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Bill Lowe - Executive Vice President and Chief Financial Officer

Analysts

KEMET Corporation (KEM) Deutsche Bank 20th Annual Leveraged Finance Conference October 11, 2012 7:10 PM ET

Bill Lowe

Good afternoon, and welcome to KEMET's presentation here at the Deutsche Bank Conference. I'm Bill Lowe, KEMET's Chief Financial Officer. I'm going to spend some time going through some general slides with you about the business and introducing you to KEMET. Some of the things we have going on at the company, and then we'll have time for a question-and-answer session after the end of my general remarks.

KEMET has been around for quite a while. We actually have 22 manufacturing locations in 10 countries. We're a manufacturer of capacitors in all shapes and forms, tantalum, ceramics, film, aluminum, electrolytic and paper. We'd like to say we offer about 95% of dielectric solutions that are possible in the [capacent] space.

We manufacture in key manufacturing facilities in Mexico, China, Indonesia and mostly throughout Europe, and as well as United States. About 10,000 employees and we have a global sales force covering split up amongst the Americas EMEA and Asia.

When we look at the business segment, again, we're broken up into maybe business types by type of materials being used in our capacitor. We have the Tantalum business unit, our Ceramic business unit and Film and Electrolytic.

In this slide, what I'd like to point out as you can see that there is some overlap between the Tantalum in the Ceramics business unit as far as the market segments that the two business group sell into from the computer, all the way into military and aerospace and medical.

Film and Electrolytics is very industrial based. Also, sells into automotive sector and is also the business group that deals mostly with our alternative energy sector and we'll talk about that in a moment as well.

Again, looking at a global reach, we can see we do have production and sales facilities across the globe. And when we look at our market, this is how our fiscal '12 revenue split between the segments, in the channels, the regions and our business groups.

Our period ended March 31st, last year, we were in our current fiscal'13 year today. So, let's start first with our channels. We were fairly evenly split last year between our OEM business and distribution business, and 15% into the EMS sector. And segments, industrial and lighting was about 26% last year. Transportation, which is primarily light automotive, it was 19%. Again, defense and medical and military and medical was about 11%, and has been consistently 10% or 11% in most annual periods.

Telecom, which for us is mostly base stations, it was 19% last year, and computer which is primarily notebooks, laptops, tablets about 15% and consumer at 10%, which goes across broad spectrum of everything from gaming consoles to some minor into TVs and things like that.

From a region, last year we had a substantial portion of business in EMEA or in Europe; it's generally split about this way with Asian and European being the two with higher percentages and the Americas, last year at 28%. Many years we see Asia and the EMEA at about the same rate 33% or 34% each and the Americas being the difference.

From a BG standpoint, business group standpoint, Tantalum is our largest business group at 42% last fiscal year, and they traditionally have been. The Ceramics business, see on this chart 22% and Film and Electrolytics at 36%.

We have a strong customer relationship. I am not going to spend a lot of time on this slide, but you can see that most of these names I am sure you're familiar with, especially in the OEM space and then in our distribution space are many of our key distributors that are listed here such as TTI, Avnet, Arrow, etcetera.

I did mention alternative energy. We do have reduced on alternative energy market both, all the way from hybrid vehicles, although way to electric motors and motor starts, wind, solar, thermal and storage as well as the smart grid. And, again, another sampling of some of the customers we sell into. You'll recognize most of these names as well in the green energy space, and we recently in the last year or so we've actually put production back in United States.

It was nice to bring some jobs back into the United States in the Simpsonville, which is basically manufacturing facility that is bringing some of our technology we have in Europe and our Italian operations supplying parts to the hybrid vehicle market in the U.S., where we not supplying before and are working on generating more revenue from that facility as we go forward, and we do try to walk the talk. We do have electric vehicle at the facility as a part of our company cars that we use for local use.

One of the things we've been involved with over the past couple of years is the restructuring of our general business in Europe, and I'm talking primarily about the Film and Electrolytics business group. We've been in the process. I've you've listened to any of our calls in the past about moving production from various locations in Europe to China and Mexico, and then also into different locations within Europe, so we are in the process actually next weekend. I believe on the 18th of October, actually having opening ceremonies at this facility in Skopje Macedonia, which we built to move production from various locations within Europe, which were closing as a part of the restructuring process to get into lower-cost restrictions and one of the locations was in Macedonia, where we are starting up here very shortly.

The secondary that we are doing is we are in the process of constructing a new facility in Pontecchio, Italy, which is not too far down the road from one of our existing facilities, but over the course of time we had three facilities in Italy. One as recently closed when this facility here is completed which we believe will be in the first quarter of our next fiscal year, April-June timeframe when we expect to finally complete our restructuring process, we'll move the two facilities we have today the production there in to Pontecchio, and some of that production has also gone to Macedonia already. And, we have about 586 people remain in Italy when we are complete.

The couple of other things that KEMET has been working on and it has to do with lowering our cost of production. The first is, that was a small acquisition we made in our foil facility in Knoxville, Tennessee. This facility was acquired in June 2011, and it allows us to secure long-term supply of quality formed aluminum foil for our business in Europe and it is made here and then used within our own facilities in our production of our film and electrolytic facility over in Europe.

The second thing which is probably a bigger process for us is, which took us a couple of years to put in place, is the sourcing of tantalum ore as well as I'll talk about the full supply chain. We're basically in the process vertically integrating our entire supply chain for tantalum powder for the use at KEMET.

As I said, the Tantalum business group is our largest business group. Tantalum powder represented our largest raw material buy has represented us is largest material buy, and prices have been going up constantly over the past several years and so chose to take a different tact. And of course, you've read, I am sure, several articles about tantalum ore in the DRC. We've been very active and involved with various agencies in the government as well as Congress themselves, regarding the Dodd-Frank ACT, Section 1502 which has a impact on companies who are using tantalum, tungsten, gold et cetera and tin.

So, we've been a part of that. We're one of the leading companies to assure continuous improvements also in the quality of life in the DRC. We are cooperating to do that. I'll show you some pictures of some things we are actually doing in the DRC, in the village in which the mine is located that we are working with. We've been very involved with the SEC all the way back to last year when they started the roundtable discussions about the Dodd-Frank Section 1502 about our conflict minerals in the Democratic Republic of the Congo. And, as a part of that what we had to do in addition to sourcing ore from mines, which is where tantalite comes from is we acquired a company called Niotan. It was a powder producer based in Nevada, in the United States. We now call that that entity KEMET Blue Powder, so that's how you'll hear as referred to it in the future, and they were leading manufacturer of tantalum powders that was a previous supplier to us. We purchased about $75 million plus $10 million royalty payments. We did pay $30 million at closing. We'll pay $45 million over the course of 30 months. The closing occurred in March 2012, and that's $45 million over 30 months with no interest rate applied to that. It's is essentially we paid, I believe, $5 million, six months after closing and then 10 months every six months thereafter until the $45 million is paid.

What that allows us to do with our vertically integrated supply chain? It takes us from the mine from where the ore is found, where it is bagged and tagged and kept in a close loop system as we would refer so we know that the ore that has been dug up and KEMET title to at the mine site is the same amount of ore that we receive at the dock and the ship and that the ship also where the ship docks to take it to the next step of the process it also always the same, so we assure ourselves that is not been tampered with.

The next step of the process, the ore is received at a facility primarily right now in Johannesburg that converts the ore to refer to K-Salt, and then we convert that K-Salt to powder and that's basically 1metric ton of earth that we dig out or that is dug up at the mine turns into about one pound of powder, so it is a significant process but for us it's a way to control our supply chain, it's a way to lower our cost of production. We have said that when we get this completed and fully ramped up, and we're in the process of fully ramping up, we will be saving on average about $10 million a quarter from what our spend was in the first quarter of this fiscal year. And, we've said on our last earnings call that in this particular quarter, September, it would be a small amount about $2 million, because we are ramping up, so it's maybe hard to see in the financial statements and then we would see another in the December quarter, another $5 to $7 million and then ramping up to around $10 million in the fourth fiscal quarter ended March.

Of course, that is predicated off the volumes that we saw in the first quarter of this fiscal year for Tantalum business group, but all-in-all, a very large significant reduction in our cost of production that will enable the Tantalum business group to regain their margins that they had prior to rising prices that were not able to recapture by raising prices in the marketplace.

As I mention, we do believe in social responsibility in that location. And, as you can imagine some of the conditions around the village, it's a fairly small village if you're doing research on it. It is Kisengo village in the Katanga of Congo. Here we're just depicting that at the time that we first got involved with the location and the individuals who live in the area, you can see a picture the existing hospital.

Here on upper right-hand side of the screen, and then where we have a hospital under construction that we are helping construct for the village as well as a school. You can see the interior of the school did not look like we are used to seeing of course, and we are in the process of conducting or constructing up a new school for the children in the village, as well as helping some trained doctors in the area that the doctors will be working at in the hospital for the villagers, so we are very interested in making sure that not only do they have work at the mine, but they also have better the conditions for the entire village.

One of the other major things that we've announced over the course of this particular calendar year has been an investment in NEC TOKIN. We announced back in March that we entered into an agreement to acquire 34% economic interest with a 51% voting control interest in NEC TOKIN. That comes with two different call options which I'll cover in just a minute, but it does make possible for KEMET to go a 100% in the future.

It is currently a wholly-owned subsidiary of NEC Corporation and the NEC TOKIN company which we are making the acquisition, is a manufacturer of both, tantalum and other capacitors as well as electromagnetic materials passive electric components and electromechanical devices as well as access devices, so it has three different, four different distinct business groups, Tantalum been one of the larger of the group.

And, as they reported they are the results for March 31st 2011, which we publicly disclosed in the past, their revenue was approximate $755 million. This slide here trying depicts the various steps. The one thing we wanted to assure ourselves over the course of this acquisition was that we had time to acclimate ourselves, acclimate the existing senior management team at NEC TOKIN as well as our customers across the globe both at KEMET and NEC TOKIN, so I described step one $50 million, investment for 34%, interest into NEC TOKIN. Step two, which really starts to occur in the August 2014 timeframe really allows us to do several things actually.

It's a call, so therefore we could do nothing. If economic conditions were such that we thought the best action was to not exercise call at that time. We could do that. Secondarily, we could make a second $50 million investment and take our economic interest to 49%, or at the time we could actually make an election to go 100% hundred percent on the basis of formula 6 times 12 months trailing EBITDA.

When we get to that date, I guess, we'll determine what's the best course of action for the company? We anticipate good working relationship with the team there. We're waiting at this point for regulatory approval from China. We have approval from Japan. We have approval from the European Union and awaiting approval from China.

Just an overview quickly of what TOKIN looks like there from a percentage, so you can understand the breakdown of the revenue of the $755 million that I mentioned. In first slide, the capacitors about 40%, the EM devices or electromechanical devices 11%, K-Salt, about 7%, access devices 5% and a smattering of other products around 2%, and they do have multiple locations for manufacturing they are in Sendai, Shiroishi and Toyama. They're in China. They are in Vietnam, the Philippines and in Thailand.

Kind of a wrap-up slide for us. If you look at our financials, our target margins where we are not at today, our target margins for the company on a consolidated basis is to be back to 25% through the cost actions that we've described both, in the tantalum space for our raw materials as well as the cost reduction actions that we discussed and announced in our earnings call in July, which we are implementing between that date. I believe that date was late July. That we are implementing between that date and end of this calendar year December, to get our margins back up the 25% level as we as operating margins at 10%. Our goal is to get back to the proper or at the revenue levels we are seeing today, which everyone I think agrees at a macro base we are seeing across industry is you know a bit less than what we'd all like to see at this point in time, but our goal is to get back to being profitable at these revenue levels we are seen today and we announced those actions on our last earnings call.

So, with that I believe we have some time for questions, and I'll open the floor to questions.

Question-and-Answer Session

Unidentified Analyst

(Inaudible).

Bill Lowe

I am going to repeat the question since it's being webcasted. The question is, is there anything else that we ever looked to do on our supply chain that we haven't done yet today that we would look and anticipate?

I don't think so. Again, tantalum powder is our largest raw material buy. We did do the foil, so we've actually done two transactions and also two strategies in two different areas at this point. I don't know that there's a third that we need to do at this time, so we are working to execute the second one which is larger one tantalum. There was a question in the back. Yes.

Unidentified Analyst

(Inaudible).

Bill Lowe

Well, we are working to fill that pipeline. It's actually, when you go through the stages of how you know how much ore is being supplied and versus how much powder is being produced, I would just say that our goal is as we exit this fiscal year that the facility, our powder facility will be providing somewhere between 75% and 80% of our internal powder needs. It won't be 100% at least 75% to 80% as we exit the fiscal year.

Yes?

Unidentified Analyst

(Inaudible).

Bill Lowe

Well, the question by the way was what was the purpose behind the NEC transaction? What do we see the benefits of buying was it just for scale or other purposes. Again, while we are waiting for regulatory approval, I will be relatively silent other than to say that the two companies have known each other for quite a while. Our R&D people have worked together developing product together, as well as we've licensed some of their technology over time, so our research and development people know each other pretty well. This is on the tantalum space side.

So, certainly there are advantages to bringing together two companies that know each other, have similar technologies and you could potentially develop a product that would be beneficial to our customers and their customers as well, and so that's one of the main positives that come from this combination for the two companies.

Yes?

Unidentified Analyst

(Inaudible).

Bill Lowe

Okay. That was two questions, so one of the first one was the question of what capital are we deploying in the Congo, and the second question was the reason why we are going to be in Pontecchio, Italy and why we would have not exited Italy.

Regarding capital deployed in the Congo, we are not mine owners. We have not purchased an equity interest in the mine. We have supply contracts with the mine owners. We are not miners. So, we've deployed some capital from a social responsibility standpoint, but not from the standpoint of purchasing an interest in a mine.

The response to the question on Italy is that there are many products that are made Italy for Italy, as well as from a design standpoint, we determine that many of the products that are being made within our European business group from a design factor standpoint is best to be designed still in Italy working with our customers closely, because that when you are designing in products, you are not actually selling through the normal course of our purchasing agent and the sales person, so you are actually worked and engineered engineer, you are working with the customer on designing new product into the design of their product and we thought that was best to continue to remain doing that in Italy as well as producing some of those products specifically in Italy rather than exiting Italy. Next question?

Unidentified Analyst

(Inaudible).

Bill Lowe

Well, again, as I said we are actually working to get close to those goals at current revenue we are, that we reported in the first quarter. Now jumping our point as we discussed on earnings calling in July was using for that quarter as a basis to reduce costs to allow us to get the combination of the company three business groups of 25%.

Now, having said that, until the Film and Electrolytics business groups restructuring is complete, we won't be at that 25% level. We need to get that complete which is, as I said the first quarter of next year as well we do need some macroeconomic help on the top line within Europe for the Film and Electrolytics business group to have their margins increases at the current level was reported in the first quarter. It would be difficult to get them a percentage that would help us blend to a 25%, so we do need some economic recovery in Europe to help us get to that point as a combined company.

Our Ceramics business group in the first quarter ended June reported gross margins I believe close to somewhere on 30% range. I don't remember the exact percentile on top of my head. So, the Ceramics group is in excess of that percentage today. And, we believe that the Tantalum business group with the changes in the supply chain has an opportunity to get to that level or greater even at the revenue levels that they reported in the first quarter, so the key to the combined gross margins is getting the Film and Electrolytics group restructuring completed as well as getting some microeconomic assistance where things are recovering a bit in Europe.

Unidentified Analyst

(Inaudible).

Bill Lowe

Sure. The question was kind of review the cost actions that we described in our last earnings: call in June, as well as what we see as a movement on I guess the macroeconomic environment is what you are asking whether it's up, down or sideways or whatever?

Unidentified Analyst

(Inaudible).

Bill Lowe

How are we responding to it? And, I guess, first of all we are responding to it by the standpoint we have started those cuts. What we announced in last earnings call was that in addition to the tantalum of course which we talked at length about is that we said we will be taking various actions across all three business groups as well as our corporate overhead fixed costs to reduce fixed cost this particular fiscal year, and so I was starting announced in August taking actions between August-December that would generate approximately $16 million of savings this fiscal year and will have an annualized effect of $24 million and that's on top of the tantalum. That's outside the tantalum space that we are talking about.

So, we are in the process of implementing those changes now. We started those actions actually immediately upon the announcement at the last earnings call, so we are already, I guess, reacting to your second question by doing that. And, again, the goal assuming that we're at those levels of revenue that was selling in the June quarter, is to move the company into a proper position assuming it stays at that level, and if more action is needed, we'll take more action but we've wanted to get ahead of it and I believe we've already announced those cuts and we are in the process of implementing those. Many those things have occurred.

From an impact standpoint, we said on that call that you will start to see the impact more in December, and then finally in March, because of course we just announced it in August, and so there's not a lot of time that they would have an impact in this particular quarter.

Yes. In the back?

Unidentified Analyst

(Inaudible).

Bill Lowe

Well, it depends on which business group the competitor is. The question was who are our competitors, and remind me the first part of the question. I missed it.

Unidentified Analyst

What's the long-term growth rate?

Bill Lowe

What the long-term growth. I am sorry. What's our long-term growth rate? And, again, it depends on which particular dielectric you are talking about. I am going to refer to third-party statistics on this rather than the company's, but if you look at Almanac for instance who publishes what they see as growth rates for our particular industry.

I think I saw last I saw for about 2012 to 2017 was a CAGAR rate of some around 7-plus percent for the industry. Now that depending on which dialect you are talking about, one might be a little more and one might be less. I have also seen statistics recently that says in particular the ceramic space because of the volume of handsets or cell phones are being made that there is a significant fairly large significant growth rate in that area. However, KEMET does not really participate that much in that market.

Some of our competition that's in that spaces produces those of particular parts and we actually exited some of that business about three years ago because of the competition for that space and it's a very large, takes a very large runs and long runs to actually make any money at that, so our Ceramics business has improved since we decided to not compete in that space and we don't plan to compete in that space, so you do have to look at the growth rates really as to which dielectric and then is KEMET playing in that space as well.

Unidentified Analyst

(Inaudible).

Bill Lowe

Biggest competitor? Sorry. I'll hit a few of them in few different areas. We thought of giving them low publicity. AVX compete with us, Vishay competes with us.

Certainly, in Film and Electrolytic business group, EPCOS would be a competitor. Certainly, Murata competes with us in certain areas in the ceramic space, so there's a number of large companies that compete with us. There's a lot of smaller ones as well.

Any more questions? Yes?

Unidentified Analyst

(Inaudible).

Bill Lowe

Right. The question is whether with the vertical integration we see there is more we see on M&A side. And, of course, if we were going to do something on M&A, we wouldn't talk about it the way I actually did, but I think it's fair to say that we have enough on her plate at the moment with the NEC TOKIN transaction potentially coming up to deal with. There will be a lot of senior management effort as well as other KEMET managers' effort to make sure that's successful.

We've already integrated Niotan or KEMET Blue Power and the team that's involved with that particular process for the, the Powder is not the same team that's involved in making sure that we integrate and are successful in our NEC TOKIN transaction, but I think that's significant enough for now. And, again we wouldn't pre-announcing it anyway on an M&A basis, but I think KEMET has a substantial amount of work to do to be successful in NEC TOKIN transaction, which we fully expect to do. You can see, we try to structure the transactions, so that gives us time to be successful rather than jumping in with both, feet on day one, gives us the chance to really structure it not that the full company on the transaction and we said we do expect it to be successful as well as potentially being game changing for the company going forward in future years.

Unidentified Analyst

(Inaudible).

Bill Lowe

Well, I guess I won't tell you how it's developed, because it's of course it's developed of what our internal plans are, but of course we didn't make it year, right? So, it's developed off of what expectation is that that the board of directors has as we go through our plan for the year is basically. The number we report to you as what we call EBITDA and we call it actually call it adjusted EBITDA, right? Is the same number we internally, so there's not two different numbers. We are not reflecting one number on our website that we put out for our earnings and another that we use internally is the same number.

Any more questions, or do we wrap up the session? Well, if there's no more questions then I appreciate your attendance in this late afternoon on the last day of the conference. Again, thanks very much for your interest. Thank you.

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