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Edited Transcript of KEM earnings conference call or presentation 12-Nov-19 1:00pm GMT

Q2 2020 KEMET Corp Earnings Call

SIMPSONVILLE Nov 14, 2019 (Thomson StreetEvents) -- Edited Transcript of KEMET Corp earnings conference call or presentation Tuesday, November 12, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gregory C. Thompson

KEMET Corporation - Executive VP & CFO

* Richard J. Vatinelle

KEMET Corporation - VP & Treasurer

* William M. Lowe

KEMET Corporation - CEO & Director

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Conference Call Participants

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* Craig Andrew Ellis

B. Riley FBR, Inc., Research Division - Senior MD & Director of Research

* Jonathan Doherty Lopez

The Vertical Trading Group, LLC, Research Division - Research Analyst

* Marco Andres Rodriguez

Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst

* Matthew John Sheerin

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the KEMET's Second Quarter Fiscal Year 2020 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your first speaker today, Richard Vatinelle. Thank you. Please go ahead, sir.

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Richard J. Vatinelle, KEMET Corporation - VP & Treasurer [2]

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Thank you, Prince, and good morning, everyone. This is Richard Vatinelle, Vice President and Treasurer. Welcome to KEMET's conference call to discuss the financial results for the second quarter of fiscal year 2020, which concluded on September 30, 2019.

Joining me today on the call is Bill Lowe, Chief Executive Officer; and Greg Thompson, Executive Vice President and Chief Financial Officer.

As a reminder to you, a presentation is available on our website that should help you follow along in the financial portion of the presentation.

Before we begin, we would like to advise you that all statements addressing expectations or projections about the future are forward-looking statements. Some of these statements include words such as expects, anticipates, estimates, believes, plans, intends, projects and indicates. Although they reflect our current expectations, these statements are not guarantees of future performance and they involve a number of risks, uncertainties and assumptions.

Please refer to our 10-Ks, our 10-Qs and our registration filing statements for additional information on the risks and uncertainties.

Now I will turn the call over to Bill.

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William M. Lowe, KEMET Corporation - CEO & Director [3]

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Thank you, Richard, and good morning, everyone. In addition to reporting our quarterly results, we're also excited to talk this morning about what we believe is a compelling strategy and strategic combination for our shareholders, customers, business partners and our employees.

Yesterday evening, we announced an agreement to be acquired by Yageo, a leading global electronic component company headquartered in Taiwan and listed on the Taiwan Stock Exchange, in an all-cash transaction valued at $1.8 billion, which includes the assumption of net debt.

Shareholders of KEMET will receive $27.20 per share in cash, which is not subject to a financing contingency. Yageo is similar to KEMET with a complete product portfolio and capabilities on a global scale, including production and sales facilities in Asia, Europe and the Americas.

Because of KEMET's and Yageo's complementary product offerings, the combined company will be an industry leader in the $28 billion to $32 billion passive components industry and serve as a one-stop provider of a robust portfolio of polymer, tantalum, ceramic, film and electrolytic capacitors, chip resistors, circuit protection as well as magnetic sensors and actuators with revenues of approximately $3 billion.

Our Board of Directors conducted a thorough process in evaluating this transaction with outside advisers over a number of months, along with other potential opportunities to enhance value for shareholders. The board determined entering into this agreement is in the best interest of the company and our stakeholders.

First and foremost, this transaction will deliver the certainty of immediate cash to shareholders at a 30-day trading premium of 26% and a 90-day trading premium of 37%. It is also a premium of 14% over our 52-week high. Second, we are confident this transaction will position KEMET for long-term growth as we enter our second 100 years as a company, providing quality products and service.

Together with Yageo, we'll have an enhanced global footprint and be better able to partner with long-standing blue-chip customers worldwide through a combined 42 manufacturing plants and 14 dedicated R&D centers with an increased presence in attractive high-growth segments and applications.

This includes consumer electronics as well as in the high-end automotive, industrial, aerospace, telecom and medical sectors. The Yageo team has made it clear their admiration for the KEMET brand and the quality of our operations and our success in capturing increased worldwide demand for customer-designed higher-margin electronic components and capacitors and our talented workforce.

Further, Yageo and KEMET each have a proven track record of completing major cross-border acquisitions and believe this transaction will generate enhanced value for customers and shareholders of both companies as well as greater opportunities for employees.

As I stated earlier, and is in our joint press release, the transaction is not subject to a financing contingency. Yageo intends to fund the transaction with a combination of cash on hand and committed financing. We would expect to close the transaction in the second half of 2020, subject to customary closing conditions, which including KEMET shareholder approval and the receipt of required regulatory approvals in various jurisdictions in which we operate.

Until then, KEMET and Yageo will continue to operate as independent companies. Following the close of the transaction, KEMET will become a wholly owned subsidiary of Yageo. This is an incredible opportunity for our company to capitalize our momentum and provide an enhanced experience, superior service and broader selection of passive component technologies to our customers across the globe. We are excited to take this next step, and I'm optimistic as ever about KEMET's future.

Now let me turn the call over to Greg to go through the numbers in the quarter, and then I'll come back to you with some comments on the markets and our business units.

We did have a great quarter, meeting all of our goals and seeing less of an impact from the slowdown than our competition with historical margins continuing to improve, built by our tireless efforts over the years to embed changes in our structure. Greg?

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Gregory C. Thompson, KEMET Corporation - Executive VP & CFO [4]

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Thank you, Bill, and good morning, everyone. I'm sure you've had a chance to review our press release this morning, so I will highlight only a few key metrics. I will start my review on Slide 4 and 5 of the webcast slides.

Revenue for the second quarter was down 6.3% to $327.4 million compared to Q2 last year of $349.2 million, as we continue our efforts to reduce excess inventory in the distribution channel. GAAP net income was negative $15.3 million or $0.26 per share loss for the quarter compared to GAAP net income of $37.1 million or $0.63 per diluted share for the quarter ended September 30, 2018. This decline was driven by onetime items relating to litigation settlements.

As detailed in our 8-K filed this morning, the company entered into a settlement agreement with the plaintiffs in the Antitrust Litigation originally filed on December 4, 2014, in which KEMET and more than 20 other capacitor manufacturers and subsidiaries are defendants in a purported class action complaint relating to the sale of capacitors in the U.S.

KEMET has reached a settlement agreement subject to court approval, and has agreed to pay an aggregate of $62 million to settlement of the class of plaintiffs. Pursuant to the terms of this settlement agreement, KEMET will pay $10 million within 30 calendar days of the date of the settlement agreement and the remaining amount within 12 months.

As part of the settlement agreement, the company did not admit to violating any statute or law, any wrongdoing. The company recorded a total charge for litigation settlements of $63 million in the second quarter.

Non-GAAP adjusted net income was $39.3 million in the second quarter versus $50.8 million in the same quarter last year, a decrease of 22.6% due to lower revenues and much higher tax rate in FY '20, which I'll touch on a bit later.

In spite of lower revenues, GAAP gross margin was up significantly compared to last year's second quarter by 220 basis points from $32.5 million to $34.7 million due to continuing improvements in operational efficiencies in the Solid Capacitor segment.

GAAP diluted EPS was $0.26 negative compared to $0.63 for the second quarter last year. Non-GAAP diluted EPS was $0.66, down compared to $0.86 in the second quarter last year. Again, this decline was due to the higher income tax rate in fiscal year '20.

Our adjusted EBITDA for the second quarter was up 3.5% to $75 million from $72.5 million in the same quarter last year.

Now on Slide 6. The LTM adjusted EBITDA margins have steadily increased over the last 2 fiscal years from 17.4% at September 30, 2018, to 23.1% for the period ending September 30, 2019.

During our first quarter call, we discussed the structural changes that we have made over the last few years in terms of segmenting the ceramics product line to focus on value-added applications with a design-in focus, vertically integrating the tantalum business to improve cost and focus on the newer polymer technology and, of course, acquiring TOKIN to expand our offering and strengthen our balance sheet.

This quarter's results continue to highlight that these structural changes make us a different company today than we were several years ago as we demonstrate continuing strong, sustainable profitability performance in spite of the slowdown in the electronics industry.

Non-GAAP SG&A expenses came in below our forecast at $42.2 million or 12.9% of revenue compared to Q2 last year of $45.3 million or 13%.

Non-GAAP income taxes were $18.7 million at an effective tax rate of 32.2% compared to Q2 last year of $2.2 million at an effective tax rate of 4.1%.

As explained in our last earnings call, the increase in the non-GAAP income tax effective rate is due to the release in Q4 of last year of our U.S. net operating loss valuation allowance and partial valuation allowance in Japan. This is a result of the significant improvements in our profitability along with our forecast for continued strong profitability going forward.

The further increase in the company's effective tax rate this quarter and in our projection for next quarter is a result of lower projected earnings for the year, which changes the mix of earnings by tax jurisdiction and increases the impacts from the permanent differences related to the Tax Reform Act provisions.

Turning now to Slide 7. Capital expenditures during the second quarter were $36.3 million compared to $37.1 million in the previous quarter. This coming quarter, we expect to spend in the range of $45 million to $55 million for capital expenditures as we continue our planned capacity expansion focused on ceramics and tantalum polymer to support future customer demand.

Along with investments in our IT infrastructure around the globe, we expect capital expenditures for the full year ending March 2020 to be in the range of $120 million to $135 million, excluding approximately $45 million to $50 million of customer-funded capacity expansion related to the customer capacity agreements which we've discussed over the last couple of earnings calls.

Net inventories increased $12.1 million in the second quarter to $268.2 million compared to the previous quarter of $256.1 million due to higher ceramics work in process to support future demand and some opportunistic raw material purchases in our tantalum product line.

Cash on hand was $192.7 million. Our cash balances and accounts receivable DSO were negatively impacted by approximately $10 million by Typhoon Mitag, which caused banking closures throughout Taiwan a few days before quarter end. We do process a significant amount of our cash collections in Asia Pacific through our Taiwan subsidiary.

We generated $51.7 million of cash from operating activities during the second quarter.

Turning to Slide 8. Net debt stands at $113 million at quarter end, and net debt to LTM EBITDA of 0.4 is on Slide 8. This slight increase from a Q1 net debt to LTM EBITDA of 0.3 is due mainly to the increase in customer capacity agreement funding between quarters, which gets recorded as down the balance sheet as well as the lower cash number, as I explained earlier.

During the second quarter, we made our semi-annual principal payment of approximately $12.7 million on the outstanding TOKIN debt. And overall, our financial position remains very strong.

Now I will turn the call back over to Bill to comment on the business groups.

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William M. Lowe, KEMET Corporation - CEO & Director [5]

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Thanks, Greg. And so turning to our business groups and starting with Solid Capacitors. Solid Capacitor revenue was up -- was, sorry, $1.8 million lower or down 0.8% versus the same quarter last fiscal year. So looking at the 2 Solid Capacitor business product lines, the revenue for the ceramic product line actually increased $21.1 million or 24.1% versus the same quarter the previous year.

The ceramic revenue increased in each channel and increased in each region as compared to the same quarter a year ago. These increases were driven by product mix and a favorable MLCC pricing. Growth versus the same quarter a year ago was broad-based across almost all ceramic segments.

Our focus segments led the growth, which includes automotive, industrial, defense and aerospace, medical and energy. Our focus for future growth in our ceramic product segment continues to be development, design-in and supply of ceramic capacitors requiring high performance, reliability based on more robust designs and materials.

Many of these require larger sizes to handle higher current and voltage and power requirements. As compared to the global MLCC market, our ceramic revenue has remained at a high level as compared to the global MLCC market, which has experienced about a 23% reduction from the peak quarter in September 2018 based upon the world cap reporting.

We've said previously that we are insulated but not immune from the global market dynamics because of our product focus and our business model. However, we are forecasting reduced ceramic revenue for the upcoming quarter due to general global market conditions that remain sluggish and specifically demand that is somewhat stagnant or declining in the automotive and industrial markets because of tariffs and other global market economic factors.

We also plan on reducing ceramics inventory within our distribution network this quarter by shipping in lower volumes than our distribution partners will ship to their customers to help balance out the inventory in the channel. Given the global market conditions, we believe this is the right thing to do.

Lastly, the December quarter is a seasonally low quarter for automotive. And historically, we typically observe a reduction in the December quarter of 6% to 10% related to automotive, except in years where demand might be accelerating.

Revenue for the tantalum product line decreased $22.9 million or 15.5% versus the same quarter last fiscal year. The decline in revenue was driven primarily by weakness in the distribution and OEM channels for our legacy MnO2 products with MnO2 declining approximately $15.7 million or 50%.

Polymer revenue declined only $8 million or about 8%, impacted primarily by the distribution channel and telecom segment softness in EMS.

Revenue for our specialty tantalum products increased slightly, almost about $1 million year-over-year, driven by the strength in the military and medical segments. Our focus for future growth in the tantalum product segment remains on new product development and design-in success for applications requiring higher frequency, harsh environments, limited board space and enhanced audio quality. These application requirements cross many end segments, including tablet, PC, telecom, automotive, industrial and cloud.

SCBG, the Solid Capacitor business group gross margin increased to 44.4% or 420 basis points higher versus the same quarter last fiscal year. This improvement was driven by product mix optimization, favorable pricing for MLCCs and favorable manufacturing performance as a result of continued focus on recurring cost-out initiatives, yield improvement and alignment of our manufacturing cost structure with lower volumes.

Backlog in tantalum is stable with normalized lead times. Backlog in ceramics is approximately 7 months with more normalized lead times for lower CV products but still constrained in many high CV, large case sizes. We continue to add capacity to support this demand.

Our Film and Electrolytic business revenue was $41.8 million. That's $8.8 million lower than the same quarter in fiscal 2019. Revenue slowed across distribution and OEM channels during the second quarter, mostly in the EMEA, which is Europe and APAC regions, driven by softening automotive market.

Gross margin was 5% compared to 12.4% in the same quarter in the fiscal year 2019. Decreasing volumes in the automotive market and a shift in product mix contributed to the lower margin in the second quarter.

For Magnetic, Sensors and Actuators group, revenue for the quarter came in at $52 million, which was $11.2 million lower than the same quarter in fiscal 2019. Gross margin came in at 14.9%, which was a decrease of 530 basis points year-over-year. But the decrease was mainly driven by lower demand for EMI flex suppression sheets, primarily related to a slowdown in the smartphone market.

We are experiencing a continued slowdown in demand for piezo actuator products used in the semiconductor production equipment, consistent with the overall semiconductor market situation as well as specific consumer-related markets.

In addition, we are subject to the year-over-year slowdown in the global server market. On the positive side, we continue to see strength and upward momentum in our metal wire business for the medical catheter guidewire market.

Additionally, we continue to see nice growth as well through the distribution channels we develop and place more new products in the channel to position and grow our MSA long tail business, particularly Phase 1 and 2 of our new choke coil series, which was recently released through the distribution channel and is expected to expand the business for the seeable future.

I'm pleased with the pipeline of projects we have in place for the future periods as we expand MSA's reach well beyond Japan.

Looking at the channel now. For the distribution channel, POA generated about $131 million in revenue, which was down 12% compared to the first quarter of 2020. POS for the quarter came in at $163 million, which is essentially flat to the prior quarter, and this POS to POA alignment drove the channel inventory down just slightly.

Before I turn the call back to Greg for our upcoming forecast, let me comment on what we see in the various market segments. We forecast global light vehicle sales to contract approximately 5% to 6% year-on-year, but we continue to see increases in content of electronic components.

We are forecasting moderate growth in this segment for this year, and we remain convinced that the content in automotive and mobility, in general, will continue to grow. Our backlog and channel sales POS both reflect this with positive trends year-on-year.

Demand in the Industrial segment has also been impacted by the general slowdown in major economies, but we are still seeing pockets of growth driven by the accelerated investment and enhancement in factory and warehouse automation, and our direct and POS sales for this segment for the quarter decreased in the low single digits year-on-year.

Our business in the defense and aerospace markets continue to be robust as demonstrated by another quarter of growth in both our direct and distribution channels, and we forecast this growth to continue into next year.

In the Telecom segment, we continue to observe soft conditions in legacy solutions and applications, and a gradual ramp-up in infrastructure and applications that support 5G rollout. We remain focused on the design and efforts as we expand our product offering into 5G solutions across all of our product groups.

In the Computing segment, which for us includes devices that support cloud solutions as well as personal computing, we believe we have seen the bottom of the cycle. We see encouraging signs in the traditional server space as well as design wins with customers developing servers for edge computing and enterprise-level solid-state drives.

Demand in the mature notebook and desktop PC market has improved year-on-year, and we anticipate this to continue into next year.

On our last earnings call, I shared with you the introduction of METCOM, a metal composite power inductor line of products. This quarter, we announced the expansion of our KC-LINK capacitor series with industry-leading offerings for fast switching, wide band gap semiconductor applications, which are forecasted to grow significantly over the next few years.

Our KC-LINK components will allow designers to increase power efficiency and density in applications, such as 5G telecommunication base stations and onboard electric vehicles.

Now I'll turn the call back to Greg to discuss our outlook.

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Gregory C. Thompson, KEMET Corporation - Executive VP & CFO [6]

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Thank you, Bill. In our outlook, we expect our third quarter sales to be in the range of $285 million to $300 million, down approximately 8% to 13% from the quarter ended September 30, 2019. The lower revenue number reflects the distribution channel impact, which Bill discussed earlier.

That said, we believe our gross margin will continue to be strong and reflect the positive impact from our structural changes as we expect non-GAAP gross margin to remain between 30% and 32.5%.

SG&A expenses should be $43 million to $45 million and R&D expenses in the range of $12.5 million to $13.5 million. Our global effective tax rate is expected to be around 35% to 39% for the third quarter.

Now I will turn this back to Bill for some closing comments.

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William M. Lowe, KEMET Corporation - CEO & Director [7]

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Thank you, Greg. As noted by Greg's forecast, we expect to continue to maintain our margins at historical levels. And while we're not immune to the slowdown, as I said earlier, in some of those end markets and the inventory of the distribution channel, our expectation is to continue to perform better than our competition on both the top-line results as well as margins.

As I said in my opening remarks, by combining with Yageo Corporation, KEMET is set to begin another exciting 100 years in our journey to make the world a better, safer and more connected place to live. I believe our commitment to innovation and serving customers around the globe is profoundly unique. The unique culture of this company will endure and along with the quality of our products, will continue to make us a leading supplier of electronic components.

Yesterday's announcement is an important acknowledgment of how the services and products we provide sustain international demand of technological excellence.

Now we'll open up the call for questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Craig Ellis from B. Riley FBR.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [2]

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Congratulations both on the announcement with Yageo and the strong financial results in the quarter. Bill, I wanted to start off just by following up on one of the comments you made in the prepared remarks around the Yageo transaction and some of the other things that the executive team and board looked at. I think you said that you looked at other opportunities beyond the Yageo transaction. Can you provide more color on what those were and why you ultimately decided to move towards Yageo?

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William M. Lowe, KEMET Corporation - CEO & Director [3]

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What we can say today is that I can kind of repeat what I said, but the board did go through a thorough process, of course, with outside advisers for a number of months. And of course, that included multiple advisers and fairness opinions, et cetera. All that will be -- all the steps that the board went through will be in our proxy statement that will be filed -- preliminary proxy statement that will be filed probably early January.

That's required as a part of that proxy process. So we'll lay all that out, and it'll very clear what the full process was that the board went through over a number of months, I will say, to come to this conclusion.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [4]

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Great. And then as a follow-up, just on the approval point related to the Yageo transaction. Can you identify which major geographies will require approval, and in particular, I think our clients will be interested in whether China is needed or not. So if you could speak to that, too.

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William M. Lowe, KEMET Corporation - CEO & Director [5]

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Yes. China will be needed. We're both in China. We will be in...

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Gregory C. Thompson, KEMET Corporation - Executive VP & CFO [6]

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It's a number of locations, Craig, that we'll...

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William M. Lowe, KEMET Corporation - CEO & Director [7]

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Probably about -- probably around 4 locations including China, that would be about my guess.

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Gregory C. Thompson, KEMET Corporation - Executive VP & CFO [8]

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Yes. As well as in the U.S., you would expect a CFIUS approval is also required.

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William M. Lowe, KEMET Corporation - CEO & Director [9]

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That's correct.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [10]

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Sure. And then moving on just to the financial guidance. Greg, what I want to do was understand, in the revenue range that you provided, the $385 million (sic) [$285 million] to $300 million, how much impact is there from distribution inventory reduction versus the quarter that was just reported? And how long would you expect distribution inventory reduction to play out? Do you think you get it all behind you in this current quarter? Or is this going to be a multi-quarter effort to get inventory to the target level of the company?

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Gregory C. Thompson, KEMET Corporation - Executive VP & CFO [11]

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So Craig, it's $285 million to $300 million, is our revenue guidance. I thought you said maybe -- I couldn't -- didn't understand your first number. And I would say the majority of that decline is related to the distribution inventory impact, it came down. There was a slight decline, as Bill mentioned, but not as much as we think is required.

Also geographically in Europe, we see some overall slowdown. And automotive, while we've seen content increases, that is some slowness that we see. Relative to your specific question about the timing, I think it's too early to tell, but we -- it feels to us like it's probably more like a couple quarters, not just this quarter, that we would see slowness. But we'll see how it all develops this quarter and hopefully get the distribution inventories down to a healthy level where we would like to see, recognizing we made some impact on that in this quarter, but not as much as we think is needed, given what we see for the end demand right now.

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William M. Lowe, KEMET Corporation - CEO & Director [12]

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And I'm going to circle back to your previous question, I believe and I don't have it in front of me, but I believe an 8-K was filed this morning that has the list of countries that will -- that we need approval for. So I would just ask you to check the 8-Ks that have been filed pretty this morning.

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Gregory C. Thompson, KEMET Corporation - Executive VP & CFO [13]

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Yes. It has been filed.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [14]

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And then, Greg, a follow-up on the answer that you provided. As you look at the trailing 5-quarter revenue range, and as you look at the signals that you're getting from your customers, acknowledging that there's meaningful inventory reduction going on in the current quarter and potentially for another quarter or 2, where do you think the natural level of underlying demand or consumption is for your products? Where in that trailing 5-quarter range could you peg underlying consumption intensity?

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Gregory C. Thompson, KEMET Corporation - Executive VP & CFO [15]

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That's a tough one -- there's a lot of puts and takes in there. I think we've seen a lot of interest with our new products. Pricing has been very stable throughout that period. I think the guidance that we are looking at that we've given you for the second quarter, we would hope with all those movements in pricing and some volume increases along with the additional volume we have coming on, we should be looking up from there. But as I said earlier, it remains to be seen how this will all play out through the distribution channel and how much progress we'll make in our -- in the third quarter relating to it.

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William M. Lowe, KEMET Corporation - CEO & Director [16]

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I think we'll still see corrections happening in our fourth fiscal quarter in the distribution channel. I don't think we're going to be any substantially different than what you might have heard in the rest of the industries. It's probably the beginning of our fiscal year in April before we've -- before I think it's probably settled out a bit.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [17]

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That's fair. And then guys, lastly for me before I hop in the queue. You're keeping gross margin at a historically high level. So congratulations on all the structural gains. If we have a multi-quarter period of inventory production, is it possible to sustain these levels? Or how do we assess the gives and takes with things you can do on the continuous improvement cost reduction side versus some of the volume headwinds that are out there?

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Gregory C. Thompson, KEMET Corporation - Executive VP & CFO [18]

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Again, a lot of the things that we've done are really kind of embedded in the margin. The yield improvements and why we may have less revenue here or there as a result of a slowdown or a distribution channel correction, those structural changes are embedded in the margins, and that's what's helping to keep them up. And we continue, of course -- the business groups continue to look for ways to improve margins. So our expectation is to stay in that range for the margins even as we're seeing corrections in the channel over the next couple quarters.

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Operator [19]

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Your next question comes from Matt Sheerin from Stifel.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [20]

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So I just wanted to go back to the transaction and the acquisition, particularly on valuation. If you look at the valuation, even with the numbers scrubbed here, we're taking a step down due to the correction, as everyone else has seen, you're still looking at sort of 6.5, 7x EBITDA. And given the fact that you've really transformed the company, set it up in a much better position than past cycles, particularly with the product mix, the supply chain integration, the balance sheet, I'm just wondering why the board felt that, that was sort of a fair valuation at this juncture, given that we're basically sort of the bottom of the cycle?

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William M. Lowe, KEMET Corporation - CEO & Director [21]

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Well, Matt, unfortunately, I have to go back and repeat a little bit what I said earlier on the first question because we -- all the detail that the board has gone through over quite a number of months will be all laid out in the proxy statement that we filed right -- probably right after the 1st of the year. And I think it would be unfair to try to pick and choose various comments that would relate it to the full process that the board went through here. And I think I would say wait until that comes out. And I think that then you, along with everyone else will have a full picture of everything that the board did over the course of a number of months to reach this conclusion.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [22]

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Fair enough. But could you tell us whether -- is this something that the board initiated? Or you had some interest from outsiders and then you got into sort of a full mode of vetting other suitors? Is that how that happened? I'm just trying to figure out the timing of this.

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William M. Lowe, KEMET Corporation - CEO & Director [23]

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That is correct. We were approached earlier in this calendar year. And then, as you know, as a result of that, when that occurs, the board under the fiduciary responsibilities are basically required to start a process, which the board did. So yes, we were approached, we did not actively go out seeking.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [24]

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Okay. Fair enough. And then just on the -- some of the regulatory issues, particularly your exposure to military, aerospace, some of the industrial markets, have you vetted that just to make sure that there aren't any specific challenges or hurdles that you might have to overcome?

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William M. Lowe, KEMET Corporation - CEO & Director [25]

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We -- as Greg mentioned, we do have to file for CFIUS approval. We're not expecting that to be a particular issue, but we do have to file for that approval. That could take 6, 7 months to get that through. We do -- onetime or the other, we'll have various components that are considered to be ITAR related, not on a consistent basis. So it's not a -- it shouldn't be a major material issue to deal with. So that filing will occur. Our expectations are that we will work through that.

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Gregory C. Thompson, KEMET Corporation - Executive VP & CFO [26]

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And Matt, as you might imagine, we have a number of advisers that have helped us assess all that who deal with these kind of issues all the time. And all those kinds of things that you've mentioned and others similar to it have been looked at very, very...

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William M. Lowe, KEMET Corporation - CEO & Director [27]

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Very closely.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [28]

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I'm sure. And on the -- you said that the deal is expected to close in the second half of '20, is that your fiscal '20 or calendar '20?

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Gregory C. Thompson, KEMET Corporation - Executive VP & CFO [29]

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Calendar '20.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [30]

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Calendar '20. Okay. And just lastly...

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William M. Lowe, KEMET Corporation - CEO & Director [31]

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And of course, that is subject to -- the jurisdictions will somewhat dictate that, right.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [32]

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Understood. And then you talked about the capacitors, the tantalum versus the ceramic. Could you give us the percentage breakdown, ceramic versus tantalum?

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Gregory C. Thompson, KEMET Corporation - Executive VP & CFO [33]

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On the revenue?

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [34]

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Yes.

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Gregory C. Thompson, KEMET Corporation - Executive VP & CFO [35]

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Hang on. So for the second quarter, tantalum was -- and this is on the web slides, I believe.

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William M. Lowe, KEMET Corporation - CEO & Director [36]

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Yes.

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Gregory C. Thompson, KEMET Corporation - Executive VP & CFO [37]

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That tantalum is 38% of revenues -- of total revenues and ceramics was 33% of total revenues. MSA was -- for the others, MSA, 16%; F&E was 13%.

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Operator [38]

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Next question comes from Marco Rodriguez from Stonegate Capital.

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst [39]

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Just wanted to kind of follow up just a little bit here on the acquisition. Maybe if you can talk a little bit more about CFIUS approval. When do you expect to file that submission, if you will?

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William M. Lowe, KEMET Corporation - CEO & Director [40]

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I believe it's relatively soon. I can't give you a specific date, but I think that's one of the first filings that will probably occur over the next 60 days. And then it will be, as I said, the process there could take 6 to 7 months, just as a part of that process. But I think that's one of the first ones that gets filed fairly quickly.

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst [41]

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Got you. And then can you maybe talk a little bit about the approval you will need in China for this transaction?

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William M. Lowe, KEMET Corporation - CEO & Director [42]

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Well, it's a standard antitrust filing. We both do business there. They have facilities there. We have facilities there. Again, just broadly, not just to isolate China, but broadly, we're not expecting any particular issues in any particular jurisdiction. I think we just have to work through the timing of the regulatory approvals of the various countries to get the process through.

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst [43]

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Got it. And then in terms of the charge taken here for the legal settlement on the antitrust, can you maybe just kind of walk a little bit through that? It's a fairly large dollar figure. I think that might be one of the higher ones compared to what you've done in the past in regard to the antitrust.

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William M. Lowe, KEMET Corporation - CEO & Director [44]

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It is -- well, in total, of course, over time, the TOKIN accrual for antitrust liabilities was substantially higher than that, well over $100-some-odd million, about $110 million, I think. So but on an individual basis, you'd be correct that, that is one of the higher ones. I can't really comment on any more than what we've said in our formal comments about that settlement, other than the fact that as -- just to repeat, as Greg said, that from a payment perspective, from a cash flow perspective, we'll be paying $10 million fairly soon here in the next 30 days. The balance of it will be paid within 12 months, most likely towards the end of the 12 months for the remaining $52 million.

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst [45]

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Got it. And is that remaining $52 million, is that inside of accrued expenses on the balance sheet? Or is this someplace else?

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William M. Lowe, KEMET Corporation - CEO & Director [46]

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It's -- will now be inside accrued expenses. As of this quarter, it will be inside the accrued liabilities.

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst [47]

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Got you. And then just coming -- turning to the overall business itself and the movements. I was wondering maybe you could comment a little bit about what you've seen thus far this quarter, just as far as cadences of demand for product and things of that nature from a general perspective.

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William M. Lowe, KEMET Corporation - CEO & Director [48]

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Well, I think in Greg's outlook, when he talked about the quarter with -- while we're pulling back some of -- the percentage quarter-over-quarter or sequentially, our sales will be down less than what we're seeing and hearing in some of our competitors and others in the industry. But it's still part of that is the inventory correction and distribution-related, not just to some of the smaller-case ceramics, but in the MnO2 product, which fortunately for us, one of the reasons that I think our slowdown is a little bit less, is that we are -- our revenue in tantalum, predominantly today is coming from polymer, not the MnO2 product. So about 70% or so of our -- or more of our revenue today on a quarterly basis is polymer, not MnO2. That helps us some. But there is a general slowdown as well that's affecting some of the polymer. So it's just -- it's a mix of that. And it's both. We see some of that in the smaller-case size, some of the -- for us, I mean, we do nothing but large-case size, but our smaller of the large case is -- has got normal lead times today, a little more pricing pressure there than has been in the past because of the slowdown in the smartphone market, which gives the other manufacturers of small case ceramics an opportunity to continue to spread out a bit because they've got the capacity to do that. So that's just -- you put all that together, and we're seeing that 8% to -- and I think the forecast was 8% to 13% down on revenue sequentially, which again, from an industry standpoint, is on the low end of revenue change quarter-to-quarter.

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst [49]

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Got it. And last question here. On the automotive side of the business, the end market there for you guys, I was just wondering if maybe you might be able to share any sort of comments that you may have had with customers or your partners. Obviously, you guys have made it well-known that the content aspects are increasing, which should definitely benefit you guys over the long run. But just wondering what sort of comments and what sort of things you've been hearing as far as that overall market, that demand outlook for like, maybe the next 6 to 12 months.

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William M. Lowe, KEMET Corporation - CEO & Director [50]

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Well, I think -- in my formal remarks, I think we are thinking it's going to -- all the data we see as well as comments from -- to your point, from our customers' points to kind of a 5% to 6% decline in volume or unit volume in the automotive sector at the moment. It's -- for us, it's somewhat offset by additional content. But not 100% offset by content at this point. So there's a little mitigating factor of additional content. But we think it's a 5% -- at the moment, it appears like it looks like 5% to 6% unit volume decrease year-over-year is what we're seeing and also hearing at the same time.

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst [51]

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Right. And so is that general comment around just next quarter? Or is that sort of a sustained level?

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William M. Lowe, KEMET Corporation - CEO & Director [52]

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No. We think that's -- we see that we -- at the moment, that's kind of over the next 6 to 9 months from an automotive sector standpoint.

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Operator [53]

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Your next question comes from Jon Lopez from Vertical Group.

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Jonathan Doherty Lopez, The Vertical Trading Group, LLC, Research Division - Research Analyst [54]

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I have a couple quick ones on your ceramics business, if you don't mind. The first one is, could you just parse the calendar third quarter, it's the first time your ceramics business has declined in, I don't know, 2.5, 3 years measured quarter-to-quarter. Could you just parse out that decline in units versus prices?

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Gregory C. Thompson, KEMET Corporation - Executive VP & CFO [55]

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It would be primarily -- so our pricing is holding firm. Now we do have, in terms of overall prices, there is some mix difference. So as we continue to work down the distribution channel, distribution tends to be higher prices than OEM and EMS. So that is a component of it. But the largest would be volume, volume adjustments. Yes.

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William M. Lowe, KEMET Corporation - CEO & Director [56]

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And mostly in this -- not in the high -- not in the -- we're still somewhat maxed out on our high CV large case ceramics, we're still looking for the -- getting some equipment in that will free up some additional capacity based on our expansion. So where we're seeing the softness is on the smaller -- for us, our -- what we'll consider smaller case size for us on the commercial chip side. So we're still running fairly full -- we're not just fairly full, we're running full on the high CV side with longer lead times, still lead times 8 to 30 weeks, depending on the particular dielectric or case size in high CV and fairly normal lead times, 8 to 14 weeks on the low CV. So low CV commercial chips is where we're seeing a lot of the softness.

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Jonathan Doherty Lopez, The Vertical Trading Group, LLC, Research Division - Research Analyst [57]

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Got you. And sorry, just on that topic, can you remind me, my recollection is that automotive comprises a pretty sizable portion of your ceramics business. Is that still the case? Can you just give the ballpark on kind of what auto as a percentage of your ceramics business is?

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William M. Lowe, KEMET Corporation - CEO & Director [58]

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Yes, I think we usually say it's around 65%, somewhere in that range.

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Jonathan Doherty Lopez, The Vertical Trading Group, LLC, Research Division - Research Analyst [59]

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And have you given the rough split just distribution versus OEM with your ceramics business?

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William M. Lowe, KEMET Corporation - CEO & Director [60]

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We don't really -- it's probably pretty close to what the rest of the business is. Our overall distribution channel splits is right around a 40% number. And it -- of course, it varies quarter-to-quarter, but it will be substantially different within ceramics.

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Jonathan Doherty Lopez, The Vertical Trading Group, LLC, Research Division - Research Analyst [61]

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Got you. And sorry, just thinking about that same dynamic between your calendar third quarter and your calendar fourth, I know you haven't given explicit guidance between the 2 segments, but if we assume kind of an average decline relative to your total guidance in ceramics, is that more of the same, like mostly units? Or is there some pricing that's coming into the December quarter?

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William M. Lowe, KEMET Corporation - CEO & Director [62]

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The only thing I'll say about the pricing and without giving specific dollar comments is that we typically negotiate our OEM contracts in the fourth calendar quarter. So in the quarter that we're in, we're in the process of doing those negotiations, and those prices go into effect for OEM in -- somewhere in that first calendar quarter of next year, not necessarily January 1. Some do, but basically within that quarter. So we're in the process of those negotiations now. So I'm not really going to comment on where pricing will go calendar year versus calendar year, but that's in process.

Again, the high CV product is still in very high demand, and we are still tapped out on that at the moment, while we're trying to get more equipment in to expand that. So it's different than the commercial ship for the cellphones, smartphones, et cetera, that we don't -- if you recall, we don't sell into the smartphone market at KEMET.

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Jonathan Doherty Lopez, The Vertical Trading Group, LLC, Research Division - Research Analyst [63]

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Sure. No, that's all super helpful. And I apologize, I'm not asking for sort of how the negotiations are going. I guess my question was just as you think about the trends in the December quarter relative to September, it sounded like September was mostly units, not much pricing measured sequentially. Is it sort of that same mix into the December quarter?

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William M. Lowe, KEMET Corporation - CEO & Director [64]

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Yes. I think it's probably the same. I think we're looking at the same type of mix, yes. I don't think the mix will be substantially different.

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Jonathan Doherty Lopez, The Vertical Trading Group, LLC, Research Division - Research Analyst [65]

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Okay. Sorry, just 2 more quick ones. Just at a high level, you referenced this tightness in high CV multiple times, and it's been a trend. At the same time, my understanding is high CV is generally in automotive -- not as a rule, but there's more sort of high cap, high CV in automotive than other places. And if you look at some of your international peers, there are some new factories that are coming online late this year, early next, that appear to be sort of automotive focused. And so this was my question for you here is, how comfortable are you with this supply-demand situation in high CV as you look out over, say, 12 to 18 months?

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William M. Lowe, KEMET Corporation - CEO & Director [66]

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I think we are -- I guess the fact that we are not slowing our expansion down should be a signal that says we still expect to be very robust in the high CV market, especially in automotive. And you're right, there is some other capacity coming on. There's also capacity coming off. The competitors who announced, and that's been 1.5 years ago now, that they were going to go end of life on a number of products, they're still actively doing that. And just they've slowed the process down only because, this is not just my comment, I don't know what they're -- I don't sit in their room, so I don't know what they're actually doing. But they're running -- they want to -- if I was me, I'd be running -- wanting to run my factory as full as I can. And I think so, therefore, as the small case size has pulled back because of the smartphone market, they're continuing to run more large case size rather than extract themselves as quick as they said they would originally. So our expectation is -- and they continue to say to the customers that they're going to go end of life on those products. And so there are still products that will be pulled out of the market or components pulled out of the market by those competitors that will -- someone will have to fill that need. The need is not going away. So we see that dynamic as something that's unusual. That's in addition to whatever the market trends are with the needs for the automotive segment. So that's what we're looking at the moment.

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Jonathan Doherty Lopez, The Vertical Trading Group, LLC, Research Division - Research Analyst [67]

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Got you. Very helpful. My last question for you. I apologize. If I just kind of look at your ceramics business now, you're like $100 million, give or take. Yageo right now is, on their ceramics business, like $100 million, give or take. You guys actually appear like you have some relatively relevant, I guess is the right term there, crossover, at least like end market-wise. And I know your end market splits are across all your businesses. But I suppose my question is, as you look across those 2 businesses on the ceramic side, is there a significant amount of crossover? And if so, kind of how -- what's the plan to sort of handle that?

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William M. Lowe, KEMET Corporation - CEO & Director [68]

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Well, first of all, we are competitors. And of course, this is day 1. We just announced the transaction. And I think I'm sure that there'll be more commentary coming from Yageo as the time progresses, but I'm not going to comment on that today on day 1 of the announcement.

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Operator [69]

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(Operator Instructions)

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William M. Lowe, KEMET Corporation - CEO & Director [70]

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Okay. If there's no other questions, operator, then I think we can close the call and thank everyone for their attendance this morning. And we look forward to discussing further with you on our next earnings call in next year. Thank you.

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Operator [71]

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This concludes today's conference call. Thank you for your participation. You may now disconnect.