the tender offer plus accrued and unpaid interest to but not including the date of payment for the notes accepts for payments.

Full details of the terms and conditions of the tender offer including the [inaudible] offer to purchase which we have been filed with the Securities and Exchange Commission. I’m not going to turn the call over to William Lowe, for a review of our financial results.

William Lowe

Thanks Per and good morning. I’ll begin our review on slide three if you’re following along on the website, income statement highlights. Sales declined to $136 million from $190.7 million in the December quarter for a 29% gross decline in revenue.

Gross margin percent decreased from 12.7% to a small negative or essentially zero in the current quarter and R&D and SG&A expenses were essentially flat. Items that effected our gross margin this quarter were predominantly volume related but we did also include a negative inventory valuation adjustment of approximately $3.4 million.

Turning to slide four, at the operating income line we reflected a non-GAAP operating loss for the quarter of $26.4 million compared to a non-GAAP operating loss of $1.9 million for the third quarter which can be found on slide six.

Special items in this quarter were primarily benefit plan adjustments, write-down of assets, and restructuring charges.

Turning to the balance sheet on slide five, I want to highlight a couple of items. First our unrestricted cash balance as of the quarter end increased $13.8 million. Taking into account the principal and interest payment made to UniCredit just one day after the close of the quarter, the first day of the next fiscal year, cash would have increased as of that date which is April 1, approximately $4 million.

As Per noted earlier we have successfully completed converting our short-term debt to long-term. What remains in short-term debt is primarily the two semi annual installments due on these UniCredit loans and a few other principal payments due on subsidiary loans within the next 12 months.

Capital expenditures were $2.8 million for the quarter. We expect that first quarter capital expenditures will be approximately $3 million or less. Our bank EBITDA for the quarter was $17.3 million compared to $4 million last quarter. As a reminder our bank EBITDA covenant begins with pretax income.

For those of you who like to begin the calculation with operating income or loss, the operating loss for the quarter can be found on slide four and as I said earlier it is $26.4 million on a non-GAAP basis which resulted in negative EBITDA of $13 million after adding back depreciation expense of $13.4 million.

Regarding our bank EBITDA and covenants, our first test of these covenants under our current loan agreement with is pre tender offer, is as of June 30, 2009. While we currently expect that we will be in compliance with both covenants as of June 30, it is likely that we will not be in compliance as of September 30 absent the closing of the Platinum transaction.

As Per said in conjunction with the Platinum financing we have negotiated new covenants with the bank that are in line with the covenants negotiated with Platinum and we also negotiated with the bank the deferral of the October, 2009 principal payment. Both the principal deferral and the change in bank covenants are conditioned upon the successful completion of the Platinum financing which in turn is conditioned upon the successful tender for at least 95% of our outstanding convertible debt.

Should the Platinum financing not be successful, there are no assurances that we will have or find external sources to provide sufficient liquidity to fund our operating losses, debt amortization requirements, and the necessary working capital to support an eventual upturn in the revenue cycle.

We would have to renegotiate our covenants and the deferral of certain principal payments with UniCredit and we cannot provide assurance that we will obtain such amendments. At this point I’m going to turn the call back over to Per, who will update you on the individual business groups and our markets.

Per Loof

Thanks William, I’ll start with film and electrolytic, the systems and organizational integration that we’ve been working on for some time was completed on schedule at the end of the fiscal year and the planned relocation of operations from Europe to Asia is on schedule.

Additional headcount reductions were implemented in the fourth quarter brought on by the additional contraction of the business and markets. Currently the F&E group is operating at 45% capacity. The book to bill at the end of the quarter was 110 and as of today, it remains at 110.

Revenue dropped $13.6 million, 23%, from the previous quarter to $46 million which is 34% of our total revenue. Margins were negatively impacted by about $3 million during the quarter as we decreased our inventories adjusting to current and future demand.

Turning to our tantalum business, we saw lower volumes due to the global economic downturn but we did benefit from the implementation of cost strategies initiated and from improved ASPs. Sales revenues were $59.8 million, down about 35% from the third quarter now representing 44% of KEMET’s revenue.

Weaker sales were seen in all regions but as previously mentioned overall ASPs were better then third quarter. The tantalum business group reduced plant operational expenses to adjust to current order rates by temporarily shutting down plants and reducing headcount.

The reduction in spending however was not able to offset as expected the lower revenues. On a brighter, inventory reduction efforts resulted in a $13.6 million inventory improvement. Capacity utilization today is at 60% in total but the polymer demand is increasing and we are now bringing back staff in our Chinese facilities. The book to bill on March 31 was 115 and as of today it is 118.

The ceramic business finally experienced a decline in revenues of 23% in the quarter on a 27% drop in volume totaling $31 million and representing 22% of our business in the quarter. Margin was favorably impacted by a mix shift to higher margin products as well as continued improvement in manufacturing cost structures.

Inventories were drawn aggressively during the quarter to drive cash generation. The book to bill at the end of the quarter was 0.99 but have since turned positive and is now at 1.30 and utilization is at 50%.

Now let’s turn to sales by regions, and let’s start in Asia. Orders received started to increase just after the lunar New Year holiday. As of the end of our Q4, the book to bill rate closed at 1.2 which was a positive trend that has been improving during this current quarter and is now today at 1.27.

Revenues in Asia were down 40% quarter on quarter thus accounting for only 31% of total revenues, down from 37% of the previous quarter. This we believe is a direct result of the consistence, [obstinance], and decrease in consumer spending and countenance. One bright spot was telecom, which held up nicely on the back of the China stimulus package.

Customer confidence to place long-term orders remained cautious. Manufacturers have aggressively reduced inventory at all stages which now, not surprisingly you might say, has begun to show itself in notable increases in urgent orders and expedites, especially from the notebook and netbook manufacturers.

In distribution adjustments to inventory levels continue in order to allow them to operate in line with forecasted customer demand. Again, urgent order requests are also being seen here as a result of these inventory reductions.

Customers may be a bit too cautious, holding orders due to lack of confidence in the near-term demand scenario and now having to scramble to find components to fill incoming demand. The EMS segment was also lower driven by softness in end customer demand and inventory adjustments.

The consensus points to a lack of clarity of future demand and of course the need to be cautious given liability agreements and the continued need to manage cash. Looking forward the EMS business is now showing some positive increases in demand based on the quotation requests that we receive. It appears significant headway has been made on inventory reductions which clear the way for improved order volumes going forward.

Areas showing the most positive signs include the notebooks and netbooks along with mobile phone consumption in China. Consumer electronics appear to be stabilizing with consumers once again starting to buy albeit at a very directed and managed pace.

Our total order and shipment rate in China is increasing which we partly attribute to the positive impact of the China government four trillion Yuan stimulus package. We are quite frankly amazed by the speed by which the Chinese government has reacted. The Chinese stimulus package should increase demand in the areas of railway expansion, wind power generation, 3G infrastructure and telecom expansion, and promotion of green technologies.

These are all areas where we have existing and targeted product participation. Clearly we hope to share in the expansion resulting from this significant investment. Again, this is another area in which the successful completion of Platinum financing will enable us to access needed cash for working capital investment.

Looking at sales in our Americas region, the revenue in Q4 declined 24% versus Q3 as end demand continued to drop and accounting for 27% of our total revenues. Book to bill for Q4 finished slightly negative at 0.98 and demand was weak across all segments except for aerospace and defense.

Our distribution channel which accounts for a large portion of our Americas revenues continued to reduce inventory to match lower demand as turns decreased to 3.2. Sluggish OEM demand was also evident. Our current Americas book to bill is now positive at 1.22 and backlog is beginning to grow slightly.

Our European revenues declined by about 20% compared to the previous quarter accounting now for 42% of our total revenues. While the automotive segment showed a slight bit of resiliency, the distribution channel pull down sales in this region and in general all segments were negatively impacted by the recession.

Simply put, all products and market segments were effected in a similar way as the industry struggled to come to terms with the slowdown. Data for our tantalum in Europe shows that the overall market was effected in the same way however all overall revenues were flat for each month in Q4 maybe suggesting that the market is starting to stabilize.

Pressure on inventory was evident everywhere as customers moved to reduce inventory levels. Additionally they seemed to change their purchasing patters to a buy what you know you will consume model aiming to take advantage of shorter lead times from suppliers.

Pressure on inventory was particularly evident within the distribution channel as our partners adjusted their modus operandi in line with end customer POS. The book to bill in EMEA at the end of the quarter was 105 and is today essentially flat as 1.06.

From our data we do believe that Europe has yet to bottom. The US may be there or thereabouts shortly, and Asia re China is again in a growth mode albeit at much lower levels then six months ago. Some economists have suggested that it will take until 2013 before the global economy will see the volumes we enjoyed just nine months ago.

Looking at the segments, revenues were down across all markets except military and medical where we were essentially flat. But we also saw some relative significant shifts between segments. Medical and military accounted for 12% of revenues, up, the telecom market represented 23% of revenue which is pretty consistent with what we have seen for the past few quarters.

Consumer sales accounted for 10% of revenue, also flat. However the computer based revenue accounted for only 14%. Normally we would see 18% of our revenues from this segment. Automotive accounted for 16% of revenue, also actually slightly up. Industrial sales however accounted for only 25% of our overall revenue. Because a lot of our industrial revenue originates in Europe, this is largely a European story.

We fully expect as we see stimulus dollars start flowing our industrial business to be a clear beneficiary of this activity due to green and infrastructure activities. On a channel basis the real news is the fact that distribution only accounted for 43% of our revenues, down from 49% in the prior quarter. This is the result of continued inventory purging. We expect this business to return to more normal levels as the economy improves and stocking patterns return to normal.

EMS maintained at 19% of revenues and the OEM channel increased to 38% of overall revenues. Our direct business clearly faired better then the indirect. In these uncertain times where there might have been some balance sheet concerns, customers that we dealt with directly may have felt more comfortable. Lessons to be learned.

Regarding the future one of our growth strategies involves expanding our North American production of film and our electrolytic products in order to position us as the significant player in the alternative energy and green technology markets.

Demand for energy will continue to increase and alternative energy is an important growth market. We do produce the products to support the development of alternative energy and we aim to expand operations in the US in order to compete in the North American alternative energy market.

This expansion will create upwards of 120 new jobs in the United States. We are pursuing funding for this expansion from a number of sources, one source being the US government. We have submitted a grant request through the provisions within the US government’s economic stimulus package, specifically the electric drive vehicle battery and component manufacturing initiative. We are ready to roll on this initiative and if the US government is looking for a shovel ready, actually I would say post shovel ready project that will create green jobs immediately, we believe we should have at least a 50/50 chance of receiving grant funding.

But then again, this is unchartered territory for us and we really do not know if an when it will be approved. In normal circumstances we would have done this without the government of course, but as you all know these are not normal times.

We don’t expect to hear from the government until the fall and in any case even if we are successful and even if we staff up very quickly, the benefit to the company is several years out.

In conclusion, we believe that we have weathered the economic storm up to this point. It appears that we’ve seen some bottoming trends. However we believe we will continue to bump along the bottom for some period of time before we see any significant pick up in revenue.

In the absence of the Platinum financing, there remains significant pressure on our cash balance over the near to medium term, thus we will remain vigilant in our cash preservation efforts, continuing to manage as we have been our expenses and working capital very, very close to the vest. We’ve made significant progress over these last nine months, but clearly the work is not yet fully done.

I do want to thank all of our employees for their hard work during this trying period, participating by taking temporary salary and benefit cuts, and for their suggestions of cost reduction measures for managing savings within our facilities, to process changing improving efficiencies. All aimed at saving money for the company.

I’m also heartened by the strong support of our customer constituency. And I want to convey a special thanks to our customers as we commence our 90th year of operation. In the end as we all know nothing much happens without an order.

This concludes our prepared remarks, and we’ll now be happy to respond to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of [Sabhir Zohere] – Severn River Capital

[Sabhir Zohere] – Severn River Capital

Two questions, the first on your accounts payable, are your suppliers forcing faster payments, is that why the days payable has come down.

Per Loof

No we have pursued a strategy of ensuring that we have dealt with our suppliers in a very efficient manner and as you see we have taken measures to take that down but clearly we are seeing positive trends.

William Lowe

I would just comment that when you go back a couple of quarters, you would see that our payable days were up in the high 40’s and we did have some suppliers that we had not been diligent with as paying on time as we should, and so we have made an effort to keep our suppliers up to date and that’s the primary reason that the days have gone back down to that average.

Per Loof

Its also a bit of an Italian story here, the fact that some of the suppliers that came with some of the acquisitions were not being treated as well as well as we probably thought they should and therefore the significant effort to ensure that that was being taken care of.

William Lowe

On the other hand we look at the receivable days in the 80’s, we have a project that’s been under way and has improved that somewhat to reduce the number of receivable days because we’re upside down by 50 days there between the payables and the receivables so we have that on our radar especially the past dues that are owed to us which is pretty much global but primarily based, primarily Asian effected the Europe and the Europe and Americas are pretty much on time.

[Sabhir Zohere] – Severn River Capital

On the tender offer, is there a reason you haven’t approached the convert holders directly as opposed to paying $10 million in fees.

Per Loof

I think this is the way, this is the proper way to approach the note holders as a group and we have taken a lot of advice on this over time.

William Lowe

We started this process over 10 months ago and we have looked at all different types of ways of dealing with the strategy going forward and the way we have handled it I believe has been the most prudent way of going forward.

[Sabhir Zohere] – Severn River Capital

Is there a plan B if for some reason the tender doesn’t work out.

Per Loof

If the tender doesn’t work out as I said in my prepared remarks we will have to pursue strategies with UniCredit and others and see how we can renegotiate covenants and the like and hopefully, we are clearly hopeful that the tender will be successful.

Operator

Your next question comes from the line of Matthew Sheerin – Thomas Weisel Partners

Matthew Sheerin – Thomas Weisel Partners

So let’s just talk about demand, if you go back to your January 28 call and I certainly appreciate the fact that back then no one had any visibility but you said in the call that you expected business to be flat to down a little bit and of course it was down a ton, did that happen through the quarter. Because a lot of your competitors and even distributors did see business come back in March. Did that not work out for you or did this business get back throughout the quarter.

Per Loof

No the business, if you go back six months and we just look at monthly revenues over this period. October was $75 million, November was $60, December was $55, and then it really dipped in January down to $38 million. It started to pick up a bit to $44 million in February and $52 million or so in the March quarter.

So we have seen business come back and we’ve seen the demand improving and as I said the book to bill today for the company as a whole is 118 and we do expect that particularly in Asia that we will see an improved, we are seeing an improved demand picture.

But we had, and maybe because of our distribution focus, we had a clear drop much further drop then maybe some of our competitors in the quarter due to the inventory purging that I discussed in my prepared remarks.

Matthew Sheerin – Thomas Weisel Partners

Okay but it sounds like your expectations are growth in Asia, maybe a little bit of growth in Europe and North America so that gets you to maybe kind of low to mid single-digit sequential growth, or are you more optimistic then that.

Per Loof

I think we will see, I don’t want to make any predictions in this market because we don’t really know that the current demand picture that seems to positive and as I said we are seeing customers asking for expedites and urgent orders and the like but I would expect that we will see sequential growth in this coming quarter in the mid to upper single-digits possibly but again the demand picture is very uncertain and the times we’re living in are of course very, very difficult to predict.

But it seems right now that the demand picture is improving somewhat.

Matthew Sheerin – Thomas Weisel Partners

Okay great, and then I know that gross margin was impacted somewhat by the fact that you’re just working down inventory and brought down production to sort of below optimal levels, is that going to continue this quarter. Will you see the gross margin down in that very low range and at what point do you think you’re going to be able to get that inventory to where you want and if you are in let’s say running at, let’s just call it 150 million revenue run rate over the next two to three quarters, what inventory level would you be comfortable with.

Per Loof

We could probably draw down inventory a little bit further, not just because of demand will be low but also by just being more efficient and a lot of measures have been implemented to do just that. But the big drawdowns have largely been done and as you can see, you see the positive effect on cash of course and the negative effect on the P&L.

I think you will see that to have sort of run its major course at this time. You will see an uptick in the growth margin, yes.

William Lowe

While we’ll continue to reduce inventories to increase our turns of inventory over the course of the fiscal year, it will not be as dramatic in any one given quarter as it has over the last two, is our expectation.

Matthew Sheerin – Thomas Weisel Partners

And certainly that’s been a saving grace, the fact that you are able to generate cash, so when you do start to grow let’s say in mid to high single-digits over the next few quarters, you’re still going to be below your profitability, that $175 million break-even level, yet in theory you wouldn’t be generating much cash on the working capital because that wouldn’t be going down, so you look like you’ll be burning cash over the next few quarters, is that—

Per Loof

We have some repayments that we have to make which of course will effect cash and I think as I said in Q1 we typically, that’s in a low point in cash, and I think we will, our cash reserves go down in the first quarter.

Matthew Sheerin – Thomas Weisel Partners

And just lastly just on that tender offer, it looks like the converts are actually trading now above your offer prices, is that, are you open to raising that or is that binding, that offer.

Per Loof

The offer we have on the table is the offer. So we don’t really have any opportunity to make any changes to that. The offer is what it is.

Operator

Your next question comes from the line of Joe Wittine – Longbow Research

Joe Wittine – Longbow Research

I just wanted to go back to when you were walking through the income statement, I think you mentioned there was a negative inventory valuation adjustment of $3.4 million. I’m assuming that was run through the P&L.

William Lowe

It was and we didn’t, its included in the impact on the operating loss of $26.4 million even on the non-GAAP because I didn’t pull it out. Its not a special charge its just a, that’s what happens when you’re doing inventory adjustments and valuations and ASPs decline somewhat. So it was a standard type of adjustment you would have to make so we did not pull it out of the special charge, but I wanted to mention it because it did run through the P&L and is included in the operating loss of $26.45 million.

Joe Wittine – Longbow Research

So that was up in COGS I would assume.

William Lowe

Yes, its in COGS.

Joe Wittine – Longbow Research

And then just secondly the, you sounded like you were enacting some additional restructuring during this quarter here, what should we model for an SG&A run rate. I don’t know if you get a benefit from a full quarter of the corporate level reductions going forward or is the 18.5 non-GAAP figure that we see kind of the good baseline.

William Lowe

It kind of remains kind of flat, we had a little bit of charges this quarter that ran through SG&A that are probably non repetitive, but I think going forward you’ll see a run rate around that $19, $19.5 million kind of level on a dollar basis.

Joe Wittine – Longbow Research

And then do you have any operating cash goals for fiscal 2010 here, anything you’re working towards that you would be willing to add.

Per Loof

On operating cash balance goals?

Joe Wittine – Longbow Research

Yes, either a cash balance or a cash flow figure for the year.

Per Loof

Yes clearly we have, we don’t typically publish those but of course we have cash balance, cash goals for every quarter in every business and whatnot as you would expect.

Operator

Your next question comes from the line of [Omar Semulot] – Independent Financial Analyst

[Omar Semulot] – Independent Financial Analyst

A few housekeeping, will there be a cash, actually what was the cash restructuring charge for this quarter.

Per Loof

It was a little over, well the amount of cash that actually went out for previous restructuring actions was about $5 million I think in cash terms. Although the charge to the, the charge for restructuring in the current quarter was like $1.3 million. But cash, which encompasses those restructuring actions and then actions that were announced in the prior quarter was a little over $5 million and we would expect cash flow out the remaining fiscal 2010, that’s left over on those actions be around $4 million.

[Omar Semulot] – Independent Financial Analyst

Okay so for the quarter a little bit over $5 million and do you expect a cash charge for next quarter.

William Lowe

Yes, its not that large though. I think its $1.5 million or less.

[Omar Semulot] – Independent Financial Analyst

How does the curtailment gain, how does that effect the EBITDA calculation for your covenant with UniCredit.

William Lowe

Its included because we start with pretax income.

[Omar Semulot] – Independent Financial Analyst

So you add it in.

William Lowe

Yes.

[Omar Semulot] – Independent Financial Analyst

Okay. You have a small loss on an asset sale, could you comment on that asset sale. Was it significant at all.

William Lowe

Its not significant. This is this loss on the [inaudible] of assets is just, every business has assets that periodically you dispose of. Its just general machinery, this is not part of the business and that kind of thing.

[Omar Semulot] – Independent Financial Analyst

In terms of, you mentioned your customers being a little worried given your short-term debt situation, since that has been resolved, have you seen an improvement in their attitude towards you.

Per Loof

We have and of course we’ve had very extensive conversations with our large OEM customers and as I said in the prepared remarks we have seen very little drop out or share losses. We’ve not seen any share losses in our OEM business globally and maybe because we’ve had the opportunity to have very open conversations with them where we have NDA agreements and whatnot to be able to have open discussions about the activities that we are undertaking.

Of course they were very pleased with firstly the fact that we managed to close the €60 million debt and then again, the €35 million that we dealt with beginning of April and I think as I said, I think the customer concerns are now largely over.

[Omar Semulot] – Independent Financial Analyst

So you think any market share loss will probably have come from the distribution—

Per Loof

If you look at the numbers, the fact that our distribution business dropped from 49% of revenue to 43% of revenue kind of tells the story. And we are working with our distribution partners more actively to ensure that their sales force has the correct data to tell their customers about what really is happening with KEMET and I have to say again, on the customer side, that the support that we are receiving from our customer constituency is very heart warming and they really want KEMET to continue to be a successful company.

[Omar Semulot] – Independent Financial Analyst

How could we quantify going forward, you’ve been able to lower your structural costs significantly, so how can we quantify the operating leverage that you will have on gross margin going forward. In other words any additional dollar of sales, how will that translate into the bottom line.

Per Loof

If you look at the variable margin for our different business, they’re all, and from mid to low 40% to high 40’s. And as I said we have managed to lower our break-even point on an operating income level to $175 million from over $200 before and way over that previously.

So we have, we expect when the business returns that it will be a good leverage for us going forward. Assuming that we get a financing put in place that we now are pursuing, and assuming that the world somehow starts to return to some normalcy, the fact that we have lowered our break-even points and dealt with the restructuring efforts, moved things to where they need to be, I think will help us improve our bottom line significantly.

Having said that as part of the financing discussions with Platinum, we have some additional restructuring efforts that we would like to pursue and I mentioned that as well in the remarks and we assume that as we go forward with this we will be able to tap into Platinum to help us finance some of those restructuring efforts going forward.

Which again will improve our break-even or lower our break-even points even further.

Operator

Your next question comes from the line of Unspecified Analyst

Unspecified Analyst

A question, I assume that the, what you would like to do is consolidate the F&E facility in Italy down to one factory, would that be something you could do if the tender offer goes through or would you need additional financing from Platinum to do that.

Per Loof

That’s been the plan.

Unspecified Analyst

In other words is that in the plan you would need additional funding or it would, you would be able to do that if you just get this tender offer done.

Per Loof

Correct.

Unspecified Analyst

And how much would that lower the operating income break-even point do you believe.

Per Loof

There is a lot of things going on here, there’s the consolidation of the plant into one facility in Italy. There’s continuous movements of activity from high cost countries in Europe into our Bulgarian facilities. There is still some additional continued activities that we would like to move to Asia and of course as I said we also would like to get something done in the US. As part of this agreement with Platinum there is in addition to the $52 million that we have for dealing with the tender.

There is in additional loan facilities totaling $25 million and there is a further uncommitted $40 million that can be withdrawn in the future, largely to be invested in further restructuring activities. We don’t need all the $40 million to do this but we need some of it.

Unspecified Analyst

Would accomplishing these restructurings that you’d like to do entail any additional dilution to the common.

Per Loof

Well the dilution to the common, you’re talking about the warrants that—

Unspecified Analyst

In other words besides what you’ve already laid out in your press release.

Per Loof

No.

Unspecified Analyst

Last question and you’ve sort of answered this but I’m going to put a fine point on it, under the UniCredit agreement original agreement, you had a trailing 12 month EBITDA covenant, I think that was $60 million and you said we can make that in June and I think it was a little more problematic in September, the question is under, if the tender offer goes through can you give us a specific number that that trailing 12 month EBITDA covenant will be at or have you totally gotten rid of it, could you explain exactly how that’s going to work.

Per Loof

Basically the whole covenant structure starts again, starts anew, and in my estimate the agreement with UniCredit under the Platinum transaction will basically, the Platinum covenant and the UniCredit covenants are basically the same. And will allow us to in my view meet the September covenant and December and beyond and really [inaudible] changes the whole covenant picture.

William Lowe

I’ll just add a little color, as Per said it starts over we’ll start, and we’re not supplying a number but we’ll start with the June quarter as a one quarter test and begin to add quarters to that so eventually we end up with a four quarter rolling average. But I’ll just say that its substantially different then our current covenant levels and we’re confident in those numbers at this point.

Unspecified Analyst

But those numbers are not going to be made public.

William Lowe

Not at least those and we’re not willing to publish those today.

Unspecified Analyst

It sounds like you’re making a lot of progress, congratulations.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Per Loof

I would just like to thank you for being on the call this morning. Clearly we are living in unprecedented times and hopefully the glimmer of hope that has been cited here actually will come through and we are encouraged by the activities that we’ve undertaken.

We are very encouraged by the support we’re getting from our customers and clearly also from our financing partners, UniCredit in particular, and now hopefully our new financial partner Platinum Equity.

So thank you all for being on the call this morning and have a good rest of the day.

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Source: KEMET Corporation F4Q09 (Qtr End 03/31/09) Earnings Call Transcript
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