UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)
ý	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
	For the period ended September 30, 2004.
o	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

 

Commission File Number:  0-20289

 

KEMET CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

YES  ý   NO  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). ý   Yes  o  No

 

Common Stock Outstanding at: October 31, 2004

 

Title of Each Class		Number of Shares Outstanding
Common Stock, $.01 Par Value		86,518,799

 

 

Part I - FINANCIAL INFORMATION
ITEM 1 - Financial Statements

 

KEMET CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands except per share data)
(Unaudited)

 

		September 30, 2004			March 31, 2004
ASSETS
Current assets:
Cash and cash equivalents		$	30,919		$	183,528
Short-term investments		23,110			3,172
Accounts receivable		57,814			57,303
Inventories:
Raw materials and supplies		69,856			59,751
Work in process		42,609			41,250
Finished goods		41,490			28,015
Total inventories		153,955			129,016
Prepaid expenses and other current assets		6,188			6,979
Deferred income taxes		17,156			29,046
Total current assets		289,142			409,044
Property and equipment, net		407,211			424,161
Investments in U.S. government marketable securities		183,448			84,584
Investments in affiliates		3,459			3,610
Goodwill		30,471			30,471
Intangible assets, net		14,015			14,617
Other assets		3,537			3,321
Total assets		$	931,283		$	969,808
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable, trade		$	37,085		$	38,268
Accrued expenses		36,181			41,182
Income taxes payable		14,507			15,863
Total current liabilities		87,773			95,313
Long-term debt		100,000			100,000
Post-retirement benefits and other non-current obligations		49,317			61,623
Deferred income taxes		16,863			28,394
Total liabilities		253,953			285,330
Stockholders’ equity:
Common stock, par value $.01, authorized 300,000,000 shares, issued 87,993,321 and 87,953,720 shares at September 30, 2004, and March 31, 2004, respectively		880			879
Additional paid-in capital		317,744			317,497
Retained earnings		385,624			394,940
Accumulated other comprehensive income (loss)		393			(1,457		)
Treasury stock, at cost (1,481,635 and 1,485,455 shares at September 30, 2004, and March 31, 2004, respectively)		(27,311		)	(27,381		)
Total stockholders’ equity		677,330			684,478
Commitments and contingencies
Total liabilities and stockholders’ equity		$	931,283		$	969,808

 

See accompanying notes to consolidated financial statements.

 

2

 

KEMET CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
(Dollars in thousands except per share data)
(Unaudited)

 

		Three months ended September 30,						Six months ended September 30,
		2004			2003			2004			2003
Net sales		$	106,022		$	100,084		$	228,405		$	205,446
Operating costs and expenses:
Cost of goods sold		102,773			112,500			202,896			208,497
Loss (gain) on long-term supply contract		(11,139		)	12,355			(11,139		)	12,355
Selling, general and administrative		13,062			13,030			25,500			26,576
Research and development		6,637			5,907			13,375			11,870
Pension settlement charges		218			—			218			—
Restructuring and impairment charges		1,649			28,549			4,199			28,841
Total operating costs and expenses		113,200			172,341			235,049			288,139
Operating loss		(7,178		)	(72,257		)	(6,644		)	(82,693		)
Other (income) and expense:
Interest income		(1,455		)	(886		)	(3,365		)	(1,646		)
Interest expense		1,579			1,666			3,202			3,238
Other (income) expense		11			(797		)	2,296			(2,181		)
Total other (income) expense		135			(17		)	2,133			(589		)
Loss before income taxes		(7,313		)	(72,240		)	(8,777		)	(82,104		)
Income tax expense (benefit)		152			(28,960		)	539			(35,253		)
Net loss		$	(7,465	)	$	(43,280	)	$	(9,316	)	$	(46,851	)
Net loss per share:
Basic		$	(0.09	)	$	(0.50	)	$	(0.11	)	$	(0.54	)
Diluted		$	(0.09	)	$	(0.50	)	$	(0.11	)	$	(0.54	)
Weighted-average shares outstanding:
Basic		86,506,738			86,403,086			86,500,694			86,376,086
Diluted		86,506,738			86,403,086			86,500,694			86,376,086

 

See accompanying notes to consolidated financial statements.

 

3

 

KEMET CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)

 

		Six months ended September 30,
		2004			2003
Operating activities:
Net loss		$	(9,316	)	$	(46,851	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation, amortization, (gain) loss on long-term supply contract and impairment charges		22,372			65,202
Gain on termination of interest rate swaps		—			(1,406		)
Change in operating assets		(10,427		)	51,829
Change in operating liabilities		(19,928		)	(20,230		)
Tax benefit on stock options exercised		(212		)	160
Net cash (used in) provided by operating activities		(17,511		)	48,704
Investing activities:
Purchases of short-term investments		(20,050		)	(34,428		)
Proceeds from maturity of short-term investments		91			—
Additions to property and equipment		(16,772		)	(8,725		)
Product line acquisition		—			(2,300		)
Proceeds from termination of interest rate swaps		—			1,406
Investment in affiliates		—			(2,573		)
Purchases of U.S. government marketable securities		(104,071		)	—
Proceeds from maturity of long-term investments		5,000			—
Other		173			593
Net cash used in investing activities		(135,629		)	(46,027		)
Financing activities:
Proceeds from sale of common stock to Employee Savings Plan		501			547
Proceeds from exercise of stock options		30			768
Net cash provided by financing activities		531			1,315
Net increase (decrease) in cash and cash equivalents		(152,609		)	3,992
Cash and cash equivalents at beginning of period		183,528			263,585
Cash and cash equivalents at end of period		$	30,919		$	267,577

 

See accompanying notes to consolidated financial statements.

 

4

 

Note 1.  Basis of Financial Statement Preparation

 

The consolidated financial statements contained herein are unaudited and have been prepared from the books and records of KEMET Corporation and its Subsidiaries (“KEMET” or the “Company”).  In the opinion of management, the consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for the interim periods.  The consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and footnotes necessary for a complete presentation of financial position, results of operations, and cash flows in conformity with U.S. generally accepted accounting principles.  Although the Company believes that the disclosures are adequate to make the information presented not misleading, it is suggested that these consolidated financial statements be read in conjunction with the audited financial statements and notes thereto included in the Company’s fiscal year ending March 31, 2004, Form 10-K.  Net sales and operating results for the six-month period ended September 30, 2004, are not necessarily indicative of the results to be expected for the full year.

 

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. In consolidation, all significant intercompany amounts and transactions have been eliminated.

 

 

Impact of Recently Issued Accounting Standards

 

In December 2003, the Financial Accounting Standards Board (“FASB”) revised Statement of Financial Accounting Standards No. 132, “Employers’ Disclosures about Pensions and Other Post Retirement Benefits” (“SFAS No. 132”). SFAS No. 132 retains the disclosures required by the original SFAS No. 132, which standardized the disclosure requirements for pensions and other postretirement benefits to the extent practicable and required additional information on changes in the benefit obligations and fair values of plan assets. Revised SFAS No. 132, responding to concerns expressed by users of financial statements for the need for more information about pension plans, requires additional disclosures about assets, obligations, cash flows, and net periodic benefit cost defined benefit pension plans and other defined postretirement benefits. Generally, SFAS No. 132 is effective for beginning of the fiscal years ending after December 15, 2003 with some provisions effective in fiscal years commencing after June 15, 2004. The adoption of SFAS No. 132 did not impact the Company’s consolidated financial statements.

 

In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equities” (“SFAS No. 150”). SFAS No. 150 requires issuers to classify as liabilities (or assets in some circumstances) three classes of freestanding financial instruments that embody obligations for the issuer. Generally, SFAS No. 150 is effective for financial instruments entered or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not significantly impact the Company’s consolidated financial statements.

 

In April 2003, the FASB issued Statement of Financial Accounting Standards No. 149, “Amendment of SFAS No. 133 on Derivative Instruments and Hedging Activities” (“SFAS No. 149”). SFAS No. 149 amends FASB SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” for decisions made (1) as part of the Derivatives Implementation Group process that effectively required amendments to SFAS No. 133, (2) in connection with other Board projects dealing with financial instruments, and (3) in connection with implementation issues raised in relation to the application of the definition of a derivative; in particular, the meaning of an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors, the meaning of underlying, and the characteristics of a derivative that contains financing components. SFAS No. 149 is effective for all contracts entered into or modified after June 30, 2003, with certain exceptions. The adoption of SFAS No. 149 did not impact the Company’s consolidated financial statements.

 

In December 2003, the FASB revised Interpretation No. 46 (“FIN 46-R”), “Consolidation of Variable Interest Entities,” which was originally issued in January 2003, to provide guidance regarding issues arising from the implementation of FIN 46. Many variable interest entities have commonly been referred to as special-purpose entities or off-balance sheet structures. In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. Interpretation 46 requires a variable interest entity to be consolidated

 

5

 

by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. A company that consolidates a variable interest entity is called the primary beneficiary of that entity. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period ending after December 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The adoption of FIN 46-R did not impact the Company’s consolidated financial statements.

 

In May, 2004 the FASB issued FASB Staff Bulletin (“FSB”) 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003”, which provides guidance on the accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) for employers that sponsor postretirement health care plans that provide prescription drug benefits.    The Act introduced a prescription drug benefit under Medicare (Medicare Part D), as well as, a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D.  FSB 106-2 states that under the guidance provided by FASB 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions”, health care coverage provided by Medicare shall be taken into account in measuring the employer’s postretirement health care obligation and that currently enacted changes in relevant laws should be considered in current period measurements of net periodic postretirement benefit cost and the accumulated pension benefit obligation (“APBO”).   FSB 106-2 is effective in the first reporting period beginning after June 15, 2004.  The adoption of FSB 106-2 in the quarter ended September 30, 2004 did not impact the Company’s Consolidated Financial Statements.

 

 

Stock-based Compensation

 

The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related interpretations in accounting for stock options.  As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price.  The Company has elected the “disclosure only” provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” which provide pro forma disclosure of earnings as if stock compensation were recognized on the fair-value basis.

 

Had compensation costs for the Company’s two stock option plans been determined based on the fair value at the grant date for awards, consistent with the provisions of Statement No. 123, the Company’s net loss and loss per share would have been increased to the pro forma amounts indicated below (dollars in thousands except per share data):

 

						Three Months Ended September 30,						Six Months Ended September 30,
						2004			2003			2004			2003
Net loss
As reported						$	(7,465	)	$	(43,280	)	$	(9,316	)	$	(46,851	)
Less stock-based compensation expense determined under fair-value-based methods, net of related tax effects						(1,249		)	(886		)	(2,499		)	(1,772		)
Pro forma						$	(8,714	)	$	(44,166	)	$	(11,815	)	$	(48,623	)
Loss per share:
Basic				As reported		$	(0.09	)	$	(0.50	)	$	(0.11	)	$	(0.54	)
				Pro forma		$	(0.10	)	$	(0.51	)	$	(0.14	)	$	(0.56	)
Diluted			As reported			$	(0.09	)	$	(0.50	)	$	(0.11	)	$	(0.54	)
			Pro forma			$	(0.10	)	$	(0.51	)	$	(0.14	)	$	(0.56	)

 

6

 

The pro forma amounts indicated above recognize compensation expense on a straight-line basis over the vesting period of the grant.  The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for option grants issued during the six month period ended September 30, 2004: expected life of 5 years; a risk-free interest rate of 0.91%; expected volatility of 54.5%; dividend yield of 0.0%; and fair value of $7.02.  No options were granted in the three- and six-month periods ended September 30, 2003.  No options were granted in the three-month period ended September 30, 2004.

 

Revenue Recognition on Sales to Electronic Distributors

 

A portion of sales is made to distributors under agreements allowing certain rights of return and price protection on unsold merchandise held by distributors.  The Company’s distributor policy includes inventory price protection and “ship-from-stock and debit” (“SFSD”) programs common in the industry.

 

The price protection policy protects the value of the distributors’ inventory in the event the Company reduces its published selling price to distributors.  This program allows the distributor to debit the Company for the difference between KEMET’s list price and the lower authorized price for specific parts.  The Company establishes price protection reserves on specific parts residing in distributors’ inventories in the period that the price protection is formally authorized by management.

 

The SFSD program provides a mechanism for the distributor to meet a competitive price after obtaining authorization from the local Company sales office.  This program allows the distributor to ship its higher-priced inventory and debit the Company for the difference between KEMET’s list price and the lower authorized price for that specific transaction.

The Company established reserves for its SFSD program based on historical experience.  Management analyzes the historical trend of SFSD debit activity as it relates to historical sales activity and actual distributor inventory levels to determine the SFSD exposure at the balance sheet date.

 

The establishment of these reserves is recognized as a component of the line item Net sales on the Consolidated Statements of Operations, while the associated reserves are included the line item Accounts receivable on the Company’s Consolidated Balance Sheets.

 

 

Note 2.  Reconciliation of basic loss per common share

 

In accordance with FASB Statement No. 128, the Company has included the following table presenting a reconciliation of basic EPS to diluted EPS fully displaying the effect of dilutive securities.

 

Computation of Basic and Diluted Loss Per Share
(Dollars in thousands except per share data)

 

		For the three months ended September 30,
		2004								2003
		Loss (numerator)			Shares (denominator)		Per Share Amount			Loss (numerator)			Shares (denominator)		Per Share Amount
Basic EPS		$	(7,465	)	86,506,738		$	(0.09	)	$	(43,280	)	86,403,086		$	(0.50	)
Effect of dilutive securities:
Stock options		—			—		—			—			—		—
Put options		—			—		—			—			—		—
Diluted EPS		$	(7,465	)	86,506,738		$	(0.09	)	$	(43,280	)	86,403,086		$	(0.50	)

 

7

 

		For the six months ended September 30,
		2004								2003
		Loss (numerator)			Shares (denominator)		Per Share Amount			Loss (numerator)			Shares (denominator)		Per Share Amount
Basic EPS		$	(9,316	)	86,500,694		$	(0.11	)	$	(46,851	)	86,376,086		$	(0.54	)
Effect of dilutive securities:
Stock options		—			—		—			—			—		—
Put options		—			—		—			—			—		—
Diluted EPS		$	(9,316	)	86,500,694		$	(0.11	)	$	(46,851	)	86,376,086		$	(0.54	)

 

The three and six months ended September 30, 2004, excluded potentially dilutive securities of approximately 4,311,370 and 4,311,797, respectively, and the three and six months ended September 30, 2003, excluded potentially dilutive securities of approximately 3,650,000 and 3,660,000, respectively, in the computations of diluted loss per share because the effect would have been anti-dilutive.

 

 

Note 3. Derivatives and Hedging

The Company uses certain derivative financial instruments to reduce exposures to volatility of foreign currencies and commodities impacting the costs of its products and to convert its fixed rate debt to a floating rate basis.

 

All other contracts to purchase raw materials qualify for the normal purchases exclusion and are not accounted for as derivatives.

 

Hedging Foreign Currencies

Certain operating expenses at the Company’s Mexican facilities are paid in Mexican pesos. In order to hedge these forecasted cash flows, management purchases forward contracts to buy Mexican pesos for periods and amounts consistent with the related underlying cash flow exposures. These contracts are designated as hedges at inception and monitored for effectiveness on a routine basis. At September 30, 2004 and March 31, 2004, the Company had outstanding forward exchange contracts that mature within approximately twelve months to purchase Mexican pesos with notional amounts of $57.2 million and $57.7 million, respectively.  The fair values of these contracts totaled $1.3 million and $0.3 million at September 30, 2004 and March 31, 2004, respectively, and are recorded as a derivative asset on the Company’s consolidated balance sheets under other current assets. During the next twelve months, it is estimated that approximately $1.3 million of the gain on these contracts would be recorded to cost of goods sold. The impact of the changes in fair values of these contracts resulted in other comprehensive gain (loss), net of taxes, of $1.1 million and $(1.2) million for the three-month periods ended September 30, 2004 and 2003, respectively.  The impact of the changes in fair values of these contracts resulted in other comprehensive gain, net of taxes, of $0.6 million and $1.1 million for the six-month periods ended September 30, 2004 and 2003, respectively.

 

Certain sales are made in euros. In order to hedge these forecasted cash flows, management purchases forward contracts to sell euros for periods and amounts consistent with the related underlying cash flow exposures. These contracts are designated as hedges at inception and monitored for effectiveness on a routine basis. At September 30, 2004 and March 31, 2004, the Company had outstanding forward exchange contracts that mature within approximately twelve months to sell euros with notional amounts of $20.1 million and $17.3 million, respectively. The fair values of these contracts at September 30, 2004 and March 31, 2004, totaled $0.8 million and $1.0 million, respectively, and are recorded as a derivative liability on the Company’s consolidated balance sheets under other current liabilities. During the next twelve months, approximately $0.8 million of the loss on these contracts is expected to be charged to net sales. The impact of the changes in fair values of these contracts resulted in other comprehensive income (loss), net of taxes, of $(0.1) million and $0.1 million in the three-month periods ended September 30, 2004 and 2003, respectively.  The impact of the changes in fair values of these contracts resulted in other comprehensive income (loss), net of taxes, of $0.3 million and $(1.1) million in the six-month periods ended September 30, 2004 and 2003, respectively.

 

8

 

Interest Rate Swaps

In August 2003, the Company entered into an interest rate swap contract (the “Swap”) which effectively converted its $100 million aggregate principal amount of 6.66% senior notes to floating rate debt adjusted semi-annually based on six-month LIBOR plus 3.35%. The fair value of the Swap, based upon market estimates provided by the counterparties, was approximately $0.5 million and $2.5 million at September 30, 2004 and March 31, 2004, respectively, and is recorded as a derivative asset on the Company’s Consolidated Balance Sheets under other current assets. The change in fair value of this derivative instrument resulted in other income of $1.1 million and $1.5 million for the three-month periods ended September 30, 2004 and 2003, respectively.  The change in fair value of this derivative instrument resulted in other income (expense) of $(1.2) million and $1.5 million for the six-month periods ended September 30, 2004 and 2003, respectively.   The gain in the quarter ended September 30, 2004 was primarily the result of projected decreases in interest rates over the remaining life of the contract.

 

The Company entered into two interest rate swap contracts in April 2003 that effectively converted its $100 million aggregate principal amount of 6.66% senior notes to floating-rate debt, both of which were terminated for a $1.4 million gain and recognized in other income for the six months ended September 30, 2003.

 

 

Note 4. Put Options

 

The Company sold put options to institutional parties as part of a program to purchase up to 8.0 million of its common shares. The Company does not anticipate any further stock purchases under this authorization, and the last outstanding put options matured unexercised in July 2003. On July 1, 2003, the Company was required to adopt Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equities” (SFAS No. 150). The adoption of SFAS No. 150 did not significantly impact the Company’s consolidated financial statements.

 

 

Note 5. Restructuring and Impairment Charges

 

A reconciliation of the beginning and ending liability balances for restructuring charges included in the liabilities section of the Consolidated Balance Sheets for the periods ended September 30, 2004 and 2003 (dollars in thousands) is shown below:

 

		Three months ended September 30, 2004						Three months ended September 30, 2003
		Personnel Reductions			Manufacturing Relocations			Personnel Reductions			Manufacturing Relocations			Asset Impairment
Beginning of period		$	6,577		$	—		$	292		$	—		$	—
Costs charged to expense		—			1,649			8,398			2,291			17,860
Costs paid or settled		(535		)	(1,649		)	(646		)	(2,291		)	0
End of period		$	6,042		$	—		$	8,044		$	—		$	17,860

 

 

		Six months ended September 30, 2004						Six months ended September 30, 2003
		Personnel Reductions			Manufacturing Relocations			Personnel Reductions			Manufacturing Relocations			Asset Impairment
Beginning of period		$	7,177		$	—		$	800		$	—		$	—
Costs charged to expense		—			4,199			8,690			2,291			17,860
Costs paid or settled		(1,135		)	(4,199		)	(1,446		)	(2,291		)	0
End of period		$	6,042		$	—		$	8,044		$	—		$	17,860

 

Manufacturing relocation costs are expensed as actually incurred, therefore no liability is recorded in the Consolidated Balance Sheets for these costs.  Costs charged to expense are aggregated in the consolidated statements of operations line, Restructuring and impairment charges.

 

9

 

Manufacturing relocation and personnel reduction costs - These charges were incurred as part of an Enhanced Strategic Plan (“Plan”) announced in July 2003 that included moving manufacturing operations from the U.S. to low-cost facilities in Mexico and China. The Company estimates that it will incur approximately $35.0 million in total charges related to the Plan, which is targeted for completion in June 2005.  As of September 30, 2004, cumulative restructuring costs incurred totaled approximately $30 million.

 

Asset impairment charges – In 1999, the Company entered into the market for solid aluminum capacitors and has since made significant technology advances in both high-capacitance multilayer ceramic capacitors and organic tantalum capacitors, limiting applications of solid aluminum capacitors.  As a result, KEMET reorganized its solid aluminum capacitor business line during the quarter ended September 30, 2003 and recognized a $17.8 million non-cash charge related to the impairment of equipment and facilities associated with the aluminum capacitor business line.

 

 

Note 6.  Acquisitions

 

On June 30, 2003, the Company acquired certain assets from Wilson Greatbatch Technologies, Inc (“GTI”). The $2.3 million cash purchase included the non-medical, high-voltage and high-temperature ceramic capacitor and EMI filter product lines of GTI’s Greatbatch-Sierra, Inc. subsidiary. The product lines were acquired as part of the Company’s strategic objective to broaden its high-performance capacitor solutions to support customers’ increasing technical requirements.  No goodwill was recorded as part of the transaction.  The results of operations are not significant for pro forma purposes.

 

On December 17, 2003, the Company announced it had acquired The Forest Electric Company (“FELCO”) of Melrose Park, Illinois.  FELCO manufactures and sells industry-leading custom magnetic solutions. This $2.4 million acquisition broadens KEMET’s product portfolio, leveraging KEMET’s industry-leading capabilities in quality, delivery, and service to further penetrate customers in the military, aerospace, and industrial market segments. Approximately $2.1 million of goodwill and $0.5 million of patents and technology, which have an amortization period of seven years, were recorded as part of the transaction.  The results of operations are not significant for pro forma purposes.

 

 

Note 7.  Pension Plans

 

In fiscal year 2004, the Company provided pension benefits for certain retired employees under a domestic, non-contributory defined benefit pension plan.   The Company froze accrual of benefits of this plan on June 30, 2003 and subsequently terminated and liquidated the plan in the quarter ended March 31, 2004.  The Company will make no further contributions to the plan in the future.  The components of the expense for the pension plan are as follows (dollars in thousands):

 

		Three Months Ended September 30,							Six Months Ended September 30,
		2004				2003			2004			2003
Service cost		$		—		$	—		$	—		$	795
Interest cost		—				1,982			—			3,964
Expected return on assets		—				(2,051		)	—			(4,102		)
Amortization of prior service cost		—				(1		)	—			(2		)
Amortization of actuarial loss		—				340			—			680
Settlement charges		218				—			218			—
Curtailment		—				—			—			187
Total net periodic benefits costs		$	218			$	270		$	218		$	1,522

 

The settlement charges of $218 thousand incurred in the current quarter is associated with the pension settlement that occurred in the quarter ended March 2004.

 

Management is primarily responsible for determining the cost of pension benefits for this plan.  Management considered a number of factors, including consulting with an actuarial firm, when determining this cost.

 

10

 

Note 8. Other Post-retirement Benefit Plans

 

The Company provides health care and life insurance benefits for certain retired employees who reach retirement age while working for the Company.  The components of the expense for post-retirement medical and life insurance benefits are as follows (dollars in thousands):

 

		Three months ended September 30,							Six months ended September 30,
		2004				2003			2004			2003
Service cost		$		222		$	266		$	532		$	532
Interest costs		740				846			1,582			1,692
Expected return on assets		—				(30		)	—			(60		)
Amortization of actuarial loss		45				97			179			194
Total net periodic benefits costs		$	1,007			$	1,179		$	2,293		$	2,358

 

The Company expects to make no contributions to fund plan assets in fiscal year 2005 as the Company’s policy is to pay benefits as costs are incurred.  The Company estimates its benefits payments in fiscal year 2005 will be approximately $4.4 million.  Management is primarily responsible for determining the cost of pension benefits for this plan.  Management considered a number of factors, including consulting with an actuarial firm, when determining this cost.

 

Note 9. Investments

 

Investments consist of debt securities as well as equity securities of public and privately-held companies.  The debt securities, which consist of U.S. government marketable securities, are classified as held-to-maturity securities, mature in one-month to six years, and are carried at amortized cost.  The effect of amortizing these securities is recorded in current loss as interest income.

 

The Company’s equity investments in public companies are classified as available-for-sale securities and are carried at fair value with adjustments recorded net of tax in stockholders’ equity.  The available-for-sale securities are intended to be held for an indefinite period but may be sold in response to unexpected future events.  The Company has an equity investment with less than 20% ownership interest in a privately-held company.  The Company does not have the ability to exercise significant influence and the investment is accounted for under the cost method.

 

On a periodic basis, the Company reviews the market values of its equity investments classified as available-for-sale securities and the carrying value of its equity investments carried at cost for the purpose of identifying “other-than-temporary” declines in market value and carrying value, respectively, as defined in EITF 03-1.   The Company’s management has conducted this review for the quarter ended September 30, 2004 and determined that an available for sale equity investment in a publicly-held company had an “other-than-temporary” decline in market value.  The market value initially declined from September 2003 to June 2004, with no significant change in market value from July 2004 to September 2004.  The Company considers the impairment “other-than-temporary” based on the duration of this market value decline and the lack of evidence that the market value will increase.  The Company has recognized a $0.9 million loss equal to the difference between the investment’s cost and its fair value at September 30, 2004.  This amount is included in Other (income) expense on the 2004 Consolidated Statements of Operations.

 

A summary of the components and carrying values of “Investments” in the Consolidated Balance Sheets is as follows (dollars in thousands):

 

		September 30, 2004			March 31, 2004
Short-term investments		$	23,110		$	3,172
Equity investments:
Available-for-sale		979			1,130
Cost		2,480			2,480
U.S. government marketable securities		183,448			84,584
		$	210,017		$	91,366

 

11

 

Short-term investments consist primarily of corporate bonds and U.S. government securities.  Recorded value approximates fair value at September 30, 2004 and March 31, 2004.

 

 

Note 10.  Supply Contracts

 

The Company has renegotiated the tantalum supply agreement with Cabot Corporation that extends through calendar year 2006. The Company records inventories at the lower of cost or market.   A reconciliation of the beginning and ending balance included in the liabilities section of the Consolidated Balance Sheets is as follows (dollars in thousands):

 

		Inventory Supply Agreement
		Six months ended September 30, 2004			Six months ended September 30, 2003
Beginning of period		$	24,275		$	24,310
Costs charged to expense		—			12,355
Liability reduction		(11,139		)	—
Costs paid or settled		(5,883		)	(3,054		)
End of period		$	7,253		$	33,611

 

For the six months ended September 30, 2004, the Company decreased its liability and recognized a gain of $11.1 million based on an amendment to the Cabot Corporation supply agreement.  As of September 30, 2004, the remaining purchase commitments for this contract are $3.3 million for calendar year 2004, $14.5 million for calendar year 2005 and $11.6 million for calendar year 2006.  For the six months ended September 30, 2003, the Company recorded additional liabilities of $12.4 million based on declining average selling prices.  See Commitment discussion in Management Discussion and Analysis of Results of Operations and Financial Condition.

 

In the current quarter, the Company cancelled silver and palladium purchase commitments with other suppliers totaling $6.6 million.  No gain or loss was recognized as a result of these cancellations.  The Company has no future commitments for these raw materials.

 

 

Note 11.  Accumulated Other Comprehensive Income (Loss)

 

Comprehensive income (loss) for the three and six months ended September 30, 2004 and 2003 include the following components (dollars in thousands):

 

		Three Months Ended September 30,						Six Months Ended September 30,
		2004			2003			2004			2003
Net loss		$	(7,465	)	$	(43,280	)	$	(9,316	)	$	(46,851	)
Other comprehensive income (loss), net of tax:
Currency forward contract (losses) gains		1,037			(1,135		)	870			(10		)
Unrealized securities gains		914			1,116			838			1,376
Currency translation gain		28			18			142			55
Total other comprehensive loss		$	(5,486	)	$	(43,281	)	$	(7,466	)	$	(45,430	)

 

The components of “Accumulated other comprehensive loss” in the Consolidated Balance Sheets are as follows (dollars in thousands):

 

		September 30, 2004			March 31, 2004
Currency forward contract gains (losses), net of tax		$	203		$	(667	)
Unrealized securities losses, net of tax		—			(838		)
Currency translation gains		190			48
Total accumulated other comprehensive income (loss)		$	393		$	(1,457	)

 

12

 

Note 12.  Goodwill and Intangible Assets

 

In July 2001, the FASB issued Statement of Financial Accounting Standards No. 141, “Business Combinations” (SFAS No. 141), and Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (SFAS No. 142). Statement No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also specifies criteria that intangible assets acquired in a purchase method business combination must meet in order to be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment. In addition, any unamortized negative goodwill must be written off at the date of adoption. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001, and was adopted by the Company effective April 1, 2002.

 

In connection with the adoption of SFAS No. 142, the Company completed impairment tests of its goodwill and other identifiable intangible assets including indefinite-lived trademarks, as well as patents and technology that have definite lives and will continue to be amortized. No impairment of goodwill or intangible assets was noted.

 

For purposes of determining the fair value of its trademarks, the Company utilizes a discounted cash flow model which considers the costs of royalties in the absence of trademarks owned by the Company.  Based upon our analysis of legal, regulatory, contractual, competitive and economic factors, we deemed that trademarks, which consist of the KEMET trade name and logo, have an indefinite useful life because they are expected to contribute to cash flows indefinitely.

 

The Company’s goodwill is tested for impairment at least on an annual basis. The impairment test involves a comparison of the fair value of its reporting units as defined under SFAS No. 142, with carrying amounts. For purposes of determining potential impairment of goodwill, the Company aggregates its similar components as its segments are aggregated to a single reporting segment under SFAS No. 131. If the reporting unit’s aggregated carrying amount exceeds its fair value, then an indication exists that the reporting unit’s goodwill may be impaired. The impairment to be recognized is measured by the amount by which the carrying value of the reporting unit being measured exceeds its fair value, up to the total amount of its assets. The Company determined fair value based on a market approach which incorporates quoted market prices of the Company’s common stock and the premiums offered to obtain controlling interest for companies in the electronics industry.

 

KEMET performs its impairment tests during the first quarter of each fiscal year and when otherwise warranted.   KEMET performed this impairment test in the quarters ended June 30, 2004 and 2003 and concluded no goodwill impairment existed.

 

On June 30, 2003, the Company acquired certain assets from Wilson Greatbatch Technologies, Inc (“GTI”). The $2.3 million cash purchase included the non-medical, high-voltage and high-temperature ceramic capacitor and EMI filter product lines of GTI’s Greatbatch-Sierra, Inc. subsidiary. The product lines were acquired as part of the Company’s strategic objective to broaden its high-performance capacitor solutions to support customers’ increasing technical requirements.  No goodwill was recorded as part of the transaction.

 

On December 17, 2003, the Company announced it had acquired The Forest Electric Company (“FELCO”) of Melrose Park, Illinois.  FELCO manufactures and sells industry-leading custom magnetic solutions. This $2.4 million acquisition broadens KEMET’s product portfolio, leveraging KEMET’s industry-leading capabilities in quality, delivery, and service to further penetrate customers in the military, aerospace, and industrial market segments. Approximately $2.1 million of goodwill and $0.5 million of patents and technology, which have an amortization period of seven years, were recorded as part of the transaction.

 

13

 

The carrying amounts, accumulated amortization, and amortization expense for each of the periods presented are noted below by intangible asset class (dollars in thousands):

 

		September 30, 2004							March 31, 2004
		Carrying Amount				Accumulated Amortization			Carrying Amount			Accumulated Amortization
Unamortized Intangibles:
Goodwill		$		30,471		$	—		$	30,471		$	—
Trademarks		7,181				—			7,181			—
Unamortized intangibles		37,652				—			37,652			—
Amortized Intangibles:
Patents and technology – 5-25 Years		14,655				8,099			14,655			7,549
Other – 8-10 Years		914				636			914			584
Amortized intangibles		15,569				8,735			15,569			8,133
Total goodwill and intangibles		$	53,221			$	8,735		$	53,221		$	8,133

 

The expected amortization expense for the fiscal years ending March 31, 2005, 2006, 2007, 2008, and 2009 is $1,105, $1,005, $974, $942, and $590, respectively.

 

 

Note 13.  Income Taxes Payable

 

Income taxes payable on the Company’s consolidated balance sheets includes estimated amounts due in both U.S. and foreign tax jurisdictions.  This liability is recorded net of anticipated refunds due from the same aforementioned tax authorities.   The table set forth below provides the components of incomes taxes payable for each period presented (dollars in thousands):

 

		September 30, 2004			March 31, 2004
Income tax provision		$	(25,965)		$	(26,719)
U.S. Federal and state income tax refunds due		11,458			10,856
Income taxes payable		$	(14,507	)	$	(15,863	)

 

 

Note 14.  Segment Information

 

Under SFAS 131, the Company has only one reporting segment, which is passive components.  These passive components consists primarily of two product lines based on method of attachment: surface mount and leaded.  Net sales by product line are presented below (dollars in thousands):

 

		Three months ended September 30,						Six months ended September 30,
		2004			2003			2004			2003
Surface mount		$	86,492		$	81,243		$	185,726		$	161,779
Leaded		19,530			18,841			42,679			43,667
Net Sales		$	106,022		$	100,084		$	228,405		$	205,446

 

Note 15.  Concentrations of Risks

 

Sales and Credit Risk

The Company sells to customers located throughout the United States and the world.  Credit evaluations of its customers’ financial conditions are performed periodically, and the Company generally does not require collateral from its customers.

 

14

 

Electronics distributors are an important distribution channel in the electronics industry and accounted for approximately 51%, 43% and 33% of the Company’s net sales in fiscal years 2004, 2003, and 2002, respectively.   For the six months ended September 30, 2004, sales to electronic distributors accounted for approximately 53% of the Company’s net sales.   For the six months ended September 30, 2003, sales to electronic distributors accounted for approximately 49% of the Company’s net sales.  As a result of the Company’s concentration of sales to electronic distributors the Company may experience fluctuations in its operating results as electronic distributors experience fluctuations in end-market demand or adjust their inventory stocking levels.

 

At September 30 and March 31, 2004, one customer accounted for more than 10% of the Company’s accounts receivable balance.

 

Employees

As of September 30, 2004, KEMET had approximately 9,400 employees, of whom approximately 1,500 were located in the United States, approximately 7,350 were located in Mexico, 500 in China, and the remainder were located in the Company’s foreign sales offices.  The Company believes that its future success will depend in part on its ability to recruit, retain, and motivate qualified personnel at all levels of the Company.  The Company has approximately 5,100 hourly employees in Mexico represented by labor unions as required by Mexican law.  The Company has not experienced any major work stoppages and considers its relations with its employees to be good.

 

 

Note 16.  Subsequent Events

 

On October 25, 2004, KEMET announced a workforce reduction of approximately 820 employees worldwide, or approximately 10%, which will result in one-time charges of $5.5 million in the December 2004 quarter and annualized savings of $11.1 million.

 

In addition, KEMET expects to record one-time charges for impairment and disposal of certain assets totaling approximately $20 million in the December 2004 quarter.

 

In August 2003, the Company entered into an interest rate swap contract that effectively converted its $100 million aggregate principal amount of 6.66% senior notes to floating rate debt adjusted semi-annually based on six-month LIBOR plus 3.35%  (See Note 3.  Derivates and Hedging).  In October 2004, this contract was terminated for a $0.6 million gain and will be recognized in Other (income) expense in the December 2004 quarter.

 

 

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

 

From time to time, information provided by the Company, including but not limited to statements in this report or other statements made by or on behalf of the Company, may contain “forward-looking” information within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934.  Such statements involve a number of risks and uncertainties.  The Company’s actual results could differ materially from those discussed in the forward-looking statements.  The cautionary statements set forth in the Company’s 2004 Annual Report under the heading Safe Harbor Statement identify important factors that could cause actual results to differ materially from those in any forward-looking statements made by or on behalf of the Company.

 

ACCOUNTING POLICIES AND ESTIMATES

 

The following discussion and analysis of financial condition and results of operations are based on the Company’s unaudited Consolidated Financial Statements included herein. The Company’s significant accounting policies are described in Note 1 to the Consolidated Financial Statements in KEMET’s annual report on Form 10-K for the year ended March 31, 2004. The Company’s critical accounting policies are described under the caption “Critical Accounting Policies and Estimates” in Item 7 of KEMET’s annual report on Form 10-K for the year ended March 31, 2004.

 

15

 

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

 

The Company’s judgments are based on management’s assessment as to the effect certain estimates, assumptions, or future trends or events may have on the financial condition and results of operations reported in KEMET’s unaudited Consolidated Financial Statements. It is important that readers of these unaudited financial statements understand that actual results could differ from these estimates, assumptions, and judgments.

 

 

Overview

 

KEMET Corporation is one of the world’s largest manufacturers of tantalum, multilayer ceramic capacitors, and solid aluminum capacitors. Capacitors are electronic components that store, filter, and regulate electrical energy and current flow and are one of the essential passive components used on circuit boards. Virtually all electronic applications and products contain capacitors, including communication systems, data processing equipment, personal computers, cellular phones, automotive electronic systems, military and aerospace systems, and consumer electronics.

 

The Company’s business strategy is to generate revenues by being the preferred capacitor supplier to the world’s most successful electronics original equipment manufacturers, electronics manufacturing services providers, and electronics distributors. The Company reaches these customers through a direct, salaried sales force that calls on customer locations around the world.

 

The Company manufactures capacitors in the United States, Mexico, and China. Commodity manufacturing in the United States is being relocated (see “Enhanced Strategic Plan”) to the Company’s lower-cost manufacturing facilities in Mexico and China. Production that remains in the U.S. will focus primarily on early-stage manufacturing of new products and other specialty products for which customers are predominantly located in North America.

 

The market for tantalum, ceramic, and aluminum capacitors is highly competitive. The capacitor industry is characterized by, among other factors, a long-term trend toward lower prices for capacitors, low transportation costs, and few import barriers. Competitive factors that influence the market for the Company’s products include product quality, customer service, technical innovation, pricing, and timely delivery. The Company believes that it competes favorably on the basis of each of these factors.

 

 

Enhanced Strategic Plan

 

On July 2, 2003, KEMET announced its Enhanced Strategic Plan (“Plan”) to enhance the Company’s position as a global leader in passive electronic technologies. KEMET believes that there have been profound changes in the competitive landscape of the electronics industry over the past several years. The Company listened closely to its customers’ description of their future directions, and is aligning KEMET’s future plans closely with their plans. Building on the Company’s foundation of success in being the preferred supplier to the world’s most successful electronics manufacturers and distributors, KEMET is adapting so as to continue to succeed in the new global environment.

 

KEMET’s strategy has three foundations:

 

• Enhancing the Company’s position as the market leader in quality, delivery, and service through outstanding execution;

 

• Having a global mindset, with an increased emphasis on growing KEMET’s presence in Asia; and

 

• Accelerating the pace of innovations to broaden the Company’s product portfolio.

 

16

 

To execute the Plan, KEMET is reorganizing its operations around the world. Over the next twelve months, several KEMET facilities will be relocated based on access to key customers, access to key technical resources and knowledge, and availability of low-cost resources. KEMET estimates it will incur special charges of approximately $35 million over the period of the reorganization related to movement of manufacturing operations.  This will yield an approximate one-year payback based on unit volumes at the time of the announcement, and a $50-60 million savings with volume recovery by fiscal 2006, if unit growth continues as it has in recent quarters. In addition, there will be special charges reflecting the change in status of the facilities that will be vacated through this move. The timing of the special charges is dependent on the timing of operational decisions, some of which have not yet been finalized, and on operational activities yet to occur. See Restructuring and Impairment Charges under Results of Operations.

 

 

KEMET in the United States

 

KEMET’s corporate headquarters will remain in Greenville, South Carolina, though individual functions will evolve to support global activities in Asia, Europe and North America, either from Greenville or through locations in appropriate parts of the world.

 

Commodity manufacturing currently in the United States will be relocated to the Company’s lower-cost manufacturing facilities in Mexico and China.  Approximately 650 production-related jobs in the United States will be impacted by this relocation over the next twelve months.  Production that remains in the U.S. will focus primarily on early-stage manufacturing of new products and other specialty products for which customers are predominantly located in North America.

 

To accelerate the pace of innovations, the KEMET Innovation Center was created. The primary objectives of the Innovation Center are to ensure the flow of new products and robust manufacturing processes that will keep the Company at the forefront of its customers’ product designs, while enabling these products to be transferred rapidly to the most appropriate KEMET manufacturing location in the world for low-cost, high-volume production. The KEMET Innovation Center is located in the Greenville, South Carolina, area.

 

 

KEMET in Mexico

 

KEMET believes its Mexican operations are among the finest and most cost efficient in the world, and they will continue to be the Company’s primary production facilities supporting North American and European customers. One of the strengths of KEMET de Mexico is that it is truly a Mexican operation, including Mexican management and workers. These facilities will be responsible for maintaining KEMET’s traditional excellence in quality, service, and delivery, while driving costs down. The facilities in Victoria and Matamoros will remain focused primarily on tantalum capacitors, and the facilities in Monterrey will continue to support ceramic capacitor lines.

 

 

KEMET in China

 

In recent years, low production costs and proximity to large, growing markets have caused many of KEMET’s key customers to relocate production facilities to Asia, particularly China. KEMET has a well-established sales and logistics network in Asia to support customers’ Asian operations. The Company’s initial China production facilities in Suzhou near Shanghai commenced shipments in October 2003. Manufacturing operations in China will grow rapidly, and KEMET anticipates that production capacity in China may be equivalent to Mexico within two to three years, with most of the equipment to support these operations being transferred from existing capacity in the United States or Mexico. The vision for KEMET China is to be a Chinese operation, with Chinese management and workers, to help achieve KEMET’s objective of being a global company. These facilities will be responsible for maintaining KEMET’s traditional excellence in quality, service, and delivery, while accelerating cost-reduction efforts and supporting efforts to grow the Company’s customer base in Asia.

 

 

KEMET in Europe

 

KEMET will maintain and enhance its strong European sales and customer service infrastructure, allowing KEMET to continue to meet the local preferences of European customers who remain an important focus for KEMET going forward.

 

17

 

Global Sales and Logistics

 

In recent years, it has become more complex to do business in the electronics industry. Market-leading electronics manufacturers have spread their facilities more globally. The growth of the electronics manufacturing services (EMS) industry has resulted in a more challenging supply chain. New Asian electronics manufacturers are emerging rapidly. The most successful business models in the electronics industry are based on tightly integrated supply chain logistics to drive down costs. KEMET’s direct salaried sales force worldwide and a well-developed global logistics infrastructure distinguish it in the marketplace and will remain a hallmark of KEMET in meeting the needs of its global customers.

All components of the Enhanced Strategic Plan are within their budgeted costs and are expected to be completed within twelve months of the date of this filing.

 

 

Subsequent Events

 

On October 25, 2004, KEMET announced a workforce reduction of approximately 820 employees worldwide, or approximately 10%, which will result in one-time charges of $5.5 million in the December 2004 quarter and annualized savings of $11.1 million.

 

In addition, KEMET expects to record one-time charges for impairment and disposal of certain assets totaling approximately $20 million in the December 2004 quarter.

 

In August 2003, the Company entered into an interest rate swap contract that effectively converted its $100 million aggregate principal amount of 6.66% senior notes to floating rate debt adjusted semi-annually based on six-month LIBOR plus 3.35%  (See Note 3.  Derivates and Hedging).  In October 2004, this contract was terminated for a $0.6 million gain and will be recognized in Other (income) expense in the December 2004 quarter.

 

 

Pension Plan

 

The Company froze accrual of benefits of its domestic non-contributory pension plan on June 30, 2003.  Prior to the end of fiscal year 2004, KEMET terminated and liquidated its defined benefit pension plan and, as a result, recognized $50.4 million in pension settlement charges in the fiscal year ended March 31, 2004.  During the quarter ended September 30, 2004, the Company recognized $218 thousand of additional costs related to the settlement of the pension plan which are included in the line item, Pension settlement charges in the Consolidated Statements of Operations.  The Company does not anticipate any further additional costs associated with the settlement of this plan.  The termination of the pension plan is anticipated to result in future savings of $6 million per year. KEMET continues to provide other defined contribution retirement plans to its employees.

 

 

Employees

 

As of September 30, 2004, KEMET had approximately 9,400 employees, of whom approximately 1,500 were located in the United States, approximately 7,350 were located in Mexico, 500 in China, and the remainder were located in the Company’s foreign sales offices.  The Company believes that its future success will depend in part on its ability to recruit, retain, and motivate qualified personnel at all levels of the Company.  The Company has approximately 5,100 hourly employees in Mexico represented by labor unions as required by Mexican law.  The Company has not experienced any major work stoppages and considers its relations with its employees to be good.

 

 

RESULTS OF OPERATIONS

 

Recent Industry Trend

 

Over the course of the summer and continuing into the fall, KEMET has been negatively impacted by an inventory cycle in the capacitor industry, especially at our distribution customers which represent approximately one half of our revenue. Based on the best information we have from customers, we do not believe this represents a prolonged slump in our industry, but the inventory correction has continued into the December 2004 quarter, which we anticipate will be flat in terms of revenue with the September 2004 quarter.

 

18

 

Average selling prices for the September 2004 quarter, adjusted for changes in product mix, declined by 8% compared to average selling prices for the June 2004 quarter. A significant portion of this price decline is due to the changes in the mix of sales channels during the quarter. Pricing is lowest in our Electronic Manufacturing Services channel, and average selling prices declined as sales to Electronic Manufacturing Services customers became a greater percentage of our business due to the correction of inventory in our Distribution channel.

 

By channel, 50% percent of total sales for the September 2004 quarter were to distribution customers, 27% were to Electronic Manufacturing Services customers, and 23% were to Original Equipment Manufacturing customers. In the June 2004 quarter, 56% of total sales were to distribution customers, and the reduction in the September quarter is primarily the result of a reduction in inventory levels by our Distribution customers.

 

 

Comparison of the Three-Month Period Ended September 30, 2004, with the Three-Month Period Ended September 30, 2003

 

 

Net Sales

 

Net sales for the three months ended September 30, 2004, increased 6% to $106 million as compared to the same period last year. The increase in net sales was attributable to higher unit volumes for both tantalum and ceramic capacitors. Unit volumes in the three-month period ended September 30, 2004, exceeded the volumes of the prior period by approximately 27%.  This was the fourth consecutive quarter that net sales increased compared to the same quarter in the prior year. Mix-adjusted average selling prices for the September 2004 quarter decreased approximately 8% compared to average selling prices for the September 2003 quarter.

 

Net sales of surface-mount capacitors were $86.5 million for the three months ended September 30, 2004, compared to $81.2 million for the same period last year. Net sales of leaded capacitors were $19.5 million for the three months ended September 30, 2004, versus $18.8 million during the same period last year.  Unit volume increased approximately 27% for surface-mount capacitors and decreased approximately 5% for leaded capacitors.

 

Export net sales decreased sequentially during the three-month period ended September 30, 2004, by 13.3% to $64.3 million.  Domestic net sales decreased sequentially during the three-month period ended September 30, 2004, by 13.4% to $41.7 million.

 

 

Cost of Sales

 

Cost of sales for the three months ended September 30, 2004, was $102.8 million, or 97% of net sales, as compared to $112.5 million, or 112% of net sales, for the same period last year.  Approximately $5.6 million of the decrease from the prior year can be attributed to inventory charges associated with the impairment of the solid aluminum product line (see discussion below under “Restructuring and impairment charges”).  No similar inventory charges existed in the current quarter.  The remaining $4.1 million decrease in cost of sales from the prior year can be attributed, in part, to lower per-unit costs as a result of various cost-saving initiatives implemented over the past fifteen months at the Company’s manufacturing facilities. These lower per-unit costs partially offset the 8% year-over-year decline in average selling prices. As a result, cost of sales as a percentage of net sales decreased compared to the same period last year.

 

 

Selling, General and Administrative Expenses

 

Selling, general, and administrative expenses for the three months ended September 30, 2004, were $13.1 million, or 12% of net sales, as compared to $13.0 million, or 13% of net sales for the same period last year. SG&A spending reflects the Company’s continuing commitment to invest in long-term relationships with its customers through its direct sales and customer service professionals. Selling, general, and administrative expenses decreased slightly as a percent of net sales largely as the result of higher net sales in the current quarter compared to the same quarter in the prior fiscal year.

 

19

 

Research and Development Expenses

 

Research and development expenses for the three months ended September 30, 2004, were $6.6 million, or 6.3% of net sales, as compared to $5.9 million, or 5.9% of net sales for the same period last year. The 12% increase in spending reflects the Company’s continuing commitment to invest in the development of new products and technologies. As a result of this increase in spending, research and development expenditures increased as a percentage of net sales.

 

 

Restructuring and Impairment Charges

 

A summary of the restructuring and impairment charges recognized in the quarters ended September 30, 2004 and 2003 were as follows (in millions):

 

		Three Months Ended September 30,
		2004			2003
Manufacturing relocation costs		$	1.6		$	2.3
Employee termination costs		—			8.4
Asset impairment charges		—			17.8
Total restructuring and impairment charges		$	1.6		$	28.5

 

Manufacturing relocation and Employee termination costs -  These charges were incurred as part of an Enhanced Strategic Plan (“Plan”) announced in July 2003 that included moving manufacturing operations from the U.S. to low-cost facilities in Mexico and China. The Company estimates that it will incur approximately $35.0 million in total charges related to the Plan, which is targeted for completion in June 2005.

 

Asset impairment charges – In 1999, the Company entered into the market for solid aluminum capacitors and has since made significant technology advances in both high-capacitance multilayer ceramic capacitors and organic tantalum capacitors, limiting applications of solid aluminum capacitors.  As a result, KEMET reorganized its solid aluminum capacitor business line during the quarter ended September 30, 2003 and recognized a $17.8 million non-cash charge related to the impairment of equipment and facilities associated with the aluminum capacitor business line.

 

 

(Loss) Gain on Long-term Supply Contract

 

The Company has a tantalum supply agreement with Cabot Corporation that extends through calendar 2007.  The Company records inventory at the lower of cost or market and had previously recorded a loss of $12.4 million for estimated future losses for the commitment to purchase tantalum at above-market prices during the quarter ended September 30, 2003.

 

The Company renegotiated and amended this contract during the current quarter.  As a result, tantalum purchase commitments have been reduced to $29.4 million through fiscal year 2007.  The Company recognized an $11.1 million gain in the current quarter to reflect the decrease in its liability as a result of the amended contract.

 

These gains (losses) are included in the line item, Loss (gain) on long-term supply contract on the consolidated statements of operations.  See Note 10 to the Consolidated Financial Statements for additional information.

 

 

Operating Loss

 

Operating loss for the three months ended September 30, 2004, was $7.2 million, compared to an operating loss of $72.3 million for the quarter ended September 30, 2003. The decrease in operating loss in the current period resulted primarily from higher net sales, lower per-unit manufacturing costs, lower restructuring and impairment charges and recognition of the gain associated with the amended tantalum supply contract with Cabot Corporation.

 

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Other Income and Expense

 

Interest income was higher in the three months ended September 30, 2004 versus the comparable period in the prior year primarily due to the Company’s increased investment in longer-term U.S. government securities with higher yields.  Also, the Company recognized $0.1 million of interest income in the quarter ended September 30, 2004 as a result of anticipated U.S. federal and state income tax refunds expected to be realized in the current fiscal year.

 

Other (income) expense was $0.8 million lower in the three months ended September 30, 2004 versus the comparable period in the prior year. In the current quarter, other (income) expense included income of $1.1 million associated with the mark-to-market adjustment of an interest rate swap contract.  This income was offset, in part, by a $0.9 million non-cash loss recognized as a result of an “other-than-temporary” decline in the market value in an “available-for-sale” equity investment (see Note 9 to the Consolidated Financial Statements).  In the comparable prior year quarter, the Company recognized income of $1.5 million associated with the mark-to-market adjustment on interest rate swap contracts and a loss of $1.0 million as a result of an “other-than-temporary” market decline on the same “available-for-sale” equity investment.

 

 

Income Taxes

 

The income tax expense totaled $0.2 million for the three months ended September 30, 2004, compared to an income tax benefit of $29.0 million for the three months ended September 30, 2003. The increase in the expense (benefit) between periods is attributable to the lower pre-tax loss in the current quarter and the existence of a valuation allowance, which prevents the Company from recognizing additional income tax benefits resulting from current period operating losses, until a sustained level of profitability has been achieved.

 

 

Comparison of the Six- Month Period Ended September 30, 2004, with the Six- Month Period Ended September 30, 2003

 

Net Sales

 

Net sales for the six months ended September 30, 2004, increased 11% to $228.4 million as compared to the same period last year. The increase in net sales was attributable to higher unit volumes for both tantalum and ceramic capacitors. Unit volumes in the six-month period ended September 30, 2004, exceeded the volumes of the prior period by approximately 39%.  Mix-adjusted average selling prices for the six-month period ended September 2004 decreased approximately 10% compared to average selling prices for the same six-month period last year.

 

Net sales of surface-mount capacitors were $185.7 million for the six months ended September 30, 2004, compared to $161.8 million for the same period last year. Net sales of leaded capacitors were $42.7 million for the six months ended September 30, 2004, versus $43.7 million during the same period last year.  Unit volume increased approximately 40% for surface-mount capacitors and decreased approximately 1% for leaded capacitors.

 

 

Cost of Sales

 

Cost of sales for the six months ended September 30, 2004, was $202.9 million, or 89% of net sales, as compared to $208.5 million, or 101% of net sales, for the same period last year.  A majority of the $5.6 million decrease from the prior year can be attributed to inventory charges associated with the impairment of the solid aluminum product line recognized during the six months ended September 30, 2003 (see discussion below under “Restructuring and impairment charges”).  No similar inventory charges exist in the current fiscal year.  Additionally, lower per-unit costs partially offset the 10% year-over-year decline in average selling prices. As a result, cost of sales as a percentage of net sales decreased compared to the same period last year.

 

Commencing in the quarter ended June 30, 2004, KEMET has included as a reduction to cost of goods sold an estimate of duty refunds earned on the importation of certain raw materials into the United States which were purchased from foreign suppliers.  Previously, KEMET would recognize a reduction in cost of goods sold after duty refund claims were filed with the appropriate customs agency, which frequently occurred in periods subsequent to the period in which the duty refund was earned.  During the six months ended September 30, 2004, KEMET reduced cost of goods sold by $610 thousand and recorded a receivable for duty refund claims earned in fiscal 2004, which the Company has determined does not have a significant impact on the consolidated financial statements.

 

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Selling, General and Administrative Expenses

 

Selling, general, and administrative expenses for the six months ended September 30, 2004, were $25.5 million, or 11% of net sales, as compared to $26.6 million, or 13% of net sales for the same period last year. SG&A spending reflects the Company’s continuing commitment to invest in long-term relationships with its customers through its direct sales and customer service professionals. Selling, general, and administrative expenses decreased as a percent of net sales largely as the result of higher net sales in the current fiscal year.

 

 

Research and Development Expenses

 

Research and development expenses for the six months ended September 30, 2004, were $13.4 million, or 5.8% of net sales, as compared to $11.9 million, or 5.8% of net sales for the same period last year. The increase in spending reflects the Company’s continuing commitment to invest in the development of new products and technologies.  However, due to the increase in net sales from the prior fiscal year, research and development expenses as a percentage of net sales remained unchanged.

 

 

Restructuring and Impairment Charges

 

A summary of the restructuring and impairment charges expensed in the periods ended September 30, 2004 and 2003, were as follows (in millions):

 

		Six Months Ended September 30,
		2004			2003
Manufacturing relocation costs		$	4.2		$	2.3
Employee termination costs		—			8.7
Asset impairment charges		—			17.8
Total restructuring and impairment charges		$	4.2		$	28.8

 

These charges were incurred as part of an Enhanced Strategic Plan (“Plan”) announced in July 2003 that included moving manufacturing operations from the U.S. to low-cost facilities in Mexico and China. The Company estimates that it will incur approximately $35.0 million in total charges related to the Plan, which is targeted for completion in June 2005.  All cost incurred during the six months ended September 30, 2004 relate to the relocation of manufacturing equipment to other low cost facilities in Mexico and China.

 

 

Extension of Raw Material Contract

 

The Company renegotiated the tantalum supply contract with Cabot Corporation in the current quarter.  The Company recognized an $11.1 million gain in the current quarter to reflect the decrease in its liability as a result of the amended contract.  Purchase commitments have been reduced to $29.4 million through fiscal year 2007.  See Note 10 to the Consolidated Financial Statements and the Commitment section of Management Discussion and Analysis of Results of Operations and Financial Condition for additional information.

 

 

Operating Loss

 

Operating loss for the six months ended September 30, 2004, was $6.6 million, compared to an operating loss of $82.7 million for the comparable period in the prior year.  The decrease in operating loss in the current period resulted primarily from higher net sales, lower per-unit manufacturing costs, lower restructuring and impairment charges and recognition of the gain associated with the amended tantalum supply contract with Cabot Corporation.

 

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