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KEMET CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This report contains certain statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Actual outcomes and results may differ materially from those expressed in, or implied by, our forward-looking statements. Words such as "expects," "anticipates," "believes," "estimates" and other similar expressions or future or conditional verbs such as "will," "should," "would" and "could" are intended to identify such forward-looking statements. Readers of this report should not rely solely on the forward-looking statements and should consider all uncertainties and risks throughout this report as well as those discussed under Part I, Item 1A of the Company's 2012 Annual Report. The statements are representative only as of the date they are made, and we undertook no obligation to update any forward-looking statement. All forward-looking statements, by their nature, are subject to risks and uncertainties. Our actual future results may differ materially from those set forth in our forward-looking statements. We face risks that are inherent in the businesses and the market places in which we operate. While management believes these forward-looking statements are accurate and reasonable, uncertainties, risks and factors, including those described below, could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that may cause actual outcome and results to differ materially from those expressed in, or implied by, these forward-looking statements include, but are not necessarily limited to, the following: (i) adverse economic conditions could impact our ability to realize operating plans if the demand for our products declines, and such conditions could adversely affect our liquidity and ability to continue to operate; (ii) adverse economic conditions could cause the write down of long-lived assets or goodwill; (iii) an increase in the cost or a decrease in the availability of our raw materials; (iv) changes in the competitive environment; (v) uncertainty of the timing of customer product qualifications in heavily regulated industries; (vi) changes in economic, political, or regulatory environment in the countries in which we operate; (vii) difficulties, delays or unexpected costs in completing the restructuring plan; (viii) equity method investments expose us to a variety of risks; (ix) acquisitions and other strategic transactions expose us to a variety of risks; (x) the inability to attract, train and retain effective employees and management; (xi) the inability to develop innovative products to maintain customer relationships and offset potential price erosion in older products; (xii) exposure to claims alleging product defects; (xiii) the impact of laws and regulations that apply to our business, including those relating to environmental matters; (xiv) the impact of international laws relating to trade, export controls and foreign corrupt practices; (xv) volatility of financial and credit markets affecting our access to capital; (xvi) the need to reduce the total costs of our products to remain competitive; (xvii) potential limitation on the use of net operating losses to offset possible future taxable income; (xviii) restrictions in our debt agreements that limit our flexibility in operating our business; and (xix) additional exercise of the warrant by K Equity, LLC which could potentially result in the existence of a significant stockholder who could seek to influence our corporate decisions. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations and could cause actual results to differ materially from those included, contemplated or implied by the forward-looking statements made in this report, and the reader should not consider the above list of factors to be a complete set of all potential risks or uncertainties. ACCOUNTING POLICIES AND ESTIMATES The following discussion and analysis of financial condition and results of operations are based on the unaudited condensed consolidated financial statements included herein. Our significant accounting policies are described in Note 1 to the consolidated financial statements in our 2012 Annual Report. Our critical accounting policies are described under the caption "Critical Accounting Policies" in Item 7 of our 2012 Annual Report. The preparation of financial statements in conformity with U.S. generally accepted accounting principles ("U.S. GAAP") requires management to make estimates, assumptions, and judgments based on historical data and other assumptions that management believes are reasonable. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. In addition, they affect the reported amounts of revenues and expenses during the reporting period. Our judgments are based on management's assessment as to the effect certain estimates, assumptions, or future trends or events may have on the financial condition and results of operations reported in the unaudited condensed consolidated financial statements. It is important that readers of these unaudited financial statements understand that actual results could differ from these estimates, assumptions, and judgments. 28 -------------------------------------------------------------------------------- Table of Contents Business Overview We are a leading global manufacturer of a wide variety of capacitors. Capacitors are fundamental components of most electronic circuits and are found in communication systems, data processing equipment, personal computers, cellular phones, automotive electronic systems, defense and aerospace systems, consumer electronics, power management systems and many other electronic devices and systems. Capacitors are typically used to filter out interference, smooth the output of power supplies, block the flow of direct current while allowing alternating current to pass and for many other purposes. We manufacture a broad line of tantalum, multilayer ceramic, solid and electrolytic aluminum and film and paper capacitors in many different sizes and configurations using a variety of raw materials. Our product line consists of over 250,000 distinct part configurations distinguished by various attributes, such as dielectric (or insulating) material, configuration, encapsulation, capacitance level and tolerance, performance characteristics and packaging. Because most of our customers have multiple capacitance requirements, often within each of their products, our broad product offering allows us to meet the majority of those needs independent of application and end use. In fiscal year 2012, we shipped approximately 32 billion capacitors and in the nine months ended December 31, 2012, we shipped approximately 24 billion capacitors. We believe the long-term demand for various types of capacitors we offer will grow on a regional and global basis due to a variety of factors, including increasing demand for and complexity of electronic products, growing demand for technology in emerging markets and the ongoing development of new solutions for energy generation and conservation. We operate 22 production facilities and employ approximately 9,800 employees worldwide. We manufacture capacitors in Europe, North America, and Asia. Commodity manufacturing in the United States has been substantially relocated to our lower-cost manufacturing facilities in Mexico and China. Production that remains in the United States focuses primarily on early-stage manufacturing of new products and other specialty products for which customers are predominantly located in North America. For the nine months ended December 31, 2012 and 2011, our consolidated net sales were $639.9 million and $774.2 million, respectively. We are organized into three business groups: Tantalum, Ceramic, and Film and Electrolytic. The Film and Electrolytic Business Group ("Film and Electrolytic") includes a machinery division located in Italy that provides automation solutions for the manufacture, processing and assembly of; metalized films, film/foil and electrolytic capacitors; and designs, assembles; and installs automation solutions for the production of energy storage devices. Each business group is responsible for the operations of certain manufacturing sites as well as all related research and development efforts. The sales and marketing functions are shared by each of the business groups and the costs of these functions are allocated to the business groups. Our Competitive Strengths We believe that we benefit from the following competitive strengths: Strong Customer Relationships. We have a large and diverse customer base. We believe that our emphasis on quality control and history of performance establishes loyalty with original equipment manufacturers ("OEMs"), electronics manufacturing services providers ("EMSs") and distributors. Our customer base includes most of the world's major electronics OEMs (including Alcatel-Lucent USA, Inc., Apple Inc., Bosch Group, Cisco Systems, Inc., Continental AG, Dell Inc., Hewlett-Packard Company, International Business Machines Corporation, Intel Corporation, Motorola, Inc., Nokia Corporation, and TRW Automotive), EMSs (including Celestica Inc., Elcoteq SE, Flextronics International LTD, Jabil Circuit, Inc. and Sanmina-SCI Corporation) and distributors (including TTI, Inc., Arrow Electronics, Inc. and Avnet, Inc.). Our strong, extensive and efficient worldwide distribution network is one of our differentiating factors. We believe our ability to provide innovative and flexible service offerings, superior customer support and focus on speed-to-market result in a more rewarding customer experience, earning us a high degree of customer loyalty. Breadth of Our Diversified Product Offering and Markets. We believe that we have the most complete line of primary capacitor types, across a full spectrum of dielectric materials including tantalum, ceramic, solid and electrolytic aluminum, film and paper. As a result, we believe we can satisfy virtually all of our customers' capacitance needs, thereby strengthening our position as their supplier of choice. We sell our products into a wide range of different end markets, including computing, industrial, telecommunications, transportation, consumer, defense and healthcare markets across all geographic regions. No single end market segment accounted for more than 30% and only one customer, TTI, Inc., accounted for more than 10% of our net sales in the nine months ended December 31, 2012. Our largest customer is a distributor, and no single end use customer accounted for more than 8% of our net sales in the nine months ended December 31, 2012. We believe that well-balanced product, geographic and customer diversification help us mitigate some of the negative financial impact through economic cycles. Leading Market Positions and Operating Scale. Based on net sales, we believe that we are the largest manufacturer of tantalum capacitors in the world and one of the largest manufacturers of direct current film capacitors in the world; we have a 29 -------------------------------------------------------------------------------- Table of Contents significant market position in the specialty ceramic and custom wet aluminum electrolytic markets. We believe that our leading market positions and operating scale allow us to realize production efficiencies, leverage economies of scale and capitalize on growth opportunities in the global capacitor market. Strong Presence in Specialty Products. We engage in design collaboration with our customers in order to meet their specific needs and provide them with customized products satisfying their engineering specifications. During the nine months ended December 31, 2012 and 2011, respectively, specialty products accounted for 41.1% and 39.1% of our revenue. By allocating an increasing portion of our management resources and research and development investment to specialty products, we have established ourselves as one of the leading innovators in this fast growing emerging segment of the market, which includes healthcare, renewable energy, telecommunication infrastructure, and oil and gas. For example, in August 2009, we were selected as one of thirty companies to receive a grant from the Department of Energy. Our $15.1 million award has enabled us to produce film capacitors within the United States to support alternative energy products and green technologies such as hybrid electric drive vehicles. Producing these parts in the United States will allow us to compete effectively in the alternative energy market domestically. We began production in the fourth quarter of fiscal year 2012. Low-Cost Production. We believe we have some of the lowest cost production facilities in the industry. Many of our key customers have relocated their production facilities to Asia, particularly China. We believe our manufacturing facilities in China have low production costs and are in close proximity to the large and growing Chinese market; in addition, we have the ability to increase capacity and change product mix to meet our customers' needs. We believe our operations in Mexico are among the most cost-efficient in the world. In addition, we believe our manufacturing facility in Bulgaria has low production costs; in the second quarter of fiscal year 2013 we expanded our manufacturing to Macedonia, which we believe will also have low production costs. Our Brand. Founded by Union Carbide in 1919 as KEMET Laboratories, we believe that we have established a reputation as a high quality, efficient and affordable partner that sets our customers' needs as the top priority. This has allowed us to successfully attract loyal clientele and enabled us to expand our operations and market share over the past few years. We believe our commitment to addressing the needs of the industry in which we operate has differentiated us from our competitors and established us as the "Easy-To-Buy-From" company. Our People. We believe that we have successfully developed a unique corporate culture based on innovation, customer focus and commitment. We have a strong, highly experienced and committed team in each of our markets. Many of our professionals have developed unparalleled experience in building leadership positions in new markets, as well as successfully integrating acquisitions. Our 16 member executive management team has an average of over 15 years of experience with us and an average of 25 years of experience in the manufacturing industry. Business Strategy Our strategy is to use our position as a leading, high-quality manufacturer of capacitors to capitalize on the increasingly demanding requirements of our customers. Key elements of our strategy include: One KEMET Campaign. We continue to focus on improving our business capabilities through various initiatives that all fall under our One KEMET campaign. The One KEMET campaign aims to ensure that we, as a company, are focused on the same goals and working with the same processes and systems to ensure consistent quality and service. This effort was launched to ensure that as we continue to grow, we not only remain grounded in our core principles but that we also use those principles, operating procedures and systems as the foundation from which to expand. These initiatives include our global Oracle software implementation, which we expect to complete in the first half of fiscal year 2014, our Lean and Six Sigma culture evolution and our global customer accounts management program, which is now implemented and will be expanding. Develop Our Significant Customer Relationships and Industry Presence. We intend to continue to be responsive to our customers' needs and requirements and to make order entry and fulfillment easier, faster, more flexible and more reliable for our customers by focusing on building products around customers' needs, by giving decision making authority to customer-facing personnel and by providing purpose-built systems and processes, such as our Easy-To-Buy-From order entry system. Continue to Pursue Low-Cost Production Strategy. We continue to evaluate and are actively pursuing measures that will allow us to maintain our position as a low-cost producer of capacitors with facilities close to our customers. We have shifted and will continue to shift production to low cost locations in order to reduce material and labor costs. We plan to expand our manufacturing in Macedonia which we believe will have low production costs. Additionally, we are focused on developing more cost-efficient manufacturing equipment and processes, designing manufacturing plants for more efficient production and reducing work-in-process ("WIP") inventory by building products from start to finish in one factory. Furthermore, we continue to implement the Lean and Six Sigma methodology to drive towards zero product defects so that quality remains a given in the minds of our customers. 30 -------------------------------------------------------------------------------- Table of Contents Leverage Our Technological Competence and Expand Our Leadership in Specialty Products. We continue to leverage our technological competence to introduce new products in a timely and cost-efficient manner and generate an increasing portion of our sales from new and customized solutions to meet our customers' varied and evolving capacitor needs as well as to improve financial performance. We believe that by continuing to build on our strength in the higher growth and higher margin specialty segments of the capacitor market, we will be well-positioned to achieve our long-term growth objectives while also improving our profitability. During the third quarter of fiscal year 2013, we introduced 399 new products of which 84 were first to market, and specialty products accounted for 41.1% of our revenue over this period. Further Expand Our Broad Capacitance Capabilities. We identify ourselves as "The Capacitance Company" and strive to be the supplier of choice for all our customers' capacitance needs across the full spectrum of dielectric materials including tantalum, ceramic, solid and electrolytic aluminum, film and paper. While we believe we have the most complete line of capacitor technologies across these primary capacitor types, we intend to continue to research and pursue additional capacitance technologies and solutions in order to maximize the breadth of our product offerings. Selectively Target Complementary Acquisitions and Equity Investments. As strategic opportunities are identified, we will evaluate and possibly pursue them if they would enable us to enhance our competitive position and expand our market presence. Our strategy is to acquire complementary capacitor and other related businesses that would allow us to leverage our business model, potentially including those involved in other passive components that are synergistic with our customers' technologies and our current product offerings. For example, on February 21, 2012, the Company completed its acquisition of Niotan Incorporated (whose name was subsequently changed to KEMET Blue Powder Corporation ("Blue Powder")), a leading manufacturer of tantalum powders, from an affiliate of Denham Capital Management LP. In addition, on February 1, 2013 we acquired a 34% economic interest in NEC TOKIN Corporation ("NT"), a manufacturer of tantalum capacitors and electro-magnetic, electro-mechanical and access devices. Promote the KEMET Brand Globally. We are focused on promoting the KEMET brand globally by highlighting the high-quality and high reliability of our products and our superior customer service. We will continue to market our products to new and existing customers around the world in order to expand our business. We continue to be recognized by our customers as a leading global supplier. For example, in calendar year 2012 we received Rockwell Collins' "Top Supplier Award" and in calendar year 2011, we received the "Supplier of the Year Award" from TTI, Inc. and from Arrow Electronics, Inc., both of which are electronics distributors. Global Sales & Marketing Strategy. Our motto "Think Global Act Local" describes our approach to sales and marketing. Each of our three sales regions (North America and South America ("Americas"), Europe, Middle East and Africa ("EMEA") and Asia and Pacific Rim ("APAC")) has account managers, field application engineers and strategic marketing managers in the region. In addition, we also have local customer and quality-control support in each region. This organizational structure allows us to respond to the needs of our customers on a timely basis and in their native language. The regions are managed locally and report to a senior manager who is on the KEMET Leadership Team. Furthermore, this organizational structure ensures the efficient communication of our global goals and strategies and allows us to serve the language, cultural and other region-specific needs of our customers. Recent Developments and Trends Despite declining sales over the past three fiscal quarters, our efforts to reduce our fixed costs across the entire company have been successful, and we have seen gross margin as a percentage of sales improve from 14.4% in the first quarter of fiscal year 2013 to 17.1% in the third quarter of fiscal year 2013. We have continued to shift production to lower cost locations and to restructure our operations. Through our recent acquisition and equity investment activity we believe we can enhance our competitive position. These trends are described in more detail below. Shift to Lower Cost Production In September 2012 we began production in Skopje, Macedonia; this facility will allow for a significant reduction in cost while increasing our total production capability. In addition, we initiated the relocation of some of our Film and Electrolytic manufacturing operations to our manufacturing facility in Evora, Portugal. Impairment Charge Consistent with prior years, we performed our annual impairment test of goodwill and indefinite lived assets as of May 31st. Due to reduced earnings and cash flows caused by macro-economic factors and excess capacity issues in our industry, we revised our 31 -------------------------------------------------------------------------------- Table of Contents earnings forecast; as a result, we recorded a $1.1 million goodwill impairment charge in the second quarter of fiscal year 2013, which represents all of the goodwill related to the KEMET Foil Manufacturing, LLC ("KEMET Foil") reporting unit. Write Down of Long-Lived Assets During the third quarter of fiscal year 2013 and corresponding with a restructuring of our Tantalum operations in the Evora, Portugal manufacturing facility, we incurred impairment charges totaling $3.1 million. This restructuring is expected to be completed during the quarter ending March 31, 2014. As a part of our ongoing commitment to expand our polymer capacity we will be moving Tantalum manufacturing operations from the Evora, Portugal facility to a manufacturing facility in Mexico and the equipment in Portugal will be disposed. We used an income approach to estimate the fair value of the assets to be disposed. During the second quarter of fiscal year 2013 and in connection with the consolidation of two Film and Electrolytic manufacturing facilities within Italy, we incurred impairment charges totaling $4.2 million. Appraisals for these manufacturing facilities indicated there was a decrease in market value and, therefore, the carrying amounts of these manufacturing facilities were reviewed for recoverability. It was determined that the carrying amounts of the manufacturing facilities were not recoverable since they exceeded the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset (asset group). The impairment was measured as the amount by which the carrying amount of a long-lived asset (asset group) exceeded its fair value. Issuance of 10.5% Senior Notes Add-On On March 27, 2012 and April 3, 2012, the Company completed the sale of $110.0 million and $15.0 million aggregate principal amount of its 10.5% Senior Notes due 2018, respectively, at an issue price of 105.5% of the principal amount plus accrued interest from November 1, 2011. The Senior Notes were issued as additional notes under the indenture, dated May 5, 2010, among the Company, the guarantors party thereto and Wilmington Trust Company, as trustee. Equity Investment On July 11, 2012, we received antitrust clearance from the European Commission under the European Union Merger Regulation for our previously announced intent to acquire a 34% economic interest in NT by KEMET Electronics Corporation ("KEC"), our wholly owned subsidiary, for $50.0 million. On January 2, 2013, we announced that KEC received regulatory clearance from the Anti-monopoly Bureau of the Ministry of Commerce of the People's Republic of China for KEC's proposed acquisition of a 34% interest in NT. All required governmental approvals to complete the transaction have now been obtained. The closing of the transaction occurred on February 1, 2013. We will account for the equity investment using the equity method in a non-consolidated variable interest entity since we do not have the power to direct significant activities of NT. Advance On August 28, 2012, we entered into an agreement, as amended on the same date (the "Agreement"), with an original equipment manufacturer (the "OEM") pursuant to which the OEM agreed to advance us $24.0 million (the "Advance Payment"). The Agreement provides that on a monthly-basis starting eight months following the receipt of the Advance Payment, we will pay the OEM an amount equal to a percentage of the aggregate purchase price of the capacitors sold to the OEM the preceding month, not to exceed $1.0 million per month. Pursuant to the terms of the Agreement, the percentage of the aggregate purchase price of capacitors sold to the OEM that will be used to repay the Advance Payment could double under certain circumstances described therein. Thirty-two months after the date of the Advance Payment, the remaining outstanding balance, if any, is due in full. Pursuant to the terms of the Agreement, we delivered to the OEM an irrevocable standby letter of credit in the amount of $16.0 million on October 8, 2012 which reduced our availability under the Loan and Security Agreement. On October 22, 2012 we received the Advance Payment from the OEM. Restructuring On July 25, 2012, we committed to a global restructuring plan to respond to the continued economic slowdown and in the quarter ended September 30, 2012 we incurred a $7.5 million charge to earnings related to termination benefits. On October 26, 2012, we expanded the global restructuring plan to include additional headcount reductions, and in the quarter ended December 31, 2012 we incurred an additional $3.4 million charge to earnings related to termination benefits. As a result of the restructuring of our Evora, Portugal plant, we expect to incur additional termination related expenses through March 31, 2014. 32 -------------------------------------------------------------------------------- Table of Contents Outlook For the fourth quarter of fiscal year 2013, we expect net sales to be consistent with the quarter ended December 31, 2012. We expect to incur capital expenditures in the range of $7.0 million to $9.0 million and Selling, General and Administrative ("SG&A") costs to decrease between $0.3 million to $0.5 million. CONDENSED CONSOLIDATED RESULTS OF OPERATIONS Comparison of the Third Quarter of Fiscal Year 2013 with the Third Quarter of Fiscal Year 2012 The following table sets forth the operating income (loss) for each of our business segments for the quarters ended December 31, 2012 and December 31, 2011. The table also sets forth each of the segments' net sales as a percent to total net sales and the net income (loss) components as a percent to total net sales (dollars in thousands): 33 -------------------------------------------------------------------------------- Table of Contents Quarters Ended December 31, 2012 December 31, 2011 Amount % to Total sales Amount % to Total sales Net sales Tantalum $ 98,496 49.2 % $ 92,091 42.1 % Ceramic 51,276 25.6 % 47,510 21.7 % Film and Electrolytic 50,525 25.2 % 79,194 36.2 % $ 200,297 100.0 % $ 218,795 100.0 % Gross margin (loss) Tantalum $ 17,492 $ 14,576 Ceramic 18,562 16,317 Film and Electrolytic (1,874 ) 9,597 34,180 17.1 % 40,490 18.5 % SG&A expenses Tantalum 724 637 Ceramic 754 727 Film and Electrolytic 1,919 2,760 3,397 1.7 % 4,124 1.9 % R&D expenses Tantalum 2,807 3,021 Ceramic 1,640 1,609 Film and Electrolytic 1,650 2,034 6,097 3.0 % 6,664 3.0 % Restructuring charges Tantalum 652 6 Ceramic 1,378 1 Film and Electrolytic 1,856 10,741 3,886 1.9 % 10,748 4.9 % Other operating expenses Tantalum 3,192 15,754 Ceramic 151 53 Film and Electrolytic 132 (12 ) 3,475 1.7 % 15,795 7.2 % Segment operating income (loss) Tantalum 10,117 (4,842 ) Ceramic 14,639 13,927 Film and Electrolytic (7,431 ) (5,926 ) 17,325 8.6 % 3,159 1.4 % Unallocated operating expenses SG&A expenses 22,014 20,613 R&D expenses 601 508 22,615 21,121 Operating loss (5,290 ) (17,962 ) Other (income) expense, net 8,552 4.3 % 7,690 3.5 % Loss before income taxes (13,842 ) -6.9 % (25,652 ) -11.7 % Income tax expense 415 0.2 % 2,119 1.0 % Net loss $ (14,257 ) -7.1 % $ (27,771 ) -12.7 % 34 -------------------------------------------------------------------------------- Table of Contents Consolidated Comparison of the Third Quarter of Fiscal Year 2013 with the Third Quarter of Fiscal Year 2012 Net Sales Net sales of $200.3 million for the quarter ended December 31, 2012 decreased 8.5% compared to net sales of $218.8 million in the third quarter of fiscal year 2012 due primarily to a $28.7 million decrease in Film and Electrolytic where average selling prices and unit sales volumes decreased due to a general softening in the market. This decrease was partially offset by an increase in net sales for Tantalum and the Ceramic Business Group ("Ceramic"), by $6.4 million and $3.8 million, respectively. The Tantalum increase was primarily driven by an increase in unit sales volumes while the Ceramic increase related to an increase in average selling prices due to an increase in specialty unit sales volumes. The following table reflects the percentage of net sales by region for the quarters ended December 31, 2012 and 2011: Quarters Ended December 31, 2012 2011 Americas 31 % 29 % EMEA 33 % 39 % APAC 36 % 32 % 100 % 100 % The following table reflects the percentage of net sales by channel for the quarters ended December 31, 2012 and 2011: Quarters Ended December 31, 2012 2011 Distributors 45 % 39 % EMS 18 % 16 % OEM 37 % 45 % 100 % 100 % Gross Margin Gross margin decreased $6.3 million in the quarter ended December 31, 2012 as compared to the quarter ended December 31, 2011 due primarily to an $11.5 million decrease in Film and Electrolytic where a general softening of the market drove a decrease in average selling prices and unit sales volumes. In addition, $1.5 million of plant start-up costs were incurred by Film & Electrolytic in the third quarter of fiscal year 2013 related to the Skopje, Macedonia and Evora, Portugal facilities compared to $0.7 million in the third quarter of fiscal year 2012. Decreases in Film and Electrolytic margins were partially offset by an increase in the gross margins for Tantalum and Ceramic, of $2.9 million and $2.2 million, respectively. The Tantalum increase was driven by an increase in unit sales volumes while the Ceramic increase related to an increase in average selling prices due to an increase in specialty unit sales volumes. Selling, General and Administrative Expenses SG&A expenses were $25.4 million, or 12.7% of net sales for the third quarter of fiscal year 2013 compared to $24.7 million or 11.3% of net sales for third quarter of fiscal year 2012. The $0.7 million increase in SG&A expenses primarily consists of a $2.0 million increase in incentive expense primarily related to stock based compensation, a $0.9 million increase in professional fees and $0.2 million in additional expense related to our investment to improve the health and educational facilities in the community of the Katanga Province of the Democratic Republic of the Congo. Partially offsetting these increases were a $1.4 million decrease in selling expenses consistent with the decrease in net sales, a $0.4 million decrease in ERP integration costs, and a $0.5 million decrease in marketing activities and projects. Research and Development Research and development ("R&D") expenses were $6.7 million or 3.3% of net sales for the third quarter of fiscal year 2013, compared to $7.2 million, or 3.3% of net sales for the third quarter of fiscal year 2012. The 6.6% decrease resulted from headcount reductions taken in fiscal year 2013 to align R&D expenses with an acceptable percentage of net sales. 35 -------------------------------------------------------------------------------- Table of Contents Restructuring Charges We incurred $3.9 million in restructuring charges in the third quarter of fiscal year 2013 compared to $10.7 million in restructuring charges in the third quarter of fiscal year 2012. Restructuring charges in the third quarter of fiscal year 2013 included $1.6 million for reductions in administrative overhead primarily in the Corporate headquarters, $0.7 million for reductions in production workforce in Mexico, $0.6 million in termination benefits associated with converting the Weymouth, United Kingdom manufacturing facility into a technology center and $0.5 million for reductions in workforce across the Company as a whole in response to lower volumes and demand. The total termination benefits expected for the conversion of the Weymouth manufacturing facility are $2.6 million of which $2.3 million have been recognized, the expected completion is the third quarter of fiscal year 2014. In addition to these personnel reduction costs, we incurred manufacturing relocation costs of $0.5 million for relocation of equipment to China, Bulgaria, Macedonia and Mexico and for the consolidation of manufacturing operations within Italy. The restructuring charges in the third quarter of fiscal year 2012 included $6.1 million for termination benefits related to facility closures in Italy and $4.5 million also incurred in Italy to participate in a plan to save labor costs whereby a company may temporarily "lay off" employees while the government continues to pay their wages for a certain period of time. In addition, we incurred manufacturing relocation costs of $0.3 million for relocation of equipment to China and Mexico. Operating Income (Loss) Operating loss for the quarter ended December 31, 2012 was $5.3 million compared to an operating loss of $18.0 million for the quarter ended December 31, 2011 for which the difference was primarily due to a decrease in the write down of long-lived assets of $12.7 million. In the third quarter of fiscal year 2013 a $3.1 million loss was realized on the impairment of Tantalum equipment in Evora, Portugal compared to an impairment charge of $15.8 million during the third quarter of fiscal year 2012 related to idled equipment in Evora, Portugal. In addition, Restructuring and R&D expenses decreased by $6.9 million and $0.5 million, respectively in the third quarter of fiscal year 2013 as compared to the third quarter of fiscal year 2012. These improvements were partially offset by a $6.3 million decrease in gross margin for the third quarter of fiscal year 2013 as compared to the third quarter of fiscal year 2012, a $0.7 million increase in SG&A expenses and a $0.6 million curtailment loss on a defined benefit pension plan recognized in the third quarter of fiscal year 2013. Other (Income) Expense, net Other (income) expense, net was an expense of $8.6 million in the third quarter of fiscal year 2013 compared to an expense of $7.7 million in the third quarter of fiscal year 2012. Interest expense for the third quarter of fiscal year 2013 increased $3.2 million compared to the third quarter of fiscal year 2012 due to a $125 million increase in our 10.5% Senior Notes. Offsetting this increase was a $0.6 million gain recognized in the third quarter of fiscal year 2013 due to a cancellation fee related to an order in the machinery division of Film and Electrolytic. In addition, during the third quarter of fiscal year 2013, we recognized a $0.5 million foreign currency exchange gain as compared to a $0.3 million loss on foreign currency exchange in the third quarter of fiscal year 2012, primarily due to the change in the value of the Euro and Mexican Peso compared to the U.S. dollar. Income Taxes Income tax expense for the third quarter of fiscal year 2013 was $0.4 million compared to $2.1 million of income tax expense for the third quarter fiscal year 2012. Income tax expense for the third quarter of fiscal year 2013 was comprised of a $0.9 million expense related to foreign operations and a $0.1 million state income tax expense and $0.6 million tax benefit resulting from the release of an uncertain tax position in a foreign jurisdiction. There is no U.S. federal income tax benefit from the third quarter of fiscal year 2013 loss due to a valuation allowance on net deferred tax assets. Income tax expense for the third quarter of fiscal year 2012 was comprised of $1.4 million related to two foreign tax jurisdictions that imposed new tax laws which limited the utilization of net operating losses and $0.7 million primarily related to income taxes for foreign operations There was no U.S. federal income tax expense related to the third quarter of fiscal year 2012 earnings due to the utilization of net operating loss carryforward deductions and a valuation allowance on net deferred tax assets. 36 -------------------------------------------------------------------------------- Table of Contents Business Groups Comparison of the Quarter Ended December 31, 2012 with the Quarter Ended December 31, 2011 Tantalum The following table sets forth Net sales, Gross margin, Gross margin as a percentage of Net sales, Segment Operating income (loss) and Segment Operating income (loss) as a percentage of Net sales for our Tantalum business group for the quarters ended December 31, 2012 and 2011 (amounts in thousands, except percentages): Quarters Ended December 31, 2012 December 31, 2011 Amount % to Net sales Amount % to Net sales Net sales $ 98,496 $ 92,091 Gross margin 17,492 17.8 % 14,576 15.8 % Segment operating income (loss) 10,117 10.3 % (4,842 ) -5.3 % Net Sales Net sales increased 7.0% during the third quarter of fiscal year 2013 as compared to the third quarter of fiscal year 2012. The increase in net sales in the third quarter of fiscal year compared to the third quarter of fiscal year 2012 is driven by an increase in unit sales volume of 7.1%. The increase in unit sales volume is due to increased demand in APAC, which was partially offset by a decrease in demand in EMEA. The current difficult economic environment in EMEA decreased net sales to $19.9 million in the third quarter of fiscal year 2013 as compared to $25.0 million in the third quarter of fiscal year 2012. Net sales in Asia increased to $49.2 million in the third quarter of fiscal year 2013 as compared to $41.2 million in the third quarter of fiscal year 2012. This increase was partially offset by a 0.1% decrease in average selling prices for the third quarter of fiscal year 2013 as compared to the third quarter of fiscal year 2012. Gross Margin Gross margin increased by $2.9 million during the quarter ended December 31, 2012, as compared to the quarter ended December 31, 2011 primarily due to cost savings achieved through our vertical integration of the tantalum supply chain and an increase in unit sales volumes. Cost reductions through vertical integration and lean/process engineering improvements are ongoing. Segment Operating Income (Loss) Segment operating income for the third quarter of fiscal year 2013 was $10.1 million compared to a segment operating loss of $(4.8) million in the third quarter of fiscal year 2012. The $15.0 million improvement was primarily attributable to a decrease in the write down of long-lived assets of $12.7 million. In the third quarter of fiscal year 2013 a $3.1 million loss was realized on the impairment of Tantalum equipment in Evora, Portugal compared to an impairment of $15.8 million during the third quarter of fiscal year 2012 related to idled equipment in Evora, Portugal. In addition, gross margin improved $2.9 million in the third quarter of fiscal year 2013 compared to the third quarter of fiscal year 2012. These improvements were partially offset by a $0.6 million increase in restructuring charges when comparing the third quarter of fiscal year 2013 to the third quarter of fiscal year 2012. Ceramic The following table sets forth Net sales, Gross margin, Gross margin as a percentage of Net sales, Segment operating income and Segment operating income as a percentage of Net sales for our Ceramic business group for the quarters ended December 31, 2012 and 2011 (amounts in thousands, except percentages): Quarters Ended December 31, 2012 December 31, 2011 Amount % to Net sales Amount % to Net sales Net sales $ 51,276 $ 47,510 Gross margin 18,562 36.2 % 16,317 34.3 % Segment operating income 14,639 28.5 % 13,927 29.3 % 37 -------------------------------------------------------------------------------- Table of Contents Net Sales Net sales increased $3.8 million, or 7.9% in the third quarter of fiscal year 2013 as compared to the third quarter of fiscal year 2012 primarily due to a 4.6% increase in average selling prices driven by an increase in the unit sales volumes of specialty products. Unit sales volume increased 3.2% during the third quarter of fiscal year 2013, as compared to the third quarter of fiscal year 2012 due to increased demand across all regions. Gross Margin Gross margin as a percentage of Ceramic net sales improved to 36.2% as compared to 34.3% in the third quarter of fiscal year 2012 primarily attributable to an increase in unit sales volume and a shift to higher margin specialty products. Segment Operating Income Segment operating income for the third quarter of fiscal year 2013 improved by $0.7 million due to a $2.2 million increase in gross margin when comparing the third quarter of fiscal year 2013 to the third quarter of fiscal year 2012. Partially offsetting this improvement was an increase in restructuring charges of $1.4 million when comparing the third quarter of fiscal year 2013 to the third quarter of fiscal year 2012. Film and Electrolytic The following table sets forth Net sales, Gross margin (loss), Gross margin (loss) as a percentage of Net sales, Segment operating income (loss) and Segment operating income (loss) as a percentage of Net sales for our Film and Electrolytic business group for the quarters ended December 31, 2012 and 2011 (amounts in thousands, except percentages): Quarters Ended December 31, 2012 December 31, 2011 Amount % to Net sales Amount % to Net sales Net sales $ 50,525 $ 79,194 Gross margin (loss) (1,874 ) -3.7 % 9,597 12.1 % Segment operating loss (7,431 ) -14.7 % (5,926 ) -7.5 % Net Sales Net sales decreased 36.2% in the third quarter of fiscal year 2013 compared to the third quarter of fiscal year 2012. Average selling prices for capacitors decreased 9.4% in the third quarter of fiscal year 2013 as compared to the same quarter last year. Average selling prices decreased due to the European economic slowdown and pressure on pricing. Capacitor unit sales volume for the third quarter of fiscal year 2013 decreased 17.6% compared to the third quarter of fiscal year 2012 due to an overall decrease in customer demand seen across all regions and channels. Capacitor net sales were unfavorably impacted by $1.5 million related to foreign exchange, primarily the Euro. The Film and Electrolytic machinery division's net sales decreased by $6.5 million in the third quarter of fiscal year 2013 compared to the third quarter of fiscal year 2012. The decrease in the Film and Electrolytic machinery division's net sales is primarily due to a decrease in unit sales volume and a $0.2 million unfavorable impact related to foreign exchange. Gross Margin (Loss) Gross margin (loss) as a percentage of Film and Electrolytic net sales decreased to (3.7)% in the third quarter of fiscal year 2013 as compared to 12.1% in the third quarter of fiscal year 2012. The decrease is primarily due to a decrease in capacitor unit sales volumes and lower production levels. In addition, we incurred $1.5 million of plant start-up costs related to the Skopje, Macedonia and Evora, Portugal facilities in the third quarter of fiscal year 2013 compared to $0.7 million in the third quarter of fiscal year 2012. The machinery division's gross loss decreased to $0.8 million in the third quarter of fiscal year 2013 as compared to a $1.1 million gross margin in the third quarter of fiscal year 2012 primarily due to a decrease in unit sales volumes. Segment Operating Income (Loss) Segment operating loss for the third quarter of fiscal year 2013 was $7.4 million as compared to Segment operating loss of $5.9 million in the third quarter of fiscal year 2012. The $1.5 million increase in segment operating loss is primarily attributable to an $11.4 million decrease in gross margin in the third quarter of fiscal year 2013 compared to the third quarter of fiscal year 2012. This decrease was partially offset by decreases in restructuring charges and SG&A expenses of $8.9 million and $0.8 million, respectively when comparing the third quarter of fiscal year 2013 to the same quarter of fiscal year 2012. 38 -------------------------------------------------------------------------------- Table of Contents Comparison of the Nine Months Ended December 31, 2012 with the Nine Months Ended December 31, 2011 The following table sets forth the operating income (loss) for each of our business segments for the nine months ended December 31, 2012 and December 31, 2011. The table also sets forth each of the segments' net sales as a percent to total net sales and the net income components as a percent to total net sales (dollars in thousands): 39 -------------------------------------------------------------------------------- Table of Contents Nine Months Ended December 31, 2012 December 31, 2011 Amount % to Total sales Amount % to Total sales Net sales Tantalum $ 317,003 49.5 % $ 326,824 42.2 % Ceramic 155,937 24.4 % 163,001 21.1 % Film and Electrolytic 166,980 26.1 % 284,340 36.7 % $ 639,920 100.0 % $ 774,165 100.0 % Gross margin (loss) Tantalum $ 52,945 $ 74,123 Ceramic 49,003 53,441 Film and Electrolytic (2,519 ) 54,473 99,429 15.5 % 182,037 23.5 % SG&A expenses Tantalum 3,400 1,919 Ceramic 2,076 2,307 Film and Electrolytic 6,347 8,918 11,823 1.8 % 13,144 1.7 % R&D expenses Tantalum 9,524 9,078 Ceramic 4,846 4,791 Film and Electrolytic 4,893 5,822 19,263 3.0 % 19,691 2.5 % Restructuring charges Tantalum 2,759 905 Ceramic 2,630 89 Film and Electrolytic 8,283 12,384 13,672 2.1 % 13,378 1.7 % Other operating expenses Tantalum 3,212 15,803 Ceramic 176 55 Film and Electrolytic 3,811 20 7,199 1.1 % 15,878 2.1 % Segment operating income (loss) Tantalum 34,050 46,418 Ceramic 39,275 46,199 Film and Electrolytic (25,853 ) 27,329 47,472 7.4 % 119,946 15.5 % Unallocated operating expenses SG&A expenses 68,826 70,224 R&D expenses 2,001 1,929 70,827 72,153 Operating income (loss) (23,355 ) 47,793 Other (income) expense, net 29,603 4.6 % 23,500 3.0 % Income (loss) before income taxes (52,958 ) -8.3 % 24,293 3.1 % Income tax expense 3,973 0.6 % 5,897 0.8 % Net income (loss) $ (56,931 ) -8.9 % $ 18,396 2.4 % 40 -------------------------------------------------------------------------------- Table of Contents Consolidated Comparison of the Nine Months Ended December 31, 2012 with the Nine Months Ended December 31, 2011 Net Sales Net sales for the nine months ended December 31, 2012 decreased by $134.2 million, or 17.3% to $639.6 million compared to the same period in fiscal year 2012 primarily due to a $117.4 million decrease in Film and Electrolytic where unit sales volumes decreased due to a decrease in demand seen across all regions and channels. The decrease in unit sales volume for Film and Electrolytic was partially offset by an increase in average selling prices due to favorable product mix shifts. The other driver for the decrease in net sales related to Film and Electrolytic's machinery division net sales decrease of $36.0 million in the nine months ended December 31, 2012 compared to the nine months ended December 31, 2011. In addition, net sales decreased for Tantalum and Ceramic by $9.8 million and $7.1 million, respectively. The Tantalum decrease was driven by a decrease in average selling prices due to a shift in sales from EMEA to APAC. The Ceramic decrease related to a decrease in average selling prices and unit sales volumes due to excess capacity in the market place. The following table reflects the percentage of net sales by region for the nine months ended December 31, 2012 and 2011: Nine Months Ended December 31, 2012 2011 Americas 29 % 28 % EMEA 34 % 38 % APAC 37 % 34 % 100 % 100 % The following table reflects the percentage of net sales by channel for the nine months ended December 31, 2012 and 2011: Nine Months Ended December 31, 2012 2011 Distributors 44 % 43 % EMS 17 % 14 % OEM 39 % 43 % 100 % 100 % Gross Margin Gross margin was $99.4 million, or 15.5% of net sales for the nine months ended December 31, 2012 compared to $182.0 million, or 23.5% of net sales for the nine months ended December 31, 2011. The primary contributors to the decline in gross margin were lower unit sales volume, a shift in sales to APAC where product margins are lower and the difficulty reducing our operating costs in proportion with the decline in production volumes. In addition, for Tantalum, efforts to reduce costs through vertical integration and lean/process engineering improvements are ongoing; however, have not offset the significant unfavorable shift in regional sales mix. In addition, we incurred $4.8 million of plant start-up costs in the nine months ended December 31, 2012 compared to $1.4 million in the nine months ended December 31, 2011. Selling, General and Administrative Expenses SG&A expenses for the nine months ended December 31, 2012 were $80.6 million, or 12.6% of net sales, as compared to $83.4 million, or 10.8% of net sales for the same period in fiscal year 2012. The $2.8 million decrease in SG&A expenses included a decrease of $4.2 million in selling and incentive expenses consistent with the decrease in sales and a $0.9 million decrease in marketing activities and projects. Partially offsetting these decreases were a $1.5 million increase in incentive compensation related to stock based compensation, and an increase of $0.3 million related to ERP integration costs due to an increase in activities as we work toward completing Oracle ERP implementations during the first half of fiscal year 2014. In addition, in the nine months ended December 31, 2012, we incurred a $0.8 million expense related to our investment to improve the health and educational facilities in the community of the Katanga Province of the Democratic Republic of the Congo. 41 -------------------------------------------------------------------------------- Table of Contents Research and Development Expenses R&D expenses for the nine months ended December 31, 2012 were $21.3 million, or 3.3% of net sales compared to $21.6 million, or 2.8% of net sales for the same period in fiscal year 2012. The $0.3 million decrease resulted from headcount reductions taken in fiscal year 2013 to align the R&D expenses with an acceptable percentage of net sales.` Restructuring Charges During the nine months ended December 31, 2012, we incurred $13.7 million in restructuring charges compared to $13.4 million in restructuring charges for the nine months ended December 31, 2011. The restructuring charges for personnel reductions totaled $12.0 million in the nine months ended December 31, 2012 and were comprised of the following: $2.8 million in termination benefits associated with converting the Landsberg, Germany manufacturing facility into a technology center, $2.3 million in termination benefits associated with converting the Weymouth, United Kingdom manufacturing facility into a technology center, $2.3 million for reductions in administrative overhead primarily in the Corporate headquarters, $2.0 million for reductions in production workforce and administrative overhead across the entire Company, $1.5 million for reductions in production workforce in Mexico and $1.1 million for reductions in production workforce in Portugal,. In addition to these personnel reduction costs, the Company incurred manufacturing relocation costs of $1.7 million for relocation of equipment to Bulgaria, China, Macedonia and Mexico and for the consolidation of manufacturing operations within Italy. The restructuring charges for the nine months ended December 31, 2011 included termination benefits of $6.1 million related to facility closures in Italy that commenced during fiscal year 2013 and $4.5 million also incurred in Italy to participate in a plan to save labor costs whereby a company may temporarily "lay off" employees while the government continues to pay their wages for a certain period of time. Additionally, we incurred $1.2 million in personnel reduction costs primarily due to headcount reductions in the Mexican operations of Tantalum. We also incurred manufacturing relocation costs of $1.6 million for relocation of equipment to China and Mexico. Operating Income (Loss) Operating loss for the nine months ended December 31, 2012 was $23.4 million, compared to operating income of $47.8 million for the nine months ended December 31, 2011. The $71.2 million decrease in the nine months ended December 31, 2012 compared to the nine months ended December 31, 2011 is primarily due to the $82.6 million decrease in Gross margin. Also, $1.1 million was recognized for goodwill impairment in the nine months ended December 31, 2012. Partially offsetting these decreases to operating income were a decrease in Write down of long-lived assets, SG&A expenses, and curtailment and settlement gains of $8.5 million, $2.7 million and $1.1 million, respectively. During the nine months ended December 31, 2012, a $3.1 million loss was realized on the impairment of Tantalum equipment in Evora, Portugal and a $4.2 million loss was realized on the impairment of two manufacturing facilities in Italy compared to an impairment of $15.8 million during the third quarter of fiscal year 2012 related to idled equipment in Evora, Portugal. Other (Income) Expense, net Other (income) expense, net was an expense of $29.6 million in the nine months ended December 31, 2012 compared to an expense of $23.5 million in the nine months ended December 31, 2011. Interest expense for the nine months ended December 31, 2012 increased $9.1 million compared to the third quarter of fiscal year 2012 due to a $125 million increase in our 10.5% Senior Notes. Offsetting this increase was a $0.6 million gain recognized in the nine months ended December 31, 2012 due to a cancellation fee imposed on a customer. In addition, during the nine months ended December 31, 2012, we recognized a $0.9 million foreign currency exchange loss as compared to a $1.6 million loss on foreign currency exchange in the nine month period ended December 31, 2011, primarily due to the change in the value of the Euro and Mexican Peso compared to the U.S. dollar. Income Taxes For the nine months ended December 31, 2012, income tax expense of $4.0 million was comprised of a $4.4 million income tax expense related to foreign operations, $0.2 million of state income tax expense and $0.6 million income tax benefit related to a release of an uncertain tax position in a foreign jurisdiction. During the nine months ended December 31, 2011, we recognized net income tax expense of $5.9 million comprised of a $5.5 million income tax expense related to foreign operations, $1.4 million related to two foreign tax jurisdictions that imposed new tax laws which limited the utilization of net operating losses, $0.1 million of state income tax benefits, and a $0.9 million U.S. federal income tax benefit related to a prior year settlement. 42 -------------------------------------------------------------------------------- Table of Contents Business Groups Comparison of the Nine Months Ended December 31, 2012 with the Nine Months Ended December 31, 2011 Tantalum The table sets forth Net sales, Gross margin, Gross margin as a percentage of net sales, Segment operating income and Segment operating income as a percentage of net sales for our Tantalum business group for the quarters ended December 31, 2012 and 2011 (amounts in thousands, except percentages): Nine Months Ended December 31, 2012 December 31, 2011 % to Net % to Net Amount sales Amount sales Net sales $ 317,003 $ 326,824 Gross margin 52,945 16.7 % 74,123 22.7 %Segment operating income 34,050 10.7 % 46,418 14.2 % Net Sales Net sales decreased 3.0% during the nine months ended December 31, 2012, as compared to the same period of fiscal year 2012. Average selling prices decreased 3.0% and unit sales volume remained relatively flat for the nine months ended December 31, 2012 as compared to the same period ended December 31, 2011. The decrease in average selling prices was primarily related to a regional shift from EMEA to APAC. The current economic situation in EMEA caused a decline in net sales to $70.3 million for the nine months ended December 31, 2012 as compared to $93.7 million in the period ended December 31, 2011. APAC revenue increased to $159.0 million for the nine months ended December 31, 2012 as compared to $143.6 million in the period ended December 31, 2011. Gross Margin Gross margin decreased by $21.2 million, or 28.6% during the nine months ended December 31, 2012, as compared to the nine months ended December 31, 2011. Gross margin as a percentage of Tantalum net sales decreased to 16.7% in the nine months ended December 31, 2012 as compared to 22.7% in the nine months ended December 31, 2011. The decrease in gross margin was significantly impacted by the shift in sales from higher margin products sold into EMEA to lower margin products sold into APAC. In addition, plant start-up costs related to the vertical integration efforts totaled $0.9 million during the nine months ended December 31, 2012 compared to zero in the nine month period ended December 31, 2011. These decreases to gross margin were partially offset by cost savings achieved through our vertical integration of the tantalum supply chain. Segment Operating Income Segment operating income for the nine months ended December 31, 2012 was $34.1 million, as compared to segment operating income of $46.4 million in the nine months ended December 31, 2011. The decline is attributable to the decrease in gross margin of $21.2 million as compared to the nine months ended December 31, 2011. In addition, SG&A and Restructuring expenses increased $1.5 million and $1.9 million, respectively during the nine months ended December 31, 2012 as compared to the nine months ended December 31, 2011. These decreases were partially offset by a decrease in the write down of long-lived assets of $12.7 million. In the nine month period ended December 31, 2012, a $3.1 million loss was realized on the impairment of Tantalum equipment in Evora, Portugal compared to an impairment of $15.8 million in the nine month period ended December 31, 2011 related to idled equipment in Evora, Portugal. 43 -------------------------------------------------------------------------------- Table of Contents Ceramic The table sets forth Net sales, Gross margin, Gross margin as a percentage of net sales, Segment operating income and Segment operating income as a percentage of net sales for our Ceramic business group for the nine months ended December 31, 2012 and 2011 (amounts in thousands, except percentages): Nine Months Ended December 31, 2012 December 31, 2011 % to Net % to Net Amount sales Amount sales Net sales $ 155,937 $ 163,001 Gross margin 49,003 31.4 % 53,441 32.8 % Segment operating income 39,275 25.2 % 46,199 28.3 % Net Sales Net sales decreased by 4.3% during the nine months ended December 31, 2012 as compared to the same period of fiscal year 2011. The decrease was primarily attributable to the 2.9% decrease in unit sales volumes and a 1.4% decline in average sales price during the nine months ended December 31, 2012 as compared to the same period of fiscal year 2011. The decrease in average sales price is due to excess capacity in the marketplace which is driving aggressive price competition. Gross Margin Gross margin decreased by $4.4 million during the nine months ended December 31, 2012, as compared to the nine months ended December 31, 2011. Gross margin as a percentage of Ceramic net sales decreased to 31.4% in the nine months ended December 31, 2012 as compared to 32.8% in the nine months ended December 31, 2011. The decrease in gross margin is primarily attributable to a decrease in unit sales volumes and average selling prices. Segment Operating Income Segment operating income declined from $46.2 million in the nine months ended December 31, 2011 to $39.3 million in the nine months ended December 31, 2012. The decrease in Segment operating income of $6.9 million was attributable to the $4.4 million decrease in gross margin in the nine months ended December 31, 2012 compared the nine months ended December 31, 2011. In addition, restructuring expenses in the nine months ended December 31, 2012 were $2.5 million higher than the nine months ended December 31, 2011. Film and Electrolytic The table sets forth Net sales, Gross margin (loss), Gross margin (loss) as a percentage of net sales, Segment operating income (loss) and Segment operating income (loss) as a percentage of net sales for our Film and Electrolytic business group for the nine months ended December 31, 2012 and 2011 (amounts in thousands, except percentages): Nine Months Ended December 31, 2012 December 31, 2011 % to Net % to Net Amount sales Amount sales Net sales $ 166,980 $ 284,340 Gross margin (loss) (2,519 ) -1.5 % 54,473 19.2 % Segment operating income (loss) (25,853 ) -15.5 % 27,329 9.6 % Net Sales Net sales decreased by 41.3% from $284.3 million in the nine months ended December 31, 2011 to $167.0 million in the nine months ended December 31, 2012. Capacitor unit sales volume for the nine months ended December 31, 2012 decreased 35.6% compared to the same period in fiscal year 2012 due to an overall decrease in customer demand seen across all regions and channels. Capacitor sales were unfavorably impacted by $9.7 million related to foreign exchange. The Film and Electrolytic machinery division's net sales decreased by $36.0 million in the nine months ended December 31, 2012 compared to the same period of fiscal year 2012. The decrease in the Film and Electrolytic machinery division net sales is primarily due to a decrease in unit sales volume and an unfavorable impact of $2.0 million related to foreign exchange. These decreases were partially offset by an increase in 44 -------------------------------------------------------------------------------- Table of Contents capacitor average selling prices which increased 8.5% at comparable exchange rates for the nine months ended December 31, 2012 as compared to the same nine months in fiscal year 2012 driven by a favorable shift in product line mix. Gross Margin (Loss) Gross margin decreased $57.0 million in the nine months ended December 31, 2012 compared to the nine months ended December 31, 2011 resulting in a gross loss of $2.5 million. The decrease in gross margin was primarily due to a decrease in capacitor unit sales volumes and lower production levels (for both capacitors and the machinery division). In addition we incurred $4.0 million of plant start-up costs related to the Skopje, Macedonia and Evora, Portugal manufacturing facilities in the nine months ended December 31, 2012 compared to $1.4 million in the nine months ended December 31, 2011. Gross margin (loss) as a percentage of Film and Electrolytic net sales decreased to (1.5)% in the nine months ended December 31, 2012 as compared to 19.2% in the same nine months in fiscal year 2012. Segment Operating Income (Loss) Segment operating loss was $(25.9) million in the nine months ended December 31, 2012 compared to an operating income of $27.3 million in the nine months ended December 31, 2011. The decrease in Segment operating income of $53.2 million was attributable primarily to the $57.0 million decrease in gross margin during the nine months ended December 31, 2012 as compared to the nine months ended December 31, 2011. In addition we realized a loss of $4.2 million in the nine months ended December 31, 2012 related to the impairment of two manufacturing facilities in Italy and a $1.1 million charge was recognized for goodwill impairment in the nine months ended December 31, 2012 as compared to no write downs in the corresponding period during the prior fiscal year. These expenses were offset by the following: a $4.1 million decrease in restructuring charges, $1.5 million net curtailment and settlement gain on benefit plan recognized in the nine months ended December 31, 2012, a $2.6 million decrease in SG&A expenses and a $0.9 million decrease in R&D expenses. Liquidity and Capital Resources Our liquidity needs arise from working capital requirements, capital expenditures, acquisitions, principal and interest payments on debt, and costs associated with the implementation of our restructuring plans. Historically, these cash needs have been met by cash flows from operations, borrowings under our loan agreements and existing cash balances. Issuance of 10.5% Senior Notes On May 5, 2010, we completed a private placement of $230.0 million in aggregate principal amount of our 10.5% Senior Notes due 2018 (the "10.5% Senior Notes"). On March 27, 2012 and April 3, 2012, we completed the sale of $110.0 million and $15.0 million aggregate principal amount of its 10.5% Senior Notes due 2018, respectively, at an issue price of 105.5% of the principal amount plus accrued interest from November 1, 2011. The Senior Notes were issued as additional notes under the indenture, dated May 5, 2010, among the Company, the guarantors party thereto and Wilmington Trust Company, as trustee. Revolving Line of Credit On September 30, 2010, KEMET Electronics Corporation ("KEC") and KEMET Electronics Marketing (S) Pte Ltd. ("KEMET Singapore") (each a "Borrower" and, collectively, the "Borrowers") entered into a Loan and Security Agreement (the "Loan and Security Agreement"), with Bank of America, N.A, as the administrative agent and the initial lender. The Loan and Security Agreement provides a $50 million revolving line of credit, which is bifurcated into a U.S. facility (for which KEC is the Borrower) and a Singapore facility (for which KEMET Singapore is the Borrower). The size of the U.S. facility and Singapore facility can fluctuate as long as the Singapore facility does not exceed $30 million and the total facility does not exceed $50 million. A portion of the U.S. facility and of the Singapore facility can be used to issue letters of credit. The facilities expire on September 30, 2014. Advanced Payment from OEM On August 28, 2012, we entered into an Agreement, with an OEM pursuant to which the OEM agreed to the Advance Payment. The Agreement provides that on a monthly-basis starting eight months following the receipt of the Advance Payment, we will pay the OEM an amount equal to a percentage of the aggregate purchase price of the capacitors sold to the OEM the preceding month, not to exceed $1.0 million per month. Pursuant to the terms of the Agreement, the percentage of the aggregate purchase price of capacitors sold to the OEM that will be used to repay the Advance Payment will double, and the total amount to be repaid will not exceed $2.0 million per month, in the event that (1) the OEM provides evidence that the price charged by us for a particular capacitor during any prior quarter was equal to or greater than 110% of the price paid by the OEM or its affiliates for a third-party part qualified for the same product, and shipping in volume during such period, and (2) agreement cannot be reached between the OEM and KEMET for a price adjustment during the current quarter which would bring our price within 110% of the third-party price. Thirty- 45 -------------------------------------------------------------------------------- Table of Contents two months after the date of the Advance Payment, the remaining outstanding balance, if any, is due in full. Pursuant to the terms of the Agreement, we delivered to the OEM an irrevocable standby letter of credit in the amount of $16.0 million on October 8, 2012 which reduced our availability under the Loan and Security Agreement. On October 22, 2012 we received the Advance Payment from the OEM. There were no other borrowings against the Loan and Security Agreement as of December 31, 2012 or March 31, 2012. Short-term Liquidity Cash and cash equivalents totaled $137.6 million as of December 31, 2012, a decrease of $73.0 million as compared to $210.5 million as of March 31, 2012. Our net working capital (current assets less current liabilities) as of December 31, 2012 was $341.8 million compared to $398.6 million of net working capital as of March 31, 2012. Cash and cash equivalents held by our foreign subsidiaries totaled $34.5 million and $24.4 million at December 31, 2012 and March 31, 2012, respectively. Our operating income outside the U.S. is deemed to be permanently reinvested in foreign jurisdictions. As a result, we currently do not intend nor foresee a need to repatriate cash and cash equivalents held by foreign subsidiaries. If these funds are needed for our operations in the U.S., we would be required to accrue and pay U.S. taxes to repatriate these funds. In light of current global economic conditions, we have taken steps to improve our operating results by decreasing global headcount and vertically integrating our supply chain. Based on our current operating plans, we believe that domestic cash and cash equivalents and cash from the revolving line of credit will continue to be sufficient to fund our operating requirements for the next twelve months, including $50.0 million for the investment in NT, $37.3 million in interest payments, expected capital expenditures in the range of $35.0 million to $40.0 million, $7.0 million related to the Advance Payment discussed above, deferred acquisition payments of $21.0 million, payments related to restructuring liabilities, and $1.3 million in debt principal payments. Should we require more capital in the U.S. than is generated by our operations domestically or available through our revolving line of credit, we believe we could raise capital in the U.S. through debt issuances. However, due to market conditions beyond our control, there can be no assurance that we will be able to complete such an offering. The incurrence of additional debt would result in increased interest expense. We have borrowed funds domestically and expect to continue to have the ability to do so at competitive interest rates. Cash and cash equivalents decreased by $73.0 million for the nine months ended December 31, 2012 as compared with a decrease of $16.0 million during the nine months ended December 31, 2011. The following table provides a summary of cash flows for the quarters presented (amounts in thousands): Nine Months Ended December 31, 2012 2011Net cash provided by (used in) operating activities $ (41,622 ) $ 71,903 Net cash used in investing activities (62,349 ) (43,377 ) Net cash provided by (used in) financing activities 31,090 (43,545 ) Effects of foreign currency fluctuations on cash (81 ) (983 ) Net decrease in cash and cash equivalents $ (72,962 ) $ (16,002 ) Operations Cash used in operating activities in the nine months ended December 31, 2012 totaled $41.6 million compared to cash provided by operating activities of $71.9 million in the nine months ended December 31, 2011. This decrease was primarily a result of an $81.4 million decrease in cash flows related to operations (net income (loss) adjusted for the change in: depreciation and amortization, net (gain) loss on sales and disposals of assets, amortization of debt discounts and debt issuance costs, goodwill impairment, write down of long-lived assets, net curtailment and settlement gain on benefit plans and stock-based compensation) for fiscal year 2013 compared to fiscal year 2012. The change in operating assets resulted in a $51.9 million decrease in cash generation in the nine months ended December 31, 2012 as compared to the nine months ended December 31, 2011. The decrease is primarily related to a decrease in cash generated through accounts receivable; in the nine months ended December 31, 2012, we generated $8.3 million in accounts receivable as compared to the nine months ended December 31, 2011, where we generated $47.2 million in accounts receivable. We used $4.8 million through an increase in prepaid expenses in the nine months ended December 31, 2012, compared to the nine months ended December 31, 2011 where we generated $3.0 million due to a decrease in prepaid expenses. In addition we used $9.0 million through an increase in inventories in the nine months ended December 31, 2012, compared to the nine months ended December 31, 2011 46 -------------------------------------------------------------------------------- Table of Contents where we used $3.9 million through the increase in inventories. The increase in inventory for the nine months ended December 31, 2012 is primarily related to an increase in raw materials as we are establishing our vertical integration. Offsetting these uses of cash was $28.2 million of cash used for operating liabilities in the nine months ended December 31, 2012 compared to $48.1 million of cash used in operating liabilities in the nine months ended December 31, 2011. Within operating liabilities, a decrease in accounts payable and accrued expenses accounted for $20.7 million in cash used in the nine months ended December 31, 2012 compared to $47.4 million cash used related to the decrease in accounts payable and accrued expenses in the nine months ended December 31, 2011. The decrease in accounts payable and accrued expenses in the nine month period ended December 31, 2012 corresponds with the decrease in production activities. In addition we used $6.3 million in the nine months ended December 31, 2011 related to other long-term obligations compared to a $0.4 million use of cash for long-term obligations in the nine months ended December 31, 2012. Investing Cash used in investing activities increased $19.0 million in the nine months ended December 31, 2012 compared to the nine months ended December 31, 2011. The variance is comprised of a $24.0 million use of cash related to a restriction that was placed on a portion of our cash balance arising from the OEM Advance Payment and a $6.6 million increase in capital expenditures in the nine months ended December 31, 2012 compared to the nine months ended December 31, 2011. For the nine months ended December 31, 2012, capital expenditures were primarily related to the new manufacturing facilities in Skopje, Macedonia and Pontecchio, Italy. The increases in the use of cash were offset by an $11.6 million decrease in cash used for acquisitions. During the nine months ended December 31, 2011, we paid $11.6 million for the acquisition of KEMET Foil. Financing Cash provided by financing activities increased $74.6 million in the nine months ended December 31, 2012 as compared to the nine months ended December 31, 2011. In the nine months ended December 31, 2012, we received a $24.0 million Advance Payment from an OEM and the $15.8 million in proceeds from the issuance of debt resulted from the private placement of our 10.5% Senior Notes. In the nine months ended December 31, 2012 we used $6.6 million for deferred acquisition payments related to the KEMET Foil and Blue Powder acquisitions and $1.9 million for debt payments. In the nine months ended December 31, 2011, we used $43.7 million for payments on both long-term and short-term debt, primarily related to the retirement of the Convertible Notes. Commitments In addition to the contractual obligations disclosed in the Company's 2012 Annual Report, we had contractual obligations related to the OEM Advanced Payment as of December 31, 2012 as follows (amounts in thousands): Payments Due by Period More than Total Year 1 Years 2-3 Years 4-5 5 years Advance payment from OEM $ 24,000 $ 7,000 $ 17,000 $ - $ - Non-U.S. GAAP Financial Measures To complement our Condensed Consolidated Statements of Operations and Cash Flows, we use non-U.S. GAAP financial measures of Adjusted operating income, Adjusted net income (loss) and Adjusted EBITDA. Management believes that Adjusted operating income, Adjusted net income and Adjusted EBITDA are complements to U.S. GAAP amounts and such measures are useful to investors. The presentation of these non-U.S. GAAP measures is not meant to be considered in isolation or as an alternative to net income as an indicator of our performance, or as an alternative to cash flows from operating activities as a measure of liquidity. 47 -------------------------------------------------------------------------------- Table of Contents Adjusted operating income is calculated as follows (amounts in thousands): Quarters Ended December 31, Nine Months Ended December 31, 2012 2011 2012 2011 Operating income (loss) $ (5,290 ) $ (17,962 ) $ (23,355 ) $ 47,793 Adjustments: Restructuring charges 3,886 10,748 13,672 13,378 Write down of long-lived assets 3,084 15,786 7,318 15,786 ERP integration costs 1,458 1,812 5,233 4,935 Plant start-up costs 1,524 666 4,814 1,384 Settlement gain on benefit plan 587 - (1,088 ) - Stock-based compensation expense 1,078 (797 ) 3,584 1,378 Goodwill impairment - - 1,092 - Acquisition related fees 164 - 1,592 610 Net loss on sales and disposals of assets (196 ) 9 (123 ) 92 Registration related fees - - 20 281 Adjusted operating income $ 6,295 $ 10,262 $ 12,759 $ 85,637 Adjusted net income (loss) is calculated as follows (amounts in thousands): Quarters Ended December 31, Nine Months Ended December 31, 2012 2011 2012 2011 Net income (loss) $ (14,257 ) $ (27,771 ) $ (56,931 ) $ 18,396 Adjustments: Restructuring charges 3,886 10,748 13,672 13,378 Write down of long-lived assets 3,084 15,786 7,318 15,786 ERP integration costs 1,458 1,812 5,233 4,935 Plant start-up costs 1,524 666 4,814 1,384 Net curtailment and settlement (gain) loss on benefit plans 587 - (1,088 ) - Stock-based compensation expense 1,078 (797 ) 3,584 1,378 Goodwill impairment - - 1,092 - Amortization included in interest expense 1,122 847 3,046 2,903 Acquisition related fees 164 - 1,592 610 Net foreign exchange (gain) loss (464 ) 303 883 1,571 Net (gain) loss on sales and disposals of assets (196 ) 9 (123 ) 92 Registration related fees - - 20 281 Income tax impact of adjustments (1) (228 ) 398 (315 ) 788 Adjusted net income (loss) $ (2,242 ) $ 2,001 $ (17,203 ) $ 61,502 -------------------------------------------------------------------------------- (1) The income tax effect of the excluded items is calculated by applying the applicable jurisdictional income tax rate, considering the deferred tax valuation for each applicable jurisdiction. 48 -------------------------------------------------------------------------------- Table of Contents Adjusted EBITDA is calculated as follows (amounts in thousands): Quarters Ended December 31, Nine Months Ended December 31, 2012 2011 2012 2011 Net income (loss) $ (14,257 ) $ (27,771 ) $ (56,931 ) $ 18,396 Adjustments: Interest expense, net 10,193 6,974 30,729 21,582 Income tax expense 415 2,119 3,973 5,897 Depreciation and amortization 10,502 10,373 33,679 33,384 Restructuring charges 3,886 10,748 13,672 13,378 Write down of long-lived assets 3,084 15,786 7,318 15,786 ERP integration costs 1,458 1,812 5,233 4,935 Plant start-up costs 1,524 666 4,814 1,384 Stock-based compensation expense 1,078 (797 ) 3,584 1,378 Goodwill impairment - - 1,092 - Acquisition related fees 164 - 1,592 610 Net curtailment and settlement (gain) loss on benefit plans 587 - (1,088 ) - Net foreign exchange (gain) loss (464 ) 303 883 1,571 Net (gain) loss on sales and disposals of assets (196 ) 9 (123 ) 92 Registration related fees - - 20 281 Adjusted EBITDA $ 17,974 $ 20,222 $ 48,447 $ 118,674 Adjusted operating income represents operating income, excluding adjustments which are outlined in the quantitative reconciliation provided above. We use Adjusted operating income to facilitate our analysis and understanding of our business operations and believe that Adjusted operating income is useful to investors because it provides a supplemental way to understand our underlying operating performance. Adjusted operating income should not be considered as an alternative to operating income or any other performance measure derived in accordance with U.S. GAAP. Adjusted net income represents net income (loss), excluding adjustments which are more specifically outlined in the quantitative reconciliation provided above. We use Adjusted net income to evaluate our operating performance and believe that Adjusted net income is useful to investors because it provides a supplemental way to understand our underlying operating performance. Adjusted net income should not be considered as an alternative to net income (loss), operating income or any other performance measures derived in accordance with U.S. GAAP. Adjusted EBITDA represents net income (loss) before interest expense, net, income tax expense, and depreciation and amortization expense, adjusted to exclude goodwill impairment, write down of long-lived assets, net curtailment and settlement gain/loss on benefit plans, restructuring charges, plant start-up costs, net foreign exchange gain/loss, stock-based compensation expense/recovery, net gain/loss on sales and disposals of assets, ERP integration costs, registration related fees, and acquisition related fees. We present Adjusted EBITDA as a supplemental measure of our performance and ability to service debt. We also present Adjusted EBITDA because we believe such measure is frequently used by securities analysts, investors and other interested parties in the evaluation of companies in our industry. We believe Adjusted EBITDA is an appropriate supplemental measure of debt service capacity, because cash expenditures on interest are, by definition, available to pay interest, and tax expense is inversely correlated to interest expense because tax expense goes down as deductible interest expense goes up; and depreciation and amortization are non-cash charges. The other items excluded from Adjusted EBITDA are excluded in order to better reflect our continuing operations. In evaluating Adjusted EBITDA, you should be aware that in the future we may incur expenses similar to the adjustments noted above. Our presentation of Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by these types of adjustments. Adjusted EBITDA is not a measurement of our financial performance under U.S. GAAP and should not be considered as an alternative to net income, operating income or any other performance measures derived in accordance with U.S. GAAP or as an alternative to cash flow from operating activities as a measure of our liquidity. Our Adjusted EBITDA measure has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under U.S. GAAP. Some of these limitations are: † it does not reflect our cash expenditures, future requirements for capital expenditures or contractual commitments; † it does not reflect changes in, or cash requirements for, our working capital needs; 49 -------------------------------------------------------------------------------- Table of Contents † it does not reflect the significant interest expense or the cash requirements necessary to service interest or principal payments on our debt; † although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and our Adjusted EBITDA measure does not reflect any cash requirements for such replacements; † it is not adjusted for all non-cash income or expense items that are reflected in our statements of cash flows; † it does not reflect the impact of earnings or charges resulting from matters we consider not to be indicative of our ongoing operations; † it does not reflect limitations on or costs related to transferring earnings from our subsidiaries to us; and † other companies in our industry may calculate this measure differently than we do, limiting its usefulness as a comparative measure. Because of these limitations, Adjusted EBITDA should not be considered as a measure of discretionary cash available to us to invest in the growth of our business or as a measure of cash that will be available to us to meet our obligations. You should compensate for these limitations by relying primarily on our U.S. GAAP results and using Adjusted EBITDA only supplementally. Off-Balance Sheet Arrangements Other than operating lease commitments, we are not a party to any material off-balance sheet financing arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources. Impact of Recently Issued Accounting Standards New accounting standards adopted In September 2011, the FASB issued ASU 2011-08, Guidance on Testing Goodwill for Impairment. ASU 2011-08 gives entities testing goodwill for impairment the option of performing a qualitative assessment before calculating the fair value of a reporting unit in Step 1 of the goodwill impairment test. If entities determine, on the basis of qualitative factors, that it is more likely than not that the fair value of a reporting unit is not less than the carrying amount, the two-step impairment test would be required. Otherwise, further testing would not be needed. ASU 2011-08 was effective for the Company on April 1, 2012 and did not have a material effect on the Company's financial position. In December 2011, the FASB issued ASU 2011-12, Comprehensive Income. ASU 2011-12 defers the requirement in ASU 2011-05 that companies present reclassification adjustments for each component of AOCI in both OCI and net income on the face of the financial statements. ASU 2011-12 requires companies to continue to present amounts reclassified out of AOCI on the face of the financial statements or disclosed in the notes to the financial statements. ASU 2011-12 also defers the requirement to report reclassification adjustments in interim periods and requires companies to present only total comprehensive income in either a single continuous statement or two consecutive statements in interim periods. ASU 2011-05 and ASU 2011-12 was effective for the Company on April 1, 2012 and did not have a material effect on the Company's financial position. There are currently no other accounting standards that have been issued that will have a significant impact on the Company's financial position, results of operations or cash flows upon adoption. |